GENERAL MEDIA INC - 10-K Annual Report

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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-K

Annual Report Pursuant to Section 13 or 15(d) of
the Securities Exchange Act of 1934

For the Fiscal Year Ended December 31, 1998 Commission File Number: 33-76716

GENERAL MEDIA, INC.
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(Exact name of registrant as specified in its charter)

DELAWARE 13-3750988
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(State of incorporation) (IRS Employer Identification No.)

11 Penn Plaza, New York, NY 10001.
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(Address of principal executive offices)

(212) 702-6000
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(Registrant's telephone number)
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Securities registered pursuant to Sections 12(b) or 12(g) of the Act: NONE
---------------------

Indicate by check mark whether 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 each 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 by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of Registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [N/A]

The aggregate market value of the Registrant's common stock, par value $.01 per
share, held by non-affiliates of the Registrant was $0.

As of March 17, 1999, there were 475,000 shares outstanding of the Registrant's
common stock, par value $.01 per share.

DOCUMENTS INCORPORATED BY REFERENCE

Location in Form 10-K in Which
Document Document is Incorporated
-------- ------------------------

Registration Statement No. 33-76716 on Part IV, Items 14(a)(3) and 14(c),
Form S-4, filed with the Securities to the extent indicated therein.
and Exchange Commission on March 22, 1994.

GENERAL MEDIA, INC.
FORM 10-K ANNUAL REPORT
FOR THE YEAR ENDED DECEMBER 31, 1998

TABLE OF CONTENTS
Page
PART I ----

Item 1. BUSINESS........................................................... 3
Item 2. PROPERTIES.........................................................12
Item 3. LEGAL PROCEEDINGS..................................................12
Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY
HOLDERS............................................................13

PART II

Item 5. MARKET FOR THE REGISTRANT'S COMMON STOCK
AND RELATED STOCKHOLDER MATTERS..................................13
Item 6. SELECTED FINANCIAL DATA............................................15
Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS..............................16
Item 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES
ABOUT MARKET RISK ...............................................29
Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA........................29
Item 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON
ACCOUNTING AND FINANCIAL DISCLOSURE................................29

PART III

Item 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.................30
Item 11. EXECUTIVE COMPENSATION.............................................32
Item 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS
AND MANAGEMENT.....................................................35
Item 13. CERTAIN RELATIONSHIPS AND RELATED
TRANSACTIONS.......................................................35

PART IV

Item 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND
REPORTS ON FORM 8-K................................................36

2

PART I

Item 1. BUSINESS.

In General

General Media, Inc. ("General Media"), together with its subsidiaries
(General Media and its subsidiaries are collectively referred to as the
"Company"), is a publishing and entertainment company engaged in the production
and sale of men's magazines, various entertainment products and until March
1999, automotive magazines and an automotive television series.

On March 2, 1999 (the "Closing Date"), the Company sold substantially all
of the assets, exclusive of net newsstand and advertising accounts receivable,
of its wholly-owned subsidiary, General Media Automotive Group, Inc.("GMAG") to
EMAP Petersen, Inc.("EMAP") for $35 million in cash plus the assumption of
certain liabilities and deferred subscription liabilities, as defined in the
Asset Sale and Purchase Agreement between EMAP and GMAG dated as of February 9,
1999 (the "Asset Purchase Agreement"). The sale price is subject to an
adjustment to be finalized within 60 days from the Closing Date and shall be
increased or decreased on a dollar for dollar basis by the amount that net
working capital, as defined in the Asset Purchase Agreement, deviates from $1.5
million. The Company expects to realize a gain of approximately $29 million.

General Media is a wholly owned subsidiary of General Media International,
Inc. ("GMI"). GMI, together with its subsidiaries other than the Company (such
subsidiaries are collectively referred to as the "Other GMI Subsidiaries"),
engages in operations that are organized into the Real Estate Group (which owns
various properties and real estate holdings), and the Fine Arts Group (which
buys, sells and holds for sale a substantial inventory of works of art). GMI
formed General Media, a Delaware corporation, in November 1993 to implement a
new operating and financing plan, which included (i) the transfer to General
Media of the stock of certain subsidiaries that formed a portion of the
publishing and the entertainment segments of GMI and (ii) the private offering
of senior debt securities and common stock purchase warrants (the "Private
Offering"). See "Market for the Registrant's Common Stock and Related
Stockholder Matters." Such plan enabled GMI to, among other things, direct
resources to certain subsidiaries within its publishing and entertainment
segments and improve operational and financial flexibility by replacing
short-term debt with fixed-rate, long-term debt.

The Company is currently engaged in activities in two industry segments:
publishing and entertainment. The publishing segment of the Company is engaged
in the publication of Penthouse magazine and six affiliate magazines (the
"Affiliate Publications"), the licensing of the Penthouse brand name to
publishers in foreign countries and until March 1999, the publication of four
specialty automotive magazines. The entertainment segment of the Company
provides a number of adult-oriented entertainment products and services,
including internet subscription services, pay-per-call telephone lines, video
cassette products and pay-per-view programming.

The net revenues, income from continuing operations and identifiable
assets attributable to each of the Company's industry segments are presented in
Note 10 to Consolidated Financial Statements included in Part IV, Item 14.

3

Products and Services - Publishing Segment

Penthouse Magazine and the Affiliate Publications

Penthouse magazine was founded by Robert Guccione, who first published the
magazine in London in 1965 and in the United States in 1969. Penthouse magazine,
the magazine of sex, politics and protest, offers its readers a combination of
photography, investigative journalism, fiction, illustration, humor, politics,
art and business. This creative mix of informative and entertaining articles
combined with high quality photography has enabled Penthouse magazine to
maintain a loyal consumer base.

Penthouse magazine prides itself on the quality of the editorial package
it presents to its readers every month. Its investigative reporting over the
years has been credited with significant "news breaks" that have resulted in
press conferences and national headlines. The monthly Penthouse magazine
interview of public personalities is also a hallmark of the magazine. Over the
years, Penthouse magazine has interviewed major international figures, domestic
politicians, sports heroes and entertainment personalities.

In addition, leading figures of American political and social life have
written provocative articles for Penthouse magazine. Some of the country's best
selling writers contribute their fiction and non-fiction stories to Penthouse
magazine. The magazine also includes monthly fashion features, as well as
reviews of films, books, computer products, wine and spirits and regular
coverage of health and fitness issues for men.

To capitalize on the success of Penthouse magazine, the Company
established six Affiliate Publications. Each of the Affiliate Publications is
further described below.

Forum: A monthly publication in digest form that includes adult
information, advice and entertainment provided by authors, journalists and
medical and legal experts. The magazine is published domestically and licensed
in Europe and Australia. In addition, the Company publishes several special
issues of Forum each year. Forum is sold at newsstands and through
subscriptions.

Variations: A monthly publication in digest form that features articles
detailing the latest trends in adult entertainment. In addition, the Company
publishes several special issues of Variations each year. Variations is sold at
newsstands and through subscriptions.

Hot Talk: A monthly full-sized publication that features adult
entertainment articles and letters describing erotic telephone conversations.
Hot Talk is sold only through newsstands.

The Girls of Penthouse: A monthly full-sized publication featuring
photographs of the most popular models who have appeared in Penthouse magazine.
The Girls of Penthouse is sold only through newsstands.

Penthouse Letters: A monthly full-sized publication featuring letters
written by readers describing their erotic experiences and fantasies. Penthouse
Letters is sold at newsstands and through subscriptions.

Penthouse Comix: A bi-monthly, adult-theme comic book featuring the
creative work of well-known comic artists. The first issue was published in
April 1994. Penthouse Comix is available at newsstands and through
subscriptions. In April 1995, a second adult-theme comic book, Men's Adventure
Comix, began publication, bi-monthly, in alternating months with Penthouse
Comix. Men's Adventure Comix discontinued bi-monthly publication in March 1996
and Penthouse Comix was then published 10 times annually and Men's

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Adventure Comix was published only twice. In June of 1998 the Company published
the final issue of Penthouse Comix and Men's Adventure Comix.

Circulation.

In 1998, Penthouse magazine had a domestic average monthly circulation of
approximately 1,016,000 copies and the Affiliate Publications had a combined
domestic average monthly circulation of approximately 525,000 copies. The table
below presents domestic average monthly circulation figures for Penthouse
magazine and the Affiliate Publications for the years ended December 31, 1994
through 1998.

Penthouse Magazine and the Affiliate Publications
Domestic Average Monthly Circulation
(Copies in Thousands)

Penthouse Magazine Affiliate Publications
----------------------------------- ---------------------------------- Total
Year Ended Domestic
December 31, Newsstand Subscription Total Newsstand Subscription Total Circulation
- ----------- --------- ------------ ----- --------- ------------ ----- -----------

1994 ...... 856 343 1,199 872 53 925 2,124
1995 ...... 720 401 1,121 779 64 843 1,964
1996 ...... 645 356 1,001 634 58 692 1,693
1997 ...... 533 379 912 554 50 604 1,516
1998 ...... 578 438 1,016 475 50 525 1,541

Penthouse magazine and the Affiliate Publications are primarily sold
through newsstand distribution by convenience stores, bookstores and newsstands.
Approximately 44% of Penthouse's newsstand sales are derived from convenience
stores, while approximately 11% and 12 % of such sales are derived from
bookstore and newsstand distribution channels, respectively. Newsstand copies
sold as a percentage of total copies sold of Penthouse magazine and the
Affiliate Publications were approximately 84% for the year ended December 31,
1998.

The number of magazine copies sold on newsstands varies monthly, depending
on, among other things, the cover, pictorials and editorial content.
Approximately 17% of total newsstand copies are sold internationally.

Newsstand revenues for Penthouse magazine and the Affiliate Publications
were $41.2 million, $42.0 million and $49.5 million for the years ended December
31, 1998, 1997 and 1996, respectively, representing approximately 39%, 40% and
43% of the Company's net revenues for these periods, respectively.

In recent years, domestic newsstand circulation for men's magazines has
been declining. From 1994 to 1998, Penthouse magazine's and the Affiliate
Publications' domestic average monthly newsstand circulation

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decreased by 39%. This was partially offset by an 8% increase from 1997 to 1998
in newsstand circulation for Penthouse magazine. The Company believes that the
loss of several newsstand distribution outlets due to the change in social
climate toward men's magazines, together with certain advances in electronic
technology, including the proliferation of retail video outlets and the
increased market share of cable television and the internet, have largely
contributed to the overall decrease in circulation.

This decrease in domestic average monthly circulation for Penthouse
magazine and the Affiliate Publications has been partially offset, however, by
the Company's ability to maintain consistent cover price increases and the
recapture of certain convenience store distribution channels. Penthouse
magazine's cover price, for example, has steadily increased from $3.00 per issue
in 1983 to $5.99 per issue for eight issues and $6.99 per issue for four issues
in 1998. The Company regularly price tests its magazines. However, no cover
price increases are planned in fiscal 1999.

While newsstand circulation is the Company's principal means of
distribution for Penthouse magazine and the Affiliate Publications, the Company
has sought to increase their subscription circulation. The price of a twelve
month subscription to Penthouse magazine ranged from $23.00 to $46.00 in 1998,
depending upon the source of the subscription. The Company attracts new
subscribers to its magazines primarily through its own direct mail advertising
campaign, and through subscription agent campaigns. The Company recognizes
revenues from its magazine subscriptions over the term of the subscriptions.

Subscription revenues for Penthouse magazine and the Affiliate
Publications were $7.7 million, $7.2 million and $7.9 million for the years
ended December 31, 1998, 1997 and 1996, respectively, representing approximately
7% of the Company's net revenues for these periods.

Advertising.

Penthouse magazine and the Affiliate Publications are relatively less
dependent on advertising revenues than many other magazines as approximately 66%
of their respective revenues are generated from newsstand sales, while
approximately 12% are generated from subscription sales and approximately 20%
are generated from advertising. Advertising revenues (excluding affiliated
advertising revenues) for Penthouse magazine and the Affiliate Publications were
$12.3 million, $12.9 million and $15.8 million for the years ended December 31,
1998, 1997 and 1996, representing approximately 12%, 12% and 14% of the
Company's net revenues for these periods, respectively.

In 1998, Penthouse magazine's advertising pages (excluding affiliated
advertising pages) decreased by 5% from the prior year, while advertising
revenues (excluding affiliated advertising revenue) decreased by 2%. In 1997,
Penthouse magazine's advertising pages decreased by 16% while advertising
revenues (excluding affiliated advertising revenue) decreased 17% from 1996.

Penthouse magazine also includes advertising for the Company's products,
primarily its pay-per-call telephone lines, video cassettes, internet products
and pay-per-view programming.

The Food and Drug Administration (the "FDA") issued regulations in August
1996 which prohibits the publication of tobacco advertisements containing
drawings, color or pictures. The regulation does not apply to a magazine which
is demonstrated to be an "adult publication". An adult publication is one (i)
whose readers younger than 18 years of age constitute no more than 15% of total
readership, and (ii) is read by fewer than two million persons younger than 18
years of age, in each case as measured by competent and reliable survey
evidence. The Company believes that its magazines qualify as adult publications
and the regulations do not apply

6

to them. In April 1997, the Federal District Court for the Middle District of
North Carolina ruled that the FDA does not have the authority under existing law
to implement the advertising restrictions contained in the regulation. The FDA
appealed the ruling, but the appeal was denied.

Foreign Edition Licensing

The Company has sought to expand its readership through foreign edition
licensing arrangements pursuant to which the Company licenses the Penthouse
brand name to publishers in foreign countries. Licensees typically use
pictorials from the Company's library and provide their own editorial content to
create the foreign editions. The Company, however, oversees the finished product
to insure quality control and to maintain the spirit of the domestic edition.
Under current licensing arrangements, the Company generally receives a one-time
up-front fee and a royalty based upon a percentage of both circulation and
advertising revenues, subject to certain minimum payments. In 1998, the Company
received revenues from licensing agreements with publishers in Australia,
Brazil, Bulgaria, Croatia, Czech Republic, France, Germany, Greece, Holland,
Hong Kong, Italy, Japan, Korea, Spain, Taiwan, Thailand and the United Kingdom.

Revenues from licensing of foreign editions were $2.1 million, $2.3
million and $4.9 million for the years ended December 31, 1998, 1997 and 1996,
respectively, representing approximately 2%, 2% and 4% of the Company's net
revenues for these periods, respectively. Revenues for the year ended December
31, 1996 includes $2.0 million received as settlement of litigation involving
the Company's licensee in the United Kingdom.

Automotive Magazines

The Company published four domestic automotive titles (the "Automotive
Magazines") until March 1999, as described below, that had a combined average
monthly circulation of approximately 749,000 copies. The Company published them
at its offices located in Santa Monica, California and Newburyport,
Massachusetts.

Four Wheeler: a monthly publication that featured the sports truck field
and was dedicated to the four-wheel drive enthusiast and industry. Four
Wheeler's editorial coverage catered to the technical and lifestyle interests of
off-road drivers and their vehicles. Four Wheeler's comprehensive coverage of
the light truck field included new product testing, travel and adventure
photography, competitive coverage, project-vehicle features and do-it-yourself
articles for novice and veteran four-wheelers.

Stock Car Racing: a monthly publication that featured stock car racing and
included articles written by well-known drivers and industry personalities.
Stock Car Racing's editorial coverage included articles on the technical side of
racing, presented in a form that could help racers learn and fans understand, as
well as profiles on racing personalities and reports on important racetracks,
series and events.

Open Wheel: a monthly publication that was devoted entirely to sprint
cars, midgets, super modified and "Indy" cars. This special interest publication
contained technical articles that were written with a practical, hands-on
approach. In addition, Open Wheel published race reports and racing personality
profiles.

Drag Racing Monthly: a monthly publication that was devoted to the drag
racing enthusiast. The magazine provided comprehensive coverage of the latest
developments in this sport. It appealed to the experienced as well as the novice
drag racer who is still sharpening his or her race car driving and building
skills.

7

Circulation.

The following table sets forth the circulation for the Automotive
Magazines.

Automotive Magazines
Domestic Average Monthly Circulation
(Copies in Thousands)

Year Ended
December 31, Newsstand Subscription Total
- ------------ --------- ------------ -----
1994.............................. 222 413 635
1995.............................. 226 426 652
1996.............................. 211 414 625
1997.............................. 210 441 651
1998.............................. 203 546 749

All the Automotive Magazines were sold at newsstands and through
subscriptions. Subscription copies sold as a percentage of total copies sold of
the Automotive Magazines were approximately 73% for the year ended December 31,
1998. A twelve-month subscription to one of the Automotive Magazines was
typically $15.97. The Company generally obtained new subscribers to the
Automotive Magazines, as well as its other magazines, through its own direct
mail campaigns and agent-operated direct mail campaigns. The Company recognized
revenues from its magazine subscriptions over the term of the subscription.
Deferred subscription liabilities remaining at the sale closing date were
assumed by EMAP.

Subscription revenues of the Automotive Magazines were $4.2 million, $3.7
million and $3.7 million for the years ended December 31, 1998, 1997 and 1996,
respectively, representing approximately 4% of the Company's net revenues in
1998 and 1997and 3% of the Company's net revenues in 1996. Newsstand revenues of
the Automotive Magazines were $4.8 million, $4.7 million and $4.6 million for
the years ended December 31, 1998, 1997 and 1996, respectively, representing
approximately 5% of the Company's net revenues in 1998 and 1997 and 4% of the
Company's net revenues in 1996.

Advertising.

Advertising revenues of the Automotive Magazines were $13.8 million, $12.5
million and $11.3 million for the years ended December 31, 1998, 1997 and 1996,
respectively, representing approximately 13%, 12% and 10% of the Company's net
revenues for these periods, respectively. Advertising revenues were primarily
derived from the automobile industry, including automobile manufacturers and
distributors of automotive parts and accessories. As compared to 1997,
advertising revenues from Automotive Magazines increased 7.3% and advertising
pages increased 1.3% in 1998. Additionally, in 1998, advertising revenue of $0.4
million was derived from Four Wheeler Television (which was also purchased by
EMAP), a monthly television program produced by the Company which aired on the
ESPN 2 television network. Advertising revenues increased 10.5% and advertising
pages increased 2.3% in 1997, from the 1996 levels.

8

Production, Printing, Newsstand Distribution and Subscription Fulfillment

The Company employs a staff of professionals that oversees the production,
printing, distribution and fulfillment of its magazines. Through the use of
state-of-the-art production equipment, economies of scale in printing contracts
and efficiencies in subscription solicitation and fulfillment, the Company is
able to effectively produce and distribute all of its publications. The
Company's production system for both graphics and editing is state-of-the-art.
Approximately twenty employees produced the Company's eleven magazines with
minimal overtime until March 1999. Currently, there are fourteen employees
producing the Company's seven remaining titles with minimal overtime.

In 1998, the Company's magazines, with the exception of Forum and
Variations, were printed by R. R. Donnelley Corporation ("Donnelley") pursuant
to several agreements which, after giving effect to an extension and amendment
dated July 1997, expire in December 2003. In 1998, Forum and Variations were
printed by Access Printing. Should the Company wish to change printers, it is
confident that other printers of similar quality could be engaged.

The domestic newsstand distribution of the Company's magazines is handled
by the Curtis Circulation Company ("Curtis Circulation") pursuant to an
agreement in effect until termination upon prior notice by either the Company or
Curtis Circulation. Curtis Circulation distributes the Company's publications
through a network of approximately 225 marketing representatives to independent
wholesalers, as well as to other channels of distribution. Curtis Circulation
also provides the Company with other services, including management information
and promotional and specialty marketing services. The Company receives a cash
advance from Curtis Circulation at the time each issue is released for sale. The
Company recognizes revenue from newsstand sales based on its estimate of copy
sales at such time as the issue is released for sale and adjusts the estimate
periodically based upon actual sales information. Each issue is settled with
Curtis Circulation based upon the number of magazines actually sold, compared to
the estimated number of copies sold that Curtis Circulation used to determine
its cash advance. The international newsstand distribution of the Company's
magazines is handled by Worldwide Media Services, Inc.

The Company's subscriptions are currently serviced by Palm Coast Data
Service, Inc. ("PCD"). PCD performs the following services: receiving,
verifying, balancing and depositing payments from subscribers; maintaining
master files on all subscribers by magazine; issuing bills and renewal notices
to subscribers; issuing labels; packaging and mailing magazines as directed by
the Company; and furnishing various reports to monitor all aspects of the
subscription operations.

Subscription copies of the magazines are delivered through the U.S. Postal
Service as second class mail. The Company experienced a general postal rate
increase of 6% in January 1999. The next postal rate increase has not yet been
scheduled.

Products and Services - Entertainment Segment

The Company's entertainment segment produces and distributes
adult-oriented entertainment products, including internet pay services,
pay-per-call telephone lines, video cassettes and pay-per-view programming, and
also includes the licensing of video cassettes under the Penthouse brand name.
Revenues of the entertainment segment were $17.6 million, $16.8 million and
$15.1 million for the years ended December 31, 1998, 1997 and 1996,
respectively, representing 17%, 16% and 13% of the Company's net revenues for
these periods, respectively.

9

The Company provides adult-oriented entertainment through pay-per-call
telephone lines which feature both recorded audio programs and live operators on
900 and 800 number telephone lines. The Company's recorded audio programs are
created and broadcast by independent service bureaus. The operators on the live
telephone lines are employed by the service bureaus and are not employees of the
Company.

The Company's 900 number telephone lines are romantic in nature and
feature programs where users can listen to computerized conversations, speak
with live operators and participate in live one-on-one talk, dating and chat
lines. The 900 number telephone calls are billed directly to the caller's
telephone number and typically cost between $3.95 and $4.95 per minute. The
Company's 800 number telephone lines are explicit and uncensored in nature and
include certain live Penthouse party lines and live one-on-one talk, dating and
chat lines and typically cost $4.95 per minute. The 800 number telephone calls
are billed to credit cards in accordance with the Federal Communications
Commission safe harbor provisions, which require that such telephone calls be
billed to credit cards to insure that calls are not made by minors. The Company
has pay-per-call telephone lines in the United States, United Kingdom, Canada,
Germany, Russia, Greece and France.

The Company develops, produces and distributes products for the domestic
and international home video and pay-per-view markets. Since 1990, the Company
has produced 67 videos, which have been released for domestic distribution
through Warner Home Video, a subsidiary of Time Warner, Inc. The videos are also
offered for sale through the Company's magazines and through the Penthouse
internet site. These videos are generally approximately 60 minutes in length,
have a level of explicitness greater than "R" and feature Penthouse centerfold
models. Many of the Company's videos are also sold internationally through
licensing arrangements. In April 1997, the Company entered into an agreement
with Request Television, whereby the Company's videos are first shown on
Request's pay-per-view network prior to retail distribution. Revenues received
from the agreement is based upon the number of pay-per-view purchases and was
$0.4 million in 1998. In June of 1998, Request Television ceased all business
operations. The Company has pursued other Pay-per-view outlets.

Between 1994 and 1996, the Company released eight CD-ROM interactive
products. These products were unprofitable and the Company discontinued this
product line in 1997.

In August 1995, the Company launched a pay service, Penthousemag.com, on
the internet. Customers are sold a subscription ranging from one month to one
year, at a price of $14.95 - $99.95, as well as a lifetime subscription at a
price of $199.95. Revenues received from the sale of subscriptions to the
Compnay's internet site are recognized over the term of the subscription. The
subscription gives the customer access to adult-oriented photographs via a
personal identification number. The personal identification number expires
according to the terms of the subscription. The subscriptions are billed to
customers' credit cards in accordance with the Federal Communications
Commission's safe harbor provision. Penthousemag.com also contains access to
Penthouselive.com, which provides paying customers other adult oriented
products, such as videos. Penthouselive.com is a joint venture, whereby the
content and maintenance of the site is the responsibility of the other venturer
and the Company receives 50% of all net revenues from the site. Net revenues
from the internet for the years ended December 31, 1998, 1997and 1996 were $11.9
million, $4.7 million and $1.0 million.

Sources and Availability of Raw Materials

Paper is the primary raw material used in the production of the Company's
magazines. The Company uses a variety of high quality coated and uncoated paper
that is purchased from a number of suppliers. The Company believes that there
are several alternative suppliers in the event of its inability to purchase from
its present suppliers.

10

The Company experienced significant paper price increases in 1995. As a
result, during 1995, the Company implemented certain measures to attempt to
partially offset the effect of the paper price increase, including reducing
print orders, trim size, paper weight and other production efficiencies. The
effect of these measures and the reduction in paper prices throughout 1996, is
reflected in lower paper costs in 1997 and 1998.

Trademarks

The Company's trademarks are essential to the Company's current business
operations and future expansion. The trademarks, which are renewable
indefinitely, include Penthouse, Forum, Variations, Penthouse Letters, Hot Talk,
Girls of Penthouse, Penthouse Comix and Penthouse Max. Until March 1999, the
Company's trademarks included Four Wheeler, Open Wheel, Stock Car Racing and
Drag Racing Monthly.

Seasonality

The Company's business is generally not seasonal in nature. Issues of
Penthouse magazine with female celebrity covers or pictorials, however, have
historically resulted in higher newsstand sales than non-celebrity issues. Sales
of the Company's video cassette products may vary based upon the timing of the
release of new videos.

Dependence on Customers

No customer of the Company accounted for more than five percent of the
Company's net revenues in 1998, 1997 or 1996, and no part of the business is
dependent upon a single customer or a few customers, the loss of any one or more
of which would have a material adverse effect on the Company. However, one
advertising agency placed $2.4 million, $6.0 million and $8.0 million in
advertising revenues in Penthouse magazine and the Affiliate Publications in
1998, 1997 and 1996, respectively. These revenues represent 2%, 6% and 7% of the
Company's net revenues in 1998, 1997 and 1996, respectively.

Competitors

Magazine publishers face intense competition for both circulation and
advertising revenues. The main competitors of Penthouse magazine and the
Affiliate Publications are magazines that primarily target a male audience.
Other types of media that carry advertising also compete for advertising with
the Company's magazines.

Competition in the internet business comes from many different
competitiors. The Company's advantage in this area is the Penthouse Trademark
and the low cost of advertisement for its internet service in its own magazines.
Few other magazine publishers has either more adult-oriented magazines or a
comparable combined circulation for such magazines.

Competition in the pay-per-call business is generally limited to a few
major competitors. The Company's advantage in this area is the low cost of
advertisement for such pay-per-call service in its own magazines. Few other
magazine publishers has either more adult-oriented magazines or a comparable
combined circulation for such magazines.

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Employees

As of March 17, 1999, the Company employed 208 full-time employees, none
of whom are members of a union, and 13 part-time employees.

Item 2. PROPERTIES.

The Company's principal corporate offices for both the publishing and
entertainment segments are located in New York City at 11 Penn Plaza. The
Company leases office space for its principal corporate offices, the publishing
and sales offices of its publishing segment and the production and sales offices
of its entertainment segment at various locations, as set forth below.

Approx. Lease
Sq. Ft. Expiration
Location Principal Use Occupied Date
- -------- ------------- -------- ----
11 Penn Plaza, Principal Corporate Offices
New York, New York Publishing and Sales Office 49,000 May 31, 2009
Chicago, Illinois Sales Office 800 March 31, 2002
Newburyport,
Massachusetts Publishing and Sales Office 3,200 May 15, 1999
Santa Monica, California Production and Sales Office 14,019 April 30, 2000

The Company has a ten-year seven month lease for its principal corporate
offices which commenced on November 1, 1998 and requires annual lease payments
of $1.7 million until December 31, 2001 and thereafter of $1.9 million until the
expiration of lease. The Company believes that its principal corporate offices
are suitable and adequate for its current business operations and that, upon
expiration of the lease, it will be able to obtain similarly suitable and
adequate office space in Manhattan at a competitive price.

The Company also uses a 17,000 square foot townhouse located in New York
City (the "Townhouse"), owned by GMI and Robert C. Guccione, for Company related
activities, including business meetings and promotional and marketing events.
Pursuant to a Properties and Salary Allocation Agreement among the Company, GMI
and a GMI subsidiary (the "Properties and Salary Allocation Agreement"), the
Company reimbursed GMI approximately $0.5 million in 1998 and 1997 and $0.7
million in 1996 for the use of such property. See "Certain Relationships and
Related Transactions."

Item 3. LEGAL PROCEEDINGS.

The Internal Revenue Service has completed an audit of GMI's Federal
income tax returns for 1979 through 1985. New York State and New York City have
completed audits of GMI's income tax returns for years 1992 and 1993,
respectively. Subsequent years' income tax and other tax returns filed by GMI
are being audited or are subject to audit by governmental authorities. Under the
terms of a Tax Sharing and Indemnification Agreement among the Company, GMI and
the Other GMI Subsidiaries (the "Tax Sharing Agreement"), GMI and the Other GMI
Subsidiaries will be liable for any payments due as a result of these audits
through fiscal 1993.

12

In August 1996, an action was brought against the Company alleging various
wrongs in connection with the Company's dealings with the former editor of
Penthouse Comix and Men's Adventure Comix. The complaint alleges RICO
violations, breach of contract, trademark and copyright infringement and other
charges and demands damages in excess of $20 million. The Company believes that
the claim is without merit and has tendered defense of this action to its
insurance carrier. In the opinion of management, the outcome of this litigation
is not reasonably likely to have a material adverse effect on the Company's
financial position or results of operations.

On January 23,1997, the Company filed in United States District Court for
the Southern District of New York an action (the "Action") under the Racketeer
Influenced and Corrupt Organizations Act ("RICO") alleging, among other things,
that certain defendants conspired to defraud the Company by fraudulently
backdating a contract (the "DEC Contract") which awarded exclusive rights to
develop a "live" Penthouse internet site to defendant Deluxe Entertainment Corp.
("DEC"). On January 24, 1997 DEC served a demand on the Company for arbitration
under the DEC Contract on the issues of breach and damages. The DEC Contract
provides a minimum damage award of $30 million in addition to incidental,
consequential and punitive damages and compensation for lost profits. The
Company moved to enjoin the arbitration and defendant DEC cross-moved to compel
arbitration. By decision dated July 24, 1998, District Court Judge Deborah A.
Batts denied the Company's motion and granted the cross motion compelling
arbitration. The Company intends to vigorously defend the arbitration. In the
event of an adverse outcome, the Company intends to challenge on appeal the
decision compelling arbitration.

The Company's subsidiaries are parties to various other pending legal
proceedings arising in the ordinary course of business. While the outcome of
these proceedings cannot be predicted with certainty, the Company believes that
these proceedings are not reasonably likely to have a material adverse effect on
the Company's financial condition or results of operations.

Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.

None.

PART II
-------

Item 5. MARKET FOR THE REGISTRANT'S COMMON STOCK
AND RELATED STOCKHOLDER MATTERS.

As of March 17, 1999, GMI was the sole holder of the 475,000 shares of
common stock, $.01 par value per share (the "Common Stock"), of the Company
currently issued and outstanding. There is no established public trading market
for the Common Stock.

Holders of shares of Common Stock are entitled to receive dividends out of
funds legally available for payment thereof in such amounts per share as may be
declared by the Company's Board of Directors, subject to the restrictions
contained in an Indenture (the "Indenture"), dated December 21, 1993, which was
entered into by the Company and IBJ Whitehall Bank & Trust Company, as trustee,
in connection with the issuance of Series A 10 5/8% Senior Secured Notes Due
2000 (the "Series A Notes") in the aggregate principal amount of $85

13

million in the Private Offering. Pursuant to the Indenture, the Company may not
declare a dividend on the Common Stock, subject to certain exceptions, unless it
meets certain financial covenants set forth therein. The Company's subsidiaries,
however, are permitted to make inter-company dividends on their shares of common
stock.

The Company declared and paid a dividend of $0.4 million in accordance
with the terms and conditions of the Indenture in 1998. The Company did not
declare any dividend for the fiscal years ended December 31, 1997 and 1996.

Pursuant to a Registration Rights Agreement, dated December 21, 1993,
among the Company, Jefferies & Company, Inc. and Furman Selz Incorporated (the
"Underwriters"), the Company consummated an exchange offer in July 1994 to
exchange the Series A Notes for Series B 10 5/8% Senior Secured Notes Due 2000
(the "Series B Notes"), which were registered under the Securities Act of 1933.
The Series B Notes are substantially identical to the Series A Notes (including
principal amount, interest rate and maturity), except that the Series B Notes
are freely transferable.

There is no established public trading market for the Series B Notes.
Jeffries & Company, Inc. is currently making a market in the Series B Notes,
although they are not obligated to do so. Any such market-making may be
discontinued at any time at the sole discretion of Jeffries & Company, Inc.
without notice. The Company currently does not intend to list the Series B Notes
on any securities exchange.

The Company also issued in the Private Offering 187,506 common stock
purchase warrants (the "Warrants") to purchase an aggregate of 25,000 shares of
Common Stock (approximately 5% of the outstanding Common Stock) (the "Warrant
Shares"). The Warrants are exercisable for Warrant Shares at an exercise price
of $.01 per Warrant Share until December 22, 2000. Under the Warrant Agreement,
dated as of December 21, 1993, between the Company and IBJ Whitehall Bank &
Trust Company, as warrant agent, the Company is obligated to use its best
efforts to register the Warrants and Warrant Shares if it proposes to register
any shares of Common Stock under the Securities Act of 1933, upon the request of
the holders of such Warrants and Warrant Shares. At any time after December 21,
1998, the holders of the Warrants and Warrant Shares may request that the
Company purchase for cash all of their Warrants or Warrant Shares.

14

Item 6. SELECTED FINANCIAL DATA.

Year Ended December 31,
-----------------------
1994 1995 1996 1997 1998
---- ---- ---- ---- ----
($ in Millions)
Operating Data:
Net revenue $122.2 $120.4 $114.6 $103.8 $105.1
Operating income (loss) 13.7 (0.3) 8.9 7.4 5.5
Interest expense, net 9.9 9.8 9.6 9.3 9.4
Income (loss) from continuing
operations 2.0 (10.0) (1.0) (1.9) (3.9)
Other Data:
Depreciation and amortization $1.2 $1.6 $1.9 $1.9 $1.8
Capital expenditures 1.3 4.7 0.4 0.3 2.8
Ratio of earnings to fixed
charges 1.3 0.0 0.9 0.8 0.6
Balance Sheet Data:
Total assets $63.3 $51.5 $45.6 $42.6 $41.9
Total long-term debt 83.9 79.1 79.3 79.5 79.6
Total stockholders' deficiency (61.5) (70.9) (71.9) (73.8) (78.1)

Certain amounts have been retroactively restated to reflect an accounting change
from the LIFO to FIFO inventory valuation method in 1997.

15

Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS.

YEAR ENDED DECEMBER 31, 1998 COMPARED TO YEAR ENDED DECEMBER 31, 1997

The Company is currently engaged in activities in two industry segments:
publishing and entertainment. The publishing segment of the Company is engaged
in the publication of Penthouse magazine and six affiliate magazines (the
"Affiliate Publications" and, together with Penthouse magazine, the "Mens
Magazines"), the licensing of the Penthouse brand name to publishers in foreign
countries and until March 1999, the publication of four specialty automotive
magazines: Four Wheeler; Stock Car Racing; Open Wheel; and Drag Racing Monthly
(the "Automotive Magazines"). The entertainment segment of the Company produces
a number of adult-oriented entertainment products, including pay-per-call
telephone lines, video cassettes, pay-per-view programming and pay subscription
service on the internet.

Effective January 1, 1998, the Company changed its presentation of
Management's Discussion and Analysis of Financial Condition and Results of
Operations, whereby income from operations of each business unit excludes
corporate administrative expenses. Corporate administrative expenses include
executive, legal, human resources, finance and accounting, management
information systems and various other expenses. The 1997 and 1996 periods have
been restated to conform to the 1998 presentation.

The Company's revenues were $105.1 million for the year ended December 31,
1998, compared to revenues of $103.8 million for the year ended December 31,
1997, an increase of $1.3 million. Newsstand revenues were $46.2 million and
$46.6 million for the year ended December 31, 1998 and 1997, respectively, a
decrease of $0.4 million. Newsstand revenues for Mens Magazines were $41.3 and
$42.0 million for the year ended December 31, 1998 and 1997, respectively, a
decrease of $0.7 million. Newsstand revenues from the Automotive Magazines were
$4.9 million and $4.6 million for the year ended December 31, 1998 and 1997,
respectively, an increase of $0.3 million. Advertising revenues were $26.1
million and $25.4 million for the year ended December 31, 1998 and 1997,
respectively, an increase of $0.7 million. Advertising revenues from Mens
Magazines decreased $0.6 million and advertising revenues from Automotive
Magazines increased $1.3 million during the period. Subscription revenues were
$11.9 million and $10.9 million for the year ended December 31, 1998 and 1997,
respectively, an increase of $1.0 million. The increase in subscription revenues
is attributable to a $0.5 million increase in subscription revenues from Mens
Magazines and an increase of $0.5 million in subscription revenues from
Automotive Magazines. Revenues for the Entertainment Segment were $17.6 million
and $16.8 million for the year ended December 31, 1998 and 1997, respectively,
an increase of $0.8 million. Revenues from the Company's video business were
$3.3 million and $3.6 million for the year ended December 31, 1998 and 1997,
respectively, a decrease of $0.3 million. Revenues from the Company's
pay-per-call business were $2.5 million and $8.5 million for the year ended
December 31, 1998 and 1997, respectively, a decrease of $6.0 million. Revenues
from the Company's internet business were $11.8 million and $4.7 million for the
year ended December 31, 1998 and 1997, respectively, an increase of $7.1
million.

Income from operations was $5.5 million for the year ended December 31,
1998, compared to $7.4 million for the year ended December 31, 1997. Income from
operations was positively impacted by increased revenues, as discussed above,
but was more than offset by increased selling, general and administrative
expenses associated with increased sales, increased advertising and promotional
expenses, increased legal spending and costs associated with the relocation of
the Company's corporate offices in December 1998.

16

Net non-operating expenses were $9.4 million and $9.3 million for the year
ended December 31, 1998 and 1997, respectively. Included in interest expense is
the amortization of debt issuance costs and discounts of $1.2 million for the
year ended December 31, 1998 and 1997.

Net loss for the year ended December 31, 1998 was ($3.9) million, compared
to ($1.9) million for the year ended December 31, 1997, as a result of the above
discussed factors.

The net revenues and income from operations of the Company were as
follows:

Income
Net Revenue from operations
----------- ---------------
Year Ended Year Ended
December 31, December 31,
------------ ------------
1997 1998 1997 1998
---- ---- ---- ----

Publishing Segment $86.9 $87.5 $15.8 $13.8
Entertainment Segment 16.9 17.6 6.6 9.7
------ ------ ----- -----
$103.8 $105.1 $22.4 $23.5
Corporate Administrative Expenses -- -- (15.0) (18.0)
------ ------ ----- ------
$103.8 $105.1 $7.4 $ 5.5
====== ====== ===== =====

Publishing Segment

The net revenues and income from operations of the Publishing Segment were
as follows :

Income
Net Revenues from operations
------------ ---------------
Year Ended Year Ended
December 31, December 31,
------------ ------------
1997 1998 1997 1998
---- ---- ---- ----
Penthouse Magazine and
the Affiliate Publications $ 63.7 $ 62.3 $ 10.1 $ 9.5
Foreign edition licensing 2.3 2.1 1.9 1.7
Automotive Magazines 20.9 23.1 3.8 2.6
------- ------- ------- -------
$ 86.9 $ 87.5 $ 15.8 $ 13.8
======= ======= ======= =======

Penthouse Magazine and the Affiliate Publications

Revenues for Penthouse magazine and the Affiliate Publications were $62.3
million and $63.7 million for the year ended December 31, 1998 and 1997,
respectively, a decrease of $1.4 million. Newsstand revenue was $41.3 million
and $42.0 million for the year ended December 31, 1998 and 1997, respectively, a
decrease of $0.7 million. Penthouse magazine experienced an 8.5% increase in
copies sold. However, the decreased frequency of certain of the Affiliate
Publications as well as the discontinued publication of Penthouse Comix more
than offset the increased circulation of Penthouse. Advertising revenue was
$12.3 million and $12.9 million for the year ended December 31, 1998 and 1997,
respectively, a decrease of $0.6 million. The decrease in advertising revenue is
primarily attributable to a 20% decrease in advertising pages sold in the
Affiliate Publications during the year ended December 31, 1998, compared to the
1997 period. Subscription revenue was

17

$7.7 million and $7.2 million for the year ended December 31, 1998 and 1997,
respectively, an increase of $0.5 million. This increase is attributable to an
increase in subscription copies sold, partially offset by decreased revenue per
copy.

Publishing-production, distribution and editorial expenses were $32.8
million and $35.4 million for the year ended December 31, 1998 and 1997,
respectively, a decrease of $2.6 million. Paper costs were $12.4 million and
$12.8 million for the year ended December 31, 1998 and 1997, respectively, a
decrease of $0.4 million. The decrease is due to the decrease in the number of
pages per issue and copies printed of certain publications, as well as fewer
issues of certain Affiliate Publications and the discontinued publication of
Penthouse Comix, as noted above. These decreases were partially offset by an
increased cost per pound of paper. Print costs were $12.2 million for the year
ended December 31, 1998, compared to $13.9 million for the year ended December
31, 1997, a decrease of $1.7 million. The decrease is due to the decrease in the
number of pages per issue and copies printed of certain publications, fewer
issues of certain Affiliate Publications and the discontinued publication of
Penthouse Comix, as well as reduced printing costs due to the renegotiation of
the Company's printing contracts in the third quarter of 1997. Distribution
costs were $4.9 million and $5.2 million for the year ended December 31, 1998
and 1997, respectively, a decrease of $0.3 million. The decrease is attributable
to a decrease in copies being distributed, as noted above. Editorial costs were
$3.2 million and $3.5 million for the year ended December 31, 1998 and 1997,
respectively, a decrease of $0.3 million. The decrease is primarily due to lower
spending levels in Penthouse magazine and secondarily to the factors noted
above.

Selling, general and administrative expenses were $19.9 million for the
year ended December 31, 1998, compared to $18.1 million for the year ended
December 31, 1997, an increase of $1.8 million. The increase is primarily
attributable to the increase in bad debt expense related to an uncollectible
advertising accounts receivable of $2.4 million which arose through billings
during the year ended December 31, 1998 in connection with the termination of
the Company's agreement with an advertising agency that had an exclusive
arrangement to sell audiotext advertising in the Company's magazines. The
Company has entered into a new agreement with another advertising agency on
similar terms to that of the prior agreement. Management believes the
termination of the advertising agency will have minimal effect on the results of
the Company's future operations.

Foreign Edition Licensing

Revenues from licensing of foreign editions, which are included in other
revenue, were $2.1 million and $2.3 million for the year ended December 31, 1998
and 1997, respectively, a decrease of $0.2 million. This decrease is due
primarily to the termination of certain contracts with foreign licensees of
Penthouse magazine.

Selling, general and administrative expenses were $0.4 million for the
year ended December 31, 1998 and 1997.

Automotive Magazines

Revenues for the Automotive Magazines were $23.1 million and $20.9 million
for the year ended December 31, 1998 and 1997, respectively, an increase of $2.2
million. Newsstand revenues were $4.9 million and $4.6 million for the year
ended December 31, 1998 and 1997, respectively, an increase of $0.3 million. The
increase is due primarily to increased cover price of Four Wheeler and Stock Car
magazines. Advertising revenues were $13.8 million and $12.5 million for the
year ended December 31, 1998 and 1997, respectively, an increase of $1.3
million, resulting from an increase in advertising page rates and pages sold, as
well as

18

advertising revenue of $0.4 million generated from Four Wheeler Television,
which produced its first in a series of 13 cable television shows in February
1998. Subscription revenues were $4.2 million and $3.7 million for the year
ended December 31, 1998 and 1997, respectively, an increase of $0.5 million due
to an increase in subscription copies sold.

Publishing-production, distribution and editorial expenses were $11.3
million and $10.2 million for the year ended December 31, 1998 and 1997,
respectively, an increase of $0.9 million. Paper costs were $4.6 million and
$3.8 million for the year ended December 31, 1998 and 1997, respectively, an
increase of $0.8 million. Paper costs increased due to an increase in magazine
copies printed, increased pages per copy and an increase in the cost of paper.
Print costs were $3.8 million for the year ended December 31, 1998 and 1997.
Distribution costs were $2.5 million and $2.1 million for the year ended
December 31, 1998 and 1997, respectively, an increase of $0.4 million, due to
the increase in copies distributed. Editorial costs were $0.4 million for the
year ended December 31, 1998 and 1997. In 1998, there were $0.5 million in
production costs related to Four Wheeler television.

Selling, general and administrative expenses were $8.8 million and $7.0
million for the year ended December 31, 1998 and 1997, respectively, an increase
of $1.8 million. The increase is primarily attributable to subscription
acquisition spending ($0.7 million), increased salaries, benefits and sales
commissions ($0.3 million), increased advertising expense ($0.3 million),
increased bad debt expense($0.1 million) and increased subscription fulfillment
expense ($0.1 million) related to increased subscription copies distributed
during the year ended December 31, 1998, as compared to the year ended December
31, 1997.

Entertainment Segment

Revenues from the Entertainment Segment were $17.6 million for the year
ended December 31, 1998, compared to $16.9 million for the year ended December
31, 1997, an increase of $0.7 million. The Company's video business revenues
were $3.3 million for the year ended December 31, 1998 compared to $3.6 million
for the year ended December 31, 1997, a decrease of $0.3 million. The decrease
is due to a decline in sales through the Company's national wholesale
distributor, partially offset by revenue received from the sale of a
videocassette featuring a well know television personality, revenues received
for a pay-per-view joint venture and increased licensing revenue. Revenues from
the Company's pay-per-call business were $2.5 million and $8.5 million for the
year ended December 31, 1998 and 1997, respectively, a decrease of $6.0 million.
Effective January 1, 1998, the Company engaged a new service bureau to process
its pay-per-call business. Accordingly, revenues during 1998 were lower due to
the transition and due to the arrangement with its new service bureau whereby
the Company receives a fixed rate per minute, on a net basis. The arrangement
with the Company's previous service bureau paid revenue on a gross basis and the
Company paid certain expenses directly. Under the new agreement these expenses
have been eliminated. The Company's internet business revenues were $11.8
million and $4.7 million for the year ended December 31, 1998 and 1997,
respectively, an increase of $7.1 million. Internet revenues increased due to
increased revenues received from the sale of subscriptions to the Company's
"Private Collection", contained within the Company's internet site. Revenues
were also received from an arrangement whereby the Company receives a minimum
guaranteed revenue from another internet site "linked" to the Company's internet
site. Such arrangement began in April of 1997.

Direct costs were $2.2 million for the year ended December 31, 1998,
compared to $6.4 million for the year ended December 31, 1997, a decrease of
$4.2 million. The decrease is due primarily to the change in service bureaus
processing the Company's pay-per-call business, as discussed above.
Additionally, in 1997 the Company incurred $0.5 million in costs related to the
production of a feature motion picture.

19

Selling, general and administrative expenses were $5.7 million and $3.8
million for the year ended December 31, 1998 and December 31, 1997,
respectively, an increase of $1.9 million. The increase is due primarily to
higher computer processing, personnel and commission expense relating to the
internet business increased revenues, partially offset by lower promotional
spending related to the video division.

Corporate Administrative Expense

Corporate administrative expenses 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 $18.0 million for the year
ended December 31, 1998, compared to $15.0 million for the year ended December
31, 1997, an increase of $3.0 million. The Company relocated its corporate
offices in December 1998 and incurred costs related to the relocation of $1.0
million. In addition, the increase is due to increased salary and benefits
expense ($1.1 million), increased consulting fees ($0.3 million) and increased
legal expense($0.5 million).

Rent Expense From Affiliated Companies

Rent expense from affiliated companies represents charges from affiliated
companies for the use of the Company's executive offices. The charge is based
upon the Company's proportionate share of the operating expenses of such
offices. Rent expense from affiliated companies was $0.5 million for the year
ended December 31, 1998 and 1997.

YEAR ENDED DECEMBER 31, 1997 COMPARED TO YEAR ENDED DECEMBER 31, 1996

The Company's revenues were $103.8 million for the year ended December 31,
1997, compared to revenues of $114.6 million for the year ended December 31,
1996, a decrease of $10.8 million. Newsstand revenues were $46.6 million and
$54.1 million for the years ended December 31, 1997 and 1996, respectively, a
decrease of $7.5 million, primarily due to a decrease in sales of Mens
Magazines. Advertising revenues were $25.4 million and $27.1 million for the
years ended December 31, 1997 and 1996, respectively, a decrease of $1.7
million, due primarily to a decrease of $2.9 million in advertising sales of
Mens Magazines, offset by an increase of $1.2 million in advertising sales of
the Automotive Magazines. Subscription revenues were $10.9 million and $11.6
million for the years ended December 31, 1997 and 1996, respectively, a decrease
of $0.7 million, primarily due to decreased sales of Mens Magazines. Revenues
from the Entertainment segment were $16.8 million and $15.1 million for the
years ended December 31, 1997 and 1996, an increase of $1.7 million. Revenues
from the Company's video business were $3.6 million and $3.2 million for the
years ended December 31, 1997 and 1996, respectively, an increase of $0.4
million. Revenues from the Company's pay-per-call business were $8.5 million and
$10.8 million for the years ended December 31, 1997 and 1996, respectively, a
decrease of $2.3 million . Revenue from the Internet business was $4.7 million
and $1.0 million for the years ended December 31, 1997 and 1996, respectively,
an increase of $3.7 million.

Income from operations was $7.4 million and $8.9 million for the years
ended December 31, 1997 and 1996, respectively. Income from operations was
negatively impacted by decreased revenues, as previously discussed. Income from
operations was positively impacted in 1997 by lower production, distribution and
editorial costs associated with fewer magazines being printed, and decreased
selling, general and administrative expenses primarily related to lower employee
costs associated with corporate restructuring, lower direct subscription
acquisition spending and reduced legal fees.

20

Net non-operating expenses were $9.3 million for the year ended December
31, 1997 compared to $9.6 million for the year ended December 31, 1996, a
decrease of $0.3 million, as a result of an increase in interest income in 1997.
Included in interest expense is the amortization of debt issuance costs and
discounts of $1.2 million for the years ended December 31, 1997 and 1996.

No provision for income taxes was required in 1997 due to the loss
incurred in such year. Provision for income taxes was $0.3 million for the year
ended December 31, 1996, which represented foreign income taxes incurred.

Net loss for the year ended December 31, 1997 was ($1.9) million, compared
to ($1.0) million for the year ended December 31, 1996.

The net revenues and income (loss) from operations of the Company were as
follows ($ in millions):

Income (loss)
Net Revenues from operations
------------ ---------------
Year Ended Year Ended
December 31, December 31,
------------ ------------

1996 1997 1996 1997
---- ---- ---- ----
Publishing segment $99.5 $86.9 $20.9 $15.8
Entertainment segment 15.1 16.9 3.9 6.6
---- ---- --- -----
$114.6 $103.8 $24.8 $22.4
Corporate Administrative Expenses (15.9) (15.0)
------ ------ ----- ------
$114.6 $103.8 $8.9 $7.4
====== ====== ===== ======

Publishing Segment

The net revenues and income (loss) from operations of the Publishing
Segment were as follows ($ in millions) :

Income (loss)
Net Revenue from operations
----------- ---------------
Year Ended Year Ended
December 31, December 31,
------------ ------------
1996 1997 1996 1997
---- ---- ---- ----
Penthouse Magazine and
the Affiliate Publications $75.0 $63.7 $13.0 $10.1
Foreign edition licensing 4.9 2.3 4.5 1.9
Automotive Magazines 19.6 20.9 3.4 3.8
----- ----- ----- -----
$99.5 $86.9 $20.9 $15.8
===== ====== ===== =====

21

Penthouse Magazine and the Affiliate Publications

Revenues for Penthouse Magazine and the Affiliate Publications were $63.7
million and $75.0 million for the years ended December 31, 1997 and 1996,
respectively, a decrease of $11.3 million. Newsstand revenue for the year ended
December 31, 1997 was $42.0 million, compared to $49.5 million for the year
ended December 31, 1996, a decrease of $7.5 million. The decrease is
attributable to a $ 4.8 million decrease in newsstand revenue from Penthouse
magazine, which resulted from a 17% decrease in the number of newsstand copies
sold and a $2.7 million decrease in newsstand revenue from the Affiliate
Publications, which resulted from a decrease of 13% in the number of newsstand
copies sold. Advertising revenue for Penthouse magazine and the Affiliate
Publications was $12.9 million for the year ended December 31, 1997, compared to
$15.8 million for the year ended December 31, 1996, a decrease of $2.9 million.
Advertising revenues in Penthouse magazine decreased $2.2 million as a result of
a 16% decrease in advertising pages sold during 1997. Advertising revenues in
the Affiliate Publications decreased $0.7 million as a result of a 23% decrease
in advertising pages sold, partially offset by an increase in advertising rates
per page. Subscription revenue was $7.2 million for the year ended December 31,
1997, compared to $7.9 million for the year ended December 31, 1996, a decrease
of $0.7 million, due primarily to a decline in the net revenue per copy. The
decreased revenue per copy was due primarily to a change in the mix between
agency sales (which generate a low per copy rate) and direct to customer sales.
Other revenue was $1.6 million for the year ended December 31, 1997, compared to
$1.9 million for the year ended December 31, 1996, a decrease of $0.3 million.
The decrease in other revenue is primarily attributable to a decrease in
revenues received from the sale of past issues of the Company's publications
sold as value-packs and a decrease in royalty revenue.

Publishing-production, distribution and editorial expenses were $35.4
million for the year ended December 31, 1997, compared to $41.7 million for the
year ended December 31, 1996, a decrease of $6.3 million. Paper costs were $12.8
million for the year ended December 31, 1997, compared to $17.0 million for the
year ended December 31, 1996, a decrease of $4.2 million. Paper costs were
reduced primarily because of a decrease in the cost of paper and additionally by
decreasing the number of copies printed and the number of pages printed of
certain publications. Print costs were $13.9 million for the year ended December
31, 1997, compared to $14.6 million for the year ended December 31, 1996, a
decrease of $0.7 million. Print costs were reduced by decreasing the number of
copies printed and number of pages per copy printed in certain publications.
Editorial and art costs were $3.5 million for the year ended December 31,1997,
compared to $3.8 million in 1996, a decrease of $0.3 million. The decrease is
due primarily to decreased spending levels related to Penthouse Comix and Forum
magazine, partially offset by increased write-offs of pictorial inventory during
the year ended December 31, 1997, as compared to the year ended December 31,
1996. Distribution costs were $5.2 million for the year ended December 31, 1997,
compared to $5.8 million for the year ended December 31, 1996, a decrease of
$0.6 million. The decrease in distribution costs was generally due to fewer
copies of magazines being distributed. Other production costs of $0.5 million
were incurred during the year ended December 31, 1996 related to an insert
placed in certain publications to promote the Company's pay-per-call services.

Selling, general and administrative expenses were $18.1 million for the
year ended December 31, 1997, compared to $20.4 million for the year ended
December 31, 1996, a decrease of $2.3 million. The decrease is primarily
attributable to lower salaries ($0.4 million), lower retail display allowance
costs associated with lower newsstand circulation ($0.9 million), lower
advertising expenses ($0.8 million) and lower commission expenses related to
lower advertising sales ($0.3 million). These decreases were partially offset by
an increase in promotional spending ($0.3 million).

22

Foreign Edition Licensing

Revenues from foreign edition licensing were $2.3 million for the year
ended December 31, 1997, compared to $4.9 million for the year ended December
31, 1996, a decrease of $2.6 million. The decrease is primarily the result of a
$2.0 million litigation settlement in October 1996, which was in settlement of a
dispute with a former licensee of the United Kingdom edition of Penthouse
magazine. Additional revenue decreases were due primarily to the loss of the
South African licensee of Penthouse magazine and reduced revenues from several
other licensees. Selling, general and administrative expenses were $0.4 million
for the years ended December 31, 1997 and 1996.

Automotive Magazines

Revenues for the Automotive Magazines were $20.9 million for the year
ended December 31, 1997, compared to $19.6 million for the year ended December
31, 1996, an increase of $1.3 million. Newsstand revenues were $4.7 million for
the year ended December 31, 1997, compared to $4.6 million for the year ended
December 31, 1996, an increase of $0.1 million, due primarily to more copies
sold of Four Wheeler magazine. Advertising revenues were $12.5 million for the
year ended December 31, 1997, compared to $11.3 million for the year ended
December 31, 1996, an increase of $1.2 million, resulting primarily from an 8%
increase in advertising rates per page. Subscription revenues were $3.7 million
for the years ended December 31, 1997 and 1996.

Publishing-production, distribution and editorial expenses were $10.2
million for the year ended December 31, 1997, compared to $10.4 million for the
year ended December 31, 1996, a decrease of $0.2 million. Paper costs were $3.8
million for the year ended December 31, 1997, compared to $4.4 million for the
year ended December 31, 1996, a decrease of $0.6 million. The decrease in paper
costs in 1997 is primarily attributable to decreased cost of paper, offset by an
increase in the number of magazines printed and page per copy printed in 1997,
as compared to 1996. Print costs were $3.8 million for the years ended December
31, 1997 and 1996. Distribution costs were $2.1 million and $1.9 million for the
years ended December 31, 1997 and 1996, respectively, an increase of $0.2
million, due primarily to more copies being distributed and more pages per
copy printed. Editorial and art costs were $0.3 million for the years ended
December 31, 1997 and 1996.

Selling, general and administrative expenses were $7.0 million for the
year ended December 31, 1997, compared to $5.7 million for the year ended
December 31, 1996, an increase of $1.3 million. The increase is primarily
attributable to increased salaries ($0.3 million), increased commission expense
associated with increased advertising revenues ($0.1 million), increased
subscription fulfillment expense ($0.2 million) and increased subscription
spending ($0.4 million) in 1997.

Entertainment Segment

Revenues from the Entertainment Segment were $16.9 million for the year
ended December 31, 1997, compared to $15.1 million for the year ended December
31, 1996, an increase of $1.8 million. The Company's video business revenues
were $3.6 million for the year ended December 31, 1997, compared to $3.2 million
for the year ended December 31, 1996, an increase of $0.4 million. The increase
is due to nine new video titles being released in 1997, compared to six titles
in 1996, increased licensing revenue and revenues from a pay-per-view joint
venture. These increases were offset by decreased revenue of $0.4 million as a
result of the Company's discontinuing the sale of its unprofitable CD-ROM
products. The Company's pay-per-call business revenue was

23

$8.5 million and $10.8 million for the years ended December 31, 1997 and 1996,
respectively, a decrease of $2.3 million. The decrease in pay-per-call revenues
is primarily attributable to a required reduction in the extension of credit to
callers that did not meet certain criteria established by the Company, the
purpose of which was to reduce the amount of customer charge backs to a level
acceptable to credit card companies. The new criteria took effect in mid- June,
1996. Additionally, lower circulation of the Company's Mens Magazines in all
likelihood contributed to lower revenues. The Company's internet business
revenues were $4.7 million and $1.0 million for the years ended December 31,
1997 and 1996, respectively, an increase of $3.7 million. Internet revenues
increased due to revenues received from the sale of subscriptions to the
Company's "Private Collection", contained within the Company's internet site
that began operations in April 1997. Revenues were also received from a new
arrangement, whereby the company received revenue from another internet site
"linked" to the Company's internet site. Such arrangement also began in April
1997.

Direct costs were $6.4 million for the year ended December 31, 1997,
compared to $7.9 million for the year ended December 31, 1996, a decrease of
$1.5 million. The Company's video business experienced a $0.5 million decrease
in direct costs primarily associated with lower video production costs, offset
by higher fulfillment and distribution costs associated with higher sales
volume. The Company's pay-per-call business experienced a $0.9 million reduction
in costs attributed to lower sales volume and lower levels of customer charge
backs due to the reduction in the extension of credit to callers who did not
meet certain criteria established by the Company, as previously discussed.

Selling, general and administrative expenses were $3.8 million for the
year ended December 31,1997, compared to $3.2 million for the year ended
December 31, 1996, an increase of $0.6 million. The increase is attributable to
increased expenses related to the new video licencing agreements referred to
above and computer processing fees and consulting fees related to the higher
levels of revenues from the internet business.

Corporate Administrative Expense

Corporate administrative expenses includes executive, human resources,
finance and accounting, management information systems, costs related to the
operation the corporate and executive offices and various other expenses.
Corporate administrative expenses were $15.0 million for the year ended December
31, 1997, compared to $15.9 million for the year ended December 31, 1996, a
decrease of $0.9 million. The decrease is due primarily to decreased legal fees
in 1997.

Rent Expense From Affiliated Companies

Rent expense from affiliated companies represents charges from affiliated
companies for the use of the Company's corporate and executive offices. The
charge is based upon the Company's proportionate share of the operating expenses
of such offices. Rent expense from affiliated companies was $0.5 million for the
year ended December 31, 1997, compared to $0.7 million for the year ended
December 31, 1996, a decrease of $0.2 million

24

Impact of Year 2000

The Company has reviewed its computer systems and operations to identify
and determine the extent to which any significant systems will be vulnerable to
potential errors and failures as a result of the "Year 2000" problem and has
been remediating non-compliant systems. The Year 2000 problem is the result of
computer programs being written using two digits, rather than four digits, to
define the applicable year. Any of the Company's programs that have
time-sensitive software may recognize a date using "00" as the year 1900 rather
than the year 2000. This could result in a major system failure or
miscalculations, causing disruptions of operations including, among other
things, a temporary inability to process transactions, billing, customer service
or to engage in similar normal business activities.

The Company has conducted a comprehensive review of its computer systems
to ensure that all such systems are, or prior to the end of 1999 will be, Year
2000 compliant. The Company has completed the comprehensive review and is
remediating non-compliant systems it has identified. The Company presently
believes that the Year 2000 problem will not pose significant operational
problems for the Company's computer infrastructure as such infrastructure has
generally been recently implemented or upgraded. Additionally, the Company has
taken occupancy of new corporate office facilities in December 1998 and
technology acquired for that facility is Year 2000 compliant. The Company's plan
for its Year 2000 project includes the following steps: (i)conducting a
comprehensive inventory of the Company's internal systems, including information
technology systems and non-information technology systems (which include, among
other things, telecommunications and electrical systems) and systems to be
acquired by the Company, (ii) assessing and prioritizing the required
remediation, (iii) remediating any problems by repairing or, if appropriate,
replacing the non-compliant systems and (iv) testing all remediated systems for
Year 2000 compliance.

In addition to assessing its own systems, the Company has sent
questionnaires to its vendors and suppliers, including outside service providers
and printers, to determine their vulnerability to Year 2000 problems and any
potential impact on the Company. The Company has evaluated the responses to
these questionnaires. Based upon written responses the Company believes its
national wholesale magazine distributor, its subscription fulfillment company
and all major printers, vendors and suppliers will be fully compliant by the end
of 1999. Nevertheless, there can be no assurance that problems experienced by
external vendors, suppliers and customers will not have a material adverse
effect on the Company.

The Company expects to complete all steps of the process described above
by September 30, 1999 and further expects that all of its critical computer
systems will be fully Year 2000 compliant before the end of 1999. There can be
no assurance, however, that the Company will achieve full Year 2000 compliance
before the end of 1999 or that effective contingency plans will be developed or
implemented. A failure of the Company's computer systems or the Company's
vendors or customers to effectively upgrade their software and systems for the
transition to the year 2000 could have a material adverse effect on the
Company's business, financial position and results of operations.

The Company estimates that it will incur costs of between $1.0 million and
$1.5 million to become Year 2000 compliant (this estimate has been revised
downward in light of the recent sale of the Automotive Magazines); although the
Company's evaluation of the Year 2000 problem is not yet complete and actual
costs may be higher. Costs will be expensed or capitalized, as appropriate, as
they are incurred. As of March 1999 approximately $0.7 million of such costs had
already been incurred.

25

While the Company has completed its Year 2000 assessment, it has not yet
determined the nature and extent of any contingency plans that may be required.
Even if the Company's plan to become Year 2000 compliant is completed and all
systems operated by, or in control of, the Company are properly remediated, the
most reasonable likely worst case scenario would be a system failure beyond the
control of the Company to remedy. Such a failure could materially prevent the
Company from operating its business. The Company believes that such a failure
would likely lead to lost revenues, increased operating costs, loss of customers
or other business interruptions of a material nature.

LIQUIDITY AND CAPITAL RESOURCES

At December 31, 1998, the Company had $ 6.4 million in cash and cash
equivalents, compared to $7.3 million at December 31, 1997. The decrease in cash
and cash equivalents during the year ended December 31, 1998 resulted from net
cash flows provided by operating activities of $2.4 million, net cash flows used
in investing activities of $1.9 million and net cash flows used in financing
activities of $1.4 million.

Cash flows from operating activities

Net cash provided by operating activities was $2.4 million for the year
ended December 31, 1998, compared to net cash provided by operating activities
of $1.7 million for the year ended December 31, 1997. Net cash provided from
operating activities in 1998 was primarily the result of the increase of $3.4
million in accounts payable and accrued expenses due to the timing of payments
to vendors. Of this amount, $1.5 million relates to the relocation of the
Company's corporate office in December 1998. Additionally, accrued expenses and
deferred revenues directly related to the increased revenue in the Company's
internet business increased $2.7 million. Net cash provided by operating
activities for the year ended December 31, 1997 was primarily a result of the
reduction of paper and film and programming cost inventory, decreased accounts
receivable and increased deferred subscription revenue due in part to increased
subscription acquisition spending during the year ended December 31, 1997. The
decrease in accounts receivable in 1997 was the result of the sale of an
accounts receivable balance due from a customer totaling $2.2 million.

Cash flows from investing activities

Cash used in investing activities for the year ended December 31, 1998 was
$1.9 million, compared to cash used in investing activities of $1.0 million for
the year ended December 31, 1997. The cash used in investing activities in 1998
was primarily due to the purchase of fixed assets and leasehold improvements
related to the Company's relocation to new corporate offices in December of
1998. The Company expended $2.7 million, however it was reimbursed $1.1 million
by its new landlord for renovations. Additionally, the cash used in investing
activities in 1998, includes an increase of $0.2 million in its loan to GMI's
principal shareholder. The cash used in investing activities in 1997, includes a
$0.7 million loan to GMI's principal shareholder and $0.3 million in capital
expenditures.

Cash flows from financing activities

Cash flows used in financing activities were $1.4 million and $0.5 million
for the years ended December 31, 1998 and 1997, respectively. Cash flows used in
financing activities in 1998 related to affiliated company investments and
advances and cash dividends paid. Cash flows used in financing activities in
1997 related to affiliated company investments and advances.

Affiliated company investments and advances at December 31, 1998 increased
$1.0 million from the December 31, 1997 balance, whereby the Company is owed
$2.1 million by GMI as of December 31, 1998. These balances regularly result
from the impact of certain cost sharing and expense allocation agreements with

26

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 amounts due to
the Company, and are generally repaid sixty days after the end of each quarter
in accordance with the terms of an expense sharing agreement. In June 1998, the
Company received as partial payment of the amount the outstanding stock of a
subsidiary of GMI, whose net assets have an appraised value of approximately
$0.5 million. The net assets of the subsidiary consist of works of art.
Management intends to sell such assets. The reimbursement by GMI, in the amount
of $2.1 million, has not been made by March 17, 1999. Demand for payment has
been made in writing. Management of the Company believes that GMI and its
subsidiaries have sufficient assets to enable the Company to ultimately recover
its advance through liquidation of certain of those assets or through
refinancing of GMI's debts. The ability of the Company to realize repayment of
its advance is dependant upon the success of GMI in refinancing its existing
debt obligations, some of which are currently in default. The principal
shareholder of GMI has guaranteed the full amount due to the Company. At
December 31, 1998, the Company has a loan outstanding to the principal
shareholder of GMI of $1.0 million. The loan is evidenced by a promissory note,
bears interest at 11% per annum, and is payable on December 31, 1999.

The ability of the Company to incur additional debt is severely limited by
the terms of its Notes and the Indenture. Pursuant to the Indenture, the Company
may not declare a dividend on its common stock, subject to certain exceptions,
unless it meets certain financial covenants set forth therein. In May 1998, the
Company declared and paid a $0.4 million cash dividend to GMI in accordance with
the terms and conditions of the Indenture.

Future outlook

The Company's revenues increased in 1998, however the Company's results
from operations were negatively impacted by increased operating expenses in the
second half of 1998, which resulted in continued net losses to the Company in
1998. While it is difficult to predict future results of operations, it is
unlikely that the Company can achieve profitable net income in 1999 from
continuing operations. However, the Company does expect the entertainment
segment will contribute increased profitability in 1999, due to continued growth
of the Company's internet pay subscription service. Furthermore, under the
Indenture, should the Company incur additional losses in the future such that
the Company's tangible net worth (deficiency) declines from the amount at
December 31, 1998 of ($80.6) million to below ($81.6) million for two
consecutive quarters, the Company would be required to purchase, on the last day
of the next following fiscal quarter, ten percent of the principal amount of the
Notes then outstanding at a price of 101% of the principal amount thereof. In
light of the approximately $29 million gain on sale described below, the
Company's net deficiency would have improved to approximately ($52.0) million
had the transaction occured at December 31, 1998.

On March 2, 1999 (the "Closing Date"), the Company sold substantially all
of the assets, exclusive of net newsstand and advertising accounts receivable,
of its wholly-owned subsidiary, General Media Automotive Group, Inc.("GMAG") to
EMAP Petersen, Inc.("EMAP") for $35 million in cash plus the assumption of
certain liabilities and deferred subscription liabilities, as defined in the
Asset Sale and Purchase Agreement between EMAP and GMAG dated as of February 9,
1999 (the "Asset Purchase Agreement"). There are no material relationships
between EMAP and the Company or any of its affiliates, any director or officer
of the Company, or any associate of any such director or officer. The sale price
is subject to an adjustment to be finalized within 60 days from the Closing Date
and shall be increased or decreased on a dollar for dollar basis by the amount
that net working capital, as defined in the Asset Purchase Agreement, deviates
from $1.5 million. The Company expects a gain of approximately $29 million on
the sale.

27

Under the Indenture, the Company has 180 days from the Closing Date to
apply the net proceeds to an investment in another business or capital
expenditure or other tangible or long-term assets in the same or similar line of
business as the Company was engaged in on the date of the Indenture. To the
extent that any net proceeds are not so applied, the remaining amount are deemed
excess proceeds. Should the excess proceeds exceed $5 million, the Company is
required to make an offer to all note holders to purchase the maximum principal
amount of notes plus accrued interest that may be purchased from the excess
proceeds. The Company is currently in negotiations with its note holders and
intends to purchase a substantial portion of its outstanding notes upon
successful completion of negotiations. If such a purchase of the notes is
consummated the amount of cash required to pay semiannual interest payments will
be substantially reduced.

The Company's cash balance at December 31, 1998 was $6.4 million. The
Company has $4.2 million semiannual interest payment due on June 30, 1999,
subject to decrease pending successful purchase of outstanding notes as
discussed above. Management of the Company believes that it will have sufficient
cash resources through positive cash flows from operations and use of its
existing cash balances to enable it to meet its obligations over the next twelve
months.

Forward-Looking Statements

In addition to historical information, "Management's Discussion and
Analysis of Financial Condition and Results of Operations" contains
forward-looking statements. The forward-looking statements are subject to
certain risks and uncertainties and are based on certain assumptions, including
that, as to the Year 2000 problem, third parties respond fully and accurately to
the Company's inquiries, and that, as to the Company's publications, there are
no adverse governmental regulations promulgated that could cause actual results
to differ materially from those reflected in such forward looking statements.
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.

Change in Accounting Principle

In 1997, the Company changed its method of determining the cost of
inventories from the LIFO method to the FIFO method. Under the current
environment of low inflation, the Company believes that the FIFO method will
result in a better measurement of operating results. This change has been
applied by retroactively restating the Company's consolidated financial
statements for 1996. The effect of the restatement was to decrease 1997 net loss
by $178,000 and increase 1996 net loss by $499,000.

28

New Authoritative Accounting Pronouncement

In 1998, the Company adopted Statement of Financial Accounting Standards
No. 131 ("FAS No. 13"), "Disclosures About Segments of an Enterprise and Related
Information." FAS 131 supersedes FAS 14 replacing the "industry segment"
approach with the "management" approach. The management approach designates the
internal organization that is used by management for making operating decisions
and assessing performance as the source of the Company's reportable segments.
FAS 131 also requires disclosures about products and services, geographic areas
and major customers. The adoption of FAS 131 did not affect the results of
operations or financial position but did affect the disclosure about segment
information.

Item 7A. 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, 1998, the Company had debt of $79.6
million with a fixed rate of 10 5/8%. 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 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.

See page F-1 for a listing of the Consolidated Financial Statements.

Item 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON
ACCOUNTING AND FINANCIAL DISCLOSURE.

None.

29

PART III

Item 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.

The directors of the Company serve until the next annual meeting of
stockholders or until their successors are elected and qualified. The executive
officers serve at the discretion of the Board of Directors in the absence of
employment agreements. The following information is submitted with respect to
each director and executive officer of the Company at March 31, 1999.

Date Date
Elected Elected to
Positions Presently Held as Present
Name Age with the Registrant Director Office
- --------------------- --- -------------------------- ------- --------

Robert C. Guccione 68 Director, Chairman of the 1993 1993
Board, Publisher

Nina Guccione 39 Director, Executive Vice 1997 1998
President, President-
New Media, Secretary

John D. Orlando 44 Director, Senior Vice 1999 1998
President, Chief
Financial Officer and
Treasurer

Laurence B. Sutter 57 Senior Vice President, -- 1997
General Counsel,
Assistant Secretary

William F. Marlieb 70 Director 1993 --

John L. Decker 62 Director 1993 --

Phyllis Schwebel 71 Director 1993 --

The business experience for the last 5 years of the current directors and
executive officers of the Company and those individuals who were directors or
executive officers during 1998 is presented below.

Robert C. Guccione has been a Director, Chairman of the Board and Publisher of
the Company, since 1993 and prior to January, 1998 was also Chief Executive
Officer of the Company. Mr. Guccione founded Penthouse Publications in London in
1965 after having served as managing director and editor-in-chief of London
American, a weekly newspaper.

Robert H. Altman was a Director, President and Chief Executive Officer of the
Company from January 1998 until December 1998. Prior to joining the Company, Mr.
Altman was a partner in the law firm of Bryan Cave LLP

30

from June 1995 to December 1997. From 1990 to 1995, Mr. Altman was a partner in
the law firm of Holtzman, Wise & Sheperd.

Patrick J. Gavin was a Director, Executive Vice President and Chief Operating
Officer of the Company from February 1998 until March 1999. Prior to the
appointment to those positions, Mr. Gavin was Executive Vice President- Chief
Financial Officer and Treasurer of the Company or its affiliates since 1990. Mr.
Gavin received his B.S. in Management and an M.B.A. from St. John's University.

Nina Guccione has been a Director, Executive Vice President, President- New
Media and Secretary of the Company since February 1998. Prior to the appointment
to her current position, Ms. Guccione was Executive Vice President- New Media
and Secretary of the Company since 1996. Ms. Guccione has served in various
capacities within the Company for in excess of five years. Ms. Guccione is the
daughter of Robert C. Guccione.

John D. Orlando has been the Senior Vice President-Chief Financial Officer and
Treasurer of the Company since August 1998 and a Director since March 1999.
Prior to joining the Company, Mr. Orlando was the President of Konica
Environmental Products Division of Konica Graphic Imaging International, Inc.
(Konica) from 1997 to 1998 and was the Senior Vice President-Chief Financial
Officer-Treasurer and Secretary of Konica from 1987 to 1997. Mr. Orlando is a
certified public accountant.

James M. Follo was Vice President- Chief Financial Officer and Treasurer of the
Company from February 1998 until June 1998 . Prior to appointment to those
positions, Mr. Follo was Vice President-Financial Operations of the Company
since January 1994. Prior to joining the Company, Mr. Follo was Senior Audit
Manager with the accounting firm of Grant Thornton, where he was employed from
1984 to 1994. Mr Follo is a certified public accountant.

Laurence B. Sutter has been a Senior Vice President, General Counsel and
Assistant Secretary of the Company, since January 1997. Prior to his appointment
to his current position, Mr. Sutter was Associate Counsel/Publications and
Assistant Secretary. Mr. Sutter has been employed by the Company or its
affiliates since 1982. Mr. Sutter has been a practicing attorney since 1977.

William F. Marlieb is a Director of the Company. Mr. Marlieb was
President/Marketing, Sales and Circulation of the Company until his retirement
in April 1997. He has been associated with the Company or its affiliates for 24
years. Prior to joining an affiliated company in 1973, he was President of
Tilley Marlieb Advertising, Inc. Mr. Marlieb is a past President and Chairman of
the Advertising Club of New York.

John L. Decker is a Director of the Company. Since 1983, he has been President
of Decker & Associates, the publisher of The Advertiser and Agency magazines.
From 1978 to 1983, Mr. Decker was Senior Vice President and Group Publisher of
Knapp Communications, which is responsible for the advertising and circulation
of Architectural Digest, Bon Appetit, Go, and Home magazines. Mr. Decker
received his B.S. in Economics from Villanova University.

Phyllis F. Schwebel is a Director of the Company. Since 1992, she has been
President of The Garth Company, a strategic marketing organization. From 1983
through 1991, Ms. Schwebel was Manager of Market Research for Time magazine and
Manager of Corporate Management Research for Time Inc. Ms. Schwebel is a member
of the Board of Directors of the American Advertising Federation and immediate
past Chairman of its Counsel of Governors. She holds a B.A. from The City
University of New York.

31

Item 11. EXECUTIVE COMPENSATION.

The following table summarizes the compensation for services rendered to
the Company during fiscal years 1996, 1997 and 1998 by (I) the Company's
Principal Executive Officer*, Robert C. Guccione, and (ii) each of the Company's
other most highly compensated executive officers whose total annual salary and
bonus exceeded $100,000 and whose compensation is required to be disclosed under
S.E.C. rules. The compensation for all such officers represents the amounts paid
by the Company in respect thereof pursuant to the Properties and Salary
Allocation Agreement (for Mr. Guccione and Ms. Keeton) and the Expense
Allocation Agreement and employment agreements (for all other such officers).
See "Certain Relationships and Related Transactions."

- -----------

*Mr. Guccione was Chief Executive Officer during 1996 and 1997 and
currently functions as principal executive officer. During 1998,
Mr. Robert Altman was Chief Executive Officer.

32

Name and Principal Position Annual Compensation
- ------------------------------- ------------------------------------------
Year Salary(1) Bonus(5) Other (3)
-------- ---------- ------- ----------
Robert C. Guccione 1998 $ 1,530,000 $450,000 $ 704,740
Chairman and Publisher and 1997 $ 1,530,000 $ 233,855
Principal Executive Officer 1996 $ 1,615,500 $ 120,886

Nina Guccione 1998 $ 176,716
Executive Vice President
President New Media

Kathryn Keeton Guccione (2) 1997 $ 347,114 $ 233,855
Vice Chairman 1996 $ 475,000 $ 120,886

Robert H. Altman 1998 $ 370,828 $142,500
President and Chief Executive
Officer (1998 only)

Eugene Boffa, Jr.(4) 1998 $ 292,370
President and Chief Operating 1997 $ 398,739
Officer 1996 $ 286,000

Patrick J. Gavin 1998 $ 345,838
Executive Vice President, 1997 $ 347,949
Chief Financial Officer and 1996 $ 345,838
Treasurer

Lawrence B. Sutter 1998 $ 151,095
Senior Vice President, 1997 $ 148,575
and Assistant Secretary 1996 $ 137,247

(1) Executive officer compensation is determined pursuant to the allocation
provisions of the Properties and Salary Allocation Agreement and the Expense
Allocation Agreement referred to above. The allocations were approved by the
nonemployee members of the Board of Directors of the Company. See
"Compensation Committee Interlock and Insider Participation in Compensation
Decisions" and "Certain Relationships and Related Transactions."

(2) Deceased as of September 1997.

(3) Other compensation represents life insurance premiums paid on behalf of Mr.
and Mrs. Guccione, under split dollar policy arrangements. In 1997 and 1996,
one-half of the total premium paid is allocated above to each of Mr.
and Mrs. Guccione.

(4) In 1996, salary represents payments under a consultant arrangement. In 1997,
salary represents $115,200 under a consulting arrangement and $283,539
in salary.

33

Compensation of Directors

Directors who are also employees of the Company or any of its subsidiaries
do not currently receive any additional compensation for serving as a director
or committee member or for attending Board or committee meetings. All other
directors receive an annual retainer of $5,000 plus $1,000 for each Board
meeting and committee meeting attended.

Compensation Committee Interlock and Insider Participation in Compensation
Decisions

During 1998, two non-employee directors, Mr. Decker and Ms. Schwebel (the
"Non-employee Members"), who have never served as officers of the Company or
been employees of the Company, acted as the Company's Compensation Committee.
Mr. Avrett (who died in August 1997) was the Chairman of the Board and a
principal of the firm Avrett, Free and Ginsberg which provides advertising
services to the Company. The Company paid Avrett, Free and Ginsberg
approximately $ 0.5 million and $1.2 million for such services in 1997 and 1996
respectively. See "Certain Relationships and Related Transactions."

The salaries of Mr. Guccione, Ms. Keeton and Ms. Guccione are determined
and paid by GMI. The Non-employee Members reviewed and approved the
reimbursement of GMI by the Company in an amount equal to the portion of the
salaries of Mr. Guccione and Ms. Keeton allocated to the Company pursuant to the
Properties and Salaries Allocations Agreement. In addition, the Non-employee
Members reviewed and approved the expenses allocated to the Company for its use
of the Townhouse pursuant to the Properties and Salary Allocation Agreement. See
"Certain Relationships and Related Transactions."

Retirement Savings Plan

The General Media Communications, Inc. Employees' Retirement Savings
Plan and Trust (the "Plan") is a tax-exempt defined contribution plan covering
all employees of GMI and its affiliates (including the Company) who have
completed 1,000 hours of service in one plan year and are twenty-one years of
age or older. GMI may make contributions to the Plan from its current profits,
before profit-sharing costs and income taxes, in each plan year, in such amounts
as authorized by the Board of Directors of GMI, provided that the amount of the
contribution for each plan year does not exceed 3% of the qualified earnings of
each participant. Participants may contribute up to 15% of their annual wages
before bonuses and overtime up to a maximum pre-tax contribution of $10,000 in
1998. Participant's accounts are credited with the participant's contribution
and an allocation of (a) GMI's contribution, if any, (b) Plan earnings, and (c)
forfeitures of terminated participants' nonvested accounts, if any. Allocations
are based on participant earnings on account balances. The benefit to which a
participant is entitled is the benefit that can be provided from the
participant's account. Participants are immediately vested in their pre-tax
contributions plus actual earnings thereon. Vesting in the remainder of their
accounts begins after completing two years of service and vests in equal amounts
until the participant has completed five years of service, at which time the
participant becomes 100% vested. Under the Plan, participating employees can
allocate funds in their account among several investment options. Upon
termination of service, a participant may elect to receive an amount equal to
the vested value of his or her account, in either a lump-sum or in monthly,
quarterly, or semiannual payments from the Plan over a period not extending
beyond the life expectancy of the participant and his or her spouse. As of
December 31, 1998, Messrs. Guccione, Gavin, and Marlieb were 100% vested in
profit sharing contributions. Amounts contributed by GMI, if any, on behalf of
employees who performed services for the Company are reimbursed to GMI by the
Company pursuant to the Expense Allocation Agreement. See "Certain Relationships
and Related Transactions." The Company did not make any contributions to the
Plan in fiscal years 1996, 1997 and 1998.

34

Item 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND
MANAGEMENT.

All of the issued and outstanding Common Stock of the Company is owned
by GMI. The following table sets forth certain information regarding the
beneficial ownership of GMI's common stock as of March 17, 1999.

GMI Shares Percent
Name and Address Common Stock(1) Beneficially Owned of Class
- ----------------------- --------------- ------------------ --------

Robert C. Guccione Class A 6.67 66.7%
16 East 67th Street Class B 0.00 0.0
New York, New York 10022

Robert C. Guccione Family Class A 3.33 33.3
Trust No. 1 Class B 1.62 100.0

(1) Holders of Class A and Class B common stock have equal voting rights and are
entitled to one vote per share.

Item 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.

GMI owns (together with Robert C. Guccione, who owns a 1% interest and
utilizes such facilities as his residence and his executive offices) a
Townhouse. The Townhouse is used for various Company related activities,
including business meetings, client entertainment, charitable functions,
magazine photography sessions and promotional and marketing events. Expenses of
maintaining the Townhouse, as well as any applicable debt service requirements,
are the responsibility of GMI. Pursuant to the Properties and Salary Allocation
Agreement among the Company, GMI and a GMI subsidiary, the Company reimbursed
GMI in the amounts of approximately $0.5 million in 1998 and 1997 and $0.7
million during 1996, for the use of the Townhouse for Company purposes. See
"Compensation Committee Interlock and Insider Participation in Compensation
Decisions."

The Properties and Salary Allocation Agreement also provides that the
salaries of Mr. Guccione and Ms. Keeton are determined and paid by GMI. Pursuant
to this agreement, the Company reimburses GMI for a portion of such salaries
based upon an allocation of the relative business time spent by Mr. Guccione and
Ms. Keeton on GMI related business and on Company related business. In 1998,
1997 and 1996, the Company reimbursed GMI in the amounts of approximately $2.0
million , $1.9 million and $2.1 million, respectively, for the allocable amount
of Mr. Guccione's and Ms. Keeton's salaries.

GMI, the Company and the Other GMI Subsidiaries are parties to the Tax
Sharing Agreement pursuant to which such parties file consolidated federal
income tax returns and, so long as permitted by the relevant tax authorities,
combined New York State and New York City tax reports. New York State and New
York City have preliminarily agreed to allow the Company to file combined
returns for certain years, and it is anticipated that continued permission will
be granted, although no assurance of such permission can be given. The Tax
Sharing Agreement sets forth the methodology for allocating income taxes and the
use of net operating losses ("NOLs") between the Company, GMI and the Other GMI
Subsidiaries. The Company, however, is not required to pay income or franchise
taxes (except certain alternative taxes) to the extent that it can utilize a
portion of the NOLs of GMI and the Other GMI Subsidiaries pursuant to the terms
of the Tax Sharing Agreement. The Company is not required to reimburse GMI and
the Other GMI Subsidiaries for the use of the NOLs generated by these entities
until after all of the Series B Notes are redeemed or paid, and then only for
the NOLs used in that or any subsequent year. In addition, the Tax Sharing
Agreement provides that GMI and the Other GMI Subsidiaries indemnify the Company
from any income or franchise tax liabilities of the consolidated group in excess
of the $26 million arising during years ending through December 31, 1993.

35

The Company, GMI and the Other GMI Subsidiaries also have entered into an
Expense Allocation Agreement, which sets forth the methodology for allocating
common expenses as among the parties to the Expense Allocation Agreement
including expenses related to the use of and occupancy costs for the Company's
principal corporate offices in New York City. Pursuant to the Expense Allocation
Agreement, items of common expense are allocated primarily on the basis of
estimates of time spent and space occupied by relevant personnel, including
executive personnel (other than Mr. Guccione), data processing, accounting,
production and sales support and administrative personnel. The Company pays such
combined expenses and allocates to GMI and the Other GMI Subsidiaries the
portions due by such companies. Costs incurred directly by subsidiaries of the
Company solely for their benefit are paid directly by such companies, as are
direct costs incurred by the Other GMI Subsidiaries solely for their benefit.

In October 1997, Mr. Guccione was granted a loan in the amount of $1.2
million from a company that had simultaneously entered into an agreement with
the Company to provide services for the Company's pay-per-call business. The
loan was in consideration of Mr. Guccione personally guaranteeing all material
obligations of the Company under the agreement. Payment on the loan may be
demanded, with interest at 9% per annum, no earlier than December 31, 2001. If
the note is repaid in full prior to June 30, 2001, the unpaid principal amount
of the loan is reduced by $500,000.

At December 31, 1998, the Company had a $1.0 million loan receivable from
Mr. Guccione, pursuant to a promissory note. Such loan bears interest at 11% per
annum and is due on December 31, 1999.

At December 31, 1998, the Company had a $1.1 million loan receivable from
a foreign company which is principally owned by Mr. Guccione. Such loan bears no
interest, is due on demand and is personally guaranteed by Mr. Guccione.

In 1996, the Company sold advertising pages in several of its publications
to a Company which is owned by Mr. Marlieb, a director and officer of the
Company. The amounts charged by the Company for the advertising pages was
$81,555 in 1996, which was the average rate paid by all non-affiliated
advertisers in each issue in which the advertising appeared.

The Company utilizes the services of Avrett, Free & Ginsberg, an
advertising agency. Such agency provides for the design and placement of media
advertising. Mr. Jack Avrett, a director of the Company until his death in
August 1997, was a principal of such firm. The Company paid Avrett, Free &
Ginsberg approximately $0.2, $ 0.5 and $1.2 million for advertising services in
1998, 1997 and 1996, respectively.

PART IV

Item 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K.

(a) The following documents are being filed as part of this Report:

(1) See page F-1 for a listing of consolidated financial statements.

(2) See page F-1 for a listing of financial statement schedules.

(3) Exhibits:

Exhibit
No. Description
------ -----------
*3.1 -- Certificate of Incorporation of the Company, filed with
the Secretary of State of Delaware on November 9, 1993.

36

Exhibit
No. Description
------ -----------
*3.2 -- By-Laws of the Company.

*4.1 -- Indenture, dated as of December 21, 1993, between the
Company and IBJ Schroder Bank & Trust Company, as
trustee ("Trustee"), containing, as exhibits, specimens
of Series A Notes and Series B Notes.

*4.2 -- Registration Rights Agreement, dated as of December 21,
1993, between the Company and the Underwriters.

*4.3 -- Security Agreement, dated December 21, 1993, between the
Company and Trustee.

*4.4 -- Pledge Agreement, dated December 21, 1993, between the
Company and Trustee.

*4.5 -- Copyright Security Agreement, dated December 21, 1993,
between the Company and Trustee.

*4.6 -- Trademark Security Agreement, dated December 21, 1993,
between the Company and Trustee.

+*10.1 -- Distribution Agreement, dated September 19, 1977, among
Curtis Circulation, Penthouse International, Ltd., Forum
International, Ltd., Viva International, Ltd., Penthouse
Photo World, Ltd. and Penthouse Poster Press, Ltd.;
Amendment No. 1, undated; Amendment No. 2, dated
September 8, 1982; Amendment No. 3, dated March 18,
1985; and Amendment No. 4, dated February 1, 1986.

+*10.2 -- Printing Agreement, dated April 30, 1980, between
Penthouse International, Ltd. and Meredith Corporation
(to print Penthouse); Amendment, dated October 23,
1986; Addendum #8, dated November 7, 1986; Amendment,
dated December 8, 1986; Addendum, dated March 20, 1987;
Amendment, dated November 3, 1987; Addendum, dated
March 15, 1990; Addendum, dated June 15, 1990; and
Amendment and Extension, dated September 1, 1992.

+*10.3 -- Printing Agreement, dated May 1, 1987, between
Penthouse International, Ltd. and Meredith/Burda (to
print Four Wheeler); Amendment, dated November 3, 1987;
Addendum, dated March 15, 1990; Addendum, dated June
15, 1990; Amendment, undated, effective July 1991; and
Amendment and Extension, dated September 1, 1992.

+*10.4 -- Printing Agreement, dated May 13, 1987, between
Penthouse International, Ltd. and Meredith/Burda (to
print Girls of Penthouse); Addendum, dated March 15,
1990; Addendum, dated June 15, 1990; and Amendment and
Extension, dated September 1, 1992.

+*10.5 -- Printing Agreement, dated July 15, 1991, among Four
Wheeler Publishing, Ltd., General Media International,
Inc. and R.R. Donnelley & Sons Co. (to print Open Wheel,
Stock Car Racing and Super Stock & Drag Illustrated);
Amendment and Extension, dated September 1, 1992.

+*10.6 -- Printing Agreement, dated July 20, 1993, among Hot Talk
Publications, Ltd., Penthouse Letters, Ltd., General
Media International, Inc. and R.R. Donnelley & Sons Co.
(to print Hot Talk and Penthouse Letters).

*10.7 -- Warrant Agreement, dated December 21, 1993, between the
Company and Trustee.

*10.8 -- Properties and Salary Allocation Agreement, dated
December 21, 1993, among the Company, GMI and Locusts on
the Hudson River Corp.

37

Exhibit
No. Description
------ -----------
*10.9 -- Expense Allocation Agreement, dated December 21, 1993,
among the Company, GMI and the Other GMI Subsidiaries.

*10.10-- Tax Sharing and Indemnification Agreement, dated
December 21, 1993, among the Company, GMI and the Other
GMI Subsidiaries.

*10.11-- Employment Agreement, dated as of January 1, 1994,
between the Company and William F. Marlieb.**

*10.12-- Employment Agreement, dated as of January 1, 1994,
between the Company and Patrick J. Gavin.**

+10.14-- Circulation Subscription Fulfillment Services Agreement,
dated September 15, 1994, between Palm Coast Data, Ltd.,
Penthouse International, Ltd., Omni Publications
International, Ltd., Longevity International, Ltd., Four
Wheeler Publishing, Ltd., Stock Car Racing Publications,
Inc., Open Wheel Publications, Inc., Super Stock
Publications, Inc., Forum International, Ltd. and
Variations Publishing International, Ltd.; Amendment,
dated September 16, 1994 (incorporated by reference to
Exhibit 10.14 to the Company's Annual Report on Form
10-K for the year ended December 31, 1994).

10.15-- Employment Agreement, dated December 17, 1997, between
the Company and Robert H. Altman.** (incorporated by
reference to Exhibit 10.15 on the Company's Annual
Report on Form 10-K for the year ended December 31,
1997).

10.16-- Retirement Agreement, effective April 4, 1997, between
the Company and William F. Marlieb.**(incorporated by
reference to Exhibit 10.16 to the Company's Annual
Report on Form 10-K for the year ended December 31,
1997).

+10.17-- Amendment and Extension by and among R.R. Donnelly &
Sons and General Media International, Inc., General
Media, Inc., General Media Communications, Inc. And
General Media Automotive Group, Inc. (incorporated by
reference to Exhibit 10.1 to the Company's Quarterly
Report on Form 10-Q for the quarter ended September 30,
1997).

+10.18-- Printing Contract between Access Printing and General
Media Communications, Inc. (incorporated by reference to
Exhibit 10.1 to the Company's Quarterly Report on Form
10- Q for the quarter ended September 30, 1998).

10.19-- Agreement of Lease between M393 Associates LLC and
General Media, Inc. (incorporated by reference to
Exhibit 10.2 to the Company's Quarterly Report on Form
10-Q for the quarter ended September 30, 1998).

10.20-- Assignment of Lease and Agreement between General Media,
Inc. and 277 Park Ave, LLC (incorporated by reference to
Exhibit 10.3 to the Company's Quarterly Report on Form
10-Q for the quarter ended September 30, 1998).

10.21-- Asset Sale and Purchase Agreement between EMAP Petersen,
Inc. and General Media Automotive Group, Inc. Dated as
of February 9, 1999 (incorporated by reference to
exhibit 10.21 to the Company's Current Report on Form
8-K dated March 2, 1999).

12.1 -- Computation of ratio of earnings to fixed charges.

18.1 -- Letter on change in accounting principle.

38

Exhibit
No. Description
------ -----------
21.1 -- Subsidiaries of the Company.

27 -- Financial Data Schedule.

- ----------
* Previously filed with Registration Statement No. 33-76716 on Form S-4, and
incorporated herein by reference to such Registration Statement.

** Compensatory arrangement.

+ Confidential treatment has been granted with respect to certain
information contained in this exhibit.

(b) Reports on Form 8-K:

No reports on Form 8-K were filed by the Company during the fourth
quarter of 1998.

(c) Exhibits:

See paragraph (a)(3) above for a listing of items filed as exhibits
to this Form 10-K as required by Item 601 of Regulation S-K.

(d) Financial Statement Schedules:

See page F-1 for a listing of financial statement schedules filed as
part of this Form 10-K.

39

General Media, Inc. and Subsidiaries

INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
AND SCHEDULES

Page
----

Report of Independent Certified Public Accountants F-2

Financial Statements

Consolidated Balance Sheets, December 31, 1997 and 1998 F-3 - F-4

Consolidated Statements of Operations For the Years
Ended December 31, 1996, 1997 and 1998 F-5

Consolidated Statement of Stockholder Deficiency
For the Years Ended December 31, 1996, 1997
and 1998 F-6

Consolidated Statements of Cash Flows For the Years
Ended December 31, 1996, 1997 and 1998 F-7 - F-8

Notes to Consolidated Financial Statements F-9 - F-24

Report of Independent Certified Public Accountants
on Schedule S-1

Schedule II - Valuation and Qualifying Accounts S-2

All other schedules are omitted because they are not applicable or the required
information is contained in the financial statements or notes thereto.

F-1

REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS

Board of Directors
General Media, Inc. and Subsidiaries

We have audited the accompanying consolidated balance sheets of General Media,
Inc. (a Delaware corporation and wholly-owned subsidiary of General Media
International, Inc.) and Subsidiaries as of December 31, 1997 and 1998, and the
related consolidated statements of operations, stockholder deficiency and cash
flows for each of the three years in the period ended December 31, 1998. These
financial statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.

We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the financial statements referred to above present fairly, in
all material respects, the consolidated financial position of General Media,
Inc. and Subsidiaries as of December 31, 1997 and 1998, and the consolidated
results of their operations and their consolidated cash flows for each of the
three years in the period ended December 31, 1998, in conformity with generally
accepted accounting principles.

/s/ GRANT THORNTON LLP
GRANT THORNTON LLP

New York, New York
March 9, 1999

F-2

General Media, Inc. and Subsidiaries

CONSOLIDATED BALANCE SHEETS

December 31,
(amounts in thousands)

ASSETS 1997 1998
---- ----
CURRENT ASSETS
Cash and cash equivalents $ 7,308 $ 6,432
Accounts receivable, net of allowance for
doubtful accounts of $951 in 1997 and
$918 in 1998 9,177 9,083
Inventories 5,097 4,658
Prepaid expenses and other current
assets 3,580 3,378
Due from affiliated companies 1,148 2,143
Loan to shareholder 732 985
-------- --------

Total current assets 27,042 26,679

PROPERTY AND EQUIPMENT - AT COST,
net of accumulated depreciation and amortization 3,793 3,743

OTHER ASSETS
Intangible assets, net 3,194 2,577
Deferred subscription acquisition costs, net 3,075 3,041
Deferred debt issuance costs, net 2,988 1,998
Loan to affiliated company 1,086 1,086
Rent security deposits 766 1,866
Other 683 958
-------- --------
11,792 11,526
-------- --------
$ 42,627 $ 41,948
======== ========

The accompanying notes are an integral part of these statements.

F-3

General Media, Inc. and Subsidiaries

CONSOLIDATED BALANCE SHEETS

December 31,
(amounts in thousands)

LIABILITIES AND STOCKHOLDER DEFICIENCY 1997 1998
---- ----

CURRENT LIABILITIES

Accounts payable $ 13,909 $ 16,538
Accrued retail display allowances 2,849 2,242
Deferred subscription revenues 11,748 11,729
Deferred revenue 1,800
Other liabilities and accrued expenses 1,583 2,930
Income taxes payable 372 254
--------- ---------

Total current liabilities 30,461 35,493

SENIOR SECURED NOTES 79,467 79,645

UNEARNED REVENUE 4,699 3,089

COMMITMENTS AND CONTINGENCIES

REDEEMABLE WARRANTS 1,791 1,791

STOCKHOLDER DEFICIENCY
Common stock, $.01 par value; authorized, 1,000,000
shares; issued and outstanding, 475,000 shares 5 5
Capital in excess of par value 1,418 1,418
Accumulated deficit (75,214) (79,493)
--------- ---------

(73,791) (78,070)
--------- ---------

$ 42,627 $ 41,948
========= =========

The accompanying notes are an integral part of these statements.

F-4

General Media, Inc. and Subsidiaries

CONSOLIDATED STATEMENTS OF OPERATIONS

Year ended December 31,
(amounts in thousands)

1996 1997 1998
--------- --------- ------
(Restated - Note 3)

Net revenues
Publishing
Newsstand $ 54,114 $ 46,635 $ 46,179
Advertising 27,068 25,372 26,061
Subscription 11,558 10,895 11,881
Other 6,826 4,016 3,382
Entertainment 15,056 16,842 17,647
--------- --------- ---------
114,622 103,760 105,150
--------- --------- ---------

Operating costs and expenses
Publishing - production, distribution and
editorial 52,189 45,586 44,095
Entertainment - direct costs 7,947 6,363 2,672
Selling, general and administrative 42,999 41,998 50,523
Rent expense from affiliated companies 723 548 523
Depreciation and amortization 1,877 1,873 1,815
--------- --------- ---------
Total operating costs and expenses 105,735 96,368 99,628
--------- --------- ---------
Income from operations 8,887 7,392 5,522

Other income (expense)
Interest expense (9,907) (9,918) (9,918)
Interest income 319 611 517
--------- --------- ---------

Loss from operations before income
taxes (701) (1,915) (3,879)

Provision for income taxes 327
--------- --------- ---------
NET LOSS $ (1,028) $ (1,915) $ (3,879)
========= ========= =========

The accompanying notes are an integral part of these statements.

F-5

General Media, Inc. and Subsidiaries

CONSOLIDATED STATEMENT OF STOCKHOLDER DEFICIENCY

Years ended December 31, 1996, 1997 and 1998
(amounts in thousands)

Capital in
Common excess of Accumulated
stock par value deficit Total
----- --------- ------- -----

Balance - January 1, 1996 (Restated -
Note 3) $5 $1,418 $(72,271) $(70,848)

Net loss for the year (1,028) (1,028)
-- ------ -------- --------

Balance - December 31, 1996 5 1,418 (73,299) (71,876)

Net loss for the year (1,915) (1,915)
-- ------ -------- --------

Balance - December 31, 1997 5 1,418 (75,214) (73,791)

Net loss for the year (3,879) (3,879)
Less cash dividend paid (400) (400)
-- ------ -------- --------

Balance - December 31, 1998 $5 $1,418 $(79,493) $(78,070)
== ====== ======== ========

The accompanying notes are an integral part of this statement.

F-6

General Media, Inc. and Subsidiaries

CONSOLIDATED STATEMENTS OF CASH FLOWS

Year ended December 31,
(amounts in thousands)

1996 1997 1998
--------- --------- --------
(Restated - Note 3)

Cash flows from operating activities
Net loss $(1,028) $(1,915) $(3,879)
------- ------- -------
Adjustments to reconcile net loss to net cash
provided by operating activities
Depreciation and amortization 1,877 1,873 1,815
Amortization of bond costs 1,168 1,166 1,168
Amortization of unearned revenue (1,230) (1,461) (1,610)
Loss from disposal of property and
equipment 725
Changes in operating assets and liabilities
Accounts receivable 1,610 2,574 94
Inventories 3,096 866 439
Other current assets 751 (888) 202
Other assets (112) (709) (1,564)
Accounts payable and accrued expenses (376) (300) 3,366
Income taxes payable 327 (305) (118)
Deferred subscription revenue (3,265) 834 (19)
Deferred revenue 1,800
------- ------- -------
3,846 3,650 6,298
------- ------- -------
Net cash provided by operating
activities 2,818 1,735 2,419
------- ------- -------
Cash flows from investing activities
Capital expenditures (383) (335) (2,752)
Proceeds from office relocation 1,105
Loan to shareholder (732) (253)
------- ------- -------

Net cash used in investing activities (383) (1,067) (1,900)
------- ------- -------

F-7

General Media, Inc. and Subsidiaries

CONSOLIDATED STATEMENTS OF CASH FLOWS (continued)

Year ended December 31,
(amounts in thousands)

1996 1997 1998
--------- --------- --------
(Restated - Note 3)

Cash flows from financing activities
Advance to affiliated companies $ (524) $(1,465)
Repayments from affiliated companies $ 349 470
Dividends paid (400)
-------- -------- -------

Net cash provided by (used in) financing
activities 349 (524) (1,395)
-------- -------- -------

NET INCREASE (DECREASE) IN CASH
AND CASH EQUIVALENTS 2,784 144 (876)

Cash and cash equivalents at beginning of year 4,380 7,164 7,308
-------- -------- -------

Cash and cash equivalents at end of year $ 7,164 $ 7,308 $ 6,432
======= ======= =======

The accompanying notes are an integral part of these statements.

F-8

General Media, Inc. and Subsidiaries

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 1997 and 1998
(amounts in thousands)

NOTE 1 - ORGANIZATION AND SUMMARY OF ACCOUNTING POLICIES

General Media, Inc. and Subsidiaries (the "Company"), a wholly-owned
subsidiary of General Media International, Inc. ("GMI"), is a multimedia
company focused primarily on the adult and automotive enthusiast
marketplace. The Company's principal businesses are magazine publishing
and adult entertainment. Operating profits of the Publishing and
Entertainment segments were $13.8 million and $9.7 million, respectively,
of total operating profits in 1998. However, these operating profits were
offset by corporate administrative expenses of $18 million. Men's
magazines accounted for approximately 71% of revenues of the Publishing
segment in 1998, which also includes foreign edition licensing. Penthouse
is the most significant trademark of the Publishing segment and is used
extensively in magazine publishing and foreign edition licensing. The
Company's operations are located primarily in New York City, and the
Company has a broad customer base. Approximately 90% of the Company's
revenues are derived from customers within the United States.

Newsstand and advertising revenues accounted for approximately 44% and
25%, respectively, of the Company's revenues in 1998. Revenues and
operating results can be affected by changes in the demand for advertising
and/or consumer demand for the Company's products. National and economic
conditions largely affect the overall industry levels of advertising
revenues. Magazine circulation revenues are generally affected by national
and/or regional conditions and competition from other magazines and forms
of media.

A summary of the significant accounting policies consistently applied in
the preparation of the accompanying consolidated financial statements
follows:

a. Principles of Consolidation

The consolidated financial statements include the accounts of the
Company and all its subsidiaries. All significant intercompany
transactions and balances have been eliminated.

b. 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. Estimated revenues are
adjusted to actual revenues as actual sales information becomes
available. The Company receives an advance payment from its distributor
at the on-sale date of each issue.

Revenues from advertising are recognized on the on-sale date of each
issue in which the advertising was included.

F-9

General Media, Inc. and Subsidiaries

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(continued)

December 31, 1997 and 1998
(amounts in thousands)

NOTE 1 (continued)

Revenues from the sale of magazine subscriptions are recognized over
the term of the subscriptions.

Revenues from the sales of films and video cassettes are recognized in
the period in which the product is shipped. Returns are generally not
material. Revenues from product and trademark licensing are recorded in
the period in which earned.

Revenues from the sale of subscriptions to the Company's internet site
are recognized over the term of the subscription.

Revenues from pay-per-call programs are recorded in the period in which
the calls are made, net of estimated chargebacks.

c. Inventories

Paper and printing costs are valued at the lower of cost (first-in,
first-out method) or market. Editorials and pictorials are valued at
actual cost, which is not greater than market. Film and programming
costs are the direct cost of production, less amounts amortized over
the expected period of revenue, generally twelve months from the film
release date.

d. Deferred Subscription Acquisition Costs

The costs of acquiring subscriptions related to direct response
marketing are deferred and amortized over the life of the
subscriptions, generally twelve to eighteen months. Amortization of
these costs is done on a cost-pool-by-cost-pool basis over the period
during which the future benefits are expected to be received.

e. Property and Equipment

Property and equipment are stated at cost. Depreciation is provided by
the straight-line method based upon the estimated useful lives of the
assets. Furniture and equipment and computer hardware and software are
depreciated over five years and leasehold improvements are depreciated
over the life of the lease.

F-10

General Media, Inc. and Subsidiaries

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(continued)

December 31, 1997 and 1998
(amounts in thousands)

NOTE 1 (continued)

f. Intangible Assets

Intangible assets are specific advertising accounts, subscriber and
circulation lists obtained with acquisition of certain magazine assets
and are being amortized over original periods ranging from seven to
fourteen years. Goodwill represents the excess of the purchase price
over the fair value of net assets of the business acquired and is
amortized over fifteen years on a straight-line basis. On an ongoing
basis, management reviews the valuation and amortization of goodwill
and other intangible assets to determine possible impairment by
comparing the carrying value to the undiscounted future cash flows of
the related assets.

Amortization expense is approximately $617, $616 and $617 for the years
ended December 31, 1996, 1997 and 1998, respectively.

Accumulated amortization is approximately $7,294 and $7,911 at December
31, 1997 and 1998, respectively.

g. Statement of Cash Flows

The Company considers all highly liquid debt instruments purchased with
an original maturity of three months or less to be cash equivalents.

Interest paid was $8,740, $8,720 and $8,720 for the years ended
December 31, 1996, 1997 and 1998, respectively.

Income taxes paid were $248, $481 and $118 for the years ended December
31, 1996, 1997 and 1998, respectively.

h. Management Charges

The Company incurs shared common indirect expenses for the benefit of
GMI and affiliated companies, including accounting, personnel, data
processing, employee relations and other administrative services. In
addition, the Company is charged by GMI and its subsidiaries for other
corporate overhead costs, executive compensation and costs which
principally relate to office space, including interest charges and
depreciation. These allocations are based on factors determined by
management of the Company 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.

F-11

General Media, Inc. and Subsidiaries

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(continued)

December 31, 1997 and 1998
(amounts in thousands)

NOTE 1 (continued)

In the opinion of management, the results of operations of the Company
reflect all of the Company's costs, including salaries, rent,
depreciation, legal and accounting services and other general and
administrative costs.

i. Concentration and Fair Value of Financial Instruments

The Company's financial instruments that are exposed to concentrations
of credit risk consist primarily of cash and cash equivalents and trade
accounts receivable. The Company places its cash and temporary cash
investments with high credit quality institutions. In general, such
investments exceed the FDIC insurance limit. The Company provides
credit, in the normal course of business, to a significant number of
advertisers in the tobacco, alcohol and adult entertainment industries.
The Company routinely assesses the financial strength of its customers
and newsstand distributors and, as a consequence, believes that its
trade accounts receivable exposure is limited. The carrying value of
financial instruments potentially subject to valuation risk
(principally consisting of cash and cash equivalents) approximates fair
market value. Based upon the quoted market prices, the fair value of
the Company's Senior Secured Notes is $70,400 as of December 31, 1998.

j. Use of Estimates

In preparing financial statements in conformity with generally accepted
accounting principles, management makes estimates and assumptions that
affect the reported amounts of assets and liabilities and disclosures
of contingent assets and liabilities at the date of the financial
statements, as well as the reported amounts of revenues and expenses
during the reporting period. Actual results could differ from those
estimates.

k. Reclassification of Prior Periods

Certain amounts in the 1996 and 1997 financial statements have been
reclassified to conform to the 1998 presentation.

F-12

General Media, Inc. and Subsidiaries

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(continued)

December 31, 1997 and 1998
(amounts in thousands)

NOTE 1 (continued)

l. Segment Information

In 1998, the Company adopted Statement of Financial Accounting
Standards No. 131 ("FAS 131"), "Disclosures About Segments of an
Enterprise and Related Information." FAS 131 supersedes FAS 14
replacing the "industry segment" approach with the "management"
approach. The management approach designates the internal organization
that is used by management for making operating decisions and assessing
performance as the source of the company's reportable segments. FAS 131
also requires disclosures about products and services, geographic areas
and major customers. The adoption of FAS 131 did not affect the results
of operations or financial position but did affect the disclosure of
segment information (see "Note 10 - Segment Information").

NOTE 2 - LIQUIDITY

The Company's revenues increased in 1998; however, the Company's results
from operations were negatively impacted by increased operating expenses
in the second half of 1998, which resulted in continued net losses to the
Company in 1998. While it is difficult to predict future results of
operations, it is unlikely that the Company can achieve profitable net
income in 1999 from continuing operations. However, the Company does
expect the entertainment segment will contribute increased profitability
in 1999 due to continued growth of the Company's internet pay subscription
service and, as discussed in Note 11, the Company recorded a gain in 1999
of approximately $29 million related to the sale of its Automotive
division.

However, the Company's cash balance at December 31, 1998 is $6.4 million.
The Company has a $4.2 million semiannual interest payment due on June 30,
1999. Management of the Company believes that it will have sufficient cash
resources through positive cash flows from operations and use of its
existing cash balances to enable it to meet its obligations over the next
twelve months.

F-13

General Media, Inc. and Subsidiaries

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(continued)

December 31, 1997 and 1998
(amounts in thousands)

NOTE 3 - INVENTORIES

Inventories include the following at December 31,:

1997 1998
---- ----
Paper and printing $2,063 $1,807
Editorials and pictorials 2,210 2,080
Film and programming costs 824 771
------- ------

$5,097 $4,658
====== ======

In 1997, the Company changed its method of determining the cost of paper
and printing inventories from the LIFO method to the FIFO method. Under
the current economic environment of low inflation, the Company believes
that the FIFO method will result in a better measurement of operating
results. This change has been applied by retroactively restating the
accompanying 1996 consolidated financial statements. The effect of the
change was to decrease 1997 net loss by $178 and increase 1996 net
loss by $499.

The January 1, 1996 balance of accumulated deficit has been adjusted for
the effect of applying retroactively the new method of pricing
inventories.

F-14

General Media, Inc. and Subsidiaries

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(continued)

December 31, 1997 and 1998
(amounts in thousands)

NOTE 4 - PROPERTY AND EQUIPMENT

Property and equipment as of December 31, consist of:

1997 1998
------ ------

Furniture and equipment $ 7,039 $ 6,613
Leasehold improvements 2,477 1,847
Computer hardware and software 2,268 2,549
Other 66 66
-------- --------

11,850 11,075

Accumulated depreciation and amortization (8,057) (7,332)
-------- --------

$ 3,793 $ 3,743
======== ========

NOTE 5 - SENIOR SECURED NOTES

On December 21, 1993, the Company issued $85,000 of Senior Secured Notes
(the "Notes") at an issue price equal to 99.387% of the principal amount
of the Notes. The Notes mature on December 31, 2000 and bear interest at
10-5/8% per annum, which is payable semiannually. The Notes can be
redeemed at the option of the Company during the period beginning on
December 31, 1998 at 104% of the principal amount of the Notes and
beginning December 31, 1999 and thereafter at 100% of the principal amount
of the Notes.

The Company also issued 85 common stock purchase warrants to the
purchasers of the Notes and sold to the underwriter at a discount 102
warrants (the "Warrants"). The Warrants entitle 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 are exercisable for a period of
seven years and, beginning in 1999, the holders have the right to require
the Company to purchase for cash all of the Warrants at their fair value.
The Company recorded the Warrants at fair value determined to be $1,841.
Debt issuance costs, consisting of placement agent commissions, and
professional and underwriters' fees totaling approximately $7,141, are
being amortized over seven years.

F-15

General Media, Inc. and Subsidiaries

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(continued)

December 31, 1997 and 1998
(amounts in thousands)

NOTE 5 (continued)

In July 1995, the Company repurchased $5,000 face amount of its
outstanding Senior Secured Notes, including 5,000 warrants, for cash of
$4,050.

The Notes are secured 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 and cash equivalents.

The Notes are fully and unconditionally guaranteed, jointly and severally,
by each of the Company's direct and indirect subsidiaries (the "Subsidiary
Guarantors"). Each of the Subsidiary Guarantors is a wholly-owned
subsidiary of the Company. The Company is a holding company with no
separate assets, liabilities or operations other than its investment in
its subsidiaries and the Notes. Financial statements of the Subsidiary
Guarantors have not been presented because the aggregate assets,
liabilities, operations and equity of the Subsidiary Guarantors are
substantially equivalent to the assets, liabilities, operations and equity
of the Company on a consolidated basis.

The indenture contains covenants 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 minimum consolidated tangible net worth (deficiency) of $(81.6)
million, and (iii) restrict the Company's ability to pay dividends unless
certain financial performance tests are met. The Company's subsidiaries,
who are guarantors of the Senior Secured Notes under the indenture,
however, are 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. As of December 31,
1998, the Company was in compliance with all such covenants.

NOTE 6 - INCOME TAXES

Deferred income taxes reflect the net tax effects of temporary differences
between the carrying amounts of assets and liabilities for financial
reporting purposes and the amounts used for income tax purposes.
Significant components of the deferred income tax assets and liabilities
at December 31, were as follows:

F-16

General Media, Inc. and Subsidiaries

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(continued)

December 31, 1997 and 1998
(amounts in thousands)

NOTE 6 (continued)

1997 1998
-------- -------

Deferred tax assets
Reserve for doubtful accounts $ 577 $ 700
Reserve for newsstand returns 497 302
Capitalized inventory costs 188 188
Depreciation and amortization 99 87
Loss carryforwards 44,199 50,748
-------- -------

45,560 52,025
Less valuation allowance (44,343) (50,748)
-------- -------

1,217 1,277
-------- --------
Deferred tax liabilities
Deferred subscription acquisition costs (1,217) (1,277)
-------- --------

Net deferred tax asset $ -- $ --
========= ========

A valuation allowance is recorded against tax assets which are not likely
to be realized. Specifically, the carryforwards are available to expire at
specific dates. Due to the uncertain nature of their ultimate realization
based upon past performance and expiration dates, the Company has
established a full valuation allowance against these carryforwards.

The Company and its subsidiaries are included in the consolidated Federal
income tax return of GMI. 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 Company will not be required to remit income taxes to GMI
to the extent that taxes are not payable, due to the utilization of
available net operating loss carryovers. GMI has available for Federal
income tax purposes net operating losses aggregating approximately
$105,000 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, which will
expire in tax years ending in 2009 to 2018. The Company's ability to
utilize net operating losses may be limited in the future due to
additional issuances of the Company's common stock or other changes in
control, as defined in the Internal Revenue Code and related regulations.
In addition, utilization of NOL carryforwards may be limited by the
application of the at-risk rules.

F-17

General Media, Inc. and Subsidiaries

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(continued)

December 31, 1997 and 1998
(amounts in thousands)

NOTE 6 (continued)

The Internal Revenue Service has completed an audit of GMI's Federal
income tax returns for the years ended 1979 through 1985. New York State
and New York City have completed audits through tax years 1992 and 1993,
respectively. The Company is currently subject to an audit by foreign tax
authorities and has provided a reserve of $254 against such audits in the
accompanying balance sheet as of December 31, 1998. Subsequent years'
income tax and other tax returns filed by GMI are being audited or are
subject to audit by governmental authorities.

In 1993, the Company agreed to pay up to $26,000 to satisfy a portion of
the actual and potential tax liabilities of GMI and its subsidiaries
through 1993. This liability has been fully paid since 1994. GMI has
agreed to indemnify the Company for any income tax liabilities with
respect to taxable periods ended prior to 1994 in excess of the $26,000.
If GMI does not have the resources to pay the tax assessments, the Company
will be liable for any deficiency. Management believes that GMI has
sufficient assets to pay any likely assessments in excess of $26,000.

Subsequently, on January 11, 1999, the Company and the Internal Revenue
Service completed an audit of GMI's Federal income tax returns for the
periods 1986 through 1990. This audit resulted in a tax deficiency
totaling $35 plus interest. The Internal Revenue Service billed the tax
and interest and the Company has requested a recalculation of said
interest, which is in process. As a result of the audit, the net operating
loss carryover as at December 31, 1998 will be reduced to $78,000.

NOTE 7 - COMMITMENTS AND CONTINGENCIES

Litigation

In August 1996, an action was brought against the Company alleging various
wrongs in connection with the Company's dealings with the former editor of
Penthouse Comix and Mens Adventure Comix. The complaint alleges RICO
violations, breach of contract, trademark and copyright infringement and
other charges and demands damages in excess of $20 million. The Company
believes that the claim is without merit and has tendered defense of this
action to its insurance carrier. In the opinion of management, the outcome
of this litigation is not reasonably likely to have a material adverse
effect on the Company's financial position or results of operations.

F-18

General Media, Inc. and Subsidiaries

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(continued)

December 31, 1997 and 1998
(amounts in thousands)

NOTE 7 (continued)

On January 23, 1997, the Company filed in the United States District Court
for the Southern District of New York an action (the "Action") under the
Racketeer Influenced and Corrupt Organizations Act ("RICO") alleging,
among other things, that certain defendants conspired to defraud the
Company by fraudulently backdating a contract (the "DEC Contract") which
awarded exclusive rights to develop a "live" Penthouse internet site to
defendant Deluxe Entertainment Corp. ("DEC"). On January 24, 1997, DEC
served a demand on the Company for arbitration under the DEC Contract on
the issues of breach and damages. The DEC Contract provides a minimum
damage award of $30 million in addition to incidental, consequential and
punitive damages and compensation for lost profits. The Company moved to
enjoin the arbitration and defendant DEC cross-moved to compel
arbitration. By decision dated July 24, 1998, District Court Judge Deborah
A. Batts denied the Company's motion and granted the cross-motion
compelling arbitration. The Company intends to vigorously defend the
arbitration. In the event of an adverse outcome, the Company intends to
challenge on appeal the decision compelling arbitration. In the opinion of
management, the outcome of this litigation is not reasonably likely to
have a material adverse effect on the Company's financial position or
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 these cases the outcome will not have a material effect on the
Company's financial statements.

Leases

The Company leases office space in several cities under operating leases
expiring at various dates through May 2010. Rent expense under operating
leases was $2,480, $2,440 and $2,396 during the years ended December 31,
1996, 1997 and 1998, respectively. Minimum lease commitments are set forth
below:

Year ending December 31,
1999 $ 1,965
2000 1,808
2001 1,735
2002 1,868
2003 1,863
Thereafter 10,318
-------
$19,557

F-19

General Media, Inc. and Subsidiaries

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(continued)

December 31, 1997 and 1998
(amounts in thousands)

NOTE 7 (continued)

Employee Benefit Plan

The Company's employees may participate in a GMI-sponsored employee profit
sharing and deferred compensation 401(k) benefit plan. The plan covers
substantially all employees and permits employees to defer up to 15% of
their salary. The plan also provides for GMI and the Company to make
contributions to a profit-sharing fund solely at GMI's or the Company's
discretion. There were no Company contributions to the plan for the years
ended December 31, 1996, 1997 and 1998.

NOTE 8 - UNEARNED REVENUE

During 1995, the Company received amounts aggregating $8,000 from two
distributors of Company products. One advance, totaling $5,000,
represents an advance payment which is being recognized as revenue as
Company products are sold through the distributor. The other advance,
totaling $3,000, represents an incentive to sign a new ten-year agreement
with the distributor and is being recognized as revenue on a straight-line
basis over the term of the contract.

NOTE 9 - RELATED PARTIES

Included in the accompanying statement of operations are allocated
expenses for the use of the Company's executive offices owned by
affiliated companies. Rent expense from affiliated companies was $723,
$548 and $523 for the years ended December 31, 1996, 1997 and 1998,
respectively.

On November 26, 1993, the Company entered into a Property and Salary
Allocation Agreement (the "Agreement") with GMI and a subsidiary of GMI
which allows the Company to be charged for the cost of utilizing executive
offices owned by GMI and a subsidiary of GMI. The charges are based upon
an estimate of the portion of the executive offices used by the Company
and the cost of utilizing comparable facilities as determined by the
nonemployee members of the Board of Directors of the Company.

F-20

General Media, Inc. and Subsidiaries

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(continued)

December 31, 1997 and 1998
(amounts in thousands)

NOTE 9 (continued)

The Agreement also allows for the Company to be charged for salaries of
the Chairman of the Board and the previous Vice Chairman of the Board of
the Company, which are paid by GMI. The amount of salary charged to the
Company is based upon an estimate of the time devoted to Company matters.

On November 26, 1993, the Company entered into an Expense Allocation
Agreement with GMI and its subsidiaries which allows the Company to pay
certain shared common indirect expenses. GMI and its subsidiaries are
required to reimburse the Company, within 60 days after each quarter-end,
for any payments made by the Company on its behalf. The amount of shared
common indirect expenses charged to GMI and its subsidiaries is based upon
factors determined by management of the Company to be appropriate for the
particular item, including relative time commitments, relative number of
employees and square footage of space occupied. The amount receivable
under the Property and Salary Allocation Agreement and the Expense
Allocation Agreement at December 31, 1997 and 1998 was $1,148 and $2,143,
respectively. The principal shareholder of GMI has guaranteed the
repayment of these amounts.

The Company has an unsecured loan receivable from an entity which is owned
by GMI's principal shareholder. The loan amounted to $1,086 at December
31, 1997 and 1998. The loan is due on demand, bears no interest and is
guaranteed by GMI's principal shareholder.

In October 1997, GMI's principal shareholder was granted a loan in the
amount of $1,200 from a company that had simultaneously entered into an
agreement with the Company to provide services for the Company's
pay-per-call business. The loan was in consideration of GMI's principal
shareholder personally guaranteeing all material obligations of the
Company under the agreement. The loan is payable in full, with interest at
9% per annum, no earlier than December 31, 2001. If the note is repaid in
full prior to June 30, 2001, the unpaid principal amount of the loan is
reduced by $500.

At December 31, 1998, the Company had a $985 loan receivable from GMI's
principal shareholder, pursuant to a promissory note. Such loan bears
interest at 11% per annum and is due on December 31, 1999.

F-21

General Media, Inc. and Subsidiaries

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(continued)

December 31, 1997 and 1998
(amounts in thousands)

NOTE 10 - SEGMENT INFORMATION

The Company is currently engaged in activities in two industry segments:
publishing and entertainment. The publishing segment of the Company is
engaged in the publication of Penthouse magazine and six affiliate
magazines (the "Affiliate Publications" and, together with Penthouse
magazine, the "Mens Magazines"), the licensing of the Penthouse brand name
to publishers in foreign countries and until 1999, the publication of four
specialty automotive magazines: Four Wheeler, Stock Care Racing; Open
Wheel; and Drag Racing Monthly (the "Automotive Magazines"). The
entertainment segment of the Company produces a number of adult-oriented
entertainment products, including pay-per-call telephone lines, video
cassettes, pay-per-view programming and pay subscription service on the
internet.

Corporate and
Entertain- reconciling
Publishing ment items Consolidated
---------- ---- ----- ------------

1998
Sales to customers $87,503 $17,647 $105,150
Income (loss) from operations 13,754 9,743 $(17,975) 5,522
Identifiable assets 27,482 1,352 13,114 41,948
Depreciation and amortization 1,815 1,815
Capital expenditures 2,570 182 2,752

1997
Sales to customers $86,918 $16,842 $103,760
Income from operations 15,762 6,648 $(15,018) 7,392
Identifiable assets 27,336 2,029 13,262 42,627
Depreciation and amortization 1,873 1,873
Capital expenditures 260 75 335

1996
Sales to customers $99,566 $15,056 $114,622
Income from operations 20,853 3,946 $(15,912) 8,887
Identifiable assets 29,839 2,909 12,851 45,599
Depreciation and amortization 1,877 1,877
Capital expenditures 171 212 383

F-22

General Media, Inc. and Subsidiaries

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(continued)

December 31, 1997 and 1998
(amounts in thousands)

NOTE 10 (continued)

All intersegment sales have been eliminated. The loss from operations in
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 and depreciation. Corporate and
reconciling items included in identifiable assets include all cash,
deferred debt issuance costs, loan to shareholder, loan to affiliated
company and assets held for sale.

The market for the Company's product is worldwide; however, over 90% of
the Company's revenue is derived from U.S. based sources.

No customer of the Company accounted for more than five percent of the
Company's net revenues in 1998, 1997 or 1996, and no part of the business
is dependent upon a single customer or a few customers, the loss of any
one or more of which would have a material adverse effect on the Company.
However, one advertising agency placed $2.4 million, $6.0 million and $8.0
million in advertising revenues in Penthouse magazine and the Affiliate
Publications in 1998, 1997 and 1996, respectively. These revenues
represent 2%, 6% and 7% of the Company's net revenues in 1998, 1997 and
1996, respectively.

NOTE 11 - SUBSEQUENT EVENT - SALE OF AUTOMOTIVE MAGAZINES

On March 2, 1999 (the "Closing Date"), the Company sold substantially all
of the assets, exclusive of net newsstand and advertising accounts
receivable, of its wholly-owned subsidiary, General Media Automotive
Group, Inc. ("GMAG") to EMAP Petersen, Inc. ("EMAP") for $35 million in
cash plus the assumption of certain liabilities and deferred subscription
liabilities, as defined in the Asset Sale and Purchase Agreement between
EMAP and GMAG dated as of February 9, 1999 (the "Asset Purchase
Agreement"). There are no material relationships between EMAP and the
Company or any of its affiliates, any director or officer of the Company,
or any associate of any such director or officer. The sale price is
subject to an adjustment to be finalized within 60 days from the Closing
Date and shall be increased or decreased on a dollar-for-dollar basis by
the amount that net working capital, as defined in the Asset Purchase
Agreement, deviates from $1.5 million. The Company recorded a gain of
approximately $29 million.

F-23

General Media, Inc. and Subsidiaries

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(continued)

December 31, 1997 and 1998
(amounts in thousands)

NOTE 11 (continued)

Under the Indenture, as discussed in Note 5, the Company has 180 days from
the Closing Date to apply the net proceeds to an investment in another
business or capital expenditure or other tangible or long-term assets in
the same or similar line of business as the Company was engaged in on the
date of the Indenture. To the extent that any net proceeds are not so
applied, the remaining amount shall be deemed excess proceeds. Should the
excess proceeds exceed $5 million, the Company is required to make an
offer to all bondholders to purchase the maximum principal amount of notes
plus accrued interest that may be purchased from the excess proceeds.

F-24

REPORT OF INDEPENDENT CERTIFIED
PUBLIC ACCOUNTANTS ON SCHEDULE

Board of Directors
General Media, Inc. and Subsidiaries

In connection with our audits of the consolidated financial statements of
General Media, Inc. and Subsidiaries, referred to in our report dated March 9,
1999, we have also audited Schedule II as of December 31, 1998, 1997 and 1996,
and for each of the three years in the period ended December 31, 1998.

In our opinion, this schedule presents fairly, in all material respects, the
information set forth therein.

/s/ GRANT THORNTON LLP
GRANT THORNTON LLP

New York, New York
March 9, 1999

S-1

General Media, Inc. and Subsidiaries

SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS

Years ended December 31, 1998, 1997 and 1996
(amounts in thousands)

Column A Column B Column C Column D Column E
-------- -------- -------- -------- --------
Additions
----------------------
Charged to
Balance at Charged to other Balance at
beginning costs and accounts - Deductions - end of
Description of period expenses describe describe period
----------- --------- -------- -------- -------- ------

Year ended December 31, 1998
Allowance for doubtful accounts $ 951 $2,961 $2,994 (a) $ 918
====== ====== ====== ======

Year ended December 31, 1997
Allowance for doubtful accounts $1,661 $ 555 $1,265 (a) $ 951
====== ====== ====== ======

Year ended December 31, 1996
Allowance for doubtful accounts $1,192 $ 677 $ 208 (a) $1,661
====== ====== ====== ======

(a) Accounts written off, net of recoveries.

S-2

SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this Report to be signed on
its behalf by the undersigned, thereunto duly authorized.

GENERAL MEDIA, INC.

By: /s/ Robert C. Guccione March 30, 1999
--------------------------
Robert C. Guccione,
Chairman of the Board;
Publisher
(Principal Executive Officer)

By: /s/ Jahn D. Orlando March 30, 1999
--------------------------
John D. Orlando,
Senior Vice President-
Chief Financial Officer
(Principal Financial Officer and
Principal Accounting Officer)

Pursuant to the requirements of the Securities Exchange Act of 1934, this
Report has been signed below by the following persons on behalf of the
Registrant in the capacities and on the dates indicated.

Signature Title Date
--------- ----- ----

/s/ Robert C. Guccione Chairman of the Board, March 30, 1999
- -------------------------- Publisher and Director
Robert C. Guccione

/s/ Nina Guccione President-New Media, Secretary March 30, 1999
- -------------------------- and Director
Nina Guccione

/s/ John D. Orlando Senior Vice President- Chief March 30, 1999
- -------------------------- Financial Officer and Director
John D. Orlando

/s/ William F. Marlieb Director March 30, 1999
- ---------------------------
William F. Marlieb

/s/ John L. Decker Director March 30, 1999
- ---------------------------
John L. Decker

/s/ Phyllis Schwebel Director March 30, 1999
- ---------------------------
Phyllis Schwebel

EXHIBIT INDEX
-------------

Exhibit Sequential
No. Description Numbering
--- ----------- ---------

*3.1 -- Certificate of Incorporation of the Company, filed with
the Secretary of State of Delaware on November 9, 1993.

*3.2 -- By-Laws of the Company.

*4.1 -- Indenture, dated as of December 21, 1993, between the
Company and IBJ Schroder Bank & Trust Company, as
trustee ("Trustee"), containing, as exhibits, specimens
of Series A Notes and Series B Notes.

*4.2 -- Registration Rights Agreement, dated as of December
21, 1993, between the Company and the Underwriters.

*4.3 -- Security Agreement, dated December 21, 1993, between
the Company and Trustee.

*4.4 -- Pledge Agreement, dated December 21, 1993, between the
Company and Trustee.

*4.5 -- Copyright Security Agreement, dated December 21, 1993,
between the Company and Trustee.

*4.6 -- Trademark Security Agreement, dated December 21, 1993,
between the Company and Trustee.

+*10.1 -- Distribution Agreement, dated September 19, 1977, among
Curtis Circulation, Penthouse International, Ltd.,
Forum International, Ltd., Viva International, Ltd.,
Penthouse Photo World, Ltd. and Penthouse Poster Press,
Ltd.; Amendment No. 1, undated; Amendment No. 2, dated
September 8, 1982; Amendment No. 3, dated March 18,
1985; and Amendment No. 4, dated February 1, 1986.

+*10.2 -- Printing Agreement, dated April 30, 1980, between
Penthouse International, Ltd. and Meredith Corporation
(to print Penthouse); Amendment, dated October 23,
1986; Addendum #8, dated November 7, 1986; Amendment,
dated December 8, 1986; Addendum, dated March 20, 1987;
Amendment, dated November 3, 1987; Addendum, dated
March 15, 1990; Addendum, dated June 15, 1990; and
Amendment and Extension, dated September 1, 1992.

+*10.3 -- Printing Agreement, dated May 1, 1987, between
Penthouse International, Ltd. and Meredith/Burda (to
print Four Wheeler); Amendment, dated November 3, 1987;
Addendum, dated March 15, 1990; Addendum, dated June
15, 1990; Amendment, undated, effective July 1991; and
Amendment and Extension, dated September 1, 1992.

+*10.4 -- Printing Agreement, dated May 13, 1987, between
Penthouse International, Ltd. and Meredith/Burda (to
print Girls of Penthouse); Addendum, dated March 15,
1990; Addendum, dated June 15, 1990; and Amendment and
Extension, dated September 1, 1992.

+*10.5 -- Printing Agreement, dated July 15, 1991, among Four
Wheeler Publishing, Ltd., General Media International,
Inc. and R.R. Donnelley & Sons Co. (to print Open
Wheel, Stock Car Racing and Super Stock & Drag
Illustrated); Amendment and Extension, dated September
1, 1992.

+*10.6 -- Printing Agreement, dated July 20, 1993, among Hot Talk
Publications, Ltd., Penthouse Letters, Ltd., General
Media International, Inc. and R.R. Donnelley & Sons Co.
(to print Hot Talk and Penthouse Letters).

*10.7 -- Warrant Agreement, dated December 21, 1993, between the
Company and Trustee.

i

Exhibit Sequential
No. Description Numbering
--- ----------- ---------

*10.8 -- Properties and Salary Allocation Agreement, dated
December 21, 1993, among the Company, GMI and Locusts
on the Hudson River Corp.

*10.9 -- Expense Allocation Agreement, dated December 21, 1993,
between the Company, GMI and the Other GMI
Subsidiaries.

*10.10 -- Tax Sharing and Indemnification Agreement, dated
December 21, 1993, among the Company, GMI and the Other
GMI Subsidiaries.

*10.11 -- Employment Agreement, dated as of January 1, 1994,
between the Company and William F. Marlieb.**

*10.12 -- Employment Agreement, dated as of January 1, 1994,
between the Company and Patrick J. Gavin.**

+10.14 -- Circulation Subscription Fulfillment Services
Agreement, dated September 15, 1994, between Palm Coast
Data, Ltd., Penthouse International, Ltd., Omni
Publications International, Ltd., Longevity
International, Ltd., Four Wheeler Publishing, Ltd.,
Stock Car Racing Publications, Inc., Open Wheel
Publications, Inc., Super Stock Publications, Inc.,
Forum International, Ltd. and Variations Publishing
International, Ltd.; Amendment, dated September 16,
1994 (incorporated by reference to Exhibit 10.14 to the
Company's Annual Report on Form 10-K for the year ended
December 31, 1994).

10.15 -- Employment Agreement, dated December 17, 1997, between
the Company and Robert H. Altman.**(incorporated by
reference to Exhibit 10.15 to the Company's Annual
Report on Form 10-K for the year ended December 31,
1997).

10.16 -- Retirement Agreement, effective April 4, 1997, between
the Company and William F. Marlieb.**(incorporated by
reference to Exhibit 10.16 to the Company's Annual
Report on Form 10-K for the year ended December 31,
1997).

+10.17 -- Amendment and Extension by and among R.R. Donnelly &
Sons and General Media International, Inc., General
Media, Inc., General Media Communications, Inc. And
General Media Automotive Group, Inc. (incorporated by
reference to Exhibit 10.1 to the Company's Quarterly
Report on Form 10-Q for the quarter ended September 30,
1997).

ii

Exhibit Sequential
No. Description Numbering
--- ----------- ---------

+10.18 -- Printing Contract between Access Printing and General
Media Communications, Inc. (incorporated by reference
to Exhibit 10.1 to the Company=s Quarterly Report on
Form 10-Q for the quarter ended September 30, 1998).

10.19 -- Agreement of Lease between M393 Associates LLC and
General Media, Inc. (incorporated by reference to
Exhibit 10.2 to the Company=s Quarterly Report on Form
10-Q for the quarter ended September 30, 1998).

10.20 -- Assignment of Lease and Agreement between General
Media, Inc. and 277 Park Ave, LLC(incorporated by
reference to Exhibit 10.3 to the Company's Quarterly
Report on Form 10-Q for the quarter ended September 30,
1998).

10.21 -- Asset Sale and Purchase Agreement between EMAP
Petersen, Inc. and General Media Automotive Group, Inc.
Dated as of February 9, 1999 (incorporated by reference
to Exhibit 10.21 to the Company's Current Report on
Form 8-K dated March 2, 1999).

12.1 -- Computation of ratio of earnings to fixed charges.

18.1 -- Letter on change in accounting principle.

21.1 -- Subsidiaries of the Company.

27 -- Financial Data Schedule.

- ----------
* Previously filed with Registration Statement No. 33-76176 on Form S-4,
and incorporated herein by reference to such Registration Statement.

** Compensatory arrangement.

+ Confidential treatment has been granted with respect to certain information
contained in this exhibit.

iii