<PAGE>
 
               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, 1998

                                      OR

[ ]  TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
     EXCHANGE ACT OF 1934

For the transition period from .................... to ....................


Commission file number 1-6813



                           Playboy Enterprises, Inc.
            (Exact name of registrant as specified in its charter)


          Delaware                                              36-2258830
(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, 1998, there were 4,748,954 shares of Class A Common Stock, par
value $0.01 per share, and 15,812,759 shares of Class B Common Stock, par value
$0.01 per share, outstanding.

<PAGE>
 
                           PLAYBOY ENTERPRISES, INC.
                                   FORM 10-Q
                               TABLE OF CONTENTS


                                    PART I
                             FINANCIAL INFORMATION


                                                                            Page
                                                                            ----
Item 1.  Financial Statements

         Condensed Consolidated Statements of Operations for the
         Quarters Ended September 30, 1998 and 1997 (Unaudited)                3

         Condensed Consolidated Statements of Operations for the
         Nine Months Ended September 30, 1998 and 1997 (Unaudited)             4

         Condensed Consolidated Balance Sheets at September 30,
         1998 (Unaudited) and December 31, 1997                                5

         Condensed Consolidated Statements of Cash Flows for the
         Nine Months Ended September 30, 1998 and 1997 (Unaudited)             6

         Notes to Condensed Consolidated Financial Statements               7-10

Item 2.  Management's Discussion and Analysis of Financial
         Condition and Results of Operations                               11-19

Item 3.  Quantitative and Qualitative Disclosures About Market Risk           19


                                    PART II
                               OTHER INFORMATION

Item 1.  Legal Proceedings                                                    20

Item 6.  Exhibits and Reports on Form 8-K                                     21


                                       2
<PAGE>
 
                  PLAYBOY ENTERPRISES, INC. AND SUBSIDIARIES
                CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
                for the Quarters Ended September 30 (Unaudited)
                   (In thousands, except per share amounts)


<TABLE>
<CAPTION>
                                                           1998          1997
                                                           ----          ----
<S>                                                     <C>           <C>
Net revenues                                            $ 75,655      $ 68,214
                                                        --------      --------
Costs and expenses                                                 
  Cost of sales                                          (66,558)      (57,093)
  Selling and administrative expenses                    (11,539)       (8,793)
                                                        --------      --------
    Total costs and expenses                             (78,097)      (65,886)
                                                        --------      --------
                                                                   
Operating income (loss)                                   (2,442)        2,328
                                                        --------      --------
Nonoperating income (expense)                                      
  Investment income                                           19            22
  Interest expense                                          (429)         (121)
  Other, net                                                 (79)           92
                                                        --------      --------
    Total nonoperating expense                              (489)           (7)
                                                        --------      --------

Income (loss) before income taxes                         (2,931)        2,321
                                                                   
Income tax benefit (expense)                                 242        (1,226)
                                                        --------      --------
                                                                   
Net income (loss)                                       $ (2,689)     $  1,095
                                                        ========      ========
                                                                   

Weighted average number of common shares outstanding               
  Basic                                                   20,552        20,454
                                                        ========      ========
  Diluted                                                 21,003        20,772
                                                        ========      ========
                                                                   
Net income (loss) per common share                                 
  Basic                                                 $  (0.13)     $   0.05
                                                        ========      ========
  Diluted                                               $  (0.13)     $   0.05
                                                        ========      ========
</TABLE> 


The accompanying Notes to Condensed Consolidated Financial Statements are an
integral part of these statements.

                                       3
<PAGE>
 
                  PLAYBOY ENTERPRISES, INC. AND SUBSIDIARIES
                CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
              for the Nine Months Ended September 30 (Unaudited)
                   (In thousands, except per share amounts)


<TABLE>
<CAPTION>
                                                           1998          1997
                                                        ---------     ---------
<S>                                                     <C>           <C>
Net revenues                                            $ 225,237     $ 218,834
                                                        ---------     ---------
Costs and expenses
  Cost of sales                                          (191,786)     (180,054)
  Selling and administrative expenses                     (30,658)      (28,401)
                                                        ---------     ---------
    Total costs and expenses                             (222,444)     (208,455)
                                                        ---------     ---------
 
Operating income                                            2,793        10,379
                                                        ---------     ---------
Nonoperating income (expense)
  Investment income                                            70            60
  Interest expense                                           (989)         (249)
  Other, net                                                 (535)         (450)
                                                        ---------     ---------
    Total nonoperating expense                             (1,454)         (639)
                                                        ---------     ---------

Income before income taxes                                  1,339         9,740

Income tax benefit (expense)                               (1,889)        8,887
                                                        ---------     ---------

Net income (loss)                                       $    (550)    $  18,627
                                                        =========     =========


Weighted average number of common shares outstanding
  Basic                                                    20,541        20,383
                                                        =========     =========
  Diluted                                                  21,053        20,819
                                                        =========     =========

Net income (loss) per common share
  Basic                                                 $   (0.03)    $    0.91
                                                        =========     =========
  Diluted                                               $   (0.03)    $    0.89
                                                        =========     =========

</TABLE> 

The accompanying Notes to Condensed Consolidated Financial Statements are an
integral part of these statements.

                                       4
<PAGE>
 
                  PLAYBOY ENTERPRISES, INC. AND SUBSIDIARIES
                     CONDENSED CONSOLIDATED BALANCE SHEETS
                       (In thousands, except share data)
                                        
<TABLE>
<CAPTION>
                                                                     (Unaudited)
                                                                      Sept. 30,     Dec. 31,
                                                                        1998          1997
                                                                      --------      --------
<S>                                                                   <C>           <C>
Assets
  Cash and cash equivalents                                           $  2,150      $    947
  Marketable securities                                                    441             -
  Receivables, net of allowance for doubtful accounts of
    $6,353 and $4,467, respectively                                     37,518        33,324
  Inventories                                                           28,496        25,376
  Programming costs                                                     45,415        41,504
  Deferred subscription acquisition costs                               12,848        12,143
  Other current assets                                                  14,450        11,910
                                                                      --------      --------
    Total current assets                                               141,318       125,204
                                                                      --------      --------

  Property and equipment, at cost                                       38,368        37,945
  Accumulated depreciation                                             (29,354)      (27,892)
                                                                      --------      --------
    Property and equipment, net                                          9,014        10,053
                                                                      --------      --------
 
  Programming costs - noncurrent                                         5,906         8,329
  Trademarks                                                            16,364        14,978
  Net deferred tax assets                                               13,247        13,688
  Other noncurrent assets                                               18,697        13,695
                                                                      --------      --------
 
  Total assets                                                        $204,546      $185,947
                                                                      ========      ========

Liabilities
  Short-term borrowings                                               $ 29,000       $10,000
  Accounts payable                                                      30,892        32,258
  Accrued salaries, wages and employee benefits                          4,860         4,499
  Reserves for losses on disposals of discontinued operations              607           610
  Income taxes payable                                                     558           627
  Deferred revenues                                                     41,958        43,216
  Other liabilities and accrued expenses                                 9,819         7,706
                                                                      --------      --------
    Total current liabilities                                          117,694        98,916
 
  Noncurrent liabilities                                                 8,435         8,348
                                                                      --------      --------
    Total liabilities                                                  126,129       107,264
                                                                      --------      --------

Shareholders' Equity
  Common stock, $0.01 par value
    Class A voting - 7,500,000 shares authorized; 5,042,381 issued          50            50
    Class B non-voting - 30,000,000 shares authorized; 17,112,672               
      and 17,076,518 issued, respectively                                  171           171
  Capital in excess of par value                                        44,207        43,539
  Retained earnings                                                     44,707        45,257
  Foreign currency translation adjustment                                 (168)         (131)
  Unearned compensation restricted stock                                (3,901)       (3,511)
  Unrealized loss on marketable securities                                 (59)            -
  Less cost of treasury stock                                           (6,590)       (6,692)
                                                                      --------      --------
    Total shareholders' equity                                          78,417        78,683
                                                                      --------      --------
   Total liabilities and shareholders' equity                         $204,546      $185,947
                                                                      ========      ========
</TABLE> 

The accompanying Notes to Condensed Consolidated Financial Statements are an
integral part of these statements.

                                       5
<PAGE>
 
                  PLAYBOY ENTERPRISES, INC. AND SUBSIDIARIES
                CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
              for the Nine Months Ended September 30 (Unaudited)
                                (In thousands)
                                        

<TABLE>
<CAPTION>
                                                                        1998          1997
                                                                      --------      --------
<S>                                                                   <C>           <C>
Cash Flows From Operating Activities
Net income (loss)                                                     $   (550)     $ 18,627
Adjustments to reconcile net income (loss) to net cash                       
  provided by (used for) operating activities:                               
    Depreciation of property and equipment                               1,488         1,599
    Amortization of intangible assets                                    1,298         1,428
    Amortization of investments in entertainment programming            16,750        17,468
    Investments in entertainment programming                           (18,238)      (22,828)
    Net change in operating assets and liabilities                     (14,833)      (13,089)
    Net cash used for discontinued operations                               (3)          (59)
    Other, net                                                              (4)          717
                                                                      --------      --------
      Net cash provided by (used for) operating activities             (14,092)        3,863
                                                                      --------      --------
Cash Flows From Investing Activities
Additions to property and equipment                                       (801)         (434)
Acquisitions and funding of equity         
  interests in international ventures                                   (1,598)       (1,524)
Loan to international venture                                           (1,193)            -
Purchase of marketable securities                                         (500)            -
Other, net                                                                  32            21
                                                                      --------      --------
      Net cash used for investing activities                            (4,060)       (1,937)
                                                                      --------      --------
Cash Flows From Financing Activities
Increase (decrease) in short-term borrowings                            19,000        (3,000)
Proceeds from exercise of stock options                                    199           391
Proceeds from sales under employee stock purchase plan                     156           147
                                                                      --------      --------
      Net cash provided by (used for) financing activities              19,355        (2,462)
                                                                      --------      --------
Net increase (decrease) in cash and cash equivalents                     1,203          (536)

Cash and cash equivalents at beginning of period                           947         1,061
                                                                      --------      --------
Cash and cash equivalents at end of period                            $  2,150      $    525
                                                                      ========      ========
</TABLE> 

The accompanying Notes to Condensed Consolidated Financial Statements are an
integral part of these statements.


                                       6
<PAGE>
 
                  PLAYBOY ENTERPRISES, INC. AND SUBSIDIARIES
             NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(A)  BASIS OF PREPARATION

     The financial information included herein 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 such
     results and cash flows for the entire year. These financial statements
     should be read in conjunction with the financial statements and notes
     thereto contained in the Transition Report on Form 10-K for the period from
     July 1, 1997 through December 31, 1997, as amended (the "Transition
     Report"), of Playboy Enterprises, Inc. and its subsidiaries (the
     "Company").

(B)  INCOME TAXES

     The Company's net deferred tax asset declined to $13.5 million at September
     30, 1998 based on taxable income for the current nine-month period and
     management's projection of calendar year 1998 taxable income. As reported
     in the Company's Transition Report, the deferred tax asset includes
     principally the anticipated benefit of net operating loss carryforwards
     ("NOLs"). Of the $13.5 million and $14.0 million net deferred tax assets
     included in the Condensed Consolidated Balance Sheets at September 30, 1998
     and December 31, 1997, respectively, $0.3 million is included in "Other
     current assets" with the remainder segregated as "Net deferred tax assets."

     Realization of the net deferred tax asset 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 $14.0 million at
     December 31, 1997, the Company will need to generate future taxable income
     of approximately $41.2 million prior to the expiration, beginning in 2004,
     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.


                                       7
<PAGE>
 
(C)  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):

<TABLE>
<CAPTION>

                                                    (Unaudited)           (Unaudited)
                                                  Quarters Ended       Nine Months Ended
                                                   September 30,         September 30,
                                                  --------------       -----------------
                                                  1998      1997       1998         1997
----------------------------------------------------------------------------------------
<S>                                               <C>      <C>         <C>        <C>
Numerator:
   For basic and diluted EPS--net income
   (loss) available to common shareholders       $(2,689)    $1,095     $(550)   $18,627
========================================================================================

Denominator:
   Denominator for basic EPS--
   weighted-average shares                        20,552     20,454    20,541     20,383
----------------------------------------------------------------------------------------
   Effect of dilutive potential common shares:
     Stock options                                   451        318       512        356
     Nonvested restricted stock awards                 -          -         -         80
----------------------------------------------------------------------------------------
       Dilutive potential common shares              451        318       512        436
----------------------------------------------------------------------------------------
   Denominator for diluted EPS--
     adjusted weighted-average shares             21,003     20,772    21,053     20,819
========================================================================================
Basic EPS                                         $(0.13)     $0.05    $(0.03)     $0.91
========================================================================================
Diluted EPS                                       $(0.13)     $0.05    $(0.03)     $0.89
========================================================================================
</TABLE>

     During the quarter and nine months ended September 30, 1998, approximately
     345,000 and 340,000 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 217,000 and 75,000 weighted-average shares of
     Class B common stock were outstanding during the quarter and nine months
     ended September 30, 1998, 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.


(D)  MARKETABLE SECURITIES

     The Company's marketable securities, purchased in connection with the
     Company's Deferred Compensation Plans, are classified as available-for-sale
     securities as defined by Statement of Financial Accounting Standards No.
     115, Accounting for Certain Investments in Debt and Equity Securities. As a
     result, these securities are stated at fair value and unrealized holding
     gains and losses are reflected as a net amount in a separate component of
     shareholders' equity.

     Securities available for sale at September 30, 1998 consisted of the
     following (in thousands):

<TABLE> 
<CAPTION> 
                                       Gross       Gross
                                  Unrealized  Unrealized
                                     Holding     Holding    Fair
                           Cost        Gains      Losses   Value
-----------------------------------------------------------------
<S>                        <C>     <C>         <C>         <C>

Equity Securities           $500      $    -      $   59     $441
-----------------------------------------------------------------
</TABLE>
                                       8
<PAGE>
 
(E)  INVENTORIES

     Inventories, which are stated at the lower of cost (average cost and
     specific cost) or market, consisted of the following (in thousands):


<TABLE> 
<CAPTION>                                              
                                                 (Unaudited)
                                                  Sept. 30,    Dec. 31,
                                                     1998        1997
                                                  ----------   --------
<S>                                                <C>         <C>
     Paper                                         $ 9,011     $ 7,573
     Editorial and other prepublication costs        6,930       6,002
     Merchandise finished goods                     12,555      11,801
                                                   -------     -------

     Total inventories                             $28,496     $25,376
                                                   =======     =======
</TABLE> 

(F)  TREASURY STOCK

     Treasury stock consisted of 293,427 Class A common shares and 954,500 Class
     B common shares at September 30, 1998. At December 31, 1997, treasury stock
     consisted of 293,427 Class A common shares and 974,227 Class B common
     shares.

(G)  ACCOUNTING STANDARDS

     The Company will adopt the provisions of Statement of Financial Accounting
     Standards No. 130, Reporting Comprehensive Income Summary ("Statement 130")
     for financial statements issued for fiscal years beginning after December
     15, 1997. Statement 130 establishes standards for reporting and display of
     comprehensive income and its components (revenues, expenses, gains and
     losses) in a full set of general-purpose financial statements. Management
     is evaluating the effect that adoption of Statement 130 will have on the
     Company's financial statements.

     The Company will adopt the provisions of Statement of Financial Accounting
     Standards No. 131, Disclosures about Segments of an Enterprise and Related
     Information ("Statement 131") for financial statements issued for periods
     beginning after December 15, 1997. Statement 131, which is based on the
     management approach to segment reporting, includes requirements to report
     selected segment information quarterly and entity-wide disclosures about
     products and services, major customers, and the material countries in which
     the entity holds assets and reports revenues. Management is evaluating the
     effect that adoption of Statement 131 will have on the Company's financial
     statements.

     The Company will adopt the provisions of Statement of Financial Accounting
     Standards No. 133, Accounting for Derivative Instruments and Hedging
     Activities ("Statement 133"), for financial statements issued for fiscal
     years beginning after June 15, 1999. Statement 133 provides a comprehensive
     and consistent standard for the recognition and measurement of derivatives
     and hedging activities. Management is evaluating the effect that adoption
     of Statement 133 will have on the Company's financial statements.

(H)  CONTINGENCIES

     In January 1993, the Company received a General Notice from the United
     States Environmental Protection Agency (the "EPA") as a "potentially
     responsible party" ("PRP") in connection with a site identified as the
     Southern Lakes Trap & Skeet Club, located at the Resort-Hotel in Lake
     Geneva, Wisconsin (the "Resort"), formerly owned by a subsidiary of the
     Company. The Resort was sold by the Company's subsidiary to LG Americana-
     GKP Joint Venture in 1982. Two other entities were also identified as PRPs
     in the notice. The notice relates to actions that may be ordered taken by
     the EPA to sample for and remove contamination in soils and sediments,
     purportedly caused by skeet shooting activities at the Resort property.
     During fiscal year 1994, the EPA advised the Company of its position that
     the area of land requiring remediation is approximately twice the size of
     the initial site. The Company believes that it has established adequate
     reserves, which totaled $0.6 million at September 30, 1998, to cover the
     eventual cost of its anticipated share (based on an agreement with one of
     the other PRPs) of any agreed upon remediation.

     
                                       9
<PAGE>

     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. Management believes that
     the Company's revenues attributable to its domestic pay television cable
     services may continue to be materially adversely affected as a result of
     enforcement of Section 505 of the Telecommunications Act ("Section 505"),
     which commenced May 18, 1997, due to reduced buy rates from the systems
     that roll back carriage to a 10:00 p.m. start time, subscriber declines and
     reduced carriage from cable operators due to aggressive competition for
     carriage from all program suppliers. The Company has estimated that the
     Entertainment Group's calendar year 1998 revenues will be reduced by
     approximately $3.5 million, and approximately $25 million (discounted to
     present value at a rate of 6%) over the next ten years, due to Section 505.
     These amounts do not take into account the loss of revenues due to the
     slowing of access to new homes and of upgrading of old homes from ten to 24
     hours.

     (I)  PROPOSED ACQUISITION

     On July 29, 1998, the Company and Spice Entertainment Companies, Inc.
     ("Spice") filed with the Securities and Exchange Commission ("SEC")
     preliminary proxy materials in connection with the Company's proposed
     acquisition of Spice, announced on February 3, 1998. The Company and Spice
     have responded to comments on the preliminary proxy materials from the
     staff of the SEC, are in the process of responding to additional comments,
     and are working on obtaining all other necessary consents and approvals.

     The Company has received a financing commitment from a major financial
     institution which provides that, subject to satisfaction of customary
     conditions contained in the commitment letter, the Company will be entitled
     to draw upon the commitment from and after February 12, 1999. The Company
     and Spice have agreed to amend their merger agreement to extend from
     December 31, 1998 to March 1, 1999, the date on which either party may
     terminate the merger agreement, to adjust the top of the collar from a
     maximum value of $2.88 per Spice share to $2.81 while leaving the bottom of
     the collar of $2.20 per Spice share unchanged, and to amend certain other
     terms. The Company and Spice are finalizing the specific terms of the
     amendment which will be described in and annexed to the proxy materials to
     be filed shortly with the SEC and which will be mailed after SEC clearance
     to stockholders of Spice.

     The Company expects the merger to be effected during the first two months
     of calendar year 1999.

     (J)  SUBSEQUENT EVENT

     In October 1998, the Company settled litigation in the amount of $1.4
     million related to BrandsElite International Corporation ("BrandsElite").
     The settlement was recorded in cost of sales in the quarter ended September
     30, 1998. See "Legal Proceedings."
     
                                      10
<PAGE>
 
                      MANAGEMENT'S DISCUSSION AND ANALYSIS
                OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
               (In millions of dollars, except per share amounts)



RESULTS OF OPERATIONS

   The Company's revenues increased to $75.7 for the quarter ended September 30,
1998 compared to $68.2 for the quarter ended September 30, 1997. For the nine
months ended September 30, 1998, revenues increased to $225.2 compared to $218.8
for the nine months ended September 30, 1997. The increase for the quarter was
driven by higher Entertainment and Catalog Group revenues, combined with an
increase in Playboy magazine revenues. For the nine-month period, the increase
was primarily due to higher revenues for the Entertainment and Playboy Online
Groups, partially offset by lower revenues from other domestic publishing
businesses.

   The Company reported an operating loss of $2.4 for the quarter ended
September 30, 1998 compared to operating income of $2.3 in the prior year
quarter. For the nine months ended September 30, 1998, the Company's operating
income was $2.8 compared to $10.4 in the prior year. The current year quarter
and nine-month period reflected higher operating income for the Entertainment
Group, which was more than offset by planned investments in the Playboy Online
Group and Corporate Administration and Promotion and lower operating performance
for the Publishing and Product Marketing Groups. The lower operating performance
for the Product Marketing Group was principally due to a settlement of
litigation reflected in the current year quarter and nine-month period. The
higher Corporate Administration and Promotion expenses were largely due to
increased investments in systems technology, including Year 2000 expenses, and
corporate marketing.

   For the quarter ended September 30, 1998, the Company reported a net loss of
$2.7, or basic and diluted net loss per common share of $0.13, compared to net
income of $1.1, or basic and diluted EPS of $0.05, for the prior year quarter.
The net loss for the nine months ended September 30, 1998 was $0.6, or basic and
diluted net loss per common share of $0.03, compared to net income of $18.6, or
basic EPS of $0.91 and diluted EPS of $0.89, for the prior year. Net income for
the nine months ended September 30, 1997 included a federal income tax benefit
of $13.5 related to NOLs and tax credit carryforwards. Excluding the impact of
the $13.5 federal income tax benefit, net income for the nine months ended
September 30, 1997 was $5.1, or basic and diluted EPS of $0.25.

   The net loss for the quarter ended September 30, 1998, adjusted to eliminate
noncash federal income tax items due to the Company's NOLs and tax credit
carryforwards ("tax-adjusted net loss"), was $2.9, or basic and diluted net loss
per common share of $0.15. Net income for the quarter ended September 30, 1997,
adjusted to eliminate noncash federal income tax items due to the Company's NOLs
and tax credit carryforwards ("tax-adjusted net income"), was $1.8, or basic and
diluted EPS of $0.09. For the nine months ended September 30, 1998, the tax-
adjusted net loss was $0.1, or basic and diluted net loss per common share of
$0.01, compared to tax-adjusted net income of $7.8, or basic EPS of $0.39 and
diluted EPS of $0.38, for the nine months ended September 30, 1997.

   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 with the timing of
international sales.

                                       11
<PAGE>
 
Publishing Group

     The revenues and operating income of the Publishing Group were as follows
for the periods indicated below:

<TABLE>
<CAPTION>
                                    Quarters      Nine Months
                                      Ended          Ended
                                  September 30,  September 30,
                                  -------------  -------------
                                   1998    1997   1998   1997
                                  -----   -----  -----  ------
<S>                               <C>     <C>    <C>    <C>
  Revenues
  Playboy Magazine...........     $26.2   $24.3  $77.4  $ 77.5
  Other Domestic Publishing..       5.6     5.6   14.1    15.9
  International Publishing...       2.2     2.2    7.4     6.9
                                  -----   -----  -----  ------

   Total Revenues............     $34.0   $32.1  $98.9  $100.3
                                  =====   =====  =====  ======

  Operating Income...........     $ 1.4   $ 2.5  $ 4.5  $  7.5
                                  =====   =====  =====  ======
</TABLE>

     Publishing Group revenues increased $1.9, or 6%, for the quarter ended
September 30, 1998 compared to the prior year due to higher revenues from
Playboy magazine. For the nine months ended September 30, 1998, revenues
decreased $1.4, or 1%, compared to the prior year primarily due to lower
revenues from newsstand specials.

     For the quarter ended September 30, 1998, Playboy magazine revenues
increased $1.9, or 8%, compared to the prior year. Circulation revenues
increased $1.8 primarily due to a $1.6, or 32%, increase in newsstand revenues
principally due to sales of the October 1998 issue featuring Cindy Crawford,
which also carried a higher cover price. Additionally, the quarter was favorably
impacted by higher subscription revenues of $0.2, or 2%. Advertising revenues
remained relatively flat.

     For the nine months ended September 30, 1998, Playboy magazine revenues
remained relatively flat. Circulation revenues increased $0.5, or 1%, due to
$1.1, or 3%, higher subscription revenues. The higher subscription revenues were
partially offset by $0.6, or 4%, lower newsstand revenues primarily due to 6%
fewer U.S. and Canadian newsstand copies sold in the current year. In general,
newsstand revenues have been, and are expected to continue to be, adversely
affected by the consolidation taking place nationally in the single-copy
magazine distribution system. Advertising revenues decreased $1.0, or 5%,
primarily due to 4% fewer ad pages. Advertising sales for the calendar year 1998
fourth quarter issues of the magazine are closed, and the Company expects to
report 35% more ad pages and 40% higher ad revenues compared to the quarter
ended December 31, 1997, resulting in expected 6% increases in both ad pages and
ad revenues for calendar year 1998 compared to calendar year 1997.

     Revenues from other domestic publishing businesses were flat for the
quarter and decreased $1.8, or 12%, for the nine-month period compared to the
prior year. The decrease for the nine-month period was principally due to fewer
copies of newsstand specials sold.

     International publishing revenues were flat for the quarter and increased
$0.5, or 7%, for the nine-month period compared to the prior year. The increase
for the nine-month period primarily reflected higher revenues from the Polish
edition of Playboy magazine, in which the Company owns a majority interest.

     For the quarter ended September 30, 1998, Publishing Group operating income
decreased $1.1, or 43%, compared to the prior year due to higher average paper
prices and higher editorial costs associated with the Cindy Crawford feature
combined with lower subscription profitability. Operating income declined $3.0,
or 40%, for the nine months ended September 30, 1998 largely due to the lower
revenues from newsstand specials and Playboy magazine advertising and newsstand
combined with higher average paper prices and lower subscription profitability.
Operating income in calendar year 1998 has been, and is expected to continue to
be, materially adversely impacted by an average paper price increase of
approximately 5% compared to calendar year 1997.

                                       12
<PAGE>
 
     The National Defense Authorization Act of 1997 was signed into law in
September 1996. One section of that legislation that began as the Military Honor
and Decency Act (the "Military Act") bans the sale or rental of "sexually
explicit material" on property under the jurisdiction of the Department of
Defense. A federal district court found the Military Act to be unconstitutional
and permanently enjoined its enforcement. The district court's decision also
prohibited the Department of Defense from modifying its acquisition and stocking
practices as a result of the Military Act. The government appealed the district
court's decision and the decision was stayed during this appeal. On November 21,
1997, the United States Court of Appeals (the "Court of Appeals") vacated the
district court's decision and ordered the district court to hold the Military
Act constitutional. The Court of Appeals' decision was stayed pending appeal to
the United States Supreme Court (the "Supreme Court"). On June 27, 1998, the
Supreme Court, without comment, refused to hear the appeal and the stay was
lifted. On September 21, 1998, the Department of Defense issued a directive that
the Military Act was not applicable to the Company's publications and that the
sale of Playboy magazine, newsstand specials and most of the Company's videos
would not be prohibited at commissaries, PX's and ship stores.

Entertainment Group

     The revenues and operating income of the Entertainment Group were as
follows for the periods indicated below:

<TABLE>
<CAPTION>
                                               Quarters        Nine Months
                                                 Ended            Ended
                                             September 30,    September 30,
                                             -------------   ---------------
                                              1998    1997    1998     1997
                                             -----   -----   ------   ------
<S>                                          <C>     <C>     <C>      <C>
  Revenues
  Playboy TV
   Cable...................................  $ 5.3   $ 4.4   $ 15.7   $ 15.2
   Satellite Direct-to-Home................    8.5     7.2     24.8     20.4
   Off-Network Productions and Other.......    0.2     0.9      0.7      1.9
                                             -----   -----   ------   ------
  Total Playboy TV.........................   14.0    12.5     41.2     37.5
  Domestic Home Video......................    3.2     1.7      9.0      6.4
  International TV and Home Video..........    3.1     2.6      9.0     10.4
                                             -----   -----   ------   ------
  Total Playboy Businesses.................   20.3    16.8     59.2     54.3
  AdulTVision..............................    1.5     1.1      4.3      3.2
  Movies and Other.........................    0.1     0.3      1.5      1.5
                                             -----   -----   ------   ------
   Total Revenues..........................  $21.9   $18.2   $ 65.0   $ 59.0
                                             =====   =====   ======   ======
  Operating Income
  Profit Contribution Before
   Playboy Businesses Programming Expense..  $11.3   $ 9.1   $ 33.9   $ 30.7
  Playboy Businesses Programming Expense...   (5.5)   (5.5)   (15.6)   (16.6)
                                             -----   -----   ------   ------
   Total Operating Income..................  $ 5.8   $ 3.6   $ 18.3   $ 14.1
                                             =====   =====   ======   ======
</TABLE>

     The following discussion focuses on the profit contribution of each Playboy
business before Playboy businesses programming expense ("profit contribution").

Playboy TV

     Revenues from the Company's domestic pay television service, Playboy TV,
increased $1.5, or 12%, for the quarter and $3.7, or 10%, for the nine-month
period compared to the prior year.

     Cable revenues increased $0.9, or 19%, for the quarter ended September 30,
1998 primarily due to an increase in the number of cable addressable households
to which Playboy TV was available combined with higher retail rates. For the
nine months ended September 30, 1998, cable revenues increased $0.5, or 3%,
primarily due to higher retail rates and larger favorable adjustments to prior
months, partially offset by fewer monthly subscribers and some system drops, due
in part to the implementation of Section 505 of the Telecommunications Act. At
September 30, 1998, Playboy TV was available to approximately 11.9 million cable
addressable households, a 9% increase compared to September 30, 1997 and a 2%
decrease compared to June 30, 1998.

     Management believes that the Company's revenues attributable to its
domestic pay television cable services may continue to be materially adversely
affected as a result of enforcement of Section 505, which commenced May 18,
1997, due to reduced buy rates from the systems that roll back carriage to a
10:00 p.m. start time, subscriber declines and reduced

                                       13
<PAGE>
 
carriage from cable operators due to aggressive competition for carriage from
all program suppliers. The Company has estimated that the Entertainment Group's
calendar year 1998 revenues will be reduced by approximately $3.5, and
approximately $25 (discounted to present value at a rate of 6%) over the next
ten years, due to Section 505. These amounts do not take into account the loss
of revenues due to the slowing of access to new homes and of upgrading of old
homes from ten to 24 hours. The Company is pursuing in the United States
District Court in Wilmington, Delaware (the "Delaware District Court") its case
challenging on constitutional grounds the validity of Section 505 and is seeking
a permanent injunction against the enforcement of Section 505. The Company's
full case on the merits was heard by the Delaware District Court in March 1998.
The Company is currently waiting for the Delaware District Court to render a
decision. See "Legal Proceedings."

     Additionally, management believes that the growth in cable access for the
Company's domestic pay television businesses has slowed in recent years due to
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. Further, the delay of new technology, primarily digital set-top
converters which would dramatically increase channel capacity, has contributed
to the slowdown. The major reason for this delay has been the unexpected
engineering problems and expenses associated with developing an affordable
digital set-top converter. Management believes that growth will continue to be
slow in the next two to three years as the cable television industry responds to
the FCC's rules and subsequent modifications, and develops new technology. As
digital technology (which is unaffected by the relevant sections of the
Telecommunications Act) becomes more available, however, the Company believes
that ultimately its pay television networks will be available to the majority of
cable households on a 24-hour basis.

     Satellite direct-to-home ("DTH") revenues increased $1.3, or 18%, for the
quarter and $4.4, or 22%, for the nine-month period. These improvements were
primarily due to significant increases in addressable universes for DirecTV and
PrimeStar, combined with revenues in the current year periods as a result of
calendar year 1998 launches on EchoStar and two Canadian DTH services, ExpressVu
and Star Choice. DTH is unaffected by Section 505. Revenues from TVRO, or the
big-dish market, continued to decline, as expected, due to the maturity of this
platform. Playboy TV was available to approximately 9.2 million DTH households
at September 30, 1998, an increase of 44% and 6% compared to September 30, 1997
and June 30, 1998, respectively.

     Revenues from off-network productions and other decreased $0.7 for the
quarter and $1.2 for the nine-month period primarily due to revenues in the
prior year periods from licensing episodes of Women: Stories of Passion to
Showtime Networks Inc.

     Profit contribution for Playboy TV increased $0.7 for the quarter and $2.0
for the nine-month period primarily due to the net increases in revenues
discussed above, partially offset by higher marketing expenses. The current year
quarter also included legal fees related to the Section 505 lawsuit. The nine-
month comparison also reflected expenses in the prior year for a pay-per-view
special featuring Farrah Fawcett and favorable music licensing settlements and
an adjustment to bad debt in the prior year.

Domestic Home Video

     Domestic home video revenues and profit contribution increased $1.5 and
$1.4, respectively, for the quarter ended September 30, 1998, and increased $2.6
and $2.5, respectively, for the nine months ended September 30, 1998, compared
to the prior year. These increases were primarily due to sales of The Eros
Collection of movies and higher revenues from the sale of digital video discs
("DVDs") in the current year periods. For the quarter, partially offsetting the
above were sales in the prior year of Farrah Fawcett: All of Me.

                                       14
<PAGE>
 
International TV and Home Video

     For the quarter ended September 30, 1998, profit contribution from the
international business increased $0.3 primarily due to higher international home
video revenues. For the nine months ended September 30, 1998, revenues and
profit contribution from the international business decreased $1.4 and $1.7,
respectively, primarily due to lower international television and home video
sales, partially offset by higher international network sales and contractual
revenues. Variations in quarterly performance are caused in part by revenues and
profit contribution from tier sales being recognized depending upon the timing
of program delivery, license periods and other factors.

Playboy Businesses Programming Expense

     Programming amortization expense associated with the Entertainment Group's
Playboy businesses discussed above remained flat for the quarter and decreased
$1.0 for the nine-month period. The decrease for the nine-month comparison was
primarily due to the net decrease in international revenues discussed above.

AdulTVision

     AdulTVision revenues increased $0.4 for the quarter and $1.1 for the nine-
month period compared to the prior year. These increases were primarily due to
higher revenues from the domestic network principally as a result of a
significant increase in the addressable universe. At September 30, 1998, the
network was available domestically to approximately 9.7 million cable
addressable and DTH households, an increase of 76% and 2% compared to September
30, 1997 and June 30, 1998, respectively. Operating income increased $0.3 for
the quarter and $0.4 for the nine-month period primarily due to the increases in
revenues discussed above, partially offset by increased distribution costs. The
nine-month comparison also reflected higher contractual marketing costs in the
current year.

Movies and Other

     Operating income from movies and other businesses remained relatively
stable for both the quarter and nine months ended September 30, 1998, as
revenues decreased $0.2 for the quarter and remained stable for the nine-month
period. The Entertainment Group's administrative expenses increased $0.3 for the
quarter and remained flat for the nine-month period compared to the prior year.
The higher expenses for the quarter comparison were primarily due to higher
performance-related variable compensation and new business development expenses.

Product Marketing Group

     The revenues and operating performance of the Product Marketing Group were
as follows for the periods indicated below:

<TABLE>
<CAPTION>
                                       Quarters          Nine Months
                                         Ended              Ended
                                     September 30,      September 30,
                                     -------------      -------------
                                      1998    1997      1998     1997
                                     -----    ----      ----     ----
<S>                                  <C>      <C>       <C>      <C>
  Revenues........................   $ 1.6    $2.4      $5.8     $6.1
                                     =====    ====      ====     ====

  Operating Income (Loss).........   $(1.0)   $1.5      $0.1     $2.8
                                     =====    ====      ====     ====
</TABLE>

     Revenues decreased $0.8, or 35%, for the quarter and $0.3, or 5%, for the
nine-month period compared to the prior year. Both the current year quarter and
nine-month period reflect lower international product licensing royalties,
principally from Asia. Higher revenues from Special Editions, Ltd. ("SEL") as a
result of a barter agreement related to the sale of prints and posters from the
Company's art publishing inventory partially offset the decline for the nine-
month period.

     The Product Marketing Group reported an operating loss of $1.0 for the
quarter ended September 30, 1998 compared to operating income of $1.5 in the
prior year quarter. Operating income of $0.1 for the nine months ended September
30, 1998 decreased $2.7, or 96%, compared to the prior year. The decreases in
the current year periods were largely due to a $1.4 settlement of litigation
related to BrandsElite. See "Legal Proceedings." Also unfavorably impacting the
current year periods were the lower Asian royalties previously discussed. For
the nine-month period, the higher SEL revenues were mostly offset by higher
associated costs.

                                       15
<PAGE>
 
Catalog Group


     The revenues and operating performance of the Catalog Group were as follows
for the periods indicated below:

<TABLE>
<CAPTION>

                                       Quarters        Nine Months
                                         Ended            Ended
                                     September 30,    September 30,
                                     -------------    -------------
                                      1998    1997     1998    1997
                                     -----   -----    -----   -----
<S>                                  <C>     <C>      <C>     <C>
  Revenues........................   $16.3   $14.7    $50.8   $51.0
                                     =====   =====    =====   =====

  Operating Income (Loss).........   $ 0.6   $(0.2)   $ 2.1   $ 1.6
                                     =====   =====    =====   =====
</TABLE>

     Revenues for the quarter ended September 30, 1998 increased $1.6, or 11%,
compared to the prior year largely due to the timing of sales cut-offs resulting
in an additional week of sales recorded in the current year quarter for all of
the catalogs. Sales volume for the Critics' Choice Video catalog was also higher
as a result of sales in the current year quarter from The Big Book of Movies
catalog (the "Big Book"), first available in October 1997. Also favorably
impacting the current year quarter were revenues from the Spice catalog which
launched in July 1998 under license from Spice, containing adult video tapes.
Partially offsetting the above were lower sales volume for the Playboy fall
catalog and the Collectors' Choice Music summer catalog. For the nine months
ended September 30, 1998, revenues remained relatively stable compared to the
prior year. Revenues in the current year from the Big Book and the Spice catalog
discussed above were basically offset by lower sales volume for the quarterly
Critics' Choice Video catalogs, primarily as a result of planned lower
circulation and slightly lower response rates, and the Playboy fall catalog.

     For the quarter ended September 30, 1998, operating performance increased
$0.8 compared to the prior year primarily due to the higher revenues, which were
partially offset by higher related costs. Operating income for the nine months
ended September 30, 1998 increased $0.5, or 35%, compared to the prior year as a
result of  lower expenses due in part to expenses in the prior year related to
the group's move to a new facility.

Casino Gaming Group

     The Company anticipates the opening of the Playboy Casino and Beach Hotel
in Rhodes, Greece by the end of calendar year 1998 or the first quarter of
calendar year 1999. The Company is also exploring additional casino gaming
opportunities. Operating losses of $0.2 and $0.6, respectively, were reported
for the quarter and nine months ended September 30, 1998 as a result of staffing
and overhead costs.

Playboy Online Group

     Beginning with the quarter ended March 31, 1998, Playboy Online results,
which were previously reported in the Publishing and Catalog Groups, are
reported as a separate operating group. The group's results include advertising
sales from Playboy.com, the Company's free site on the Internet; subscription
sales to Playboy Cyber Club, the Company's pay site on the Internet; and e-
commerce sales. The revenues and operating losses of the Playboy Online Group
were as follows for the periods indicated below:

<TABLE>
<CAPTION>
                                       Quarters          Nine Months
                                         Ended              Ended
                                     September 30,      September 30,
                                     -------------      -------------
                                      1998    1997       1998    1997
                                     -----   -----      -----   -----
<S>                                  <C>     <C>        <C>     <C>
  Revenues.........................  $ 1.8   $ 0.9      $ 4.8   $ 2.4
                                     =====   =====      =====   =====

  Operating Loss...................  $(2.1)  $(0.5)     $(4.3)  $(0.7)
                                     =====   =====      =====   =====
</TABLE>

     Playboy Online Group revenues doubled for both the quarter and nine-month
period compared to the prior year. These increases come from higher subscription
revenues related to Playboy Cyber Club, which launched in the summer of

                                       16
<PAGE>

1997, combined with higher e-commerce revenues primarily due to the launches of
CCVideo and CCMusic, online versions of the Critics' Choice Video and
Collectors' Choice Music catalogs, in the fall and summer of 1997, respectively.

     For the quarter and nine months ended September 30, 1998, the Playboy
Online Group reported operating losses of $2.1 and $4.3, respectively, compared
to operating losses of $0.5 and $0.7 in the prior year quarter and nine-month
period, respectively. The current year quarter and nine-month period included
higher planned investments related to the group's continued growth and
development.

Corporate Administration and Promotion

     Corporate administration and promotion expenses of $6.9 for the quarter and
$17.3 for the nine-month period both increased $2.4 compared to the prior year
periods. These increases were primarily due to increased investments in systems
technology, including Year 2000 expenses, combined with increased investment
spending on corporate marketing and promotion.

LIQUIDITY AND CAPITAL RESOURCES

     At September 30, 1998, the Company had $2.2 in cash and cash equivalents
and $29.0 in short-term borrowings, compared to $0.9 in cash and cash
equivalents and $10.0 in short-term borrowings at December 31, 1997. The Company
expects to finance its short- and long-term cash requirements through its
revolving credit agreement, cash generated from operations and additional
facilities.

Cash Flows From Operating Activities

     Net cash used for operating activities was $14.1 for the nine months ended
September 30, 1998 compared to net cash provided of $3.9 for the prior year. The
Company reported a net loss of $0.6 in the current year compared to net income
of $5.1 in the prior year, excluding the $13.5 federal income tax benefit
recorded in the prior year. Cash used for operating assets and liabilities was
$14.8 in the current year compared to $13.1 in the prior year, despite the
increase in the net deferred tax asset in the prior year which offset the
federal income tax benefit. Cash used for accounts receivable in the current
year compared to cash provided in the prior year was largely due to the higher
revenues from domestic home video and international TV networks combined with
the timing of cash receipts from the Entertainment Group's domestic home video
and international businesses. The Company invested $18.2 in Company-produced and
licensed entertainment programming during the current year compared to $22.8 in
the prior year, and expects to invest approximately $8.4 in such programming
during the remainder of calendar year 1998.

Cash Flows From Investing Activities

     Net cash used for investing activities was $4.1 for the nine months ended
September 30, 1998 compared to $1.9 in the prior year largely due to a loan to
one of the Company's international ventures in the current year period.

Cash Flows From Financing Activities

     Net cash provided by financing activities was $19.4 for the nine months
ended September 30, 1998 compared to net cash used of $2.5 for the prior year.
This increase was principally due to a $19.0 increase in the level of short-term
borrowings under the Company's revolving line of credit in the current year to
finance ongoing operations, compared to a $3.0 decrease in the level of short-
term borrowings in the prior year.

Income Taxes

     Based on current tax law, the Company will need to generate approximately
$41.2 of future taxable income prior to the expiration of the Company's NOLs for
full realization of the $14.0 net deferred tax asset recorded at December 31,
1997. At December 31, 1997, the Company had NOLs of $23.2 for tax purposes, with
$1.1 expiring in 2004, $2.1 expiring in 2007, $1.1 expiring in 2008, $16.4
expiring in 2009 and $2.5 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, 1997 and prior to the expiration of the Company's NOLs to realize the $14.0
net deferred tax asset at December 31, 1997. The Company's net deferred tax
asset declined to $13.5 at September 30, 1998 based on taxable income for the
current nine-month period and management's projection of calendar year 1998
taxable income. Following is a summary of the bases for management's belief that
a valuation allowance of $16.5 at December 31, 1997 is adequate, and that it is
more likely than not that the net deferred tax asset of $14.0 at December 31,
1997 will be realized:

                                      17
<PAGE>
 
 . 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.

 . Several of the Company's operating groups continue to generate meaningful
  earnings, particularly the Entertainment Group, and the Company's substantial
  investments in the Entertainment and Playboy Online Groups are anticipated to
  lead to increased earnings in future years.

 . 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.

Other

     In January 1993, the Company received a General Notice from the EPA as a
PRP in connection with a site identified as the Southern Lakes Trap & Skeet
Club, located at the Resort, formerly owned by a subsidiary of the Company. The
Resort was sold by the Company's subsidiary to LG Americana-GKP Joint Venture in
1982. Two other entities were also identified as PRPs in the notice. The notice
relates to actions that may be ordered taken by the EPA to sample for and remove
contamination in soils and sediments, purportedly caused by skeet shooting
activities at the Resort property. During fiscal year 1994, the EPA advised the
Company of its position that the area of land requiring remediation is
approximately twice the size of the initial site. The Company believes that it
has established adequate reserves, which totaled $0.6 at September 30, 1998, to
cover the eventual cost of its anticipated share (based on an agreement with one
of the other PRPs) of any agreed upon remediation.

     On December 18, 1995, BrandsElite, an Ontario, Canada corporation, filed a
complaint against the Company in the Circuit Court of Cook County, Illinois (the
"Illinois Circuit Court"). In the complaint, BrandsElite, an international
distributor of premium merchandise, including liquor, perfume, cosmetics and
luxury gifts, principally to duty-free retailers, alleged that the Company
breached a product license agreement, shortly after its execution by the Company
in October 1995. The agreement provided for the appointment of BrandsElite as
the exclusive, worldwide licensee of the Playboy trademark and tradename with
respect to the sale of cognac and possibly some deluxe whiskeys. The Company had
advised BrandsElite that it had determined not to proceed with the transaction
and disputed strongly BrandsElite's allegation that as a result of the Company's
breach, BrandsElite suffered millions of dollars of damages in future lost
profits and diminished value of its stock. BrandsElite also sought to recoup
out-of-pocket expenses, fees and costs incurred in bringing the action. The
license agreement provided for recovery by a party in any judgment entered in
its favor of attorneys' fees and litigation expenses, together with such court
costs and damages as are provided by law. On October 22, 1997, the Company filed
a motion for partial summary judgment challenging BrandsElite's claims for
future lost profits and stock market valuation damages. On March 4, 1998, the
Illinois Circuit Court granted the portion of the Company's motion relating to
stock market valuation damages but denied the portion of the motion relating to
future lost profits. BrandsElite's expert reports on damages asserted future
lost profits damages ranging from $3.5 to $12.5. The case was dismissed with
prejudice on October 16, 1998 in exchange for a settlement payment by the
Company of $1.4.

   The Company will adopt the provisions of Statement 130, Reporting
Comprehensive Income Summary for financial statements issued for fiscal years
beginning after December 15, 1997. Statement 130 establishes standards for
reporting and display of comprehensive income and its components (revenues,
expenses, gains and losses) in a full set of general-purpose financial
statements. Management is evaluating the effect that adoption of Statement 130
will have on the Company's financial statements.

   The Company will adopt the provisions of Statement 131, Disclosures about
Segments of an Enterprise and Related Information for financial statements
issued for periods beginning after December 15, 1997. Statement 131, which is
based on the management approach to segment reporting, includes requirements to
report selected segment information quarterly and entity-wide disclosures about
products and services, major customers, and the material countries in which the
entity holds assets and reports revenues. Management is evaluating the effect
that adoption of Statement 131 will have on the Company's financial statements.


                                      18
<PAGE>


     The Company will adopt the provisions of Statement 133, Accounting for
Derivative Instruments and Hedging Activities, for financial statements issued
for fiscal years beginning after June 15, 1999. Statement 133 provides a
comprehensive and consistent standard for the recognition and measurement of
derivatives and hedging activities. Management is evaluating the effect that
adoption of Statement 133 will have on the Company's financial statements.

     In response to the Year 2000 problem, the Company has begun to identify,
evaluate and implement 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 is communicating with its vendors and other service providers to
ensure that their products and business systems will be Year 2000 compliant. If
modifications and conversions by the Company and those it conducts business with
were not made in a timely manner, the Year 2000 problem could have a material
adverse affect on the Company's business, financial condition and results of
operations. Certain key systems of the Company have already been identified as
Year 2000 compliant, including financial applications and Playboy Online
operations. Although the Company is still quantifying the impact, the current
estimate of the total costs associated with the required modifications and
conversions are expected to be approximately $1.0, of which approximately $0.7
is expected to be expensed in calendar year 1998. These costs are being expensed
as incurred.

     As a contingency plan for the most reasonably likely worst case scenario,
the Company has addressed all major elements related to this issue. The Company
believes its technology systems will be ready for the Year 2000, but the Company
may experience isolated incidences of non-compliance. The Company plans to
allocate internal resources and retain dedicated consultants and vendor
representatives to be ready to take action if these events occur. 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 obtainable from other vendors. The Company also recognizes the
risks if other key suppliers in utilities, communications, transportation,
banking and government are not ready for the Year 2000, and is approaching this
issue in the same manner.

FORWARD-LOOKING STATEMENTS

     This Form 10-Q 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. Such 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) further
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
advertisers from other publications and media or any significant decrease in
spending by advertisers generally or with respect to the adult male market, (5)
increased competition for transponders and channel space and any decline in the
Company's access to, and acceptance by, cable and DTH systems, (6) the effects
of the consolidation taking place nationally in the single-copy magazine
distribution system, (7) new competition in the adult cable television market,
(8) uncertainty of market acceptance of the Internet as a medium for
information, entertainment, e-commerce and advertising, an increasingly
competitive environment for advertising sales, the impact of competition from
other content and merchandise providers, as well as the Company's reliance on
third parties for technology and distribution for its online business, and (9)
potential adverse effects of unresolved Year 2000 problems including external
key suppliers.

          QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

     This disclosure is currently not required as the Company's market
capitalization was less than $2.5 billion as of January 28, 1997.

                                       19
<PAGE>
 
                               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. Based on the limited information received, the Company believes
that most of the cable operators that were not in compliance with Section 505
have complied by restricting the hours of transmission.

     On February 26, 1996, one of the Company's subsidiaries filed a civil suit
in the Delaware District Court challenging Section 505 on constitutional
grounds. The suit names as defendants The United States of America, The United
States Department of Justice, Attorney General Janet Reno and the FCC. On March
7, 1996, the Company was granted a Temporary Restraining Order ("TRO") staying
the implementation and enforcement of Section 505. In granting the TRO, the
Delaware District Court found that the Company had demonstrated it was likely to
succeed on the merits of its claim that Section 505 is unconstitutional. On
November 8, 1996, eight months after the TRO was granted, a three-judge panel in
the Delaware District Court denied the Company's request for preliminary
injunction against enforcement of Section 505 and, in so denying, found that the
Company was not likely to succeed on the merits of its claim. The Company
appealed the Delaware District Court's decision to the Supreme Court and
enforcement of Section 505 was stayed pending that appeal. On March 24, 1997,
without opinion, the Supreme Court summarily affirmed the Delaware District
Court's denial of the Company's request for a preliminary injunction. On July
22, 1997, the Company filed a motion for summary judgment on the ground that
Section 505 is unconstitutionally vague based on the Supreme Court's 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.

     Management believes that the Company's revenues attributable to its
domestic pay television cable services may continue to be materially adversely
affected as a result of enforcement of Section 505, which commenced May 18,
1997, due to reduced buy rates from the systems that roll back carriage to a
10:00 p.m. start time, subscriber declines and reduced carriage from cable
operators due to aggressive competition for carriage from all program suppliers.
The Company has estimated that the Entertainment Group's calendar year 1998
revenues will be reduced by approximately $3.5 million, and approximately $25
million (discounted to present value at a rate of 6%) over the next ten years,
due to Section 505. These amounts do not take into account the loss of revenues
due to the slowing of access to new homes and of upgrading of old homes from ten
to 24 hours. The Company is pursuing in the Delaware District Court its case
challenging on constitutional grounds the validity of Section 505 and is seeking
a permanent injunction against the enforcement of Section 505. The Company's
full case on the merits was heard by the Delaware District Court in March 1998.
The Company is currently waiting for the Delaware District Court to render a
decision.

     On December 18, 1995, BrandsElite, an Ontario, Canada corporation, filed a
complaint against the Company in the Illinois Circuit Court. In the complaint,
BrandsElite, an international distributor of premium merchandise, including
liquor, perfume, cosmetics and luxury gifts, principally to duty-free retailers,
alleged that the Company breached a product license agreement, shortly after its
execution by the Company in October 1995. The agreement provided for the
appointment of BrandsElite as the exclusive, worldwide licensee of the Playboy
trademark and tradename with respect to the sale of cognac and possibly some
deluxe whiskeys. The Company had advised BrandsElite that it had determined not
to proceed with the transaction and disputed strongly BrandsElite's allegation
that as a result of the Company's breach, BrandsElite suffered millions of
dollars of damages in future lost profits and diminished value of its stock.
BrandsElite also sought to recoup out-of-pocket expenses, fees and costs
incurred in bringing the action. The license agreement provided for recovery by
a party in any judgment entered in its favor of attorneys' fees and litigation
expenses, together with such court costs and damages as are provided by law. On
October 22, 1997, the Company filed a motion for partial summary judgment
challenging BrandsElite's claims for future lost profits and stock market
valuation damages. On March 4, 1998, the Illinois Circuit Court granted the
portion of the Company's motion relating to stock market valuation damages but
denied the portion of the motion relating to future lost profits. BrandsElite's
expert reports on damages asserted future lost profits damages ranging from $3.5
million to $12.5 million. The case was dismissed with prejudice on October 16,
1998 in exchange for a settlement payment by the Company of $1.4 million.

                                      20
<PAGE>
 
                       EXHIBITS AND REPORTS ON FORM 8-K

(a)  Exhibits

Exhibit
Number                           Description
-------                          -----------

   10.1  Fourth Amendment to February 10, 1995 Credit Agreement by and among
         Playboy Enterprises, Inc., Harris Trust and Savings Bank and LaSalle
         National Bank dated as of November 5, 1998 but effective as of
         September 30, 1998

   27    Financial Data Schedule
_________

(b)  Reports on Form 8-K

     No reports on Form 8-K were filed during the quarter ended September 30,
1998.

                                      21
<PAGE>
 
                                 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 16, 1998        By  /s/  Linda Havard
       --------------------         ------------------------
                                         Linda Havard
                                         Executive Vice President,
                                         Finance and Operations,
                                         and Chief Financial Officer
                                         (Authorized Officer and
                                         Principal Financial and
                                         Accounting Officer)

                                      22