UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
|X| QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 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 1-6813
Playboy Enterprises, Inc.
(Exact name of registrant as specified in its charter)
Delaware 36-4249478
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification Number)
680 North Lake Shore Drive, Chicago, IL 60611
(Address of principal executive offices) (Zip Code)
(312) 751-8000
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
Yes |X| No |_|
As of July 31, 1999, there were 4,748,954 shares of Class A Common Stock,
par value $0.01 per share, and 18,830,535 shares of Class B Common Stock, par
value $0.01 per share, outstanding.
PLAYBOY ENTERPRISES, INC.
FORM 10-Q
TABLE OF CONTENTS
PART I
FINANCIAL INFORMATION
Item 1. Financial Statements Page
----
Condensed Consolidated Statements of Operations and
Comprehensive Income for the Quarters Ended June 30,
1999 and 1998 (Unaudited) 3
Condensed Consolidated Statements of Operations and
Comprehensive Income for the Six Months Ended June 30,
1999 and 1998 (Unaudited) 4
Condensed Consolidated Balance Sheets at June 30,
1999 (Unaudited) and December 31, 1998 5
Condensed Consolidated Statements of Cash Flows for the
Six Months Ended June 30, 1999 and 1998 (Unaudited) 6
Notes to Condensed Consolidated Financial Statements 7-11
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 12-20
Item 3. Quantitative and Qualitative Disclosures About Market Risk 21
PART II
OTHER INFORMATION
Item 1. Legal Proceedings 21
Item 4. Submission of Matters to a Vote of Security Holders 22
Item 6. Exhibits and Reports on Form 8-K 23
2
PLAYBOY ENTERPRISES, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
AND COMPREHENSIVE INCOME
for the Quarters Ended June 30 (Unaudited)
(In thousands, except per share amounts)
1999 1998
-------- --------
Net revenues $ 78,094 $ 77,820
-------- --------
Costs and expenses
Cost of sales (65,756) (63,468)
Selling and administrative expenses (13,318) (10,361)
-------- --------
Total costs and expenses (79,074) (73,829)
-------- --------
Operating income (loss) (980) 3,991
-------- --------
Nonoperating income (expense)
Investment income 474 17
Interest expense (2,465) (345)
Equity in income (loss) of investments (1,126) 56
Other, net (267) (93)
-------- --------
Total nonoperating expense (3,384) (365)
-------- --------
Income (loss) before income taxes (4,364) 3,626
Income tax benefit (expense) 1,392 (1,547)
-------- --------
Net income (loss) (2,972) 2,079
-------- --------
Other comprehensive income (loss) (net of taxes)
Foreign currency translation adjustment (3) (1)
Unrealized gain on marketable securities 88 --
-------- --------
Total other comprehensive income (loss) 85 (1)
-------- --------
Comprehensive income (loss) $ (2,887) $ 2,078
======== ========
Weighted average number of common shares outstanding
Basic 23,090 20,541
======== ========
Diluted 23,968 21,111
======== ========
Basic and diluted net income (loss) per common share $ (0.13) $ 0.10
======== ========
The accompanying Notes to Condensed Consolidated Financial Statements are an
integral part of these statements.
3
PLAYBOY ENTERPRISES, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
AND COMPREHENSIVE INCOME
for the Six Months Ended June 30 (Unaudited)
(In thousands, except per share amounts)
1999 1998
-------- --------
Net revenues $151,705 $149,582
-------- --------
Costs and expenses
Cost of sales (129,291) (125,228)
Selling and administrative expenses (25,385) (19,119)
-------- --------
Total costs and expenses (154,676) (144,347)
-------- --------
Operating income (loss) (2,971) 5,235
-------- --------
Nonoperating income (expense)
Investment income 551 51
Interest expense (3,406) (560)
Gain on sale of investment 1,728 --
Equity in loss of investments (1,126) (271)
Other, net (474) (185)
-------- --------
Total nonoperating expense (2,727) (965)
-------- --------
Income (loss) before income taxes (5,698) 4,270
Income tax benefit (expense) 1,684 (2,131)
-------- --------
Net income (loss) (4,014) 2,139
-------- --------
Other comprehensive income (loss) (net of taxes)
Foreign currency translation adjustment (61) (6)
Unrealized gain on marketable securities 95 --
-------- --------
Total other comprehensive income (loss) 34 (6)
-------- --------
Comprehensive income (loss) $ (3,980) $ 2,133
======== ========
Weighted average number of common shares outstanding
Basic 22,037 20,536
======== ========
Diluted 22,852 21,073
======== ========
Basic and diluted net income (loss) per common share $ (0.18) $ 0.10
======== ========
The accompanying Notes to Condensed Consolidated Financial Statements are an
integral part of these statements.
4
PLAYBOY ENTERPRISES, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands, except share data)
(Unaudited)
June 30, Dec. 31,
1999 1998
--------- ---------
Assets
Cash and cash equivalents $ 21,728 $ 341
Marketable securities 1,657 505
Receivables, net of allowance for doubtful accounts of
$8,174 and $6,349, respectively 39,371 49,879
Inventories 26,749 25,685
Programming costs 49,616 43,342
Deferred subscription acquisition costs 9,596 11,570
Other current assets 21,655 21,097
--------- ---------
Total current assets 170,372 152,419
--------- ---------
Property and equipment, at cost 39,415 39,042
Accumulated depreciation (30,807) (29,885)
--------- ---------
Property and equipment, net 8,608 9,157
--------- ---------
Programming costs 10,507 5,983
Goodwill, net of amortization of $1,237 and $432, respectively 105,400 2,053
Trademarks 45,549 17,294
Net deferred tax assets -- 6,525
Other noncurrent assets 27,595 18,676
--------- ---------
Total assets $ 368,031 $ 212,107
========= =========
Liabilities
Short-term borrowings $ -- $ 29,750
Current financing obligations 1,625 --
Accounts payable 23,197 30,834
Accrued salaries, wages and employee benefits 3,434 6,024
Income taxes payable 177 819
Deferred revenues 40,415 41,647
Other liabilities and accrued expenses 19,644 9,919
--------- ---------
Total current liabilities 88,492 118,993
Long-term financing obligations 108,375 --
Net deferred tax liabilities 6,740 --
Other noncurrent liabilities 9,825 8,912
--------- ---------
Total liabilities 213,432 127,905
--------- ---------
Shareholders' Equity
Common stock, $0.01 par value
Class A voting - 7,500,000 shares authorized; 4,748,954 and
5,042,381 issued, respectively 47 50
Class B nonvoting - 30,000,000 shares authorized; 19,155,966
and 17,149,691 issued, respectively 192 171
Capital in excess of par value 112,798 44,860
Retained earnings 45,563 49,577
Foreign currency translation adjustment (231) (137)
Unearned compensation restricted stock (3,884) (3,716)
Unrealized gain (loss) on marketable securities 114 (32)
Less cost of treasury stock -- (6,571)
--------- ---------
Total shareholders' equity 154,599 84,202
--------- ---------
Total liabilities and shareholders' equity $ 368,031 $ 212,107
========= =========
The accompanying Notes to Condensed Consolidated Financial Statements are an
integral part of these statements.
5
PLAYBOY ENTERPRISES, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
for the Six Months Ended June 30 (Unaudited)
(In thousands)
1999 1998
--------- ---------
Cash Flows From Operating Activities
Net income (loss) $ (4,014) $ 2,139
Adjustments to reconcile net income (loss) to net cash
used for operating activities:
Depreciation of property and equipment 946 1,002
Amortization of intangible assets 2,498 870
Gain on sale of investment (1,728) --
Amortization of investments in entertainment programming 13,235 11,723
Investments in entertainment programming (18,633) (12,991)
Net change in operating assets and liabilities (2,590) (10,572)
Other, net (61) 6
--------- ---------
Net cash used for operating activities (10,347) (7,823)
--------- ---------
Cash Flows From Investing Activities
Acquisition of Spice Entertainment Companies, Inc. (64,145) (1,516)
Sale of investments 9,693 --
Additions to property and equipment (422) (756)
Funding of equity interests in international ventures (3,713) (1,274)
Purchase of marketable securities (1,000) (250)
Other, net 3 23
--------- ---------
Net cash used for investing activities (59,584) (3,773)
--------- ---------
Cash Flows From Financing Activities
Increase (decrease) in short-term borrowings (29,750) 11,500
Increase in financing obligations 110,000 --
Net proceeds from public equity offering 24,632 --
Payment of debt assumed in acquisition of Spice Entertainment
Companies, Inc. (10,471) --
Deferred financing fees (4,425) (100)
Proceeds from exercise of stock options 1,219 123
Proceeds from sales under employee stock purchase plan 113 106
--------- ---------
Net cash provided by financing activities 91,318 11,629
--------- ---------
Net increase in cash and cash equivalents 21,387 33
Cash and cash equivalents at beginning of period 341 947
--------- ---------
Cash and cash equivalents at end of period $ 21,728 $ 980
========= =========
The accompanying Notes to Condensed Consolidated Financial Statements are an
integral part of these statements.
6
PLAYBOY ENTERPRISES, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(A) BASIS OF PREPARATION
The financial information included in these financial statements is unaudited,
but in the opinion of management, reflects all normal recurring adjustments
necessary for a fair presentation of the results for the interim periods. The
interim results of operations and cash flows are not necessarily indicative of
those results and cash flows for the entire year. These financial statements
should be read in conjunction with the financial statements and notes to the
financial statements contained in the Annual Report on Form 10-K for the fiscal
year ended December 31, 1998 (the "1998 Form 10-K") of Playboy Enterprises, Inc.
and its subsidiaries (the "Company").
(B) ACQUISITION
On March 15, 1999, the Company completed its acquisition of Spice Entertainment
Companies, Inc. ("Spice"), a leading provider of adult television entertainment.
The initial determination of the purchase price, including transaction costs and
the assumption of Spice debt, was approximately $136 million, which, net of
assets assumed, resulted in a net transaction value of approximately $117
million. The purchase price and its allocation are subject to change upon final
determination. The purchase was financed through the issuance of approximately
$48 million of the Company's Class B common stock and the remainder through the
payment and issuance of long-term debt. See Note H Financing Obligations. The
acquisition was accounted for under the purchase method of accounting and,
accordingly, the results of Spice since the acquisition date have been included
in the Company's Condensed Consolidated Statements of Operations and
Comprehensive Income. The excess of the purchase price over the fair value of
the net assets acquired was approximately $105 million and has been recorded as
goodwill, which is being amortized over 40 years.
The following unaudited pro forma information presents a summary of the results
of operations of the Company assuming the acquisition occurred on January 1,
1998 (in thousands, except per share amounts):
Six Months Ended
June 30,
---------------------
1999 1998
--------- ---------
Net revenues .......................................... $ 157,996 $ 161,697
Net loss .............................................. (5,584) (949)
Basic and diluted net loss per common share ........... $ (0.24) $ (0.04)
These unaudited pro forma results have been prepared for comparative purposes
only and include certain adjustments, such as additional amortization expense
primarily related to goodwill and increased interest expense related to the debt
financing. They do not purport to be indicative of the results of operations
which actually would have resulted had the acquisition occurred on January 1,
1998, or of future results of operations.
(C) SALE OF INVESTMENT
In the quarter ended March 31, 1999, the Company sold its wholly-owned
subsidiary, Playboy Gaming Greece Ltd., which owned a 12% equity interest in the
Playboy Casino at Hotel des Roses (the "Rhodes Casino"). Total proceeds of $5.2
million were received. These proceeds included a repayment of a loan of $1.2
million owed to the Company by the Rhodes Casino. The Company realized a gain
before income taxes of $1.7 million on the sale. The taxable gain on the sale
was immaterial and will be offset by the application of a capital loss
carryforward.
(D) INCOME TAXES
Associated with the Spice acquisition, $15.7 million of deferred tax liabilities
were recorded under the purchase method of accounting for certain identifiable
intangible assets, comprising trademarks, non-compete agreements and a film
library. After consideration of this additional $15.7 million of deferred tax
liabilities, at June 30, 1999, the Company was in a net deferred tax asset
position of $0.7 million that consisted of $7.4 million of current deferred tax
assets and $6.7 million of noncurrent deferred tax liabilities. At December 31,
1998, prior to the Spice acquisition, the Company was in a net deferred tax
asset position of $13.9 million that consisted of $7.4 million of current
deferred tax assets and $6.5 million of noncurrent deferred tax assets.
7
As reported in the Company's 1998 Form 10-K, the deferred tax assets principally
include the anticipated benefit of net operating loss carryforwards ("NOLs").
Realization of those assets is dependent upon the Company's ability to generate
taxable income in future years. The recognition of benefits in the financial
statements is based upon projections by management of future operating income
and the anticipated reversal of temporary differences that will result in
taxable income. Projections of future earnings were based on adjusted historical
earnings.
In order to fully realize the net deferred tax asset of $13.9 million at
December 31, 1998, the Company will need to generate future taxable income of
approximately $39.7 million prior to the expiration, beginning in 2009, of the
Company's NOLs. Management believes that it is more likely than not that the
required amount of such taxable income will be realized. Management will
periodically reconsider the assumptions utilized in the projection of future
earnings and, if warranted, increase or decrease the amount of deferred tax
assets through an adjustment to the valuation allowance.
(E) COMPREHENSIVE INCOME
The following sets forth the components of other comprehensive income (loss),
and the related tax expense or benefit allocated to each item (in thousands):
(Unaudited) (Unaudited)
Quarters Ended Six Months Ended
June 30, June 30,
------------------ -------------------
1999 1998 1999 1998
-------- -------- -------- --------
Foreign currency translation adjustment (1) ......... $ (3) $ (1) $ (61) $ (6)
Unrealized gain on marketable securities (2) ........ $ 88 $ -- $ 95 $ --
(1) Net of a related tax benefit of $2 and $33 for the quarter and six months
ended June 30, 1999, respectively, and $1 and $4 for the quarter and six
months ended June 30, 1998, respectively.
(2) Net of related tax expense of $47 and $51 for the quarter and six months
ended June 30, 1999, respectively.
(F) INCOME (LOSS) PER COMMON SHARE
The following table sets forth the computation of basic and diluted earnings per
share ("EPS") (in thousands, except per share amounts):
(Unaudited) (Unaudited)
Quarters Ended Six Months Ended
June 30, June 30,
------------------ -------------------
1999 1998 1999 1998
-------- -------- -------- --------
Numerator:
For basic and diluted EPS--net income (loss) ..... $ (2,972) $ 2,079 $ (4,014) $ 2,139
======== ======== ======== ========
Denominator:
Denominator for basic EPS--
weighted-average shares ....................... 23,090 20,541 22,037 20,536
-------- -------- -------- --------
Effect of dilutive potential common shares:
Stock options ................................. 878 570 815 537
-------- -------- -------- --------
Dilutive potential common shares ........... 878 570 815 537
-------- -------- -------- --------
Denominator for diluted EPS--
adjusted weighted-average shares .............. 23,968 21,111 22,852 21,073
======== ======== ======== ========
Basic and Diluted EPS ............................... $ (0.13) $ 0.10 $ (0.18) $ 0.10
======== ======== ======== ========
8
During the quarter and six months ended June 30, 1999, approximately 330,000 and
335,000 weighted-average shares of Class B restricted stock awards outstanding,
respectively, were not included in the computation of diluted EPS as the
operating income objectives applicable to these restricted awards were not met
during those periods. Additionally, options to purchase approximately 175,000
and 260,000 weighted-average shares of Class B common stock were outstanding
during the quarter and six months ended June 30, 1999, respectively, but were
not included in the computation of diluted EPS as the options' exercise prices
were greater than the average market price of the Class B common stock, the
effect of which was antidilutive.
(G) INVENTORIES
Inventories, which are stated at the lower of cost (average cost and specific
cost) or market, consisted of the following (in thousands):
(Unaudited)
June 30, Dec. 31,
1999 1998
--------- ---------
Paper ................................................. $ 7,633 $ 8,277
Editorial and other prepublication costs .............. 7,282 6,052
Merchandise finished goods ............................ 11,834 11,356
--------- ---------
Total inventories .................................. $ 26,749 $ 25,685
========= =========
(H) FINANCING OBLIGATIONS
In connection with financing the Company's acquisition of Spice, the Company
entered into a new $150.0 million credit agreement dated as of February 26,
1999. The new agreement provided financing to (a) purchase all of the
outstanding shares of Spice and pay related acquisition costs; (b) repay the
existing debt of the Company and Spice; and (c) fund future general working
capital and investment needs.
The new agreement consists of three components: a $40.0 million revolving credit
facility with a $10.0 million letter of credit sublimit; a $35.0 million tranche
A term loan; and a $75.0 million tranche B term loan. The revolving credit
facility and tranche A term loan mature on March 15, 2004. The tranche B term
loan matures on March 15, 2006. Loans bear interest at a rate equal to specified
index rates plus margins that fluctuate based on the Company's ratio of
consolidated debt to consolidated adjusted EBITDA (earnings before income taxes
plus interest expense, depreciation and amortization, less cash investments in
programming). The Company's obligations under the agreement are unconditionally
guaranteed by each of the Company's existing and subsequently acquired domestic
restricted subsidiaries (all domestic subsidiaries except Playboy Online, Inc.).
The agreement and related guarantees are secured by substantially all of Playboy
Enterprises, Inc.'s and its domestic restricted subsidiaries' assets.
The agreement contains financial covenants requiring the Company to maintain
certain leverage, cash flow, interest coverage and fixed charge coverage ratios.
Other covenants include limitations on other indebtedness, investments, capital
expenditures and dividends. The agreement also requires mandatory prepayments
with net cash proceeds resulting from excess cash flow, asset sales and the
issuance of certain debt obligations or equity securities, with certain
exceptions as described in the agreement.
(I) CONTINGENCIES
In February 1996, the Company filed suit challenging Section 505 of the
Telecommunications Act of 1996 (the "Telecommunications Act"), which, among
other things, regulates the cable transmission of adult programming, such as the
Company's domestic pay television programs. Enforcement of Section 505 of the
Telecommunications Act ("Section 505") commenced May 18, 1997. The Company's
full case on the merits was heard by the United States District Court in
Wilmington, Delaware (the "Delaware District Court") in March 1998. In December
1998, the Delaware District Court unanimously declared Section 505
unconstitutional. The defendants have appealed this judgment and the United
States Supreme Court (the "Supreme Court") will hear the appeal. Management
believes that the effect of Section 505 on the Company's financial performance
is likely to continue until the case is finally decided.
9
(J) PUBLIC EQUITY OFFERING
In May 1999, the Company completed a public equity offering of 2,875,000 shares
of nonvoting Class B common stock at a price of $30.00 per share. Two million
shares were sold by a trust established by, and for the benefit of, Hugh M.
Hefner, the Company's founder and principal stockholder, and 875,000 shares were
sold by the Company. Of the Company's shares, 375,000 were sold pursuant to an
underwriters' over-allotment provision. The Company did not receive any of the
proceeds from the sale of Class B common stock by Mr. Hefner. Mr. Hefner is
responsible for expenses related to this transaction proportionate to the number
of shares he sold to the total number of shares sold in the offering. Net
proceeds to the Company of $24.6 million are being used for general corporate
purposes.
(K) TREASURY STOCK
There were no Class A or Class B common shares held as treasury stock at June
30, 1999. All shares of treasury stock were cancelled under terms of the merger
agreement between the Company and Spice. At December 31, 1998, treasury stock
consisted of 293,427 Class A common shares and 951,041 Class B common shares.
(L) CONDENSED CONSOLIDATED STATEMENT OF CASH FLOWS
The following summarizes non-cash investing and financing activities related to
the Spice acquisition (in thousands):
(Unaudited)
Six Months
Ended
June 30, 1999
-------------
Fair value of net assets acquired, including goodwill............ $ 134,916
Acquisition liabilities.......................................... (11,544)
Payment of debt assumed.......................................... (10,471)
Common stock issued.............................................. (48,429)
-------------
Cash paid........................................................ 64,472
Less: cash acquired.............................................. (327)
-------------
Net cash paid for the Spice acquisition.......................... $ 64,145
============
See Note B Acquisition.
10
(M) SEGMENT INFORMATION
The following tables represent financial information by reportable segment (in
thousands):
(Unaudited) (Unaudited)
Quarters Ended Six Months Ended
June 30, June 30,
------------------ -------------------
1999 1998 1999 1998
-------- -------- -------- --------
Net Revenues
Publishing (1) ...................................... $ 30,790 $ 33,167 $ 64,089 $ 63,165
Entertainment ....................................... 26,246 24,766 46,689 43,060
Product Marketing ................................... 1,496 1,607 3,079 4,206
Catalog ............................................. 14,297 15,086 30,036 34,486
Casino Gaming ....................................... 300 -- 300 --
Playboy Online ...................................... 3,099 1,577 5,568 3,000
Corporate Marketing (1) ............................. 1,866 1,617 1,944 1,665
-------- -------- -------- --------
Total ........................................... $ 78,094 $ 77,820 $151,705 $149,582
======== ======== ======== ========
Income (Loss) Before Income Taxes
Publishing (1) ...................................... $ 1,059 $ 3,231 $ 2,899 $ 3,437
Entertainment ....................................... 6,039 7,592 10,428 12,451
Product Marketing ................................... 160 394 467 1,086
Catalog ............................................. (252) 514 (553) 1,554
Casino Gaming ....................................... (16) (207) (244) (398)
Playboy Online ...................................... (1,707) (1,497) (3,666) (2,191)
Corporate Administration and Promotion (1) .......... (6,263) (6,036) (12,302) (10,704)
Investment income ................................... 474 17 551 51
Interest expense .................................... (2,465) (345) (3,406) (560)
Gain on sale of investment .......................... -- -- 1,728 --
Equity in income (loss) of investments .............. (1,126) 56 (1,126) (271)
Other, net .......................................... (267) (93) (474) (185)
-------- -------- -------- --------
Total ........................................... $ (4,364) $ 3,626 $ (5,698) $ 4,270
======== ======== ======== ========
(Unaudited)
June 30, Dec. 31,
1999 1998
--------- ---------
Identifiable Assets
Publishing (1) ........................................ $ 40,768 $ 50,171
Entertainment (2) ..................................... 236,025 85,783
Product Marketing ..................................... 5,835 5,764
Catalog ............................................... 16,165 17,871
Casino Gaming ......................................... 1,406 4,416
Playboy Online ........................................ 678 1,282
Corporate Administration and Promotion (1) (3) ........ 67,154 46,820
--------- ---------
Total (2) (3) ..................................... $ 368,031 $ 212,107
========= =========
(1) Corporate amounts now include certain Company-wide marketing activities,
such as the Playboy Jazz Festival and playmate promotions, that had
previously been reported in the Publishing Group.
(2) The increase in identifiable assets since December 31, 1998 is primarily
due to the Company's acquisition of Spice on March 15, 1999.
(3) The increase in identifiable assets since December 31, 1998 is primarily
due to the net proceeds from the Company's public equity offering in May
1999.
11
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
RESULTS OF OPERATIONS
The Company's revenues for the quarter ended June 30, 1999 were relatively
flat at $78.1 million compared to the prior year quarter, as higher Playboy
Online and Entertainment Group revenues were offset by lower Publishing and
Catalog Group revenues. For the six months ended June 30, 1999, revenues
increased $2.1 million, or 1%, to $151.7 million compared to the six months
ended June 30, 1998. The increase for the six-month period was driven by higher
Entertainment and Playboy Online Group revenues, partially offset by lower
Catalog Group revenues.
The Company reported an operating loss of $1.0 million for the quarter
ended June 30, 1999 compared to operating income of $4.0 million in the prior
year quarter. The decrease in operating performance reflected lower operating
income from the Publishing and Entertainment Groups. The Company's domestic TV
networks increased profitability despite amortization related to the Spice
acquisition, but the Entertainment Group's overall operating income declined as
a result of a delay in finalizing Playboy TV International, LLC, a joint venture
the Company is forming with the Cisneros Television Group. For the six months
ended June 30, 1999, the Company reported an operating loss of $3.0 million
compared to operating income of $5.2 million in the prior year. This decline was
primarily due to lower operating performance from the Catalog and Entertainment
Groups, also as a result of the delay in finalizing Playboy TV International,
LLC, although the Company's domestic TV networks results improved despite
amortization related to the Spice acquisition. Also contributing to the decline
in operating performance were higher planned investments in the Playboy Online
Group as well as Corporate Administration and Promotion.
The net loss for the quarter ended June 30, 1999 was $3.0 million, or
$0.13 per basic and diluted common share, compared to net income of $2.1
million, or $0.10 per basic and diluted common share, for the prior year
quarter. The net loss for the six months ended June 30, 1999 was $4.0 million,
or $0.18 per basic and diluted common share, compared to net income of $2.1
million, or $0.10 per basic and diluted common share, for the prior year. The
net loss for the current year periods included higher interest expense,
primarily due to increased debt resulting from the acquisition of Spice,
combined with an equity loss related to the Company's interest in its United
Kingdom television networks. The Company's equity in these networks will be sold
to Playboy TV International, LLC when the joint venture is finalized. The net
loss for the six-month period also included a $1.7 million gain from the sale of
the Company's equity interest in the Rhodes Casino.
Several of the Company's businesses can experience variations in quarterly
performance. As a result, the Company's performance in any quarterly period is
not necessarily reflective of full-year or longer-term trends. For example,
Playboy magazine newsstand revenues vary from issue to issue, with revenues
generally higher for holiday issues and any issues including editorial or
pictorial features that generate unusual public interest. Advertising revenues
also vary from quarter to quarter, depending on product introductions by
advertising customers, changes in advertising buying patterns and economic
conditions.
12
PUBLISHING GROUP
Beginning with the quarter ended March 31, 1999, certain Company-wide
marketing activities, such as the Playboy Jazz Festival and playmate promotions,
that had previously been reported in the Publishing Group are now included in
Corporate Administration and Promotion results. The revenues and operating
income of the Publishing Group were as follows for the periods indicated below
(in millions):
Quarters Ended Six Months Ended
June 30, June 30,
------------------ -------------------
1999 1998 1999 1998
-------- -------- -------- --------
Revenues
Playboy Magazine .................................... $ 24.1 $ 25.7 $ 50.8 $ 49.7
Other Domestic Publishing ........................... 4.0 4.5 8.2 8.3
International Publishing ............................ 2.7 3.0 5.1 5.2
-------- -------- -------- --------
Total Revenues .................................. $ 30.8 $ 33.2 $ 64.1 $ 63.2
======== ======== ======== ========
Operating Income .................................... $ 1.1 $ 3.2 $ 2.9 $ 3.4
======== ======== ======== ========
Publishing Group revenues decreased $2.4 million, or 7%, for the quarter
ended June 30, 1999 compared to the prior year primarily due to lower revenues
from Playboy magazine combined with lower international publishing royalties.
For the six months ended June 30, 1999, revenues increased $0.9 million, or 1%,
compared to the prior year primarily due to higher revenues from Playboy
magazine.
For the quarter ended June 30, 1999, Playboy magazine revenues declined
$1.6 million, or 6%, compared to the prior year. Circulation revenues decreased
$1.1 million, or 7%, largely due to a $0.6 million, or 14%, decrease in
newsstand revenues principally as a result of 12% fewer U.S. and Canadian
newsstand copies sold. Subscription revenues decreased $0.5 million, or 4%,
reflecting in part the problems facing direct marketing stamp sheet agents,
which are affecting all publishers. Additionally, advertising revenues decreased
$0.3 million, or 4%, for the quarter due to 11% fewer ad pages.
For the six-month period, Playboy magazine revenues increased $1.1
million, or 2%, compared to the prior year. Circulation revenues increased $1.5
million, or 4%, primarily due to a $3.5 million, or 47%, increase in newsstand
revenues principally due to extraordinary sales of the April 1999 issue
featuring Rena Mero, the World Wrestling Federation champion formerly known as
Sable. The higher newsstand revenues were partially offset by a $2.0 million, or
7%, decrease in subscription revenues, reflecting in part the problems facing
direct marketing stamp sheet agents. Additionally, advertising revenues
increased $0.2 million, or 2%. Advertising sales for the fiscal year 1999 third
quarter issues of the magazine are closed and the Company expects to report 5%
more ad pages and 13% higher ad revenues compared to the quarter ended September
30, 1998.
Revenues from other domestic publishing businesses decreased $0.5 million,
or 12%, and $0.1 million, or 2%, for the quarter and six months ended June 30,
1999, respectively, compared to the prior year periods. These decreases were
primarily due to fewer copies of newsstand specials sold, despite an additional
issue in the six-month period.
International publishing revenues decreased $0.3 million, or 9%, and $0.1
million, or 1%, for the quarter and six months ended June 30, 1999,
respectively, compared to the prior year primarily due to lower royalties from
the Brazilian and Russian editions, principally due to economic weakness in
those countries. These lower royalties were mostly offset by higher revenues
from the Polish edition of Playboy magazine, in which the Company owns a
majority interest.
For the quarter ended June 30, 1999, Publishing Group operating income
decreased $2.1 million, or 67%, compared to the prior year primarily due to the
lower Playboy magazine newsstand and advertising and newsstand specials
revenues, combined with the lower international publishing royalties. Lower
manufacturing costs were mostly offset by higher editorial and group
administrative expenses. Operating income declined $0.5 million, or 16%, for the
six-month period primarily due to the lower Playboy magazine subscription
revenues, the lower international publishing royalties, higher editorial costs
associated in part with the April 1999 issue and higher group administrative
expenses. Partially offsetting the above were the higher Playboy magazine
newsstand revenues and lower manufacturing costs.
13
Members of the magazine publishing industry, including the Company,
receive a significant portion of their advertising revenues from companies
selling tobacco products. Significant legislative or regulatory limitations on
the ability of those companies to advertise in magazines could materially
adversely affect the Company's operating performance. The Company does not
believe that it will be impacted by the Food and Drug Administration ("the FDA")
regulation announced in August 1996 which prohibits the publication of tobacco
advertisements containing drawings, colors or pictures. The regulation does not
apply to a magazine which is demonstrated to be an "adult publication." The
Company believes that Playboy magazine qualifies as an "adult publication" and
that the regulation is not applicable to the magazine. On April 25, 1997, the
Federal District Court for the Middle District of North Carolina ruled that the
FDA has no authority under existing law to restrict the advertising and
promotion of tobacco products and ordered the FDA not to implement any of the
advertising and promotion restrictions contained in the regulation. The
government appealed this ruling. On August 14, 1998, a three-judge panel of the
Fourth Circuit Court of Appeals (the "Fourth Circuit Court") invalidated the
FDA's authority to issue regulations restricting tobacco advertising. The
government appealed this decision to the full Fourth Circuit Court, which in
November 1998 denied the government's motion for a rehearing.
ENTERTAINMENT GROUP
Beginning with the quarter ended March 31, 1999, the international home
video business, previously combined with international TV networks and sales
results, has been combined with the domestic home video business and is now
reported as worldwide home video. Additionally, programming expense for all of
the group's businesses, including certain licensing expenses that were
previously reported as direct costs, are now reported collectively as
programming expense. Previously, results from AdulTVision and movies and other
had been reported net of programming expense. Beginning with the quarter ended
June 30, 1999, all of the Company's domestic TV networks are now reported on a
combined basis. The revenues and operating income of the Entertainment Group
were as follows for the periods indicated below (in millions):
Quarters Ended Six Months Ended
June 30, June 30,
------------------ -------------------
1999 1998 1999 1998
-------- -------- -------- --------
Revenues
Domestic TV Networks ................................ $ 19.3 $ 15.2 $ 36.1 $ 30.0
International TV .................................... 1.6 4.0 3.2 5.7
Worldwide Home Video ................................ 4.2 4.4 6.1 6.0
Movies and Other .................................... 1.1 1.2 1.3 1.4
-------- -------- -------- --------
Total Revenues ................................... $ 26.2 $ 24.8 $ 46.7 $ 43.1
======== ======== ======== ========
Operating Income
Profit Contribution Before Programming Expense ...... $ 13.6 $ 14.3 $ 23.6 $ 24.2
Programming Expense ................................. (7.6) (6.7) (13.2) (11.7)
-------- -------- -------- --------
Total Operating Income ........................... $ 6.0 $ 7.6 $ 10.4 $ 12.5
======== ======== ======== ========
Entertainment Group revenues increased $1.4 million, or 6%, and $3.6
million, or 8%, for the quarter and six months ended June 30, 1999,
respectively. These increases were primarily due to higher revenues from the
domestic TV networks, principally attributable to the acquisition of Spice
effective March 15, 1999. These increases were partially offset by lower
revenues from the international TV business, primarily due to the previously
discussed delay in finalizing Playboy TV International, LLC. For the quarter and
six-month period, operating income decreased $1.6 million and $2.1 million,
respectively, reflecting increases in profit contribution from the domestic TV
networks, which were more than offset by the lower international TV revenues and
higher programming and group administrative expenses.
The following discussion focuses on the profit contribution of each
business before programming expense ("profit contribution").
14
Domestic TV Networks
For the quarter ended June 30, 1999, revenues of $19.3 million from the
Company's domestic TV networks increased $4.1 million, or 27%, and profit
contribution increased $1.7 million. These increases were primarily due to the
Spice acquisition.
For the six months ended June 30, 1999, revenues of $36.1 million
increased $6.1 million, or 20%, and profit contribution increased $2.7 million.
These increases were primarily due to the Spice acquisition combined with higher
revenues from Playboy TV, principally from the satellite direct-to-home ("DTH")
market.
The approximate number of households for the Company's domestic TV
networks were as follows for the periods indicated below (in millions):
June 30, March 31, June 30,
1999 1999 1998
-------- -------- --------
Cable (1):
Playboy TV Analog Addressable.................. 12.3 11.7 12.1
Playboy TV Digital............................. 0.4 0.2 -
Spice Analog Addressable....................... 16.6 13.0 N/A
Spice Digital.................................. 1.5 1.2 N/A
DTH:
Playboy TV..................................... 11.2 10.7 8.7
(1) Currently there is an overlap in some of the cable digital and analog
addressable households due to some cable operators offering both digital
and analog platforms to the same household.
In June 1999, the Company began the process of transferring AdulTVision
households to the Spice network.
In February 1996, the Company filed suit challenging Section 505 of the
Telecommunications Act, which, among other things, regulates the cable
transmission of adult programming, such as the Company's domestic pay television
programs. Enforcement of Section 505 commenced May 18, 1997. The Company's full
case on the merits was heard by the Delaware District Court in March 1998. In
December 1998, the Delaware District Court unanimously declared Section 505
unconstitutional. The defendants have appealed this judgment and the Supreme
Court will hear the appeal. Management believes that the effect of Section 505
on the Company's financial performance is likely to continue until the case is
finally decided. See "Legal Proceedings."
Additionally, management believes that the growth in cable access for the
Company's domestic TV networks has slowed in recent years given the combination
of constraints on channel capacity and the effects of cable reregulation by the
Federal Communications Commission (the "FCC"), including the "going-forward
rules" which provide cable operators with incentives to add basic services. As
cable operators have utilized available channel space to comply with
"must-carry" provisions, mandated retransmission consent agreements and "leased
access" provisions, competition for channel space has increased.
New technology, primarily digital set-top converters, will dramatically
increase channel capacity, and cable operators have begun to introduce digital
technology in order to upgrade their cable systems and to counteract competition
from DTH operators. Digital cable television has several advantages over analog
cable television, including more channels, better audio and video quality and
advanced set-top boxes that are addressable, provide a secure fully scrambled
signal and have integrated program guides and advanced ordering technology. As
digital technology, which is unaffected by the relevant sections of the
Telecommunications Act, becomes more available, however, the Company believes
that ultimately its domestic TV networks will be available to the majority of
cable households on a 24-hour basis.
15
International TV
For the quarter and six months ended June 30, 1999, profit contribution
from the international TV networks and sales business decreased $2.0 million and
$2.1 million, respectively, primarily due to decreases in revenues of $2.4
million and $2.5 million, respectively. These decreases were primarily due to
the delay in the completion of the international television joint venture with
the Cisneros Television Group, as the Company slowed international sales in
anticipation of the venture. In the prior year periods, the Company reported
licensing fees and options related to the sale of programming in Germany.
Worldwide Home Video
For the quarter and six months ended June 30, 1999, revenues from the
worldwide home video business decreased $0.2 million, or 4%, and increased $0.1
million, or 2%, respectively, while profit contribution for both periods
remained flat.
Movies and Other
For both the quarter and six months ended June 30, 1999, revenues and
profit contribution from movies and other businesses both remained relatively
flat compared to the prior year periods.
The Entertainment Group's administrative expenses increased $0.3 million
for the quarter and $1.1 million for the six-month period primarily to support
the group's growth.
Programming Expense
Programming amortization expense increased $0.9 million and $1.5 million
for the quarter and six-month period, respectively. These increases were
primarily due to higher amortization related to regular programming on the
domestic Playboy TV network combined with programming amortization in the
current year periods related to the Spice network.
PRODUCT MARKETING GROUP
The revenues and operating income of the Product Marketing Group were as
follows for the periods indicated below (in millions):
Quarters Ended Six Months Ended
June 30, June 30,
------------------ -------------------
1999 1998 1999 1998
-------- -------- -------- --------
Revenues ............................................ $ 1.5 $ 1.6 $ 3.1 $ 4.2
======== ======== ======== ========
Operating Income .................................... $ 0.2 $ 0.4 $ 0.5 $ 1.1
======== ======== ======== ========
Revenues decreased $0.1 million, or 7%, for the quarter ended June 30,
1999. Operating income of $0.2 million decreased $0.2 million, or 59%, compared
to the prior year quarter primarily due to higher marketing and promotion costs.
Revenues for the six-month period decreased $1.1 million, or 27%, compared
to the prior year. The decrease was primarily due to lower revenues from Special
Editions, Ltd. as a result of a barter agreement in the prior year related to
the sale of prints and posters from the Company's art publishing inventory. The
comparison also reflected lower international product licensing royalties,
principally from Asia due to depressed economic conditions there. Operating
income of $0.5 million for the six-month period decreased $0.6 million, or 57%,
compared to the prior year. The decrease was primarily due to the lower Asian
royalties combined with higher marketing and promotion costs.
16
CATALOG GROUP
The revenues and operating performance of the Catalog Group were as
follows for the periods indicated below (in millions):
Quarters Ended Six Months Ended
June 30, June 30,
------------------ -------------------
1999 1998 1999 1998
-------- -------- -------- --------
Revenues ............................................ $ 14.3 $ 15.1 $ 30.0 $ 34.5
======== ======== ======== ========
Operating Income (Loss) ............................. $ (0.3) $ 0.5 $ (0.6) $ 1.6
======== ======== ======== ========
For the quarter and six months ended June 30, 1999, the Company's
operating performance decreased $0.8 million and $2.2 million, respectively, on
revenue declines of $0.8 million, or 5%, and $4.5 million, or 13%, respectively,
compared to the prior year periods. These decreases were largely due to the
Critics' Choice Video catalog. Because of weakness in the Catalog Group, the
Company is taking steps to reduce operating expenses.
CASINO GAMING GROUP
The revenues and operating losses of the Casino Gaming Group were as
follows for the periods indicated below (in millions):
Quarters Ended Six Months Ended
June 30, June 30,
------------------ -------------------
1999 1998 1999 1998
-------- -------- -------- --------
Revenues ............................................ $ 0.3 $ -- $ 0.3 $ --
======== ======== ======== ========
Operating Loss ...................................... $ -- $ (0.2) $ (0.2) $ (0.4)
======== ======== ======== ========
In the quarter ended March 31, 1999, the Company sold its 12% equity
interest in the Rhodes Casino, which resulted in a nonoperating gain of $1.7
million. In connection with the sale, the Company negotiated a minimum guarantee
against its licensing agreement for the Rhodes Casino. The Company reported
licensing revenues of $0.3 million for both the quarter and six months ended
June 30, 1999 as a result of the opening of the Rhodes Casino in April 1999. For
both the current year quarter and six-month period, operating performance
increased $0.2 million primarily due to the licensing revenues in the current
year periods. The Company continues to explore additional domestic and
international casino gaming opportunities.
PLAYBOY ONLINE GROUP
The revenues and operating losses of the Playboy Online Group were as
follows for the periods indicated below (in millions):
Quarters Ended Six Months Ended
June 30, June 30,
------------------ -------------------
1999 1998 1999 1998
-------- -------- -------- --------
Revenues ............................................ $ 3.1 $ 1.6 $ 5.6 $ 3.0
======== ======== ======== ========
Operating Loss ...................................... $ (1.7) $ (1.5) $ (3.7) $ (2.2)
======== ======== ======== ========
For the quarter and six months ended June 30, 1999, Playboy Online Group
revenues increased $1.5 million, or 97%, and $2.6 million, or 86%, respectively,
compared to the prior year periods. These increases were due to higher
advertising, e-commerce and subscription revenues.
17
For the quarter and six months ended June 30, 1999, the Playboy Online
Group reported operating losses of $1.7 million and $3.7 million, respectively,
compared to operating losses of $1.5 million and $2.2 million in the prior year
periods, respectively. The higher operating losses reflect higher planned
investments related to the group's continued growth and development.
CORPORATE ADMINISTRATION AND PROMOTION
Beginning with the quarter ended March 31, 1999, certain Company-wide
marketing activities, such as the Playboy Jazz Festival and playmate promotions,
that had previously been reported in the Publishing Group are now included in
Corporate Administration and Promotion results. As a result, revenues are now
reported in Corporate Administration and Promotion.
Corporate Administration and Promotion net expenses for the quarter ended
June 30, 1999 of $6.3 million increased $0.2 million, or 4%, compared to the
prior year quarter. Net expenses for the six-month period of $12.3 million
increased $1.6 million, or 15%, compared to the prior year largely due to higher
marketing expenses.
LIQUIDITY AND CAPITAL RESOURCES
At June 30, 1999, the Company had $21.7 million in cash and cash
equivalents, no short-term borrowings and $110.0 million in current and
long-term financing obligations, compared to $0.3 million in cash and cash
equivalents, $29.8 million in short-term borrowings and no current or long-term
financing obligations at December 31, 1998. The Company expects to meet its
short- and long-term cash requirements through its new $150.0 million credit
agreement and $24.6 million of net proceeds from the Company's public equity
offering. See Cash Flows From Financing Activities.
CASH FLOWS FROM OPERATING ACTIVITIES
Net cash used for operating activities was $10.3 million for the six
months ended June 30, 1999, which reflected $18.6 million of investments in
Company-produced and licensed entertainment programming during the current year
period.
CASH FLOWS FROM INVESTING ACTIVITIES
Net cash used for investing activities was $59.6 million for the six
months ended June 30, 1999, primarily due to the Company's acquisition of Spice,
resulting in cash paid of $64.1 million in the current year.
On December 31, 1998, the Company sold to duPont Publishing, Inc.
("duPont") the shares of duPont's common stock owned by the Company. Sale
proceeds were $5.0 million, which consisted of $0.5 million in cash, received in
fiscal year 1998, and a $4.5 million promissory note, which was paid off January
4, 1999. In the quarter ended March 31, 1999, the Company sold its wholly-owned
subsidiary, Playboy Gaming Greece Ltd., which owned a 12% equity interest in the
Rhodes Casino. Total proceeds of $5.2 million were received. These proceeds
included a repayment of a loan of $1.2 million owed to the Company by the Rhodes
Casino.
CASH FLOWS FROM FINANCING ACTIVITIES
Net cash provided by financing activities was $91.3 million for the six
months ended June 30, 1999. This increase was principally due to the $110.0
million increase in current and long-term financing obligations combined with
$24.6 million of net proceeds from the Company's public equity offering,
partially offset by the repayment of $29.8 million of short-term borrowings and
the payment of $10.5 million of Spice's debt.
In May 1999, the Company completed a public equity offering of 2,875,000
shares of nonvoting Class B common stock at a price of $30.00 per share. Two
million shares were sold by a trust established by, and for the benefit of, Hugh
M. Hefner, the Company's founder and principal stockholder, and 875,000 shares
were sold by the Company. Of the Company's shares, 375,000 were sold pursuant to
an underwriters' over-allotment provision. The Company did not receive any of
the proceeds from the sale of Class B common stock by Mr. Hefner. Mr. Hefner is
responsible for expenses related to this transaction proportionate to the number
of shares he sold to the total number of shares sold in the offering. Net
proceeds to the Company of $24.6 million are being used for general corporate
purposes.
18
In connection with financing the Company's acquisition of Spice, the
Company entered into a new $150.0 million credit agreement dated as of February
26, 1999. The new agreement provided financing to (a) purchase all of the
outstanding shares of Spice and pay related acquisition costs; (b) repay the
existing debt of the Company and Spice; and (c) fund future general working
capital and investment needs.
The new agreement consists of three components: a $40.0 million revolving
credit facility with a $10.0 million letter of credit sublimit; a $35.0 million
tranche A term loan; and a $75.0 million tranche B term loan. The revolving
credit facility and tranche A term loan mature on March 15, 2004. The tranche B
term loan matures on March 15, 2006. Loans bear interest at a rate equal to
specified index rates plus margins that fluctuate based on the Company's ratio
of consolidated debt to consolidated adjusted EBITDA. The Company's obligations
under the agreement are unconditionally guaranteed by each of the Company's
existing and subsequently acquired domestic restricted subsidiaries (all
domestic subsidiaries except Playboy Online, Inc.). The agreement and related
guarantees are secured by substantially all of Playboy Enterprises, Inc.'s and
its domestic restricted subsidiaries' assets.
The agreement contains financial covenants requiring the Company to
maintain certain leverage, cash flow, interest coverage and fixed charge
coverage ratios. Other covenants include limitations on other indebtedness,
investments, capital expenditures and dividends. The agreement also requires
mandatory prepayments with net cash proceeds resulting from excess cash flow,
asset sales and the issuance of certain debt obligations or equity securities,
with certain exceptions as described in the agreement.
INCOME TAXES
Based on current tax law, the Company will need to generate approximately
$39.7 million of future taxable income prior to the expiration of the Company's
NOLs for full realization of the $13.9 million net deferred tax asset at
December 31, 1998. At December 31, 1998, the Company had NOLs of $14.2 million
for tax purposes, with $11.7 million expiring in 2009 and $2.5 million expiring
in 2012.
Management believes that it is more likely than not that the required
amount of such taxable income will be generated in years subsequent to December
31, 1998 and prior to the expiration of the Company's NOLs to realize the $13.9
million net deferred tax asset at December 31, 1998. Associated with the Spice
acquisition, $15.7 million of deferred tax liabilities were recorded under the
purchase method of accounting for certain identifiable intangible assets,
comprising trademarks, non-compete agreements and a film library. After
consideration of this additional $15.7 million of deferred tax liabilities, at
June 30, 1999, the Company was in a net deferred tax asset position of $0.7
million that consisted of $7.4 million of current deferred tax assets and $6.7
million of noncurrent deferred tax liabilities. Following is a summary of the
bases for management's belief that a valuation allowance of $15.4 million at
December 31, 1998 is adequate, and that it is more likely than not that the net
deferred tax asset of $13.9 million will be realized:
o In establishing the net deferred tax asset, management reviewed the
components of the Company's NOLs and determined that they primarily
resulted from several nonrecurring events, which were not indicative of
the Company's ability to generate future earnings.
o Several of the Company's operating groups continue to generate meaningful
earnings, particularly the Entertainment Group, and the Company's
investments in the Entertainment, Playboy Online and Casino Gaming Groups
are anticipated to lead to increased earnings in future years.
o The Company has opportunities to accelerate taxable income into the NOL
carryforward period. Tax planning strategies would include the
capitalization and amortization versus immediate deduction of circulation
expenditures, the immediate inclusion versus deferred recognition of
prepaid subscription income, the revision of depreciation and amortization
methods for tax purposes and the sale-leaseback of certain property that
would generate taxable income in future years.
19
YEAR 2000 COMPLIANCE
In response to the Year 2000 problem, the Company has identified and is
implementing changes to its existing computerized business systems. The Company
is addressing the issue through a combination of modifications to existing
programs and conversions to Year 2000 compliant software. In addition, the
Company has communicated with its vendors and other service providers to ensure
that their products and business systems are or will be Year 2000 compliant. If
modifications and conversions by the Company and those it conducts business with
are not made in a timely manner, the Year 2000 problem could have a material
adverse effect on the Company's business, financial condition and results of
operations. All major systems of the Company have either been identified as Year
2000 compliant, or remediation has been completed to ensure Year 2000
compliance. These major systems include financial applications, and key
operating systems for the Entertainment, Catalog and Playboy Online Groups. The
Company is currently evaluating less critical systems, such as desktop
applications, with plans for all systems to be in compliance by the end of the
third quarter of fiscal year 1999. The Company is also reviewing its
non-information technology systems to determine the extent of any modifications
and believes that there will be minimal changes necessary for compliance. The
current estimate of the total costs associated with the required modifications
and conversions are expected to be slightly in excess of $1.0 million, of which
approximately $0.8 million has been expensed through June 30, 1999. These costs
are being expensed as incurred.
The Company believes its technology systems will be ready for the Year
2000 and, as a result, has not developed a comprehensive contingency plan.
High-risk vendors, however, are being examined throughout the year with
contingency plans developed on a case-by-case basis where needed. Additionally,
the Company is aware that it may experience other isolated incidences of
non-compliance and plans to allocate internal resources and retain dedicated
consultants and vendor representatives to be ready to take action if necessary.
Although the Company values its established relationships with key vendors and
other service providers, if certain vendors are unable to perform on a timely
basis due to their own Year 2000 issues, the Company believes that substitute
products or services are available from other vendors. The Company also
recognizes that it, like all other businesses, is at risk if other key suppliers
in utilities, communications, transportation, banking and government are not
ready for the Year 2000.
FORWARD-LOOKING STATEMENTS
This Form 10-Q Quarterly Report contains "forward-looking statements,"
including statements in "Management's Discussion and Analysis of Financial
Condition and Results of Operations," as to expectations, beliefs, plans,
objectives and future financial performance, and assumptions underlying or
concerning the foregoing. These forward-looking statements involve risks and
uncertainties, which could cause actual results or outcomes to differ materially
from those expressed in the forward-looking statements. The following are some
of the important factors that could cause actual results or outcomes to differ
materially from those discussed in the forward-looking statements: (1)
government actions or initiatives, including (a) attempts to limit or otherwise
regulate the sale of adult-oriented materials, including print, video and online
materials or businesses such as casino gaming, (b) regulation of the
advertisement of tobacco products, or (c) substantive changes in postal
regulations or rates; (2) increases in paper prices; (3) changes in distribution
technology and/or unforeseen delays in the implementation of that technology by
the cable and satellite industries, which might affect the Company's plans and
assumptions regarding carriage of its program services; (4) increased
competition for transponders and channel space and any decline in the Company's
access to, and acceptance by, cable and DTH systems; (5) increased competition
for advertisers from other publications and media or any significant decrease in
spending by advertisers, either generally or with respect to the adult male
market; (6) effects of the consolidation taking place nationally in the
single-copy magazine distribution system; (7) new competition in the cable
television market; (8) uncertainty of market acceptance of the Internet as a
medium for information, entertainment, e-commerce and advertising, an
increasingly competitive environment for advertising sales, the impact of
competition from other content and merchandise providers, as well as the
Company's reliance on third parties for technology and distribution for its
online business; (9) potential problems associated with the integration of the
Company's business with Spice's business; and (10) potential adverse effects of
unresolved Year 2000 problems, including those that may be experienced by key
suppliers.
20
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company uses derivative financial instruments to manage the risk
associated with its exposure to interest rate fluctuations. In the quarter ended
June 30, 1999, the Company entered into an interest rate swap agreement to
effectively convert $45.0 million of its floating rate debt to fixed rate debt.
The Company prepared sensitivity analyses to determine the impact of
hypothetical changes in interest rates on the Company's consolidated operating
results, financial position and cash flows. The interest rate analyses assumed a
one percentage point adverse change in interest rates, but did not consider the
effects of the reduced level of economic activity that could exist in such an
environment. Based on the results of these analyses, a one percentage point
adverse change in interest rates would not have a material effect on the
Company's consolidated operating results, financial position or cash flows.
LEGAL PROCEEDINGS
In February 1996, the Telecommunications Act was enacted. Certain
provisions of the Telecommunications Act are directed exclusively at cable
programming in general and adult cable programming in particular. In some cable
systems, audio or momentary bits of video of premium or pay-per-view channels
may accidentally become available to nonsubscribing cable customers. This is
called "bleeding." The practical effect of Section 505 is to require many
existing cable systems to employ additional blocking technology in every
household in every cable system that offers adult programming to prevent any
possibility of bleeding, or to restrict the period during which adult
programming is transmitted from 10:00 p.m. to 6:00 a.m. Penalties for violation
of the Telecommunications Act are significant and include fines and
imprisonment.
On February 26, 1996, one of the Company's subsidiaries filed a civil suit
in the Delaware District Court challenging Section 505 on constitutional
grounds. The suit names as defendants The United States of America, The United
States Department of Justice, Attorney General Janet Reno and the FCC. On March
7, 1996, the Company was granted a Temporary Restraining Order ("TRO") staying
the implementation and enforcement of Section 505. In granting the TRO, the
Delaware District Court found that the Company had demonstrated it was likely to
succeed on the merits of its claim that Section 505 is unconstitutional. On
November 8, 1996, eight months after the TRO was granted, a three-judge panel in
the Delaware District Court denied the Company's request for preliminary
injunction against enforcement of Section 505 and, in so denying, found that the
Company was not likely to succeed on the merits of its claim. The Company
appealed the Delaware District Court's decision to the Supreme Court and
enforcement of Section 505 was stayed pending that appeal. On March 24, 1997,
without opinion, the Supreme Court summarily affirmed the Delaware District
Court's denial of the Company's request for a preliminary injunction.
Enforcement of Section 505 commenced May 18, 1997. On July 22, 1997, the Company
filed a motion for summary judgment on the ground that Section 505 is
unconstitutionally vague based on a Supreme Court decision on June 26, 1997 that
certain provisions of the Telecommunications Act regulating speech on the
Internet were invalid for numerous reasons, including vagueness. On October 31,
1997, the Delaware District Court denied the motion on the grounds that further
discovery in the case was necessary to assist it in resolving the issues posed
in the motion.
The Company's full case on the merits was heard by the Delaware District
Court in March 1998. On December 28, 1998, the Delaware District Court
unanimously declared Section 505 unconstitutional. The defendants have appealed
this judgment and the Supreme Court will hear the appeal. Management believes
that the effect of Section 505 on the Company's financial performance is likely
to continue until the case is finally decided.
21
SUBSMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
The Company's annual meeting of shareholders was held on May 12, 1999. At
the meeting, the following director nominees were elected:
Nominee Votes For Withheld
- ------- --------- --------
Dennis S. Bookshester.................................... 4,202,101 57,623
David I. Chemerow........................................ 4,202,101 57,623
Donald G. Drapkin........................................ 4,202,101 57,623
Christie A. Hefner....................................... 4,200,896 58,828
Sol Rosenthal............................................ 4,202,101 57,623
Richard S. Rosenzweig.................................... 4,202,099 57,625
Sir Brian Wolfson........................................ 4,202,101 57,623
Also at the meeting, the shareholders approved, with voting as set forth
below, (i) amendments to and the restatement of the Company's 1995 Stock
Incentive Plan, as amended and restated (the "1995 Stock Incentive Plan"); (ii)
amendments to the Company's Employee Stock Purchase Plan, as amended and
restated (the "Employee Stock Purchase Plan"); (iii) an amendment to the
Restated Certificate of Incorporation of Playboy Enterprises International, Inc.
(the "Restated Certificate of Incorporation"); and (iv) ratification of
PricewaterhouseCoopers LLP as independent auditors ("Auditors"):
Votes Votes Votes
Matter For Against Withheld Non-Vote
- ------ -------- -------- -------- --------
1995 Stock Incentive Plan ........................... 3,660,914 283,711 2,300 312,799
Employee Stock Purchase Plan ........................ 3,932,312 12,387 2,226 312,799
Restated Certificate of Incorporation ............... 3,936,810 8,587 1,528 312,799
Auditors ............................................ 4,250,918 3,109 5,697 N/A
22
EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
Exhibit
Number Description
- ------ -----------
#10.1 Fourth Amendment to November 15, 1993 Affiliation Agreement between
Playboy Entertainment Group, Inc. and DirecTV, Inc. regarding the
satellite distribution of Playboy TV dated March 15, 1999
#10.2 Program Supply Agreement between SEI Inc ApS and SEI 1 ApS dated June 30,
1999
10.3 Amended and Restated Playboy Enterprises, Inc. 1995 Stock Incentive Plan
10.4 Amendment to Playboy Enterprises, Inc. Employee Stock Purchase Plan, as
amended and restated
10.5 Selected Employment, Termination and Other Agreements
a Letter agreement dated May 24, 1999 regarding new compensation
arrangements for Herb Laney
27 Financial Data Schedule
- ---------
# Certain information omitted pursuant to a request for confidential
treatment filed separately with the Securities and Exchange Commission
(b) Reports on Form 8-K
During the quarter ended June 30, 1999, the Company filed a Form 8-K/A
Current Report dated April 9, 1999 under Item 2 of the report. On March
15, 1999, the Company filed its original Form 8-K with respect to its
acquisition of Spice. The purpose of this amended report was to furnish
audited consolidated financial statements of Spice and unaudited pro forma
financial information of the Company giving effect to the Company's
acquisition of Spice. The original Form 8-K was also amended so that the
information reported under Item 5 is deemed reported under Item 2.
23
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, the registrant has duly caused this report to be signed on its
behalf by the undersigned thereunto duly authorized.
PLAYBOY ENTERPRISES, INC.
-------------------------
(Registrant)
Date August 13, 1999 By /s/ Linda Havard
------------------ ---------------------------------
Linda G. Havard
Executive Vice President,
Finance and Operations,
and Chief Financial Officer
(Authorized Officer and
Principal Financial and
Accounting Officer)
24