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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED YEAR ENDED COMMISSION FILE NUMBER: 333-83448
MARCH 31, 2002
PENTHOUSE INTERNATIONAL, INC.
-----------------------------
(Exact name of registrant as specified in its charter)
FLORIDA 65-1158257
------- ----------
(State of incorporation) (IRS Employer Identification No.)
11 PENN PLAZA, NEW YORK, NY 10001
---------------------------------
(Address of principal executive offices)
(212) 702-6000
--------------
(Registrant's telephone number)
SECURITIES REGISTERED PURSUANT TO SECTIONS 12(b) OR 12(g) OF THE ACT: NONE
Indicate by check mark whether the Registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for 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 [ ]
As of May 21, 2003, there were 50,000,000 shares outstanding of the Registrant's
common stock.
Documents incorporated by reference: None
PENTHOUSE INTERNATIONAL, INC. AND SUBSIDIARIES
TABLE OF CONTENTS
PAGE
PART I-FINANCIAL INFORMATION
Item 1. Financial Statements 3
Item 2. Management's Discussion and Analysis
of Financial Condition and Results of
Operations 17
Item 3. Quantitative and Qualitative Disclosures About Market Risk 32
Item 4. Controls and Procedures 32
PART II- OTHER INFORMATION
Item 1. Legal Proceedings 34
Item 2. Changes in Securities and Use of Proceeds 35
Item 3. Senior Securities 36
Item 4. Submission of Matters to a Vote
of Security Holders N/A
Item 5. Other Information N/A
Item 6. Exhibits and Reports on Form 8-K 36
Signatures 37
2
ITEM 1. FINANCIAL STATEMENTS
- ---------------------------------------
PENTHOUSE INTERNATIONAL, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
AND ACCUMULATED DEFICIT
(UNAUDITED)
(AMOUNTS IN THOUSANDS)
THREE MONTHS ENDED
MARCH 31,
-----------------------------
2002 2003
------------- -------------
NET REVENUE $ 14,208 $ 12,072
------------- -------------
COSTS AND EXPENSES
Publishing - production, distribution and editorial 5,060 4,256
Entertainment and online 237 119
Selling, general and administrative 6,622 4,625
Bad debt expense 34 (38)
Rent expense from affiliated companies 115 115
Amortizaton of pictorial costs 407 311
Depreciation 142 119
------------- -------------
Total costs and expenses 12,617 9,507
------------- -------------
Income from operations 1,591 2,565
------------- -------------
OTHER INCOME (EXPENSE)
Interest expense (1,942) (1,728)
Interest income 38 2
------------- -------------
Total other income (expense), net (1,904) (1,726)
------------- -------------
INCOME (LOSS) BEFORE PROVISION FOR INCOME TAXES (313) 839
Income tax expense 6 6
------------- -------------
Income (loss) before minority interest (319) 833
Minority interest (2) 5
------------- -------------
Net income (loss) (317) 828
============= =============
"Paid in kind" dividends on manditorily redeemable
preferred stock, net of minority interest (351) (398)
Accretion of manditorily redeemable preferred stock
to its loquidation preference, net of minority interest (84) (88)
------------- -------------
Net loss applicable to common stock ($ 752) $ 342
============= =============
Net loss per common share ($ 0.02) ($ 0.01)
============= =============
Weighted average number of shares 46,253,889 50,000,000
============= =============
SEE NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS.
3
PENTHOUSE INTERNATIONAL, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(AMOUNTS IN THOUSANDS)
DECEMBER 31, MARCH 31,
2002 2003
------------ ------------
(unaudited)
ASSETS
------
CURRENT ASSETS
- --------------
Cash and cash equivalents $ 206 $ 64
Accounts receivable, net of allowance
for doubtful accounts 2,862 2,657
Inventories 3,355 3,190
Prepaid expenses and other current assets 1,716 1,473
------------ ------------
TOTAL CURRENT ASSETS 8,139 7,384
WORKS OF ART AND OTHER COLLECTABLES 1,820 1,820
PROPERTY AND EQUIPMENT - AT COST;
net of accumulated depreciation and amortization 1,905 1,786
OTHER ASSETS
- ------------
Due from affiliated companies 1,153 1,721
Rent security deposits 1,071 1,071
Deferred subscription aquisition costs, net 248 214
Other 1,036 1,055
------------ ------------
3,508 4,061
------------ ------------
$ 15,372 $ 15,051
============ ============
LIABILITIES AND STOCKHOLDER DEFICIENCY
--------------------------------------
CURRENT LIABILITIES
- -------------------
Current maturities of notes payable $ 43,147 $ 41,847
Accounts payable 7,894 8,711
Accrued retail display allowance 1,653 1,645
Deferred revenue 7,602 7,151
Accrued Interest - notes payable 1,617 1,676
Accrued expenses and other current liabilities 3,863 3,757
Income tax payable 935 940
------------ ------------
TOTAL CURRENT LIABILITIES 66,711 65,727
DEFERRED REVENUE 1,013 916
OTHER LONG TERM LIABILITIES 867 796
COMMITMENTS AND CONTINGENCIES
MANDATORILY REDEEMABLE CONVERTIBLE PREFERRED STOCK 11,256 11,743
MINORITY INTEREST 116 118
CAPITAL DEFICIT
Common stock, $.0025 par value; authorized, 250,000,000 shares;
issued and outstanding, 50,000,000 shares 125 125
Capital in excess of par value 6,237 5,751
Subscription receivable (22) (22)
Accumulated deficit (70,931) (70,103)
------------ ------------
(64,591)
----------- -----------
$ 15,372 $ 15,051
=========== ===========
SEE NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS.
4
PENTHOUSE INTERNATIONAL, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
(AMOUNTS IN THOUSANDS)
THREE MONTHS ENDED
MARCH 31,
--------------------
2002 2003
-------- --------
CASH FLOWS FROM OPERATING ACTIVITIES
- ------------------------------------
Net income (loss) ($ 317) $ 828
Adjustments to reconcile net loss to net
cash provided by (used in) operating activities
Depreciation and amortization 142 119
Amortization of deferred revenue (132) (97)
Bad debt expense 34 (38)
Change in operating assets and liabilities
Accounts receivable 189 243
Inventories 1,038 165
Other current assets 468 243
Other assets 1,131 14
Accounts payable, accrued expenses and other
current liabilities (2,764) 701
Accrued interest on notes payable (1) 59
Income taxes payable (9) 5
Deferred revenue (792) (451)
Other long term liabilities (64) (71)
Minority Interest (2) 5
-------- --------
Net cash provided by (used in) operations (1,079) 1,725
-------- --------
CASH FLOWS FROM FINANCING ACTIVITIES
- ------------------------------------
Principal payments on notes payable (1,300)
Collections from affiliated companies (567)
Advance to affiliated companies (775)
-------- --------
Net cash used in financing activities (775) (1,867)
-------- --------
Net decrease in cash and cash equivalents (1,854) (142)
Cash and cash equivalents at beginning of year 2,431 206
-------- --------
Cash and cash equivalents at end of period $ 577 $ 64
======== ========
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
- -------------------------------------------------
Cash paid during the year for:
Interest $ 1,942 $ 1,750
Income taxes $ 4 $ 11
SUPPLEMENTAL DISCLOSURE OF NON-CASH FINANCING ACTIVITIES:
- ---------------------------------------------------------
"Paid in kind" dividends on mandatorily redeemable
preferred stock, net of minority interest $ 351 $ 398
Accretion of mandatorily redeemable preferred
stock to liquidation preference, net of minority interest $ 84 $ 88
SEE NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS.
5
PENTHOUSE FINANCIAL, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
1. BASIS OF PRESENTATION AND FINANCIAL STATUS
Penthouse International, Inc. ("PII") is the holder of 99.5% of the common stock
of General Media, Inc. and subsidiaries (the "Company" or "General Media").
General Media International, Inc. ("GMI"), which is controlled by our Chairman
and CEO, Robert Guccione, is the holder of 85% of the common stock of PII. The
accompanying unaudited consolidated financial statements have been prepared in
accordance with accounting principles generally accepted in the United States of
America for interim financial information and with the instructions to Form 10-Q
and Rule 10-01 of Regulation S-X. Accordingly, they do not include all of the
information and footnotes required by accounting principles generally accepted
in the United States of America for complete financial statements. In the
opinion of management, all adjustments, consisting only of normal, recurring
adjustments considered necessary for a fair presentation, have been included.
The results of operations for the three months ended March 31, 2003 are not
necessarily indicative of results that may be expected for any other interim
period or for the full year. The balance sheet information for December 31, 2002
has been derived from the audited financial statements at that date.
The accompanying financial statements have been prepared in conformity with
accounting principles generally accepted in the United States of America, which
contemplate continuation of the Company as a going concern. At March 31, 2003,
the Company's current liabilities exceeded current assets by $58,139,000. This
amount is principally comprised of our Series C Notes in the amount of
$41,847,000 that mature on March 29, 2004. Management is evaluating financing
alternatives which include establishing a new senior credit facility or
negotiations with the holders of a majority in principal amount of the Series C
Notes (the "Holders") to exchange the existing Notes for new Notes. Such
negotiations were successful in 2001 when our Series B Notes matured and were
exchanged for three year Series C Notes. There can be no assurances that a
similar such exchange could be accomplished or, if it is, that it will be
successful for the Company.
As of March 31, 2003, the Company was required to make principal and interest
payments on its Series C Notes totaling $3,446,000. The principal payment of
$1,950,000 has been made and the interest payment in the amount of $1,496,000,
was not made. As a result, the Series C Notes became callable. On May 14, 2003,
the Company and the Holders completed a letter agreement (See Note 4) in which
the Holders agreed to modify the terms of the Notes. The Company's Series C
Notes require interest payments of $7,195,000 (including the unpaid interest)
and principal payments of $39,897,000 during the next twelve months. The
Management does not believe it can generate sufficient funds from operations to
make all of the required payments and is seeking new sources of financing to
modify its debt service payments.
The Company leases 49,000 square feet of office facilities in Manhattan. The
Company has become arrears in its monthly lease payments. As a result, the
property manager has provided written notice to the Company that it is in
default under the terms of the lease. The Company owes approximately $449,000 of
unpaid rent (See Note 7). The Company has a cash deposit with the property
manager in the amount of $956,000 partially securing the obligations under the
lease. The property manager initiated collection proceedings against the
6
PENTHOUSE FINANCIAL, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
1. (CONTINUED)
Company in April 2003. The Company has engaged special counsel to negotiate a
settlement. The Company's management has submitted a proposal to the landlord
for restructuring its obligations under the lease that may provide a settlement
for the default.
There can be no assurance that the Company will be able to secure the financing
necessary to meet its obligations, be able to obtain a reduction in the debt
service payments or reach an agreement with the property manager.
The Company has undertaken or is planning the following actions during 2003,
which are primarily directed at improving its revenue generating capability, and
intended to improve its cash flow:
o The Company is expanding royalty income through the licensing of
its trademarks to additional adult entertainment clubs and
anticipates the opening of the flagship club in New York, New York
in June 2003;
o Through the club licensing agreements, the Company has been able
to attract capital in the form of upfront license payments and has
also attracted indirectly additional risk capital for the
construction of club facilities, including the New York facility,
which will assist in growing its licensing income;
o The Company has entered into a new video distribution agreement
with a digital cable provider to the cruise ship industry that
delivers on demand pay-per-view entertainment which will improve
the revenue generated by the Company's original movie library;
o The Company is evaluating opportunities to establish partnerships
with third party content companies to produce a larger number of
movies to be distributed using the Penthouse trademarks;
o The Company is evaluating opportunities to expand the licensing of
its trademarks to additional industries including other lifestyle
and image conscious activities such as music, fashion, live
entertainment, financial services and retail;
o The Company is also exploring the possibility of establishing
relationships with other companies to find better ways to generate
revenue from its large collection of pictorial inventory,
including reaching a wider audience on the Internet.
o The Company has engaged several new outside consultants and
engaged a new acting President and Chief Operating Officer.
In view of the matters described in the preceding paragraphs, substantial doubt
exists about the Company's ability to continue as a going concern. The financial
statements do not include any adjustments relating to the recoverability and
classification of recorded asset amounts or amounts and classification of
liabilities that might be necessary should the Company be unable to continue in
existence
7
PENTHOUSE FINANCIAL, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
2. INVENTORIES
Inventories include the following:
December 31, March 31,
2002 2003
------------ ------------
In Thousands
Paper and printing $ 1,599 $ 1,446
Editorials and pictorial 1,456 1,482
Film and programming costs 300 262
------------ ------------
$ 3,355 $ 3,190
============ ============
3. MANAGEMENT CHARGE
The Company incurs shared common indirect expenses for the benefit of GMI and
affiliated companies, including accounting, personnel, management information
systems, employee relations and other administrative services. In addition, the
Company is charged by GMI and its subsidiaries for the benefit of other
corporate overhead costs, executive compensation and other costs, which
principally relate to office space. These allocations are based on factors
determined by management of the Company and GMI to be appropriate for the
particular item, including estimated relative time commitments of managerial
personnel, relative number of employees and relative square footage of all space
occupied. Management believes that the allocation method and amounts are
reasonable.
4. NOTES PAYABLE
On December 21, 1993, the Company issued $85,000,000 of Senior Secured Notes
(the "Notes") at an issue price equal to 99.387% of the principal amount of the
Notes. As part of the issuance of the Notes, the Company issued 85,000 common
stock purchase warrants to the purchasers of the Notes and sold to the
underwriter at a discount 102,506 warrants (the "Warrants"). The Warrants,
having an expiration date of December 22, 2000, entitled the holders to purchase
in the aggregate 25,000 shares of the Company's common stock at the exercise
price of $0.01 per share. The Warrants also gave the holders the right to
require the Company to purchase for cash all of the Warrants at their fair
value. At the time of issuance, the Company recorded the Warrants at their fair
value.
The Notes were collateralized by a first priority security interest in all
intellectual property rights (including copyrights and trademarks) and
substantially all other intangible and tangible assets of the Company, other
than accounts receivable, inventory and cash equivalents.
In July 1995, the Company repurchased $5,000,000 face amount of its outstanding
Notes, including 5,000 warrants, for cash of $4,050,000. In May 1999, the
Company repurchased $28,000,000 face amount of its outstanding Notes for cash of
$26,600,000. The remaining Notes matured on December 31, 2000 and bore interest
at 10-5/8% per annum, which was payable semiannually.
On December 22, 2000, 18,009 of the Warrants were exercised to purchase 2,401
shares of the Company's Common Stock and 104,076 Warrants expired without being
timely exercised in accordance with the Warrant
8
PENTHOUSE FINANCIAL, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
4. (CONTINUED)
agreement. The due date of the remaining 60,421 Warrants held by holders of the
Notes was extended as part of the negotiations for refinancing the Notes. The
exercise of the 18,009 Warrants was recorded in December 2000 as a reduction in
redeemable warrants and a contribution to capital of $173,000. The expiration of
the 104,076 Warrants was recorded in the financial statements in December 2000
as an extraordinary gain from extinguishment of debt of $571,000, net of income
tax of $465,000.
On March 29, 2001 (the "Closing Date"), the Company refinanced the Notes. Under
the refinancing agreement, the Company exchanged the $51,507,000 of principal
amount of Notes and any Warrants held by Noteholders (the "Consenting Holders")
for Series C Notes and mandatorily redeemable convertible preferred stock (the
"Preferred Stock") with a liquidation preference of $10,000,000 (See Note 5)
meeting certain specified terms and conditions. The remaining $493,000 principal
amount of Notes that were not exchanged were retired by payments made to the
holders on March 29, 2001.
The Series C Notes mature on March 29, 2004, bear interest at a rate of 15% per
annum effective January 1, 2001 and require principal payments of $6,500,000
during 2003, with the balance due in 2004. In addition, further principal
payments equal to 50% of excess cash flow, as defined, in each year is required,
as well as any proceeds from the sale of certain real property owned by GMI
(after payment of existing debt obligations thereon) and any proceeds to the
Company from certain insurance policies (the "Policies") on the life of the
principal stockholder. The Company made principal payments of $2,943,000 and
$5,910,000 during the years ended December 31, 2001 and 2002, respectively. The
principal payments during the year ended December 31, 2002 included $935,000 of
proceeds from the sale of certain of the Policies and approximately $475,000 of
proceeds from the sale of a work of art.
The Indenture has been extended to the March 29, 2004 maturity of the Series C
Notes. The original Indenture contained covenants, that will continue to the new
maturity date, which, among other things, (i) restrict the ability of the
Company to dispose of assets, incur indebtedness, create liens and make certain
investments, (ii) require the Company to maintain a consolidated tangible net
worth deficiency of no greater than $81,600,000, and (iii) restrict the
Company's ability to pay dividends unless certain financial performance tests
are met. The Company's subsidiaries, which are guarantors of the Senior Secured
Notes under the Indenture, however, were and continue to be permitted to pay
intercompany dividends on their shares of common stock. The ability of the
Company and its subsidiaries to incur additional debt is severely limited by
such covenants. The Indenture was amended in conjunction with the issuance of
the Series C Notes to reflect the above mentioned payments, to reflect the March
29, 2004 maturity of the Series C Notes, to provide additional "Change of
Control" events (requiring the commencement of an offer to purchase Notes), to
provide additional flexibility as to the nature of, but also to set a fixed
dollar limit for, "Owner Payments", and to require Noteholder consent to enter
into new lines of business or for sales or other conveyances of the Penthouse
trademark (other than ordinary course licensing) or other assets for net
proceeds in excess of $500,000. In addition, the related Security Agreement was
amended to grant additional security interests in inventory and accounts
receivable as well as a security interest in proceeds of the sale of certain
real property owned by GMI (after payment of existing debt obligations thereon)
and on any proceeds to the Company from certain Policies on the life of the
Company's principal beneficial owner.
9
PENTHOUSE FINANCIAL, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
On August 1, 2002, the Company and the holders of a majority in principal amount
of the Series C Notes (the "Holders") entered into a Third Supplemental
Indenture to amend the "Change of Control" events in the Indenture to add
further restrictions on the amount of "Owner Payments"; to substitute John
Orlando for John Prebich in the "Change of Control" provision; and to require
that new financial covenants (the "Financial Covenants") be added that require
the Company to achieve not less than 80% of the projected revenues and EBITDA to
be set forth in a business plan in a form and substance reasonably satisfactory
to the Holders. In addition, the Company agreed to allow the Holders to audit
the books and records of the Company and the payroll records of GMI and to pay
all the legal fees, costs and expenses, and audit fees of the Holders
(collectively the "Amendment Expenses") related to the agreement. The Company
recorded $214,000 of Amendment Expenses during the year ended December 31, 2002.
In exchange for these amendments the Holders agreed to waive their prior
contention that a "Change of Control" event had occurred with respect to the
termination of John Prebich, the Company's former President and Chief Operating
Officer.
On September 13, 2002, the Company submitted a business plan to the Holders for
approval in accordance with the requirements of the Third Supplemental
Indenture. The Holders notified the Company that they had accepted the business
plan effective October 4, 2002.
On November 12, 2002, the Company and the Holders entered into a Fourth
Supplemental Indenture to incorporate the Financial Covenants into the
Indenture.
John Orlando, the Company's President and Chief Operating Officer was terminated
on January 14, 2003. The Indenture requires that the Company hire a replacement
President and Chief Operating Officer reasonably satisfactory to a majority of
the Holders within ninety days of the date of either the resignation or
termination of John Orlando, to avoid a deemed "Change of Control" which in turn
requires that an offer to purchase be made by the Company to all Holders. On
March 28, 2003, the Company hired Stephen Gross to replace John Orlando as the
Company's President and Chief Operating Officer. A proposal was submitted to the
Holders on that date requesting confirmation that Mr. Gross is reasonably
satisfactory to them.
On April 24, 2003, the Company and the Holders completed a letter agreement
that consented to the appointment of Stephen R. Gross as president and chief
operating officer of the Company, consented to the filing of the Company's Form
10-K at any time on or before April 30, 2003, consented to an amendment to the
Indenture to change the date of the payment of the $1,950,000 principal payment
that was due on March 29, 2003 to April 17, 2003, and to acknowledge the payment
in full of and the absence of any existing or continuing violation, default or
event of default under the Indenture with respect to the $1,950,000 principal
payment that was due on March 29, 2003. In addition the Company and the Holders
agreed to amend the "Change of Control" events to substitute Stephen Gross for
John Orlando and to eliminate any grace periods with respect to future principal
payments commencing with the principal payment due June 29, 2003.
As further described in Note 1, on March 31, 2003, the Company was required to
make an interest payment in the amount of $1,496,000, which was not made. On May
14, 2003, the Company and the Holders completed a letter agreement in which the
parties agreed that the Holders would forbear from exercising certain rights and
remedies under the Indenture in consideration for the agreement of Mr. Guccione
to contribute certain personal assets held by his holding company, GMI, for the
benefit of the Company, including the agreement to:
10
PENTHOUSE FINANCIAL, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
4. (CONTINUED)
a) execute and deliver to the trustee a mortgage and lien in a form
satisfactory to the Holders encumbering certain real estate owned by GMII
(subject to prior liens of not more than $25.0 million) and to pay costs
associated with the obtaining of the mortgage,
b) cause GMII to provide a non-recourse guaranty of the obligations of the
Company (the "Guaranty") and to secure its obligations under such Guaranty
with a pledge to the trustee of all of GMII's rights, title and interest in
the outstanding shares of common stock of PII ("PII Stock"), to deliver the
PII Stock certificates and stock powers to the trustee and to deliver a
letter agreement pursuant to which PII shall covenant that it will not
sell, pledge, transfer, assign or otherwise dispose of any of its
outstanding shares of common stock of the Company ("Common Stock
Obligation"),
c) pay the interest that is overdue on or before June 30, 2003. the Company
and the Holders also agreed that upon the payment of the interest on or
before June 30, 2003, the Holders will direct the trustee to cancel the
Guaranty and release PII from the Common Stock Obligation,
d) allow the Holders to audit the books, records and assets of the Company,
e) provide the Holders with a detailed plan for the restructuring of the
Company's Series C Notes, together with supporting computations, no later
than June 30, 2003, and
f) place a $100,000 deposit with the Holders by June 9, 2003 which shall be
used to reimburse the Holders for the fees, costs and expenses their audit
and legal counsel.
General Media and the Holders also agreed that upon payment of the interest on
or before June 30, 2003, the Holders will direct the Trustee to cancel the
Guaranty. Despite the historical modifications described above, there can be no
assurance that the Company will be successful in negotiating further amendments
of or extensions to the Indenture.
5. MANDATORILY REDEEMABLE CONVERTIBLE PREFERRED STOCK
On March 29, 2001, the Company issued 9,905 shares of Preferred Stock to the
Consenting Holders at a fair value of $8,200,000. The Preferred Stock carries a
liquidation preference of $10,000,000, provides for "paid-in-kind" dividends at
a 13% per annum rate and is convertible at the option of the holders, after two
years following the Closing Date, into 10% of the Company's common stock on a
fully diluted basis in the third year, 12.5% of the Company's common stock on a
fully diluted basis in the fourth year, and 15% of such common stock on a fully
diluted basis during the fifth year. The Preferred Stock is mandatorily
redeemable by the Company (subject to the aforementioned conversion rights) at
its liquidation preference including the "paid-in-kind" dividends at the end of
the fifth year.
The Preferred Stock may be optionally redeemed by the Company during the second
year following the Closing Date at a redemption price of $10,000,000 and at
increasing premiums of 110%, 115% and 120% during the third, fourth and fifth
years, respectively, provided that the Series C Notes are paid in full at or
before the time of any redemption.
The recorded value net of issuance costs is being accreted up to the redemption
value using the effective interest method through the March 29, 2006 mandatory
redemption date of the Preferred Stock. The Company
11
PENTHOUSE FINANCIAL, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
5. (CONTINUED)
recorded $84,000 and $88,000 of such accretion for the three months ended March
31, 2002 and 2001, respectively. The Company also recorded "paid-in-kind"
dividends of $352,000 and $400,000, respectively. Both the accretion of the
Preferred Stock and the "paid-in-kind" dividends are reflected in the
accompanying financial statements as an increase in Mandatorily Redeemable
Convertible Preferred Stock and a decrease in Capital In Excess Of Par Value.
6. INCOME TAXES
The Company incurred a taxable loss of approximately $940,000 for the three
months ended March 31, 2003. In addition, the Company has a net operating loss
("NOL") carryover available from the prior year of approximately $2,682,000,
which can be used to reduce future taxable income. This NOL will expire in 2022.
The income tax provision for the three months ended March 31, 2003 is comprised
of state minimum taxes.
The Company and its subsidiaries are included in the consolidated Federal and
Combined New York State and New York City income tax returns of GMI. The
provision for income taxes (benefit) in the accompanying statements of
operations is allocated to the Company from GMI as if the Company filed separate
income tax returns. Since each member of a consolidated tax group is jointly and
severally liable for Federal income taxes of the entire group, the Company may
be liable for taxes of GMI or other members of the consolidated group. Under the
terms of a Tax Sharing and Indemnification Agreement (the "Agreement"), the
Company can utilize the net operating losses GMI ("GMI NOL's") to reduce its
income taxes as long as the Company is member of GMI's consolidated group. To
the extent that the Company utilizes such GMI NOL's to reduce its income taxes,
it is required to pay GMI, within thirty days after the Company pays the group
consolidated tax liability, an amount that would have been paid in taxes had the
net operating losses of GMI not been available. At January 1, 2003, GMI had
available for Federal income tax purposes GMI NOL's aggregating approximately
$82,304,000 which can be used by the Company to reduce future income taxes, as
long as the Company is a member of GMI's consolidated group. These GMI NOL's
expire in tax years ending 2007 to 2022. The Company's ability to utilize net
operating losses may be limited in the future due to the additional issuance of
GMI's common stock or other changes in control, as defined in the Internal
Revenue Code and related regulations.
7. COMMITMENTS AND CONTINGENCIES
LITIGATION
On May 8, 2002, an action was filed in United States District Court for the
Central District of California (the "California Court"), alleging, among other
things, that the Company published photographs (the "Photographs") of a woman
topless in the June 2002 issue of Penthouse Magazine (the "Magazine"), falsely
representing them to be pictures of the plaintiff when they were in reality
photographs of someone else. The action also alleges that the Company advertised
its intention to make the Photographs and a video of the woman available on its
internet site on May 10, 2002. On May 7, 2002, the Company issued a press
release stating that it had made an unintentional error when it said the
Photographs were of the plaintiff and it apologized to the plaintiff and the
actual woman in the Photographs for the error. The Company also published the
apology on its internet site.
12
PENTHOUSE FINANCIAL, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
7. (CONTINUED)
The plaintiff seeks a permanent injunction barring the Company from any similar
acts concerning her, barring it from any further distribution of the Photographs
and the June 2002 edition of the Magazine, barring it from any references to the
plaintiff on its internet site, barring it from representing that any pictures
or photographs on the internet site are depictions of the plaintiff, ordering it
to deliver or destroy all materials that have the alleged false representations,
ordering the disgorgement and paying over of all profits it earned and any other
unjust enrichment that it received from the alleged false depiction of the
plaintiff, awarding damages in an unspecified amount not less than $10,000,000,
trebling of these unspecified damages, awarding punitive damages in an
unspecified amount and reimbursement for the plaintiff's costs and attorneys'
fees in prosecuting the action.
In May 2002, the Court dismissed portions of the complaint and is in the process
of hearing arguments for the remaining portions. The Company intends to
vigorously defend itself in this action. It is still too early to determine the
possible outcome of the proceedings. Therefore management cannot give an opinion
as to the effect this action will have on the Company's financial condition or
results of operations. There can be no assurance, however, that the ultimate
liability from these proceedings will not have a material adverse effect on its
financial condition and results of operations. The Company believes it maintains
adequate insurance with a rated insurance carrier to absorb the potential
liability, if any.
On August 26, 2002, two individuals on behalf of themselves and all others
similarly situated (the "Class Action Plaintiffs") filed in the Circuit Court of
Cook County, Illinois, (the "Illinois Court") an action alleging that the
Company committed a breach of contract, a breach of express warranty and
consumer fraud when it published the Photographs, falsely representing them to
be pictures of the aforementioned plaintiff when they were in reality
photographs of someone else. On May 20, 2003, the Illinois Court dismissed the
complaint.
On July 13, 2001, an employee filed a charge of discrimination (the "Charge")
against the Company with the U.S. Equal Employment Opportunity Commission
("EEOC"). On April 11, 2003, the District Director of the EEOC ruled that there
was reasonable cause to find that the employee had been subject to
discrimination on the basis of disability and age, and that she had been
constructively discharged. The Company and the EEOC are conducting meetings with
the employee to determine what actions need to be taken to resolve the Charge.
The Company intends to vigorously defend itself in this action. It is too early
to determine the possible outcome of the proceedings. Therefore management
cannot give an opinion as to the effect this action will have on the Company's
financial condition or results of operations. There can be no assurance,
however, that the ultimate liability from these proceedings will not have a
material adverse effect on its financial condition or results of operations.
On March 28, 2003, a former employee of the Company who was terminated for what
the Company believes to be reasonable cause, filed a claim in the Supreme Court
of the State of New York seeking damages of
13
PENTHOUSE FINANCIAL, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
7. (CONTINUED)
$75,000 plus an accounting of their incentive compensation. The Company believes
it has no liability to this individual and is vigorously defending itself
against this claim.
In December 2002, the Company received correspondences form a third party that
transmission of video content on the Internet is a violation of patents that the
third party claims to own. The third party has demanded that the Company execute
a royalty agreement in favor of the third party with respect to revenue from any
videos that it displayed on its Internet Site. To the Company's knowledge, no
action has been instituted against it by the third party. The Company believes
that it does not owe any royalties to this third party and intends to vigorously
defend itself in any action brought against it by the third party.
The Company has breached the terms of its rent obligations on its principal
office in the amount of approximately $449,000. On April 24, 2003, the property
manager filed a petition in the Civil Court of the City Of New York requesting a
judgement of eviction against the Company. The Company has a cash deposit with
the property manager in the amount of $956,000. The Company's has engaged
special counsel to negotiate a settlement. The Company's management has
submitted a proposal to the landlord for a restructuring of its obligations
under the lease which may provide a settlement.
There are various lawsuits claiming amounts against the Company. While the
outcome of these matters is currently not determinable, it is the opinion of the
Company's management that the ultimate liabilities, if any, from the outcome of
these cases will not have a material effect on the Company's financial
statements.
OTHER CONTINGENCY
The Company is determining what changes, if any, need to be made to its existing
Property and Salary Allocation and Expense Allocation Agreements with GMI and an
affiliate to comply with the Prohibition on Personal Loans Section of the
Sarbanes-Oxley Act. Such determination is currently being undertaken with advice
of Company counsel.
8. SEGMENT INFORMATION
The Company is currently engaged in activities in three industry segments:
publishing, online and entertainment. The publishing segment of the Company is
engaged in the publication of Penthouse magazine and four affiliate magazines
(the "Affiliate Publications" and, together with Penthouse magazine, the "Men's
Magazines"), the licensing of the Company's trademarks to publishers in foreign
countries, for use on various consumer products and services, and, starting in
2002, for use in the operation of adult entertainment clubs. The online segment
is engaged in the sale of memberships to the Company's Internet site (the
"Internet Site"), the sale of advertising banners posted on the Internet Site
and the sale of adult-oriented consumer products through the Company's online
store. The entertainment segment of the Company produces a number of
adult-oriented entertainment products and services, including pay-per-call
telephone lines, digital video discs ("DVD's"), video cassettes and pay-per-view
programming.
14
PENTHOUSE FINANCIAL, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
8. (CONTINUED)
Corporate and
reconciling
Publishing Online Entertainment items Consolidated
----------- ----------- ----------- ----------- -----------
(in thousands)
THREE MONTHS ENDED
MARCH 31, 2003
REVENUES FROM CUSTOMERS
CIRCULATION $ 7,000 $ 7,000
ADVERTISING 1,358 1,358
ONLINE $ 2,519 2,519
ENTERTAINMENT $ 343 343
OTHER 852 -- -- 852
----------- ----------- ----------- ----------- -----------
TOTAL REVENUE FROM CUSTOMERS 9,210 2,519 343 12,072
DEPRECIATION AND AMORTIZATION 104 14 1 119
INCOME (LOSS) FROM OPERATIONS 1,724 974 151 (1,229) 1,620
INTEREST EXPENSE 27 1,672 1,699
INTEREST INCOME 2 2
SEGMENT PROFIT (LOSS) BEFORE INCOME TAXES 1,699 1,974 151 (2,901) 923
SEGMENT ASSETS 8,894 85 383 5,910 15,272
Three Months Ended
March 31, 2002
Revenues from customers
Circulation $ 9,065 $ 9,065
Advertising 1,903 1,903
Online $ 2,084 2,084
Entertainment $ 402 402
Other 754 -- -- 754
----------- ----------- ----------- ----------- -----------
Total revenue from customers 11,722 2,084 402 14,208
Depreciation and amortization 122 19 1 142
Income (loss) from operations 3,116 1,110 91 (2,726) 1,591
Interest expense 82 1,860 1,942
Interest income 38 38
Segment profit (loss) before income taxes 3,034 1,110 91 (4,548) (313)
Segment assets 9,905 174 909 10,718 21,706
15
PENTHOUSE FINANCIAL, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
9. WEBSITE MANAGEMENT AGREEMENT
As of January 13, 2003, three of the Company's subsidiaries, General Media
Communications, Inc., GMCI Internet Operations, Inc. and General Media
Entertainment, Inc. (together the "Internet Operations") entered into a
trademark licensing and website management agreement (the "Website Agreement")
with Penthouse Financial LLC. Penthouse Financial LLC is an independent company
that is not owned or operated by the Company, PII or GMI. As consideration for
the Company entering into the Website Agreement, an affiliate of Penthouse
Financial LLC agreed to pay a non-refundable fee of $1,000,000 in January 2003,
which was received by the Company on January 6, 2003. The Company routinely
licenses its trademarks to third party specialists in exchange for up front
fees, upfront loans and recurring royalty payments typically paid as a
percentage of gross revenue derived from the licensed activity and the Company
has recoreded loans from its Website Agreement was a one-time royalty payment
and is non-refundable and non-recoupable. The Website Agreement gives Penthouse
Financial LLC exclusive responsibility for the design, management and day-to-day
operations of Internet websites that use the Company's registered trademarks and
URL's for a period of five years beginning on March 31, 2003, in exchange for
50% of the gross revenue from the websites (the "Gross Revenue"), in excess of
revenue attributable to existing members, as defined. Penthouse Financial LLC
will provide its know-how and trade secrets in the administration and design of
websites. The rights granted to Penthouse Financial LLC under the contract are
not transferable. The Company is obligated during the period of the contract to
provide Penthouse Financial LLC with access to all content purchased for its
magazines and free advertising at no charge equal to at least two pages each
month in each of its Magazines. The Company will also make all of its subscriber
databases and billings systems available to Penthouse Financial LLC. The Website
Agreement is cancelable subject to cure periods, if Penthouse Financial LLC does
not have redesigned website at www.penthouse.com operational by August 31, 2002,
if the Gross Revenue from the websites, is less than 125% of the Gross Revenue
generated by the site in the twelve months prior to the first year of the
contract, provided however that Penthouse Financial LLC can cure this default by
paying 50% of the shortfall to the Company or if the rate of growth in the Gross
Revenue for years after the first year is less than 10% of each preceding year,
as well as for several other factors, as defined.
10. LETTER OF INTENT
In May 2003, PII entered into a letter of intent with Fernando Molina ("Seller")
outlining the terms of a series of proposed transactions under which a newly
formed, wholly owned subsidiary of PII, Penthouse in Ixtapa, Inc. would acquire
certain real property consisting of 712 acres of ocean-front property in Mexico
(the "Mexico Property") from the Seller in consideration for 120,000 shares of
Series C Redeemable Preferred Stock with a face amount of $1,000 per share,
8,000,000 shares of common stock of PII, a fee of 2,000,000 newly issued shares
of common stock of PII to be issued to designated individuals of Ixtapa
Consultants, Inc. and the agreement of the principal shareholder of GMI, Robert
Guccione, to contribute ownership of the common stock of GMI, exclusive of GMI's
ownership of PII, to PII in exchange for 10,000,000 newly issued shares of the
common stock of PII and 119,000 new issued shares of the common stock of the
Company. The letter of intent also provides that PII will use its best efforts
to secure a third party loan, the net proceeds of which are not less than
$25,000,000, which are to be used to redeem a portion of the Series C Redeemable
Preferred Stock The Series C Redeemable Preferred Stock would be senior to all
outstanding preferred stock of PII, pay dividends at the rate of 4% per annum,
payable if and when declared by the board of directors of PII and carries a
liquidation preference equal to the lesser of (1) $1,000 per share, plus accrued
but unpaid dividends, or, (2) the proceeds from the sale of the Mexico Property
or capital stock of Penthouse in Ixtapa, Inc. The terms and conditions of the
letter of intent are not legally binding.
16
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS.
FORWARD LOOKING STATEMENTS
In addition to historical information, "Management's Discussion and Analysis of
Financial Condition and Results of Operations" contains forward-looking
statements as to expectations, beliefs, plans, objectives and future financial
performance, and assumptions underlying or concerning the foregoing. These
forward-looking statements involve risks and uncertainties and are based on
certain assumptions, which could cause actual results or outcomes to differ
materially from those expressed in the forward looking statements. The following
are important factors that could cause actual results or outcomes to differ
materially from those discussed in the forward-looking statements: (a) the
ability of the Company to generate sufficient cash from future operations to
make all the payments required under the Series C Notes; (b) government actions
or initiatives, including (1) attempts to limit or otherwise regulate the sale
of adult-oriented materials, including print, video and online materials, (2)
regulation of the advertisement of tobacco products, or (3) significant changes
in postal regulations or rates; (c) increases in paper and printing prices; (d)
increased competition for advertisers from other publications and media or any
significant decrease in spending by advertisers generally, or with respect to
the adult male market; (e) effects of the consolidations taking place among
businesses which are part of the magazine distribution system; (f) uncertainty
with regard to the future market for entertainment, e-commerce and advertising
by way of the Internet; (g) the impact on advertising sales of a slow-down or
possible recession in the economy, an increasingly competitive environment and
competition from other content and merchandise providers; and (h) the impact of
terrorist attacks and international conflicts. Readers are cautioned not to
place undue reliance in these forward-looking statements, which reflect
management's opinions only as of the date hereof. We undertake no obligation to
revise or publicly release the results of any revision to these forward-looking
statements.
OVERVIEW
We are a brand-driven global entertainment company founded in 1965 by Robert C.
Guccione. We cater to men's interests through various trademarked publications,
movies, the Internet, location-based live entertainment clubs and consumer
product licenses. Our flagship Penthouse brand is widely identified with premium
entertainment for adult audiences. Our trademarks are licensed to third parties
worldwide in exchange for recurring royalty payments.
Beginning in 1995, we developed our Internet website with the introduction of
Penthousemag.com through which we began digitally distributing our proprietary
content. Today we operate through the domain names www.Penthouse.com and
www.Penthousefetish.com where members pay subscription fees for access to our
content. We believe we have a loyal customer base, which is retained for
unusually long periods based on comparable industry statistics.
General Media also holds significant intellectual property and other intangible
assets. We own various trademarks developed over 37 years, which we believe are
commercially valuable, including Penthouse, Forum, Variations, Penthouse
Letters, the Three Key Logo, the One Key Logo, Pet of the Year, Penthouse Pet,
Mind & Muscle Power, Hot Talk, Penthouse Comix and Penthouse Men's Adventure
Comix. Through the publication of our magazines we have also accumulated a
library of approximately one million photographic images. We seek to protect our
trademarks through registration and periodic infringement enforcement. We
regularly evaluate requests to license our brands, our video library or to
participate in other commercial ventures by contributing our trademarks,
including events with our Penthouse Pets. Our trademarks and copyrights are
critical to the success and potential growth of all of our businesses.
17
Beginning in the third quarter of 2002, we began to license our trademarks to
select luxury gentlemen's clubs, referred to as Location-based Entertainment, in
consideration for a percentage of the gross revenue of the clubs. Based
substantially on the value of our recognized brand, we have been able to
negotiate terms that we believe are favorable to us. We have induced third
parties to invest substantial capital into the facilities while requiring no
capital expenditure from us. Royalty income from this business segment generally
maintains favorable net margins.
We are currently generating revenues in three industry segments: publishing,
online and entertainment. The publishing segment is engaged in publication of
PENTHOUSE magazine and the Affiliate Publications, the licensing of our
trademarks to publishers in foreign countries, for use on various consumer
products and, starting in 2002, for use in the operation of adult clubs. The
online segment is engaged in the sale of memberships to our Internet Site, the
sale of advertising banners posted on the Internet Site and, starting in 2001,
the sale of adult-oriented consumer products through our online store. The
entertainment segment provides a number of adult-oriented entertainment products
and services, including pay-per-call telephone lines, digital video discs,
videocassettes and pay-per-view programming.
During the three months ended March 31, 2003, net revenues declined by 15.0%
which we primarily attribute to the weak economy and the impact of the war in
Iraq and troop deployment that caused an industry wide decrease in newsstand
magazine sales, as well as, the unusually severe weather in many parts of the
country during the current period.
Management was successful in reducing selling, general and administrative
expenses by 31% during the three months ended March 31, 2003, as a result of
cost reduction measures implemented during 2002 and 2003. We anticipate
additional cost cutting measure which are currently scheduled.
Income from operations increased from $1,591,000 to $2,620,000, an increase of
64.7% during the period ended March 31, 2003.
Operating margins increased 111.0% from 11.2% to 23.7%, in the comparable
quarters ending March 31, 2002 and 2003, respectively.
Net income increased from a loss of $0.3 million to net income of $0.9 million,
an increase of $1.2 million, in the comparative quarters.
EBITDA increased by 47.6%, from $2.1 million to $3.1 million, in the comparable
quarters ending March 31, 2002 and 2003, respectively.
EBITDA during the three months ended March 31, 2002 and 2003 was as follows:
EBITDA (1)
Three Months
March 31,
--------------------
2002 2003
---- ----
Net income (loss) $(0.3) $0.9
Adjusted for:
Amortization of pictorial costs 0.4 0.3
Depreciation 0.1 0.1
Interest expense, net 1.9 1.7
Other (rounding) 0.1
----- -----
$ 2.1 $ 3.1
(1) EBITDA represents earnings (loss) from continuing operations before
amortization of pictorial costs, depreciation, interest expense and
interest income. We evaluate our operating results based on several
factors, including EBITDA. We consider EBITDA an important indicator of the
operation strength and performance of our ongoing businesses, including our
ability to provide cash flows to pay interest, service debt and fund
capital expenditures. EBITDA also eliminates the impact of how we fund our
businesses and the effect of changes in interest rates, which are not
necessarily indicative of our operating performance. EBITDA should not be
considered an alternative to any measure of performance or liquidity under
accounting principles generally accepted in the United States of America.
EBITDA should not be inferred as more meaningful than any of those
measures.
18
The following table sets forth our selected quarterly data for the three months
ended March 31, 2002 and 2003:
Three Months
March 31,
---------------
2002 2003
---- ----
Net revenues $14.2 $11.1
Income from operations 1.6 1.6
Net income (loss) (0.3) 0.9
The Company has undertaken or is planning the following actions during 2003,
which are primarily directed at improving its revenue generating capability, to
attempt to improve its cash flow:
o The Company is expanding royalty income through the licensing of
its trademarks to additional adult entertainment clubs and
anticipates the opening of the flagship club in New York, New York
in June;
o Through the club licensing agreements, the Company has been able
to attract capital in the form of upfront license payments and has
also attracted indirectly additional risk capital for the
construction of branded club facilities, including the New York
facility, which will assist in growing its licensing income;
o The Company has entered into a new video distribution agreement
with a digital cable provider to the cruise ship industry that
delivers on demand pay-per-view entertainment which will improve
the revenue generated by the Company's original movie library;
o The Company is evaluating opportunities to establish partnerships
with third party content companies to produce a larger number of
movies to be distributed using the Penthouse trademarks;
o The Company is evaluating opportunities to expand the licensing of
its trademarks to additional industries including lifestyle and
image-conscious activities, such as music, fashion, live
entertainment, financial services and retail;
o The Company is also exploring the possibility of establishing
relationships with other companies to find better ways to generate
revenue from its large collection of pictorial inventory and to
reach a wider audience on the internet;
o The Company has engaged several new outside consultants and
engaged a new acting President and Chief Operating Officer.
19
RESULTS OF OPERATIONS (THREE MONTHS ENDED MARCH 31, 2003 VS. 2002)
NET REVENUES
Total net revenues were $14.2 million for the three months ended March 31, 2002,
compared to revenues of $12.1 million for the three months ended March 31, 2003,
a decrease of $2.1 million. This decrease was a combination of $2.5 million from
our Publishing Segment and $0.1 million from our Entertainment Segment,
partially offset by an increase of $0.5 million for the Online Segment.
Net Revenue
Three Months
March 31,
----------------
2002 2003
---- ----
Publishing Segment $11.7 $9.2
Online Segment 2.1 2.6
Entertainment Segment 0.4 0.3
----- -----
$14.2 $12.1
===== =====
PUBLISHING SEGMENT
The decrease in revenue in the publishing segment was primarily attributable to
a decrease in Newsstand revenues, as a result of a decrease in the number of
copies of Penthouse magazine and the Affiliate Publications sold. Newsstand
revenues decreased $1.7 million, from $7.2 million in 2002 to $5.5 million for
the three months ended March 31, 2003. Newsstand sales have been adversely
affected by the continued weakness in the economy, the impact of the war in Iraq
which caused an industry wide decrease in magazine sales, the unusually severe
weather in many parts of the country during the current period and by the
continued loss of newsstand distribution outlets due to the change in social
climate towards men's magazines, advances in electronic technology, including
the proliferation of retail video outlets and the increased market share of
cable television and the internet, as well as ongoing acquisitions and
consolidations of companies in the magazine distribution industry which have for
several years resulted in a reduction in the number of outlets carrying our
magazines. To attempt to offset this decline, we have implemented special
marketing strategies aimed at developing new outlets for our magazines and
rewarding growth in sales by distributors.
Over the last several years, the number of newsstand copies of PENTHOUSE
magazine and the Affiliate Publications sold per issue has trended downward.
From March 31, 1999 to March 31, 2003, PENTHOUSE magazine and the Affiliate
Publications domestic average monthly newsstand circulation decreased by 49%. We
believe that the loss of several newsstand distribution outlets due to the
change in the social climate towards men's magazines, together with advances in
electronic technology, as outlined above, as well as ongoing acquisitions and
consolidations of companies in the magazine distribution industry have largely
contributed to the overall decrease in circulation. Newsstand sales during 2003
have also been negatively impacted by the economic recession that began in 2001
and the failure of the economy to make a significant recovery during 2002 and
2003. In addition, as stated above, sales in the first quarter of 2003
experienced a further decline due to the impact of the war in Iraq which caused
an industry wide decrease in magazine sales and the unusually severe weather in
many parts of the country during the period. We have raised the cover prices of
the magazines and reduced production costs to partially offset the decline in
newsstand circulation. We are attempting to increase newsstand sales though the
use of special marketing strategies we have implemented aimed at developing new
outlets for its magazines and rewarding growth in sales by distributors and the
addition of extra issues of certain of our magazines. We employ a direct
newsstand sales force to call on wholesalers and retailers to promote our
magazines and to provide information back to our corporate office on the success
of our marketing efforts. However due to the negative factors listed above and
the current weakness of the economy that has resulted in an increase in the
number of bankruptcies or near bankruptcies of companies within the magazine
distribution system, the newsstand sales have fallen below that of the prior
year. We believe that newsstand sales may recover somewhat during 2003 if the
economy improves and our special marketing strategies are successful.
20
Advertising revenue represented $0.5 million of the publishing segment revenue
decrease, dropping from $1.9 million for the three months ended March 31, 2002
to $1.4 million for the three months ended March 31, 2003. This decrease is
attributable to a decrease in the number of advertising pages sold and a
decrease in the average rate per page of advertising pages sold in PENTHOUSE
magazine and the Affiliate Publications.
The advertising revenues of PENTHOUSE magazine and the Affiliate Publications
have also declined over the past several years. The primary reason for the
decrease in advertising revenue has been the decrease in the average monthly
circulation of our magazines, which has the effect of decreasing advertising
rates and making our magazines less attractive to advertisers. In addition, many
advertisers scaled back advertising in PENTHOUSE magazine during 2002 and the
early part of 2003 as a result of the continuing weakness in the economy, and
many cigarette companies have either suspended or scaled back advertising in
magazines as a result of increased pressure from regulatory agencies and
concerns over litigation against tobacco companies. There has also been a steady
decrease in pay-per-call advertising over the past several years as competition
in the pay-per-call industry has caused rates per minute to decrease and as
pay-per-call services have attracted less of an audience in recent years.
Partially offsetting these negative factors has been an increase in demand for
advertising for sexual enhancement products. We are also pursuing advertisers in
many other industries in an attempt to improve our advertising revenue. We
believe, however, that due to the above mentioned negative factors, 2003
advertising revenues will fall below 2002 revenue.
Subscription revenue accounted for $0.4 million of the decrease in our
publishing segment, decreasing from $1.9 million for the three months ended
March 31, 2002 to $1.4 million for the three months ended March 31, 2003. The
decrease is attributable to a decrease in the number of subscription copies sold
per issue as a result of a decrease in the number of subscription acquisition
direct mailings done in the current year, and by a slight decrease in the rate
per copy sold of PENTHOUSE magazine. This was partially offset by a slight
increase in the rate per copy sold of the Affiliate Publications.
We have experienced a steady decline in the number of sales of subscription
copies of PENTHOUSE magazine and the Affiliate Publications over the past
several years. We believe the reasons for the decrease are similar to the
reasons for the declining newsstand sales. Subscription revenue also decreased
as a result of a decrease in the number of subscription acquisition direct
mailings done over the past two years. In the first quarter of 2003 we decreased
the subscription prices of the magazines in an effort to attract more
subscribers and we have elected to delay subscription direct mailings that had
been planned for the first half of 2003. The level of expected revenue from
subscriptions is heavily dependent on the number of subscription acquisition
direct mailings done during the year. We therefore expect subscription revenues
to fall below that of 2002. Also, the 11.6% increase in postal rates that went
into effect in July 2002 is expected to reduce the profitability of subscription
sales by approximately $350,000 on an annualized basis.
Revenues from licensing of foreign editions were $0.5 million for both the three
months ended March 31, 2002 and 2003, respectively.
We expect revenue from foreign licensing to increase moderately in 2003 as a
result of two new agreements with licensees that have been completed in 2003 and
several others that are in the process of being negotiated. However, this result
is partially dependent on the strength of the economy in the foreign countries
that we have existing and potential new licensees during 2003, which is
uncertain at this time.
21
ONLINE SEGMENT
Decreasing revenue in the online segment is primarily attributable to a decrease
in revenue from the sale of memberships to the Internet Site of $0.5 million.
The decrease in revenue resulted from a decrease in the average price of the
memberships sold and a decrease in the number of members as compared to the
prior year. Sales of memberships have been adversely affected by the weakness in
the economy, declining circulation of the Company's magazines that provide a
major source of advertising for the site and the war in Iraq, that is believed
to have temporarily taken attention away from the site. In October 2002, we
increased the price of memberships to the Internet Site and eliminated some
lower priced options in order to increase the average price paid for memberships
going forward. We also redesigned the site to add more features and content to
make it more appealing to members. These changes have helped to encourage
members to retain their memberships for longer periods of time and increase the
average price of memberships. However, the increased pricing has also lead to a
decrease in the number of members. We expect the average price of memberships to
continue to increase as new members are added at the higher prices. We also plan
to enter into cross-marketing programs with other web sites to increase the
amount of traffic coming to the Internet Site.
Revenues from the online segment, which began declining during 2001, primarily
as a result of the use of more aggressive credit card validation methods
required to comply with Visa's requirements, continued to decline in 2002 as a
result of decreases in the pricing of its memberships. As explained above,
revenue has decreased in the first quarter of 2003 as compared to the prior
year. We believe, however, that revenues from memberships will start to increase
slightly towards the middle of 2003 as a result of the changes we have made to
the pricing structure, the cross-marketing programs we plan to enter into to
bring traffic to the Internet Site and the redesign of the Internet Site that
was made to retain members for longer periods of time. However, the results will
depend partially on the strength of the economy during 2003, which is uncertain
at this time. We do not believe we will need to improve our validation methods
any further to meet Visa's requirements. However, Visa has the right to modify
the maximum allowable chargeback level at any time. Should Visa decide to reduce
the maximum chargeback level, we may need to intensify our validation methods
further to meet the new requirements, which would result in a decrease in the
number of customers who would be accepted as members of the Internet Site.
MasterCard recently established its own regulations for maximum chargeback and
refund levels that went into effect in April 2002. Our chargeback and refund
levels have remained well within those required by the new MasterCard
regulations and these new regulations have had no material effect on the sales
of memberships to the Internet Site. There is also the possibility that one or
more of the credit card companies may decide to stop processing adult on-line
internet transactions altogether, which most likely would result in a decrease
in online revenues. We believe revenues from the advertising banners in the
internet site for 2003 will fall below that of 2002. However we have added
several links to other sites in place of traditional ads, that are generating
revenue roughly equivalent to the amounts generated by traditional
advertisements sold in the prior year. The revenue from these links is expected
to offset any decline experienced from the decrease in advertising banners.
Revenue from the online store in 2003 are expected to remain fairly consistent
with that of 2002
ENTERTAINMENT SEGMENT
The decrease in revenue in the entertainment segment was primarily due to our
video business. Revenues of the video business were $0.3 million for the three
months ended March 31, 2002 compared to $0.2 million for the three months ended
March 31, 2003, a decrease of $0.1 million. Revenues for the three months ended
March 31, 2003 were lower due to fewer new movies being produced and released
for sale during the last 12 months. The amount of video business revenues earned
in each period varies with the timing of new contracts for the production and
distribution of movies.
Revenues from the Company's pay-per-call business were $0.1 million for both the
three months ended March 31, 2002 and 2003, respectively.
22
Revenues from the Entertainment Segment have been declining over the past few
years as a result of decreases in our video business revenues and demand for
pay-per-call services. Our video business revenues for the three months ended
March 31, 2003 have decreased over the prior year for the reasons stated above.
We are in the process of establishing new business relationships to increase our
video business revenue for 2003 and thereafter. However results for 2003 will
depend on how quickly we are able to reach agreements with prospective partners
in producing and distributing the movies and the timing of the movie releases.
We are also working with our pay-per-call service provider to increase the
revenue of the pay-per-call business through improved marketing and coordination
efforts by the two companies.
PUBLISHING - PRODUCTION, DISTRIBUTION AND EDITORIAL
Publishing-production, distribution and editorial expenses were $5.1 million and
$4.3 million for the three months ended March 31, 2002 and 2003, respectively, a
decrease of $0.8 million.
Paper costs were $1.9 million and $1.5 million for the three months ended March
31, 2002 and 2003, respectively, representing $0.4 million of the decrease.
Printing costs were $2.0 million for the three months ended March 31, 2002,
compared to $1.8 million for the three months ended March 31, 2003, representing
$0.2 million of the decrease. These decreases are primarily the result of
negotiating reductions in the price of paper and printing costs, by changing the
grades of paper used to produce the magazines and by changing their design to
improve production efficiencies.
Distribution costs were $0.9 million and $0.8 million for the three months ended
March 31, 2002 and 2003, respectively, a decrease of $0.1 million.
Editorial costs were $0.3 million and $0.2 million for the three months ended
March 31, 2002 and 2003, respectively, a decrease of $0.1 million.
We have been steadily reducing our publishing-production, distribution and
editorial expenses over the past several years by reducing the number of copies
printed, reducing the number of pages per issue, negotiating reductions in paper
and printing costs, changing the grades of paper used to produce the magazines
and changing their design to improve production efficiencies. We expect these
expenses to fall below that of 2002 as a result of the cost saving measures
taken during 2002 and further reductions in the number of copies printed,
partially offset by increases in printing costs as a result of increases for
inflation contained in contracts with our printers. Paper prices are expected to
remain stable for the near future. However, paper prices tend to be volatile and
a large increase in prices could have a material adverse affect on our cash
flows and profitability.
ONLINE - DIRECT COSTS
Direct costs for the online segment were $58,000 and $21,000 for the three
months ended March 31, 2002 and 2003, respectively, a decrease of $37,000. The
decrease is primarily attributable to a decrease in fees paid to content
providers of $40,000, partially offset by an increase in expenditures for
content purchased for the Internet Site of $3,000 for the three months ended
March 31, 2003. Direct costs are expected to increase at about the same rate as
inflation in future years.
ENTERTAINMENT - DIRECT COSTS
Entertainment direct costs were $0.2 million and $0.1 million for the three
months ended March 31, 2002 and 2003, respectively. Direct costs for the
remainder of 2003 are expected to increase due to increased levels of production
of films and the rate of inflation.
23
SELLING, GENERAL AND ADMINISTRATIVE
Selling, general and administrative expense was $6.6 million for the three
months ended March 31, 2002, compared to $4.6 million for the three months ended
March 31, 2003, a decrease of $2.0 million. The decrease is primarily due to a
decrease in salaries and benefits of $1.1 million, subscription acquisition
expenses of $0.5 million, bank charges of $0.1 million, legal expense of $0.1
million, data processing expenses of $0.1 million and insurance expense of $0.1
million for the three months ended March 31, 2003.
Selling, general and administrative expenses for the Publishing Segment were
$3.1 million for the three ended March 31, 2002, compared to $2.2 million for
the three months ended March 31, 2003, a decrease of $0.9 million. The decrease
is primarily due to a decrease in subscription expense of $0.5 million and
salaries and benefits of $0.4 million, during the three months ended March 31,
2003.
Selling general and administrative expenses for the online segment were $0.9
million for the three months ended March 31, 2002, compared to $0.5 million for
the three months ended March 31, 2003, a decrease of $0.4 million. The decrease
is primarily attributable to a decrease in salaries and benefits of $0.2
million, bank charges of $0.1 million and data processing expense of $0.1
million during the three months ended March 31, 2003.
Selling, general and administrative expenses for the entertainment segment were
$0.1 million for both the three months ended March 31, 2002 and March 31, 2003,
respectively.
Included in selling, general and administrative expenses are corporate
administrative expenses which includes executive, legal, human resources,
finance and accounting, management information systems, costs related to
the operation of the corporate and executive offices and various other expenses.
Corporate administrative expenses were $2.5 million for the three months ended
March 31, 2002, compared to $1.8 million for the three months ended March 31,
2003, a decrease of $0.7 million. This decrease is primarily attributable to
decreased salaries and benefits of $0.5 million, legal expense of $0.1 million
and insurance expense of $0.1 million for the three months ended March 31, 2003.
In future years we expect selling, general and administrative expenses to
increase at about the same rate as inflation.
BAD DEBTS EXPENSE
Bad debt expense was $34,000 for the three months ended March 31, 2002, compared
to recoveries of bad debts of $38,000 for the three months ended March 31, 2003,
a decrease of $0.1 million. The decrease is primarily due to collections of
subscription receivables of $54,000 that had previously been reserved for, as
their collectability was uncertain, and lower reserves for advertising accounts
receivable due to lower advertising revenues.
RENT EXPENSE FROM AFFILIATED COMPANIES
Rent expense from affiliated companies represents charges from an affiliated
company for our use of the affiliate's facilities. The charge is based upon our
proportionate share of the operating expenses of such facilities. Rent expense
from affiliated companies was $0.1 million for both the three months ended March
31, 2002 and 2003.
24
AMORTIZATION OF PICTORIAL COSTS
Amortization of pictorial costs was $0.4 million for the three months ended
March 31, 2002, compared to $0.3 million for the three months ended March 31,
2003, a decrease of $0.1 million. The decrease is due to a reduction in number
of pictures purchased compared to the prior period.
DEPRECIATION AND AMORTIZATION
Depreciation and amortization expense was $0.1 million for both the three months
ended March 31, 2002, and March 31, 2003, respectively.
INCOME FROM OPERATIONS
As a result of the above discussed factors, income from operations was $1.6
million for the three months March 31, 2002, compared to $2.6 million for the
three months ended March 31, 2003, respectively.
INTEREST EXPENSE
Interest expense was $1.9 million for the three months ended March 31, 2002,
compared to $1.7 million for the three months ended March 31, 2003, a decrease
of $0.2 million. This decrease is due to a decrease in the total outstanding
principal amount of our Series C Notes.
INTEREST INCOME
Interest income was $37,000 for the three months ended March 31, 2002, compared
to $2,000 for the three months ended March 31, 2003, a decrease of $35,000. The
decrease is due to a decrease in the amount of cash available for investment
during the current year.
INCOME BEFORE THE PROVISION FOR INCOME TAXES
As a result of the above discussed factors, loss before income tax expense for
the three months ended March 31, 2002 was $0.3 million, compared to a net income
before income tax expense of $0.9 million for the three months ended March 31,
2003.
LIQUIDITY AND CAPITAL RESOURCES
At March 31, 2002, we had $0.6 million in cash and cash equivalents, as compared
to $0.1 million at March 31, 2003, a decrease of $0.5 million. During the three
months ended March 31, 2003 there was a net decrease in cash and cash
equivalents of $0.1 million. The decrease was due to the use of $1.3 million in
mandatory principal payments for our Series C Notes. This was offset in part by
a net increase of $0.8 million in cash provided by operations and a decrease in
advances from affiliated companies of $0.4 million. At March 31, 2003, our
current liabilities exceeded current assets by $58.1 million.
On March 31, 2003, the Company was required to make principal and interest
payments on its Series C Notes totaling $3,446,000. The principal payment of
$1,950,000 has been made and the interest payment in the amount of $1,496,000,
was not made. As a result, the Series C Notes became callable. On May 14, 2003,
the Company and the Holders completed a letter agreement (See Note 4) in which
the Holders agreed to modify the terms of the Notes. The modification provided
forbearance from exercising certain rights and remedies under the Indenture in
return for the Company's agreement to, among other things, pay the interest by
June 30, 2003 and to cause GMII agreement to provide a non-recourse guaranty of
the obligations of the Company (the "Guaranty") to the trustee under the
Indenture (the "Trustee") and to secure its obligations under such Guaranty with
a pledge to the Trustee of all of GMII's rights, title and interest in the
outstanding common stock of PII and GMII's agreement to record a junior mortgage
on the personal residence of Mr. Guccione. General Media and the Holders also
agreed that upon payment of the interest on or before June 30, 2003, the Holders
will direct the Trustee to cancel the Guaranty. The Company's Series C Notes
require interest payments of $7,195,000 (including the unpaid interest) and
principal payments of $39,897,000 during the next twelve months. The Management
does not believe it can generate sufficient funds from operations to make all of
the required payments and is seeking new sources of financing to modify its debt
service payments.
25
The Company leases 49,000 square feet of office facilities in Manhattan. The
Company has become arrears in its monthly lease payments. As a result, the
property manager has provided written notice to the Company that it is in
default under the terms of the lease. As a result, the property manager has
provided written notice to the Company that it is in default under the terms of
the lease. The Company owes approximately $449,000 of unpaid rent (See Note 7).
The Company has a cash deposit with the property manager in the amount of
$956,000 partially securing the obligations under the lease. The property
manager has initiated collections proceedings against the Company in April 2003.
The Company has engaged special counsel to negotiate a settlement. The Company's
management has submitted a proposal to the landlord for restructuring its
obligations under the lease that may provide a settlement for the default.
There can be no assurance that the Company will be able to secure the financing
necessary to meet its obligations, be able to obtain a reduction in the debt
service payments or reach an agreement with the property manager.
The Company has undertaken or is planning the following actions during 2003,
which are primarily directed at improving its revenue generating capability, to
attempt to improve its cash flow:
o The Company is expanding royalty income through the licensing of
its trademarks to additional adult entertainment clubs and
anticipates the opening of the flagship club in New York, New York
in June 2003;
o Through the club licensing agreements, the Company has been able
to attract capital in the form of upfront license payments and has
also attracted indirectly additional risk capital for the
construction of club facilities, including an estimated $12.0
million invested in the New York facility, which will assist in
growing its licensing income;
o The Company has entered into a new video distribution agreement
with a digital cable provider to the cruise ship industry that
delivers on demand pay-per-view entertainment which will improve
the revenue generated by The Company's original movie library;
o The Company is evaluation opportunities to establish partnerships
with third party content companies to produce a larger number of
movies to be distributed using the Penthouse trademarks;
o The Company is evaluating opportunities to expand the licensing of
its trademarks to additional industries including other lifestyle
and image conscious activities such as music, fashion, live
entertainment, financial services and retail;
o The Company is also exploring the possibility of establishing
relationships with other companies to find better ways to generate
revenue from its large collection of pictorial inventory,
including reaching a wider audience on the internet.
o The Company has engaged several new outside consultants and
engaged a new acting President and Chief Operating Officer.
26
Since the above actions will not generate sufficient improvements to cash flow
to meet current debt service requirements, we are contemplating additional
actions, including seeking other sources of financing, to provide cash. However,
there can be no assurances that we will be able to achieve such a result.
CASH FLOWS FROM OPERATING ACTIVITIES
Net cash used in operating activities was $1.1 million for the three months
ended March 31, 2002, compared to net cash provided by operating activities of
$1.8 million for the three months ended March 31, 2003. The primary reason for
the increase in cash flow from operating activities for the three months ended
March 31, 2003 was the net loss for the three months, adjusted for a significant
increase in accounts payable due to the timing of payments to vendors and a
reserve for bad debt for amounts due from GMI and other GMI subsidiaries. This
was partially offset by decreases in deferred revenues. The net cash provided by
operating activities for the three months ended March 31, 2002, was derived by
adjusting the net loss for the period by a significant decrease in accounts
payable due to the timing of payments to vendors and decreases in deferred
revenues. This was partially offset by a decrease in inventories, prepaid
insurance and spending on subscription acquisition drives during the three
months ended March 31, 2002.
CASH FLOWS FROM FINANCING ACTIVITIES
Cash flows used in financing activities were $0.8 million for the three months
ended March 31, 2002, compared to cash flows used in financing activities of
$2.0 million for the three months ended March 31, 2003. Cash used in financing
activities for the three months ended March 31, 2003 was the result of payments
of $1.3 million in mandatory principal payments for its Series C Notes and
advances to affiliated companies of $0.6 million. Cash used in financing
activities for the three months ended March 31, 2002 was the result of advances
of $0.8 million to GMI.
Affiliated company advances at March 31, 2003 increased $0.7 million from
December 31, 2002. These balances regularly result from the effect of certain
cost sharing and expense allocation agreements with GMI and its subsidiaries,
whereby certain costs, such as shared corporate salaries and overhead, are paid
by us and a portion is charged to GMI and its subsidiaries as incurred. These
charges generally result in amounts due to General Media, and are to be repaid
sixty days after the end of each quarter in accordance with the terms of an
expense sharing agreement. The expense sharing agreement will need to be
modified as a result of changes in provisions of the Indenture specified in the
Third Supplemental Indentures which established limits for the amounts of
payments on behalf of Robert C Guccione and his Affiliates, but did not specify
dates for repayment. These changes have the effect of permitting an increase in
amounts that may be due from affiliates. General Media intends to amend the
expense sharing agreement in the near future to match those specified in the new
provisions of the Indenture. The ability of General Media to realize repayment
of its advance is dependent upon the success of GMI in refinancing its existing
debt obligations, most of which are currently in default.
DEBT
The Company's debt includes Series C Senior Secured Notes, which are
collateralized by substantially all of our assets. The Series C Notes, which
bear interest at a rate of 15% per annum, have a maturity date of March 29,
2004. As of March 31, 2003, General Media's unpaid principal balance on the
Series C Notes was approximately $41.8 million.
The Series C Notes require amortization payments of $6.5 million during the
calendar year 2003, with the balance of $35.3 million due in 2004. In addition,
further amortization equal to 50% of excess cash flow in each year is required,
as well as any proceeds from the sale of certain real property owned by GMI
(after payment of existing debt obligations thereon) and any proceeds to us from
certain insurance policies on the life of the principal shareholder.
27
The Indenture has been extended to the March 29, 2004 maturity of the Series C
Notes. The original Indenture contained covenants, that continue to the new
maturity date, which, among other things, (i) restrict our ability to dispose of
assets, incur indebtedness, create liens and make certain investments, (ii)
require us to maintain a consolidated tangible net worth deficiency of no
greater than $81.6 million, and (iii) restrict our ability to pay dividends
unless certain financial performance tests are met. Our subsidiaries, which are
guarantors of the Series C Notes under the Indenture, however, were and continue
to be permitted to pay intercompany dividends on their shares of common stock.
The ability of General Media and its subsidiaries to incur additional debt is
severely limited by such covenants.
The Indenture was amended in conjunction with the issuance of the Series C Notes
to reflect the above mentioned payments, to reflect the March 29, 2004 maturity
of the Series C Notes, to provide additional "Change of Control" events
(requiring the commencement of an offer to purchase Notes), to provide
additional flexibility as to the nature of, but also to set a fixed dollar limit
for, "Owner Payments", and to require Noteholder consent to entering into new
lines of business or for sales or other conveyances of the PENTHOUSE trademark
(other than ordinary course licensing) or other assets for net proceeds in
excess of $0.5 million. In addition, the related Security Agreement was amended
to grant additional security interests in inventory and accounts receivable as
well as a security interest in the proceeds of the sale of certain real property
owned by GMI (after payment of existing debt obligations thereon) and on any
proceeds to us from certain insurance policies on the life of our principal
beneficial owner.
On August 1, 2002, General Media and the Holders entered into a Third
Supplemental Indenture to amend the "Change of Control" events in the Indenture
to add further restrictions on the amount of "Owner Payments"; to substitute
John Orlando for John Prebich in the "Change of Control" provision; and to
require that new financial covenants (the "Financial Covenants") be added that
require us to achieve not less than 80% of the projected revenues and EBITDA to
be set forth in a business plan in a form and substance reasonably satisfactory
to the Holders. In addition we agreed to allow the Holders to audit the books
and records of General Media and the payroll records of General Media and GMI
and to pay all the legal fees, cost and expenses, and audit fees (collectively
the "Amendment Expenses") related to the agreement. We recorded $0.1 million of
Amendment Expenses during the year ended December 31, 2002. In July 2002, we
also paid $0.1 million to the Holders as a deposit against Amendment Expenses
expected to be incurred by the Holders in completing the further amendments to
the Indenture required to incorporate the accepted business plan into the
financial covenants. In exchange for these amendments the Holders agreed to
waive their prior contention that a "Change of Control" event had occurred with
respect to the termination of John Prebich, one of our former President and
Chief Operating Officer's.
The Indenture requires that General Media hire a replacement President and Chief
Operating Officer reasonably satisfactory to a majority of the Holders within
ninety days of the date of either the resignation or termination of John
Orlando, our last President and Chief Operating Officer, to avoid a deemed
"Change of Control" which in turn requires that an offer to purchase be made by
the Company to all Holders. On January 14, 2003, John Orlando was terminated. On
March 28, 2003, the Company hired Steve Gross to replace John Orlando as the
Company's President and Chief Operating Officer. A proposal was submitted to the
Holders on that date requesting confirmation that Mr. Gross is reasonably
satisfactory to them.
On September 13, 2002, we submitted a business plan to the Holders for approval
in accordance with the requirements of the Third Supplemental Indenture. The
Holders notified us that they had accepted the business plan effective October
4, 2002. On November 12, 2002, General Media and the Holders entered into the
Fourth Supplemental Indenture to incorporate the Financial Covenants into the
Indenture. As of March 31, 2003, we were in compliance with all the Financial
Covenants.
28
General Media was required to make a principal payment of $2.0 million on March
29, 2003 and an interest payment of $1.5 million on March 31, 2003. On April 14,
2003, the Trustee issued a notice of event of default with respect to the
principal payment. On April 15 and 16, 2003 General Media transferred additional
funds (including $0.2 million made available through the repayment of an
intercompany balance from GMI) and has fully paid the $2.0 million principal
amount. General Media had until April 30, 2003 (30-day grace period) to make the
interest payment, but was unable to do so. Accordingly, the underlying debt
became callable by the Holders.
On April 24, 2003, the General Media and the Holders completed a letter
agreement that consented to the appointment of Stephen R. Gross as president and
chief operating officer of the Company, consented to the filing of the General
Media's Form 10-K at any time on or before April 30, 2003, consented to an
amendment to the Indenture to change the date of the payment of the $2.0 million
principal payment that was due on March 29, 2003 to April 17, 2003, and to
acknowledge the payment in full of and the absence of any existing or continuing
violation, default or event of default under the Indenture with respect to the
$2.0 million principal payment that was due on March 29, 2003. In addition
General Media and the Holders agreed to amend the "Change of Control" events to
substitute Stephen Gross for John Orlando and to eliminate any grace periods
with respect to future principal payments commencing with the principal payment
due June 29, 2003.
On May 14, 2003, General Media and the Holders completed a letter agreement in
which the parties agreed that the Holders would forbear from exercising their
rights and remedies under the Indenture in consideration for the agreement of
Mr. Guccione to contribute certain personal assets held by his personal holding
company, GMI, for the benefit of the Company, including the agreement to:
a) execute and deliver to the trustee a mortgage and lien in a form
satisfactory to the Holders encumbering certain real estate owned by GMII
(subject to prior liens of not more than $25.0 million) and to pay costs
associated with the obtaining of the mortgage,
b) cause GMII to provide a non-recourse guaranty of the obligations of General
Media (the "Guaranty") and to secure its obligations under such Guaranty
with a pledge to the trustee of all of GMII's rights, title and interest in
the outstanding shares of common stock of PII ("PII Stock"), to deliver the
PII Stock certificates and stock powers to the trustee and to deliver a
letter agreement pursuant to which PII shall covenant that it will not
sell, pledge, transfer, assign or otherwise dispose of any of its
outstanding shares of common stock of General Media ("Common Stock
Obligation"),
c) pay the interest that is overdue on or before June 30, 2003. General Media
and the Holders also agreed that upon the payment of the interest on or
before June 30, 2003, the Holders will direct the trustee to cancel the
Guaranty and release PII from the Common Stock Obligation,
d) allow the Holders to audit the books, records and assets of General Media,
e) provide the Holders with a detailed plan for the restructuring of General
Media's Series C Notes, together with supporting computations, no later
than June 30, 2003, and
f) place a $0.1 million deposit with the Holders by June 9, 2003 which shall
be used to reimburse the Holders for the fees, costs and expenses their
audit and legal counsel.
There can be no assurance that General Media will be successful in negotiating
further amendments of or extensions to the Indenture.
29
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Securities and Exchange Commission Financial Reporting Release No. 60 requires
all companies to include a discussion of critical accounting policies or methods
used in the preparation of the consolidated financial statements. In addition,
Financial Reporting Release No. 61 requires all companies to include a
discussion to address, among other things, liquidity, off-balance sheet
arrangements, contractual obligations and commercial commitments. The following
discussion is intended to supplement the summary of significant accounting
policies included in Note 1 of the Notes To Consolidated Financial Statements.
These policies were selected because they represent the more significant
accounting policies and methods that are broadly applied in the preparation of
the consolidated financial statements. Revenues, expenses, accrued liabilities
and allowances related to certain of these policies are initially based on our
best estimates at the time of original entry in our accounting records.
Adjustments are recorded when our actual experience differs from the expected
experience underlying the estimates. These adjustments could be material if our
experience were to change significantly in a short period of time. We make
frequent comparisons of actual experience and expected experience in order to
mitigate the likelihood of material adjustments.
a. REVENUE RECOGNITION - Sales of magazines for retail distribution
are recorded on the on-sale date of each issue based on an
estimate of the revenue for each issue of the magazine, net of
estimated returns. These estimates are based upon several factors,
including but not limited to historical trends, days on sale and
special editorial or pictorial content. Estimated revenues are
adjusted to actual revenues as actual sales information becomes
available. Actual sales information generally becomes available
ninety days after the on-sale date for U.S. and Canadian sales and
final settlement occurs one hundred and eighty days after the
off-sale date for U.S., Canadian and international sales.
Advances in the amounts of $1.0 million and $3.0 million relating
to two distribution agreements for our magazines are being
recognized as revenue on a straight-line basis over the ten year
terms of each of the related contracts. An advance in the amount
of $0.9 million relating to a licensing agreement for domestic
sales of our digital video disc versions of our video products is
being recognized as revenue on a straight line basis over the
seven year term of the agreement.
b. RETAIL DISPLAY ALLOWANCES - Retail display allowances are payments
made to convenience stores, bookstores and newsstands as an
incentive to handle and sell magazines. The formula used to
calculate the allowance is negotiated on an individual basis with
each outlet owner and varies accordingly. However each formula is
based on a combination of a percentage of sales dollars and an
amount per copy sold. Accruals for retail display allowances are
recorded as a reduction of newsstand revenues on the on-sale date
based upon past experience using the estimated sales of each
issue, net of estimated returns. As new information becomes
available the accruals are adjusted accordingly.
c. TAXES - In preparing our financial statements we make estimates of
our current tax exposure and temporary differences resulting from
timing differences for reporting items for book and tax purposes.
We recognize deferred taxes by the asset and liability method of
accounting for income taxes. Under the asset and liability method,
deferred taxes are recognized for differences between the
financial statement and tax bases of assets and liabilities at
enacted statutory tax rates in effect for the years in which the
differences are expected to reverse. The effect on deferred taxes
of a change in tax rates is recognized in income in the period
that includes the enactment date. In addition, valuation
allowances are established when necessary to reduce deferred tax
assets to the amounts expected to be realized. In consideration of
our taxable loss in the current year and lack of historical
ability to generate taxable income to utilize our deferred tax
assets, we have recorded a full valuation allowance.
30
GMI, General Media and the Other GMI Subsidiaries are parties to
the Tax Sharing Agreement pursuant to which such parties file
consolidated federal, state and local income tax returns so long
as permitted by the relevant tax authorities. The Tax Sharing
Agreement sets forth the methodology for allocating income taxes
and the use of net operating losses ("NOLs") between General
Media, GMI and the Other GMI Subsidiaries. We, however, are not
required to pay income or franchise taxes (except certain
alternative taxes) to the extent that we can utilize a portion of
the NOLs of GMI and the Other GMI Subsidiaries pursuant to the
terms of the Tax Sharing Agreement. Prior to 2000, we were not
required to reimburse GMI and the Other GMI Subsidiaries for the
use of the NOLs generated by these entities. In addition, the Tax
Sharing Agreement provides that GMI and the other GMI Subsidiaries
indemnify us 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.
d. OTHER LOSS RESERVES - We have other loss exposures, such as
accounts receivable reserves and reserves for refunds that would
be required if we do not attain circulation levels stipulated in
contracts with advertisers. Establishing allowances for doubtful
accounts and loss reserves for these matters requires the use of
estimates and judgment in regards to risk exposure and the
ultimate liability. We estimate losses using consistent and
appropriate methods; however, changes to our assumptions could
materially affect our estimate of allowances and losses. Where
available we utilize published credit ratings for our debtors to
assist us in determining the amount of required reserves.
IMPACT OF RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS
Certain provisions of The Emerging Issues Task Force pronouncement EITF 01-9,
"Accounting for Consideration Given by a Vendor to a Customer (Including a
Reseller of the Vendor's Products)", are effective for fiscal periods beginning
after December 15, 2001. The Task Force reached a consensus that consideration
from a vendor to a reseller of the vendor's products is presumed to be a
reduction of the selling prices of the vendor's products and, therefore, should
be characterized as a reduction of revenue when recognized in the vendor's
income statement. Beginning January 2002 we adopted this policy as it relates to
retail display allowances. Retail display allowances had been included in
selling, general and administrative expenses prior to the adoption of this
policy. The effect on General Media of the adoption of the policy is a reduction
of newsstand revenue and an equivalent reduction in selling, general and
administrative expenses.
In April 2002, the FASB issued SFAS 145, which rescinded certain prior FASB
statements, amended a FASB statement and made technical corrections to a number
of prior pronouncements. This statement is effective for fiscal years beginning
after May 15, 2002. The Company does not believe that this statement will have a
material effect on the Company's financial statements.
In June 2002, the FASB issued SFAS 146, "Accounting for Costs Associated with
Exit or Disposal Activities". This statement is effective for exit or disposal
activities initiated after December 31, 2002. The Company does not believe that
this statement will have a material effect on the Company's financial
statements.
In October 2002, the FASB issued SFAS 147, "Acquisitions of Certain Financial
Institutions". This statement is effective for acquisitions for which the date
of acquisition is on or after October 1, 2002. The Company does not believe that
this statement will have a material effect on the Company's financial
statements.
31
In December 2002, the FASB issued SFAS 148, "Accounting for Stock-Based
Compensation-Transition and Disclosure". The statement amends SFAS 123,
"Accounting for Stock-Based Compensation", and is effective for fiscal years
ending after December 15, 2002. The Company does not believe that this statement
will have a material effect on the Company's financial statements.
CONTRACTUAL OBLIGATIONS AND COMMERCIAL COMMITMENTS
The Company does not utilize off balance sheet financing other than operating
lease arrangements for office premises and related equipment. The following
table summarizes all commitments under contractual obligations as of March 31,
2003:
Obligations due
-------------------------------------------------
Total 1 2-3 4-5 Over 5
Amount Year Years Years Years
-------------------------------------------------
(In millions)
Senior Secured Notes $41.8 $41.8 $ - $ - $ -
Operating Leases 11.3 1.9 3.7 3.8 1.9
Other Long-Term Liabilities 0.7 0.2 0.3 0.2 -
------ ------ ------ ------ ------
Total Cash Obligations $53.8 $43.9 $ 4.0 $ 4.0 $ 1.9
====== ====== ====== ====== ======
Interest On Senior Secured Notes $ 7.2 $ 7.2 $ - $ - $ -
====== ====== ====== ====== ======
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
We are exposed to market risk from changes in interest rates. Management does
not believe that it has any foreign currency rate risk.
Interest Rates-As of December 31, 2000, we had debt of $52.0 million with a
fixed rate of 10 5/8%. On March 29, 2001 we exchanged $51.5 million of this debt
for new debt with a fixed rate of 15% and retired $0.5 million of the debt. In
July 2001, October 2001 and December 2001, we retired $0.7 million, $1.1
million, $0.7 million of the new debt, respectively, in accordance with the
requirements of the Series C Notes. In April, May, July, October and December
2002, we retired $1.3 million, $0.9 million, $1.3 million, $1.9 million and $0.5
million of the new debt, respectively, in accordance with the requirements of
the Series C Notes. In January and April 2003 we retired $1.3 million and $1.9
million of the new debt, respectively, in accordance with the requirements of
the Series C Notes. We are subject to market risk based on potential
fluctuations in current interest rates.
Foreign-Exchange Rate Risk - We do not believe it has exposure to foreign
exchange rate risk because all of its financial instruments are denominated in
U.S. dollars.
ITEM 4. CONTROLS AND PROCEDURES
Within the 90 days prior to the date of this Quarterly Report on Form 10-Q, we
evaluated the effectiveness of the design and operation of our "disclosure
controls and procedures" ("Disclosure Controls") pursuant to Rules 13a-14(c) of
the Securities Exchange Act of 1934, as amended (the "Exchange Act") and our
"internal controls and procedures for financial reporting" (Internal Controls).
This evaluation (the "Controls Evaluation") was done under the supervision and
with the participation of management.
32
Disclosure Controls are procedures that are designed with the objective of
ensuring that information required to be disclosed in our reports filed under
the Exchange Act is recorded, processed, summarized and reported within the time
periods specified in the SEC's rules and forms. Disclosure Controls are also
designed with the objective of ensuring that such information is accumulated and
communicated to our management, including the Chief Executive Officer (CEO) to
allow timely decisions regarding required disclosure. Internal Controls are
procedures which are designed with the objective of providing reasonable
assurance that (1) our transactions are properly authorized; (2) our assets are
safeguarded against unauthorized or improper use; and (3) our transactions are
properly recorded and reported, all to permit the preparation of our financial
statements in conformity with generally accepted accounting principles in the
United States Of America.
Among other matters, we sought in our Controls Evaluation to determine whether
there were any "significant deficiencies" or "material weaknesses" in our
Internal Controls, or whether we had identified any acts of fraud involving
personnel who have a significant role in our Internal Controls. In professional
auditing literature, "significant deficiencies" are referred to as "reportable
conditions"; these are control issues that could have a significant adverse
effect on the ability to record, process, summarize and report financial data in
the financial statements. A "material weakness" is defined in the auditing
literature as a particularly serious reportable condition where the internal
control does not reduce to a relatively low level the risk that misstatements
caused by error or fraud may occur in amounts that would be material in relation
to the financials statements and not be detected within a timely period by
employees in the normal course of performing their assigned functions. We also
sought to deal with other controls matters in the Controls Evaluation, and in
each case if a problem was identified, we considered what revision, improvement
and/or correction to make in accord with our on-going procedures.
The CEO note that, since the date of the Controls Evaluation to the date of this
Quarterly Report, there have been no significant changes in Internal Controls or
in other factors that could significantly affect Internal Controls, and no
corrective actions were required or taken with regard to significant
deficiencies and material weaknesses.
Based upon the Controls Evaluation, our CEO has concluded that our Disclosure
Controls were effective to ensure that material information relating to General
Media, Inc. and its consolidated subsidiaries is made known to management,
including the CEO.
33
PART II-OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
On May 8, 2002, an action was filed in United States District Court for the
Central District of California (the "California Court"), alleging, among other
things, that General Media published photographs (the "Photographs") of a woman
topless in the June 2002 issue of Penthouse Magazine (the "Magazine"), falsely
representing them to be pictures of the plaintiff when they were in reality
photographs of someone else. The action also alleges that General Media
advertised its intention to make the Photographs and a video of the woman
available on its internet site on May 10, 2002. On May 7, 2002, General Media
issued a press release stating that it had made an unintentional error when it
said the Photographs were of the plaintiff and it apologized to the plaintiff
and the actual woman in the Photographs for the error. General Media also
published the apology on its internet site.
The plaintiff seeks a permanent injunction barring General Media from any
similar acts concerning her, barring it from any further distribution of the
Photographs and the June 2002 edition of the Magazine, barring it from any
references to the plaintiff on its internet site, barring it from representing
that any pictures or photographs on the internet site are depictions of the
plaintiff, ordering it to deliver or destroy all materials that have the alleged
false representations, ordering the disgorgement and paying over of all profits
it earned and any other unjust enrichment that it received from the alleged
false depiction of the plaintiff, awarding damages in an unspecified amount not
less than $10.0 million, trebling of these unspecified damages, awarding
punitive damages in an unspecified amount and reimbursement for the plaintiff's
costs and attorneys' fees in prosecuting the action. In May 2002, the Court
dismissed portions of the complaint and is in the process of hearing arguments
for the remaining portions. General Media intends to vigorously defend itself in
this action. It is still too early to determine the possible outcome of the
proceedings. Therefore management cannot give an opinion as to the effect this
action will have on General Media's financial condition or results of
operations. There can be no assurance, however, that the ultimate liability from
these proceedings will not have a material adverse effect on its financial
condition and results of operations.
On August 26, 2002, two individuals on behalf of themselves and all others
similarly situated (the "Class Action Plaintiffs") filed in the Circuit Court of
Cook County, Illinois (the "Illinois Court"), an action alleging that General
Media committed a breach of contract, a breach of express warranty and consumer
fraud when it published the Photographs, falsely representing them to be
pictures of the aforementioned plaintiff when they were in reality photographs
of someone else. The Class Action Plaintiffs have filed a request that the
action be certified as a class action. On May 20, 2003, the Illinois Court
dismissed the complaint.
On July 13, 2001, an employee filed a charge of discrimination (the "Charge")
against General Media with the U.S. Equal Employment Opportunity Commission
("EEOC"). On April 11, 2003, the District Director of the EEOC ruled that there
was reasonable cause to find that the employee had been subject to
discrimination on the basis of disability and age, and that she had been
constructively discharged. General Media and the EEOC are conducting meetings
with the employee to determine what actions need to be taken to resolve the
Charge. General Media intends to vigorously defend itself in this action. It is
too early to determine the possible outcome of the proceedings. Therefore
management cannot give an opinion as to the effect this action will have on
General Media's financial condition or results of operations. There can be no
assurance, however, that the ultimate liability from these proceedings will not
have a material adverse effect on its financial condition or results of
operations.
On March 28, 2003, a former employee of General Media who was terminated for
what General Media believes to be reasonable cause, filed a claim in the Supreme
Court of the State of New York seeking damages of $75,000 plus an accounting of
their incentive compensation. General Media believes it has no liability to this
individual and is vigorously defending itself against this claim.
In December 2002, General Media received correspondences form a third party that
transmission of video content on the Internet is a violation of patents that the
third party claims to own. The third party has demanded that General Media
execute a royalty agreement in favor of the third party with respect to revenue
from any videos that it displayed on its Internet Site. To General Media's
knowledge, no action has been instituted against it by the third party. General
Media believes that it does not owe any royalties to this third party and
intends to vigorously defend itself in any action brought against it by the
third party.
34
The Company has breached the payment terms of its rent obligations on its
principal office in the amount of approximately $0.4 million. On April 24, 2003,
the property manager filed a petition in the Civil Court of the City Of New York
requesting a judgement of eviction against the Company. The Company has a cash
deposit with the property manager in the amount of $956,000. The Company's has
engaged special counsel to negotiate a settlement. The Company's management has
submitted a proposal to the landlord for a restructuring of its obligations
under the lease which would provide a settlement for the default.
There are various lawsuits claiming amounts against General Media. While the
outcome of these matters is currently not determinable, it is the opinion of
General Media's management that the ultimate liabilities, if any, from the
outcome of these cases will not have a material effect on the Company's
financial statements.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
On April 24, 2003, the General Media and the Holders completed a letter
agreement that consented to the appointment of Stephen R. Gross as president and
chief operating officer of the Company, consented to the filing of the General
Media's Form 10-K at any time on or before April 30, 2003, consented to an
amendment to the Indenture to change the date of the payment of the $2.0 million
principal payment that was due on March 29, 2003 to April 17, 2003, and to
acknowledge the payment in full of and the absence of any existing or continuing
violation, default or event of default under the Indenture with respect to the
$2.0 million principal payment that was due on March 29, 2003. In addition
General Media and the Holders agreed to amend the "Change of Control" events to
substitute Stephen Gross for John Orlando and to eliminate any grace periods
with respect to future principal payments commencing with the principal payment
due June 29, 2003.
As of March 31, 2003, the Company was required to make principal and interest
payments on its Series C Notes totallying $3.5 million. The principal payment of
$1,950,000 has been made and the interest payment of $1.5 million was not made.
On May 14, 2003, General Media and the Holders completed a letter agreement in
which the parties agreed that the Holders would forbear from exercising their
rights and remedies under the Indenture as a result of the General Media's
failure to pay interest that
was due on April 30, 2003 (after 30-day grace period) in return for General
Media's agreement to:
a) execute and deliver to the trustee a mortgage and lien in a form
satisfactory to the Holders encumbering certain real estate owned by GMII
(subject to prior liens of not more than $25.0 million) and to pay costs
associated with the obtaining of the mortgage,
b) cause GMII to provide a non-recourse guaranty of the obligations of General
Media (the "Guaranty") and to secure its obligations under such Guaranty
with a pledge to the trustee of all of GMII's rights, title and interest in
the outstanding shares of common stock of PII ("PII Stock"), to deliver the
PII Stock certificates and stock powers to the trustee and to deliver a
letter agreement pursuant to which PII shall covenant that it will not
sell, pledge, transfer, assign or otherwise dispose of any of its
outstanding shares of common stock of General Media ("Common Stock
Obligation"),
c) pay the interest that is overdue on or before June 30, 2003. General Media
and the Holders also agreed that upon the payment of the interest on or
before June 30, 2003, the Holders will direct the trustee to cancel the
Guaranty and release PII from the Common Stock Obligation,
d) allow the Holders to audit the books, records and assets of General Media,
e) provide the Holders with a detailed plan for the restructuring of General
Media's Series C Notes, together with supporting computations, no later
than June 30, 2003, and
f) to place a $0.1 million with the Holders by June 9, 2003 which shall be
used to reimburse the Holders for the fees, costs and expenses their audit
and legal counsel.
35
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
As of March 31, 2003, the Company was required to make principal and interest
payments on its Series C Notes totallying $3.5 million. The principal payment of
$1,950,000 has been made and the interest payment of $1.5 million was not made.
As of March 31, 2003, General Media had not made a required interest payment of
$1.5 million on its Series C Notes, that was due by that date. General Media had
until April 30, 2003 (30-day grace period) to make the interest payment, but was
unable to do so. On May 14, 2003, General Media and the Holders completed a
letter agreement in which the parties agreed that the Holders would forbear from
exercising their rights and remedies under the Indenture as a result of the
failure to pay the interest in return for certain concessions by General Media
and GMI as specified in Item 2 "Changes in Securities and Use of Proceeds"
above. As of May 20, 2003 the total arrearage due is $1,529,000.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) The exhibits listed in the "Exhibit Index" are filed as part of this
report.
(b) Reports on Form 8-K.
No reports on Form 8-K were filed during the quarter ended March 31, 2003.
36
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Penthouse Financial, Inc.
(Registrant)
Dated: May 20, 2003 By: /s/ R C Guccione
---------------------------------------
Robert C. Guccione
Chairman of the Board, Chief Executive
Officer and Publisher
(Principal Executive Officer)
CERTIFICATIONS
I, Robert C. Guccione, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Penthouse
Financial, Inc.;
2. Based on my knowledge, this quarterly report does not contain any
untrue statement of a material fact or omit to state a material fact
necessary to make the statements made, in light of the circumstances
under which such statements were made, not misleading with respect to
the period covered by this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and
cash flows of the registrant as of, and for, the periods presented in
this quarterly report;
4. I am responsible for establishing and maintaining disclosure controls
and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14)
for the registrant and I have;
a. designed such disclosure controls and procedures to ensure
that material information relating to the registrant,
including its consolidated subsidiaries, is made known to me
by others within those entities, particularly during the
period in which this quarterly report is being prepared;
b. evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior to
the filing date of this quarterly report (the "Evaluation
Date"); and
c. presented in this quarterly report my conclusions about the
effectiveness of the disclosure controls and procedures
based on my evaluation as of the Evaluation Date;
5. I have disclosed, based on our most recent evaluation, to the
registrant's auditors and the registrant's board of directors;
a. all significant deficiencies in the design or operation of
internal controls which could adversely affect the
registrant's ability to record, process, summarize and
report financial data and have identified for the
registrant's auditors any material weaknesses in internal
controls; and
b. any fraud, whether or not material, that involves management
or other employees who have a significant role in the
registrant's internal controls; and
6. I have indicated in this quarterly report whether or not there were
significant changes in internal controls or in other factors that
could significantly affect internal controls subsequent to the date of
our most recent evaluation, including any corrective actions with
regard to significant deficiencies and material weaknesses.
/s/ Robert C. Guccione
--------------------------------
Chief Executive Officer
(Principal Executive Officer and
Principal Financial Officer)
May 20, 2003
38
Exhibit Index
-------------
Exhibit No. Description
- ----------- -----------
99.1 -- Certification Of Robert C. Guccione, Chief Executive Officer,
Pursuant to 18 U.S.C. Section 1350, As Adopted Pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002
39