UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
|X| QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 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 October 31, 1999, there were 4,748,954 shares of Class A Common
Stock, par value $0.01 per share, and 18,868,606 shares of Class B Common Stock,
par value $0.01 per share, outstanding.
PLAYBOY ENTERPRISES, INC.
FORM 10-Q
TABLE OF CONTENTS
PART I
FINANCIAL INFORMATION
Page
----
Item 1. Financial Statements
Condensed Consolidated Statements of Operations and
Comprehensive Income for the Quarters Ended September 30,
1999 and 1998 (Unaudited) 3
Condensed Consolidated Statements of Operations and
Comprehensive Income for the Nine Months Ended September 30,
1999 and 1998 (Unaudited) 4
Condensed Consolidated Balance Sheets at September 30,
1999 (Unaudited) and December 31, 1998 5
Condensed Consolidated Statements of Cash Flows for the
Nine Months Ended September 30, 1999 and 1998 (Unaudited) 6
Notes to Condensed Consolidated Financial Statements 7-12
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 13-22
Item 3. Quantitative and Qualitative Disclosures About Market Risk 22
PART II
OTHER INFORMATION
Item 1. Legal Proceedings 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 September 30 (Unaudited)
(In thousands, except per share amounts)
1999 1998
-------- --------
Net revenues $104,445 $ 75,655
-------- --------
Costs and expenses
Cost of sales (71,755) (66,558)
Selling and administrative expenses (17,270) (11,539)
-------- --------
Total costs and expenses (89,025) (78,097)
-------- --------
Operating income (loss) 15,420 (2,442)
-------- --------
Nonoperating income (expense)
Investment income 489 19
Interest expense (2,470) (429)
Gain on sale of investments, net 571 --
Equity in income (loss) of investments (2,470) 15
Other, net (269) (94)
-------- --------
Total nonoperating expense (4,149) (489)
-------- --------
Income (loss) before income taxes 11,271 (2,931)
Income tax benefit (expense) (5,939) 242
-------- --------
Net income (loss) 5,332 (2,689)
-------- --------
Other comprehensive income (loss) (net of taxes)
Foreign currency translation adjustment 1 (18)
Unrealized loss on marketable securities (38) (38)
-------- --------
Total other comprehensive loss (37) (56)
-------- --------
Comprehensive income (loss) $ 5,295 $ (2,745)
======== ========
Weighted average number of common shares outstanding
Basic 23,583 20,552
======== ========
Diluted 24,276 21,003
======== ========
Basic and diluted net income (loss) per common share $ 0.24 $ (0.13)
======== ========
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 Nine Months Ended September 30 (Unaudited)
(In thousands, except per share amounts)
1999 1998
-------- --------
Net revenues $256,150 $225,237
-------- --------
Costs and expenses
Cost of sales (201,046) (191,786)
Selling and administrative expenses (42,655) (30,658)
-------- --------
Total costs and expenses (243,701) (222,444)
-------- --------
Operating income 12,449 2,793
-------- --------
Nonoperating income (expense)
Investment income 1,040 70
Interest expense (5,876) (989)
Gain on sale of investments, net 2,299 --
Equity in loss of investments (3,596) (256)
Other, net (743) (279)
-------- --------
Total nonoperating expense (6,876) (1,454)
-------- --------
Income before income taxes 5,573 1,339
Income tax expense (4,255) (1,889)
-------- --------
Net income (loss) 1,318 (550)
-------- --------
Other comprehensive income (loss) (net of taxes)
Foreign currency translation adjustment (60) (24)
Unrealized gain (loss) on marketable securities 57 (38)
-------- --------
Total other comprehensive loss (3) (62)
-------- --------
Comprehensive income (loss) $ 1,315 $ (612)
======== ========
Weighted average number of common shares outstanding
Basic 22,558 20,541
======== ========
Diluted 23,327 21,053
======== ========
Basic and diluted net income (loss) per common share $ 0.06 $ (0.03)
======== ========
The accompanying Notes to Condensed Consolidated Financial Statements are an
integral part of these statements.
4
PLAYBOY ENTERPRISES, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands, except share data)
(Unaudited)
Sept. 30, Dec. 31,
1999 1998
-------- --------
Assets
Cash and cash equivalents $ 23,506 $ 341
Marketable securities 2,606 505
Receivables, net of allowance for doubtful accounts of
$8,809 and $6,349, respectively 46,535 49,879
Inventories 26,400 25,685
Programming costs 50,691 43,342
Deferred subscription acquisition costs 12,059 11,570
Other current assets 20,554 21,097
-------- --------
Total current assets 182,351 152,419
-------- --------
Property and equipment, at cost 39,682 39,042
Accumulated depreciation (31,286) (29,885)
-------- --------
Property and equipment, net 8,396 9,157
------- -------
Receivables 62,500 --
Programming costs 6,487 5,983
Goodwill, net of amortization of $1,887 and $432, respectively 94,282 2,053
Trademarks 46,384 17,294
Net deferred tax assets -- 6,525
Other noncurrent assets 28,652 18,676
-------- --------
Total assets $429,052 $212,107
======== ========
Liabilities
Short-term borrowings $ -- $ 29,750
Current financing obligations 1,969 --
Accounts payable 26,646 30,834
Accrued salaries, wages and employee benefits 8,140 6,024
Income taxes payable 1,227 819
Deferred revenues 51,292 41,647
Other liabilities and accrued expenses 11,863 9,919
-------- --------
Total current liabilities 101,137 118,993
Long-term financing obligations 88,031 --
Deferred revenues 55,650 --
Net deferred tax liabilities 11,196 --
Other noncurrent liabilities 13,001 8,912
-------- --------
Total liabilities 269,015 127,905
-------- --------
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; 19,172,566
and 17,149,691 issued, respectively 192 171
Capital in excess of par value 112,951 44,860
Retained earnings 50,895 49,577
Foreign currency translation adjustment (230) (137)
Unearned compensation restricted stock (3,873) (3,716)
Unrealized gain (loss) on marketable securities 55 (32)
Less cost of treasury stock -- (6,571)
-------- --------
Total shareholders' equity 160,037 84,202
-------- --------
Total liabilities and shareholders' equity $429,052 $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 Nine Months Ended September 30 (Unaudited)
(In thousands)
1999 1998
-------- --------
Cash Flows From Operating Activities
Net income (loss) $ 1,318 $ (550)
Adjustments to reconcile net income (loss) to net cash
provided by (used for) operating activities:
Depreciation of property and equipment 1,424 1,488
Amortization of intangible assets 4,382 1,298
Gain on sale of investments, net (2,299) --
Amortization of investments in entertainment programming 25,913 17,758
Investments in entertainment programming (28,366) (19,246)
Net change in operating assets and liabilities 15,988 (12,729)
Other, net 376 (4)
-------- --------
Net cash provided by (used for) operating activities 18,736 (11,985)
-------- --------
Cash Flows From Investing Activities
Acquisition of Spice Entertainment Companies, Inc. (64,600) (2,007)
Sale of investments 12,693 --
Additions to property and equipment (687) (801)
Acquisitions and funding of equity interests
in international ventures (12,174) (2,791)
Purchase of marketable securities (2,000) (500)
Other, net 4 32
-------- --------
Net cash used for investing activities (66,764) (6,067)
-------- --------
Cash Flows From Financing Activities
Increase (decrease) in short-term borrowings (29,750) 19,000
Increase in financing obligations 110,000 --
Repayment of financing obligations (20,000) --
Net proceeds from public equity offering 24,561 --
Payment of debt assumed in acquisition of Spice Entertainment
Companies, Inc. (10,471) --
Deferred financing fees (4,669) (100)
Proceeds from exercise of stock options 1,350 199
Proceeds from sales under employee stock purchase plan 172 156
-------- --------
Net cash provided by financing activities 71,193 19,255
-------- --------
Net increase in cash and cash equivalents 23,165 1,203
Cash and cash equivalents at beginning of period 341 947
-------- --------
Cash and cash equivalents at end of period $ 23,506 $ 2,150
======== ========
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 current determination of the purchase price, including transaction costs and
the assumption of Spice debt, is approximately $128 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 I 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 is currently
approximately $94 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):
Nine Months Ended
September 30,
--------------------
1999 1998
-------- --------
Net revenues ........................................ $262,441 $243,409
Net loss ............................................ (252) (4,775)
Basic and diluted net loss per common share ......... $ (0.01) $ (0.21)
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) PLAYBOY TV INTERNATIONAL, LLC JOINT VENTURE
During the quarter ended September 30, 1999, the Company entered into a joint
venture with a wholly owned subsidiary of the Cisneros Group of Companies. The
venture, Playboy TV International, LLC ("PTVI"), has the exclusive right to
create and launch new television networks under the Playboy and Spice brands in
territories outside of the United States and Canada and, under certain
circumstances, to license programming to third parties. PTVI will also own and
operate existing international Playboy TV and Spice networks, which either have
been or will be sold or contributed by the Company to PTVI. In addition, the
Company and PTVI have entered into program supply and trademark license
agreements. Currently, the Company has a 19.9% interest in PTVI with an option
to increase up to 50% for a certain period of time. Each of the members of PTVI
has committed to fund the capital needs of PTVI in proportion to their
respective equity ownership. The Company expects that the revenues it receives
from the joint venture will exceed its funding obligations.
Under the arrangements with PTVI, the Company will receive $100 million, $30
million of which was received during the current year quarter, with the
remainder to be received over the next five years. PTVI also has a long-term
commitment with the Company to license international television rights to each
year's production output, with payments representing a percentage of the
Company's annual production spending.
7
(D) SALE OF INVESTMENTS
In the quarter ended September 30, 1999, the Company sold its interests in
certain of its international TV networks to PTVI. Total proceeds under the
contract are $10.0 million, consisting of $3.0 million in cash in the current
year quarter with the remainder to be received over the next five years. The
Company realized a net gain before income taxes of $0.6 million in the current
year periods and recorded a deferred gain of $3.5 million, which is expected to
be realized over the next five years. The taxable gain on the sale was
immaterial and was offset by the application of a capital loss carryforward.
In the quarter ended March 31, 1999, the Company sold its wholly-owned
subsidiary, Playboy Gaming Greece Ltd., which owned a 12% 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 was offset by the application of a capital loss carryforward.
(E) 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. Accordingly, after consideration of this additional $15.7 million of
deferred tax liabilities, at September 30, 1999, the Company was in a net
deferred tax liability position of $3.8 million that consisted of $7.4 million
of current deferred tax assets and $11.2 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.
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.
(F) 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 Nine Months Ended
September 30, September 30,
------------------- -------------------
1999 1998 1999 1998
-------- -------- -------- --------
Foreign currency translation adjustment (1) . $ 1 $ (18) $ (60) $ (24)
Unrealized gain (loss) on marketable
securities (2) ......................... $ (38) $ (38) $ 57 $ (38)
(1) Net of a related tax benefit of $33 for the nine months ended September
30, 1999, and $9 and $13 for the quarter and nine months ended September
30, 1998, respectively. There was no related income tax expense for the
quarter ended September 30, 1999.
(2) Net of a related tax benefit of $21 and tax expense of $30 for the quarter
and nine months ended September 30, 1999, respectively, and a related tax
benefit of $21 for both the quarter and nine months ended September 30,
1998.
8
(G) INCOME (LOSS) PER COMMON SHARE
The following table sets forth the computation of basic and diluted earnings per
share ("EPS") (in thousands, except per share amounts):
(Unaudited) (Unaudited)
Quarters Ended Nine Months Ended
September 30, September 30,
------------------- -------------------
1999 1998 1999 1998
-------- -------- -------- --------
Numerator:
For basic and diluted EPS-net income (loss) $ 5,332 $ (2,689) $ 1,318 $ (550)
======== ======= ======== ========
Denominator:
Denominator for basic EPS-
weighted-average shares ................. 23,583 20,552 22,558 20,541
-------- ------- -------- --------
Effect of dilutive potential common shares:
Stock options ........................... 693 451 769 512
-------- ------- -------- --------
Dilutive potential common shares ...... 693 451 769 512
-------- ------- -------- --------
Denominator for diluted EPS-
adjusted weighted-average shares ........ 24,276 21,003 23,327 21,053
======== ======= ======== ========
Basic and Diluted EPS ....................... $ 0.24 $ (0.13) $ 0.06 $ (0.03)
======== ======= ======== ========
During the quarter and nine months ended September 30, 1999, approximately
325,000 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
345,000 and 285,000 weighted-average shares of Class B common stock were
outstanding during the quarter and nine months ended September 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.
(H) INVENTORIES
Inventories, which are stated at the lower of cost (average cost and specific
cost) or market, consisted of the following (in thousands):
(Unaudited)
Sept. 30, Dec. 31,
1999 1998
-------- --------
Paper ............................................... $ 7,190 $ 8,277
Editorial and other prepublication costs ............ 6,865 6,052
Merchandise finished goods .......................... 12,345 11,356
-------- --------
Total inventories ................................ $ 26,400 $ 25,685
======== ========
(I) 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 originally consisted 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. On
September 16, 1999, the Company used $20.0 million of the cash proceeds from
PTVI to repay the term debt which reduced the credit facility to $130.0 million.
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.
9
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.
For the quarter ended September 30, 1999, the Company received a waiver on the
financial covenants contained in the credit agreement, until January 12, 2000.
During this period, the Company and the banks will reset the covenant levels to
reflect recent business developments, including, among other things, the benefit
of the PTVI venture and the decline in the Catalog business. Management expects
to have the new covenants in place prior to the end of the fiscal year. While
the waiver remains in effect, the Company has agreed to not draw upon the
revolving credit facility. Management believes that the Company's cash and cash
equivalents on hand will provide the necessary liquidity during this period.
(J) 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 on November 30,
1999. Management believes that the effect of Section 505 on the Company's
financial performance is likely to continue until the case is finally decided.
(K) 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 upon exercise by
the underwriters of their over-allotment option. 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.
(L) TREASURY STOCK
There were no Class A or Class B common shares held as treasury stock at
September 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.
(M) CONDENSED CONSOLIDATED STATEMENT OF CASH FLOWS
The following summarizes non-cash investing and financing activities related to
the Spice acquisition (in thousands):
(Unaudited)
Nine Months
Ended
Sept. 30, 1999
--------------
Fair value of net assets acquired, including goodwill.......... $ 127,562
Acquisition liabilities........................................ (3,735)
Payment of debt assumed........................................ (10,471)
Common stock issued............................................ (48,429)
---------
Cash paid...................................................... 64,927
Less: cash acquired............................................ (327)
---------
Net cash paid for the Spice acquisition........................ $ 64,600
=========
See Note B Acquisition.
10
(N) SEGMENT INFORMATION
The following tables represent financial information by reportable segment (in
thousands):
(Unaudited) (Unaudited)
Quarters Ended Nine Months Ended
Sept. 30, Sept. 30,
------------------- -------------------
1999 1998 1999 1998
-------- -------- -------- --------
Net Revenues
Publishing (1) .............................. $ 33,586 $ 33,946 $ 97,675 $ 97,111
Entertainment ............................... 52,009 21,942 98,698 65,002
Product Marketing ........................... 1,361 1,556 4,440 5,762
Catalog ..................................... 13,776 16,295 43,812 50,781
Casino Gaming ............................... 300 25 600 25
Playboy Online .............................. 3,294 1,797 8,862 4,797
Corporate Marketing (1) ..................... 119 94 2,063 1,759
-------- -------- -------- --------
Total .................................... $104,445 $ 75,655 $256,150 $225,237
======== ======= ======== ========
Income (Loss) Before Income Taxes
Publishing (1) .............................. $ 542 $ 1,465 $ 3,441 $ 4,902
Entertainment ............................... 25,537 5,825 35,965 18,276
Product Marketing ........................... 75 (985) 542 101
Catalog ..................................... (704) 573 (1,257) 2,127
Casino Gaming ............................... (217) (201) (461) (599)
Playboy Online .............................. (1,919) (2,128) (5,585) (4,319)
Corporate Administration and Promotion (1) .. (7,894) (6,991) (20,196) (17,695)
Investment income ........................... 489 19 1,040 70
Interest expense ............................ (2,470) (429) (5,876) (989)
Gain on sale of investments, net ............ 571 -- 2,299 --
Equity in income (loss) of investments ...... (2,470) 15 (3,596) (256)
Other, net .................................. (269) (94) (743) (279)
-------- -------- -------- --------
Total .................................... $ 11,271 $ (2,931) $ 5,573 $ 1,339
======== ======= ======== ========
(Unaudited)
Sept. 30, Dec. 31,
1999 1998
-------- --------
Identifiable Assets
Publishing (1) ...................................... $ 44,259 $ 50,171
Entertainment (2) ................................... 289,491 85,783
Product Marketing ................................... 5,519 5,764
Catalog ............................................. 17,653 17,871
Casino Gaming ....................................... 1,717 4,416
Playboy Online ...................................... 1,344 1,282
Corporate Administration and Promotion (1) (3) ...... 69,069 46,820
-------- --------
Total (2) (3) .................................... $429,052 $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 and the
formation of PTVI in the quarter ended September 30, 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
(O) PLAYBOY ONLINE PUBLIC EQUITY OFFERING
On September 28, 1999, the Company announced that the Board of Directors (the
"Board") approved plans to sell a minority interest in Playboy Online, its
online business group, to the public. The Company intends to file a registration
statement relating to the securities to be offered later this fiscal year.
(P) ACCOUNTING STANDARDS
The Company will adopt the provisions of Statement of Financial Accounting
Standards No. 137, Accounting for Derivative Instruments and Hedging Activities
- - Deferral of the Effective Date of FASB Statement No. 133 ("Statement 137").
Statement 137 defers the effective date for financial statements issued for
fiscal years beginning after June 15, 2000.
12
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
RESULTS OF OPERATIONS
The Company's revenues increased 38% to $104.4 million for the quarter
ended September 30, 1999 compared to $75.7 million for the quarter ended
September 30, 1998. Revenues were $256.2 million for the nine months ended
September 30, 1999, a 14% increase over revenues of $225.2 million for the nine
months ended September 30, 1998. These increases were primarily due to higher
revenues from the Entertainment Group, principally due to the formation of PTVI,
a joint venture the Company entered into with the Cisneros Television Group
during the current year quarter. Also contributing to the increases were higher
revenues from the Playboy Online Group, partially offset by lower Catalog Group
revenues.
The Company reported operating income of $15.4 million for the quarter
ended September 30, 1999 compared to an operating loss of $2.4 million in the
prior year quarter. For the nine months ended September 30, 1999, the Company's
operating income was $12.4 million compared to $2.8 million in the prior year.
These increases were primarily due to higher operating income from the
Entertainment Group, principally due to the revenues related to PTVI. Lower
operating performance from the Catalog and Publishing Groups, as well as higher
Corporate Administration and Promotion expenses, partially offset the above for
both the quarter and nine-month period.
Net income for the quarter ended September 30, 1999 was $5.3 million, or
$0.24 per basic and diluted common share, compared to a net loss of $2.7
million, or $0.13 per basic and diluted common share, for the prior year
quarter. Net income for the nine months ended September 30, 1999 was $1.3
million, or $0.06 per basic and diluted common share, compared to a net loss of
$0.6 million, or $0.03 per basic and diluted common share, for the prior year.
Net income for the current year periods included higher interest expense,
primarily due to increased debt resulting from the acquisition of Spice. Both
current year periods also included a $0.6 million net gain from the sale of the
Company's interests in certain of its international TV networks to PTVI. Net
income for the current year nine-month period also reflected a $1.7 million gain
from the sale of the Company's interest in the Rhodes Casino. Additionally, both
of the current year periods included equity losses primarily related to the
Company's interest in PTVI. The current year nine-month period also included an
equity loss related to the Company's interests in its United Kingdom television
networks, which were sold to PTVI in the current year quarter.
Several of the Company's businesses can experience variations in quarterly
performance. As a result, the Company's performance in any quarterly period is
not necessarily reflective of full-year or longer-term trends. For example,
Playboy magazine newsstand revenues vary from issue to issue, with revenues
generally higher for holiday issues and any issues including editorial or
pictorial features that generate unusual public interest. Advertising revenues
also vary from quarter to quarter, depending on product introductions by
advertising customers, changes in advertising buying patterns and economic
conditions. In addition, Entertainment Group revenues vary due to the timing of
recognizing library license fees related to PTVI.
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 Nine Months Ended
September 30, September 30,
------------------- -------------------
1999 1998 1999 1998
-------- -------- -------- --------
Revenues
Playboy Magazine ............................ $ 25.9 $ 26.2 $ 76.7 $ 75.8
Other Domestic Publishing ................... 5.6 5.5 13.8 13.9
International Publishing .................... 2.1 2.2 7.2 7.4
-------- ------- -------- --------
Total Revenues ........................... $ 33.6 $ 33.9 $ 97.7 $ 97.1
======== ======= ======== ========
Operating Income ............................ $ 0.5 $ 1.5 $ 3.4 $ 4.9
======== ======= ======== ========
13
Publishing Group revenues decreased $0.3 million, or 1%, for the quarter
ended September 30, 1999 compared to the prior year primarily due to lower
revenues from Playboy magazine. For the nine months ended September 30, 1999,
revenues increased $0.6 million, or 1%, compared to the prior year primarily due
to higher revenues from Playboy magazine.
For the quarter, Playboy magazine revenues declined $0.3 million, or 1%,
compared to the prior year. Circulation revenues decreased $1.2 million, or 6%,
primarily due to a $0.9 million, or 14%, decrease in newsstand revenues
principally as a result of fewer copies sold in comparison with the prior year
quarter which included a best-selling issue featuring Cindy Crawford.
Subscription revenues decreased $0.3 million, or 2%, reflecting in part the
problems facing direct marketing stamp sheet agents, which are affecting all
publishers. The lower circulation revenues were mostly offset by a $0.9 million,
or 14%, increase in advertising revenues due to increases in both the average
net revenue per page and ad pages.
For the nine-month period, Playboy magazine revenues increased $0.9
million, or 1%, compared to the prior year. Circulation revenues increased $0.3
million, or 1%, primarily due to a $2.6 million, or 19%, increase in newsstand
revenues largely due to strong sales of the April and September 1999 issues
featuring Rena Mero, the World Wrestling Federation champion formerly known as
Sable. The higher newsstand revenues were mostly offset by a $2.3 million, or
6%, decrease in subscription revenues, reflecting in part the problems facing
direct marketing stamp sheet agents. Additionally, advertising revenues
increased $1.2 million, or 6%, due to increases in both the average net revenue
per page and ad pages. Advertising sales for the fiscal year 1999 fourth quarter
issues of the magazine are closed and the Company expects to report 19%
increases in both ad pages and ad revenues compared to the quarter ended
December 31, 1998, resulting in expected 6% and 10% increases in ad pages and ad
revenues, respectively, for fiscal year 1999 compared to fiscal year 1998.
For the quarter and nine months ended September 30, 1999, other domestic
publishing revenues remained relatively flat. The current year nine-month period
included an additional newsstand special issue.
International publishing revenues remained relatively flat for the quarter
and decreased $0.2 million, or 3%, for the nine-month period compared to the
prior year. The decrease for the nine-month period was caused by lower royalties
from the Brazilian and Russian editions, largely due to economic weakness in
those countries, and were mostly offset by higher revenues from the Polish
edition of Playboy magazine, in which the Company owns a majority interest.
For the quarter, Publishing Group operating income decreased $1.0 million,
or 63%, compared to the prior year. This decrease was primarily due to higher
overhead and ancillary businesses expenses combined with the net lower Playboy
magazine revenues, partially offset by lower paper prices. Operating income
declined $1.5 million, or 30%, for the nine-month period. This decrease was
primarily due to higher overhead and ancillary businesses expenses, higher
editorial costs associated in part with the April and September 1999 issues and
the lower international publishing royalties, partially offset by the net higher
Playboy magazine revenues and lower paper prices.
Many magazines receive a significant portion of their advertising revenues
from companies selling tobacco products. Because only approximately 30% of
Playboy magazines's revenues are from advertising, the 20%-25% of ad pages from
tobacco is a smaller overall percentage than for others. Nevertheless,
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 because 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. On April 25, 1997, the Federal District Court for the Middle
District of North Carolina ruled that the FDA has no authority anyway 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. The government appealed to the Supreme
Court, which will hear and decide the appeal.
14
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 Nine Months Ended
September 30, September 30,
------------------- -------------------
1999 1998 1999 1998
-------- -------- -------- --------
Revenues
Domestic TV Networks ............................. $ 19.0 $ 15.5 $ 55.1 $ 45.5
International TV ................................. 29.7 2.7 32.9 8.4
Worldwide Home Video ............................. 1.8 3.6 7.8 9.6
Movies and Other ................................. 1.5 0.1 2.9 1.5
-------- -------- -------- --------
Total Revenues ................................. $ 52.0 $ 21.9 $ 98.7 $ 65.0
======== ======== ======== ========
Operating Income
Profit Contribution Before Programming Expense.... $ 38.2 $ 11.8 $ 61.9 $ 36.1
Programming Expense .............................. (12.7) (6.0) (25.9) (17.8)
-------- -------- -------- --------
Total Operating Income ......................... $ 25.5 $ 5.8 $ 36.0 $ 18.3
======== ======== ======== ========
Entertainment Group revenues increased $30.1 million, or 137%, and $33.7
million, or 52%, for the quarter and nine months ended September 30, 1999,
respectively. These increases were primarily due to international TV revenues in
the current year periods related to the previously discussed new joint venture,
PTVI. Also contributing to these increases were higher revenues from the
domestic TV networks, principally attributable to the acquisition of Spice
effective March 15, 1999. For the quarter and nine-month period, operating
income increased $19.7 million and $17.7 million, respectively, primarily due to
the higher revenues, which were partially offset by higher related expenses.
The following discussion focuses on the profit contribution of each
business before programming expense ("profit contribution").
Domestic TV Networks
For the quarter ended September 30, 1999, revenues of $19.0 million from
the Company's domestic TV networks increased $3.5 million, or 23%, and profit
contribution increased $1.2 million. These increases were primarily due to the
Spice acquisition, partially offset by lower Playboy TV satellite direct-to-home
("DTH") revenues, principally from PrimeStar. In April 1999, PrimeStar was
acquired by Hughes Electronics Corporation, which owns DirecTV. Over the next
two years, PrimeStar subscribers will be transitioned primarily to DirecTV or
other DTH and cable services.
For the nine-month period, revenues of $55.1 million increased $9.6
million, or 21%, and profit contribution increased $3.9 million. These increases
were primarily due to the Spice acquisition.
15
The approximate number of households for the Company's domestic TV
networks were as follows for the periods indicated below (in millions):
Sept. 30, June 30, Sept. 30,
1999 1999 1998
--------- -------- ---------
Cable (1):
Playboy TV Analog Addressable.................. 12.3 12.3 11.9
Playboy TV Digital............................. 0.7 0.4 0.1
Spice Analog Addressable....................... 14.9 16.6 N/A
Spice Digital.................................. 1.6 1.5 N/A
DTH:
Playboy TV..................................... 11.9 11.2 9.2
(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 networks.
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 on November 30, 1999. 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."
Management believes that the slowdown in growth in cable access for the
Company's domestic TV networks over recent years is due to 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, the Company believes that its
domestic TV networks will be available to the majority of cable households on a
24-hour basis.
International TV
For the quarter and nine months ended September 30, 1999, profit
contribution from the international TV business increased $27.2 million and
$25.1 million, respectively, on $27.0 million and $24.5 million increases in
revenues. These increases were primarily due to revenues related to PTVI for
library license fees, trademark royalties and output license fees.
Worldwide Home Video
For the quarter ended September 30, 1999, revenues from the worldwide home
video business decreased $1.8 million, or 51%, while profit contribution
decreased $1.6 million. These decreases were largely due to fewer titles
released domestically in the current year quarter from The Eros Collection.
16
For the nine-month period, revenues decreased $1.8 million, or 18%, while
profit contribution decreased $1.6 million. These decreases were primarily due
to lower domestic sales of Playboy Home Video titles combined with lower
revenues from continuity series' programs.
Movies and Other
For the quarter and nine months ended September 30, 1999, profit
contribution from movies and other businesses increased $1.4 million and $1.3
million, respectively, on $1.4 million increases in revenues for both periods.
These increases were primarily due to library license fees in the current year
periods from PTVI.
The Entertainment Group's administrative expenses increased $1.8 million
for the quarter and $2.9 million for the nine-month period primarily to support
the group's growth. Both periods also reflected higher performance-related
variable compensation expense.
Programming Expense
Programming amortization expense increased $6.7 million and $8.1 million
for the quarter and nine-month period, respectively. These increases were
primarily related to the revenues in the current year periods from PTVI. Also
contributing to the increases were higher amortization related to regular
programming on the domestic Playboy TV network and programming amortization in
the current year periods related to the Spice network.
PRODUCT MARKETING GROUP
The revenues and operating performance of the Product Marketing Group were
as follows for the periods indicated below (in millions):
Quarters Ended Nine Months Ended
September 30, September 30,
------------------- -------------------
1999 1998 1999 1998
-------- -------- -------- --------
Revenues .................................... $ 1.4 $ 1.6 $ 4.4 $ 5.8
======== ======= ======== ========
Operating Income (Loss) ..................... $ 0.1 $ (1.0) $ 0.5 $ 0.1
======== ======= ======== ========
Revenues for the quarter and nine months ended September 30, 1999
decreased $0.2 million, or 13%, and $1.4 million, or 23%, respectively, compared
to the prior year periods. Both the current year quarter and nine-month period
reflect lower international product licensing royalties, largely due to
depressed economic conditions in Asia. Also unfavorably impacting the nine-month
period were 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.
Operating income of $0.1 million and $0.5 million for the quarter and
nine-month period increased $1.1 million and $0.4 million, respectively,
compared to the prior year periods due to a prior year $1.4 million settlement
of litigation related to BrandsElite International Corporation. Partially
offsetting these increases were the lower Asian royalties and higher salary and
related expenses.
CATALOG GROUP
The revenues and operating performance of the Catalog Group were as
follows for the periods indicated below (in millions):
Quarters Ended Nine Months Ended
September 30, September 30,
------------------- -------------------
1999 1998 1999 1998
-------- -------- -------- --------
Revenues .................................... $ 13.8 $ 16.3 $ 43.8 $ 50.8
======== ======= ======== ========
Operating Income (Loss) ..................... $ (0.7) $ 0.6 $ (1.3) $ 2.1
======== ======= ======== ========
17
For the quarter and nine months ended September 30, 1999, revenues
decreased $2.5 million, or 15%, and $7.0 million, or 14%, respectively, compared
to the prior year periods. These decreases reflected lower revenues for all of
the Company's catalogs, except for the Spice catalog which was launched during
the summer of 1998. These net lower revenues, partially offset by lower related
costs, resulted in operating losses of $0.7 million and $1.3 million for the
quarter and nine-month period, respectively, compared to operating income of
$0.6 million and $2.1 million for the prior year periods, respectively.
The Catalog Group has taken steps to reduce its cost structure and the
Company's management has decided to refocus sales of the former Playboy and
Spice catalogs to the Playboy Online Group, transitioning the print catalogs,
effective October 1, 1999, into direct marketing promotion to support
e-commerce. The Company is working with ING Barings Furman Selz to help it
assess strategic options for the Catalog Group.
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 Nine Months Ended
September 30, September 30,
------------------- -------------------
1999 1998 1999 1998
-------- -------- -------- --------
Revenues .................................... $ 0.3 $ -- $ 0.6 $ --
======== ======= ======== ========
Operating Loss .............................. $ (0.2) $ (0.2) $ (0.5) $ (0.6)
======== ======= ======== ========
In the quarter ended March 31, 1999, the Company sold its 12% 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 and $0.6 million for the quarter and nine months ended
September 30, 1999 as a result of the opening of the Rhodes Casino in April
1999. Operating performance remained flat and increased $0.1 million for the
quarter and nine-month period, respectively. The Company continues to explore
additional 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 Nine Months Ended
September 30, September 30,
------------------- -------------------
1999 1998 1999 1998
-------- -------- -------- --------
Revenues .................................... $ 3.3 $ 1.8 $ 8.9 $ 4.8
======== ======= ======== ========
Operating Loss .............................. $ (1.9) $ (2.1) $ (5.6) $ (4.3)
======== ======= ======== ========
For the quarter and nine months ended September 30, 1999, Playboy Online
Group revenues increased $1.5 million, or 83%, and $4.1 million, or 85%,
respectively, compared to the prior year periods. These increases were due to
higher advertising, e-commerce and subscription revenues.
For the quarter and nine-month period, the Playboy Online Group reported
operating losses of $1.9 million and $5.6 million, respectively, compared to
operating losses of $2.1 million and $4.3 million in the prior year periods,
respectively. The current year operating losses reflect higher planned
investments related to the group's continued growth and development.
On September 28, 1999, the Company announced that the Board approved plans
to sell a minority interest in Playboy Online to the public. The Company intends
to file a registration statement relating to the securities to be offered later
this fiscal year.
18
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
September 30, 1999 of $7.9 million increased $0.9 million, or 13%, compared to
the prior year quarter. Net expenses for the nine-month period of $20.2 million
increased $2.5 million, or 14%, compared to the prior year period. Both of these
increases were largely due to higher marketing expenses and the timing of
peformance-related variable compensation expenses.
LIQUIDITY AND CAPITAL RESOURCES
At September 30, 1999, the Company had $23.5 million in cash and cash
equivalents, no short-term borrowings and $90.0 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-term
cash requirements through its cash and cash equivalents and to meet its
long-term cash requirements through its $130.0 million credit agreement as soon
as the agreement is amended to reflect new financial covenants. Management
expects to have the new covenants in place prior to the end of the fiscal year.
See Cash Flows From Financing Activities.
CASH FLOWS FROM OPERATING ACTIVITIES
Net cash provided by operating activities was $18.7 million for the nine
months ended September 30, 1999, which reflected $16.0 million of cash provided
from operating assets and liabilities, largely due to lower Playboy magazine
newsstand and advertising receivables compared to December 31, 1998, which
included higher revenues related to holiday issues. Additionally, the current
year period reflected cash receipts related to films sold to HBO and Showtime.
CASH FLOWS FROM INVESTING ACTIVITIES
Net cash used for investing activities was $66.8 million for the
nine-month period, primarily due to the Company's acquisition of Spice,
resulting in cash paid of $64.6 million in the current year.
During the nine-month period, the Company sold certain investments
totaling $12.7 million. In the quarter ended September 30, 1999, the Company
sold its interests in certain of its international TV networks to PTVI. Total
proceeds under the contract are $10.0 million, consisting of $3.0 million in
cash in the current year quarter with the remainder to be received over the next
five years. In the quarter ended March 31, 1999, the Company sold its
wholly-owned subsidiary, Playboy Gaming Greece Ltd., which owned a 12% 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. On December 31, 1998, the Company sold to duPont Publishing,
Inc. ("duPont") the shares of duPont's common stock owned by the Company. Total
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.
During the nine-month period, the Company paid $12.2 million related to
its equity interests in international ventures, including the funding of its
19.9% interest in PTVI in the current year quarter.
CASH FLOWS FROM FINANCING ACTIVITIES
Net cash provided by financing activities was $71.2 million for the
nine-month period. 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 $20.0
million of long-term financing obligations combined with 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 upon
exercise by the underwriters of their over-allotment option. The Company did not
receive any of the proceeds from the sale of Class B common stock by Mr. Hefner.
Mr. Hefner is
19
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.
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 originally consisted 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. On September 16, 1999, the Company used $20.0 million of the cash
proceeds from PTVI to repay the term debt which reduced the credit facility to
$130.0 million. 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.
For the quarter ended September 30, 1999, the Company received a waiver on
the financial covenants contained in the credit agreement, until January 12,
2000. During this period, the Company and the banks will reset the covenant
levels to reflect recent business developments, including, among other things,
the benefit of the PTVI venture and the decline in the Catalog business.
Management expects to have the new covenants in place prior to the end of the
fiscal year. While the waiver remains in effect, the Company has agreed to not
draw upon the revolving credit facility. Management believes that the Company's
cash and cash equivalents on hand will provide the necessary liquidity during
this period.
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. Accordingly,
after consideration of this additional $15.7 million of deferred tax
liabilities, at September 30, 1999, the Company was in a net deferred tax
liability position of $3.8 million that consisted of $7.4 million of current
deferred tax assets and $11.2 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.
20
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.
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
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 $0.9
million has been expensed through September 30, 1999. These costs are being
expensed as incurred. The Company does not separately track internal costs
incurred related to the Year 2000 problem, principally payroll related for its
technology department.
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 incidents 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.
OTHER
The Company will adopt the provisions of Statement 137, Accounting for
Derivative Instruments and Hedging Activities - Deferral of the Effective Date
of FASB Statement No. 133. Statement 137 defers the effective date for financial
statements issued for fiscal years beginning after June 15, 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
21
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.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company is exposed to certain market risks, which include changes in
interest rates. The Company prepared sensitivity analyses to determine the
impact of a hypothetical one percentage point increase in interest rates on the
Company's consolidated operating results, financial position and cash flows.
Based on its sensitivity analyses at September 30, 1999, such a change in
interest rates would affect the Company's annual consolidated operating results,
financial position and cash flows by approximately $0.9 million. In order to
manage the risk associated with its exposure to such interest rate fluctuations,
the Company uses derivative financial instruments. 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, thereby
significantly reducing its risk related to interest rate fluctuations.
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 a 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 on November 30, 1999.
Management believes that the effect of Section 505 on the Company's financial
performance is likely to continue until the case is finally decided.
22
EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
Exhibit
Number Description
- ------ -----------
#10.1 Operating Agreement for Playboy TV International, LLC dated as of
August 31, 1999 between Playboy Entertainment Group, Inc. and
Victoria Springs Investments Ltd.
#10.2 Program Supply Agreement dated as of August 31, 1999 between Playboy
Entertainment Group, Inc., Playboy TV International LLC and PTV
U.S., LLC
#10.3 Trademark License Agreement dated as of August 31, 1999 between
Playboy Enterprises International, Inc. and Playboy TV
International, LLC
10.4 Playboy Magazine Distribution Agreement dated as of July 2, 1999
between Playboy Enterprises, Inc. and Warner Publisher Services,
Inc.
10.5 Waiver dated as of November 3, 1999 to the Credit Agreement dated as
of February 26, 1999, among Playboy Enterprises, Inc., PEI Holdings,
Inc., the Lenders named in the Credit Agreement, and Credit Suisse
First Boston, as Administrative Agent, as Collateral Agent and as
Issuing Bank
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
No reports on Form 8-K were filed during the quarter ended September 30,
1999.
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 November 12, 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