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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(MARK ONE)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2003
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
COMMISSION FILE NUMBER: 333-83448
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 [ ]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act).
YES [ ] NO [X]
As of December 1, 2003, there were 184,690,000 shares outstanding of the
Registrant's common stock.
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 28
Item 3. Quantitative and Qualitative Disclosures About Market Risk 54
Item 4. Controls and Procedures 54
PART II- OTHER INFORMATION
Item 1. Legal Proceedings 56
Item 2. Changes in Securities and Use of Proceeds 57
Item 3. Defaults Upon Senior Securities 59
Item 5. Other Events 60
Item 6. Exhibits and Reports on Form 8-K 63
Signatures 64
2
ITEM 1. FINANCIAL STATEMENTS
- ---------------------------------------
PENTHOUSE INTERNATIONAL, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
(AMOUNTS IN THOUSANDS)
NINE MONTHS ENDED THREE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
--------------------------------- -------------------------------
2002 2003 2002 2003
--------------- --------------- -------------- --------------
NET REVENUE $ 42,120 $ 26,971 $ 11,838 $ 8,161
--------------- --------------- -------------- --------------
COSTS AND EXPENSES
Publishing - production, distribution and editorial 16,744 9,743 5,113 2,416
Entertainment and online 637 420 195 215
Selling, general and administrative 18,152 13,691 5,742 4,594
Loss on impairment of assets 2,153 1,092
Bad debt expense 339 285 261 446
Rent expense from affiliated companies 430 243 97 28
Depreciation 399 255 126 67
--------------- --------------- -------------- --------------
Total costs and expenses 36,701 26,790 11,534 8,858
--------------- --------------- -------------- --------------
Income (loss) from operations 5,419 181 304 (697)
--------------- --------------- -------------- --------------
OTHER INCOME (EXPENSE)
Interest expense (5,571) (3,910) (1,780) (714)
Reorganization expenses (945) (945)
Gain on forgiveness of debt 210 210
Debt restructuring expenses (142) (142)
Interest income 65 3 4 (1)
Gain on sale of officer's life insurance 811
--------------- --------------- -------------- --------------
Total other income (expense), net (4,695) (4,784) (1,776) (1,592)
--------------- --------------- -------------- --------------
INCOME (LOSS) BEFORE PROVISION FOR INCOME TAXES 724 (4,603) (1,472) (2,289)
Income tax expense / (benefit) 18 (813) 5 (825)
--------------- --------------- -------------- --------------
Income (loss) before minority interest 706 (3,790) (1,477) (1,464)
Minority interest (4) 17 7 5
--------------- --------------- -------------- --------------
Net income (loss) 702 (3,773) (1,470) (1,459)
"Paid in kind" dividends on mandatorily redeemable
preferred stock, net of minority interest (1,086) (1,232) (377) (428)
Accretion of mandatorily redeemable preferred stock
to its liquidation preference, net of minority interest (255) (265) (86) (89)
--------------- --------------- -------------- --------------
Net loss applicable to common stock ($639) ($5,270) ($1,933) ($1,976)
=============== =============== ============== ==============
Net loss per common share, basic and diluted ($0.01) $(0.03) ($0.02) ($0.01)
=============== =============== ============== ==============
Weighted average number of shares, basic and diluted 127,560,000 151,690,000 127,560,000 151,690,000
=============== =============== ============== ==============
SEE NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS.
3
PENTHOUSE INTERNATIONAL, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(AMOUNTS IN THOUSANDS)
DECEMBER 31, SEPTEMBER 30,
2002 2003
------------- --------------
(unaudited)
ASSETS
------
CURRENT ASSETS
- --------------
Cash and cash equivalents $ 206 $ 672
Accounts receivable, net of allowance
for doubtful accounts 2,451 820
Inventories 3,355 2,325
Prepaid insurance 702 304
Prepaid expenses and other current assets 1,014 1,089
------------- --------------
TOTAL CURRENT ASSETS 7,728 5,210
WORKS OF ART AND OTHER COLLECTABLES,
NET OF RESERVES FOR IMPAIRMENT 1,820 728
PROPERTY AND EQUIPMENT - AT COST;
net of accumulated depreciation and amortization 1,905 589
OTHER ASSETS
- ------------
Restricted accounts receivable 411 2,250
Cash surrender value of officers life insurance 919 960
Restricted cash 507
Deferred subscription aquisition costs, net 248 110
Due from affiliated companies 1,153
Rent security deposits 1,071
Other 117 50
------------- --------------
3,919 3,877
------------- --------------
$ 15,372 $ 10,404
============= ==============
LIABILITIES AND STOCKHOLDERS DEFICIENCY
---------------------------------------
CURRENT LIABILITIES
- -------------------
LIABILITIES NOT SUBJECT TO COMPROMISE
Current maturities of notes payable $ 43,147
Debtor In Possession Financing $ 2,049
Accounts payable 7,894 1,305
Deferred revenue 7,602 7,231
Accrued Interest - notes payable 1,617
Accrued retail display allowance 1,653 1,507
Accrued expenses and other current liabilities 3,863 1,290
Due to affiliated companies 518
Income tax payable 935 -
------------- --------------
TOTAL CURRENT LIABILITIES 66,711 13,900
LIABILITIES SUBJECT TO COMPROMISE 12,570
BONDS PAYABLE SUBJECT TO COMPROMISE 39,897
DEFERRED REVENUE 1,013 692
OTHER LONG TERM LIABILITIES 867 354
MANDATORILY REDEEMABLE CONVERTIBLE PREFERRED STOCK 11,256 12,753
COMMITMENTS AND CONTINGENCIES
MINORITY INTEREST 116 92
STOCKHOLDERS DEFICIENCY
- -----------------------
Series A Preferred Stock, $.0025 par value; 20,000,000 shares
authorized, 5,000 shares issued and outstanding
Series B Preferred Stock, $.0025 par value; 20,000,000 shares
authorized, none outstanding
Common stock, $.0025 par value; 250,000,000 shares authorized;
150,000,000 and 151,690,000 shares issued and outstanding 375 379
Capital in excess of par value 5,987 4,493
Subscription receivable (22) (22)
Accumulated deficit (70,931) (74,704)
------------- --------------
(64,591) (69,854)
------------- --------------
$ 15,372 $ 10,404
============= ==============
SEE NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS.
4
PENTHOUSE INTERNATIONAL, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
(AMOUNTS IN THOUSANDS)
NINE MONTHS ENDED
SEPTEMBER 30,
------------------------
2002 2003
----------- ----------
CASH FLOWS FROM OPERATING ACTIVITIES
- ------------------------------------
Net income (loss) $ 702 ($3,773)
Adjustments to reconcile net income / (loss) to net
cash provided by (used in) operating activities:
Depreciation and amortization 399 255
Amortization of deferred revenue (324) (321)
Gain on sale of officer's life insurance policies (811)
Loss on impairment of assets 2,153
Gain on forgiveness of debt (210)
Bad debt expense 285
Change in operating assets and liabilities:
(Increase) decrease in:
Accounts receivable 1,164 1,648
Inventories 1,074 1,030
Prepaid insurance 398
Prepaid expenses and other current assets 798 (75)
Restricted accounts receivable (151) (1,839)
Other assets 1,711 728
Increase (decrease) in:
Accounts payable, accrued expenses and other
current liabilities (4,300) 3,263
Accrued interest on notes payable (132) (1,617)
Income taxes payable (3) (935)
Deferred revenue (2,006) (371)
Other long term liabilities (195) (514)
Minority interest 4 (17)
----------- ----------
Net cash (used in) provided by operations (2,070) 88
----------- ----------
CASH FLOWS FROM INVESTING ACTIVITIES
- ------------------------------------
Proceeds from sale of officer's life insurance policies 935
----------- ----------
Net cash provided by investing activities 935
----------- ----------
CASH FLOWS FROM FINANCING ACTIVITIES
- ------------------------------------
Principal payments on notes payable (3,485) (3,250)
Advances from DIP Financing 2,049
Collections from affiliated companies 1,328 1,579
Repayments from shareholder 1,000
----------- ----------
Net cash (used in) provided by financing activities (1,157) 378
----------- ----------
Net (decrease) increase in cash and cash equivalents (2,292) 466
Cash and cash equivalents at beginning of year 2,431 206
----------- ----------
Cash and cash equivalents at end of period $ 139 $ 672
=========== ==========
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
- -------------------------------------------------
Cash paid during the year for:
Interest $ 5,668 $ 3,335
Income taxes $ 19 $ 20
SUPPLEMENTAL DISCLOSURE OF NON-CASH FINANCING ACTIVITIES:
- ---------------------------------------------------------
"Paid in kind" dividends on mandatorily redeemable
preferred stock $ 1,086 $ 1,232
Accretion of mandatorily redeemable preferred
stock to liquidation preference $ 255 $ 265
Reclass of accounts payable to liabilities subject
to compromise $ 12,507
SEE NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS.
5
PENTHOUSE INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
1. NATURE OF OPERATIONS, BASIS OF PRESENTATION, FINANCIAL STATUS AND
SIGNIFICANT ACCOUNTING POLICIES
Penthouse International, Inc. ("PII") holds 99.5% of the common stock of General
Media, Inc. ("General Media") and, after the completion of transactions for
which definitive agreements were reached on November 6, 2003, all of the
membership interests of Del Sol Investments L.L.C. ("Del Sol LLC"). As a result
of the acquisition of Del Sol LLC, PII will indirectly own 99.5% of Del Sol
Investment S.A. de C.V., a Mexican real estate development company which holds
or has rights to 370.5 acres of land with ocean frontage in Zihuatanejo, State
of Guerrero, Mexico (the "Property"). The Property is a planned resort
development in the resort area known as Ixtapa. Until November 6, 2003, PII was
majority owned by General Media International, Inc. ("GMII"). GMII ceded control
of PII to The Molina Vector Investment Trust on November 6, 2003. See Note 17 of
the Notes to Condensed Consolidated Financial Statements.
General Media, and its subsidiaries, operate the adult oriented entertainment
company formed in 1965, by Robert G. Guccione, which caters to men's interests
through various trademarked publications, movies, the Internet, adult
entertainment clubs and consumer product licenses under the brand "PENTHOUSE"
and others. General Media International, Inc. ("GMI") is the holder of 85% of
the common stock of the Company. On August 12, 2003, General Media and its
direct and indirect subsidiaries, General Media Art Holdings, Inc., General
Media Communications, Inc., General Media Entertainment, Inc., General Media
(UK), Ltd., GMCI Internet Operations, Inc., GMI On-Line Ventures, Ltd.,
Penthouse Images Acquisitions, Ltd. and Pure Entertainment Telecommunications,
Inc., (collectively, the "Debtors"), filed voluntary petitions for relief under
Chapter 11 of Title 11 of the United States Code (the "Bankruptcy Code") in the
United States Bankruptcy Court for the Southern District of New York (the
"Bankruptcy Court"). The Debtors are managing their properties and operate their
businesses as "debtors-in-possession" subject to the jurisdiction, supervision
and orders of the Bankruptcy Court (Case No. 03-15078) and in accordance with
Sections 1107(a) and 1108 of the Bankruptcy Code. As a debtor-in-possession,
General Media and the other Debtors authorized to operate our business, but not
engage in transactions outside the ordinary course of business without the
approval of the Bankruptcy Court. PII did not file for protection under the
Bankruptcy Code and its activities are not subject to Bankruptcy Court
supervision. Prior to the acquisition of Del Sol LLC, all of PII's consolidated
net revenue is generated and substantially all of the our assets are owned by
the Debtors.
Basis of Presentation and Financial Status
- ------------------------------------------
The accompanying unaudited condensed consolidated financial statements of PII,
General Media and subsidiaries have been prepared by us pursuant to the rules
and regulations of the Securities and Exchange Commission. Certain information
and footnote disclosures normally included in financial statements prepared in
accordance with accounting principles generally accepted in the United States of
America have been condensed or omitted pursuant to such rules and regulations.
These condensed consolidated financial statements should be read in conjunction
with the financial statements and notes thereto included in our Annual Report on
Form 10-K for the year ended December 31, 2002.
In the opinion of management, all adjustments, consisting only of normal,
recurring adjustments considered necessary for a fair presentation, have been
included. These results 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.
6
PENTHOUSE INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
1. (CONTINUED)
The accompanying condensed consolidated financial statements have been prepared
on a going concern basis, which assumes continuity of operations and realization
of assets and settlement of liabilities and commitments in the ordinary course
of business. However, as a result of the Bankruptcy proceedings and
circumstances relating thereto (see Note 2 of the Notes to Condensed
Consolidated Financial Statements), including our leveraged financial structure
and cumulative net losses, the realization of assets and settlement of
liabilities are subject to significant uncertainty. During the period of the
Bankruptcy proceedings, we may sell or otherwise dispose of assets and liquidate
or settle liabilities for amounts other than those reflected in the consolidated
financial statements. Furthermore, a plan or plans of reorganization could
materially change the amounts reported in the condensed consolidated financial
statements, which do not give effect to any adjustments of the carrying value of
assets or liabilities that might be necessary as a consequence of a plan or
plans of reorganization. Our ability to continue as a going concern is dependent
upon, among other things, confirmation of a plan or plans of reorganization,
future profitable operations, the ability to comply with the terms of our
financing agreements and the ability to generate sufficient cash from operations
and/or financing to meet obligations and capital asset expenditure requirements.
The accompanying condensed financial statements have also been presented in
accordance with American Institute of Certified Public Accountants (the "AICPA")
Statement of Position 90-7, FINANCIAL REPORTING BY ENTITIES IN REORGANIZATION
UNDER THE BANKRUPTCY CODE ("SOP 90-7"). The statement requires a segregation of
liabilities subject to compromise by the Bankruptcy Court as of the Petition
Date and identification of all transactions and events that are directly
associated with our reorganization. Pursuant to SOP 90-7, pre-petition
liabilities are reported on the basis of the expected amounts of such allowed
claims, as opposed to the amounts for which claims may be settled. Under a
confirmed final plan of reorganization, those claims may be settled at amounts
substantially less than their allowed amounts.
Our historical liquidity issues, net losses and the bankruptcy proceedings raise
substantial doubt about our ability to continue as a going concern. Our ability
to continue the business of General Media as a going concern and the
appropriateness of using the going concern basis of accounting depends upon,
among other things, the Debtors' ability to comply with the terms of the
debtor-in-possession financing arrangement with Madeleine L.L.C. ("DIP
Financer"), our ability to obtain debt, equity or alternative financing for
General Media before deadlines established by agreements for
debtor-in-possession financing or imposed by order of the Bankruptcy Court to
avoid a public auction of the assets of the Debtors, confirmation of a plan of
reorganization, success of future operations after such confirmation and the
ability to generate sufficient cash from operations and financing sources to
meet obligations. The Debtors filed a motion on November 26, 2003 to extend the
time in which they have the exclusive right to file a reorganization plan and
solicit acceptances of such plan form December 1, 2003 and February 8, 2004,
respectively to February 9, 2004 and March 9, 2004, respectively. If the motion
is not granted, the assets of the Debtors risk being auctioned.
Significant Accounting Policies
- -------------------------------
The significant accounting policies we followed in preparing our financial
statements are set forth in Note 31, 2003. Except as required by SOP 90-7, we
have made no changes to these policies during the three months or nine months
ended September 30, 2003.
7
PENTHOUSE INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
1. (CONTINUED)
Certain other reclassifications have also been made to amounts from prior years
to conform to the 2003 presentation.
Use of Estimates - The preparation of financial statements in conformity with
generally accepted accounting principles requires management to make estimates
and assumptions that affect the reported amounts of assets and liabilities,
disclosure of contingent assets and liabilities at the date of the financial
statements, and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
Net Loss Per Common Share - Basic loss per common share is calculated by
dividing net income (loss) after reductions for "paid in kind" dividends and
accretion by the weighted average number of common shares outstanding during the
period. Diluted loss per common share reflects the potential dilution that would
occur if dilutive stock options and warrants were exercised. These potentially
dilutive securities were not included in the calculation of loss per share for
the periods presented because we incurred a loss during the periods in which the
dilutive securities have been outstanding and thus their effect would have been
anti-dilutive. Accordingly, basic and diluted loss per common share is the same
for all periods presented.
On May 13, 2003, we declared a 3 for 1 stock split (see Note 14 of the Notes to
Condensed Consolidated Financial Statements). Loss per common share calculations
for the three months and nine months ended September 30, 2003 and 2002 give
retroactive effect to the 3-for-1 split as if it occurred on January 1, 2002.
Recent Accounting Pronouncements
- --------------------------------
In June 2002, the FASB issued SFAS No. 146, "Accounting for Costs Associated
with Exit or Disposal Activities," which requires companies to recognize costs
associated with exit or disposal activities when they are incurred rather than
at the date of a commitment to an exit or disposal plan. Such costs covered by
SFAS No. 146 include lease termination costs and certain employee severance
costs that are associated with a restructuring, discontinued operation, plant
closing, or other exit or disposal activity. SFAS No. 146 replaces the previous
accounting guidance provided by the EITF No. 94-3, "Liability Recognition for
Certain Employee Termination Benefits and Other Costs to Exit an Activity
(including Certain Costs Incurred in a Restructuring)." SFAS No. 146 is to be
applied prospectively to exit or disposal activities initiated after December
31, 2002. We do not expect that the adoption of SFAS No. 146 will have a
significant effect on our financial statement presentation or disclosures.
8
PENTHOUSE INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
1. (CONTINUED)
In December 2002, the FASB issued SFAS No. 148, "Accounting for Stock-Based
Compensation - Transition and Disclosure". SFAS No. 148 amends SFAS No. 123,
"Accounting for Stock-Based Compensation", to provide alternative methods of
transition for a voluntary change to the fair value based method of accounting
for stock-based employee compensation. In addition, SFAS No. 148 amends the
disclosure requirements of SFAS No. 123 to require prominent disclosures in both
annual and interim financial statements about the method of accounting for
stock-based employee compensation and the effect of the method used on reported
results. SFAS No. 148 is effective for fiscal years beginning after December 15,
2002. The interim disclosure provisions are effective for financial reports
containing financial statements for interim periods beginning after December 15,
2002. We do not expect that the adoption of SFAS No. 148 will have a significant
effect on our financial statement presentation or disclosures.
In January 2003, the FASB issued Interpretation No. 46, "Consolidation of
Variable Interest Entities (an Interpretation of ARB No. 51)" ("FIN 46"). FIN 46
requires that the primary beneficiary in a variable interest entity consolidate
the entity even if the beneficiary does not have a majority voting interest. The
consolidation requirements of FIN 46 are required to be implemented for any
variable interest entity created on or after January 31, 2003. In addition, FIN
46 requires disclosure of information regarding guarantees or exposures to loss
relating to any variable interest entity existing prior to January 31, 2003 in
financial statements issued after January 31, 2003. The implementation of the
provisions of FIN 46 effective January 31, 2003 did not have a significant
effect on our consolidated financial statement presentation or disclosures.
In May 2003, the FASB issued SFAS No. 150, "Accounting for Certain Financial
Instruments with Characteristics of both Liabilities and Equity". SFAS No. 150
establishes standards for how an issuer classifies and measures in its statement
of financial position certain financial instruments with characteristics of both
liabilities and equity. SFAS No. 150 requires that an issuer classify a
financial instrument that is within its scope as a liability (or an asset in
some circumstances) because that financial instrument embodies an obligation of
the issuer. SFAS No. 150 is effective for financial instruments entered into or
modified after May 31, 2003 and otherwise is effective at the beginning of the
first interim period beginning after June 15, 2003. SFAS No. 150 is to be
implemented by reporting the cumulative effect of a change in accounting
principle for financial instruments created before the issuance date of SFAS No.
150 and still existing at the beginning of the interim period of adoption.
Restatement is not permitted. We do not expect that the adoption of SFAS No. 150
will have a significant effect on our financial statement presentation or
disclosures.
2. PROCEEDINGS UNDER CHAPTER 11 OF BANKRUPTCY CODE
Events Leading To Bankruptcy
- ----------------------------
As further described in Note 8 of the Notes to Condensed Consolidated Financial
Statements and in the liquidity section of the Management Discussion and
Analysis of Financial Position and Results of Operations section of this Report
on Form 10-Q, our subsidiary, General Media, was late in paying a required
interest payment of $1,496,000 due on March 31, 2003 under approximately $52
million of Series C Secured Notes scheduled to mature on March 29, 2004 (the
"Notes"). The payment of this interest was made on June 3, 2003.
9
PENTHOUSE INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
2. (CONTINUED)
General Media also did not make a required principal payment in the amount of
$1,300,000 and a required interest payment of $48,000 that was due on June 29,
2003, did not make a required interest payment on the Notes of $1,447,000 that
was due on June 30, 2003 and has not yet delivered quarterly financial
statements for the period ending March 31, 2003 (the "Financial Statements) to
the holders of the Notes as required by the indenture (the "Indenture") defining
the relative rights of General Media and the Note holders. On July 3, 2003, the
holders of a majority of the principal amounts of the Notes (the "Holders") sent
a notice to General Media advising it of the failure to make the required
interest payment due on June 30, 2003, the failure to make required principal
payment of $1,300,000 that was due on June 29, 2003 and the failure to deliver
the required Financial Statements. On July 8, 2003, the trustee issued a notice
of event of default with respect to the principal payment and the Notes became
callable. The Notes require interest payments of $5,679,000 (including the
unpaid interest) and principal payments of $39,897,000 during the next twelve
months plus default interest.
General Media and the affiliated Debtors filed for protection under Chapter 11
after unsuccessful negotiations with the holders of a majority of the principal
amounts of the Series C Notes (the "Holders") did not result in a waiver of the
defaults and the provision of working capital for the Debtors operations.
Debtor-In Possession Financing
- ------------------------------
On August 12, 2003, concurrent with the Debtors filing their petition for relief
under Chapter 11 of the Bankruptcy Code, two of the Holders entered into a
financing agreement with General Media to provide up to $5,000,000 of
debtor-in-possession financing with interest at 13% per annum (the "Preliminary
DIP Financing" or "Agreement"). The Preliminary DIP Agreement limited the
financing to $3,000,000 until a final financing order was signed by the
Bankruptcy Court. This Agreement was approved for the payment of certain
permitted pre-petition claims, working capital needs and other general corporate
purposes. It also provides a source of outside financing in order for us to make
up potential gaps in our cash flow during the course of the Bankruptcy. The
Preliminary DIP Agreement also limited the amount of advances to an amount of
principal that was projected to be outstanding on a weekly basis as set forth in
a budget provided by General Media on a schedule to the Agreement.
In September 2003, the Debtors defaulted on certain covenants relating to the
Preliminary DIP Agreement when they borrowed amounts in excess of those allowed
in the budget. As a result of the default, the two Holders threatened to stop
making advances under the Preliminary DIP Financing. On October 3, 2003, a new
agreement was reached with the two Holders (the "Final Agreement" or "DIP
Financing") under which the DIP Financiers agreed to provide General Media with
up to $6,000,000 of secured debtor-in-possession financing with interest at 13%
per annum in return for General Media and the other Debtors agreeing to file a
public auction sale motion pursuant to section 363 of the Bankruptcy Code of all
or substantially all of General Media and the other Debtors assets on or before
December 1, 2003. This deadline may be extended by the entry of an order by the
Bankruptcy Court granting Debtors' Motion filed November 26, 2003 to extend
certain deadlines in the Bankruptcy Case. The Debtors' obligations under the
Final Agreement are secured by a superpriority lien on substantially all the
assets of the Debtors, including their registered trademarks. The superpriority
10
PENTHOUSE INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
2. (CONTINUED)
lien supercedes all other liens on the assets of the Debtors except for priority
professional expenses for attorneys, accountants and other professionals
retained in the Chapter 11 proceedings up to $1,000,000 (the "Professional Carve
Out") and the outstanding amount of a carve out for expenses of Curtis
Circulation Company, General Media's magazine distributor, of an amount up to
$500,000 (the "Curtis Carve Out"). The Final Agreement limits the amount of
advances under the DIP Financing to the amount of principal projected to be
outstanding on a cumulative basis as was set forth on a revised budget provided
by General Media on a schedule to the Final Agreement. Under the Final
Agreement, General Media has drawn down approximately $2,647,000 as of October
28, 2003 and is in compliance with all the covenants of the Final Agreement.
The Final Agreement specifies that the bidding procedures for the public
auction, should it become necessary, are to be conducted in a form and substance
reasonably acceptable to the DIP lenders and the Indenture Trustee with a
minimum bid of $23,500,000, plus the outstanding amount of the DIP loan at the
time of closing, plus the outstanding amount of the Professional Carve Out and
the Curtis Carve Out. The Final Agreement provides that an auction shall occur
no later than December 21, 2003 with the sale of assets to the winning bidder to
occur no later than January 15, 2004. For additional information, reference is
made to publicly available documents filed with the bankruptcy court to
determine the most current status of all matters related to the bankruptcy case
of General Media.
Development of a Plan of Reorganization
- ---------------------------------------
We are developing a plan of reorganization and negotiating with potential debt
and equity investors to provide financing for the Debtors before deadlines set
by the DIP Financing and the Bankruptcy Court to avoid the public auction of the
Debtors' assets. The beneficial owner of a majority of the outstanding PII
common stock has retained bankruptcy counsel and investment bankers independent
of those retained by the Debtors to assist in developing and financing a Plan of
Reorganization for the Debtors. There can be no assurance that such a plan will
be effectively developed, accepted by the requisite participants in the
Bankruptcy Case or that such a plan will be approved by the Bankruptcy Court.
Further, there is no assurance that debt or equity financing will be available
to fund such a plan or our other operations or that we will retain any equity in
General Media as a result of the Bankruptcy. Even if an equity investor or
alternative financing is available for a reorganization plan, there can be no
assurance that such financing would be upon favorable terms under which we can
retain these assets. For additional information, reference is made to publicly
available documents filed with the bankruptcy court to determine the most
current status of all matters related to the bankruptcy case of General Media.
Effects of Chapter 11 on our Business
- -------------------------------------
The potential adverse publicity associated with the Chapter 11 filings and the
resulting uncertainty regarding our future may hinder our ongoing business
activities and our ability to operate, fund and execute our business plans. Such
potential negative publicity may impair relations with existing and potential
customers, negatively impact our ability to attract and retain key employees,
limit our ability to obtain trade credit and impair present and future
relationships with vendors and service providers.
As a result of the Chapter 11 filings, the realization of assets and the
liquidation of liabilities are subject to uncertainty. While operating as
debtors-in-possession under the protection of the Bankruptcy Code, and while
subject to Bankruptcy Court approval or otherwise as permitted in the normal
course of business, the Debtors may sell or otherwise dispose of assets or
11
PENTHOUSE INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
2. (CONTINUED)
liquidate or settle liabilities for amounts other than those reflected in the
condensed financial statements. Further, a plan of reorganization could
materially change the amounts and classifications reported in the consolidated
historical financial statements, which do not give effect to any adjustments in
the carrying values of assets or amounts of liabilities that might be necessary
as a consequence of confirmation of a plan of reorganization.
Under the system of priorities of claims established by the Bankruptcy Code,
unless the creditors agree otherwise, pre- and post-petition liabilities must be
satisfied in full before shareholders are entitled to receive any distribution
or retain any property under a plan. The ultimate recovery to creditors and/or
common shareholders, if any, will not be determined until confirmation of a plan
or plans of reorganization. No assurance can be given as to what values, if any,
will be ascribed in the Chapter 11 cases to each of these constituencies, or
what types or amounts of distributions, if any, they will receive. A plan of
reorganization could result our receiving no distribution on account of our
interests in General Media stock and cancellation of our equity ownership. For
additional information, reference is made to publicly available documents filed
with the bankruptcy court to determine the most current status of all matters
related to the bankruptcy case of General Media.
The Debtors were overdue in payments to their vendors, but collection efforts
following August 12, 2003 are stayed by the Bankruptcy Proceeding. General Media
was unable to print and distribute PENTHOUSE, PENTHOUSE LETTERS and GIRLS OF
PENTHOUSE magazines during May 2003 and all of its publications during June
2003. In July 2003 General Media was unable to print issues of FORUM and
VARIATION. In the month of August 2003, General Media was able to distribute
PENTHOUSE, PENTHOUSE LETTERS and GIRLS OF PENTHOUSE magazines, but was unable to
print issues of FORUM, VARIATIONS and DIGEST and in September, PENTHOUSE,
PENTHOUSE LETTERS and VARIATIONS were delayed. These disruptions resulted from
failing to reach an agreement with printing contractors, paper suppliers and
magazine distributor regarding past due invoices. In September 2003, the
Company's magazine distributor ("Curtis") threatened to suspend distribution of
General Media's publications and entered into negotiations with General Media to
determine the terms under which magazines will be distributed while General
Media and the other Debtors are operating under Chapter 11 protection. On
October 3, 2003, General Media and Curtis received approval from the Bankruptcy
Court to continue to allow Curtis to distribute the magazines pending the
assumption or rejection of General Media's distribution contract with Curtis
under terms and conditions that include an agreement that for the period
September 28, 2003 to December 31, 2003, Curtis will advance funds net of
estimated retail display allowances and other expenses of distribution in
accordance with a schedule agreed to between General Media and Curtis, that
subsequent to December 31, 2003, Curtis will determine advances based upon the
actual sales of the two previous issues less a good faith estimate of retail
display allowances and other expenses of distribution. In addition Curtis was
given a priority claim of up to $500,000 for any over-advances made on the
issues distributed during the period of this agreement.
In October 2003, the Civil Court of The City Of New York (the "Court") ruled to
allow General Media's landlord to apply a security deposit against pre-petition
past due rent. The Company is now current with its rent and is on a month to
month lease as long as it fulfills its monthly obligation. We have recorded an
impairment charge for fixed asset leasehold improvements in the amount of
$1,061,000 as part of the loss on impairment of assets in the Condensed
Consolidated Statements of Operations for the nine months ended September 30,
2003 (see Note 13 of the Notes to Condensed Consolidated Financial Statements).
12
PENTHOUSE INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
2. (CONTINUED)
The impairment charge is necessary because it is uncertain that General Media
will remain in its principal office facilities to the end of the lease term.
Reorganization Expenses
Reorganization expenses represent the net amounts we incurred as a direct result
of the Chapter 11 filing and are presented separately in the Condensed
Consolidated Statements of Operations. We incurred and will continue to incur
significant costs associated with the reorganization. The amount of these costs,
which are being expensed as incurred, are expected to significantly and
adversely affect our results of operations.
Reorganization expenses included in our Condensed Consolidated Statement of
Operations for the three months and nine months ended September 30, 2003 consist
of the following (unaudited, in thousands):
Professional services $934
United States Trustee Filing Fees 11
-----
Total $945
=====
Gain on Forgiveness of Debt
- ---------------------------
The gain on forgiveness of debt of $210,000 for the three and nine months ended
September 30, 2003 was due to relief of certain liabilities after filing for
Chapter 11 protection.
Debt Restructuring Expenses
- ---------------------------
We incurred $142,000 of debt restructuring expenses during the three months and
nine months ended September 30, 2003, which principally relate to fees
associated with the DIP Financing.
3. LIABILITIES SUBJECT TO COMPROMISE
"Liabilities subject to compromise" refers to liabilities incurred prior to the
commencement of the Chapter 11 filings. These liabilities, consist primarily of
long-term debt, certain accounts payable, income taxes payable and accrued
liabilities, represent management's estimate of known or potential pre-petition
claims to be resolved in connection with the Chapter 11 filings.
Under the Bankruptcy Code, the Debtors may assume, assume and assign, or reject
executory contracts and unexpired leases, including leases of real and personal
property, subject to the approval of the Bankruptcy Court and certain other
conditions. Rejection constitutes a court-authorized breach of the lease or
contract, but creates a deemed pre-petition claim for damages caused by such
breach or rejection. Parties whose contracts or leases are rejected may file
claims against the rejecting Debtor for damages. Generally, the assumption, or
assumption and assignment, of an executory contract or unexpired lease requires
the Debtors to cure all prior defaults under such executory contract or
unexpired lease, including all pre-petition arrearages, and to provide adequate
assurance of future performance. In this regard, we expect that liabilities
subject to compromise and resolution in the Chapter 11 case will arise in the
future as a result of claims for damages created by the Debtors' rejection of
various executory contracts and unexpired leases. Conversely, we would expect
that the assumption, or assumption and assignment, of certain executory
contracts and unexpired leases might convert liabilities shown as subject to
compromise, into liabilities not subject to compromise.
13
PENTHOUSE INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
3. (CONTINUED)
Under bankruptcy law, actions by creditors to collect indebtedness we owed prior
to the Petition Date are stayed and certain other pre-petition contractual
obligations may not be enforced against the Debtors. We have received approval
from the Court to pay certain pre-petition liabilities including employee
salaries and wages, benefits and other employee obligations. Adjustments to the
claims may result from negotiations, payments authorized by Court order,
additional rejection of executory contracts including leases and other events.
We are in the process of filing a motion with the Court to request a date of
January 12, 2004 as the deadline for filing proofs of claim with the Court. Upon
the approval by the Court of the deadline we will mail notices to all known
creditors to inform them of the deadline. Any differences between amounts
scheduled by us and claims by creditors will be investigated and resolved in
connection with our claims resolution process. Until the process is complete,
the ultimate number and amount of allowable claims cannot be ascertained. In
this regard, it should be noted that the claims resolution process may result in
material adjustments to current estimates of allowable claims. The ultimate
resolution of these claims will be based upon the final plan of reorganization
or sale of the assets of General Media and the other Debtors.
The following table summarizes the components of liabilities subject to
compromise in our Condensed Consolidated Balance Sheets as of September 30,
2003:
(in thousands)
Liabilities Subject To Compromise:
----------------------------------
Accounts payable $ 6,829
Accrued expenses and other current liabilities 2,792
Accrued interest - notes payable 2,171
Income taxes payable 132
Other long term liabilities 583
--------
$12,507
========
Notes Payable Subject To Compromise:
------------------------------------
Notes payable $39,947
========
Approximately $12,239,000 of the liabilities subject to compromise and all of
the notes payable subject to compromise would have been included in current
liabilities if the Chapter 11 petitions had not been filed. Filing a petition
generally causes the payment of unsecured or undersecured liabilities to be
prohibited before a plan is confirmed. The Chapter 11 reorganization ending in
confirmation of a plan typically takes more than one year or one operating
cycle, if longer. Therefore, we classified all debt and liabilities subject to
compromise as non-current.
In accordance with SOP 90-7, we discontinued accruing interest relating to
certain debt currently classified as notes payable subject to compromise and
liabilities subject to compromise effective August 12, 2003. Thus, contractual
interest for notes payable subject to compromise for the nine months ended
14
PENTHOUSE INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
3. (CONTINUED)
September 30, 2003 was $2,942,000, which is $758,000 in excess of interest
included in the accompanying financial statements.
Our indebtedness at September 30, 2003 consisted of $39,947,000 of Series C
Notes, which are all subject to compromise. Due to failure to make scheduled
payments and the commencement of the Chapter 11 proceedings, we are in default
of substantially all of our pre-petition debt and other long-term obligations.
Under Chapter 11 of the Bankruptcy Code, actions against Debtors to collect
pre-petition indebtedness are subject to an automatic stay provision. These debt
obligations at September 30, 2003 are classified as liabilities subject to
compromise in the accompanying Condensed Consolidated Balance Sheets in
accordance with SOP 90-7.
4. RESTRICTED ACCOUNTS RECEIVABLE
Restricted accounts receivable of $2,250,000 consist of circulation accounts
receivables that are being held by Curtis as security for the payment of retail
display allowances, merchandising allowances and expenses of distribution
(collectively the "Expenses") pending the outcome of the Bankruptcy. In
September 2003, Curtis threatened to suspend distribution of General Media's
publications and entered into negotiations with Debtors to determine the terms
under which magazines will be distributed while the Debtors are operating under
Chapter 11 protection. On October 3, 2003, Curtis and the Debtors reached an
agreement (the "Continued Distribution Agreement") on the terms under which
Curtis would continue to distribute General Media's publications pending the
Debtors assumption or rejection of the distribution contract between Curtis and
General Media, pending the assumption or rejection of a June 2, 1999 agreement
(the "Auto Agreement") to compensate Curtis for lost revenue and to repay a
portion of an advance related to the March 2, 1999 sale of General Media's
automotive magazines and the resolution of a dispute with the Debtors over a
claim made by Curtis concerning an April 15, 2003 amendment to its agreements
with Curtis (the "Amendment").
The Amendment extended the expiration date of its distribution agreement from
November 8, 2005 to November 8, 2009 and eliminated the Company's right to
terminate the distribution agreement upon notice, as defined, in return for
Curtis's agreement to allow GMI and General Media to repay notes payable owed by
GMI in the amount of $3,000,000 and accounts receivable owed by General Media in
the amount of $75,000 by payments of $50,000 per month until such time as
General Media refinances not less than 50% of its outstanding debt and $125,000
per month thereafter. The Amendment also provides for further extensions of the
distribution agreement of two months beyond the new expiration date for each
month that payments made under the amendment do not equal to $125,000 per month
commencing on July 2003. Curtis claims that it may deduct any amounts owed to it
by GMI under the agreement from monies owed to General Media under its
distribution agreement with Curtis and this claim is disputed by the Debtors.
General Media acknowledged that GMI and Robert C. Guccione had made certain
guaranties at the foot of the amendment.
Under the terms of the Continued Distribution Agreement, the parties agreed that
Curtis will pay General Media advances up to December 31, 2003, equal to amounts
15
PENTHOUSE INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
4. (CONTINUED)
that have been agreed upon reflecting the expected revenue less expected
expenses for magazines that are to go on sale up to December 31, 2003 and for
Curtis to determine advances after December 31, 2003 based on its best estimate
of the expected revenue less expected expenses for the magazines. The Continued
Distribution Agreement also provides for a secured reserve of $500,000 as a
carve out against the DIP Financing in the event that Curtis is unable to
recover and/or retain any refunds of post petition advances paid by Curtis, any
pre- or post-petition distribution fees earned by Curtis or any payments of
pre-petition Expenses made on a post-petition basis. The Continued Distribution
Agreement stipulates that any objection or asserted claims with respect to the
$3,000,000 claim or the Auto Agreement must be made by December 1, 2003 and if
an objection or asserted claim is filed, Curtis has the right to terminate any
further advances. The collection of this receivable is dependent upon the
ability of the Debtors to reach an agreement with Curtis concerning the
$3,000,000 claim and the Auto Agreement.
5. SEC ENFORCEMENT ACTION
We previously reported that the staff of the SEC was conducting an investigation
pertaining to our financial statements for the year ended December 31, 2002 and
the quarter ended March 31, 2003, the accounting treatment of a $1.0 million
cash payment received on January 6, 2003 relating to a website management
agreement and the engagement and termination of auditing services during 2002
and 2003. We cooperated in the investigation by producing documents in our
possession and making available persons in our employ in response to requests
for information and SEC subpoenas. In July 2003, the SEC staff informed us that
it intends to recommend that the SEC bring a civil injunctive action against PII
and two officers, alleging violations of the federal securities laws, including
Section 10(b), 13(b)(2), 13(b)(5), and 15(d) of the Securities Exchange Act of
1934 and of Rules 10b-5, 12b-20, 15d-1, 15d-11, 15d-13, and 15d-14 thereunder,
and against the officers for all those violations and also violations of Rules
13b-1 and 13b-2. The SEC staff invited PII and the officers to make Wells
Submissions describing the reasons why no action should be brought. In September
2003, we filed a Wells Submission and have engaged in discussions with the SEC
staff as to a settlement of this investigation. Since the discussions have not
resulted in a settlement, we cannot predict what action the SEC will take, when
it will take it or its outcome.
6. INVENTORIES
Inventories include the following:
December 31, September 30,
2002 2003
------- -------
--- In Thousands ---
(Unaudited)
Paper and printing $1,599 $1,030
Editorials and pictorial 1,456 1,233
Film and programming costs 300 62
------- -------
$3,355 $2,325
======= =======
16
PENTHOUSE INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
7. MANAGEMENT CHARGES
Up until the filing of the Bankruptcy Proceeding on August 12, 2003, General
Media shared common indirect expenses for the benefit of GMI and affiliated
companies, including accounting, personnel, management information systems,
employee relations and other administrative services. During the nine months
ended September 30, 2003, General Media charged GMI $192,000 for these shared
expenses. In addition, up until the filing of the Bankruptcy Proceeding, General
Media was 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. During the nine months ended September 30, 2003, GMI charged
General Media $267,000 for these shared expenses. These allocations were based
on factors determined by management of General Media 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 were reasonable. As part of the DIP Financing, the arrangement has been
suspended and replaced by compensation payments to General Media's Chairman and
Chief Executive Officer, and Executive Vice President that may not exceed
$41,667 and $12,500 per month, respectively, commencing August 2003.
8. NOTES PAYABLE
On December 21, 1993, General Media 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, General Media 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 General Media's common stock at the
exercise price of $0.01 per share. The Warrants also gave the holders the right
to require General Media to purchase for cash all of the Warrants at their fair
value. At the time of issuance, General Media 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 General Media, other
than accounts receivable, inventory and cash equivalents.
In July 1995, General Media repurchased $5,000,000 face amount of its
outstanding Notes, including 5,000 warrants, for cash of $4,050,000. In May
1999, General Media 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 General Media's Common Stock and 104,076 Warrants expired without
being timely exercised in accordance with the Warrant agreement. The due date of
the remaining 60,421 Warrants held by holders of the Notes was extended as part
of the negotiations for refinancing the Notes. The exercise of the 18,009
Warrants was recorded in December 2000 as a reduction in redeemable warrants and
a contribution to capital of $173,000. The expiration of the 104,076 Warrants
17
PENTHOUSE INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
8. (CONTINUED)
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"), General Media refinanced the Notes.
Under the refinancing agreement, General Media exchanged the $51,507,000 of
principal amount of Notes and any Warrants held by the 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 9 of the Notes to Condensed Consolidated Financial
Statements) 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 28, 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 the proceeds from the sale of certain real property owned by GMI
(after payment of existing debt obligations thereon) and any proceeds to General
Media from certain insurance policies (the "Policies") on the life of the
principal stockholder.
The Indenture was 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 thing, (i) restrict the ability of General
Media to dispose of assets, incur indebtedness, create liens and make certain
investments, (ii) require General Media to maintain a consolidated net worth
deficiency of no greater than $81,600,000, and (iii) restrict General Media's
ability to pay dividends unless certain financial performance tests are met.
General Media'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 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 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
General Media from certain Policies on the life of the Company's 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 General Media to achieve not less than 80% of the projected revenues and
18
PENTHOUSE INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
8. (CONTINUED)
EBITDA to be set forth in a business plan in a form and substance reasonably
satisfactory to the Holders. In addition, General Media agreed to allow the
Holders to audit the books and records of General Media 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.
General Media 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, General Media's former President and
Chief Operating Officer.
On September 13, 2002, General Media submitted a business plan to the Holders
for approval in accordance with the requirements of the Third Supplemental
Indenture. The Holders notified General Media that they had accepted the
business plan effective October 4, 2002.
On November 12, 2002, General Media and the Holders entered into a Fourth
Supplemental Indenture to incorporate the Financial Covenants into the
Indenture.
John Orlando, General Media's President and Chief Operating Officer was
terminated on January 14, 2003. 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, to avoid a deemed "Change of Control" which in
turn requires that an offer to purchase be made by General Media to all Holders.
On March 28, 2003, a proposal was submitted to the Holders requesting
confirmation that Steven Gross would be reasonably satisfactory to them as a
replacement for John Orlando as General Media's President and Chief Operating
Officer.
General Media 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.
On March 29, 2003, General Media was required to make a principal payment of
$1,950,000. On April 14, 2003, the Indenture 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 the $185,000 made available
through the repayment of an inter-company balance from GMI) and fully paid the
$1,950,000 principal amount. On April 24, 2003, General Media and the Holders
completed a letter agreement that consented to the appointment of Stephen Gross
as president and chief operating officer of General Media, consented to the
filing of 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 $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 General Media and the Holders agreed to amend the "Change of Control"
events to substitute Stephen Gross for John Orlando, to eliminate any grace
periods with respect to future principal payments commencing with the principal
payment due June 29, 2003, to provide the Holders with a copy of the employment
agreement between General Media and Stephen Gross (the "Gross Employment
Agreement") by May 19, 2003, to liquidate no less than 50% of the aggregate book
value of all its artwork pieces in commercially reasonable sales (the "Sales")
on or before October 31, 2003 and to use 100% of the net proceeds of such Sales
to make additional principal redemption's of the Series C Notes. The agreement
was subject to approval by the Holders of the Gross Employment Agreement and the
completion of a supplemental indenture incorporating the terms of the letter
agreement on or before May 26, 2003. General Media, however, did not enter into
or supply the Gross Employment Agreement to the Holders and has not completed
the supplemental indenture incorporating the terms of the letter agreement and
as a result the letter agreement was terminated. In August 2003, the Company
terminated its relationship with Mr. Gross.
19
PENTHOUSE INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
8. (CONTINUED)
On March 31, 2003, General Media was required to make an interest payment in the
amount of $1,496,000, which was not made. As a result, the Series C Notes became
callable. 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 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 General Media, including the agreement
to:
a) execute and deliver to the trustee, on or before June 16, 2003, a mortgage
and lien in a form satisfactory to the Holders encumbering certain real
estate owned by GMI (subject to prior liens of not more than $25,000,000)
and to pay costs associated with the obtaining of the mortgage,
b) cause GMI, on or before May 30, 2003, 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
GMI'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 May 30, 2003,
d) 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,
e) 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 of their
audit and legal counsel, and
f) allow the Holders to audit the books, records and assets of General Media.
General Media paid the overdue interest on June 3, 2003 and has allowed the
Holders to audit the books, records and assets of General Media, but they failed
to comply with the other requirements of the letter agreement.
General Media also did not make a required principal payment in the amount of
$1,300,000 and a required interest payment of $48,000 that was due on June 29,
2003, did not make a required interest payment on the Series C Notes of
$1,447,000 that was due on June 30, 2003 and did not deliver quarterly financial
statements for the period ending March 31, 2003 (the "Financial Statements) to
the holders of the Series C Notes as required by the indenture (the "Indenture")
defining the relative rights of General Media and the Series C Note holders. On
July 3, 2003, the holders of a majority of the principal amounts of the Notes
20
PENTHOUSE INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
8. (CONTINUED)
(the "Holders") sent a notice to General Media advising it of the failure to
make the required interest payment due on June 30, 2003, the failure to make
required principal payment of $1,300,000 that was due on June 29, 2003 and the
failure to deliver the required Financial Statements. On July 8, 2003, the
trustee issued a notice of event of default with respect to the principal
payment and the Notes became callable. The Series C Notes require interest
payments of $5,679,000 (including the accrued and unpaid interest) and principal
payments of $39,897,000 during the next twelve months plus default interest,
however payments have been suspended as a result of the bankruptcy.
9. MANDATORILY REDEEMABLE CONVERTIBLE PREFERRED STOCK
On March 29, 2001, General Media 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 General Media's common stock on a
fully diluted basis in the third year, 12.5% of General Media'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 General Media (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 General Media 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 recorded $255,000 and $265,000 of such accretion for the nine months
ended September 30, 2002 and 2003, respectively. The Company also recorded
"paid-in-kind" dividends of $1,086,000 and $1,232,000 for the nine months ended
September 30, 2002 and 2003, 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.
10. INCOME TAXES
We incurred a taxable loss of approximately $4,602,000 for the nine months ended
September 30, 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 benefit for the nine months ended September 30, 2003, is comprised of
a reduction in reserves for state income 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
21
PENTHOUSE INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
10. (CONTINUED)
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 "Tax 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
$82,383,000 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.
11. COMMITMENTS AND CONTINGENCIES
LITIGATION
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 a well known woman topless in the June 2003 issue of Penthouse
Magazine when they were in reality photographs of someone else. On May 16, 2003,
the Illinois Court dismissed the case. In June 2003 the Class Action Plaintiffs
filed an amended complaint and asked for reconsideration of the dismissal.
General Media intends to vigorously defend itself against this claim.
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 have been conducting
meetings with the employee to determine what actions need to be taken to resolve
the Charge. On May 9, 2003, the EEOC recommended a settlement of various
institutional training for the Company and a monetary award of $700,000 for the
employee. General Media has rejected the EEOC's recommendation on legal and
factual grounds and intends to vigorously defend itself in this action. It is
too early to determine the possible outcome of the proceedings. Therefore we
cannot give an opinion as to the effect this action will have on our 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 our 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.
On March 10, 2003, a former employee of General Media filed a claim in the
Supreme Court of the State of New York seeking damages of $1,000,000 for an
alleged breach of her employment contract and loss of outside opportunities. The
plaintiff claims she was setting up an outside business venture to become a
consultant to General Media when she handed in her resignation. She claims that
she handed in her resignation, but was persuaded to withdraw it, was allegedly
offered her job back, following which her employment was terminated. General
Media denies the claims and is vigorously defending itself against this claim.
On June 20, 2003, Fraserside Holdings Limited and Milcap Media Limited filed a
claim in the Supreme Court of the State of New York, for an alleged breach of
contract regarding a 1999 agreement with General Media to jointly produce and
distribute a series of adult motion pictures. The complaint alleges damages of
$2,200,000 for breach of contract, breach of fiduciary responsibility, duty of
loyalty and fair dealing, and demands for an accounting of revenues and expenses
related to the pictures and a declaration that all property in the movies
belongs to the plaintiff. General Media believes the claims are without merit
and intends to vigorously defend itself in this claim.
22
PENTHOUSE INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
11. (CONTINUED)
In December 2002, General Media received correspondence from 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 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.
On July 22, 2003, the landlord for General Media's principal offices obtained a
judgement from the Civil Court of The City Of New York against General Media for
$449,000 of unpaid rent and expenses. As of the date of the Bankruptcy filing,
the Company owed a total of $1,038,000 to the landlord consisting of the
$449,000 judgement plus additional rent and other expenses incurred up to the
date of filing for Bankruptcy. On October 21, 2003, the Bankruptcy Court
approved a settlement with the landlord that allowed the landlord to apply a
security deposit held by the landlord in the amount of $956,000 against the
$1,038,000 of pre-petition past due rent in exchange for an extension of time to
assume or reject the lease to January 31, 2004. General Media has fully paid all
its monthly rent obligations under the lease since the Bankruptcy and has until
January 31, 2004 to decide if it will assume or reject the lease. We have
recorded an impairment charge for fixed asset leasehold improvements in the
amount of $1,061,000 as part of the loss from impairment of assets in the
Condensed Consolidated Statements of Operations for the nine months ended
September 30, 2003. The impairment charge is necessary because it is uncertain
that General Media will remain in its office facilities to the end of the lease
term.
In connection with an amendment to the Distribution Agreement between Curtis
Circulation Company ("Curtis") and the Debtors dated April 15, 2003, Curtis
claims that it may deduct any amounts owed to it by GMI under the Agreement from
monies owed to General Media under its distribution agreement with Curtis, which
the Debtors dispute.
There are various other lawsuits claiming amounts against the Debtors. 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.
23
PENTHOUSE INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
11. (CONTINUED)
Unless modified by the Bankruptcy Court, pursuant to an automatic stay provision
of section 362 of the Bankruptcy Code, all of the above described pre-petition
legal proceedings against General Media and the other Debtors are currently
stayed. The claims may be subject to compromise.
12. SEGMENT INFORMATION
Through General Media, we are 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.
We are planning to be engaged in the development of theme-oriented resort
development and operation through Del Sol LLC and its subsidiaries.
24
PENTHOUSE INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
12. (CONTINUED)
Corporate and
reconciling
Publishing Online Entertainment items Consolidated
------------------------------(in thousands)---------------------------
NINE MONTHS ENDED - SEPT 30, 2003
REVENUES FROM CUSTOMERS
CIRCULATION $ 15,825 -- -- $ 15,825
ADVERTISING 2,866 -- -- 2,866
ONLINE -- $ 4,513 -- -- 4,513
ENTERTAINMENT -- -- $ 1,077 -- 1,077
OTHER 2,690 -- -- -- 2,690
--------- --------- --------- --------- ---------
TOTAL REVENUE FROM CUSTOMERS 21,381 4,513 1,077 -- 26,971
LOSS ON IMPAIRMENT OF ASSETS 2,153 2,153
DEPRECIATION AND AMORTIZATION 216 36 3 -- 255
INCOME (LOSS) FROM OPERATIONS 5,458 3,116 194 (8,587) 181
INTEREST EXPENSE 77 -- -- 3,833 3,910
REORGANIZATION EXPENSES -- -- -- 945 945
GAIN ON FORGIVENESS OF DEBT -- -- -- 210 210
DEBT RESTRUCTURING EXPENSE -- -- -- 142 142
INTEREST INCOME 3 -- -- -- 3
SEGMENT PROFIT (LOSS) BEFORE
INCOME TAXES 5,384 3,116 194 (13,297) (4,603)
MINORITY INTEREST -- -- -- 17 17
SEGMENT ASSETS 7,866 431 98 2,009 10,404
Nine Months Ended - Sept. 30, 2002
Revenues from customers
Circulation $ 27,079 -- -- -- $ 27,079
Advertising 6,053 -- -- -- 6,053
Online -- $ 5,637 -- -- 5,637
Entertainment -- -- $ 1,333 -- 1,333
Other 2,018 -- -- -- 2,018
--------- --------- --------- --------- ---------
Total revenue from customers 35,150 5,637 1,333 -- 42,120
Depreciation and amortization 341 55 3 -- 399
Income (loss) from operations 10,234 3,107 485 (8,407) 5,419
Interest expense 191 -- -- 5,380 5,571
Interest income 5 -- -- 60 65
Gain on sale of officer's life
insurance policies -- -- -- 811 811
Segment profit (loss) before
income taxes 10,048 3,107 485 (12,916) 724
Minority interest (4) (4)
Segment assets 8,155 128 628 7,136 16,047
25
PENTHOUSE INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
13. LOSS ON IMPAIRMENT OF ASSETS
We have provided for the impairment of certain of its assets in the amount of
$2,153,000 consisting of a fixed asset leasehold improvement impairment charge
in the amount of $1,061,000 and a charge for the impairment of its collection of
works of art and other collectibles in the amount of $1,092,000 on the Condensed
Consolidated Statements of Operations for the nine months ended September 30,
2003. The fixed asset leasehold improvement impairment charge is being provided
because it is uncertain that General Media will remain in its principal office
facilities to the end of the lease term (See Note 11 of the Notes To Condensed
Consolidated Financial Statements). The charge for impairment of the collection
of works of art and other collectibles is being provided because there is
significant risk that General Media will be required to liquidate these assets
under less than favorable conditions as a result of the Bankruptcy.
14. THREE FOR ONE STOCK SPLIT
On May 15, 2003 our Board of Directors declared a three for one stock split of
our common stock by means of a 200% stock dividend. We distributed two
additional shares of common stock to the shareholders through the distribution
of a dividend of two additional shares for each share owned on the record date
of May 12, 2003. The stock split occurred on May 22, 2003. The accompanying
financial statements have been restated effective January 1, 2002 to reflect the
effect of the three for one stock split on the respective periods.
15. OUTSTANDING SHARES
The number of shares outstanding includes 1,690,000 restricted shares which the
registered holder claims were lost or stolen. Despite receiving the affidavit of
loss and indemnification agreement from the registered holder, our transfer
agent will not cancel the certificates without receipt of a indemnity bond which
the holder refuses to pay for. We will not permit the transfer or make any
distribution in respect of the shares represented by the lost or stolen
certificates and is investigating whether and under what circumstances it would
pay for an indemnity bond.
16. CONSOLIDATING FINANCIAL STATEMENTS
The accompanying condensed consolidated financial statements include Penthouse
International, Inc., which did not file for protection, and General Media, Inc.
and the other Debtors who declared Bankruptcy. The financial statements of
General Media, Inc. and the other Debtors represent substantially all of the
assets and liabilities of the consolidated companies prior to November 6, 2003.
The balance sheet of Penthouse International, Inc. as of September 30, 2003
without General Media, Inc. and the other Debtors consists of accrued expenses
and other current liabilities of $325,000, payables to affiliated companies of
$518,000, minority interest of $92,000 and a stockholders deficit of $935,000.
The statement of operations of Penthouse International, Inc. for the nine months
ended September 30, 2003 without General Media and the other Debtors consists of
selling, general and administrative expenses of $501,000, income tax expense of
$1,000 and minority interest of $17,000. The statement of operations of
Penthouse International, Inc. for the three months ended September 30, 2003
without General Media, Inc. and the other Debtors consists of selling, general
and administrative expenses of $428,000, income tax expense of $1,000 and
minority interest of $5,000.
26
PENTHOUSE INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
17. SUBSEQUENT EVENT - ACQUISITION OF DEL SOL INVESTMENTS LLC
On November 6, 2003, we entered into a Membership Interest Purchase Agreement
(the "Purchase Agreement") with Del Sol Investments, GP a California general
partnership under which we agreed to acquire 100% of the membership interests of
Del Sol Investments LLC, an Arizona limited liability company (formerly known as
Mortgage Capital Fund One, L.L.C) in exchange for 30,000,000 shares of our
common stock and 10,500,000 shares of newly authorized Series C Preferred Stock,
which will have an aggregate liquidation preference of $105 million and a
cumulative preferred dividend of 4% of the liquidation preference per year,
payable quarterly in kind. In addition, we agreed to issue 3,000,000 shares of
common stock and 1,050,000 shares of Series C Preferred Stock to ANL Capital GP
as a consulting fee equal to 10% of the consideration received by the seller.
The Series C Preferred Shares will be convertible into common shares at $3.00
per share and may not be converted until our common stock is listed on a
recognized national stock exchange. We issued the shares of common stock to the
seller called for by the agreement and, prior to issuing the Series C Preferred
Stock, we will, subject only to the procedural requirements of Florida corporate
law, file an amendment and restatement to our articles of incorporation (which
has been approved by the requisite majority of the outstanding shares of our
capital stock) to designate the Series C Preferred Shares, having the relative
rights and preferences called for by the agreement, eliminate the Series B
Shares (which were authorized and never issued) and eliminate certain protective
provisions relating to 5,000 outstanding shares of Series A Preferred Stock that
have been waived by the holder. The Del Sol LLC transaction set forth in the
Purchase Agreement will close when the amendment to our articles of
incorporation is recorded with the state of Florida and we have issued and
delivered the preferred stock consideration described hereinabove, as well as
our completion of any other legal requirements that may be required to
consummate the transaction.
At the time the Purchase Agreement was entered into, Del Sol Investments, LLC
owned 99.5% of Del Sol Investments, S.A. de C.V., an organization formed by
Sergio Martinez, the brother of the beneficiary of the majority shareholder,
which owns by contract real estate consisting of 150 hectares (370.5 acres) of
land with ocean frontage in the city and harbor of Zihuatanejo, State of
Guerrero, Mexico (the "Property"). The Property is a planned resort development
in the resort area known as Ixtapa.
We plan to develop the Property in several phases, including a themed resort, a
golf course, residential development and timeshare facilities. We also intend to
utilize financing secured by the property for general corporate purposes. The
property asset may be included as collateral, or other contribution, in the Plan
of Reorganization for General Media and its subsidiaries which are subject to
Chapter 11 proceedings. The beneficial owner of a majority of the outstanding
PII common stock has retained bankruptcy counsel and investment bankers
independent of those retained by the Debtors to assist in developing and
financing a Plan of Reorganization for the Debtors and to provide advice on the
use of the Property in connection with the proceedings.
27
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
impact of the reorganization and possible section 363 sale of General Media,
Inc., and the other Debtors under Chapter 11 of the Bankruptcy Code which
involves substantially all of our assets (prior to November 6, 2003) and
operations and which may result in the loss of any equity in General Media,
Inc.; (b) the ability of such entities to operate pursuant to the terms of the
debtor-in-possession financing facility; (c) the ability of such entities to
obtain court approval with respect to motions in the Chapter 11 proceeding made
by them from time to time; (d) the ability of such entities to develop, obtain
approval for and implement a plan of reorganization; (e) risks associated with
third parties seeking and obtaining court approval to terminate or shorten the
exclusivity period for the entities to propose and confirm a plan of
reorganization or to convert the case to a Chapter 7 case; (f) the ability of
the entities to obtain and maintain normal terms with vendors and service
providers; (g) the ability of the entities to maintain contracts that are
critical to its operations; (h) the potential adverse impact of the Chapter 11
case on the entities liquidity or results of operations; (i) 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; (j) increases in paper and printing prices; (k)
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; (l) effects of the consolidations taking place among
businesses which are part of the magazine distribution system; (m) uncertainty
with regard to the future market for entertainment, e-commerce and advertising
by way of the Internet; and (n) 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. Readers are
cautioned not to place undue reliance on 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
Penthouse International, Inc. ("PII") owns 99.5% of General Media and
will own, subject to the procedural requirements of Florida corporate law
discussed below, 100% of Del Sol Investments, LLC.
Del Sol LLC owns 99.5% of Del Sol Investments S.A. de C.V. ("Del Sol SA"), a
Mexican real estate development company which owns by contract 370.5 acres
of land with ocean frontage in Zihuatanejo, State of Guerrero, Mexico (the
"Property"). The Property is a planned resort development in the resort area
known as Ixtapa. We plan to develop the Property in several phases, including a
themed resort, a golf course, residential development and timeshare facilities.
We also intend to utilize financing secured by the property for general
corporate purposes. The property asset may be included as collateral, or other
contribution, in the Plan of Reorganization for General Media, Inc. and its
subsidiaries which are subject to Chapter 11 proceedings. The beneficial owner
of a majority of the outstanding PII common stock has retained bankruptcy
counsel and investment bankers to provide advice on the use of the Property in
connection with the proceedings.
28
General Media is a brand-driven global entertainment company founded in 1965 by
Robert C. Guccione. General Media caters to men's interests through various
trademarked publications, movies, the Internet, adult entertainment clubs and
consumer product licenses. General Media's flagship PENTHOUSE brand is widely
identified with premium entertainment for adult audiences. Its trademarks are
licensed to third parties worldwide in exchange for recurring royalty payments.
RECENT DEVELOPMENTS
ACQUISITION OF DEL SOL
On November 6, 2003, we entered into a Membership Interest Purchase Agreement
with Del Sol Investments, GP a California general partnership under which we
will acquire 100% of the membership interests of Del Sol Investments, L.L.C., an
Arizona limited liability (formerly known as Mortgage Capital Fund One, L.L.C.)
in exchange for 30,000,000 shares of our common stock and 10,500,000 shares of
Series C Preferred Stock, having an aggregate liquidation preference of $105
million and a cumulative preferred dividend of 4% of the liquidation preference
per year, payable quarterly in kind. In addition, we agreed to issue 3,000,000
shares of common stock and 1,050,000 shares of Series C Preferred Stock to ANL
Capital GP as a consulting fee equal to 10% of the consideration received by the
sellers. The shares of Series C Preferred, when issued pursuant to an amendment
and restatement of our articles of incorporation that has been approved by the
holders of the requisite number of outstanding shares of our capital stock ,will
convertible into common shares at $3.00 per share and may not be converted until
our common stock is listed on a recognized national stock exchange. The Del Sol
LLC transaction set forth in the Purchase Agreement will close when the
amendment to our articles of incorporation is recorded with the state of Florida
and we have issued and delivered the preferred stock consideration described
hereinabove, as well as our completion of any other legal requirements that may
be required to consummate the transaction.
At the time the Purchase Agreement was entered into, Del Sol Investments, LLC
owned 99.5% of Del Sol Investments, S.A. de C.V., which owns by contract real
estate consisting of 150 hectares (370.5 acres) of land with ocean frontage in
the city and harbor of Zihuatanejo, State of Guerrero, Mexico and a lease of
adjacent land presently used as a cattle ranch and coconut plantation (the
"Property"). The Property is a planned resort development in the resort area
known as Ixtapa.
CHANGE IN CONTROL
In a series of simultaneous transactions related to the acquisition of Del Sol,
LLC, beneficial ownership of 127,500,000 shares of our outstanding common stock
was transferred from General Media International, Inc. ("GMII") to Dr. Luis
Enrique Fernando Molina and The Molina Vector Investment Trust.
RECENT OPERATING RESULTS
Consolidated net revenue for the month of October was $4,139,791, up from
$1,474,053 in September, an increase of $2,665,738. Consolidated operating
income for the month of October was $882,763, up from a loss of $213,204 in
September, an increase of $1,095,967. After giving effect to bankruptcy
restructuring expense of $696,569 and $544,075 in October and September,
respectively, after tax net income in October was $149,414 versus a loss of
$877,259 in September, an increase of $1,026,673. The increase in net revenue,
net operating income and after tax net income was principally attributable to
General Media resuming full publication of its six magazines. The above
information has not been reviewed by our independent auditors.
29
CHAPTER 11 BANKRUPTCY FILING
PII is the holder of 99.5% of the common stock of General Media, Inc. and
subsidiaries ("General Media"). The Company is majority owned by General Media
International, Inc. ("GMI"). On August 12, 2003, General Media and its direct
and indirect subsidiaries, General Media Art Holdings, Inc., General Media
Communications, Inc., General Media Entertainment, Inc., General Media (UK),
Ltd., GMCI Internet Operations, Inc., GMI On-Line Ventures, Ltd., Penthouse
Images Acquisitions, Ltd. and Pure Entertainment Telecommunications, Inc.,
(collectively, the "Debtors"), filed voluntary petitions for relief under
Chapter 11 of Title 11 of the United States Code (the "Bankruptcy Code") in the
United States Bankruptcy Court for the Southern District of New York (the
"Bankruptcy Court"). The Debtors are managing their properties and operate their
businesses as "debtors-in-possession" subject to the jurisdiction, supervision
and orders of the Bankruptcy Court (Case No. 03-15078) and in accordance with
Sections 1107(a) and 1108 of the Bankruptcy Code. Penthouse International, Inc.
("PII") did not file for protection.
The Debtors filed a motion on November 26, 2003 to extend the time in which they
have the exclusive right to file a reorganization plan and solicit acceptances
of such plan form December 1, 2003 and February 8, 2004, respectively to
February 9, 2004 and March 9, 2004, respectively. If the motion is not granted,
the assets of the Debtors risk being auctioned.
Additional information concerning the Chapter 11 proceeding can be found in the
Notes to Condensed Consolidated Financial Statements. For additional
information, Reference is made to publicly available documents filed with the
bankruptcy court to determine the most current status of all matters related to
the bankruptcy case of General Media.
OVERVIEW
Beginning in 1995, General Media developed its Internet website with the
introduction of Penthousemag.com through which it began digitally distributing
our proprietary content. It operates through the domain name www.Penthouse.com
where members pay subscription fees for access to our content.
General Media also holds significant intellectual property and other intangible
assets. It owns 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 its magazines General Media has also
accumulated a library of approximately one million photographic images. General
Media seeks to protect its trademarks through registration and periodic
infringement enforcement. General Media regularly evaluates requests to license
its brands, its video library or to participate in other commercial ventures by
contributing its trademarks, including events with its PENTHOUSE PETS. General
Media's trademarks and copyrights are critical to the success and potential
growth of all of our businesses.
Beginning in the third quarter of 2002, General Media began to license
trademarks to select adult entertainment clubs in consideration for a percentage
of the gross revenue of the clubs.
General Media is 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
entertainment clubs. The online segment is engaged in the sale of memberships to
General Media's 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.
30
During the nine months ended September 30, 2003, net revenues declined by 36.0%
from the comparable period in 2002. This decline is primarily attributable to
General Media being unable to print and distribute PENTHOUSE, PENTHOUSE LETTERS
and GIRLS OF PENTHOUSE magazines during May 2003 and all of its publications
during June 2003. In July 2003 the Company was unable to print issues of FORUM
and VARIATION. In the month of August 2003, the Company was able to distribute
PENTHOUSE, PENTHOUSE LETTERS and GIRLS OF PENTHOUSE magazines, but was unable to
print issues of FORUM, VARIATIONS and DIGEST and in September, PENTHOUSE,
PENTHOUSE LETTERS and VARIATIONS were delayed. These disruptions in magazine
distribution (collectively the "Disrupted Publications") were a result of the
need to reach an agreement with printing contractors, paper suppliers and
magazine distributor regarding past due invoices. An agreement for these
services was reached in the Chapter 11 proceeding resulting in the publication
of six magazines commencing November, 2003.
Management was successful in reducing selling, general and administrative during
the nine months ended September 30, 2003, by 24.5% from the comparable period in
2002 as a result of cost reduction measures implemented during 2002 and 2003 and
tight controls over cash spending in 2003.
Income from operations decreased 96.7% during the nine months ended September
30, 2003, primarily as a result of the effect of the lost revenue from the
Bankruptcy and delayed issuance of the magazines, and impairment charges on
assets in the amount of $2.2 million, partially offset by reduced selling,
general and administrative expenses. The impairment charges on assets resulted
from an impairment of fixed asset leasehold improvements as a result of
uncertainty that we would remain in our current principal office to the end of
the lease term and an impairment of our collection of works of art and other
collectibles as a result of the Bankruptcy.
Operating margins decreased from 12.9% to 4.7%, for the nine months ending
September 30, 2002 and 2003, respectively, primarily as a result of the same
factors as the decrease in income from operations.
Net income was $0.7 million for the nine months ended September 30, 2002,
compared to a net loss of $3.8 million for the nine months ended September 30,
2003, a decrease of $4.5 million, primarily as a result of the same factors
given above.
EBITDA decreased from $5.8 million to $2.6 million, a decrease of $3.2 million
in the comparable quarters.
31
EBITDA during the nine months ended September 2002 and 2003 was computed as
follows:
EBITDA (1)
Nine Months
September 30,
(Unaudited)
2002 2003
---- ----
Net income (loss) $ 0.7 $ (3.8)
Adjusted for:
Interest expense, net 5.5 3.9
Loss on impairment of assets -- 2.2
Reorganization expenses -- 0.9
Tax adjustment -- (0.8)
Depreciation 0.4 0.3
Gain on forgiveness of debt -- (0.2)
Debt restructuring costs -- 0.1
Gain on sale of officer's life
insurance (0.8) --
------- -------
$ 5.8 $ 2.6
======= =======
(1) EBITDA represents income from operations before interest expense, interest
income, loss on impairment of assets, reorganization expenses, tax
adjustments, depreciation, gain on forgiveness of debt, debt restructuring
costs and gain on sale of officer's life insurance. 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.
The following table sets forth our selected quarterly data for the nine months
and three months ended September 30, 2002 and 2003:
Nine Months Three Months
September 30, September 30,
------------- -------------
2002 2003 2002 2003
---- ---- ---- ----
Net revenues $42.1 $27.0 $11.8 $8.2
Income (loss) from operations 5.4 0.2 0.3 (0.7)
Net income (loss) 0.7 (3.8) (1.5) (1.5)
We have undertaken or are planning the following actions during 2003, which are
primarily directed at improving its revenue generating capability, with the
intention of improving its cash flow:
o Developing a reorganization plan for General Media's
operations as part of the Chapter 11 Bankruptcy Proceeding in
an effort to improve the performance of its operations;
32
o Expanding royalty income through the licensing of its
trademarks to additional adult entertainment clubs. A new club
in New York, New York was opened by a licensee in June 2003;
o Attracting capital in the form of upfront license payments
from club licensing, and indirect additional risk capital for
the construction of branded club facilities, including the New
York facility, which will assist in growing its licensing
income;
o 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 Evaluating opportunities to expand the licensing of its
trademarks;
o 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.
RESULTS OF OPERATIONS (THREE MONTHS ENDED SEPTEMBER 30, 2003 VS. 2002)
- ----------------------------------------------------------------------
NET REVENUES
- ------------
Total net revenues were $11.8 million for the three months ended September 30,
2002, compared to revenues of $8.2 million for the three months ended September
30, 2003, a decrease of $3.6 million. This decrease was a combination of $3.3
million from General Media's Publishing Segment, $0.1 million from General
Media's Entertainment Segment and $0.2 million for the Online Segment.
Net Revenue
Three Months
September 30,
2002 2003
---- ----
Publishing Segment $9.7 $6.4
Online Segment 1.7 1.5
Entertainment Segment 0.4 0.3
------ -----
$11.8 $8.2
====== =====
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 $1.9 million, from $5.8 million in 2002 to $3.9 million for
the three months ended September 30, 2003. This decrease is primarily
attributable to our being unable to distribute the Disrupted Publications in the
months of July, August and September described in the Overview above, which was
caused by our liquidity problems. Newsstand sales have also been adversely
affected by the continued weakness in the economy, by the continued loss of
newsstand distribution outlets due to the change in social climate towards men's
magazines, by 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 General Media's magazines. To
attempt to offset this decline, General Media has implemented special marketing
strategies aimed at developing new outlets for its magazines and rewarding
growth in sales by distributors.
33
Advertising revenue represented $1.0 million of the publishing segment revenue
decrease, dropping from $1.7 million for the three months ended September 30,
2002 to $0.7 million for the three months ended September 30, 2003. This
decrease is primarily attributable to our being unable to distribute the
Disrupted Publications in the months of July, August and September 2003. This
decrease is also attributable to a decrease in the number of advertising pages
sold per issue and a decrease in the average rate per page of advertising pages
sold in PENTHOUSE magazine and the Affiliate Publications.
Subscription revenue accounted for $0.8 million of the decrease in our
publishing segment, decreasing from $1.6 million for the three months ended
September 30, 2002 to $0.8 million for the three months ended September 30, 2003
due. The decrease is primarily due to our inability to distribute the Disrupted
Publications in the months of July, August and September 2003. In addition, the
decrease is partially 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 a slight decrease in
the rate per copy sold of PENTHOUSE magazine.
Revenues from licensing of foreign editions increased from $0.4 million for the
three months ended September 30, 2002 to $0.5 million for the three months ended
September 30, 2003.
ONLINE SEGMENT
- --------------
The decrease in revenue in the online segment is primarily attributable to a
decrease in revenue from the sale of memberships to the Internet Site of $0.2
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
negative publicity and disruptions to credit card processing and hosting
services caused by the Bankruptcy. In addition sales were adversely affected the
declining circulation of General Media's magazines that provide a major source
of advertising for the site.
ENTERTAINMENT SEGMENT
- ---------------------
The decrease in revenue in the entertainment segment was primarily due to
General Media's video business. Revenues of the video business were $0.3 million
for the three months ended September 30, 2002 compared to $0.2 million for the
three months ended September 30, 2003, a decrease of $0.1 million. Revenues for
the three months ended September 30, 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 General Media's pay-per-call business were $0.1 million for the
three months ended September 30, 2002 compared to $0.2 million for the three
months ended September 30, 2003, an increase of $0.1 million.
PUBLISHING - PRODUCTION, DISTRIBUTION, PICTORIAL AND EDITORIAL
- --------------------------------------------------------------
Publishing-production, distribution, pictorial and editorial expenses were $5.1
million and $2.4 million for the three months ended September 30, 2002 and 2003,
respectively, a decrease of $2.7 million. The decrease is primarily due to
General Media's inability to print and distribute the Disrupted Publications in
the months of July, August and September 2003, as explained above.
34
Paper costs were $1.6 million and $0.8 million for the three months ended
September 30, 2002 and 2003, respectively, representing $0.8 million of the
decrease. Printing costs were $1.8 million for the three months ended September
30, 2002, compared to $0.9 million for the three months ended September 30,
2003, representing $0.9 million of the decrease. These decreases are primarily
the result of our being unable to distribute a majority of our magazines in the
months of July, August and September 2003, as explained above. In addition, the
decreases were 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 $0.5 million for the three months ended
September 30, 2002 and 2003, respectively, a decrease of $0.4 million. The
decrease is primarily the result of General Media being unable to distribute the
Disrupted Publications in the months of July, August and September 2003.
Pictorial and editorial costs were $0.8 million and $0.3 million for the three
months ended September 30, 2002 and 2003, respectively, a decrease of $0.5
million. The decrease is primarily the result of General Media being unable to
distribute the Disrupted Publications in the months of July, August and
September 2003.
ONLINE - DIRECT COSTS
- ---------------------
Direct costs for the online segment were $30,000 and $38,000 for the three
months ended September 30, 2002 and 2003, respectively, an increase of $8,000.
The increase is primarily attributable to an increase in fees paid to content
providers.
ENTERTAINMENT - DIRECT COSTS
- ----------------------------
Entertainment direct costs were $0.2 million for both the three months ended
September 30, 2002 and 2003.
SELLING, GENERAL AND ADMINISTRATIVE
- -----------------------------------
Selling, general and administrative expense was $5.7 million for the three
months ended September 30, 2002, compared to $4.6 million for the three months
ended September 30, 2003, a decrease of $1.1 million. The decrease is primarily
due to a decrease in legal expense of $0.3 million, consulting expense of $0.2
million, data processing expense of $0.2 million, bank charges of $0.2 million,
subscription acquisition cost of $0.2 million, promotional expense of $0.1
million, fulfillment expense of $0.1 million, security expense of $0.1 million
and commission expense of $0.1 million. This was partially offset by an increase
in professional fees of $0.4 million for the three months ended September 30,
2003.
Selling, general and administrative expenses for the Publishing Segment were
$2.4 million for the three months ended September 30, 2002, compared to $1.9
million for the three months ended September 30, 2003, a decrease of $0.5
million. The decrease is primarily due to a decrease in subscription acquisition
expenses of $0.2 million, fulfillment expense of $0.1 million and promotional
expense of $0.1 million and commission expense of $0.1 million during the three
months ended September 30, 2003.
Selling general and administrative expenses for the online segment were $0.8
million for the three months ended September 30, 2002, compared to $0.3 million
for the three months ended September 30, 2003, a decrease of $0.5 million. The
decrease is primarily attributable to a decrease in data processing expense of
$0.2 million, a decrease in bank charges of $0.2 million and a decrease in
salaries and benefits of $0.1 million during the three months ended September
30, 2003.
35
Selling, general and administrative expenses for the entertainment segment were
$0.1 million for both the three months ended September 30, 2002 and 2003.
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 $2.4 million for the three months ended
September 30, 2002, compared to $2.3 million for the three months ended
September 30, 2003, a decrease of $0.1 million. This decrease is primarily
attributable to decreased legal expense of $0.3 million, consulting fees of $0.1
million and security expense of $0.1 million. This decrease was partially offset
by an increase in professional fees of $0.4 million for the three months ended
September 30, 2003.
LOSS ON IMPAIRMENT OF ASSETS
- ----------------------------
We have provided for the impairment of certain of General Media's assets in the
amount of $1.1 million a charge for the impairment of our collection of works of
art and other collectibles on the Condensed Consolidated Statements of
Operations for the three months ended September 30, 2003. The charge for
impairment of the collection of works of art and other collectibles is being
provided because there is significant risk that General Media will be required
to liquidate these assets under less than favorable conditions as a result of
the Bankruptcy.
BAD DEBT EXPENSE
- ----------------
Bad debt expense was $0.5 million for the three months ended September 30, 2002,
compared to $0.3 million for the three months ended September 30, 2003, a
decrease of $0.2 million. The decrease is primarily due to allowances recorded
in the prior year for receivables from our video distributor of $0.1 million and
for telephone services of $0.1 million.
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 $97,000 and $28,000 for the three months ended
September 30, 2002 and September 30, 2003, respectively.
DEPRECIATION AND AMORTIZATION
- -----------------------------
Depreciation and amortization expense was $0.1 million for both the three months
ended September 30, 2002, and September 30, 2003, respectively.
INCOME (LOSS) FROM OPERATIONS
- -----------------------------
As a result of the above-discussed factors, income from operations was $0.3
million for the three months ended September 30, 2002, compared to a loss of
$0.7 million for the three months ended September 30, 2003.
36
INTEREST EXPENSE
- ----------------
Interest expense was $1.8 million for the three months ended September 30, 2002,
compared to $0.7 million for the three months ended September 30, 2003, a
decrease of $1.1 million. This decrease is due to a decrease in the total
outstanding principal amount of General Media's Series C Notes during the period
up to August 12, 2003 and not having any interest on the Series C Notes after
that date due to the bankruptcy.
REORGANIZATION EXPENSES
- -----------------------
We have incurred $0.9 million of bankruptcy expenses during the nine months
ended September 30, 2003, which principally relates to professional fees related
to the Bankruptcy.
GAIN ON FORGIVENESS OF DEBT
- ---------------------------
The gain on forgiveness of debt of $0.2 million for the three months ended
September 30, 2003 was due to relief of certain liabilities after filing for
Chapter 11 bankruptcy.
DEBT RESTRUCTURING EXPENSES
- ---------------------------
We incurred $0.1 million of debt restructuring expenses during the nine months
ended September 30, 2003, which principally relate to fees associated with the
DIP Financing.
INTEREST INCOME
- ---------------
Interest income was $0.04 million for the three months ended September 30, 2002,
compared to no interest income for the three months ended September 30, 2003, a
decrease of $0.04 million. The decrease is due to a decrease in the amount of
cash available for investment during the current year.
INCOME (LOSS) BEFORE THE PROVISION FOR INCOME TAXES
- ---------------------------------------------------
As a result of the above discussed factors, loss before income tax expense for
the three months ended September 30, 2002 was $1.5 million, compared to a loss
before income tax expense of $2.3 million for the three months ended September
30, 2003.
RESULTS OF OPERATIONS (NINE MONTHS ENDED SEPTEMBER 30, 2003 VS. 2002)
- ---------------------------------------------------------------------
NET REVENUES
- ------------
Total net revenues were $42.1 million for the nine months ended September 30,
2002, compared to revenues of $27.0 million for the nine months ended September
30, 2003, a decrease of $15.1 million. This decrease was a combination of $13.8
million from General Media's Publishing Segment, $0.2 million from General
Media's Entertainment Segment and $1.1 million for the Online Segment.
Net Revenue
Nine Months
September 30,
(thousands)
2002 2003
---- ----
Publishing Segment $35.2 $21.4
Online Segment 5.6 4.5
Entertainment Segment 1.3 1.1
------ ------
$42.1 $27.0
====== ======
37
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 $8.8 million, from $21.4 million in 2002 to $12.6 million for
the nine months ended September 30, 2003. This decrease is primarily
attributable to our being unable to distribute the Disrupted Publications in the
months of May, June, July, August and September 2003, as explained above, 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 first two months of 2003 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 been decreasing. From
September 30, 1999 to September 30, 2003, PENTHOUSE magazine and the Affiliate
Publications domestic average monthly newsstand circulation decreased by 44%.
The decrease in circulation was due to our inability to distribute the Disrupted
Publications during the months of May, June, July, August and September 2003, as
explained above, 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 first two months of 2003, the loss of several newsstand
distribution outlets due to the change in the social climate towards men's
magazines, advances in electronic technology, as outlined above, and ongoing
acquisitions and consolidations of companies in the magazine distribution
industry. General Media is 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. General
Media employs 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 General
Media's newsstand sales have fallen below that of the prior year due to the
negative factors listed above and the weakness of the economy over the past few
years that has resulted in an increase in the number of bankruptcies or near
bankruptcies of companies within the magazine distribution system. We expect
newsstand sales for the fourth quarter and the year to remain lower than the
prior year as a result of these factors.
Advertising revenue represented $3.2 million of the publishing segment revenue
decrease, dropping from $6.1 million for the nine months ended September 30,
2002 to $2.9 million for the nine months ended September 30, 2003. This decrease
is primarily attributable to our being unable to distribute the Disrupted
Publications in the months of May, June, July, August and September 2003, as
explained above. In addition, there was 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.
Advertising revenue for the first six months of 2003 was adversely affected by
inability to distribute the Disrupted Publications in the months of May, June,
July, August and September 2003, as explained above. The advertising revenues of
PENTHOUSE magazine and the Affiliate Publications have been declining 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
38
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. In addition, the delays in the distribution
of the magazines and negative affects of our Chapter 11 bankruptcy filing on
customer goodwill have adversely affected our sales efforts. 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 $2.5 million of the decrease in our
publishing segment, decreasing from $5.6 million for the nine months ended
September 30, 2002 to $3.1 million for the nine months ended September 30, 2003.
This decrease is primarily attributable to our being unable to distribute the
Delayed and Suspended Publications in the months of May, June, July, August and
September 2003, as explained above. In addition, there was 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 cancel subscription direct mailings that had
been planned for the first nine months of 2003 due to our liquidity problems.
The level of expected revenue from subscriptions is heavily dependent on the
number of subscription acquisition direct mailings done during the year. We also
expect a decrease in new customer orders as a result of the delays in the
distribution of the magazines mentioned above and the negative affects of our
Chapter 11 bankruptcy filing on customer goodwill, although the impact of these
factors is not yet known. We therefore expect subscription revenues to fall
below that of 2002.
Revenues from licensing of foreign editions increased from $1.2 million for the
nine months ended September 30, 2002 to $1.4 million for the nine months ended
September 30, 2003, an increase of $0.2 million.
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.
ONLINE SEGMENT
- --------------
The decrease in revenue in the online segment is primarily attributable to a
decrease in revenue from the sale of memberships to the Internet Site of $1.1
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 and declining circulation of the Company's magazines
that provide a major source of advertising for the site. In October 2002, we
39
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 also decreased in the first nine months of 2003 as compared to the
prior year. Revenue in the first nine months of 2003 has been negatively
impacted by temporary disruptions in operations caused by problems with vendors
and service providers because of past due invoices as a result of our liquidity
problems and subsequent bankruptcy filing, as well as weakness in the economy
which has caused revenue to fall below that of the prior year. Revenue in the
fourth quarter of 2003 will depend on the strength of the economy during the
remainder of 2003, which is uncertain at this time and our ability to maintain
normal operations while operate under Chapter 11 of the Bankruptcy Code. Visa
has recently announced a tightening of its chargeback limits effective October
1, 2003. We do not believe we will need to improve our validation methods any
further to meet the new requirements and the change will have no material effect
on the sales of memberships to the Internet Site. 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 established its own regulations for maximum chargeback and
refund levels that went into effect in April 2002. General Media's chargeback
and refund levels have remained well within those required by MasterCard's
regulations and these 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 is expected to remain fairly consistent
with that of 2002.
ENTERTAINMENT SEGMENT
- ---------------------
The decrease in revenue in the entertainment segment was primarily due to
General Media's declining video business. Revenues of the video business were
$0.9 million for the nine months ended September 30, 2002 compared to $0.6
million for the nine months ended September 30, 2003, a decrease of $0.3
million. Revenues for the nine months ended September 30, 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 General Media's pay-per-call business were $0.4 million and $0.5
million for the nine months ended September 30, 2002 and 2003, respectively, an
increase of $0.1 million.
40
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 nine months ended
September 30, 2003 have decreased over the prior year for the reasons stated
above and are expected to remain below the prior year levels for the remainder
of the 2003. Future results will depend on how quickly General Media is able to
reach agreements with prospective partners in producing and distributing the
movies, the timing of the movie releases and our ability to maintain normal
operations while we operate under Chapter 11 of the Bankruptcy Code. 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 of efforts by
the two companies.
PUBLISHING - PRODUCTION, DISTRIBUTION, PICTORIAL AND EDITORIAL
- --------------------------------------------------------------
Each of the following were caused by General Media being unable to distribute
the Disrupted Publications in May, June, July, August and September, 2003:
o Publishing-production, distribution, pictorial and editorial
expenses were $16.7 million and $9.7 million for the nine
months ended September 30, 2002 and 2003, respectively, a
decrease of $7.0 million.
o Paper costs were $5.7 million and $3.2 million for the nine
months ended September 30, 2002 and 2003, respectively,
representing $2.5 million of the decrease. Printing costs were
$6.0 million for the nine months ended September 30, 2002,
compared to $3.6 million for the nine months ended September
30, 2003, representing $2.4 million of the decrease. In
addition, the decreases were 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.
o Distribution costs were $2.8 million and $1.8 million for the
nine months ended September 30, 2002 and 2003, respectively, a
decrease of $1.0 million.
o Pictorial and editorial costs were $2.2 million and $1.2
million for the nine months ended September 30, 2002 and 2003,
respectively, a decrease of $1.0 million.
General Media has been steadily reducing its publishing-production, distribution
and editorial expenses over the past several years by reducing the number of
copies printed, reducing the number of pages per issue, negotiating reductions
in paper and printing costs. General Media has also changed the grades of paper
used to produce the magazines and changing their design to improve production
efficiencies. We expect expenses to be lower due to 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 $0.1 million for both the nine months
ended September 30, 2002 and 2003, respectively. Direct costs are expected to
increase at about the same rate as inflation in future years.
41
ENTERTAINMENT - DIRECT COSTS
- ----------------------------
Entertainment direct costs were $0.5 million for the nine months ended September
30, 2002 and $0.3 million for the nine months ended September 30, 2003, a
decrease of $0.2 million. The decrease in entertainment direct costs was due to
lower levels of production of films during the first nine months of 2003. Direct
costs for the remainder of 2003 are expected to remain below prior year levels
and to increase in 2004 and thereafter due to increased levels of production of
films and inflation.
SELLING, GENERAL AND ADMINISTRATIVE
- -----------------------------------
Selling, general and administrative expense was $18.2 million for the nine
months ended September 30, 2002, compared to $13.7 million for the nine months
ended September 30, 2003, a decrease of $4.5 million. The decrease is primarily
due to a decrease in salaries and benefits of $1.6 million, subscription
acquisition expenses of $1.1 million, legal expense of $0.6 million, bank
charges of $0.3 million, promotional expense of $0.2 million, data processing
expenses of $0.2 million, service contract expense of $0.2 million, consulting
expense of $0.1 million, fulfillment expense of $0.1 million, security expense
of $0.1 million, commission expense of $0.1 million, dues and subscription
expense of $0.1 million and initial placement allowance expense of $0.1 million
This was partially offset by an increase in professional fees of $0.3 million
for the nine months ended September 30, 2003.
Selling, general and administrative expenses for the Publishing Segment were
$7.9 million for the nine months ended September 30, 2002, compared to $6.2
million for the nine months ended September 30, 2003, a decrease of $1.8
million. The decrease is primarily due to a decrease in subscription acquisition
expenses of $1.1 million, promotional expense of $0.2 million, salaries and
benefits of $0.1 million, commission expense of $0.1 million, fulfillment
expense of $0.1 million, initial placement allowance expense of $0.1 million and
promotional expense of $0.1 million during the nine months ended September 30,
2003.
Selling general and administrative expenses for the online segment were $2.4
million for the nine months ended September 30, 2002, compared to $1.3 million
for the nine months ended September 30, 2003, a decrease of $1.1 million. The
decrease is primarily attributable to a decrease in salaries and benefits of
$0.5 million, bank charges of $0.3 million, data processing expense of $0.2
million and service contract expense of $0.1 million during the nine months
ended September 30, 2003.
Selling, general and administrative expenses for the entertainment segment were
$0.3 million for both the nine months ended September 30, 2002 and 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 $7.6 million for the nine months ended
September 30, 2002, compared to $6.0 million for the nine months ended September
30, 2003, a decrease of $1.6 million. This decrease is primarily attributable to
decreased salaries and benefits of $1.0 million, legal expense of $0.6 million,
security expense of $0.1 million, service contract expense of $0.1 million, dues
and subscription expense of $0.1 million and consulting fees of $0.1 million.
This decrease was partially offset by an increase in professional fees of $0.3
million and meal and travel expense of $0.1 million for the nine months ended
September 30, 2003.
In future years we expect selling, general and administrative expenses to
increase at about the same rate as inflation.
42
LEASEHOLD IMPROVEMENT IMPAIRMENT CHARGE
- ---------------------------------------
We provided for a leasehold improvement impairment charge of $1.1 million for
the nine months ended September 30, 2003 because it is uncertain that we will
remain in our principal office facilities to the end of the lease term.
LOSS ON IMPAIRMENT OF ASSETS
- ----------------------------
We have provided for the impairment of certain of our assets in the amount of
$2.2 million consisting of a fixed asset leasehold improvement impairment charge
in the amount of $1.1 million and a charge for the impairment of our collection
of works of art and other collectibles in the amount of $1.1 million on the
Condensed Consolidated Statements of Operations for the nine months ended
September 30, 2003. The fixed asset leasehold improvement impairment charge is
being provided because it is uncertain that the Company will remain in its
principal office facilities to the end of the lease. The charge for impairment
of the collection of works of art and other collectibles is being provided
because there is significant risk that the Company will be required to liquidate
these assets under less than favorable conditions as a result of the Bankruptcy.
BAD DEBT EXPENSE
- ----------------
Bad debt expense was $0.3 million for both nine months ended September 30, 2002
and 2003, respectively.
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 $0.4 million and $0.2 million for the nine months
ended September 30, 2002 and 2003, respectively.
DEPRECIATION AND AMORTIZATION
- -----------------------------
Depreciation and amortization expense was $0.4 million for the nine months ended
September 30, 2002, compared to $0.3 million for the nine months ended September
30, 2003, a decrease of $0.1 million. The decrease was primarily due to
decreased spending on fixed assets.
INCOME FROM OPERATIONS
- ----------------------
As a result of the above-discussed factors, income from operations was $5.4
million for the nine months ended September 30, 2002 as compared to income of
$0.2 million for the nine months ended September 30, 2003.
INTEREST EXPENSE
- ----------------
Interest expense was $5.6 million for the nine months ended September 30, 2002,
compared to $3.9 million for the nine months ended September 30, 2003, a
decrease of $1.7 million. This decrease is due to a decrease in the total
outstanding principal amount of General Media's Series C Notes through August
12, 2003 and not being required to record any interest on the Series C Notes
after that date due to the Bankruptcy.
43
REORGANIZATION EXPENSES
- -----------------------
We have incurred $0.9 million of bankruptcy expenses during the nine months
ended September 30, 2003, which principally relates to professional fees related
to the Bankruptcy.
GAIN ON FORGIVENESS OF DEBT
- ---------------------------
The gain on forgiveness of debt of $0.2 million for the three months ended
September 30, 2003 was due to relief of certain liabilities after filing for
chapter 11 Bankruptcy.
DEBT RESTRUCTURING EXPENSES
- ---------------------------
We incurred $0.1 million of debt restructuring expenses during the nine months
ended September 30, 2003, which principally relate to fees associated with the
DIP Financing.
INTEREST INCOME
- ---------------
Interest income was $0.1 million for the three months ended September 30, 2002,
compared to $0.003 million for the three months ended September 30, 2003, a
decrease of $0.1 million. The decrease is due to a decrease in the amount of
cash available for investment during the current year.
INCOME (LOSS) BEFORE THE PROVISION FOR INCOME TAXES
- ---------------------------------------------------
As a result of the above discussed factors, income before income tax expense for
the nine months ended September 30, 2002 was $0.7 million, compared to a loss
before income tax expense of $4.6 million for the nine months ended September
30, 2003.
44
LIQUIDITY AND CAPITAL RESOURCES
In addition to actions and plans relating to General Media's business and its
Chapter 11 Reorganization proceeding, we plan to use the assets of Del Sol as an
asset base to obtain financing for both Del Sol's resort development efforts and
to support General Media's reorganization.
On August 12, 2003, as a result of principal payments due on outstanding Series
C Notes and continuing operating losses, the Debtors filed voluntary petitions
for relief under the Bankruptcy in the Bankruptcy Court.
Our ability to continue operations and execute any of the business plans
described below is subject to many uncertainties, including our ability to
develop a plan of reorganization and obtain equity or debt financing by the
dates established by the DIP Financing and Bankruptcy Court. to avoid a public
sale auction pursuant to section 363 of the Bankruptcy Code of all or
substantially all of the Debtors assets, the availability of post-petition
financing and the willingness of third parties to deal with the Debtors while
they are involved in the Bankruptcy Proceeding. We cannot presently predict the
outcome of these matters or the extent by which our equity ownership in the
Debtors will be impaired
At September 30, 2002, we had $0.3 million in cash and cash equivalents, as
compared to $0.7 million at September 30, 2003, an increase of $0.4 million.
During the nine months ended September 30, 2003 there was a net increase in cash
and cash equivalents of $0.5 million. The increase was due to $0.1 million in
cash provided by operations, $2.0 million in advances from the DIP Financing and
$1.6 million in collections from affiliated companies, partially offset by $3.3
million in mandatory principal payments for General Media's Series C Notes. At
September 30, 2003, our current liabilities exceeded current assets by $8.7
million.
In March 2003, General Media was required to make principal and interest
payments on its Series C Notes totaling $3.5 million. On April 14, 2003, the
Indenture trustee issued a notice 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. In
addition, a required interest payment in the amount of $1.5 million was not made
timely. As a result, the Series C Notes became callable. On May 14, 2003,
General Media and the Holders completed a letter agreement in which the Holders
granted an extension of time for the payment of the overdue interest to May 30,
2003 in return for certain collateral and a guaranty from GMI (See Note 8 of the
Notes to Condensed Consolidated Financial Statements). General Media paid the
overdue interest on June 3, 2003, but failed to comply with several requirements
of the letter agreement.
General Media also did not make a required principal payment in the amount of
$1.3 million and a required interest payment of $0.05 million that was due on
June 29, 2003, did not make a required interest payment on the Series C Notes of
$1.5 million that was due on June 30, 2003 and did not deliver quarterly
financial statements for the period ending March 31, 2003 (the "Financial
Statements) to the holders of the Series C Notes as required by the indenture
(the "Indenture") defining the relative rights of General Media and the Series C
Note holders. On July 3, 2003, the holders of a majority of the principal
amounts of the Notes (the "Holders") sent a notice to General Media advising it
of the failure to make the required interest payment due on June 30, 2003, the
failure to make required principal payment of $1.3 million that was due on June
29, 2003 and the failure to deliver the required Financial Statements. On July
8, 2003, the trustee issued a notice of event of default with respect to the
principal payment and the Series C Notes became callable. The Series C Notes
require interest payments of $5.7 million (including the unpaid and accrued
interest) and principal payments of $39.9 million during the next twelve months
plus default interest.
45
On August 12, 2003, General Media and the other Debtors filed for protection
under Chapter 11 after negotiations with the holders of a majority of the
principal amounts of the Holders failed to obtain a waiver of the defaults and
to provide working capital for our operations. On October 3, 2003, two of the
Holders finalized an agreement with General Media to provide up to $6.0 million
of debtor-in-possession financing with interest at 13% per annum (the
"Agreement" or "DIP Financing"). The Agreement limits the amount of advances
under the DIP Financing to the amount of principal projected to be outstanding
on a cumulative basis as was set forth on a budget provided by General Media on
a schedule to the Agreement. Under the Agreement, General Media has drawn down
approximately $2.6 million as of October 28, 2003, which is within the amount
allowed for under the budget.
The Agreement also stipulates that by no later than December 1, 2003, General
Media and the other Debtors must file a public auction sale motion pursuant to
section 363 of the Bankruptcy Code of all or substantially all of General Media
and the other Debtors' assets. [This deadline may be extended by the entry of an
order by the Bankruptcy Court granting Debtors' Motion filed November 26, 2003
to extend certain deadlines in the Bankruptcy Case.] The bidding procedures for
the public auction are to be conducted in a form and substance reasonably
acceptable to the DIP lenders and the Indenture Trustee with a minimum bid of
$23.5 million, plus the outstanding amount of the DIP loan at the time of
closing, plus the outstanding amount of a carve-out of expenses for attorneys,
accountants and other professionals retained in the Chapter 11 proceedings in an
amount not to exceed $1.0 million and the outstanding amount of a carve out of
expenses for Curtis Circulation Company, our magazine distributor, of an amount
up to $0.5 million. The auction shall occur no later than December 21, 2003 with
the sale of assets to the winning bidder to occur no later than January 15,
2004.
We are developing a plan of reorganization including negotiations with potential
debt and equity investors to provide financing for the Debtors before deadlines
set by the DIP Financing and the Bankruptcy Court to avoid the public auction of
their assets. PII has retained bankruptcy counsel and investment bankers
independent of those retained by the Debtors to assist in developing and
financing a Plan of Reorganization for the Debtors. There can be no assurance
that such a plan will be effectively developed, accepted by the requisite
participants in the Bankruptcy Case or that it will be approved by the
Bankruptcy Court. Further, there is no assurance that debt or equity financing
will be available to fund such a plan or our other operations or that we will
retain any equity in General Media as a result of the Bankruptcy. Even if an
equity investor or alternative financing is available for a reorganization plan,
there can be no assurance that such financing favorable terms under which we can
retain these assets.
On July 22, 2003, the landlord for General Media's principal offices obtained a
judgment from the Civil Court of The City Of New York against General Media for
$0.4 million of unpaid rent and expenses. As of the date of the Bankruptcy
filing, General Media owed a total of $1.0 million to the landlord consisting of
the $0.4 million judgment plus additional rent and other expenses incurred up to
the date of filing for Bankruptcy. On October 21, 2003, the Bankruptcy Court
approved a settlement with the landlord that allowed the landlord to apply a
security deposit held by the landlord in the amount of $1.0 million against the
$1.0 million of pre-petition past due rent in exchange for an extension of time
to assume or reject the lease to January 31, 2004. General Media has fully paid
all its monthly rent obligations under the lease since the Bankruptcy and have
until January 31, 2004 to decide if it will assume or reject the lease. Included
in loss on impairment of assets is a fixed asset leasehold improvement
impairment charge in the amount of $1.1 million in the Condensed Consolidated
Statements of Operations for the nine months ended September 30, 2003. The
impairment charge is necessary because it is uncertain that we will remain in
our office facilities to the end of the lease term.
46
In connection with an amendment to the Distribution Agreement between Curtis
Circulation Company ("Curtis") and the Debtors dated April 15, 2003, Curtis
claims that it may deduct any amounts owed to it by GMI under the Agreement from
monies owed to General Media under its distribution agreement with Curtis, which
the Debtors dispute.
We have undertaken or are planning the actions described in "Overview, above,
during 2003, which are primarily directed at improving our revenue generating
capability, with the intention of improving our cash flow. Any or all of such
actions will be effected by the Chapter 11 bankruptcy filing and will not
generate sufficient improvements to cash flow to meet current debt service
requirements. We are contemplating additional actions, to provide cash and
reduce liabilities. However, there can be no assurances that we will be able to
achieve such a result. All of such actions, but not actions taken by Del Sol SA
or PII, are subject to the Bankruptcy Court's jurisdiction and the claims of
various parties to the Bankruptcy proceeding.
CASH FLOWS FROM OPERATING ACTIVITIES
- ------------------------------------
Net cash used in operating activities was $2.1 million for the nine months
September 30, 2002, compared to net cash provided by operating activities of
$0.01 million for the nine months ended September 30, 2003. Net cash provided by
operating activities for the nine months ended September 30, 2003 was derived by
adjusting the net loss for the period by the effect of the loss on impairment of
assets and other non-cash items, as well as a decrease in paper inventories,
partially offset by a decrease in accounts payable, due to the timing of
payments to vendors. Net cash used in operating activities for the nine months
ended September 30, 2002 was derived by adjusting the net profit for the period
by the effect of a gain from the sale of officer's life insurance policies and
non-cash items as well as decreased accounts payable due to the timing of
payments to vendors, during the nine months ended September 30, 2002. This was
partially offset by decreased purchases of paper and pictorial inventory,
decreased prepaid insurance balances, decreased spending on subscription
acquisition drives and a reduction in circulation accounts receivable due to the
timing of advance payments from the Company's newsstand distributor
CASH FLOWS FROM INVESTING ACTIVITIES
- ------------------------------------
Cash flows provided by investing activities were $0.9 million for the nine
months ended September 30, 2002. The cash provided by investing activities was
the result of the sale of certain officer's life insurance policies to an
unrelated third party
CASH FLOWS FROM FINANCING ACTIVITIES
Cash flows used in financing activities were $1.2 million for the nine months
ended September 30, 2002, compared to cash flows provided by financing
activities of $0.4 million for the nine months ended September 30, 2003. Cash
provided by financing activities for the nine months ended September 30, 2003
was the result of borrowings under the DIP Financing of $2.0 million,
collections from GMI of $1.6 million, partially offset by $3.2 million in
mandatory principal payments for General Media's Series C Notes. Cash used in
financing activities for the nine months ended September 30, 2002 was the result
of payments of $3.5 million in mandatory principal payments for its Series C
Notes. This was partially offset by repayments of $1.3 million from GMI and $1.0
million in cash received against a loan from the principal shareholder.
Affiliated company advances at September 30, 2003 decreased $1.7 million from
December 31, 2002. Up until the filing of the Bankruptcy Proceeding on August
12, 2003, General Media shared common indirect expenses for the benefit of GMI
and affiliated companies, including accounting, personnel, management
information systems, employee relations and other administrative services.
During the nine months ended September 30, 2003, General Media charged GMI $0.2
million for these shared expenses. In addition, up until the filing of the
Bankruptcy Proceeding, General Media was charged by GMI and its subsidiaries for
47
the benefit of other corporate overhead costs, executive compensation and other
costs, which principally relate to office space. During the nine months ended
September 30, 2003, GMI charged General Media $0.3 million for these shared
expenses. These allocations were 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 were reasonable. As part of the DIP
Financing, the arrangement has been suspended and replaced by compensation
payments to our Chairman/ Chief Executive Officer, and the Executive Vice
President that may not exceed $41,667 and $12,500 per month, respectively,
commencing August 2003.
DEBT
Our debt includes our DIP Financing and General Media's Series C Senior Secured
Notes, which are both collateralized by substantially all of our assets. The DIP
Financing, which bears interest at 13%, has a maturity date of January 31, 2004
and the Series C Notes, which bear interest at a rate of 15% per annum, have a
maturity date of March 29, 2004. As of September 30, 2003, General Media's
unpaid principal balance on the DIP Financing was $2.0 million and the unpaid
balance in the Series C Notes was approximately $39.9 million.
The Series C Notes require amortization payments of $6.5 million during the
calendar year 2003, of which $1.9 million was paid in April 2003, with the
balance of the Series C Notes in the amount 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.
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
48
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, a former President and Chief
Operating Officer of General Media.
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.
John Orlando, General Media'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 General Media to all Holders.
On March 28, 2003, General Media hired Stephen Gross to replace John Orlando as
the General Media's President and Chief Operating Officer. A proposal was
submitted to the Holders on that date requesting confirmation that Mr. Gross
would be reasonably satisfactory to them as a replacement for John Orlando as
General Media's President and Chief Operating Officer.
On March 29, 2003, General Media was required to make a principal payment of
$2.0 million. On April 14, 2003, the Indenture 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 the $0.2 million made
available through the repayment of an intercompany balance from GMI) and has
fully paid the $2.0 million principal amount. On April 24, 2003, General Media
and the Holders completed a letter agreement that consented to the appointment
of Stephen Gross as president and chief operating officer of General Media,
consented to the filing of 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, to
eliminate any grace periods with respect to future principal payments commencing
with the principal payment due June 29, 2003, to provide the Holders with a copy
of the employment agreement between General Media and Stephen Gross (the "Gross
Employment Agreement") by May 19, 2003, to liquidate no less than 50% of the
aggregate book value of all its artwork pieces in commercially reasonable sales
(the "Sales") on or before October 31, 2003 and to use 100% of the net proceeds
of such Sales to make additional principal redemption's of the Series C Notes.
The agreement was subject to approval by the Holders of the Gross Employment
Agreement and the completion of a supplemental indenture incorporating the terms
of the letter agreement on or before May 26, 2003. General Media has not entered
into or supplied the Gross Employment Agreement to the Holders or completed the
supplemental indenture incorporating the terms of the letter agreement and as a
result the letter agreement was terminated. In August 2003, the Company
terminated its relationship with Mr. Gross.
49
On March 31, 2003, General Media was required to make an interest payment in the
amount of $1.5 million, which was not made. As a result, the Series C Notes
became callable. 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 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 General Media, including the agreement
to:
a) execute and deliver to the trustee, on or before June 16, 2003, a mortgage
and lien in a form satisfactory to the Holders encumbering certain real
estate owned by GMI (subject to prior liens of not more than $25.0 million)
and to pay costs associated with the obtaining of the mortgage,
b) cause GMI, on or before May 30, 2003, 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
GMI'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 May 30, 2003,
d) 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,
e) 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 of their
audit and legal counsel, and
f) allow the Holders to audit the books, records and assets of General Media,
General Media paid the overdue interest on June 3, 2003, but failed to comply
with several requirements of the letter agreement.
General Media also did not make a required principal payment in the amount of
$1.3 million and a required interest payment of $0.05 million that was due on
June 29, 2003, did not make a required interest payment on the Notes of $1.5
million that was due on June 30, 2003 and did not yet deliver quarterly
Financial Statements to the holders of the Notes as required by the Indenture
defining the relative rights of General Media and the Note holders. On July 3,
2003, the Holders sent a notice to General Media advising it of the failure to
make the required interest payment due on June 30, 2003, the failure to make
required principal payment of $1.3 million that was due on June 29, 2003 and the
failure to deliver the required Financial Statements. On July 8, 2003, the
trustee issued a notice of event of default with respect to the principal
payment and the Notes became callable. The Notes require interest payments of
$5.7 million (including the unpaid interest) and principal payments of $39.9
million during the next twelve months plus default interest.
On August 12, 2003, General Media and the other Debtors filed for protection
under Chapter 11 after negotiations with the holders of a majority of the
principal amounts of the Holders failed to obtain a waiver of the defaults or to
provide working capital for our operations. On October 3, 2003, two of the
Holders finalized an agreement with General Media to provide up to $6.0 million
50
of debtor-in-possession financing with interest at 13% per annum (the
"Agreement" or "DIP Financing"). The Agreement limits the amount of advances
under the DIP Financing to the amount of principal projected to be outstanding
on a cumulative basis as was set forth on a budget provided by General Media on
a schedule to the Agreement. Under the Agreement, General Media has drawn down
approximately $2.6 million as of October 28, 2003, which is within the amount
allowed for under the budget.
The Agreement also stipulates that by no later than December 1, 2003, General
Media and the other Debtors must file a public auction sale motion pursuant to
section 363 of the Bankruptcy Code of all or substantially all of General Media
and the other Debtors assets. The bidding procedures for the public auction are
to be conducted in a form and substance reasonably acceptable to the DIP lenders
and the Indenture Trustee with a minimum bid of $23.5 million, plus the
outstanding amount of the DIP loan at the time of closing, plus the outstanding
amount of a carve-out of expenses for attorneys, accountants and other
professionals retained in the Chapter 11 proceedings in an amount not to exceed
$1.0 million and the outstanding amount of a carve out of expenses for Curtis
Circulation Company, the Company's magazine distributor, of an amount up to $0.5
million. The auction shall occur no later than December 21, 2003 with the sale
of assets to the winning bidder to occur no later than January 15, 2004.
The Company is developing a plan of reorganization and attempting to locate an
equity investor or alternative financing for the Company before December 1, 2003
to avoid the public auction of the assets of General Media and the other
Debtors. There can be no assurance that an equity investor can be located, that
alternative financing will be made available to the Company or that the Company
will retain any equity in General Media as a result of the Bankruptcy. Even if
an equity investor or alternative financing can be located there can be no
assurance that the Company can obtain favorable terms under which it can retain
these assets.
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
for the year ended December 31, 2002 included in the Company's annual report on
Form 10-K.
These policies were selected because they represent the more significant
accounting policies and methods that are broadly applied in the preparation of
the consolidated financial statements. Revenues, expenses, accrued liabilities
and allowances related to certain of these policies are initially based on our
best estimates at the time of original entry in our accounting records.
Adjustments are recorded when our actual experience differs from the expected
experience underlying the estimates. These adjustments could be material if our
experience were to change significantly in a short period of time. We make
frequent comparisons of actual experience and expected experience in order to
mitigate the likelihood of material adjustments.
a. REVENUE RECOGNITION - Sales of magazines for retail distribution are
recorded on the on-sale date of each issue based on an estimate of the
revenue for each issue of the magazine, net of estimated returns.
These estimates are based upon several factors, including but not
limited to historical trends, days on sale and special editorial or
pictorial content. Estimated revenues are adjusted to actual revenues
as actual sales information becomes available. Actual sales
information generally becomes available 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.
51
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.
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
52
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 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. We do not believe that this
statement will have a material effect on our 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. We do not believe that this
statement will have a material effect on our financial statements.
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. We do not believe that this statement will have
a material effect on the Company's financial statements.
In January 2003, the FASB issued Interpretation No. 46, "Consolidation of
Variable Interest Entities (an Interpretation of ARB No. 51)" ("FIN 46"). FIN 46
requires that the primary beneficiary in a variable interest entity consolidate
the entity even if the beneficiary does not have a majority voting interest. The
consolidation requirements of FIN 46 are required to be implemented for any
variable interest entity created on or after January 31, 2003. In addition, FIN
46 requires disclosure of information regarding guarantees or exposures to loss
relating to any variable interest entity existing prior to January 31, 2003 in
financial statements issued after January 31, 2003. The implementation of the
provisions of FIN 46 effective January 31, 2003 did not have a significant
effect on the Company's consolidated financial statement presentation or
disclosures.
In May 2003, the FASB issued SFAS No. 150, "Accounting for Certain Financial
Instruments with Characteristics of both Liabilities and Equity". SFAS No. 150
establishes standards for how an issuer classifies and measures in its statement
of financial position certain financial instruments with characteristics of both
liabilities and equity. SFAS No. 150 requires that an issuer classify a
financial instrument that is within its scope as a liability (or an asset in
some circumstances) because that financial instrument embodies an obligation of
the issuer. SFAS No. 150 is effective for financial instruments entered into or
modified after May 31, 2003 and otherwise is effective at the beginning of the
first interim period beginning after June 15, 2003. SFAS No. 150 is to be
implemented by reporting the cumulative effect of a change in accounting
principle for financial instruments created before the issuance date of SFAS No.
150 and still existing at the beginning of the interim period of adoption.
Restatement is not permitted. We do not expect that the adoption of SFAS No. 150
will have a significant effect on our financial statement presentation or
disclosures.
53
CONTRACTUAL OBLIGATIONS AND COMMERCIAL COMMITMENTS
We do not utilize off balance sheet financing other than operating lease
arrangements for office premises and related equipment. The following table
summarizes all commitments under contractual obligations as of September 30,
2003:
-----------------Obligations due------------------
Total 1 2-3 4-5 Over 5
Amount Year Years Years Years
--------------------(In millions)-----------------
Senior Secured Notes $ 39.9 $ 39.9 $ -- $ -- $ --
Other Long-Term Liabilities 0.6 0.3 0.3 -- --
-------- -------- ------- ------ -----
Total Cash Obligations $ 40.5 $ 40.2 $ 0.3 $ 3.8 $ --
======== ======== ======= ====== =====
Interest On Senior Secured Notes $ 5.7 $ 5.7 $ -- $ -- $ --
======== ======== ======= ====== =====
All of the above contractual obligations and commercial commitments are subject
to compromise as part of the Bankruptcy Proceedings.
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. During the period from the our filing for Bankruptcy on
August 12, 2003 to September 30, 2003 we borrowed $2.0 million from our DIP
Financing with a fixed rate of 13%. We are subject to market risk based on
potential fluctuations in current interest rates.
Foreign-Exchange Rate Risk - We do not believe we have exposure to foreign
exchange rate risk because all of our financial instruments are denominated in
U.S. dollars.
ITEM 4. CONTROLS AND PROCEDURES
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)
as of the end of the period covered by this report. This evaluation (the
"Controls Evaluation") was done under the supervision and with the participation
of management.
54
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. As a result of
a change in control on November 6, 2003, we are reevaluating errors in procedure
which led up to the unauthorized initial filing of the Quarterly report for the
period ended March 31, 2003 on May 23, 2003 containing financial statements
having inaccuracies and without the completion of a review of our principal
independent auditor. Based on this evaluation, the Company will attempt to
improve its Disclosure Controls.
The CEO notes 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 there are serious
and material weaknesses in our Disclosure Controls which will have to modified
going forward. However, the existing Disclosure Controls when combined with
further investigation were found to be effective to ensure that material
information relating to the Company's financial statements and its consolidated
subsidiaries contained in this report was made known to management, including
the CEO.
55
PART II-OTHER INFORMATION
-------------------------
ITEM 1. LEGAL PROCEEDINGS
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 a well known woman topless in the June 2003 issue of Penthouse
Magazine when they were in reality photographs of someone else. On May 16, 2003,
the Illinois Court dismissed the case. In June 2003 the Class Action Plaintiffs
filed an amended complaint and asked for reconsideration of the dismissal.
General Media intends to vigorously defend itself against this claim.
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 have been conducting
meetings with the employee to determine what actions need to be taken to resolve
the Charge. On May 9, 2003, the EEOC recommended a settlement of various
institutional training for the Company and a monetary award of $700,000 for the
employee. General Media has rejected the EEOC's recommendation on legal and
factual grounds and intends to vigorously defend itself in this action. It is
too early to determine the possible outcome of the proceedings. Therefore we
cannot give an opinion as to the effect this action will have on our 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 our 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.
On March 10, 2003, a former employee of General Media filed a claim in the
Supreme Court of the State of New York seeking damages of $1,000,000 for an
alleged breach of her employment contract and loss of outside opportunities. The
plaintiff claims she was setting up an outside business venture to become a
consultant to General Media when she handed in her resignation. She claims that
she handed in her resignation, but was persuaded to withdraw it, was allegedly
offered her job back, following which her employment was terminated. General
Media denies the claims and is vigorously defending itself against this claim.
On June 20, 2003, Fraserside Holdings Limited and Milcap Media Limited filed a
claim in the Supreme Court of the State of New York, for an alleged breach of
contract regarding a 1999 agreement with General Media to jointly produce and
distribute a series of adult motion pictures. The complaint alleges damages of
$2,200,000 for breach of contract, breach of fiduciary responsibility, duty of
loyalty and fair dealing, and demands for an accounting of revenues and expenses
related to the pictures and a declaration that all property in the movies
belongs to the plaintiff. General Media believes the claims are without merit
and intends to vigorously defend itself in this claim.
56
In December 2002, General Media received correspondence from 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 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.
On July 22, 2003, the landlord for General Media's principal offices obtained a
judgement from the Civil Court of The City Of New York against General Media for
$449,000 of unpaid rent and expenses. As of the date of the Bankruptcy filing,
the Company owed a total of $1,038,000 to the landlord consisting of the
$449,000 judgement plus additional rent and other expenses incurred up to the
date of filing for Bankruptcy. On October 21, 2003, the Bankruptcy Court
approved a settlement with the landlord that allowed the landlord to apply a
security deposit held by the landlord in the amount of $956,000 against the
$1,038,000 of pre-petition past due rent in exchange for an extension of time to
assume or reject the lease to January 31, 2004. General Media has fully paid all
its monthly rent obligations under the lease since the Bankruptcy and has until
January 31, 2004 to decide if it will assume or reject the lease. We have
recorded an impairment charge for fixed asset leasehold improvements in the
amount of $1,061,000 as part of the loss from impairment of assets in the
Condensed Consolidated Statements of Operations for the nine months ended
September 30, 2003. The impairment charge is necessary because it is uncertain
that General Media will remain in its office facilities to the end of the lease
term.
In connection with an amendment to the Distribution Agreement between Curtis
Circulation Company ("Curtis") and the Debtors dated April 15, 2003, Curtis
claims that it may deduct any amounts owed to it by GMI under the Agreement from
monies owed to General Media under its distribution agreement with Curtis, which
the Debtors dispute.
There are various other lawsuits claiming amounts against the Debtors. 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.
Unless modified by the Bankruptcy Court, pursuant to an automatic stay provision
of section 362 of the Bankruptcy Code, all of the above described pre-petition
legal proceedings against General Media and the other Debtors are currently
stayed. The claims may be subject to compromise.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
On March 29, 2003, General Media was required to make a principal payment of
$2.0 million. On April 14, 2003, the Indenture trustee issued a notice of event
of default with respect to the principal payment. On April 15 and 16, 2003 the
Company 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. On April 24, 2003, General Media and the
Holders completed a letter agreement that required the appointment of Stephen
Gross as president and chief operating officer of PII, the filing of our Form
10-K on or before April 30, 2003, amendmended 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 acknowledged 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 the Company and the Holders agreed to amend the
"Change of Control" events to substitute Stephen Gross for John Orlando, to
eliminate any grace periods with respect to future principal payments commencing
with the principal payment due June 29, 2003, to provide the Holders with a copy
of the employment agreement between PII and Stephen Gross (the "Gross Employment
Agreement") by May 19, 2003, to liquidate no less than 50% of the aggregate book
value of all its artwork pieces in commercially reasonable sales (the "Sales")
on or before October 31, 2003 and to use 100% of the net proceeds of such Sales
to make additional principal redemption's of the Series C Notes. The agreement
57
was subject to approval by the Holders of the Gross Employment Agreement and the
completion of a supplemental indenture incorporating the terms of the letter
agreement on or before May 26, 2003. The Company did not supply the Gross
Employment Agreement to the Holders or complete the supplemental indenture
incorporating the terms of the letter agreement and as a result the letter
agreement was terminated. In August 2003, we terminated our relationship with
Mr. Gross.
On March 31, 2003, General Media was required to make an interest payment in the
amount of $1.5 million, which was not made. As a result, the Series C Notes
became callable. 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 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 General Media, including the
agreement to:
a) execute and deliver to the trustee, on or before June 16, 2003, a mortgage
and lien in a form satisfactory to the Holders encumbering certain real
estate owned by GMI (subject to prior liens of not more than $25.0 million)
and to pay costs associated with the obtaining of the mortgage,
b) cause GMI, on or before May 30, 2003, to provide a non-recourse guaranty of
the obligations of the General Media (the "Guaranty") and to secure its
obligations under such Guaranty with a pledge to the trustee of all of
GMI'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
General Media ("Common Stock Obligation"),
c) pay the interest that is overdue on or before May 30, 2003,
d) 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,
e) 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 of their
audit and legal counsel, and
f) allow the Holders to audit the books, records and assets of General Media.
General Media paid the overdue interest on June 3, 2003 and has allowed the
Holders to audit the books, records and assets of General Media, but they failed
to comply with the other requirements of the letter agreement.
General Media also did not make a required principal payment in the amount of
$1.3 million and a required interest payment of $0.05 million that was due on
June 29, 2003, did not make a required interest payment on the Notes of $1.5
million that was due on June 30, 2003, did not make a required principal payment
of $2.0 million and a required interest payment of $0.07 that was due on
September 29, 2003 and did not make a required interest payment of $1.4 million
that was due on September 30, 2003 and did not deliver quarterly Financial
Statements to the holders of the Notes as required by the Indenture defining the
relative rights of General Media and the Note holders. On July 3, 2003, the
holders of a majority of the principal amounts of the Notes (the "Holders") sent
a notice to General Media advising it of the failure to make the required
interest payment due on June 30, 2003, the failure to make a required principal
payment of $1.3 million that was due on June 29, 2003 and the failure to deliver
the required Financial Statements. On July 8, 2003, the trustee issued a notice
of event of default with respect to the principal payment and the Notes became
callable. The Notes require interest payments of $5.7 million (including the
unpaid interest) and principal payments of $39.9 million during the next twelve
months plus default interest.
58
As stated in Notes 1 and 2 of the Notes to Condensed Consolidated Financial
Statements, on August 12, 2003, General Media and the other Debtors filed for
protection under Chapter 11 after negotiations with the holders of a majority of
the principal amounts of the Holders failed to obtain a waiver of the defaults
or to provide working capital for General Media's operations. On October 3,
2003, two of the Holders finalized an agreement with General Media to provide up
to $6.0 million of debtor-in-possession financing with interest at 13% per annum
(the "Agreement" or "DIP Financing"). The Agreement limits the amount of
advances under the DIP Financing to the amount of principal projected to be
outstanding on a cumulative basis as was set forth on a budget provided by
General Media on a schedule to the Agreement. Under the Agreement, General Media
has drawn down approximately $2.6 million as of October 28, 2003, which is
within the amount allowed for under the budget.
The Agreement also stipulates that by no later than December 1, 2003, General
Media and the other Debtors must file a public auction sale motion pursuant to
section 363 of the Bankruptcy Code of all or substantially all of General Media
and the other Debtors assets. The bidding procedures for the public auction are
to be conducted in a form and substance reasonably acceptable to the DIP lenders
and the Indenture Trustee with a minimum bid of $23.5 million, plus the
outstanding amount of the DIP loan at the time of closing, plus the outstanding
amount of a carve-out of expenses for attorneys, accountants and other
professionals retained in the Chapter 11 proceedings in an amount not to exceed
$1.0 million and the outstanding amount of a carve out of expenses for Curtis
Circulation Company, the Company's magazine distributor, of an amount up to $0.5
million. The auction shall occur no later than December 21, 2003 with the sale
of assets to the winning bidder to occur no later than January 15, 2004. These
time periods and deadlines may be effected by a motion filed by the Debtors on
November 26, 2003 to extend the time during which the Debtors have an exclusive
right to file a plan of reorganization and solicit acceptances and by
negotiation with the DIP Financier.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
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. The Company 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. General Media paid the overdue interest on June 3, 1003, but failed to
comply with several requirements of the letter agreement as specified in Item 2
"Changes in Securities and Use of Proceeds" above.
General Media also did not make a required principal payment in the amount of
$1.3 million and a required interest payment of $0.05 million that was due on
June 29, 2003, did not make a required interest payment on the Notes of $1.5
million that was due on June 30, 2003, did not make a required principal payment
of $2.0 million and a required interest payment of $0.07 that was due on
September 29, 2003 and did not make a required interest payment of $1.4 million
that was due on September 30, 2003.
59
The Debtors made their Chapter 11 filing on August 12, 2003. As a result of the
filings, no principal or interest payments have been or will be made on
indebtedness incurred by the Debtors prior to August 12, 2003, until a plan of
reorganization defining the payment terms has been approved by the Bankruptcy
Court.
On August 12, 2003, two of the Holders entered into a financing agreement with
General Media to provide up to $5,000,000 of debtor-in-possession financing with
interest at 13% per annum (the "Preliminary DIP Financing"). The Preliminary DIP
Agreement limited the financing to $3,000,000 until a final financing order was
signed by the Bankruptcy Court. This Agreement was approved for the payment of
certain permitted pre-petition claims, working capital needs and other general
corporate purposes. It also provides a source of outside financing in order for
us to make up potential gaps in our cash flow during the course of the
Bankruptcy. The Preliminary DIP Agreement also limited the amount of advances to
an amount of principal that was projected to be outstanding on a weekly basis as
set forth in a budget provided by General Media on a schedule to the Agreement.
In September 2003, the Debtors defaulted on certain covenants relating to the
Preliminary DIP Agreement when they borrowed amounts in excess of those allowed
in the budget. As a result of the default, the two Holders threatened to stop
supplying advances under the Preliminary DIP Financing. On October 3, 2003,
General Media settled the default by finalizing an new agreement with the two
Holders (the "Final Agreement" or "DIP Financing") under which General Media has
been provided with up to $6,000,000 of secured debtor-in-possession financing
with interest at 13% per annum in return for its agreement that by no later than
December 1, 2003, General Media and the other Debtors must file a public auction
sale motion pursuant to section 363 of the Bankruptcy Code of all or
substantially all of General Media and the other Debtors assets. The Final
Agreement limits the amount of advances under the DIP Financing to the amount of
principal projected to be outstanding on a cumulative basis as was set forth on
a revised budget provided by General Media on a schedule to the Final Agreement.
Under the Final Agreement, General Media has drawn down approximately $2.6
million as of October 28, 2003 and is in compliance with all the covenants of
the Final Agreement.
The Final Agreement specifies that the bidding procedures for the public
auction, should it become necessary, are to be conducted in a form and substance
reasonably acceptable to the DIP lenders and the Indenture Trustee with a
minimum bid of $23,500,000, plus the outstanding amount of the DIP loan at the
time of closing, plus the outstanding amount of a carve-out of expenses for
attorneys, accountants and other professionals retained in the Chapter 11
proceedings in an amount not to exceed $1,000,000 and the outstanding amount of
a carve out of expenses for Curtis Circulation Company, the Company's magazine
distributor, of an amount up to $500,000 (See Note 2 of the Notes to Condensed
Consolidated Financial Statements for further details of the Curtis carve out.).
Certain deadlines to the process are described in Item 2 Changes in Securities
and Use of Proceeds.
ITEM 5. OTHER INFORMATION
The following information is submitted in lieu of filing a Form 8-K Report.
ACQUISITION OF DEL SOL INVESTMENTS, LLC
On November 6, 2003, we entered into a Membership Interest Purchase Agreement
with Del Sol Investments, GP a California general partnership under which we
will acquire 100% of the membership interests of Del Sol Investments, L.L.C., an
Arizona limited liability (formerly known as Mortgage Capital Fund One, L.L.C.)
in exchange for 30,000,000 shares of our common stock and 10,500,000 shares of
Series C Preferred Stock, having an aggregate liquidation preference of $105
million and a cumulative preferred dividend of 4% of the liquidation preference
per year, payable quarterly in kind. In addition, we agreed to issue 3,000,000
60
shares of common stock and 1,050,000 shares of Series C Preferred Stock to ANL
Capital GP as a consulting fee equal to 10% of the consideration received by the
sellers. The shares of Series C Preferred, when issued pursuant to an amendment
and restatement of our articles of incorporation that has been approved by the
holders of the requisite number of outstanding shares of our capital stock ,will
convertible into common shares at $3.00 per share and may not be converted until
our common stock is listed on a recognized national stock exchange. The Del Sol
LLC transaction set forth in the Purchase Agreement will close when the
amendment to our articles of incorporation is recorded with the state of Florida
and we have issued and delivered the preferred stock consideration described
hereinabove, as well as our completion of any other legal requirements that may
be required to consummate the transaction.
At the time of enter into the Purchase Agreements, Del Sol Investments, LLC
owned 99.5% of Del Sol Investments, S.A. de C.V., which owns by contract real
estate consisting of 150 hectares (370.5 acres) of land with ocean frontage in
the city and harbor of Zihuatanejo, State of Guerrero, Mexico (the "Property").
The Property is a planned resort development in the resort area known as Ixtapa.
We plan to develop the Property in several phases, including a themed resort, a
golf course, residential development and timeshare facilities. We also intend to
utilize financing secured by the property for general corporate purposes. The
property asset may be included as collateral, or other contribution, in the Plan
of Reorganization for General Media, Inc. and its subsidiaries which are subject
to Chapter 11 proceedings. The beneficial owner of a majority of the outstanding
PII common stock has retained bankruptcy counsel and investment bankers to
provide advice on the use of the Property in connection with the proceedings.
CHANGE OF CONTROL
In a series of simultaneous transactions related to the acquisition of Del Sol
Investments, LLC, beneficial ownership of 127,500,000 shares of our outstanding
common stock was transferred from General Media International, Inc. ("GMII") to
Dr. Luis Enrique Fernando Molina, who subsequently transferred his interest to
The Molina Vector Investment Trust, for which Dr. Molina is sole trustee and
beneficiary. The shares were the subject of a pledge securing a $1,650,000 loan
from IIG Trade Opportunities Fund NV to General Media International, Inc., made
in June, 2003 and which was in default since July 2003, 2003. The proceeds of
the loan were used to reduce the principal balance outstanding on the senior
secured notes of General Media, Inc.
Del Sol Investments, LLC, acquired the right to the shares under an Assignment
and Assumption Agreement dated November 6, 2003. The consideration for the
Assignment was the delivery of a promissory note in the amount of $3.0 million.
The note is guaranteed by Dr. Molina and his agreement to grant, or cause the
owner to grant, a mortgage on the Property to secure the repayment of the
$1,650,000 loan and other obligations aggregating $3.0 million. GMII agreed to
deliver the 127,500,000 shares of our common stock to Del Sol Investments, LLC
in lieu of a foreclosure proceeding and Del Sol Investments, LLC transferred
beneficial ownership through its sole member, Del Sol Investments GP, a
California general partnership to the general partnerships members just prior to
our acquisition of Del Sol Investments, LLC described above, in proportion to
their ownership in the partnership.
As a result of the foregoing transactions, control of our voting stock
passed to the principal shareholders named in the following table:
- --------------------------------------- ------------------------------------------- ----------------------------------
Number of shares Percent of Class (1)
- --------------------------------------- ------------------- ----------------------- ------------------ ---------------
Name of Beneficial Owner Before After Before After
- --------------------------------------- ------------------- ----------------------- ------------------ ---------------
The Molina Vector Investment Trust (2) 127,500,000 157,500,000 82% 86%
- --------------------------------------- ------------------- ----------------------- ------------------ ---------------
61
- ---------
(1) Percentages based upon 151,690,000 shares of common stock
outstanding as of October 31, 2003 and adjusted to give effect
to the issuance of 30,000,000 [or 33,000,000] common shares in
connection with the Acquisition of Del Sol Investments, LLC
described below. Does not give effect to the possible
conversion of 10,500,000 shares of Series C Preferred Stock
held by the Trust, which , following listing of our common
stock on a National Exchange, are convertible into up to
35,000,000 additional shares of common stock.
(2) Dr. Molina, as sole trustee, may be deemed the beneficial
owner of all shares held by the Trust.
GMII owns 5,000 shares of our Series A Preferred stock having an aggregate
liquidation preference of $5.0 million. In order to permit the assignment
described above to occur, the acquisition of Del Sol Investments, LLC and to
permit us to obtain financing in the future for the development of real estate
and working capital, we induced GMII to waive all restrictive provisions of the
Series A Preferred Stock in exchange for a one year option which permits GMII to
exchange all 5,000 shares of the Company's Series A Preferred Stock for 475,000
shares of General Media, Inc. The 475,000 shares of General Media constitute all
of our interest in General Media and its principal operating subsidiaries, which
are in reorganization proceedings under Chapter 11 of the U.S. Bankruptcy Code.
Immediately following the above described transactions, Robert C. Guccione and
Charles Samel resigned as officers and directors. They did not resign any
position they held with General Media, Inc., the publisher of Penthouse
magazine, or any of General Media's subsidiaries. Del Sol Investments, LLC, as
the owner of approximately 84% of our voting stock immediately prior to our
acquisition of Del Sol, approved an amendment to the Company's articles of
incorporation to authorize the issuance of shares of Series A Preferred Stock,
approved the acquisition transactions described above and appointed the
following officers and directors of the Company.
- ---------------------------------------- -------- -----------------------------------------------------
NAME AGE OFFICES
- ---------------------------------------- -------- -----------------------------------------------------
Amb. Milton R. Polland (Ret.) 92 Chairman and Acting Chief Executive Officer
- ---------------------------------------- -------- -----------------------------------------------------
Claude Bertin 55 Executive Vice President, Secretary and a Director
- ---------------------------------------- -------- -----------------------------------------------------
Milton Polland has been active in politics and business since 1940. He founded
The Polland Company, Ltd. in 1952 as actuarial consultants and has been Chairman
of the Board of several life insurance companies and a principal shareholder in
other insurance companies. He was partners with California Gov. Goodwin Knight
in Knight-Polland Financial Consultants. He is a past director of the Wilshire
Bank. He was appointed to a post in the Commerce Department by President Kennedy
and was National Chairman of Republicans for Presidential Nominee Hubert
Humphrey. Since 1962, he has been a member of the American Arbitration Panel. He
represented President Kabua of the former US territory of the Marshall Islands,
including serving at request as Ambassador to Mexico. He was co-manager for the
Gov. Dewey/Gov. Earl Warren US Presidential nomination and was a member of both
the State of Wisconsin and the National Republican Finance Committee. He has
written extensively in politics and insurance and remains an active investor in
several financial services companies. He is a graduate of Marquette University
and has a law degree from Milwaukee Law School.
Claude Bertin began his career in 1973 with Wagonlit/Cook travel as operation
manager. He became director at American Express in 1983 with responsibility for
travel product marketing. From 1994-1995 he was Director Business Development at
Harvard Consulting Group before taking the position of General Manager France &
Northern Europe of Aeromexico with responsibilities for airport operation and
tour operations. He became Director Business Development and Financial Analysis
at Thomas Cook Group, the largest leisure group in the world. He became vice
president at Azteca Airlines subsequently. Mr. Bertin is fluent in French,
English, German, Italian and Spanish and is a Mexican and French citizen. He is
a graduate of Universite de Paris-Sorbonne Paris, France and has a diploma from
Harvard University.
62
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.
Form 8-K dated August 12, 2003, filed on August 8, 2003 reporting under
Item 3 "Bankruptcy or Receivership," the filing by General Media, Inc.
and the other Debtors of voluntary petitions of relief under Chapter 11
of Title 11 of the United State Code (the "Bankruptcy") and under Item
5 "Other Events and Regulation FD Disclosure", press release
information concerning the Bankruptcy.
63
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 International, Inc.
(Registrant)
Dated: November 10, 2003 By: /s/ Milton Polland
-------------------------------------
Milton Polland
Chairman of the Board and CEO
(Principal Executive and Financial
Officer)
64
Exhibit Index
-------------
Exhibit No. Description
- ----------- -----------
10.1 Membership Interest Purchase Agreement dated as of November 6,
2003 by and between Penthouse International, Inc. and Del Sol
Investments G.P.
31.1 Certification of Chief Executive Officer of Periodic Report
pursuant to Rule 13a-14a and Rule 15d-14(a)
31.2 Certification of Chief Financial Officer of Periodic Report
pursuant to Rule 13a-14a and Rule 15d-14(a)
32.1 Certification of Chief Executive Officer pursuant to 18 U.S.C.
- Section 1350
65