CONFORMED COPY
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the Quarterly period ended September 30, 1996
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR
15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from
Commission file number 0-21150
Graff Pay-Per-View Inc.
(Exact name of registrant as specified in its charter)
Delaware 11-2917462
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
536 Broadway, New York, NY 10012
(Address of principal executive offices)
(212) 941-1434
(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
filing requirements for the past 90 days.
Yes X No
Number of shares outstanding of Registrant's Common Stock as of October 31,
1996: 11,339,928
<PAGE>
PART I
ITEM 1: FINANCIAL STATEMENTS
GRAFF PAY-PER-VIEW INC. and SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
<TABLE>
September 30, December 31,
1996 1995
-------------------------------------------------------------------------------------------------------------
(Unaudited)
Assets
Current assets:
<S> <C> <C>
Cash and cash equivalents $1,573,000 $1,483,000
Accounts receivable, net of allowance for doubtful accounts 5,897,000 7,836,000
Income tax refunds receivable 485,000 570,000
Film and CD-ROM costs, net 400,000
Prepaid expenses and other current assets 1,261,000 2,391,000
Deferred subscription costs 214,000 511,000
Due from related parties 426,000 364,000
Investment in TeleSelect, asset held for sale 3,177,000
------------------- -------------------
Total current assets 9,856,000 16,732,000
Property and equipment, net of accumulated depreciation 68,019,000 70,771,000
Due from related parties 86,000 621,000
Library of movies 4,281,000 2,990,000
Cost in excess of net assets acquired, net of
accumulated amortization 10,494,000 10,961,000
Other assets 868,000 403,000
------------------- -------------------
Total assets $93,604,000 $102,478,000
=================== ===================
Liabilities and Stockholders' Equity
Current liabilities:
Current portion of obligations under capital leases $4,455,000 $3,978,000
Current portion of long-term debt 15,775,000 2,540,000
Royalties payable 2,178,000 2,611,000
Accounts payable 3,379,000 3,722,000
Accrued expenses payable 2,871,000 2,241,000
Current portion of accrued restructuring costs 958,000 2,205,000
Deferred subscription revenue 1,328,000 2,337,000
------------------- -------------------
Total current liabilities 30,944,000 19,634,000
Obligations under capital leases 54,826,000 56,230,000
Long-term debt 1,203,000 16,897,000
Accrued restructuring costs 875,000 1,450,000
Deferred Income 400,000
Deferred compensation 269,000 198,000
Minority Interest 301,000
------------------- -------------------
Total liabilities 88,818,000 94,409,000
------------------- -------------------
Stockholders' equity
Preferred stock, $.01 par value; authorized 10,000,000
shares, none were issued or outstanding
Common stock, $.01 par value; authorized 25,000,000 shares;
11,340,000 and 11,358,000 shares issued and outstanding at
September 30, 1996 and December 31, 1995, respectively 113,000 114,000
Additional paid-in capital 22,645,000 22,997,000
Unearned compensation (822,000) (1,323,000)
Accumulated (deficit) (16,908,000) 13,438,000)
Cumulative translation adjustments 209,000 210,000
------------------- -------------------
5,237,000 8,560,000
Stockholders' loan collateralized by common stock (451,000) (491,000)
------------------- -------------------
Total stockholders' equity 4,786,000 8,069,000
------------------- -------------------
Total liabilities and stockholders'
equity $93,604,000 $102,478,000
=================== ===================
The accompanying notes are an integral part of these consolidated financial statements.
</TABLE>
<PAGE>
GRAFF PAY-PER-VIEW INC. and SUBSIDIARIES
CONSOLIDATED STATEMENTS of OPERATIONS
(Unaudited)
<TABLE>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
1996 1995 1996 1995
----------- ----------- ----------- -----------
<S> <C> <C> <C> <C>
Revenues: $10,240,000 $12,527,000 $30,894,000 $39,280,000
----------- ----------- ----------- -----------
Operating expenses:
Cost of goods sold 240,000 32,000 587,000 472,000
Salaries, wages and benefits 2,478,000 2,875,000 7,580,000 8,275,000
Producer royalties and film cost amortization 1,185,000 1,473,000 4,022,000 4,749,000
Satellite, uplinking and playback expenses 1,290,000 3,019,000 3,460,000 10,093,000
Selling, general and administrative expenses 2,919,000 4,716,000 8,748,000 13,463,000
Depreciation of fixed assets and amortization
of goodwill 2,075,000 736,000 6,147,000 2,021,000
----------- ----------- ----------- -----------
Operating expenses 10,187,000 12,851,000 30,544,000 39,073,000
----------- ----------- ----------- -----------
Total income (loss) from operations 53,000 (324,000) 350,000 207,000
Interest expense 1,629,000 323,000 5,039,000 815,000
Loss on disposal of property and equipment 47,000 47,000 0
Minority interest (277,000) (740,000)
Gain on disposition of AGN (875,000)
Provision for write down of related party note 418,000 418,000
----------- ----------- ----------- -----------
Loss before provision for income taxes (1,764,000) (647,000) (3,539,000) (608,000)
Provision (benefit) for income taxes (120,000) 555,000 (69,000) 824,000
----------- ----------- ----------- -----------
Net loss ($1,644,000) ($1,202,000) ($3,470,000) ($1,432,000)
=========== =========== =========== ===========
Loss per common and common
equivalent share, primary ($0.14) ($0.10) ($0.31) ($0.12)
=========== =========== =========== ===========
Weighted average number of shares outstanding,
primary 11,340,000 12,071,000 11,354,000 11,713,000
=========== =========== ========== ==========
The accompanying notes are an integral part of these consolidated financial statements.
</TABLE>
<PAGE>
GRAFF PAY-PER-VIEW and SUBSIDIARIES
CONSOLIDATED STATEMENT of STOCKHOLDERS' EQUITY
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1996
(Unaudited)
- -------------------------------------------------------------------------------
<TABLE>
Foreign
Currency
Common Paid-in Unearned Accumulated Transaction
Stock Capital Compensation Deficit Adjustment Total
------- ----------- ------------ ------------ ----------- ----------
<S> <C> <C> <C> <C> <C> <C>
Balance, January 1, 1996 $114,000 $22,997,000 ($1,323,000) $13,438,000) $210,000 $8,560,000
Shares issued in connection
with the exercise of
employee options 27,000 27,000
Pro rata share of Restricted
Stock granted to executive
officers 121,000 121,000
Cancellation of Restricted
Stock issued to an
executive officer (1,000) (379,000) 380,000
Net loss for the period (3,470,000) (3,470,000)
Foreign currency translation
adjustment (1,000) (1,000)
-------- ----------- ----------- ----------- -------- ---------
113,000 22,645,000 (822,000) (16,908,000) 209,000 5,237,000
Less shareholders' loans (451,000)
======== =========== =========== ============ =========== ===========
Balance at September 30, 1996 $113,000 $22,645,000 ($822,000) ($16,908,000) $209,000 $4,786,000
======== =========== =========== ============ =========== ===========
The accompanying notes are an integral part of these consolidated financial statements.
</TABLE>
<PAGE>
GRAFF PAY-PER-VIEW INC. and SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
<TABLE>
NINE MONTHS ENDED
SEPTEMBER 30,
1996 1995
Cash flows from operating activities:
<S> <C> <C>
Net income (loss) ($3,470,000) ($1,432,000)
------------------ -------------------
Adjustments to reconcile net income to net cash used in operating
activities:
Minority interest (740,000)
Gain on disposition of AGN and Property and Equipment (875,000)
Other, net 33,000
Depreciation and amortization of fixed assets 5,661,000 1,290,000
Amortization of goodwill 467,000 682,000
Amortization of film costs and CD-ROM costs 400,000 1,183,000
Amortization of library of movies 1,032,000 760,000
Contributed capital 72,000
Provision for bad debts 309,000 236,000
Compensation satisfied through the issuance of common stock 121,000 264,000
Deferred compensation expense 71,000 49,000
Loss (gain) on sale of equipment 47,000 (8,000)
Changes in assets and liabilities:
Decrease in accounts receivable 1,602,000 293,000
Increase in film and CD-ROM costs (2,971,000)
Decrease in prepaid expenses and other current assets 597,000 277,000
Decrease in deferred subscription cost 297,000 190,000
(Decrease) increase in royalties payable (433,000) 334,000
Increase in accounts payable and accrued expenses 288,000 1,068,000
Decrease in accrued restructuring expenses (1,822,000)
Decrease in deferred subscription revenue (1,009,000) (679,000)
Decrease (increase) in loans receivable from officers 513,000 (305,000)
------------------ ------------------
Total adjustments 6,559,000 2,735,000
------------------ ------------------
Net cash provided by operating activities 3,089,000 1,303,000
------------------ ------------------
Cash flows from investing activities:
Purchase of property and equipment (1,022,000) (3,771,000)
Proceeds from the sale of equipment 41,000 5,000
Investment in library of movies (1,677,000) (1,553,000)
Investment in TeleSelect (67,000) (2,526,000)
Proceeds from the sale of TeleSelect 3,244,000
Increase in other assets (394,000)
Investment in American Gaming Network (425,000)
------------------- ------------------
------------------- ------------------
Net cash (used in) provided by investing activities 519,000 (8,664,000)
------------------- ------------------
Cash flows from financing activities:
Proceeds from the issuance of common stock and detachable warrants 27,000 28,000
Proceeds from capital contributed to CVSP by a third party 1,000,000
Proceeds from the issuance of long-term debt 9,085,000
Repayment of long-term debt (1,684,000) (1,678,000)
Repayment of obligations under capital leases (2,861,000)
Repurchase of outstanding warrants (25,000)
Distribution to the former shareholders of SEG (481,000)
------------------ -----------------
Net cash (used in) provided by financing activities (3,518,000) 6,929,000
------------------ -----------------
Net increase (decrease) in cash and cash equivalents 90,000 (432,000)
Cash and cash equivalents, beginning of the period 1,483,000 1,598,000
------------------ ------------------
Cash and cash equivalents, end of the period $1,573,000 $1,166,000
================== ==================
The accompanying notes are an integral part of these consolidated financial statements.
</TABLE>
<PAGE>
GRAFF PAY-PER-VIEW INC. and SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1996
1. In the opinion of Graff Pay-Per-View Inc. and its wholly-owned
subsidiaries and majority-owned affiliates (the "Company"), the accompanying
consolidated financial statements contain all adjustments (consisting of only
normal recurring accruals) necessary to present fairly the financial position as
of September 30, 1996 and the results of operations and cash flows for the three
and nine months then ended.
2. The results of operations for the three and nine months ended September
30, 1996 are not necessarily indicative of the results to be expected for the
full year.
3. The accompanying financial statements include the accounts of the
Company, its wholly-owned subsidiaries and a majority-owned partnership. All
intercompany transactions and balances have been eliminated in consolidation.
Certain information and footnote disclosures normally included in financial
statements prepared in accordance with generally accepted accounting principles
("GAAP") have been condensed or omitted. These consolidated financial statements
should be read in conjunction with the financial statements and notes thereto
included in the Company's December 31, 1995 annual report on Form 10K/A-1.
4. The interim periods from 1995 have been restated as a result of three
items which were previously not accounted for in accordance with GAAP. In early
1995, the Company entered into an agreement with AT&T to provide satellite
services for its domestic networks. The purpose of this new agreement was
twofold: 1) to replace the existing service provider which was at a much higher
per transponder rate and, 2) to transition the Company's transponder
requirements to AT&T's new Telstar 402R satellite which was scheduled to be in
operation by December, 1995. During the transition period (which occurred in the
first half of 1995) the Company incurred approximately $1.0 million of added
satellite costs by providing dual satellite coverage to its customers thereby
ensuring continuous service. The Company has restated the quarterly results of
operations for 1995 with respect to these domestic satellite costs. The effect
of this restatement was to reduce net income for the nine months ended September
30, 1995 by $0.3 million or $.03 per share and increase net income for the three
months ended September 30, 1996 by $0.3 million or $0.03 per share. This
restatement will continue during the fourth quarter of 1995 when the reduction
of net income reflected during the first half of 1995 will have completely
reversed itself. In addition, during the first six months of 1995, The Home
Video Channel, Ltd. ("HVC") the Company's wholly-owned U.K. subsidiary received
free satellite services as an inducement from its satellite provider to move
from one transponder to another within the same satellite grouping. The free
satellite time was not reflected in the 1995 financial statements. Accordingly,
the Company has restated the interim results of operation for 1995 to properly
reflect these free satellite services. The effect of this restatement was to
reduce net income for the nine months ended September 30, 1995 by $0.1 million
or $0.01 per share.
In February, 1995, the Company launched EUROTICA, a European satellite
delivered subscription network based in Denmark. The Company deferred the
recognition of the operating losses associated with the EUROTICA operation until
the third and fourth quarters of 1995. This deferral of operating losses is
inconsistent with generally accepted accounting principles. Accordingly, the
company has restated the results of operations for 1995 to properly reflect
EUROTICA's interim operating results. The effect of this restatement was to
reduce net income for the nine months ended September 30, 1995 by $0.4 million
or $0.03 per share and increase net income for the three months ended September
30, 1995 by $0.3 million or $0.03 per share.
5. The following summary is presented to reconcile revenue and earnings for
the three and nine months ended September 30, 1995 as previously reported by the
Company with the amounts currently presented in the Statement of Operations due
to the correction of certain accounting treatments (see Note 4):
For the Nine Months Ended September 30, 1995
<TABLE>
Correction of
Previously Accounting
Stated Treatments Restated
---------------- --------------- ----------------
<S> <C> <C> <C>
Revenue $39,190,000 $90,000 $39,280,000
Net Income ($647,000) ($785,000) ($1,432,000)
EPS-Primary ($0.05) ($0.07) ($0.12)
For the Three Months Ended September 30, 1995
Correction of
Previously Accounting
Stated Treatments Restated
---------------- --------------- ----------------
Revenue $12,540,000 ($13,000) $12,527,000
Net Income ($1,939,000) $737,000 ($1,202,000)
EPS-Primary ($0.15) $0.06 ($0.10)
</TABLE>
6. On August 31, 1995, the Company acquired, by merger (the "SEG Merger"),
Spector Entertainment Group, Inc. ("SEG"). At the date of the SEG Merger, SEG
had a note receivable from Buccaneer Gaming, Inc. ("Buccaneer"), a developmental
corporation owned by Eric M. Spector, an officer and director of SEG. The note
is due in five equal annual installments commencing September, 1996. The payment
due September, 1996 was not made and Buccaneer has indicated to the Company that
it has no resources and will be unable to pay the note. Accordingly, the Company
has established a reserve for the full amount of the note ($418,000).
7. As part of the SEG Merger, the shareholders of United Transactive
Systems, Inc. ("UTI"), who were also SEG's stockholders prior to the SEG Merger,
granted the Company an option to acquire the UTI stock for a formula determined
number of shares of the Company's common stock of no less than 100,000 shares
pursuant to a letter agreement dated August 14, 1995 as amended as of August 30,
1995. If the Company does not exercise its option, the UTI shareholders may put
the UTI shares for the same number of shares of common stock determined under
the formula. The Company may issue shares of common stock to the UTI
shareholders without being obligated to acquire the UTI shares. The UTI
shareholders have exercised their put and demanded that the Company issue
approximately 500,000 shares of common stock to the UTI shareholders. The
Company believes that the UTI shareholders are entitled to 100,000 shares of
common stock.
8. As part of the Company's restructuring, the Company has determined that
it would refocus on its core adult entertainment business. As a consequence, the
Board of Directors has determined to analyze its available options with regard
to SEG. One such transaction under consideration involves spinning off SEG to
the former SEG shareholders in exchange for the 700,000 shares of common stock
of the Company they received in the SEG Merger. The former SEG shareholders
believe that they have been damaged in an amount in excess of $8.0 million and
are seeking, as a part of any rescission transaction, additional consideration
including, the retention by the former SEG shareholders of the shares of the
Company's common stock to be received upon exercise of the UTI put described in
Note 7 above.
No assurances can be given that any transaction with regard to SEG can be
consummated or the terms thereof. If such a transaction cannot be consummated on
terms acceptable to the Company and the former SEG shareholders, the former SEG
shareholders have indicated that they believe they have claims against the
Company and are considering suing the Company to rescind the SEG Merger and
intend to seek monetary damages in any such action.
9. On March 6, 1996, the Company contributed the assets of the CABLE VIDEO
STORE network and certain other assets to CVS Partners ("CVSP"), a newly formed
partnership owned 75% by the Company and 25% by WilTech Cable Television
Services, Inc. ("WCTV"), a wholly-owned subsidiary of The WilTech Group, Inc.
("WilTech"). WCTV has two calls to acquire portions of the Company's partnership
interest in CVS Partners at formula determined prices; if both calls are
exercised, the Company's partnership interest will be reduced to 20%.
As part of the contribution, the Company entered into a Services Agreement
with CVS Partners to provide certain sales, marketing, administrative and
operational services to CVS Partners and granted CVS Partners a royalty free
license of the CABLE VIDEO STORE name and related identity. WCTV is required to
contribute approximately $2.6 million to CVS Partners' capital (of which $1.0
million has been contributed as of September 30, 1996), part in cash and part by
a credit for services to be provided to CVS Partners pursuant to a Services
Agreement between Vyvx, Inc., an affiliate of WCTV, and CVS Partners to provide
services relating to the installation and operation of video file services,
transmission services, satellite uplink services and local access services from
the playback to the uplink facility.
The parties are currently in discussion to revise their interests and
responsibilities in CVSP. The parties are considering, among other things, the
Company agreeing to the reduction of its interest in CVSP in exchange for the
reduction in the level of services the Company is obligated to provide to CVSP.
There are no assurances that these discussions will result in a material change
to the current arrangement.
10. The Company, Phillips Media B.V. ("Phillips") and Royal PTT Netherlands
NV ("KPN") established TeleSelect B.V. ("TeleSelect"), a Netherlands joint
venture, to create joint ventures with European cable operators to enable them
to provide conditional access services. On April 3, 1996, the Company sold its
TeleSelect interest to Phillips and KPN for $3.2 million, an amount roughly
equal to its cash investment in TeleSelect. $1.0 million of the proceeds were
utilized to pay down long-term debt and the remaining funds were used for
working capital.
11. The Company has a credit facility from PNC Bank, N.A. ("PNC"), as
successor in interest to Midlantic Bank, N.A., which at September 30, 1996
amounts to $14.6 million. No further funds are available. At December 31, 1995,
the Company had violated certain financial covenants. Pursuant to a Third
Amendatory Agreement dated March 29, 1996, PNC has (i) extended the term of the
loan until January 2, 1997, (ii) waived certain financial covenant violations
through the date of the agreement and (iii) eliminated all of the financial
covenants for the balance of the loan's term except for the net worth covenant
and a covenant requiring the Company to maintain specified levels of cash flows.
The revised net worth covenant, which was revised in accordance with the
Company's projections, requires the Company to maintain a net worth (after
adjusting the AT&T lease to an operating lease) of at least $6.75 million as of
December 31, 1995, $5.75 million from January 1, 1996 through June 29, 1996 and
at least $6.0 million through January 2, 1997. The cash flow covenant requires
the Company to maintain specified levels of cash flows in accordance with a cash
flow report prepared by the Company and approved by PNC. PNC has also consented
to certain transactions relating to the restructuring and other transactions
including permitting HVC to borrow approximately $750,000 from a bank in
England.
12. On August 14, 1996, the Company entered into an equipment lease
agreement for approximately $1.8 million of equipment from Vendor Capital Group.
The lease was accounted for as a capital lease. The equipment included a
Digicipher encoder and approximately 1,200 decoder boxes which were provided to
the Company's cable systems customers. This equipment enabled the Company to
digitally compress its domestic television networks, freeing up two transponders
for other uses.
13. Pursuant to two short-term agreements effective as of September 1,
1996, the Company subleased one of its transponders, made available as a result
of the digital compression of the Company's domestic networks, and agreed to
provide certain telecommunications services to Emerald Media, Inc. ("EMI"). The
Company also agreed to license pictures from its adult film library and licensed
the "EUROTICA" name and related identity to EMI. EMI owns and operates EUROTICA,
a premium television network featuring explicit version adult movies which is
distributed to the domestic direct-to-home C-band satellite dish market. EMI
also granted the Company an option to acquire its stock or business.
14. The accompanying financial statements have been prepared assuming that
the Company will be able to meet its obligations in the ordinary course of
business. Management believes that the restructuring undertaken at the end of
1995 and the during the first half of 1996 has positively influenced cash flow
and operating results for the first nine months of 1996. The Company also
expects to realize significant operational efficiencies from the digital
compression project which was recently implemented. As a direct result of this
project the Company is presently exploring various opportunities to take
advantage of the excess transponder capacity created by this conversion to
digital compression. The Company reported income from operations of $350,000 for
the nine months ending September 30, 1996. While the Company is servicing the
interest on its credit facility from PNC, the Company does not currently have
the resources available to repay the principal of this obligation when it
matures on January 2, 1997. When the loan matures, the Company will be required
to obtain replacement financing or alternative sources of capital. There is no
assurance that the Company will be able to obtain such financing or, if
obtained, that the terms of any such financing or alternative sources of capital
will not be more costly then the Company's current cost of capital. PNC has
liens on substantially all of the Company's assets. If the Company is unable to
locate replacement financing, PNC could exercise its rights as a secured
creditor and foreclose on its lien or force the Company into bankruptcy.
15. The accrued restructuring reserve at January 1, 1996, March 31, 1996,
June 30, 1996 and September 30, 1996 was approximately $3.7 million, $3.0
million, $2.3 and $1.8 million, respectively. The accrued restructuring reserve
is comprised of corporate level restructuring and the suspension of production
activities formerly conducted by CPV Productions, Inc. ("CPV"). Each component
involved contraction of the Company's workforce and facilities and other
miscellaneous costs associated with the restructuring. The balances of each
component at December 31, 1995, March 31, 1996, June 30, 1996 and September 30,
1996 were as follows:
<TABLE>
December 31, Cash March 31, Cash June 30, Cash September
Corporate 1995 Outflows 1996 Outflows 1996 Outflows 30, 1996
-------------- ----------- ------------- ------------ ------------- ----------- -------------
<S> <C> <C> <C> <C> <C> <C> <C>
Salaries $2,750,000 $296,000 $2,454,000 $409,000 $2,045,000 $286,000 $1,759,000
Facilities and Other 250,000 106,000 144,000 60,000 84,000 42,000 42,000
CPV
Salaries 464,000 138,000 326,000 151,000 175,000 143,000 32,000
Facilities and Other 191,000 106,000 85,000 68,000 17,000 17,000 0
-------------- ----------- ------------- ------------ ------------- ----------- -------------
Total $3,655,000 $646,000 $3,009,000 $688,000 $2,321,000 $488,000 $1,833,000
-------------- ----------- ------------- ------------ ------------- ----------- -------------
</TABLE>
16. Pursuant to a joint venture agreement dated June 28, 1995, the Company
formed American Gaming Network, J.V. ("AGN") with TV Games, Inc. ("TVG"), a
wholly-owned subsidiary of Multimedia Games, Inc. ("MGAM"), to jointly develop
and promote high stakes proxy play Class II tribal bingo games. The Company
contributed approximately $1.4 million of intellectual property and working
capital to AGN's capital. The Company had acquired the intellectual property
from MGAM for cash and notes. In related transactions, the Company acquired for
cash and notes 275,000 shares of MGAM's outstanding stock and a warrant to
acquire an additional 175,000 shares at an exercise price of $3.50 per share.
The parties were unable to agree on a business plan or a strategy for going
forward with AGN.
Pursuant to a Purchase Agreement dated June 28, 1996, the parties resolved
their differences with the Company giving up its interest in AGN and the 275,000
shares of MGAM stock in exchange for (i) the cancellation of an aggregate of
$775,000 of liabilities owed to MGAM and TVG, (ii) $100,000 pursuant to a note
due on July 25, 1996 and (iii) $400,000 due pursuant to a note due in three
years. The Company retained a warrant to acquire 175,000 shares of common stock
of MGAM stock and the parties released each other. Due to the likelihood that
the parties would not proceed forward with AGN and as part of the Company's
restructuring at December 31, 1995, the Company wrote off its investment in AGN
and the MGAM stock. As a result of the foregoing transaction, the Company
recognized a nonrecurring gain of $875,000 in the second quarter and will
recognize an additional nonrecurring gain of $400,000 when the $400,000 note is
paid.
17. In 1995, the Company entered into agreements with IBM and others to
construct a master control and digital playback center (the "Operations
Facility") at its New York City headquarters. IBM Credit Corporation ("ICC")
initially provided approximately $1.5 million of financing by entering into an
equipment lease with the Company. The equipment lease was accounted for as a
capital lease. The Company anticipates putting the Operations Facility into
service in the first quarter of 1997, a delay of more than a year from the
anticipated in-service date. As a result of the delay, the Company suspended
making payments under the equipment lease. The delay was attributable to the
non-delivery of certain critical equipment which the Company now anticipates
will be delivered by year-end. As a consequence and pursuant to agreements with
IBM and ICC, the equipment lease agreement has been revised. ICC has agreed, in
principle, to provide an additional $526,000 of financing to complete the
Operations Facility and to reduce the monthly lease payments to $37,000 from the
previous monthly payment of $43,000. If the transaction is consummated, the
Company has agreed to resume making lease payments commencing February 1, 1997.
18. The Communications Decency Act of 1996 (the "CDA") included a
provision, Section 505, which required full audio and video scrambling of
channels which are primarily dedicated to sexually explicit programming. If a
multi-channel video program distributor (which includes a cable system operator)
cannot comply with the full scrambling requirement, the channel cannot be
offered during the hours when children are likely to be watching television,
which, has now been determined to be the hours between 6:00 a.m. and 10:00 p.m.
Spice and the Adam & Eve Channel (the "SPICE Networks") which are owned and
operated by the Company, both feature "sexually explicit programming" within the
contemplation of Section 505. Section 505 was scheduled to take effect on March
9, 1996. The Company filed an action in Delaware District Court challenging the
constitutionality of Section 505 and on March 7, 1996, the Court granted the
Company's application for a temporary restraining order. On November 8, 1996,
the Delaware District Court denied the Company's motion for a preliminary
injunction, however, pursuant to an order issued by the Delaware District Court,
Section 505 will not take effect until that court rules on the Company's motion
to stay enforcement pending appeal to the Supreme Court. The hearing on the
motion to stay will occur no earlier than November 27, 1996. The CDA grants
Supreme Court review as a matter of right. The Supreme Court's determination as
to the provision's constitutionality will not be issued any earlier than the
second quarter of 1997. If Section 505 takes effect, management's best estimate
is that the Company's revenues will be adversely affected in the range of $2.4
million to $4.0 million.
19. The Company has entered into agreements with Capital Distribution,
Inc., d/b/a Cupid Network Television ("CNT") to provide merchandising services
on the SPICE Networks under the Amended and Restated Distribution Agreement and
to provide audiotext services on the Spice Networks under the Telephone Services
Agreement (collectively, the "Agreements"). The Company believes that CNT has
breached the Agreements and has issued notices of default to CNT. CNT responded
by filing an Application for a Temporary Restraining Order preventing the
Company from terminating the Agreements and also commenced an arbitration under
both Agreements. The Company believes that it has the contractual right to
terminate the Agreements and will seek such an order in the arbitration in
addition to monetary damages. CNT has sought to prevent the Company from
terminating the Agreements and for monetary damages. There are no assurances
that Company will be successful in terminating the Agreements or whether the
arbitrator may seek to impose monetary damages as a result of the Company's
actions against CNT.
20. The Company, through CPV Productions, Inc. ("CPV"), a wholly owned
Company subsidiary, is a defendant in Monopoli Studio, Inc., et. al. v. Cinema
Products Video, Inc., et. al., an action brought in U.S. District Court in
California. The complaint alleges, among other things copyright infringement and
seeks damages of approximately $1.6 million. The Company is vigorously defending
the action and believes it is without merit and that it has meritorious
defenses. The Company also believes the action is frivolous. The Company is
seeking indemnification from the former CPV shareholders.
21. Eric M. Spector, as trustee of the Eric M. Spector Revocable Living
Trust (the "Trust") and a former Senior Vice President of the Company, has filed
a request under Delaware General Corporation Law ("GCL") Section 220, to review
the Company's stockholder list and substantially all of the Company's books and
records. The Company believes and has informed Mr. Spector that, based on the
request filed, (i) the Trust only has the right to review the Company's
stockholder list and (ii) the request to review other books and records fails to
state a "proper purpose" under GCL Section 220 and has, as a consequence, been
denied.
On November 15, 1996, the Trust filed an action in the Delaware Chancery
Court seeking to compel the Company to produce the requested books and records.
The stated purposes of demanding these books and records were to obtain
information as to the Company's financial condition and determine whether the
Company is being mismanaged for use in possible litigation against the Company
and its current and former officers and directors. The Company has not yet
responded but believes that the Trust is not entitled to the requested Company
books and records under GCL Section 220.
<PAGE>
Item 2: Management Discussion and Analysis of
Financial Condition and Results of Operations
Graff Pay-Per-View Inc. and Subsidiaries
Results of Operations
The Consolidated Statements of Operations include the results of CVS
Partners, a partnership in which the Company owns, since March 1, 1996, a 75%
interest.
Revenues
Total revenues for the nine months ended September 30, 1996 decreased by
approximately $8.4 million (21%) to approximately $30.9 million compared to
total revenues of approximately $39.3 million for the nine months ended
September 30, 1995. Total revenues for the three months ended September 30, 1996
decreased by approximately $2.3 million (18%) to approximately $10.2 million
compared to total revenue of approximately $12.5 million for the three months
ended September 30, 1995. The decrease in revenue is primarily attributable to a
decline in revenues from the Company's adult networks in the domestic C-Band
direct to home ("TVRO") market, the United Kingdom direct to home markets and
the curtailment of film and television production and distribution by CPV as a
part of the Company's restructuring plan. Offsetting these declines were
revenues from the domestic direct broadcast satellite system market and
EUROTICA, one of the Company's European satellite delivered networks, of $0.9
million and $0.6 million for the nine month period, ended September 30, 1996,
and $0.4 million and $0.1 million for the three month period ended September 30,
1996, respectively. The Company started realizing revenue from the direct
broadcast satellite system market in the second quarter of 1995 and EUROTICA in
the first quarter of 1995.
In the domestic C-band TVRO market, several competing adult explicit
services were launched during 1994 and 1995. The explicit adult services compete
directly with the SPICE and THE ADAM & EVE CHANNEL (the "SPICE Networks") in the
domestic C-band TVRO market and have resulted in a decline in revenues in this
market of approximately $4.9 million and $1.7 million for the nine and three
months ended September 30, 1996, respectively, as compared to the same periods
for 1995. These explicit adult services are not distributed by cable operators
and therefore, do not have an impact on the SPICE Networks' revenues in the
cable market. As a result of this decline in revenues, the Company suspended the
distribution of the SPICE Networks programming in the TVRO markets on September
1, 1996, effectively removing approximately $125,000 of revenues a month.
In the United Kingdom, two new competing adult services were launched in
the fourth quarter of 1995. The new adult services compete directly with THE
ADULT CHANNEL, the Company's United Kingdom satellite delivered adult network.
In addition, in the second half of 1995 THE ADULT CHANNEL switched satellites to
a satellite which could not be viewed by many of its existing subscribers
without the purchase of new equipment. These two factors have resulted in a
decline in revenues of approximately $2.7 million and $0.9 million for the nine
and three months periods ended September 30, 1996, respectively, as compared to
the same periods in 1995. Revenues from the SPICE Networks cable market
decreased by approximately $0.6 million and $0.1 million for the nine and three
month periods ended September 30, 1996 , respectively, as compared to the same
periods in 1995. The Company was able to increase the number of addressable
households with access to the SPICE Networks at September 30, 1996 by
approximately 12% over the number of such addressable households at September
30, 1995 even though the Company lost approximately 8% of its addressable
subscriber base on July 1, 1995 as a result of the disaffiliation of the Time
Warner New York City cable system. The increase in addressable subscribers did
not translate into greater revenues due to normal delays in realizing revenues
from new subscribers and a reduction in the Company's share of revenues from
cable sales of the SPICE Networks. This reduction in license fees is a result of
increased competition in the Company's market segment and the growing
concentration in the ownership of cable systems by multiple system operators
("MSOs"). Management expects this downward trend to slow and for license fees to
stabilize as a result of the Company entering into long-term agreements with
several of the major MSOs.
Expenditures
Salaries, wages and benefits decreased by approximately $0.7 million to
approximately $7.6 million for the nine months ended September 30, 1996 as
compared to approximately $8.3 million for the same period in 1995. Salaries,
wages and benefits for the three months ended September 30, 1996 decreased by
approximately $0.4 million to approximately $2.5 million as compared to
approximately $2.9 million in the same period for 1995. The decrease in salaries
is primarily attributable to the Company's Restructuring Plan which
significantly reduced personnel in its corporate operations and eliminated
substantially all of CPV's personnel.
Producer royalties and film cost amortization in the nine and three months
ended September 30, 1996 have decreased by approximately $0.7 million and $0.3
million as compared to the same periods in 1995. The decline is primarily
attributable to the reduction in film cost amortization resulting from the write
down CPV's film and CD-ROM costs in the fourth quarter of 1995.
In December, 1995, the Company entered into a service agreement with AT&T
for the use of 5 transponders on Telstar 402R for the satellite's useful life,
estimated to be 12 years. The Company is using the transponders for broadcast of
its domestic networks (including broadcasting to the pari-mutuel industry by its
wholly-owned subsidiary SEG). The transponder agreement is being accounted for
as a capital lease as required by Statement of Financial and Accounting
Standards No. 13, "Accounting for Leases". As a result, the Company is required
to establish an asset and a corresponding offsetting interest bearing obligation
equal to $58.7 million, the present value of the expected future minimum lease
payments at the lease inception. The asset is depreciated, on the straight-line
method, over the satellite's estimated 12 year useful life. The actual lease
payments are applied against the principal and interest of the obligation
similar to a fully amortizing mortgage loan. For the nine months ending
September 30, 1996 the Company recognized total expenses attributable to the
lease of approximately $7.7 million comprised of depreciation expense of
approximately $4.0 million and interest expense of approximately $3.7 million.
Had the lease been accounted for as an operating lease, the Company would have
recognized approximately $1.5 million less in total expenses attributable to the
AT&T transponder lease for the nine months ending September 30, 1996.
Satellite, playback and uplink expenses for the nine and three months ended
September 30, 1996 have decreased by approximately $6.6 million and $1.7
million, respectively, as compared to the same periods in 1995. The decrease is
primarily attributable to the capitalized AT&T transponder lease as compared to
the treatment during the same periods in 1995 when domestic transponder expenses
were accounted as operating leases.
Had the AT&T lease been accounted for as an operating lease, the Company's
satellite expense for the nine months ended September 30, 1996 would have
decreased by approximately $0.4 million as compared to the same period in 1995.
The decrease in satellite expense resulted from non-recurring expenses
associated with dual satellite coverage in the first half of 1995. The increase
in the number of domestic transponders used by the Company has been effectively
offset by a reduction in the per transponder cost. Offsetting this reduction was
the increase in satellite expense associated with the Company's European
networks of approximately $0.7 million.
Selling, general and administrative expenses for the nine and three months
ended September 30, 1996 have decreased by approximately $4.7 million and $1.8
million, respectively, as compared to the same periods in 1995. The decrease is
attributable to, among other items, the suspension of the exploration of
international opportunities and decrease in marketing, advertising and sales
promotions. Also, the implementation of the restructuring plan has contributed
to the reduction of selling, general and administrative expenses by suspending
the exploration of new businesses. The Company has also reduced selling, general
and administrative expenses by amending the Company's travel policies and
reducing employee benefits as well as overhead expenditures. Offsetting these
reductions is an increase in legal fees primarily attributable to litigation
with the government over Section 505 of the Communication Decency Act (see
footnote 18) and an increase of $275,000 in the allowance for doubtful accounts
relating to the collection of receivables at CPV which was closed down during
1996.
Depreciation of fixed assets and the amortization of goodwill for the nine
and three months ended September 30, 1996 increased by approximately $4.1
million and $1.3 million, respectively, as compared to the same periods in 1995.
Approximately $4.0 million and $1.3 million for the nine and three months ended
September 30, 1996, respectively, was attributable to accounting for the AT&T
transponder lease as a capital lease.
Interest expense increased by approximately $4.2 million to approximately
$5.0 million for the nine months ended September 30, 1996 as compared to the
same period in 1995. Interest expense increased by approximately $1.3 million to
approximately $1.6 million for the three months ended September 30, 1996 as
compared to the same period in 1995. Approximately $3.7 million and $1.2 million
of the increase for the nine and three months ended September 30, 1996,
respectively, is attributable to accounting for the AT&T transponder lease as a
capital lease and $0.6 million and $0.2 million of the increase is attributable
to additional borrowings under the credit facility from PNC.
The provision for income taxes for the three and nine months ended
September 30, 1996 represents a tax benefit of approximately $120,000 and
$69,000, respectively as compared to a tax expense of approximately $555,000 and
$824,000 for the same periods in 1995. The tax benefit realized in 1996 was the
result of a third quarter tax settlement associated with the Company's European
HVC operation. The income tax expense in the three and nine months ended
September 30, 1995 was a result of the income generated from the Company's
European HVC operations.
Liquidity and Capital Resources
At September 30, 1996, the Company had a working capital deficit of
approximately $21.0 million compared to a $2.9 million deficit at December 31,
1995. The decrease in working capital is primarily attributable to the
classification of all of the $14.6 million of the PNC loan as current at
September 30, 1996 as compared to only $1.1 million classified as current and
$14.5 million classified as long-term at December 31, 1995. Also contributing to
the decrease in working capital was the purchase of property and equipment,
additional investment in library of movies, principal payments on long-term debt
and principal payments on capital lease obligations (totaling $7.2 million).
The Company currently has a credit facility from PNC which, at September
30, 1996, had a principal balance of $14.6 million. No further funds are
available. At December 31, 1995, the Company had violated certain covenants.
Pursuant to a Third Amendatory Agreement dated March 29, 1996, PNC has waived
those violations through the date of the agreement, eliminated all of the
financial covenants for the balance of the loan's term except for two financial
covenants, net worth and cash flow requirements, which were revised in
accordance with the Company's projections.
The Company has obtained a commitment letter from a lender which includes a
line of credit. The closing of the loan is dependent upon, among other things,
the lender's ability to acquire the credit facility from PNC at a substantial
discount. PNC has not yet indicated it's willingness to accept a discount on the
Company's credit facility and there are no assurances that the Company will be
able to consummate the refinancing transaction. If the Company is unable to
obtain replacement financing when the loan matures on January 2, 1997, PNC, as
the Company's senior secured lender, could foreclose on its security interest
and otherwise exercise its rights as a senior secured creditor.
The Company has reduced expenses in the areas of salaries and overhead
which together with its sale of its TeleSelect interest, a federal income tax
refund amounting to $457,000 and the repayment of a $476,000 note owed by the
former CPV shareholders currently allowed the Company to fund day-to-day
operations. The Company is currently in discussions with parties and is
evaluating its alternatives concerning additional financing to repay its bank
debt and to fund the expansion of its core businesses and other future projects.
There are no assurances that the Company will be able to secure alternate
financing and to repay all or a portion of the PNC indebtedness with such
financing.
The accrued restructuring reserve at January 1, 1996, March 31, 1996, June
30, 1996 and September 30, 1996 was approximately $3.7 million, $3.0 million,
$2.3 million and $1.8 million, respectively. The accrued restructuring reserve
is comprised of corporate level restructuring and the suspension of production
activities formerly conducted by CPV.
The cash outflows associated with the accrued restructuring reserve
aggregated approximately $0.7 million in each of the first two quarters of 1996
and $0.5 million in the third quarter of 1996. Company management estimates the
cash outflows associated with the restructuring will aggregate $0.4 million for
the quarter ended December 31, 1996, and $0.8 million in 1997, and $0.7 million
in 1998. Anticipated expense savings from the restructuring are estimated to
aggregate approximately $6 million in 1996 when compared to 1995, with a
majority of the expense savings in 1996 occurring in the second half of the
year.
Stockholders' equity at September 30, 1996 was approximately $4.8 million
compared to approximately $8.1 million at December 31, 1995. The decline in
stockholders' equity was primarily attributable to interest expense of
approximately $5.0 million (see "Transponder Lease") and the provision to
writedown the Buccaneer note which was offset by minority interest of
approximately $0.7 million and a gain on disposition of AGN of approximately
$0.9 million. The Company's income from operations was approximately $0.4
million for the nine months ended September 30, 1996.
Net cash provided by operating activities was approximately $3.1 million
for the nine months ended September 30, 1996 as compared to approximately $1.3
million for the same period in 1995. The increase in cash from operating
activities was primarily attributable to the increased depreciation and
amortization of fixed assets and the decrease in purchases of films and CD-ROMs
for the nine months ended September 30, 1996 as compared to the same period in
1995. Offsetting these increases are cash outflows associated with the accrued
restructuring reserve at December 31, 1995, gain on disposition of AGN and
losses allocated to the minority partner in CVS Partners for the nine months
ended September 30, 1996.
Net cash provided by investing activities was approximately $0.5 million
for the nine months ended September 30, 1996 as compared to approximately $8.7
million used in investing activities for the nine months ended September 30,
1995. The increase in cash provided by investing activities is primarily
attributable to the sale of TeleSelect in April of 1996. Contributing to the
increase was the decline in purchases of property and equipment and investments
in TeleSelect for the nine months ended September 30, 1996 as compared to the
same period in 1995.
Net cash used in financing activities was approximately $3.5 million for
the nine months ended September 30, 1996 as compared to approximately $6.9
million provided by financing activities for the same period in 1995. The
decrease in cash provided from financing activities is primarily attributable to
repayments of a portion of the amount borrowed from PNC in the nine months ended
September 30, 1996 as compared to additional borrowings in the same period in
1995. Contributing to the decrease in cash provided by financing activities was
the treatment of the Company's domestic satellite lease in 1996 as a capital
lease. Offsetting these declines is the capital contribution to CVS Partners by
the minority partner.
<PAGE>
PART II - OTHER INFORMATION
Item 1: Legal Proceedings
1. Graff Pay-Per-View Inc., et. al v. United States. (See Note 18)
2. Capital Distribution, Inc. v. Spice, Inc. (See Note 19)
3. Monopoli Studio, Inc., et. al. v. Cinema Products Video, Inc.,
et. al. (See Note 20)
4. Eric M. Spector as Trustee v. Graff Pay-Per-View Inc.
(See Note 21)
Item 4: Submission of Matters to a Vote of Security Holders
A. The Company's Annual Meeting of Shareholders was held on July 23, 1996.
B. The motions before the shareholders were:
1. To elect six Directors of the Company to serve for the ensuing
year.
<TABLE>
Name of Director Votes For Votes Against Votes Withheld Abs
<S> <C> <C> <C> <C>
J. Roger Faherty 5,189,039 -- 3,427,357 --
Edward M. Spector 7,413,293 -- 1,203,103 --
Leland H. Nolan 4,930,552 -- 3,685,844 --
Dean Ericson 7,309,013 -- 1,307,383 --
Christopher Yates 7,771,364 -- 845,032 --
Rudy R. Miller 7,379,613 -- 1,236,783 --
</TABLE>
2. To approve the Amendment of Certificate of Incorporation to change
the Company's Name to Spice Entertainment Companies, Inc.
Votes For 8,076,454
Votes Against 501,642
Votes Withheld --
Abstentions 38,300
Broker Nonvotes --
3. To approve adoption of the 1995 Restricted Stock Incentive Plan.
Votes For 5,940,241
Votes Against 2,225,011
Votes Withheld --
Abstentions 119,397
Broker Nonvotes --
4. To approve the amendments to the 1994 and 1994 Employee's Stock
Option Plans.
Votes For 4,472,879
Votes Against 3,740,608
Votes Withheld --
Abstentions 71,162
Broker Nonvotes --
5. To approve the selection of Coopers & Lybrand LLP, independent
public accountants, as auditors for the Company for the fiscal
year ended December 31, 1996.
Votes For 8,524,741
Votes Against 48,400
Votes Withheld --
Abstentions 43,255
Broker Nonvotes --
Item 6: Exhibits and Reports on Form 8-K
(a) Exhibits - Exhibit 11.01 - Compensation of Earnings
Per Share
Exhibit 27.00 - Financial Data Schedule
(b) Reports on Form 8-K - None
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf of the
undersigned, thereunto duly authorized.
GRAFF PAY-PER-VIEW INC.
By: /s/ Harlyn C. Enholm
Harlyn C. Enholm
Executive Vice President
& Chief Financial Officer
November 19, 1996
<PAGE>
Exhibit 11.01
GRAFF PAY-PER-VIEW INC. and SUBSIDIARIES
COMPUTATION of EARNINGS PER SHARE
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1996 and 1995
(Unaudited)
<TABLE>
1996 1995
---------------------- ----------------------
Primary
<S> <C> <C>
Net Income ($3,470,000) ($1,432,000)
---------------------- ----------------------
Weighted average number of common shares outstanding 11,354,000 11,713,000
====================== ======================
Earnings per share ($0.31) ($0.12)
====================== ======================
Note to Primary Earnings Per Share:
EPS calculation does not include common stock equivalents because this
would have an anti-dilutive effect on the loss per share
</TABLE>
<PAGE>
Exhibit 27.00
SUMMARY FINANCIAL DATA SCHEDULE
FOR THE NINE MONTHS ENDING SEPTEMBER 30, 1996
This schedule contains summary financial information extracted from the
Form 10-Q for the quarter ended September 30, 1996 of Graff Pay-Per-View Inc.
<PAGE>
<TABLE> <S> <C>
<ARTICLE> 5
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1996
<PERIOD-END> SEP-30-1996
<CASH> 1,573,000
<SECURITIES> 0
<RECEIVABLES> 5,897,000
<ALLOWANCES> 0
<INVENTORY> 0
<CURRENT-ASSETS> 9,856,000
<PP&E> 68,019,000
<DEPRECIATION> 0
<TOTAL-ASSETS> 93,604,000
<CURRENT-LIABILITIES> 30,944,000
<BONDS> 76,259,000
0
0
<COMMON> 113,000
<OTHER-SE> 4,673,000
<TOTAL-LIABILITY-AND-EQUITY> 93,604,000
<SALES> 0
<TOTAL-REVENUES> 30,894,000
<CGS> 587,000
<TOTAL-COSTS> 30,544,000
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 5,039,000
<INCOME-PRETAX> (3,539,000)
<INCOME-TAX> (69,000)
<INCOME-CONTINUING> (3,470,000)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (3,470,000)
<EPS-PRIMARY> (0.31)
<EPS-DILUTED> 0
</TABLE>
