Back to GetFilings.com
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) of the Securities
Exchange Act of 1934
Commission
For the Quarterly Period Ended September 30, 2002 File No. 33-76716
General Media, Inc.
------------------------------------------------------------------------
(Exact Name of Registrant as Specified in its Charter)
Delaware 13-3750988
- ------------------------------------- ----------------------
(State or other jurisdiction (IRS Employer
of incorporation or organization) Identification Number)
11 Penn Plaza, New York, NY 10001
- ------------------------------------- ----------------------
(Address of Principal Executive Zip Code
Offices)
(212) 702-6000
- -------------------------------------------------------------------
(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
-------- --------
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date.
Class Outstanding at November 14, 2002
----- --------------------------------
Common stock, $.01 par value 477,401
GENERAL MEDIA, INC. AND SUBSIDIARIES
TABLE OF CONTENTS
PAGE
PART I-FINANCIAL INFORMATION
Item 1. Financial Statements 3
Item 2. Management's Discussion and Analysis
of Financial Condition and Results of
Operations 16
Item 3. Quantitative and Qualitative Disclosures About Market Risk 35
Item 4. Controls and Procedures 35
PART II- OTHER INFORMATION
Item 1. Legal Proceedings 36
Item 2. Changes in Securities and Use of Proceeds 38
Item 3. Defaults Upon Senior Securities N/A
Item 4. Submission of Matters to a Vote
of Security Holders N/A
Item 5. Other Information N/A
Item 6. Exhibits and Reports on Form 8-K 38
Signatures 39
2
ITEM 1. FINANCIAL STATEMENTS
GENERAL MEDIA, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
AND ACCUMULATED DEFICIT
(UNAUDITED)
(AMOUNTS IN THOUSANDS)
NINE MONTHS ENDED THREE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
----------------------- -----------------------
2001 2002 2001 2002
-------- -------- -------- --------
NET REVENUES $ 47,061 $ 42,120 13,863 11,838
-------- -------- -------- --------
OPERATING COSTS AND EXPENSES
Publishing-production, distribution and editorial 18,203 16,744 6,131 5,113
Entertainment-direct costs 815 637 304 195
Selling, general and administrative 19,054 18,152 6,140 5,742
Bad debt expense 933 339 88 261
Rent expense from affiliated companies 533 430 192 97
Depreciation and amortization 453 399 149 126
-------- -------- -------- --------
Total operating costs and expenses 39,991 36,701 13,004 11,534
-------- -------- -------- --------
Income from operations 7,070 5,419 859 304
-------- -------- -------- --------
OTHER INCOME (EXPENSE)
Interest expense (6,086) (5,571) (1,993) (1,780)
Gain on sale of officer's life insurance 811
Interest income 231 65 59 4
Debt restructuring expenses (Note 6) (9,558) (34)
-------- -------- -------- --------
Total other income (expense), net (15,413) (4,695) (1,968) (1,776)
-------- -------- -------- --------
INCOME (LOSS) BEFORE PROVISION FOR INCOME TAXES (8,343) 724 (1,109) (1,472)
Income tax expense (benefit) 25 18 (351) 5
-------- -------- -------- --------
Net income (loss) (8,368) 706 (758) (1,477)
Accumulated deficit-beginning of period (55,807) (65,715) (63,417) (63,532)
-------- -------- -------- --------
Accumulated deficit-end of period ($64,175) ($65,009) ($64,175) ($65,009)
======== ======== ======== ========
SEE NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS.
3
GENERAL MEDIA, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(AMOUNTS IN THOUSANDS)
DECEMBER 31, SEPTEMBER 30,
2001 2002
------------ -------------
(UNAUDITED)
ASSETS
CURRENT ASSETS
Cash and cash equivalents $ 2,431 $ 290
Accounts receivable, net of allowance
for doubtful accounts 3,340 2,176
Inventories 4,447 3,373
Prepaid expenses and other current assets 1,855 1,057
-------- --------
TOTAL CURRENT ASSETS 12,073 6,896
WORKS OF ART AND OTHER COLLECTABLES 2,270 2,270
PROPERTY AND EQUIPMENT - AT COST;
net of accumulated depreciation and amortization 2,420 2,021
OTHER ASSETS
Due from affiliated companies 3,805 2,477
Rent security deposits 1,496 1,107
Loan to shareholder 1,000
Deferred subscription aquisition costs, net 1,282 283
Other 1,440 993
-------- --------
9,023 4,860
-------- --------
$ 25,786 $ 16,047
======== ========
LIABILITIES AND STOCKHOLDER DEFICIENCY
CURRENT LIABILITIES
Current maturities of Senior Secured Notes $ 5,800 $ 8,450
Accounts payable 12,439 6,299
Accrued retail display allowance 1,407 1,678
Deferred revenue 9,551 7,545
Accrued Interest - Senior Secured Notes 1,840 1,708
Other liabilities and accrued expenses 2,442 4,012
Income tax payable 925 922
-------- --------
TOTAL CURRENT LIABILITIES 34,404 30,614
SENIOR SECURED NOTES, LESS CURRENT MATURITIES 43,257 37,122
UNEARNED REVENUE 1,433 1,108
OTHER NON-CURRENT LIABILITIES 1,130 935
CONTINGENCIES
MANDATORILY REDEEMABLE CONVERTIBLE PREFERRED STOCK 9,450 10,791
STOCKHOLDER DEFICIENCY
Common stock, $.01 par value; 1,000,000
shares; issued and outstanding, 477,401 shares 5 5
Capital in excess of par value 1,822 481
Accumulated deficit (65,715) (65,009)
-------- --------
(63,888) (64,523)
-------- --------
$ 25,786 $ 16,047
======== ========
SEE NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS.
4
GENERAL MEDIA, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
(AMOUNTS IN THOUSANDS)
NINE MONTHS ENDED
SEPTEMBER 30,
-----------------------
2001 2002
-------- --------
CASH FLOWS FROM OPERATING ACTIVITIES
Net income (loss) ($ 8,368) $ 706
Adjustments to reconcile net loss to
cash provided by (used in) operating activities
Depreciation and amortization 453 399
Amortization of unearned revenue (273) (324)
Gain on sale of officer's life insurance policies (811)
Debt restructuring cost 9,558
Income taxes reimbursable to affiliated companies 25
Change in operating assets and liabilities:
Accounts receivable 2,636 1,164
Inventories 1,871 1,074
Other current assets 684 798
Other assets (296) 1,711
Accounts payable, accrued expenses and other
current liabilities (651) (4,300)
Accrued interest on Senior Secured Notes (858) (132)
Income taxes payable 19 (3)
Deferred revenue (360) (2,006)
Other long term liabilities (66) (195)
-------- --------
Net cash provided by (used in) operations 4,374 (1,919)
-------- --------
CASH FLOWS FROM INVESTING ACTIVITIES
Proceeds from sale of officer's life insurance policies 935
Capital expenditures (110)
-------- --------
Net cash provided by (used in) investing activities (110) 935
-------- --------
CASH FLOWS FROM FINANCING ACTIVITIES
(Advances to) / repayments from affiliated companies (2,832) 1,328
Debt issuance costs (1,939)
Repayment of Senior Secured Notes (1,193) (3,485)
Loan to shareholder 1,000
-------- --------
Net cash used in financing activities (5,964) (1,157)
-------- --------
Net decrease in cash and cash equivalents (1,700) (2,141)
Cash and cash equivalents at beginning of period 6,425 2,431
-------- --------
Cash and cash equivalents at end of period $ 4,725 $ 290
======== ========
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid during the period for:
Interest $ 6,943 $ 5,668
Income taxes $ 33 $ 19
SUPPLEMENTAL DISCLOSURE OF NON-CASH FINANCING ACTIVITIES:
Noncash issuance of mandatorily redeemable convertible
preferred stock $ 8,200
Noncash expiration of redeemable common stock warrants $ 582
Noncash "paid in kind" dividends on mandatorily redeemable
preferred stock $ 674 $ 1,086
Noncash accretion of mandatorily redeemable preferred
stock to liquidation preference $ 165 $ 255
Noncash exchange of Senior Secured Notes $ 51,507
SEE NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS.
5
GENERAL MEDIA, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS (UNAUDITED)
1. BASIS OF PREPARATION AND LIQUIDITY
General Media International, Inc. ("GMI") is the holder of 99.5% of the common
stock of General Media, Inc. (the "Company"). On March 29, 2001 the Company
issued 9,905 shares of mandatorily redeemable convertible preferred stock to
third parties (See Note 7). The accompanying unaudited consolidated financial
statements have been prepared in accordance with accounting principles generally
accepted in the United States of America for interim financial information and
with the instructions to Form 10-Q and Rule 10-01 of Regulation S-X.
Accordingly, they do not include all of the information and footnotes required
by accounting principles generally accepted in the United States of America for
complete financial statements. In the opinion of management, all adjustments,
consisting only of normal, recurring adjustments considered necessary for a fair
presentation, have been included. The results of operations for the three months
and nine months ended September 30, 2002 are not necessarily indicative of
results that may be expected for any other interim period or for the full year.
The balance sheet information for December 31, 2001 has been derived from the
audited financial statements at that date.
The accompanying financial statements have been prepared in conformity with
accounting principles generally accepted in the United States of America, which
contemplate continuation of the Company as a going concern. At September 30,
2002, the Company's cash balance was $290,000 as compared to $2,431,000 at
December 31, 2001, a decrease of $2,141,000 during the nine month period ended
September 30, 2002. This decrease was due to the use of $1,919,000 in operating
activities and mandatory principal payments of $3,485,000 for its Series C
Notes. This was offset in part by the receipt of $935,000 from the sale of
officer's life insurance policies on the life of the principal shareholder, net
repayments from affiliated companies of $1,328,000 and the collection of
$1,000,000 of loans receivable from the principal shareholder that arose in
prior periods. In August and October 2002, the Company received approximately
$188,000 and $1,500,000, respectively, in repayments from GMI on amounts due the
Company by affiliated companies. These funds, along with $1,970,000 of cash from
operations, were used during October 2002 to pay principal and interest payments
totaling $3,658,000 on the Series C Notes. At September 30, 2002, the Company's
current liabilities exceeded current assets by $23,718,000.
In addition to the principal and interest payments made in October 2002, the
Company's Series C Notes require interest payments of approximately $6,199,000
and amortization payments of $6,500,000 during the period November 1, 2002 to
September 30, 2003. The management of the Company does not believe it can
generate sufficient funds from operations to make all of these required
payments. In the event that the Company is unable to make these payments, the
trustee under the Indenture could assume control over the Company and
substantially all of its assets including its registered trademarks. The Company
is seeking other sources of financing to replace its current debt arrangements.
There can be no assurance that the Company will be successful in obtaining other
sources of financing.
In view of the matters described in the preceding paragraph, recoverability of a
major portion of the recorded asset amounts shown in the accompanying balance
sheets is dependent upon the Company's ability to obtain financing and continue
operations. The financial statements do not include any adjustments relating to
the recoverability and classification of recorded asset amounts, or amounts and
classification of
6
GENERAL MEDIA, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS (UNAUDITED)
1. (CONTINUED)
liabilities that might be necessary should the Company be unable to continue in
existence.
The Company has undertaken the following actions to attempt to improve its
profitability and cash flow:
- - On February 28, 2002, the Company reduced its workforce by 39 employees
(26% of total workforce). This action reduced the amount of cash required
for salary and benefit expenses.
- - Reduced the production and distribution costs of its magazines by
negotiating reductions in the price of paper and printing costs, changing
the paper grades on its magazines, reducing the number of copies printed,
reducing the number of pages per issue and by changing their design to
improve production efficiencies.
- - Reduced the amount of cash expended to promote subscriptions and reduced
the amount of cash expended on other selling, general and administrative
expenses.
- - Improved revenue by adding additional special issues of its magazines.
- - Delayed employee salary increases for five months during 2002.
- - The principal shareholder of GMI repaid a $1,000,000 loan that arose in
prior periods.
- - During the nine months ended September 30, 2002, GMI repaid $2,748,000 of
intercompany advances.
- - During the month of October 2002, GMI repaid an additional $1,500,000 of
intercompany advances.
Since the above actions will not generate sufficient improvements to cash flow
to meet current debt service requirements, the Company is contemplating
additional actions, including seeking other sources of financing, to provide
cash. However, there can be no assurances that management will be able to
achieve such a result.
These financial statements should be read in conjunction with the financial
statements and notes thereto for the year ended December 31, 2001 included in
the Company's Annual Report on Form 10-K. The accounting policies used in
preparing these financial statements are the same as those described in the
financial statements and notes thereto for the year ended December 31, 2001.
2. ACCOUNTING FOR RETAIL DISPLAY ALLOWANCES
Certain provisions of The Emerging Issues Task Force pronouncement EITF 01-9,
"Accounting for Consideration Given by a Vendor to a Customer (Including a
Reseller of the Vendor's Products)", are effective for fiscal periods beginning
after December 15, 2001. The Task Force reached a consensus that consideration
from a vendor to a reseller of the vendor's products is presumed to be a
reduction of the selling prices of the vendor's products and, therefore, should
be characterized as a reduction of revenue when recognized in the
7
GENERAL MEDIA, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS (UNAUDITED)
2. (CONTINUED)
vendor's income statement. Beginning January 2002 the Company adopted this
policy as it relates to retail display allowances. Retail display allowances had
been included in selling, general and administrative expenses prior to the
adoption of this policy. The effect on the Company of the adoption of the policy
is a reduction of newsstand revenue and an equivalent reduction in selling,
general and administrative expenses of $2,210,000 and $1,899,000 for the nine
months ended September 30, 2002 and 2001, respectively. As a result of this
adjustment, the net revenue and the selling, general and administrative expenses
of the publishing segment for the nine months ended September 30, 2001 have each
been reduced by approximately $1,899,000 to conform to the September 30, 2002
presentation.
3. INVENTORIES
Inventories consist of the following:
December 31, September 30,
2001 2002
------ ------
----- In Thousands ----
Paper and printing $1,411 $1,469
Editorials and pictorial 2,239 1,510
Film and programming costs 797 394
------ ------
$4,447 $3,373
====== ======
4. MANAGEMENT CHARGE
The Company incurs shared common indirect expenses for the benefit of GMI and
affiliated companies, including accounting, personnel, management information
systems, employee relations and other administrative services. In addition, the
Company is charged by GMI and its subsidiaries for the benefit of other
corporate overhead costs, executive compensation and other costs, which
principally relate to office space. These allocations are based on factors
determined by management of the Company and GMI to be appropriate for the
particular item, including estimated relative time commitments of managerial
personnel, relative number of employees and relative square footage of all space
occupied. Management believes that the allocation method and amounts are
reasonable.
5. SENIOR SECURED NOTES
On December 21, 1993, the Company issued, pursuant to an indenture (the
"Indenture"), $85,000,000 of Senior Secured Notes (the "Notes") at an issue
price equal to 99.387% of the principal amount of the Notes. As part of the
issuance of the Notes, the Company issued 85,000 common stock purchase warrants
to the purchasers of the Notes and sold to the underwriter, at a discount,
102,506 warrants (the "Warrants"). The
8
GENERAL MEDIA, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS (UNAUDITED)
5. (CONTINUED)
Warrants, having an expiration date of December 22, 2000, entitled the holders
to purchase in the aggregate 25,000 shares of the Company's common stock at the
exercise price of $0.01 per share. The Warrants also gave the holders the right
to require the Company to purchase for cash all of the Warrants at their fair
value. At the time of issuance, the Company recorded the Warrants at their fair
value. The Notes were collateralized by a first priority security interest in
all intellectual property rights (including copyrights and trademarks) and
substantially all other intangible and tangible assets of the Company, other
than accounts receivable, inventory and cash equivalents.
In July 1995, the Company repurchased $5,000,000 face amount of its outstanding
Notes, including 5,000 warrants, for cash of $4,050,000. In May 1999, the
Company repurchased $28,000,000 face amount of its outstanding Notes for cash of
$26,600,000. The remaining Notes matured on December 31, 2000 and bore interest
at 10-5/8% per annum, which was payable semiannually.
On December 22, 2000, 18,009 of the Warrants were converted into 2,401 shares of
the Company's Common Stock and 104,076 Warrants expired without being timely
exercised in accordance with the Warrant agreement. The due date of the
remaining 60,421 Warrants held by holders of the Notes was extended as part of
the negotiations for refinancing the Notes. The exercise of the 18,009 Warrants
was recorded in December 2000 as a reduction in redeemable warrants and a
contribution to capital of $173,000. The expiration of the 104,076 Warrants was
recorded in the financial statements in December 2000 as an extraordinary gain
from extinguishment of debt of $571,000, net of income tax of $465,000.
On March 29, 2001 (the "Closing Date"), the Company refinanced the Notes. Under
the refinancing agreement, the Company exchanged the $51,507,000 of principal
amount of Notes and any Warrants held by Noteholders (the "Consenting Holders")
for Series C Notes and mandatorily redeemable convertible preferred stock (the
"Preferred Stock") with a liquidation preference of $10,000,000 (See Note 7)
meeting certain specified terms and conditions. The remaining $493,000 principal
amount of Notes that were not exchanged were retired by payments made to the
holders on March 29, 2001.
The Series C Notes will mature on March 29, 2004, bear interest at a rate of 15%
per annum from and after January 1, 2001 and require amortization payments of
$5,800,000 during the calendar year 2002 and $6,500,000 during the calendar year
2003, with the balance due in 2004. In addition, further amortization equal to
50% of excess cash flow in each year is required, as well as any proceeds from
the sale of certain real property owned by GMI (after payment of existing debt
obligations thereon) and any proceeds to the Company from certain insurance
policies (the "Policies") on the life of the principal shareholder. The Company
made amortization payments of $3,485,000 during the first nine months of 2002,
which included $935,000 of proceeds from the sale of certain of the Policies
(See Note 8).
The Indenture has been extended to the March 29, 2004 maturity of the Series C
Notes. The original Indenture contained covenants, that continue to the new
maturity date, which, among other things, (i) restrict the ability of the
Company to dispose of assets, incur indebtedness, create liens and make certain
investments, (ii) require the Company to maintain a consolidated tangible net
worth deficiency of no greater than $81,600,000, and (iii) restrict the
Company's ability to pay dividends unless certain financial performance tests
are met. The
9
GENERAL MEDIA, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS (UNAUDITED)
5. (CONTINUED)
Company's subsidiaries, which are guarantors of the Senior Secured Notes under
the Indenture, however, were and continue to be permitted to pay intercompany
dividends on their shares of common stock. The ability of the Company and its
subsidiaries to incur additional debt is severely limited by such covenants. The
Indenture was amended in conjunction with the issuance of the Series C Notes to
reflect the above mentioned payments, to reflect the March 29, 2004 maturity of
the Series C Notes, to provide additional "Change of Control" events (requiring
the commencement of an offer to purchase Notes), to provide additional
flexibility as to the nature of, but also to set a fixed dollar limit for,
"Owner Payments", and to require Noteholder consent to entering into new lines
of business or for sales or other conveyances of the Penthouse trademark (other
than ordinary course licensing) or other assets for net proceeds in excess of
$500,000. In addition, the related Security Agreement was amended to grant
additional security interests in inventory and accounts receivable as well as a
security interest in proceeds of the sale of certain real property owned by GMI
(after payment of existing debt obligations thereon) and on any proceeds to the
Company from certain Policies on the life of the Company's principal beneficial
owner. As of September 30, 2002, the Company was in compliance with all such
covenants. However as of September 30, 2002 the Company had not made a required
principal redemption of approximately $1,950,000 and a required interest payment
of approximately $1,708,000, both due by that date. In August and October 2002,
the Company received approximately $188,000 and $1,500,000, respectively, in
repayments from GMI on amounts due the Company by affiliated companies. These
funds, along with $1,970,000 of cash from operations, were used by the Company
in October 2002 to make the required principal and interest payments within the
applicable grace periods allowed for by the Indenture.
On August 1, 2002, the Company and the holders of a majority in principal amount
of the Series C Notes (the "Holders") entered into a Third Supplemental
Indenture to amend the "Change of Control" events in the Indenture to add
further restrictions on the amount of "Owner Payments"; to substitute John
Orlando for John Prebich in the "Change of Control" provision; and to require
that new financial covenants (the "Financial Covenants") be added that require
the Company to achieve not less than 80% of the projected revenues and EBITDA to
be set forth in a business plan in a form and substance reasonably satisfactory
to the Holders. In addition the Company agreed to allow the Holders to audit the
books and records of the Company and the payroll records of GMI and to pay all
the legal fees, costs and expenses, and audit fees of the Holders (collectively
the "Amendment Expenses") related to the agreement. The Company recorded
$114,000 of Amendment Expenses during the nine months ended September 30, 2002.
In July 2002, the Company also paid $100,000 to the Holders as a deposit against
Amendment Expenses expected to be incurred by the Holders in completing the
further amendments to the Indenture required to incorporate the accepted
business plan into the financial covenants. In exchange for these amendments the
Holders agreed to waive their prior contention that a "Change of Control" event
had occurred with respect to the termination of John Prebich, the Company's
former President and Chief Operating Officer.
On September 13, 2002, the Company submitted a business plan to the Holders for
approval in accordance with the requirements of the Third Supplemental
Indenture. The Holders notified the Company that they had accepted the business
plan effective October 4, 2002. The Company and the Holders are in the process
of preparing an additional supplement that will incorporate the Financial
Covenants into the Indenture.
10
GENERAL MEDIA, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS (UNAUDITED)
6. DEBT RESTRUCTURING EXPENSES
In connection with the refinancing of the Company's debt, as more fully
described in Note 5 above, the Company recorded debt restructuring expenses
during the nine months ended September 30, 2001 of $9,558,000, consisting of a
fee of approximately $1,030,000 to Consenting Holders as well as their legal
fees and expenses of approximately $177,000, legal fees and expenses for the
Company's own lawyers and representatives of approximately $733,000 and the fair
market value of 9,905 shares of Preferred Stock of $8,200,000 issued to the
Consenting Holders, as more fully described in Note 7 below, less the remaining
$582,000 of liability associated with 60,421 Warrants surrendered in connection
with the refinancing.
7. MANDATORILY REDEEMABLE CONVERTIBLE PREFERRED STOCK
On March 29, 2001, the Company issued 9,905 shares of Preferred Stock to the
Consenting Holders with a fair market value of $8,200,000. The Preferred Stock
carries a liquidation preference of $10,000,000, provides for "paid-in-kind"
dividends at a 13% per annum rate and is convertible at the option of the
holders, after two years following the Closing Date, into 10% of the Company's
common stock on a fully diluted basis in the third year, 12.5% of the Company's
common stock on a fully diluted basis in the fourth year, and 15% of such common
stock on a fully diluted basis during the fifth year. The Preferred Stock is
mandatorily redeemable by the Company (subject to the aforementioned conversion
rights) at its liquidation preference including the "paid-in-kind" dividends at
the end of the fifth year.
The Preferred Stock may be optionally redeemed by the Company at a discount
during the first and second years following the Closing Date at redemption
prices of $4,000,000 if redeemed in the first six months, $6,000,000 thereafter
in the first year and $10,000,000 in the second year, and may be optionally
redeemed at increasing premiums of 110%, 115% and 120% during the third, fourth
and fifth years, respectively, provided that the Series C Notes are paid in full
at or before the time of any redemption.
The recorded value net of issuance costs are being accreted using the effective
interest method through the March 29, 2006 mandatory redemption date of the
Preferred Stock. The Company recorded $255,000 and $165,000 of such accretion
for the nine months ended September 30, 2002 and 2001, respectively. The Company
also recorded "paid-in-kind" dividends of approximately $1,086,000 and $674,000
for the nine months ended September 30, 2002 and 2001, respectively. Both the
accretion of the Preferred Stock and the "paid-in-kind" dividends are reflected
in the accompanying financial statements as an increase in Mandatorily
Redeemable Convertible Preferred Stock and a decrease in Capital In Excess Of
Par Value.
8. GAIN ON SALE OF OFFICER'S LIFE INSURANCE POLICIES
In April 2002, certain officer's life insurance policies were sold to an
unrelated third party, resulting in proceeds to the Company of approximately
$935,000 and a net gain of approximately $811,000, after deducting the cash
surrender value of the policies of approximately $124,000. The proceeds from the
sale of the policies was applied against the Senior Secured Notes as an
additional principal payment in accordance with the requirements of the
Indenture (See Note 5).
11
GENERAL MEDIA, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS (UNAUDITED)
9. INCOME TAXES
The Company incurred a taxable loss of approximately $1,865,000 for the nine
months ended September 30, 2002. In addition the Company has a net operating
loss ("NOL") carryover available from the prior year of approximately
$1,475,000, which can be used to reduce future taxable income. This NOL will
expire in 2021. The income tax provision for the nine months ended September 30,
2002 consists of state minimum taxes of approximately $18,000.
The Company and its subsidiaries are included in the consolidated Federal income
tax return of GMI. The provision for income taxes in the accompanying statements
of operations is allocated to the Company from GMI as if the Company filed
separate income tax returns. Since each member of a consolidated tax group is
jointly and severally liable for Federal income taxes of the entire group, the
Company may be liable for taxes of GMI or other members of the consolidated
group. Under the terms of a Tax Sharing and Indemnification Agreement (the
"Agreement"), the Company can utilize the net operating losses of GMI ("GMI
NOL's") to reduce its income taxes, as long as the Company is a member of GMI's
consolidated group. To the extent that the Company utilizes such GMI NOL's to
reduce its income taxes, it is required to pay GMI, within thirty days after the
Company pays the group consolidated tax liability, an amount that would have
been paid in taxes had the net operating losses of GMI not been available. At
January 1, 2002, GMI had available for Federal income tax purposes GMI NOL's
aggregating approximately $84,751,000, which can be used by the Company to
reduce future income taxes, as long as the Company is a member of GMI's
consolidated group. These GMI NOL's expire in tax years 2007 through 2021.
10. CONTINGENCIES
On December 3, 2001, Network Telephone Services ("NTS") filed in Los Angeles
Superior Court (the "Court") a complaint against Robert C. Guccione, GMI and the
Company (collectively the "Defendants") asserting breach of promissory note,
breach of written guarantee, and a declaration of rights and injunctive relief
arising out of a promissory note and several other agreements between NTS and
the Defendants. NTS seeks damages in the amount of approximately $1,098,000,
interest at the rate of 9% per annum from September 1, 2001 and attorneys fees.
The Defendants have filed their answer to the complaint asserting a
cross-complaint requesting a declaration of whether and to what extent the
arbitrary reduction in the rates of payout by an affiliate of NTS breached its
pay-per-call service agreement with the Company. The Court ordered the case to
mediation, which began on June 4, 2002. The Company is in negotiations with NTS
to renew its pay-per-call service and advertising agreements, which renewal
could provide for the settlement of this litigation. In the event these
agreements cannot be negotiated at fair market rates and damages are assessed
against the Company, it will seek to recover any amounts paid to NTS from Robert
C. Guccione and GMI. In light of the concerns related to the Company's
liquidity, which are more fully described in Note 1, it is possible that the
Company would be unable to satisfy a judgement rendered against it by the Court,
should one be assessed. Therefore management believes that an adverse outcome
with respect to these proceedings could have a material adverse effect on its
financial condition or results of operations.
On May 8, 2002, Anna Kournikova ("Anna") filed in United States District Court
for the Central District of California (the "California Court"), an action (the
"Action") alleging, among other things, that the Company published photographs
(the "Photographs") of a woman topless in the June 2002 issue of Penthouse
Magazine
12
GENERAL MEDIA, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS (UNAUDITED)
10. (CONTINUED)
(the "Magazine"), falsely representing them to be pictures of Anna when they
were in reality photographs of someone else. The Action also alleges that the
Company advertised its intention to make the Photographs and a video of the
woman available on its Internet Site on May 10, 2002. On May 7, 2002, the
Company issued a press release stating that it had made an unintentional error
when it said the Photographs were of Anna and it apologized to Anna and the
actual woman in the Photographs for the error. The Company also published the
apology on its Internet Site.
Anna seeks a permanent injunction barring the Company from any similar acts
concerning her, barring it from any further distribution of the Photographs and
the June 2002 edition of the Magazine, barring it from any references to Anna on
its Internet Site, barring it from representing that any pictures or photographs
on the Internet Site are depictions of Anna, ordering it to deliver or destroy
all materials that have the alleged false representations, ordering the
disgorgement and paying over of all profits it earned and any other unjust
enrichment that it received from the alleged false depiction of Anna, awarding
damages in an unspecified amount not less than $10,000,000, trebling of these
unspecified damages, awarding punitive damages in an unspecified amount and
reimbursement for Anna's costs and attorneys' fees in prosecuting the Action.
The Company has filed a motion to dismiss portions of the complaint and Anna has
filed a cross-motion to freeze $15,000,000 of the Company's assets for purposes
of insuring the payment of a possible judgement. The California Court denied
both of these motions in August 2002. Anna has since filed an appeal to the
Ninth US Court of Appeals. The Company and Anna are currently engaged in
exchanging requests for documents and the taking of depositions related to
Anna's appeal. The Company intends to vigorously defend itself in this action.
It is still too early to determine the possible outcome of the proceedings.
Therefore management cannot give an opinion as to the effect this Action will
have on the Company's financial condition or results of operations. There can be
no assurance, however, that the ultimate liability from these proceedings will
not have a material adverse effect on its financial condition and results of
operations.
On May 24, 2002, Reed Somberg and Liuz Gonzalez individually and on behalf of
all others similarly situated (the "Class Action Plaintiffs") filed in the
Circuit Court of Florida, 11th Judicial Circuit for Miami/Dade County (the
"Florida Court"), an action alleging that the Company committed a "breach of
duty" when it published the Photographs, falsely representing them to be
pictures of Anna when they were in reality photographs of someone else. The
Class Action Plaintiffs claim they bought the Magazine prior to learning that
the authenticity of the Photographs was in question for the sole purpose of
looking at these Photographs. The action requested class-action certification, a
refund of the price of the Magazine, compensation for "lost value" of the
Magazine, court costs and interest. On July 22, 2002, the Company filed a motion
to dismiss the action. On October 8, 2002, the Florida Court issued an order
that gave the Class Action Plaintiffs ten days to file an amended complaint or
the case would be dismissed with prejudice. The Class Action Plaintiffs failed
to file an amended complaint within the ten day period and the Class Action
Plaintiffs have agreed to a dismissal of the action.
On August 26, 2002, Vadim Levin and Alex Sheyngis individually and on behalf of
all others similarly situated (the "Other Class Action Plaintiffs") filed in the
Circuit Court of Cook County, Illinois, an action alleging that the Company
committed a breach of contract, a breach of express warranty and consumer fraud
13
GENERAL MEDIA, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS (UNAUDITED)
10. (CONTINUED)
when it published the Photographs, falsely representing them to be pictures of
Anna when they were in reality photographs of someone else. The Other Class
Action Plaintiffs have filed a request that the action be certified as a class
action with the two plaintiffs as class representatives and their lawyer as
class counsel. The Company has filed a motion to dismiss the action. The Company
intends to vigorously defend itself in this action. It is still too early to
determine the possible outcome of the proceedings. Therefore management cannot
give an opinion as to the effect this Action will have on the Company's
financial condition or results of operations. There can be no assurance,
however, that the ultimate liability from these proceedings will not have a
material adverse effect on its financial condition and results of operations.
There are various other lawsuits claiming amounts against the Company. It is the
opinion of the Company's management that the ultimate liabilities, if any, in
the outcome of these cases will not have a material effect on the Company's
financial statements.
11. SEGMENT INFORMATION
The Company is currently engaged in activities in three industry segments:
publishing, online and entertainment. The publishing segment of the Company is
engaged in the publication of Penthouse magazine and four affiliate magazines
(the "Affiliate Publications" and, together with Penthouse magazine, the "Men's
Magazines"), the licensing of the Company's trademarks to publishers in foreign
countries and for use on various consumer products and services. The online
segment is engaged in the sale of memberships to the Company's Internet site
(the "Internet Site"), the sale of advertising banners posted on the Internet
Site and the sale of adult-oriented consumer products through the Company's
online store. The entertainment segment of the Company produces a number of
adult-oriented entertainment products and services, including pay-per-call
telephone lines, digital video discs ("DVD's"), video cassettes and pay-per-view
programming.
14
GENERAL MEDIA, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS (UNAUDITED)
11. SEGMENT INFORMATION (CONTINUED)
Corporate and
reconciling
Publishing Online Entertainment items Consolidated
---------------------------- ( in thousands) -------------------------------
NINE MONTHS ENDED
SEPTEMBER 30, 2002
REVENUES FROM CUSTOMERS $ 35,150 $ 5,637 $ 1,333 $ 42,120
DEPRECIATION AND AMORTIZATION 341 55 3 399
INCOME (LOSS) FROM OPERATIONS 10,234 3,107 485 (8,407) 5,419
INTEREST EXPENSE 191 5,380 5,571
GAIN ON SALE OF OFFICER'S
LIFE INSURANCE POLICIES 811 811
INTEREST INCOME 5 60 65
SEGMENT PROFIT (LOSS)
BEFORE INCOME TAXES 10,048 3,107 485 (12,916) 724
SEGMENT ASSETS 8,155 128 628 7,136 16,047
Nine Months Ended
September 30, 2001
Revenues from customers $ 37,064 $ 7,590 $ 2,407 $ 47,061
Depreciation and amortization 376 63 14 453
Income (loss) from operations 10,136 4,401 1,413 (8,880) 7,070
Interest expense 304 5,782 6,086
Debt restructuring expenses 9,558 9,558
Interest income 14 217 231
Segment profit (loss)
before income taxes 9,846 4,401 1,413 (24,003) (8,343)
Segment assets 11,301 336 1,467 15,578 28,682
Capital expenditures 57 53 110
The Corporate and reconciling items column represents corporate administrative
expenses such as executive, human resources, finance and accounting, management
information systems, costs related to the operation of the corporate and
executive offices, interest expense (to the extent unallocated), interest income
(to the extent unallocated), gain on sale of officer's life insurance (in 2002)
and, debt restructuring expenses (in 2001) resulting in the segment profit
(loss) shown. Corporate and reconciling items included in segment assets
includes cash, security deposits, the cash surrender value of officer's life
insurance, loan to shareholder and loan to affiliated company.
The market for the Company's products is worldwide; however approximately eighty
eight percent of the Company's revenue is derived from U.S.-based sources.
15
GENERAL MEDIA, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS (UNAUDITED)
11. SEGMENT INFORMATION (CONTINUED)
No customer of the Company accounted for more than ten percent of the Company's
net revenue during the nine months ended September 30, 2002 and 2001, and no
part of the business is dependent upon a single customer or a few customers, the
loss of any one of which would have a material adverse effect on the Company.
12. EXCHANGE OF CAPITAL STOCK
On November 8, 2002, GMI exchanged 475,000 shares or 99.5% of the Company's
issued and outstanding $.01 per share common stock for 42,500,000 shares or 85%
of the issued and outstanding $0.0025 per share common stock of American Pulp
Exchange, Inc. ("APE") pursuant to a Stock Exchange Agreement between GMI and
APE.
ITEM 2.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Securities and Exchange Commission Financial Reporting Release No. 60 requires
all companies to include a discussion of critical accounting policies or methods
used in the preparation of the consolidated financial statements. In addition,
Financial Reporting Release No. 61 requires all companies to include a
discussion to address, among other things, liquidity, off-balance sheet
arrangements, contractual obligations and commercial commitments. The following
discussion is intended to supplement the summary of significant accounting
policies as described in Note 1 of the Notes to Consolidated Financial
Statements for the year ended December 31, 2001 included in the Company's annual
report on Form 10-K.
These policies were selected because they represent the more significant
accounting policies and methods that are broadly applied in the preparation of
the consolidated financial statements. Revenues, expenses, accrued liabilities
and allowances related to certain of these policies are initially based on our
best estimates at the time of original entry in our accounting records.
Adjustments are recorded when our actual experience differs from the expected
experience underlying the estimates. These adjustments could be material if our
experience were to change significantly in a short period of time. We make
frequent comparisons of actual experience and expected experience in order to
mitigate the likelihood of material adjustments.
a. Revenue Recognition - Sales of magazines for retail distribution are
recorded on the on-sale date of each issue based on an estimate of
the revenue for each issue of the magazine, net of estimated
returns. These estimates are based upon several factors, including
but not limited to historical trends, days on sale and special
editorial or pictorial content. Estimated revenues are adjusted to
actual revenues as actual sales information becomes available.
Actual sales information generally becomes available
16
ninety days after the on-sale date for U.S. and Canadian sales and
final settlement occurs one hundred and eighty days after the
off-sale date for U.S., Canadian and international sales.
Advances in the amounts of $1.0 million and $3.0 million relating to
two distribution agreements for the Company's magazines are being
recognized as revenue on a straight-line basis over the ten year
terms of each of the related contracts. An advance in the amount of
$0.9 million relating to a licensing agreement for domestic sales of
the Company's digital video disc versions of its video products is
being recognized as revenue on a straight line basis over the seven
year term of the agreement.
b. Accrued Retail Display Allowances - Retail display allowances are
payments made to convenience stores, bookstores and newsstands as an
incentive to handle and sell magazines. The formula used to
calculate the allowance is negotiated on an individual basis with
each outlet owner and varies accordingly. However, each formula is
based on a combination of a percentage of sales dollars and an
amount per copy sold. Accruals for retail display allowances are
recorded as a reduction of newsstand revenues on the on-sale date
based upon past experience using the estimated sales of each issue,
net of estimated returns. As new information becomes available the
accruals are adjusted accordingly
c. Income Taxes - In preparing our financial statements we make
estimates of our current tax exposure and temporary differences
resulting from timing differences for reporting items for book and
tax purposes. We recognize deferred taxes by the asset and liability
method of accounting for income taxes. Under the asset and liability
method, deferred taxes are recognized for differences between the
financial statement and tax basis of assets and liabilities at
enacted statutory tax rates in effect for the years in which the
differences are expected to reverse. The effect on deferred taxes of
a change in tax rates is recognized in income in the period that
includes the enactment date. In addition, valuation allowances are
established when necessary to reduce deferred tax assets to the
amounts expected to be realized. In consideration of our taxable
loss in the current year and lack of historical ability to generate
taxable income to utilize our deferred tax assets, we have recorded
a full valuation allowance.
d. Other Loss Reserves - We have numerous other loss exposures, such as
accounts receivable reserves and reserves for refunds that would be
required if the Company does not attain circulation levels
stipulated in contracts with advertisers. Establishing allowances
for doubtful accounts and loss reserves for these matters requires
the use of estimates and judgment in regards to risk exposure and
ultimate liability. We estimate losses using consistent and
appropriate methods; however, changes to our assumptions could
materially affect our recorded liabilities for allowances and
losses. Where available we utilize published credit ratings for our
debtors to assist us in determining the amount of required reserves.
IMPACT OF RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS
In August 2001, the FASB issued SFAS 144, "Accounting for the Impairment or
Disposal of Long-Lived Assets". This statement is effective for fiscal years
beginning after December 31, 2001. This supercedes SFAS 121, "Accounting for the
Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of",
while retaining many of the requirements of such statement.
In April 2002, the FASB issued SFAS 145, "Rescission of FASB Statements No. 4,
44, and 64, Amendment of FASB Statement 13, and Technical Corrections". This
statement is effective for fiscal years beginning after May 15, 2002. This
rescinds SFAS 4, which required all gains and losses from extinguishments of
debt to be aggregated and, if material, classified as an extraordinary item, net
of related income tax effect. Upon adoption of SFAS 145, companies will be
required to apply the criteria in APB Opinion No. 30, "Reporting the Results
17
of Operations - reporting the Effects of Disposal of a Segment of a Business,
and Extraordinary, Unusual and Infrequently Occurring Events and Transactions"
in determining the classification of gains and losses resulting from the
extinguishments of debt.
In June 2002, the FASB issued SFAS 146, "Accounting for Costs Associated with
Exit or Disposal Activities". This statement is to be applied prospectively to
exit or disposal activities initiated after December 31, 2002. This requires
companies to recognize costs associated with exit or disposal activities when
they are incurred rather than at the date of a commitment to an exit or disposal
plan. Examples of costs covered by the standard include lease termination costs
and certain employee severance costs that are associated with a restructuring,
discontinued operation, plant closing, or other exit or disposal activities.
The Company does not believe that these statements have had or will have a
material effect on the Company's financial statements.
Certain provisions of The Emerging Issues Task Force pronouncement EITF 01-9,
"Accounting for Consideration Given by a Vendor to a Customer (Including a
Reseller of the Vendor's Products)", are effective for fiscal periods beginning
after December 15, 2001. The Task Force reached a consensus that consideration
from a vendor to a reseller of the vendor's products is presumed to be a
reduction of the selling prices of the vendor's products and, therefore, should
be characterized as a reduction of revenue when recognized in the vendor's
income statement. Beginning January 2002 the Company adopted this policy as it
relates to retail display allowances. Retail display allowances had been
included in selling, general and administrative expenses prior to the adoption
of this policy. The effect on the Company of the adoption of the policy is a
reduction of newsstand revenue and an equivalent reduction in selling, general
and administrative expenses of $2.2 million and $1.9 million for the nine months
ended September 30, 2002 and 2001, respectively. As a result of this adjustment,
the net revenue and the selling, general and administrative expenses of the
publishing segment for the nine months ended September 30, 2001 have each been
reduced by approximately $1.9 million to conform to the September 30, 2002
presentation.
CONTRACTUAL OBLIGATIONS AND COMMERCIAL COMMITMENTS
The Company does not utilize off balance sheet financing other than operating
lease arrangements for office premises and related equipment. The following
table summarizes all commitments under contractual obligations as of September
30, 2002:
----------------------Obligations due--------------------
Total 1 2-3 4-5 Over 5
Amount Year Years Years Years
-----------------------(In millions)---------------------
Senior Secured Notes $45.6 $ 8.5 $37.1 $ -- $ --
Operating Leases 12.3 1.9 3.8 3.8 2.8
Other Long-Term Liabilities 0.8 0.2 0.3 0.3 --
----- ----- ----- ----- -----
Total Cash Obligations $58.7 $10.6 $41.2 $ 4.1 $ 2.8
===== ===== ===== ===== =====
Interest On Senior Secured Notes $10.7 $ 7.9 $ 2.8 $ -- $ --
===== ===== ===== ===== =====
18
LIQUIDITY AND CAPITAL RESOURCES
At September 30, 2002, the Company had $0.3 million in cash and cash
equivalents, as compared to $2.4 million at December 31, 2001, a decrease of
$2.1 million during the nine month period ended September 30, 2002. The decrease
was due to the use of $1.9 million in operating activities and mandatory
principal payments for its Series C Notes of $3.5 million. This was offset in
part by a net decrease in advances from affiliated companies of $1.3 million,
the collection of $1.0 million of loans receivable from the principal
shareholder that arose in prior periods and the receipt of $0.9 million from the
sale of certain officer's life insurance policies (the "Policies") on the life
of the principal shareholder. In October 2002, the Company received $1.5 million
from GMI as a partial repayment of the balance due from affiliated companies.
This amount along with $0.2 million received from GMI in August 2002 and
approximately $2.0 million of cash from operations was used in October 2002 to
pay principal and interest payments totaling $3.7 million on its Series C Notes.
At September 30, 2002, the Company's current liabilities exceeded current assets
by $23.7 million.
In addition to the principal and interest payments made in October 2002, the
Company's Series C Notes require interest payments of approximately $6.2 million
and amortization payments of $6.5 million during the period November 1, 2002 to
September 30, 2003. The management of the Company does not believe it can
generate sufficient funds from operations to make all of these required
payments. In the event that the Company is unable to make these payments, the
trustee under the indenture governing the Series C Notes (the "Indenture") could
assume control over the Company and substantially all of its assets including
its registered trademarks. The Company is seeking other sources of financing to
replace its current debt arrangements. There can be no assurance that the
Company will be successful in obtaining other sources of financing.
The Company has undertaken the following actions to attempt to improve its
profitability and cash flow:
- On February 28, 2002, the Company reduced its workforce by 39
employees (26% of total workforce). This action is expected to
reduce the net amount of cash required for salary and benefit
expenses by an estimated $1.8 million during 2002 and an estimated
$2.3 million on an annualized basis.
- Reduced the production and distribution costs of its magazines by
negotiating reductions in the price of paper and printing costs,
changing the paper grades on its magazines, reducing the number of
copies printed, reducing the number of pages per issue and changing
their design to improve production efficiencies, thereby saving an
estimated $0.7 million in cash during 2002 and an estimated $0.9
million on an annualized basis.
- Reduced the amount of cash expended to promote subscriptions of the
Affiliate Publications and reduced the amount of cash expended on
other selling, general and administrative expenses by an estimated
$1.4 million for 2002 and an estimated $1.6 million on an annualized
basis.
- Improved revenue by adding additional special issues of its
magazines. Based on past experience, this action is expected to
generate an estimated $0.3 million in additional cash during 2002.
- Delayed employee salary increases for five months during 2002. This
action is expected to save an estimated $50,000 in 2002.
- The principal shareholder of GMI repaid a $1.0 million
loan that arose in prior periods.
19
- During the nine months ended September 30, 2002, GMI repaid $2.7
million of intercompany advances.
- During the month of October 2002, GMI repaid an additional $1.5
million of intercompany advances.
Since the above actions will not generate sufficient improvements to cash flow
to meet current debt service requirements, the Company is contemplating
additional actions, including seeking other sources of financing, to provide
cash. However, there can be no assurances that management will be able to
achieve such a result.
Cash flows from operating activities
Net cash used in operating activities was $1.9 million for nine months ended
September 30, 2002, compared to net cash provided by operating activities of
$4.4 million for the nine months ended September 30, 2001. Net cash used in
operating activities for the nine months ended September 30, 2002 was derived by
adjusting the net profit for the period by the effect of a gain from the sale of
officer's life insurance policies and non-cash items as well as decreased
accounts payable due to the timing of payments to vendors, during the nine
months ended September 30, 2002. This was partially offset by decreased
purchases of paper and pictorial inventory, decreased prepaid insurance
balances, decreased spending on subscription acquisition drives and a reduction
in circulation accounts receivable due to the timing of advance payments from
the Company's newsstand distributor. The net cash provided by operating
activities for the nine months ended September 30, 2001, was derived by
adjusting the net loss for the period by the effect of restructuring expenses
and non-cash items as well as decreased purchases of paper inventory and a
decrease in circulation accounts receivable due to the timing of advance
payments from the Company's newsstand distributor. This was partially offset by
increased spending on subscription acquisition drives and increased payments of
interest on the Senior Secured Notes during the first nine months of 2001.
Cash flows from investing activities
Cash flows provided by investing activities were $0.9 million for the nine
months ended September 30, 2002, compared to cash flows used in investing
activities of $0.1 million for the nine months ended September 30, 2001. The
cash provided by investing activities for the nine months ended September 30,
2002 was the result of the sale of the Policies on the life of the principal
shareholder. The cash used in investing activities for the nine months ended
September 30, 2001 was the result of capital expenditures made during that
period.
Cash flows from financing activities
Cash flows used in financing activities were $1.2 million for the nine months
ended September 30, 2002, compared to cash flows used in financing activities of
$6.0 million for the nine months ended September 30, 2001. Cash used in
financing activities for the nine months ended September 30, 2002 was the result
of payments of $3.5 million in mandatory principal payments for its Series C
Notes, partially offset by repayments of $1.3 million from GMI and $1.0 million
in cash received against a loan from the principal shareholder. Cash used in
financing activities for the nine months ended September 30, 2001 was primarily
the result of the payment of debt issuance costs of $1.9 million related to the
refinancing of the Company's Series C Notes (See Notes 5 and 6 of the Notes To
Condensed Consolidated Financial Statements), advances of $2.8 million to GMI
during the nine months ended September 30, 2001 and the repayment of $1.2
million of principal amount of the Notes.
Affiliated company advances at September 30, 2002 decreased $1.3 million from
December 31, 2001. These balances regularly result from the impact of certain
cost sharing and expense allocation agreements with GMI and its subsidiaries,
whereby certain costs, such as shared corporate salaries and overhead, are paid
by the Company and a portion charged to GMI and its subsidiaries as incurred.
These charges generally result in
20
amounts due to the Company, and are to be repaid sixty days after the end of
each quarter in accordance with the terms of an expense sharing agreement. In
light of the changes to the Indenture made in connection with the refinancing,
which had the effect of permitting an increase in amounts which may be due from
affiliates, the Company intends to amend the expense sharing agreement in the
near future. The ability of the Company to realize repayment of its advance is
dependant upon the success of GMI in refinancing its existing debt obligations,
most of which are currently in default. At December 31, 2001, the Company had a
loan receivable from the principal shareholder of GMI of $1.0 million. The
principal shareholder repaid $529,000 and $471,000 of this loan in April and May
2002, respectively.
The ability of the Company to incur additional debt is severely limited by the
terms of its Series C Notes and the Indenture. The Series C Notes will mature on
March 29, 2004, bear interest at a rate of 15% per annum from and after January
1, 2001 and require amortization payments of $5.8 million during the calendar
year 2002 and $6.5 million during the calendar year 2003, with the balance due
in 2004. In addition, further amortization equal to 50% of excess cash flow in
each year is required, as well as any proceeds from the sale of certain real
property owned by GMI (after payment of existing debt obligations thereon) and
any proceeds to the Company from certain insurance policies on the life of the
principal shareholder. The Company made amortization payments of $3.5 million
during the first nine months of 2002, which included $935,000 of proceeds from
the sale of the Policies (See Note 8).
The Indenture has been extended to the March 29, 2004 maturity of the Series C
Notes. The original Indenture contained covenants, that continue to the new
maturity date, which, among other things, (i) restrict the ability of the
Company to dispose of assets, incur indebtedness, create liens and make certain
investments, (ii) require the Company to maintain a consolidated tangible net
worth deficiency of no greater than $81.6 million, and (iii) restrict the
Company's ability to pay dividends unless certain financial performance tests
are met. The Company's subsidiaries, which are guarantors of the Senior Secured
Notes under the Indenture, however, were and continue to be permitted to pay
intercompany dividends on their shares of common stock. The ability of the
Company and its subsidiaries to incur additional debt is severely limited by
such covenants. The Indenture was amended in conjunction with the issuance of
the Series C Notes to reflect the above mentioned payments, to reflect the March
29, 2004 maturity of the Series C Notes, to provide additional "Change of
Control" events (requiring the commencement of an offer to purchase Notes), to
provide additional flexibility as to the nature of, but also to set a fixed
dollar limit for, "Owner Payments", and to require Noteholder consent to
entering into new lines of business or for sales or other conveyances of the
Penthouse trademark (other than ordinary course licensing) or other assets for
net proceeds in excess of $0.5 million. In addition, the related Security
Agreement was amended to grant additional security interests in inventory and
accounts receivable as well as a security interest in proceeds of the sale of
certain real property owned by GMI (after payment of existing debt obligations
thereon) and on any proceeds to the Company from certain policies on the life of
the Company's principal beneficial owner. As of September 30, 2002, the Company
was in compliance with all such covenants. However as of September 30, 2002 the
Company had not made a required principal redemption of approximately $2.0
million and a required interest payment of approximately $1.7 million, both due
by that date. During August and October 2002, the Company received $0.2 million
and $1.5 million, respectively, from GMI as repayments of amounts due the
Company by affiliated companies. These funds, along with approximately $2.0
million of cash from operations, were used by the Company in October 2002 to
make the required principal and interest payments within the applicable grace
periods allowed for by the Indenture.
On August 1, 2002, the Company and the Holders entered into a Third Supplemental
Indenture to amend the "Change of Control" events in the Indenture to add
further restrictions on the amount of "Owner Payments"; to substitute John
Orlando for John Prebich in the "Change of Control" provision; and to require
that new financial covenants (the "Financial Covenants") be added that require
the Company to achieve not less than
21
80% of the projected revenues and EBITDA to be set forth in a business plan in a
form and substance reasonably satisfactory to the Holders. In addition the
Company agreed to allow the Holders to audit the books and records of the
Company and the payroll records of the Company and GMI and to pay all the legal
fees, cost and expenses, and audit fees (collectively the "Amendment Expenses")
related to the agreement. The Company recorded $0.1 million of Amendment
Expenses during the nine months ended September 30, 2002. In July 2002, the
Company also paid $100,000 to the Holders as a deposit against Amendment
Expenses expected to be incurred by the Holders in completing the further
amendments to the Indenture required to incorporate the accepted business plan
into the financial covenants. In exchange for these amendments the Holders
agreed to waive their prior contention that a "Change of Control" event had
occurred with respect to the termination of John Prebich, the Company's former
President and Chief Operating Officer.
On September 13, 2002, the Company submitted a business plan to the Holders for
approval in accordance with the requirements of the Third Supplemental
Indenture. The Holders notified the Company that they had accepted the business
plan effective October 4, 2002. The Company and the Holders are in the process
of preparing a Fourth Supplemental Indenture that will incorporate the Financial
Covenants into the Indenture.
Results of Operations (Three Months Ended September 30, 2002 vs. 2001)
Several of the Company's businesses can experience fluctuations in quarterly
performance. For example, newsstand revenues vary from issue to issue with
higher revenues for special and higher priced issues and any issue including
editorial or pictorial features that generate unusual public interest. In
addition, revenues from the licensing of the Company's trademarks, products and
videos vary with the timing of new agreements. As a result, the Company's
performance in any quarterly period is not necessarily reflective of full-year
results.
The Company is currently engaged in activities in three industry segments:
publishing, online and entertainment. The publishing segment of the Company is
engaged in the publication of Penthouse magazine and four affiliate magazines,
the licensing of its trademarks to publishers in foreign countries and for use
on various consumer products and services. The online segment is engaged in the
sale of memberships to the Company's Internet Site, the sale of advertising
banners posted on the Internet Site and the sale of adult-oriented consumer
products through the Company's online store. The entertainment segment of the
Company produces a number of adult-oriented entertainment products and services,
including pay-per-call telephone lines, DVD's, video cassettes and pay-per-view
programming.
The Company's revenues were $11.8 million for the three months ended September
30, 2002, compared to revenues of $13.9 million for the three months ended
September 30, 2001, a decrease of $2.1 million. Newsstand revenues were $5.8
million and $6.5 million for the three months ended September 30, 2002 and 2001,
respectively, a decrease of $0.7 million. Advertising revenues were $1.7 million
and $2.1 million for the three months ended September 30, 2002 and 2001,
respectively, a decrease of $0.4 million. Subscription revenues were $1.6
million and $1.8 million for the three months ended September 30, 2002 and 2001,
respectively, a decrease of $0.2 million. Revenues for the online segment were
$1.7 million and $2.1 million for the three months ended September 30, 2002 and
2001, respectively, a decrease of $0.4 million. Revenues from the Entertainment
Segment were $0.4 million and $0.6 million for the three months ended September
30, 2002 and 2001 respectively, a decrease of $0.2 million. Revenues from the
Company's video business were $0.3 million and $0.4 million for the three months
ended September 30, 2002 and 2001, respectively, a decrease of $0.1 million.
Revenues from the Company's pay-per-call business were $0.1 million and $0.2
million for the three months ended September 30, 2002 and 2001, respectively, a
decrease of $0.1 million.
22
Income from operations was $0.3 million and $0.9 million for the three months
ended September 30, 2002 and 2001 respectively, a decrease of $0.6 million.
Income from operations was impacted by:
- - a decrease in the number of mens magazines sold,
- - a decrease in advertising revenues,
- - decreased revenues from the online and entertainment segments, and
- - an increase in bad debt expense due to the recording of additional
reserves for potentially uncollectable advertising accounts receivable,
primarily relating to amounts owed by two customers that were determined
to be potentially uncollectable during the current three month period,
partially offset by:
- - decreased production and distribution costs as a result of negotiating
reductions in the price of paper and changing the grades of paper used
to produce the magazines, and lower printing and distribution costs as
a result of negotiating reductions in the cost of printing the
magazines, by reducing the number of copies printed, by reducing the
number of pages per issue and by changing the magazines' design to
improve production efficiencies, and,
- - decreased selling, general and administrative expenses due to decreased
salaries, benefits and subscription costs, partially offset by
increased legal expenses.
Net other expense was $(1.8) million for the three months ended September 30,
2002 compared to net other expense of $(2.0) million for the three months ended
September 30, 2001. Included in net other expense for the year ended September
30, 2002 is interest expense of $1.8 million, compared to interest expense of
$2.0 million for the three months September 30, 2001, a decrease of $0.2
million.
As a result of the above discussed factors, net loss before the provision for
income taxes for the three months ended September 30, 2002 was $1.5 million,
compared to a net loss of $1.1 million for the three months ended September 30,
2001.
The net revenues and income from operations of the Company were (in millions):
Income
Net Revenue From Operations
----------- ---------------
Three Months Three Months
Ended Ended
September 30, September 30,
------------- -------------
2001 2002 2001 2002
------- ------- ------- -------
Publishing Segment $ 11.2 $ 9.7 $ 2.3 $ 2.1
Online Segment 2.1 1.7 1.0 0.9
Entertainment Segment 0.6 0.4 0.2 0.2
------- ------- ------- -------
$ 13.9 $ 11.8 $ 3.5 $ 3.2
Corporate Administrative Expenses (2.6) (2.9)
------- ------- ------- -------
$ 13.9 $ 11.8 $ 0.9 $ 0.3
======= ======= ======= =======
23
PUBLISHING SEGMENT
The net revenues and income from operations of the Publishing Segment were as
follows (in millions):
Income
From
Net Revenue Operations
-------------------- --------------------
Three Months Three Months
Ended Ended
September 30, September 30,
-------------------- --------------------
2001 2002 2001 2002
-------- -------- -------- --------
Penthouse Magazine and
the Affiliate Publications $ 10.7 $ 9.3 $ 1.9 $ 1.8
Foreign Edition Licensing 0.5 0.4 0.4 0.3
-------- -------- -------- --------
$ 11.2 $ 9.7 $ 2.3 $ 2.1
======== ======== ======== ========
PENTHOUSE MAGAZINE AND THE AFFILIATE PUBLICATIONS
Revenues for Penthouse magazine and the Affiliate Publications were $9.3 million
and $10.7 million for the three months ended September 30, 2002 and 2001,
respectively, a decrease of $1.4 million. Newsstand revenue was $5.8 million and
$6.5 million for the three months ended September 30, 2002 and 2001,
respectively, a decrease of $0.7 million. The decrease in the third quarter of
2002 is primarily attributable to a decrease in the number of copies of
Penthouse magazine and the Affiliate Publications sold. Newsstand sales
decreased as a result of continued weakness in the economy and the continued
loss of newsstand distribution outlets due to the change in social climate
towards men's magazines, together with advances in electronic technology,
including the proliferation of retail video outlets and the increased market
share of cable television and the internet, as well as ongoing acquisitions and
consolidations of companies in the magazine distribution industry which have for
several years resulted in a reduction in the number of outlets carrying the
Company's magazines. In addition, recent increases in the price of cigarettes
have caused a reduction in the number of customers visiting retail outlets,
resulting in worsening economic problems for many of the retailers who are part
of the magazine distribution network and consequently a reduction in the number
of magazines sold. To attempt to offset this decline, the Company has
implemented special marketing strategies aimed at developing new outlets for its
magazines and rewarding growth in sales by distributors. Newsstand revenues were
further impacted by an increase in retail display allowances of $0.1 million,
which are now offset against revenue as a result of the adoption of the new
Emerging Issues Task Force pronouncement EITF 01-9 as described under "Impact Of
Recently Issued Accounting Pronouncements" on page 17. Advertising revenue was
$1.7 million and $2.1 million for the three months ended September 30, 2002 and
2001, respectively, a decrease of $0.4 million. The decrease in advertising
revenue is primarily attributable to a decrease in the number of pages sold in
Penthouse magazine and a decrease in the average rate per page of advertising
pages sold in Penthouse magazine and the Affiliate Publications. The decrease in
the number of pages sold in Penthouse magazine and the rate per page of
advertising in Penthouse magazine and the Affiliate Publications is primarily
attributable to the continued weakness in the economy that caused customers to
scale back advertising during the third quarter of 2002. The decrease in
advertising in Penthouse was partially offset by an increase in the number of
pages sold in the Affiliate Publications during the third quarter of 2002 as a
result of increased emphasis on promoting sales of pages in these magazines.
Subscription revenue was $1.6 million and $1.8 million for the
24
three months ended September 30, 2002 and 2001, respectively, a decrease of $0.2
million. The decrease is primarily attributable to a decrease in the number of
subscriptions sold of Penthouse in the third quarter of 2002 as a result of a
decrease in the number of subscription acquisition direct mailings done in the
current year.
Publishing-production, distribution and editorial expenses were $5.1 million and
$6.1 million for the three months ended September 30, 2002 and 2001,
respectively, a decrease of $1.0 million. Paper costs were $1.7 million and $2.1
million for the three months ended September 30, 2002 and 2001, respectively a
decrease of $0.4 million. Print costs were $1.8 million for the three months
ended September 30, 2002, compared to $2.3 million for the three months ended
September 30, 2001, a decrease of $0.5 million. The decrease is primarily due to
a decrease in the number of copies printed per issue, a decrease in the cost of
paper as a result of negotiating a reduction in the price of paper and changing
the grades of paper used to produce the magazines, and decreased printing costs
as a result of negotiating lower costs of printing, by reducing the number of
copies printed, by reducing the number of pages per issue and by changes made in
the design of the Company's magazines to improve production efficiencies.
Distribution costs were $0.9 million and $1.0 million for the three months ended
September 30, 2002 and 2001, respectively, a decrease of $0.1 million. Editorial
costs were $0.7 million for both the three months ended September 30, 2002 and
2001, respectively.
Selling, general and administrative expenses were $2.4 million for the three
months ended September 30, 2002, compared to $2.7 million for the three months
ended September 30, 2001, a decrease of $0.3 million. The decrease is primarily
due to a decrease in salary and benefits expense of $0.5 million, partially
offset by increased bad debt expense of $0.2 million during the three months
ending September 30, 2002.
FOREIGN EDITION LICENSING
Revenues from licensing of foreign editions were $0.4 million and $0.5 million
for the three months ended September 30, 2002 and 2001, respectively, a decrease
of $0.1 million.
Selling, general and administrative expenses were $0.1 million for both the
three months ended September 30, 2002 and 2001.
ONLINE SEGMENT
Revenues for the online segment were $1.7 million and $2.1 million for the three
months ended September 30, 2002 and 2001, respectively, a decrease of $0.4
million. This decrease is primarily attributable to a decrease in the sale of
memberships to the Internet Site of $0.3 million and decreased advertising
revenues from banners on the Internet Site of $0.1 million during the three
months ending September 30, 2002. The decrease in revenue from the sale of
memberships to the Internet Site resulted from a decrease in the average price
of the memberships sold, partially offset by an increase in the number of new
members. The number of members to the Company's Internet Site has increased 20%
as compared to the third quarter of 2001 as a result of the changes in the
pricing of memberships and special promotions aimed at attracting new members.
In October 2002, the Company increased the price of memberships to the Internet
Site and eliminated some lower priced options in order to increase the average
price paid for memberships going forward. In addition, the Company began
accepting on-line electronic check payments in July 2002 as an additional method
of payment and plans to enter into cross-marketing programs with other web sites
to increase the amount of traffic to the Internet Site. The decrease in
advertising revenue is primarily attributable to the weakness in the U.S.
economy during 2001 and 2002. To offset this decline, the Company has
intensified its efforts to attract more advertising to the Internet Site.
25
Direct costs were $30,000 and $122,000 for the three months ended September 30,
2002 and 2001, respectively, a decrease of $92,000. The decrease is primarily
attributable to a decrease in fees paid to content providers of $54,000 and
direct costs of $36,000 for the three months ended September 30, 2002.
Selling general and administrative expenses were $0.8 million for the three
months ended September 30, 2002, compared to $0.9 million for the three months
ended September 30, 2001, a decrease of $0.1 million. The decrease is primarily
attributable to a decrease in salary and benefit expense of $0.1 million during
the three months ended September 30, 2002.
ENTERTAINMENT SEGMENT
Revenues from the Entertainment Segment were $0.4 million for the three months
ended September 30, 2002, compared to $0.6 million for the three months ended
September 30, 2001, a decrease of $0.2 million. The Company's video business
revenues were $0.3 million for the three months ended September 30, 2002
compared to $0.4 million for the three months ended September 30, 2001, a
decrease of $0.1 million. Revenues for the three months ended September 30, 2002
were lower due to sales in the prior period from a series of movies produced
under a joint venture co-operation agreement, revenue in the prior period from
several foreign licensing agreements which were not renewed in the current year
and sales in the prior period of several re-released catalog titles. The amount
of video business revenues earned in each period varies with the timing of new
contracts for the production and distribution of movies. During 2002 the Company
has been in the process of establishing new business relationships to provide
additional movies for distribution, but was unable to complete sufficient
contracts to sustain the level of production achieved in the prior year.
Revenues from the Company's pay-per-call business were $0.1 million and $0.2
million for the three months September 31, 2002 and 2001, respectively, a
decrease of $0.1 million. Revenues for the three months ended September 30, 2002
were lower due to lower billable minutes.
Direct costs were $0.2 million for both the three months ended September 30,
2002 and 2001, respectively
Selling, general and administrative expenses were $0.1 million and $0.2 million
for the three months ended September 30, 2002 and 2001, respectively, a decrease
of $0.1 million.
CORPORATE ADMINISTRATIVE EXPENSE
Included in selling, general and administrative expenses are corporate
administrative expenses which includes executive, legal, human resources,
finance and accounting, management information systems, costs related to the
operation of the corporate and executive offices and various other expenses.
Corporate administrative expenses were $2.9 million and $2.6 million for the
three months ended September 30, 2002 and 2001 respectively, an increase of $0.3
million. The increase in corporate overhead expense in primarily due to an
increase in legal expense of $0.8 million, professional fees of $0.1 million and
consulting fees of $0.1 million, partially offset by decreased salaries and
benefits of $0.7 million for the three months ended September 30, 2002.
BAD DEBT EXPENSE
Bad debt expense was $0.3 million for the three months ended September 30, 2002,
compared to $0.1 million for the three months ended September 30, 2001, an
increase of $0.2 million. The increase is due to an increase in bad debt
reserves for potentially uncollectable advertising accounts receivable.
26
RENT EXPENSE FROM AFFILIATED COMPANIES
Rent expense from affiliated companies represents charges from an affiliated
company for the use by the Company of the affiliate's facilities. The charge is
based upon the Company's proportionate share of the operating expenses of such
facilities. Rent expense from affiliated companies was $0.1 million for the
three months ended September 30, 2002 compared to $0.2 million for the three
months ended September 30, 2001, a decrease of $0.1 million. The decrease is
primarily attributable to lower salaries and benefits.
Results of Operations (Nine Months Ended September 30, 2002 vs. 2001)
The Company's revenues were $42.1 million for the nine months ended September
30, 2002, compared to revenues of $47.1 million for the nine months ended
September 30, 2001, a decrease of $5.0 million. Newsstand revenues were $21.4
million and $22.9 million for the nine months ended September 30, 2002 and 2001,
respectively, a decrease of $1.5 million. Advertising revenues were $6.1 million
and $6.3 million for the nine months ended September 30, 2002 and 2001,
respectively, a decrease of $0.2 million. Subscription revenues were $5.6
million and $5.5 million for the nine months ended September 30, 2002 and 2001,
respectively, an increase of $0.1 million. Revenues for the online segment were
$5.6 million and $7.6 million for the nine months ended September 30, 2002 and
2001, respectively, a decrease of $2.0 million. Revenues from the Entertainment
Segment were $1.3 million and $2.4 million for the nine months ended September
30, 2002 and 2001, respectively, a decrease of $1.1 million. Revenues from the
Company's video business were $0.9 million and $1.8 million for the nine months
ended September 30, 2002 and 2001, respectively, a decrease of $0.9 million.
Revenues from the Company's pay-per-call business were $0.4 million and $0.6
million for the nine months ended September 30, 2002 and 2001, respectively, a
decrease of $0.2 million.
Income from operations was $5.4 million and $7.1 million for the nine months
ended September 30, 2002 and 2001 respectively, a decrease of $1.7 million.
Income from operations was impacted by:
- - a decrease in the number of mens magazines sold, and
- - decreased revenues from the online and entertainment segments,
partially offset by:
- - revenue from an additional issue of Penthouse magazine and Girls of
Penthouse magazine recorded in the second quarter of 2002,
- - decreased production and distribution costs as a result of
negotiating reductions in the price of paper and changing the grades
of paper used to produce the magazines, and lower printing and
distribution costs as a result of negotiating reductions in the cost
of printing the magazines, by reducing the number of copies printed
and by changing the magazines' design to improve production
efficiencies,
- - decreased selling, general and administrative expenses due to
decreased salaries and benefits expense, partially offset by
increased insurance expense and legal expense, and
- - decreased bad debt expense.
27
Net other expense was $(4.7) million for the nine months ended September 30,
2002 compared to net other expense of $(15.4) million for the nine months ended
September 30, 2001. Included in net other expense for the nine months ended
September 30, 2002 is interest expense of $5.6 million, compared to interest
expense of $6.1 million for the nine months September 30, 2001, a decrease of
$0.5 million. Included in net other expense for the nine months ended September
30, 2002 is a gain on the sale of the Policies on the life of the principal
shareholding of $0.8 million. Included in net other expense for the nine months
ended September 30, 2001 are debt restructuring expenses of $9.6 million related
to the refinancing of the Company's Notes on March 29, 2001 (see Note 6 of the
Notes To Condensed Consolidated Financial Statements).
As a result of the above discussed factors, net income before the provision for
income taxes for the nine months ended September 30, 2002 was $0.7 million,
compared to a net loss of $8.3 million for the nine months ended September 30,
2001.
The net revenues and income from operations of the Company were (in millions):
Income
From
Net Revenue Operations
-------------------- -------------------
Nine Months Nine Months
Ended Ended
September 30, September 30,
-------------------- -------------------
2001 2002 2001 2002
-------- -------- -------- --------
Publishing Segment $ 37.1 $ 35.2 $ 10.1 $ 10.2
Online Segment 7.6 5.6 4.4 3.1
Entertainment Segment 2.4 1.3 1.5 0.5
-------- -------- -------- --------
$ 47.1 $ 42.1 $ 16.0 $ 13.8
Corporate Administrative Expenses (8.9) (8.4)
-------- -------- -------- --------
$ 47.1 $ 42.1 $ 7.1 $ 5.4
======== ======== ======== ========
PUBLISHING SEGMENT
The net revenues and income from operations of the Publishing Segment were as
follows (in millions):
Income
From
Net Revenue Operations
-------------------- --------------------
Nine Months Nine Months
Ended Ended
September 30, September 30,
-------------------- --------------------
2001 2002 2001 2002
-------- -------- -------- --------
Penthouse Magazine and
the Affiliate Publications $ 35.6 $ 33.9 $ 8.9 $ 9.2
Foreign Edition Licensing 1.5 1.3 1.2 1.0
-------- -------- -------- --------
$ 37.1 $ 35.2 $ 10.1 $ 10.2
======== ======== ======== ========
PENTHOUSE MAGAZINE AND THE AFFILIATE PUBLICATIONS
Revenues for Penthouse magazine and the Affiliate Publications were $33.9
million and $35.6 million for the
28
nine months ended September 30, 2002 and 2001, respectively, a decrease of $1.7
million. Newsstand revenue was $21.4 million and $22.9 million for the nine
months ended September 30, 2002 and 2001, respectively, a decrease of $1.5
million. The decrease is primarily attributable to a decrease in the number of
copies of Penthouse magazine and the Affiliate Publications sold resulting in a
decrease in newsstand revenue of $1.2 million and increased retail display
allowances of $0.3 million, which are now offset against revenue as a result of
the adoption of the new Emerging Issues Task Force pronouncement EITF 01-9 as
described under "Impact Of Recently Issued Accounting Pronouncements" on page
17. Newsstand sales have been adversely affected by the continued weakness in
the economy and by the continued loss of newsstand distribution outlets due to
the change in social climate towards men's magazines, together with advances in
electronic technology, including the proliferation of retail video outlets and
the increased market share of cable television and the internet, as well as
ongoing acquisitions and consolidations of companies in the magazine
distribution industry which have for several years resulted in a reduction in
the number of outlets carrying the Company's magazines. In addition, recent
increases in the price of cigarettes have caused a reduction in the number of
customers visiting retail outlets, resulting in worsening economic problems for
many of the retailers who are part of the magazine distribution network and
consequently a reduction in the number of magazines sold. To attempt to offset
this decline, the Company has implemented special marketing strategies aimed at
developing new outlets for its magazines and rewarding growth in sales by
distributors. Advertising revenue was $6.1 million and $6.3 million for the nine
months ended September 30, 2002 and 2001, respectively, a decrease of $0.2
million. The decreased revenue is attributable to a decrease in the average rate
per page of advertising pages sold in Penthouse magazine and the Affiliate
Publications, partially offset by an increase in the number of advertising pages
sold primarily due to an additional issue of Penthouse magazine and two
additional issues of Girls of Penthouse during the nine months ended September
30, 2002. Subscription revenue was $5.6 million and $5.5 million for the nine
months ended September 30, 2002 and 2001, respectively, an increase of $0.1
million. The increase is attributable to an additional issue of Penthouse
magazine recorded in the second quarter of 2002 and a slight increase in the
rate per issue sold, partially offset by a decrease in the number of subscribers
per issue as a result of a decrease in the number of subscription acquisition
direct mailings done in the current year.
Publishing-production, distribution and editorial expenses were $16.7 million
and $18.2 million for the nine months ended September 30, 2002 and 2001,
respectively, a decrease of $1.5 million. Paper costs were $5.7 million and $6.4
million for the nine months ended September 30, 2002 and 2001, respectively, a
decrease of $0.7 million. Print costs were $6.0 million for the nine months
ended September 30, 2002, compared to $6.6 million for the nine months ended
September 30, 2001, a decrease of $0.6 million. The decreases are due primarily
to lower paper costs as a result of negotiating reductions in the price of
paper, changing the grades of paper used to produce the magazines, a decrease in
the number of pages per issue and a decrease in printing costs as a result of
negotiating lower costs of printing and changes made in the design of the
Company's magazines to improve production efficiencies, partially offset by an
increase in the number of copies printed as a result of an additional issue of
Penthouse magazine and Girls of Penthouse magazine in the second quarter of
2002. Distribution costs were $2.9 million and $3.1 million for the nine months
ended September 30, 2002 and 2001, respectively, a decrease of $0.2 million.
Editorial costs were $2.2 million and $2.0 million for the nine months ended
September 30, 2002 and 2001, respectively, an increase of $0.2 million.
Selling, general and administrative expenses were $7.9 million for the nine
months ended September 30, 2002, compared to $8.4 million for the nine months
ended September 30, 2001, a decrease of $0.5 million. The decrease is primarily
due to a decrease in salaries and benefits of $0.5 million during the nine
months ending September 30, 2002.
29
Trends - Penthouse and the Affiliate Publications
Over the last several years, the number of newsstand copies of Penthouse
magazine and the Affiliate Publications sold per issue has trended downward.
From the first nine months of 1998 to the first nine months of 2002, Penthouse
magazine and the Affiliate Publications domestic average monthly newsstand
circulation decreased by 41%. The Company believes that the loss of several
newsstand distribution outlets due to the change in the social climate towards
men's magazines, together with advances in electronic technology, as outlined
above, as well as ongoing acquisitions and consolidations of companies in the
magazine distribution industry have largely contributed to the overall decrease
in circulation. Newsstand sales during 2001 and 2002 have also been negatively
impacted by the economic recession that began in 2001 and the failure of the
economy to make a significant recovery in 2002. In addition, recent increases in
the price of cigarettes have caused economic problems for retailers of
magazines, as outlined above, resulting in a reduction in the number of
magazines sold. The Company has raised the cover prices of the magazines and
reduced production costs to partially offset the decline in newsstand
circulation. The Company is attempting to increase newsstand sales though the
use of special marketing strategies it has implemented aimed at developing new
outlets for its magazines and rewarding growth in sales by distributors and the
addition of extra issues of certain of the Company's magazines. However due to
the negative factors listed above and the current weakness of the economy that
has resulted in an increase in the number of bankruptcies or near bankruptcies
of companies within the magazine distribution system, the Company expects
newsstand sales to fall below that of the prior year. The Company believes that
newsstand sales may recover somewhat during 2003 if the economy improves and its
special marketing strategies are successful.
The advertising revenues of Penthouse magazine and the Affiliate Publications
have also declined over the past several years. The primary reason for the
decrease in advertising revenue has been the decrease in the average monthly
circulation of the Company's magazines, which has the effect of decreasing
advertising rates and making the Company's magazines less attractive to
advertisers. In addition, many advertisers scaled back advertising in 2002 as a
result of the continuing weakness in the economy and many cigarette companies
have either suspended or scaled back advertising in magazines as a result of
increased pressure from regulatory agencies and concerns over litigation against
tobacco companies. There has also been a steady decrease in pay-per-call
advertising over the past several years as competition in the pay-per-call
industry has caused rates per minute to decrease and as pay-per-call services
have attracted less of an audience in recent years. Partially offsetting these
negative factors has been an increase in demand for advertising for sexual
enhancement products. The Company is also pursuing advertisers in many other
industries in an attempt to improve its advertising revenue. The Company
believes however that due to the above mentioned negative factors, 2002
advertising revenues will fall short of 2001 revenue. The Company expects
advertising revenue to fall again in 2003 as a result of the decreasing demand
for pay-per-call services and the weak economy in the current year that will
effect advertising budgets going into next year.
The Company has also experienced a steady decline in the number of sales of
subscription copies of Penthouse magazine and the Affiliate Publications over
the past several years. The Company believes the reasons for the decrease are
similar to the reasons for the declining newsstand sales, but has also resulted
from increases in the subscription prices of the magazines and lowered discounts
offered to subscription agents. The Company increased the subscription prices of
the magazines and lowered discounts to subscription agents in order to increase
the profitability of subscription sales. Subscription revenue also decreased in
2002 as a result of a decrease in the number of subscription acquisition direct
mailings done in the current year. The Company is not planning to increase the
subscription prices for the magazines in the near term and plans to increase the
number of subscription acquisition direct mailings next year. Therefore the
Company expects the number of subscribers to decline slightly in the fourth
quarter of 2002 and then to begin to increase during 2003 as a
30
result of the increase in the number of subscription acquisition direct
mailings. However, the 11.6% increase in postal rates that went into effect in
July 2002 is expected to reduce the profitability of subscription sales by
approximately $350,000 on an annualized basis. The Company will attempt to
partially offset the effect of this increase by reducing its subscription
related promotional expenses.
The Company has been steadily reducing its publishing-production, distribution
and editorial expenses over the past several years by reducing the number of
copies printed, reducing the number of pages per issue, negotiating reductions
in paper and printing costs and changing the grades of paper used to produce the
magazines. These expenses are expected to decrease further in 2002 as a result
of further changes made in paper grades on some of the magazines and changes
made to the design of the Company's magazines to improve production
efficiencies. However, the decrease in printing costs is expected to be
partially offset by increases for inflation contained in the Company's contracts
with its printers. The Company projects that paper prices, which decreased
during 2001, will remain stable during the remainder of 2002. However, paper
prices are volatile and a large increase in prices could have a material adverse
affect on the Company's cash flows and profitability.
Selling, general and administrative expenses are expected to decrease as a
result of a reduction in the number of employees in 2002. In future years,
selling, general and administrative expenses are expected to increase at about
the same rate as inflation.
FOREIGN EDITION LICENSING
Revenues from licensing of foreign editions were $1.2 million and $1.6 million
for the nine months ended September 30, 2002 and 2001, respectively, a decrease
of $0.4 million. The decrease in revenues in 2002 resulted when some of
Company's licensees stopped publishing magazines in their respective markets.
The Company is in the process of attempting to find new licensees to replace the
ones that were lost in these markets.
Selling, general and administrative expenses were $0.3 million for both the nine
months ended September 30, 2002 and 2001.
Trends - Foreign Edition Licensing
Until 2002 revenue from licensing of foreign editions had remained fairly stable
for many years. While declining circulation in mens magazines around the world
had resulted in lower royalty payments per licensee each year, the Company had
been able to maintain its licensing revenue by adding new licensees to offset
declining royalty payments. During 2002, the Company's foreign edition licensing
revenue declined when some of the Company's licensees stopped publishing and the
Company was unable to complete a sufficient number of new licensing agreements
to replace the ones that were lost in these markets. The continuing weakness in
the economy of most foreign countries during the year and the declining
circulation of mens magazines have made it more difficult to find licensees
willing to launch new publications. Despite the results in 2002, the Company is
currently negotiating with several licensees and expects an increase in the
number of new licenses completed in 2003 and therefore revenue is expected to
increase moderately over 2002. However this expectation is partially dependent
on the strength of the economy in the foreign countries that the Company has
existing and potential licensees in during the remainder of 2002 and during
2003, which is uncertain at this time.
31
In 2002 and future years, selling, general and administrative expenses for
foreign edition licensing are expected to increase at about the same rate as
inflation.
ONLINE SEGMENT
Revenues for the online segment were $5.6 million and $7.6 million for the nine
months ended September 30, 2002 and 2001, respectively, a decrease of $2.0
million. This decrease is primarily attributable to a decrease in revenue from
the sale of memberships to the Internet Site of $1.5 million and decreased
advertising revenues from banners on the Internet Site of $0.5 million during
the nine months ending September 30, 2002. The decrease in revenue from the sale
of memberships to the Internet Site resulted from a decrease in the average
price of the memberships sold, partially offset by an increase in the number of
new members. The number of members to the Company's Internet Site has increased
20% over the past year as a result of the changes in the pricing of memberships
and special promotions aimed at attracting new members. In October 2002, the
Company increased the price of memberships to the Internet Site and eliminated
some lower priced options in order to increase the average price paid for
memberships going forward. In addition, the Company began accepting on-line
electronic check payments in July 2002 as an additional method of payment and
plans to enter into cross-marketing programs with other web sites to increase
the amount of traffic to the Internet Site. The decrease in advertising revenue
is primarily attributable to the weakness in the U.S. economy during 2001 and
2002. To offset this decline, the Company has intensified its efforts to attract
more advertising to the Internet Site.
Direct costs were $0.1 million and $0.4 million for the nine months ended
September 30, 2002 and 2001, respectively, a decrease of $0.3 million. The
decrease is primarily attributable to a decrease in fees paid to content
providers of $0.2 million and a decrease in expenditures for content purchased
for the Internet Site of $0.1 million for the nine months ended September 30,
2002.
Selling general and administrative expenses were $2.4 million for the nine
months ended September 30, 2002, compared to $2.8 million for the nine months
ended September 30, 2001, a decrease of $0.4 million. The decrease is primarily
attributable to a decrease in salaries and benefits of $0.3 million, advertising
expense of $0.1 million, bank charges of $0.1 million and trade show expense of
$0.1 million, partially offset by increased data processing fees of $0.2 million
during the nine months ended September 30, 2002.
Trends - Online Segment
Revenues from the online segment, which had declined during 2001, primarily as a
result of the use of more aggressive credit card validation methods required to
comply with Visa's requirements, continued to decline in the first nine months
of 2002. The Company believes, however, that revenues from memberships will
start to increase slightly toward the end of 2002 as a result of changes it is
making to its pricing structure and the cross-marketing programs it plans to
enter into to bring traffic to the Internet Site, as stated above. The Company
expects revenue from the online segment for 2003 to be about the same as 2002.
However, the results will depend partially on the strength of the economy during
the remainder of 2002 and during 2003, which is uncertain at this time. The
Company does not believe it will need to intensify its validation methods any
further to meet Visa's requirements. However, Visa has the right to modify the
maximum chargeback level at any time. Should Visa decide to reduce the maximum
chargeback level, the Company may need to intensify its validation methods
further to meet the new requirements, which would result in a decrease in the
number of customers who would be accepted as members of the Internet Site.
MasterCard recently established its own regulations for maximum chargeback and
refund levels that went into effect in April 2002. The Company's
32
chargeback and refund levels have remained well within those required by the new
MasterCard regulations and these new regulations have had no material effect on
the sales of memberships to the Internet Site. There is also the possibility
that one or more of the credit card companies may decide to stop processing
adult on-line internet transactions altogether, which most likely would result
in a decrease in online revenues. While the Company has intensified its efforts
to attract more advertisers to the Internet Site, it believes that the current
weak market for internet advertising will cause revenues from advertising
banners in the Internet Site for the year 2002 to fall below that of the prior
year. The Company expects advertising revenue in 2003 to be consistent with
2002. Revenues from the online store in 2002 and 2003 are expected to remain
fairly consistent with that of 2001.
Direct costs are expected to decrease in 2002 as a result of decreases in fees
paid to content providers and are expected to increase at about the same rate as
inflation in future years.
Selling, general and administrative expenses are expected to decrease in 2002
due to a reduction in the number of employees and to increase in future years at
about the same rate as inflation.
ENTERTAINMENT SEGMENT
Revenues from the Entertainment Segment were $1.3 million for the nine months
ended September 30, 2002, compared to $2.4 million for the nine months ended
September 30, 2001, a decrease of $1.1 million. The Company's video business
revenues were $0.9 million for the nine months ended September 30, 2002 compared
to $1.8 million for the nine months ended September 30, 2001, a decrease of $0.9
million. Revenues for the nine months ended September 30, 2002 were lower due to
sales in the prior period from a series of movies produced under a joint venture
co-operation agreement, revenue in the prior period from several foreign
licensing agreements which were not renewed in the current year and sales in the
prior period of several re-released catalog titles. The amount of video business
revenues earned in each period varies with the timing of new contracts for the
production and distribution of movies. During 2002 the Company has been in the
process of establishing new business relationships to provide additional movies
for distribution, but was unable to complete sufficient contracts to sustain the
level of production achieved in the prior year. Revenues from the Company's
pay-per-call business were $0.4 million and $0.6 million for the nine months
September 30, 2002 and 2001, respectively, a decrease of $0.2 million. Revenues
for the nine months ended September 30, 2002 were lower due to lower billable
minutes.
Direct costs were $0.5 million and $0.4 million for the nine months ended
September 30, 2002 and 2001, respectively, an increase of $0.1 million. The
increase is attributable to increased video production costs for the nine months
ending September 30, 2002.
Selling, general and administrative expenses were $0.3 million and $0.5 million
for the nine months ended September 30, 2002 and September 30, 2001,
respectively, a decrease of $0.2 million. The decrease is primarily attributable
to decreased salary and benefits expense of $0.1 million and decreased
commissions of $0.1 million.
Trends - Entertainment Segment
Revenues from the Entertainment Segment have been declining over the past few
years primarily as a result of a steady decrease in demand for pay-per-call
services. The Company expects pay-per-call revenue to continue to decline during
2002 and thereafter. The Company's video business revenues for the first nine
months of 2002 have decreased over the prior year, for the reasons stated above,
but revenues for the fourth
33
quarter of 2002 are expected to remain consistent with the prior year. Results
for 2002 on an annual basis are, however, expected to still fall significantly
below that of the prior year. The Company is in the process of establishing new
business relationships to increase its video business revenue for 2003 and
thereafter.
Direct costs for the fourth quarter of 2002 are expected to fall below that of
2001 due to decreases in amounts spent to produce films and due to lower levels
of film production. Direct costs for 2002 on an annual basis are expected to be
about the same as the prior year. Direct costs for 2003 are expected to increase
due to increased levels of acquisition and production of films.
Selling, general and administrative expenses are expected to decrease in 2002
due to a reduction in the number of employees and to increase at about the same
rate as inflation in 2003.
CORPORATE ADMINISTRATIVE EXPENSE
Included in selling, general and administrative expenses are corporate
administrative expenses which includes executive, legal, human resources,
finance and accounting, management information systems, costs related to the
operation of the corporate and executive offices and various other expenses.
Corporate administrative expenses were $8.4 million for the nine months ended
September 30, 2002, compared to $8.9 million for the nine months ended September
30, 2001, a decrease of $0.5 million. This decrease is primarily attributable to
decreased salaries and benefits of $1.2 million and bad debt expense of $0.5
million, partially offset by an increase in legal expenses of $0.9 million and
insurance expenses of $0.3 million for the nine months ended September 30, 2002.
Trends - Corporate Administrative Expense
Corporate administrative expenses for the fourth quarter of 2002 are expected to
be consistent with the prior year as a result of a decrease in salaries and
benefits due to a reduction in the number of employees offset by increased legal
fees in 2002. Corporate administrative expenses in 2003 are expected to increase
at about the same rate as inflation.
BAD DEBT EXPENSE
Bad debt expense was $0.3 million for the nine months ended September 30, 2002,
compared to $0.9 million for the nine months ended September 30, 2001, a
decrease of $0.6 million. The decrease is primarily attributable to the
recording of a reserve of $0.4 million in the prior year related to receivables
from KC Publishing, Inc., a company owned by the Company's former President and
Chief Operating Officer and the recording of a reserve of $0.3 million in the
prior year related to receivables from subscription agents partially offset by
increased reserves for potential uncollectable advertising accounts receivable
of $0.1 million during the nine months ended September 30, 2002. The Company has
established these reserves because collectibility of these amounts was not
assured. The reserve related to receivables from KC Publishing has been included
in corporate administrative expenses. The reserve related to receivables from
subscription agents in 2001 and the reserves for advertising accounts receivable
in 2002 have been included in the selling, general and administrative expenses
of Penthouse Magazine and the Affiliate Publications.
RENT EXPENSE FROM AFFILIATED COMPANIES
Rent expense from affiliated companies represents charges from an affiliated
company for the use by the
34
Company of the affiliate's facilities. The charge is based upon the Company's
proportionate share of the operating expenses of such facilities. Rent expense
from affiliated companies was $0.4 million for the nine months ended September
30, 2002 as compared to $0.5 million for the nine months ended September 30,
2001, a decrease of $0.1 million.
Forward-Looking Statements
In addition to historical information, "Management's Discussion and Analysis of
Financial Condition and Results of Operations" contains forward-looking
statements as to expectations, beliefs, plans, objectives and future financial
performance, and assumptions underlying or concerning the foregoing. These
forward-looking statements involve risks and uncertainties and are based on
certain assumptions, which could cause actual results or outcomes to differ
materially from those expressed in the forward looking statements. The following
are important factors that could cause actual results or outcomes to differ
materially from those discussed in the forward-looking statements: (a)
government actions or initiatives, including (1) attempts to limit or otherwise
regulate the sale of adult-oriented materials, including print, video and online
materials; (2) regulation of the advertisement of tobacco products, or (3)
significant changes in postal regulations or rates, (b) increases in paper
prices; (c) 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; (d) effects of the consolidations and
bankruptcies taking place among businesses which are part of the magazine
distribution system; (e) uncertainty with regard to the future market for
entertainment, e-commerce and advertising by way of the Internet, (f) the impact
on advertising sales of a slow-down or recession in the economy, an increasingly
competitive environment and competition from other content and merchandise
providers; (g) the impact of terrorist attacks; (h) the ability of the Company
to generate sufficient cash from future operations to make all the payments
required under the Series C Notes; and (i) the ability to obtain alternative
financial sources to repay the principal amount of the Notes at maturity.
Readers are cautioned not to place undue reliance in these forward-looking
statements, which reflect management's opinions only as of the date hereof. The
Company undertakes no obligation to revise or publicly release the results of
any revision to these forward-looking statements.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
The Company is exposed to market risk from changes in interest rates. Management
does not believe that it has any foreign currency rate risk.
Interest Rates-As of December 31, 2000, the Company had debt of $52.0 million
with a fixed rate of 10 5/8%. On March 29, 2001 the Company exchanged $51.5
million of this debt for new debt with a fixed rate of 15% and retired $0.5
million of the debt. In July 2001, October 2001, December 2001, April 2002, May
2002 and July 2002, the Company retired $0.7 million, $1.1 million, $0.7
million, $1.2 million, $0.9 million and $1.3 million of the new debt,
respectively in accordance with the requirements of the Series C Notes. The
Company is subject to market risk based on potential fluctuations in current
interest rates.
Foreign-Exchange Rate Risk-The Company does not believe it has exposure to
foreign exchange rate risk because all of its financial instruments are
denominated in U.S. dollars.
ITEM 4. CONTROLS AND PROCEDURES
Within the 90 days prior to the date of this Quarterly Report on Form 10-Q, the
Company evaluated the effectiveness of the design and operation of its
"disclosure controls and procedures" (Disclosure Controls) and
35
its "internal controls and procedures for financial reporting" (Internal
Controls). This evaluation (the "Controls Evaluation") was done under the
supervision and with the participation of management.
Disclosure Controls are procedures that are designed with the objective of
ensuring that information required to be disclosed in our reports filed under
the Securities Exchange Act of 1934 (Exchange Act) is recorded, processed,
summarized and reported within the time periods specified in the SEC's rules and
forms. Disclosure Controls are also designed with the objective of ensuring that
such information is accumulated and communicated to our management, including
the Chief Executive Officer (CEO) and the Chief Financial Officer (CFO), as
appropriate to allow timely decisions regarding required disclosure. Internal
Controls are procedures which are designed with the objective of providing
reasonable assurance that (1) our transactions are properly authorized; (2) our
assets are safeguarded against unauthorized or improper use; and (3) our
transactions are properly recorded and reported, all to permit the preparation
of our financial statements in conformity with generally accepted accounting
principles.
Among other matters, we sought in our Controls Evaluation to determine whether
there were any "significant deficiencies" or "material weaknesses" in the
Company's Internal Controls, or whether the Company had identified any acts of
fraud involving personnel who have a significant role in the Company's Internal
Controls. In professional auditing literature, "significant deficiencies" are
referred to as "reportable conditions"; these are control issues that could have
a significant adverse effect on the ability to record, process, summarize and
report financial data in the financial statements. A "material weakness" is
defined in the auditing literature as a particularly serious reportable
condition where the internal control does not reduce to a relatively low level
the risk that misstatements caused by error or fraud may occur in amounts that
would be material in relation to the financials statements and not be detected
within a timely period by employees in the normal course of performing their
assigned functions. We also sought to deal with other controls matters in the
Controls Evaluation, and in each case if a problem was identified, we considered
what revision, improvement and/or correction to make in accord with our on-going
procedures.
The CEO and CFO note that, since the date of the Controls Evaluation to the date
of this Quarterly Report, there have been no significant changes in Internal
Controls or in other factors that could significantly affect Internal Controls,
and no corrective actions were required or taken with regard to significant
deficiencies and material weaknesses.
Based upon the Controls Evaluation, our CEO and CFO have concluded that our
Disclosure Controls were effective to ensure that material information relating
to General Media, Inc. and its consolidated subsidiaries is made known to
management, including the CEO and the CFO.
PART II-OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
On December 3, 2001, Network Telephone Services ("NTS") filed in Los Angeles
Superior Court (the "Court") a complaint against Robert C. Guccione, GMI and the
Company (collectively the "Defendants") asserting breach of promissory note,
breach of written guarantee, and a declaration of rights and injunctive relief
arising out of a promissory note and several other agreements between NTS and
the Defendants. NTS seeks damages in the amount of approximately $1.1 million,
interest at the rate of 9% per annum from September 1, 2001 and attorney's fees.
The Defendants have filed their answer to the complaint asserting a
cross-complaint requesting a declaration of whether and to what extent the
arbitrary reduction in the rates of payout by an affiliate of NTS breached its
pay-per-call service agreement with the Company. The Court
36
ordered the case to mediation, which began on June 4, 2002. The Company is in
negotiations with NTS to renew its pay-per-call service and advertising
agreements, which renewal could provide for the settlement of this litigation.
In the event these agreements cannot be negotiated at fair market rates and
damages are assessed against the Company, it will seek to recover any amounts
paid to NTS from Robert C. Guccione and GMI. In light of the concerns related to
the Company's liquidity, which are more fully described in Note 1 to the
Condensed Consolidated Financial Statements, it is possible that the Company
would be unable to satisfy a judgement rendered against it by the Court, should
one be assessed. Therefore management believes that an adverse outcome with
respect to these proceedings could have a material adverse effect on its
financial condition or results of operations.
On May 8, 2002, Anna Kournakova ("Anna") filed in United States District Court
for the Central District of California (the "California Court"), an action (the
"Action") alleging, among other things, that the Company published photographs
(the "Photographs") of a woman topless in the June 2002 issue of Penthouse
Magazine (the "Magazine"), falsely representing them to be pictures of Anna when
they were in reality photographs of someone else. The Action also alleges that
the Company advertised its intention to make the Photographs and a video of the
woman available on its Internet Site on May 10, 2002. On May 7, 2002, the
Company issued a press release stating that it had made an unintentional error
when it said the Photographs were of Anna and it apologized to Anna and the
actual woman in the Photographs for the error. The Company also published the
apology on its Internet Site.
Anna seeks a permanent injunction barring the Company from any similar acts
concerning her, barring it from any further distribution of the Photographs and
the June 2002 edition of the Magazine, barring it from any references to Anna on
its Internet Site, barring it from representing that any pictures or photographs
on the Internet Site are depictions of Anna, ordering it to deliver or destroy
all materials that have the alleged false representations, ordering the
disgorgement and paying over of all profits it earned and any other unjust
enrichment that it received from the alleged false depiction of Anna, awarding
damages in an unspecified amount not less than $10.0 million, trebling of these
unspecified damages, awarding punitive damages in an unspecified amount and
reimbursement for Anna's costs and attorneys' fees in prosecuting the Action.
The Company has filed a motion to dismiss portions of the complaint and Anna has
filed a cross-motion to freeze $15.0 million of the Company's assets for
purposes of insuring the payment of a possible judgement. The California Court
denied both of these motions in August 2002. Anna has since filed an appeal with
the Ninth US Court of Appeals. The Company and Anna are currently engaged in
exchanging requests for documents and the taking of depositions related to
Anna's appeal. The Company intends to vigorously defend itself in this action.
It is still too early to determine the possible outcome of the proceedings.
Therefore management cannot give an opinion as to the effect this Action will
have on the Company's financial condition or results of operations. There can be
no assurance, however, that the ultimate liability from these proceedings will
not have a material adverse effect on its financial condition and results of
operations.
On May 24, 2002, Reed Somberg and Liuz Gonzalez individually and on behalf of
all others similarly situated (the "Class Action Plaintiffs") filed in the
Circuit Court of Florida, 11th Judicial Circuit for Miami/Dade County (the
"Florida Court"), an action alleging that the Company committed a "breach of
duty" when it published the Photographs, falsely representing them to be
pictures of Anna when they were in reality photographs of someone else. The
Class Action Plaintiffs claim they bought the Magazine prior to learning that
the authenticity of the Photographs was in question for the sole purpose of
looking at these Photographs. The action requested class-action certification, a
refund of the price of the Magazine, compensation for the "lost value" of the
Magazine, court costs and interest. On July 22, 2002, the Company filed a motion
to dismiss the action. On October 8, 2002, the Florida Court issued an order
that gave the Class Action Plaintiffs ten days
37
to file an amended complaint or the case would be dismissed with prejudice. The
Class Action Plaintiffs failed to file an amended complaint within the ten day
period and they have agreed to a dismissal of the action.
On August 26, 2002, Vadim Levin and Alex Sheyngis individually and on behalf of
all others similarly situated (the "Other Class Action Plaintiffs") filed in the
Court of Cook County, Illinois, an action alleging that the Company committed a
breach of contract, a breach of express warranty and consumer fraud when it
published the Photographs, falsely representing them to be pictures of Anna when
they were in reality photographs of someone else. The Other Class Action
Plaintiffs have filed a request that the action be certified as a class acton
with the two plaintiffs as class representatives and their lawyer as class
counsel. The Company has filed a motion to dismiss the action. The Company
intends to vigorously defend itself in this action. It is still too early to
determine the possible outcome of the proceedings. Therefore management cannot
give an opinion as to the effect this Action will have on the Company's
financial condition and results of operations. There can be no assurance,
however, that the ultimate liability from these proceedings will not have a
material adverse effect on its financial condition and results of operations.
There are various other lawsuits claiming amounts against the Company. It is the
opinion of the Company's management that the ultimate liabilities, if any, in
the outcome of these cases will not have a material effect on the Company's
financial statements.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
On August 1, 2002, the Company and the Holders completed a Third Supplemental
Indenture that amended the "Change of Control" events to add further
restrictions on the amount of "Owner Payments", to substitute John Orlando for
John Prebich in the "Change of Control" provision and to provide that new
financial covenants (the "Financial Covenants") be added that require the
Company to achieve not less than 80% of the projected revenues and EBITDA that
were set forth in a business plan in a form and substance reasonably
satisfactory to the Holders. These Financial Covenants are to be incorporated
into the Indenture pursuant to an additional supplement. In addition the Company
agreed to allow the Holders to audit the books and records of the Company and
the payroll records of GMI and to pay all the legal fees, costs and expenses and
audit fees of the Holders related to the agreement.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) The exhibits listed in the "Exhibit Index" are filed as part
of this report.
(b) Reports on Form 8-K.
No reports on Form 8-K were filed during the quarter ended
September 30, 2002.
38
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
General Media, Inc.
(Registrant)
Dated: November 14, 2002 By: /s/ John D. Orlando
---------------------------------------
Signature
John D. Orlando
President - Chief Operating Officer
and Chief Financial Officer
(Duly Authorized Officer and
Principal Accounting Officer)
39
CERTIFICATIONS
I, Robert C. Guccione, certify that:
1. I have reviewed this quarterly report on Form 10-Q of General Media,
Inc.;
2. Based on my knowledge, this quarterly report does not contain any
untrue statement of a material fact or omit to state a material fact
necessary to make the statements made, in light of the circumstances
under which such statements were made, not misleading with respect
to the period covered by this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and
cash flows of the registrant as of, and for, the periods presented
in this quarterly report;
4. The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant
and we have;
a. designed such disclosure controls and procedures to ensure
that material information relating to the registrant,
including its consolidated subsidiaries, is made known to us
by others within those entities, particularly during the
period in which this quarterly report is being prepared;
b. evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior to
the filing date of this quarterly report (the "Evaluation
Date"); and
c. presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based
on our evaluation as of the Evaluation Date;
5. The registrant's other certifying officer and I have disclosed,
based on our most recent evaluation, to the registrant's auditors
and the registrant's board of directors;
a. all significant deficiencies in the design or operation of
internal controls which could adversely affect the
registrant's ability to record, process, summarize and report
financial data and have identified for the registrant's
auditors any material weaknesses in internal controls; and
b. any fraud, whether or not material, that involves management
or other employees who have a significant role in the
registrant's internal controls; and
6. The registrant's other certifying officers and I have indicated in
this quarterly report whether or not there were significant changes
in internal controls or in other factors that could significantly
affect internal controls subsequent to the date of our most recent
evaluation, including any corrective actions with regard to
significant deficiencies and material weaknesses.
/s/ Robert C. Guccione
-----------------------------------
Chief Executive Officer
November 14, 2002
40
CERTIFICATIONS
I, John D. Orlando, certify that:
1. I have reviewed this quarterly report on Form 10-Q of General Media,
Inc.;
2. Based on my knowledge, this quarterly report does not contain any
untrue statement of a material fact or omit to state a material fact
necessary to make the statements made, in light of the circumstances
under which such statements were made, not misleading with respect
to the period covered by this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and
cash flows of the registrant as of, and for, the periods presented
in this quarterly report;
4. The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant
and we have;
a. designed such disclosure controls and procedures to ensure
that material information relating to the registrant,
including its consolidated subsidiaries, is made known to us
by others within those entities, particularly during the
period in which this quarterly report is being prepared;
b. evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior to
the filing date of this quarterly report (the "Evaluation
Date"); and
c. presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based
on our evaluation as of the Evaluation Date;
5. The registrant's other certifying officer and I have disclosed,
based on our most recent evaluation, to the registrant's auditors
and the registrant's board of directors;
a. all significant deficiencies in the design or operation of
internal controls which could adversely affect the
registrant's ability to record, process, summarize and report
financial data and have identified for the registrant's
auditors any material weaknesses in internal controls; and
b. any fraud, whether or not material, that involves management
or other employees who have a significant role in the
registrant's internal controls; and
6. The registrant's other certifying officers and I have indicated in
this quarterly report whether or not there were significant changes
in internal controls or in other factors that could significantly
affect internal controls subsequent to the date of our most recent
evaluation, including any corrective actions with regard to
significant deficiencies and material weaknesses.
/s/ John D. Orlando
-----------------------------------
Chief Operating Officer
and Chief Financial Officer
November 14, 2002
41
Exhibit Index
Exhibit No. Description
99.1 -- Certification Of Robert C. Guccione, Chief Executive Officer,
Pursuant to 18 U.S.C. Section 1350, As Adopted Pursuant to Section
906 of the Sarbanes-Oxley Act of 2002
99.2 -- Certification Of John D. Orlando, Chief Financial Officer, Pursuant
to 18 U.S.C. Section 1350, As Adopted Pursuant to Section 906 of
the Sarbanes-Oxley Act of 2002
42