In April 2001, we provided $5 million in financing to Playboy.com, Inc. in the form of an 8% convertible promissory note. The note was automatically converted on August 13, 2001 into shares of Series A Convertible Preferred Stock of Playboy.com. The Series A Convertible Preferred Stock is convertible into common stock of Playboy.com on a one-to-one basis, and may be redeemed at the holder’s option, after five years, and has customary anti-dilution provisions. Holders of the Series A Convertible Preferred Stock will receive a non-cumulative 8% per annum dividend. If Playboy.com is unable to pay the redemption price for the Series A Convertible Preferred Stock, a holder can require payment by Playboy Enterprises, Inc. In this event, Playboy Enterprises, Inc. has the option of making such payment in cash or in shares of its common stock.

Net Cash Provided By (Used In) Financing Activities. We had no significant cash provided by or used in financing activities for either the six-month periods ended June 30, 2002 or June 30, 2001. We have and continue to fund our cash requirements from the net proceeds of a public, follow-on offering completed in February 2000. Through a group of underwriters, we sold a total of 4.6 million common shares, resulting in net proceeds of $129.4 million. In addition, on March 27, 2000, Liberty Digital, Inc. invested an additional $20 million in us by exercising a warrant granted in March 1999, and OpenTV invested $10 million in our Digital ADCO subsidiary.

The cost of patents, which represents patent acquisition costs and legal costs relating to patents pending, is being amortized on a straight-line basis over the estimated economic lives of the respective patents (averaging 15 years), which is less than the statutory life of each patent.

We capitalize costs incurred for the development of software products when economic and technological feasibility of such products has been established. Capitalized software costs are amortized on a straight-line basis over the estimated useful lives of the respective products.

We record a charge or a credit to stock-based compensation expense for increases or decreases in the market value of our common stock in excess of the exercise price of certain employee options that are subject to variable option accounting treatment. Our financial results for the three-month period in 2001 and the six-month periods in both 2002 and 2001 reflect credits in stock-based compensation pursuant to certain employee options. These credits are the result of market price declines of our common stock during these periods. In the first quarter of 2002, we rescinded the applicable option exercise provisions that resulted in the variable option accounting treatment of such options, and therefore no charges were recorded in the second quarter of 2002.

In January 2002, we canceled outstanding options totaling 2,093,334 shares at exercise prices of $6.50 to $13.50 and, in their place, granted new options totaling 1,046,667 shares at an exercise price of $2.00 per share. All the grantees were employees whose salary compensation had been reduced in conjunction with the Company's restructuring efforts in the second half of 2001. However, the executive officers whose salary compensation was reduced were not eligible to participate. The newly granted options will be subject to variable option accounting treatment. That is, if the closing market price of our common stock is greater than $2.00 per share at any reporting date, we will recognize a non-cash compensation expense equal to the difference between such market price and $2.00 times the number of outstanding option shares subject to variable accounting treatment. To the extent that we are carrying an accrued expense of this type at any given reporting date and there is a decline in the market price of our stock at the end of the subsequent reporting period, we will recognize a reduction in expense for the subsequent period.

The preparation of financial statements in conformity with generally accepted accounting principles requires us to make estimates and assumptions that affect the reported amount of assets and liabilities and disclosures of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Our actual results could differ from these estimates.

Inflation has not had any significant effect on our operating costs.

Our interest income is affected by changes in the general level of U.S. interest rates. Changes in U.S. interest rates could affect the interest earned on our cash equivalents and investments. Currently, changes in U.S. interest rates would not have a material effect on the interest earned on our cash equivalents and investments. A majority of these cash equivalents and investments earn a fixed rate of interest while the remaining portion earns interest at a variable rate. We do not anticipate that exposure to interest rate market risk will have a material impact on us due to the nature of our investments.

During April 2000, we received a warrant to acquire 2,500,000 shares of Livewire, a publicly traded company. The warrant becomes exercisable at the rate of 500,000 shares per year, commencing on April 13, 2001, includes certain registration rights and may be exercised until March 31, 2015. The warrant is not transferable, except in certain circumstances. As of January 1, 2001, changes in fair value in the investment in warrant were recorded to the statement of operations as we adopted SFAS No. 133. We expect the value of the warrant to fluctuate based on the underlying stock price of Livewire. We do not currently expect to exercise or register shares in the coming year.