<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 June 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)


<TABLE>
<S>                                                     <C>
                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)
</TABLE> 

                                (312) 751-8000
             (Registrant's telephone number, including area code)


Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. 

                              Yes  X    No 
                                  ---      ---        


As of July 31, 1998, there were 4,748,954 shares of Class A Common Stock, par
value $0.01 per share, and 15,796,847 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

<TABLE> 
<CAPTION> 
                                                                          Page
                                                                          ----
<S>                                                                       <C> 
Item 1.  Financial Statements

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

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

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

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

             Notes to Condensed Consolidated Financial Statements          7-9

Item 2.  Management's Discussion and Analysis of Financial
         Condition and Results of Operations                             10-18

Item 3.  Quantitative and Qualitative Disclosures About Market Risk         18

                                    PART II
                               OTHER INFORMATION

Item 1.  Legal Proceedings                                                  19

Item 5.   Other Information                                                 20

Item 6.  Exhibits and Reports on Form 8-K                                   21
</TABLE> 
                                       2
<PAGE>
 
                  PLAYBOY ENTERPRISES, INC. AND SUBSIDIARIES
                CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
                  for the Quarters Ended June 30 (Unaudited)
                   (In thousands, except per share amounts)

<TABLE>
<CAPTION>
                                                       1998          1997
                                                      -------      --------
<S>                                                   <C>          <C> 
Net revenues                                          $77,820      $ 77,373
                                                      -------      --------

Costs and expenses
  Cost of sales                                       (63,468)      (64,108)
  Selling and administrative expenses                 (10,361)       (9,881)
                                                      -------      --------
    Total costs and expenses                          (73,829)      (73,989)
                                                      -------      --------
Operating income                                        3,991         3,384
                                                      -------      --------

Nonoperating income (expense)
  Investment income                                        17            21
  Interest expense                                       (345)          (41)
  Other, net                                              (37)         (349)
                                                      -------      --------

    Total nonoperating expense                           (365)         (369)
                                                      -------      --------

Income before income taxes                              3,626         3,015

Income tax benefit (expense)                           (1,547)       12,007
                                                      -------      --------

Net income                                            $ 2,079      $ 15,022
                                                      =======      ========

Weighted average number of common shares outstanding

  Basic                                                20,541        20,362
                                                      =======      ========
  Diluted                                              21,111        20,855
                                                      =======      ========


Net income per common share

  Basic                                               $  0.10      $   0.74
                                                      =======      ========

  Diluted                                             $  0.10      $   0.72
                                                      =======      ========

</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 Six Months Ended June 30 (Unaudited)
                   (In thousands, except per share amounts)

<TABLE>
<CAPTION>

                                                          1998           1997
                                                       ---------      ---------
<S>                                                    <C>            <C>
Net revenues                                           $ 149,582      $ 150,620
                                                       ---------      ---------

Costs and expenses
  Cost of sales                                         (125,228)      (122,961)
  Selling and administrative expenses                    (19,119)       (19,608)
                                                       ---------      ---------
     Total costs and expenses                           (144,347)      (142,569)
                                                       ---------      ---------

Operating income                                           5,235          8,051
                                                       ---------      ---------


Nonoperating income (expense)
  Investment income                                           51             38
  Interest expense                                          (560)          (128)
  Other, net                                                (456)          (542)
                                                       ---------      ---------

    Total nonoperating expense                              (965)          (632)
                                                       ---------      ---------

Income before income taxes                                 4,270          7,419

Income tax benefit (expense)                              (2,131)        10,113
                                                       ---------      ---------

Net income                                             $   2,139      $  17,532
                                                       =========      =========

Weighted average number of common shares outstanding

  Basic                                                   20,536         20,346
                                                       =========      =========
  Diluted                                                 21,073         20,843
                                                       =========      =========

Net income per common share

  Basic                                                $    0.10      $    0.86
                                                       =========      =========
  Diluted                                              $    0.10      $    0.84
                                                       =========      =========
</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)
                                                                             June 30,   Dec. 31,
                                                                               1998      1997
                                                                            ----------- --------
<S>                                                                         <C>         <C>
Assets
 Cash and cash equivalents                                                   $    980   $    947
 Receivables, net of allowance for doubtful accounts of
  $5,551 and $4,467, respectively                                              38,086     33,324
 Inventories                                                                   27,896     25,376
 Programming costs                                                             41,703     41,504
 Deferred subscription acquisition costs                                       11,455     12,143
 Other current assets                                                          11,963     11,910
                                                                             --------   --------
  Total current assets                                                        132,083    125,204
                                                                             --------   --------
 Property and equipment, at cost                                               38,663     37,945
 Accumulated depreciation                                                     (28,879)   (27,892)
                                                                             --------   --------
  Property and equipment, net                                                   9,784     10,053
                                                                             --------   --------
 Programming costs - noncurrent                                                 9,398      8,329
 Trademarks                                                                    15,853     14,978
 Net deferred tax assets                                                       12,993     13,688
 Other noncurrent assets                                                       16,404     13,695
                                                                             --------   --------
 Total assets                                                                $196,515   $185,947
                                                                             ========   ========
Labilities
 Short-term borrowings                                                       $ 21,500   $ 10,000
 Accounts payable                                                              30,670     32,258
 Accrued salaries, wages and employee benefits                                  3,178      4,499
 Reserves for losses on disposals of discontinued operations                      609        610
 Income taxes payable                                                             984        627
 Deferred revenues                                                             42,531     43,216
 Other liabilities and accrued expenses                                         7,344      7,706
                                                                             --------   --------
  Total current liabilities                                                   106,816     98,916

 Other noncurrent liabilities                                                   8,642      8,348
                                                                             --------   --------
  Total liabilities                                                           115,458    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; 17,103,810
   and 17,076,518 issued, respectively                                            171        171
 Capital in excess of par value                                                44,057     43,539
 Retained earnings                                                             47,396     45,257
 Foreign currency translation adjustment                                         (141)      (131)
 Unearned compensation restricted stock                                        (3,823)    (3,511)
 Less cost of treasury stock                                                   (6,653)    (6,692)
                                                                             --------   --------
  Total shareholders' equity                                                   81,057     78,683
                                                                             --------   --------
 Total liabilities and shareholders' equity                                  $196,515   $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 Six Months Ended June 30 (Unaudited)
                                 (In thousands)
<TABLE>
<CAPTION>
                                                               1998       1997
                                                             ---------  ---------
<S>                                                          <C>        <C>
Cash Flows From Operating Activities
Net income                                                   $  2,139   $ 17,532
Adjustments to reconcile net income to net cash
  provided by (used for) operating activities:
   Depreciation of property and equipment                       1,002      1,075
   Amortization of intangible assets                              870        990
   Amortization of investments in entertainment programming    11,064     11,736
   Investments in entertainment programming                   (12,332)   (15,229)
   Net change in operating assets and liabilities             (12,437)    (8,122)
   Net cash used for discontinued operations                       (1)       (61)
   Other, net                                                       6        744
                                                             --------   --------
     Net cash provided by (used for) operating activities      (9,689)     8,665
                                                             --------   --------
Cash Flows From Investing Activities
Additions to property and equipment                              (756)      (240)
Acquisitions and funding of equity
 interests in international ventures                           (1,274)    (1,174)
Other, net                                                         23         21
                                                             --------   --------
     Net cash used for investing activities                    (2,007)    (1,393)
                                                             --------   --------
Cash Flows From Financing Activities
Increase (decrease) in short-term borrowings                   11,500     (7,500)
Proceeds from exercise of stock options                           123        369
Proceeds from sales under employee stock purchase plan            106        101
                                                             --------   --------
     Net cash provided by (used for) financing activities      11,729     (7,030)
                                                             --------   --------
Net increase in cash and cash equivalents                          33        242
Cash and cash equivalents at beginning of period                  947      1,061
                                                             --------   --------
Cash and cash equivalents at end of period                   $    980   $  1,303
                                                             ========   ========
</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 (the "Transition Report") of Playboy Enterprises, Inc. and
   its subsidiaries (the "Company").



(B)   INCOME TAXES



   The Company's net deferred tax asset declined to $13.3 million at June 30,
   1998 based on taxable income for the current six-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
   $13.3 million and $14.0 million net deferred tax assets included in the
   Condensed Consolidated Balance Sheets at June 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 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         Six Months Ended
                                                            June 30,                June 30,
                                                         --------------         -----------------
                                                         1998      1997           1998     1997
-------------------------------------------------------------------------------------------------
<S>                                                    <C>       <C>           <C>       <C>
Numerator:
     For basic and diluted EPS--net income
       available to common shareholders              $ 2,079   $15,022      $ 2,139     $17,532
=================================================================================================

Denominator:
     Denominator for basic EPS--
       weighted-average shares                        20,541    20,362       20,536      20,346
-------------------------------------------------------------------------------------------------
     Effect of dilutive potential common shares:
        Stock options                                    570       377          537         377
        Nonvested restricted stock awards                  -       116            -         120
-------------------------------------------------------------------------------------------------
          Dilutive potential common shares               570       493          537         497
-------------------------------------------------------------------------------------------------
     Denominator for diluted EPS--
        adjusted weighted-average shares              21,111    20,855       21,073      20,843
=================================================================================================
Basic EPS                                            $  0.10   $  0.74      $  0.10     $  0.86
=================================================================================================
Diluted EPS                                          $  0.10   $  0.72      $  0.10     $  0.84
=================================================================================================
</TABLE>


   During the quarter and six months ended June 30, 1998, approximately 340,000
   weighted-average shares of Class B restricted stock awards outstanding 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, an option to purchase approximately 7,500 and 3,750
   weighted-average shares of Class B common stock was outstanding during the
   quarter and six months ended June 30, 1998, respectively, but was not
   included in the computation of diluted EPS as the option's exercise price was
   greater than the average market price of the Class B common stock, the effect
   of which was antidilutive.


(D)  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)
                                                 June 30,    Dec. 31,
                                                   1998       1997
                                                   ----       ----
<S>                                              <C>         <C>
     Paper                                       $ 9,618     $ 7,573
     Editorial and other prepublication costs      6,825       6,002
     Merchandise finished goods                   11,453      11,801
                                                 -------     -------

     Total inventories                           $27,896     $25,376
                                                 ========    =======
</TABLE>


(E)  TREASURY STOCK

   Treasury stock consisted of 293,427 Class A common shares and 966,601 Class B
   common shares at June 30, 1998. At December 31, 1997, treasury stock
   consisted of 293,427 Class A common shares and 974,227 Class B common shares.

                                       8
<PAGE>
 
(F)  ACCOUNTING STANDARDS

     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 currently evaluating the effect that
     adoption of Statement 133 will have on the Company's financial statements.

(G)  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 June 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.

(H)  SUBSEQUENT EVENT

     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 is
     awaiting comments on the preliminary proxy materials from the staff of the
     SEC and expects this transaction to close in the fourth quarter of calendar
     year 1998.

                                       9
<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 $77.8 for the quarter ended June 30,
1998 compared to $77.4 for the quarter ended June 30, 1997. For the six months
ended June 30, 1998, revenues decreased to $149.6 compared to $150.6 for the six
months ended June 30, 1997. Revenues for the Entertainment and Playboy Online
Groups were higher for both the current year quarter and six-month period. These
increases were mostly offset in the current year quarter and more than offset in
the six-month period by lower Publishing and Catalog Group revenues.

     The Company reported operating income of $4.0 for the quarter ended June
30, 1998 compared to $3.4 in the prior year quarter. For the six months ended
June 30, 1998, the Company's operating income was $5.2 compared to $8.1 in the
prior year. The current year quarter reflected higher operating income for the
Entertainment Group, which was partially offset by planned increased investments
in the Playboy Online Group, lower operating income for the Publishing Group and
higher Corporate Administration and Promotion expenses. The six-month period
also reflected higher operating income for the Entertainment Group which was
more than offset by planned increased investments in the Playboy Online Group
and lower operating income for the Publishing Group.

     Net income for the quarter ended June 30, 1998 was $2.1, or basic and
diluted EPS of $0.10, compared to $15.0, or basic EPS of $0.74 and diluted EPS
of $0.72, for the prior year quarter. Net income for the quarter ended June 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 quarter ended June 30, 1997 was $1.5, or basic EPS
of $0.08 and diluted EPS of $0.07. Net income for the six months ended June 30,
1998 was $2.1, or basic and diluted EPS of $0.10, compared to $17.5, or basic
EPS of $0.86 and diluted EPS of $0.84, for the prior year. Excluding the impact
of the federal income tax benefit, net income for the six months ended June 30,
1997 was $4.0, or basic EPS of $0.20 and diluted EPS of $0.19.

     Net income for the quarters ended June 30, 1998 and 1997, adjusted to
eliminate noncash federal income tax expense and a noncash net federal income
tax benefit, respectively, due to the Company's NOLs and tax credit
carryforwards ("tax-adjusted net income"), was $2.6, or basic EPS of $0.13 and
diluted EPS of $0.12, and $2.3, or basic and diluted EPS of $0.11, respectively.
For the six months ended June 30, 1998, tax-adjusted net income was $2.8, or
basic EPS of $0.14 and diluted EPS of $0.13, compared to $6.1, or basic EPS of
$0.30 and diluted EPS of $0.29, for the six months ended June 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.

Publishing Group

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

<TABLE>
<CAPTION>
                                               Quarters        Six Months
                                                Ended             Ended
                                               June 30,         June 30,
                                             1998   1997       1998   1997
                                             -----  ----       ----   ----
<S>                                          <C>    <C>       <C>    <C> 
  Revenues
  Playboy Magazine......................     $27.2  $28.9     $51.2  $53.2
  Other Domestic Publishing.............       4.6    5.3       8.4   10.3
  International Publishing..............       3.0    2.3       5.2    4.7
                                             -----  -----     -----  -----
   Total Revenues.......................     $34.8  $36.5     $64.8  $68.2
                                             =====  =====     =====  =====

  Operating Income......................      $2.9  $ 3.4     $ 3.1  $ 5.0
                                             =====  =====     =====  =====
</TABLE> 

                                       10
<PAGE>
 
     Publishing Group revenues decreased $1.7, or 5%, and $3.4, or 5%,
respectively, for the quarter and six months ended June 30, 1998 compared to the
prior year. These decreases were primarily due to lower revenues from Playboy
magazine and newsstand specials, partially offset by higher international
publishing revenues.



     For the quarter and six months ended June 30, 1998, Playboy magazine
revenues declined $1.7, or 6%, and $2.0, or 4%, respectively, compared to the
prior year. Playboy magazine circulation revenues decreased $1.3 for both the
quarter and six months ended June 30, 1998 primarily due to $0.9, or 17%, and
$2.2, or 23%, decreases, respectively, in newsstand revenues principally as a
result of 23% fewer U.S. and Canadian newsstand copies sold in both periods.
These lower newsstand revenues are due in part to the consolidation taking place
nationally in the single-copy magazine distribution system which the Company
expects will continue to adversely affect newsstand revenues. For the quarter
and six-month period, subscription revenues decreased $0.4, or 3%, and increased
$0.9, or 3%, respectively. Advertising revenues were $0.3, or 4%, lower for the
quarter and $1.1, or 7%, lower for the six-month period primarily due to 5% and
8% fewer ad pages, respectively. Advertising sales for the calendar year 1998
third quarter issues of the magazine are closed, and the Company expects to
report 5% more ad pages and 1% higher ad revenues compared to the quarter ended
September 30, 1997. Licensing revenues of $0.6 favorably impacted the current
year six-month period.

     Revenues from other domestic publishing businesses decreased $0.7, or 13%,
and $1.9, or 19%, for the quarter and six months ended June 30, 1998,
respectively, compared to the prior year. These decreases were primarily due to
lower revenues from newsstand specials principally due to fewer copies sold in
the current year periods due in part to the previously mentioned consolidation
in the single-copy distribution system.

     International publishing revenues increased $0.7, or 27%, and $0.5, or 10%,
for the quarter and six months ended June 30, 1998, respectively, compared to
the prior year primarily due to higher royalties from Brazil and Russia combined
with higher revenues from the Polish edition of Playboy magazine, in which the
Company owns a majority interest.

     For the quarter and six months ended June 30, 1998, Publishing Group
operating income decreased $0.5, or 14%, and $1.9, or 38%, respectively,
compared to the prior year primarily due to the net decreases in revenues
discussed above combined with higher average paper prices. Operating income in
calendar year 1998 is expected to be materially adversely impacted by an average
paper price increase of approximately 5%. Partially offsetting the above were
lower editorial costs combined with lower group administrative expenses which
were primarily due to performance-related variable compensation expenses in the
prior year periods.

     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
oriented written or videotaped 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. The Military Act, if found
applicable to the Company's products, would prohibit the sale of Playboy
magazine, newsstand specials and some videos at commissaries, PX's and ship
stores, and would adversely affect the portion of the Company's sales
attributable to such products. Based on preliminary estimates and current sales
levels at such locations, the Company believes that any such impact would be
immaterial.

                                       11
<PAGE>
 
Entertainment Group

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

<TABLE>
<CAPTION>
                                                Quarters        Six Months
                                                 Ended            Ended
                                                June 30,         June 30,
                                              -----------      ------------
                                              1998   1997      1998    1997
                                              ----   ----      ----    ----
<S>                                          <C>     <C>     <C>      <C>
Revenues
Playboy TV
  Cable....................................  $ 5.1   $ 5.1   $ 10.5   $ 10.8
  Satellite Direct-to-Home.................    8.4     7.1     16.3     13.1
  Off-Network Productions and Other........    0.3     0.8      0.5      1.1
                                             -----   -----   ------   ------
  Total Playboy TV.........................   13.8    13.0     27.3     25.0
  Domestic Home Video......................    4.3     1.5      5.8      4.6
  International TV and Home Video..........    4.1     5.6      5.8      7.9
                                             -----   -----   ------   ------
  Total Playboy Businesses.................   22.2    20.1     38.9     37.5
  AdulTVision..............................    1.4     1.0      2.8      2.1
  Movies and Other.........................    1.2     0.5      1.4      1.2
                                             -----   -----   ------   ------
   Total Revenues..........................  $24.8   $21.6   $ 43.1   $ 40.8
                                             =====   =====   ======   ======

  Operating Income
  Profit Contribution Before
   Playboy Businesses Programming Expense..  $13.1   $10.9   $ 22.6   $ 21.7
  Playboy Businesses Programming Expense...   (5.5)   (6.6)   (10.1)   (11.1)
                                             -----   -----   ------   ------
   Total Operating Income..................  $ 7.6   $ 4.3   $ 12.5   $ 10.6
                                             =====   =====   ======   ======
</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 branded domestic pay television service,
Playboy TV, were $0.8, or 6%, and $2.3, or 9%, higher, respectively, for the
quarter and six months ended June 30, 1998 compared to the prior year.

     Cable revenues remained stable for the quarter ended June 30, 1998. For the
six months ended June 30, 1998, cable revenues decreased $0.3, or 3%, primarily
due to the estimated negative effect of the enforcement of Section 505 of the
Telecommunications Act of 1996 (the "Telecommunications Act"), including a
decline in the average number of subscribing households due to some system
drops, partially offset by higher retail rates. In addition, the prior year
included revenues from a pay-per-view special event featuring Farrah Fawcett. At
June 30, 1998, Playboy TV was available to approximately 12.1 million cable
addressable households, an 8% and 7% increase compared to June 30, 1997 and
March 31, 1998, respectively.

     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, 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. There can be no assurance that the Delaware District Court
will grant an injunction. 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

                                      12
<PAGE>
 
(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. Management believes that growth will continue
to be affected in the near term 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 19%, and $3.2,
or 24%, respectively, for the quarter and six months ended June 30, 1998. 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 recent 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 8.7 million
DTH households, including approximately 0.3 million monthly subscribers, at June
30, 1998, an increase of 38% and 4% compared to June 30, 1997 and March 31,
1998, respectively.

     Revenues from off-network productions and other decreased $0.5 and $0.6,
respectively, for the quarter and six months ended June 30, 1998 primarily due
to revenues in the prior year periods from licensing episodes of Women: Stories
of Passion, one of the Company's series, to Showtime Networks Inc.

     Profit contribution for Playboy TV increased $0.7 and $1.4, respectively,
for the quarter and six months ended June 30, 1998, primarily due to the net
increases in revenues discussed above. Expenses in the prior year related to the
Section 505 lawsuit and the special event featuring Farrah Fawcett were offset
by higher marketing costs in the current year, principally related to DTH
services, and a favorable adjustment to bad debt expense in the prior year. Also
unfavorably impacting the six-month comparison were favorable music licensing
settlements in the prior year.

Domestic Home Video

     Domestic home video revenues and profit contribution increased $2.8 and
$2.7, respectively, for the quarter ended June 30, 1998, and increased $1.2 and
$1.1, respectively, for the six months ended June 30, 1998, compared to the
prior year. The increases in the current year quarter were primarily due to a
guarantee related to a backlist distribution agreement with Universal Music &
Video Distribution, Inc. ("Uni") which was recently renewed, extending the
agreement through June 2001. Both the current year quarter and six-month period
reflected higher sales of new releases, including sales in the current year of
The Eros Collection, non-Playboy-branded movies.

International TV and Home Video

     For the quarter and six months ended June 30, 1998, profit contribution
from the international TV and home video business decreased $1.3 and $2.0,
respectively, primarily due to revenue decreases of $1.5 and $2.1, respectively.
These decreases were primarily due to lower international television and home
video sales, partially offset by higher sales and contractual revenues related
to international networks. 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 decreased $1.1 and $1.0, respectively, for
the quarter and six months ended June 30, 1998, primarily due to the net
decreases in international revenues.

AdulTVision

     AdulTVision revenues increased $0.4 and $0.7, respectively, for the quarter
and six months ended June 30, 1998 compared to the prior year. These increases
were primarily due to higher revenues from the domestic network principally as a
result of an increase in the addressable universe, despite the estimated
negative effect of the enforcement of Section 505 as previously discussed. At
June 30, 1998, the network was available domestically to approximately 9.5
million cable addressable and DTH households, a 79% and 8% increase from June
30, 1997 and March 31, 1998, respectively. Operating income remained stable for
both the quarter and six months ended June 30, 1998 as the increases in revenues
were offset by higher marketing and distribution costs.

                                      13
<PAGE>
 
Movies and Other

     Operating income from movies and other businesses remained relatively
stable for both the quarter and six months ended June 30, 1998, primarily due to
higher revenues of $0.7 and $0.2, respectively, principally related to feature
films, which were offset by higher related costs. The Entertainment Group's
administrative expenses remained stable for the quarter ended June 30, 1998 and
decreased $0.3 for the six months ended June 30, 1998 compared to the prior
year. The lower expenses for the six-month period were primarily due to lower
performance-related variable compensation expense, partially offset by higher
expenses related to new business development.

Product Marketing Group

     The revenues and operating income of the Product Marketing Group were as
follows for the periods indicated below:
<TABLE>
<CAPTION>
                                                Quarters        Six Months
                                                 Ended            Ended
                                                June 30,         June 30,
                                              ------------     ------------
                                              1998    1997     1998    1997
                                              ----    ----     ----    ----
<S>                                           <C>     <C>      <C>     <C>
  Revenues................................    $1.6    $1.7     $4.2    $3.7
                                              ====    ====     ====    ====
  Operating Income........................    $0.4    $0.3     $1.1    $1.3
                                              ====    ====     ====    ====
</TABLE>

     Revenues for the quarter and six months ended June 30, 1998 decreased $0.1,
or 5%, and increased $0.5, or 14%, respectively, compared to the prior year.
Both the current year quarter and six-month period reflect lower international
product licensing royalties, principally from China. The increase in revenues
for the six-month period is principally due to 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.

     Operating income of $0.4 for the quarter ended June 30, 1998 increased
$0.1, or 22%, compared to the prior year quarter due to lower expenses.
Operating income of $1.1 for the six months ended June 30, 1998 decreased $0.2,
or 14%, due to the lower international royalties. The higher SEL revenues were
mostly offset by higher associated costs.

Catalog Group

     The revenues and operating income of the Catalog Group were as follows for
the periods indicated below:
<TABLE>
<CAPTION>
                                                 Quarters       Six Months
                                                  Ended            Ended
                                                June 30,         June 30,
                                               -----------     -----------
                                               1998   1997     1998    1997
                                               ----   ----     ----    ----
<S>                                           <C>     <C>      <C>     <C>
  Revenues................................    $15.1   $16.8    $34.5   $36.3
                                              =====   =====    =====   =====
  Operating Income........................    $ 0.5   $ 0.6    $ 1.6   $ 1.8
                                              =====   =====    =====   =====
</TABLE> 
     Revenues for the quarter and six months ended June 30, 1998, decreased
$1.7, or 10%, and $1.8, or 5%, respectively, compared to the prior year. These
decreases were largely due to a shortened sales cut-off in the current year
periods for all of the catalogs as a result of changing the Company's fiscal
year end. Sales volume for the Critics' Choice Video catalog was also lower as a
result of planned lower circulation as well as slightly lower response rates,
partially offset by sales in the current year periods from the The Big Book of
Movies catalog, first available in October 1997. Higher sales volume for the
Collectors' Choice Music spring catalog partially offset the above for the six-
month comparison.

     For the quarter and six months ended June 30, 1998, operating income
decreased $0.1, or 15%, and $0.2, or 12%, respectively, compared to the prior
year. These decreases were primarily due to the lower revenues which were mostly
offset by lower related costs and lower administrative expenses for the group as
a result of expenses in the prior year related to the group's move to a new
facility. In July 1998, under license from Spice, the Company launched its new
Spice catalog containing quality video entertainment for adults.

                                       14
<PAGE>
 
Casino Gaming Group

     The Company anticipates the opening of the Playboy Casino and Beach Hotel
in Rhodes, Greece in the fourth quarter of calendar year 1998. The Company is
also exploring additional casino gaming opportunities. Expenses of $0.2 and
$0.4, respectively, were incurred in the quarter and six months ended June 30,
1998, principally related to executive staffing and legal 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 now
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 from all of the Company's online catalog offerings. The revenues
and operating loss of the Playboy Online Group were as follows for the periods
indicated below:
<TABLE>
<CAPTION>
                                        Quarters           Six Months
                                         Ended                Ended
                                         June 30,            June 30,
                                      --------------      --------------
                                      1998      1997      1998      1997
                                      ----      ----      ----      ----
<S>                                  <C>       <C>       <C>       <C>
  Revenues........................   $ 1.6     $ 0.8     $ 3.0     $ 1.6
                                     =====     =====     =====     =====

  Operating Loss..................   $(1.5)    $(0.2)    $(2.2)    $(0.2)
                                     =====     =====     =====     =====
</TABLE>
     For the quarter and six months ended June 30, 1998, Playboy Online Group
revenues increased $0.8 and $1.4, respectively, compared to the prior year
primarily due to higher subscription revenues related to Playboy Cyber Club,
which launched in the summer of 1997. Additionally, e-commerce revenues
increased compared to the prior year periods primarily due to the launches of
CCMusic and CCVideo, online versions of the Collectors' Choice Music and
Critics' Choice Video catalogs, in the summer and fall of 1997, respectively.

     For the quarter and six months ended June 30, 1998, the Playboy Online
Group reported operating losses of $1.5 and $2.2, respectively, compared to an
operating loss of $0.2 in both the prior year quarter and six-month period. The
current year quarter and six-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 $5.7 and $10.3 for the
quarter and six months ended June 30, 1998 increased $0.6 and remained stable,
respectively, compared to the prior year periods. Both the current year quarter
and six-month period were impacted by increased investments in systems
technology, Year 2000 and higher consulting expenses and significantly lower
performance-related variable compensation expense.

                                      15
<PAGE>
 
LIQUIDITY AND CAPITAL RESOURCES

     At June 30, 1998, the Company had $1.0 in cash and cash equivalents and
$21.5 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 a revolving credit
agreement, cash generated from operations and additional facilities.

Cash Flows From Operating Activities

     Net cash used for operating activities was $9.7 for the six months ended
June 30, 1998 compared to net cash provided of $8.7 for the prior year. The
Company's net income declined $1.9, excluding the $13.5 federal income tax
benefit recorded in the prior year. Cash used for operating assets and
liabilities was $12.4 in the current year compared to $8.1 in the prior year,
despite the increase in net deferred tax assets 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 timing
of the Uni contract extension and the higher international television network
revenues previously discussed. Cash used for accrued employee costs in the
current year compared to cash provided in the prior year was largely due to the
Company's change in fiscal year end. Cash used for accounts payable in the
current year compared to cash provided in the prior year was primarily related
to Collectors' Choice Music catalog inventory and feature film profit
participants. The Company invested $12.3 in Company-produced and licensed
entertainment programming during the current year compared to $15.2 in the prior
year, and expects to invest approximately $14.4 in such programming during the
remainder of calendar year 1998.

Cash Flows From Investing Activities

     Net cash used for investing activities was $2.0 for the six months ended
June 30, 1998 compared to $1.4 in the prior year.

Cash Flows From Financing Activities

     Net cash provided by financing activities was $11.7 for the six months
ended June 30, 1998 compared to net cash used of $7.0 for the prior year. This
increase was principally due to an $11.5 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 $7.5 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 $13.3 at June 30, 1998 based on taxable income for the current
six-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:

 .    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.

 .    The Company continues to generate meaningful earnings, particularly from
     the Entertainment Group, and the Company's substantial investments in this
     group are anticipated to lead to increased earnings in future years.

                                      16
<PAGE>
 
 .    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 June 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 International Corporation, an Ontario,
Canada corporation ("BrandsElite"), 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, alleges 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 disputes strongly
BrandsElite's allegation that as a result of the Company's breach, BrandsElite
has suffered millions of dollars of damages in future lost profits and
diminished value of its stock. BrandsElite also seeks to recoup out-of-pocket
expenses, fees and costs incurred in bringing the action. The license agreement
provides 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. The action is scheduled to go to trial in September 1998.
BrandsElite's expert reports on damages assert future lost profits damages
ranging from $3.5 to $12.5.

     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 currently 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 early
estimate of the costs associated with required modifications and conversions are
expected to total approximately $2.0, of which approximately $1.0 is expected to
be expensed in calendar year 1998. All of these costs are being expensed as
incurred.

                                      17
<PAGE>
 
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, and (7) new competition in the adult cable television
market.

          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.

                                      18
<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.
There can be no assurance that the Delaware District Court will grant an
injunction.

     On December 18, 1995, BrandsElite 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, alleges 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 disputes strongly BrandsElite's allegation that as a result of the Company's
breach, BrandsElite has suffered millions of dollars of damages in future lost
profits and diminished value of its stock. BrandsElite also seeks to recoup out-
of-pocket expenses, fees and costs incurred in bringing the action. The license
agreement provides 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. The action is scheduled to go to trial in September 1998.
BrandsElite's expert reports on damages assert future lost profits damages
ranging from $3.5 million to $12.5 million.

                                      19
<PAGE>
 
                               OTHER INFORMATION

     The Company in the past has held an annual stockholders' meeting in
November of each year, in preparation for which an annual report reflecting June
30 fiscal year-end results and a proxy statement were circulated (typically in
late September). In November 1997, the Company's fiscal year end was changed
from June 30 to December 31. As a result of the change in fiscal year, the
Company will not hold an annual stockholders' meeting in November 1998 and,
instead, will hold an annual stockholders' meeting in May 1999 (the "1999 Annual
Meeting"). Proposals of stockholders intended to be included in the Company's
proxy statement for the 1999 Annual Meeting pursuant to Rule 14a-8 under the
Securities Exchange Act of 1934 (the "Exchange Act") must be received by the
Company no later than November 1, 1998 (which the Company believes is a
reasonable period of time before April 1, 1999, the date on which the Company
intends to begin to print and mail its proxy materials for the 1999 Annual
Meeting), to be considered for inclusion in the Company's proxy statement and
proxy for the 1999 Annual Meeting. Proposals of stockholders submitted outside
the processes of Rule 14a-8 of the Exchange Act in connection with the 1999
Annual Meeting ("Non-Rule 14a-8 Proposals") must be received by the Company by
January 1, 1999 or such proposals will be considered untimely. The Company's
proxy will give discretionary authority to the proxy holders to vote with
respect to all Non-Rule 14a-8 Proposals received after January 1, 1999 in
connection with the 1999 Annual Meeting. Such proposals and notices should be
addressed to the Secretary, Playboy Enterprises, Inc., 680 North Lake Shore
Drive, Chicago, Illinois 60611 and should be so transmitted by certified mail-
return receipt requested to eliminate controversy as to the date of receipt by
the Company.

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

(a)  Exhibits

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

#10.1    Distribution Agreement dated June 5, 1998 between Playboy Entertainment
         Group, Inc. and Universal Music & Video Distribution, Inc. regarding
         licensing and sale of domestic home video product

 10.2    Selected Company Remunerative Plans

         a   Amended and Restated Deferred Compensation Plan for Employees
             effective January 1, 1998

         b   Amended and Restated Deferred Compensation Plan for Board of
             Directors' effective January 1, 1998

 10.3    Selected Employment, Termination and Other Agreements

        #a   Letter Agreements dated March 16, 1998 and July 20, 1998 regarding
             employment of Buford Smith

         b   Letter Agreement dated March 27, 1998 regarding employment of
             Apostolos D. Kallis

   27    Financial Data Schedule

----------
#    Certain information omitted pursuant to a request for confidential
     treatment filed separately with the SEC

(b)  Reports on Form 8-K

     During the quarter ended June 30, 1998, the Company filed a Current Report
     on Form 8-K dated June 1, 1998 under Item 5 of such report. The purpose of
     this report was for the Company and Spice to announce a definitive merger
     agreement whereby the Company will acquire all of the outstanding shares of
     Spice, subject to the satisfactory completion of various items.

                                      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  August 12, 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