For additional discussion of our related party transactions, see “Certain Relationships and Related Party Transactions.”
General Media, Inc., or GMI, a Delaware corporation formed in 1993, filed for bankruptcy on August 12, 2003. In November 2003, Marc Bell and Daniel Staton formed PET Capital Partners LLC to acquire GMI’s secured notes and preferred stock. On October 5, 2004, GMI emerged from Chapter 11 protection with new equity distributed entirely to the holders of the GMI secured notes. The reorganized capital structure also included approximately $35.8 million of Term Loan Notes distributed to former secured and unsecured creditors and a credit facility for up to $20.0 million funded by NAFT Ventures I LLC, or NAFT, an affiliate of Messrs. Bell and Staton. An unaffiliated fund also participated in the exit financing facility. Concurrently with the plan closing, we changed our name to Penthouse Media Group Inc. and PET Capital Partners LLC sold a minority position of non-voting Series B common stock to IBD. This transaction was part of a broader settlement agreement, which ended all litigation among the parties to the transaction and allowed the company to emerge from bankruptcy without further delay. Within a year, all of the unsecured creditors with valid claims were paid in full.
In October 2004, we entered into a management agreement with Bell & Staton, Inc., a Florida corporation controlled by Marc H. Bell and Daniel C. Staton, or the managers, whereby certain management services are to be performed by these managers as designated by our board of directors. The agreement is for a term of five years with an annual fee of $0.5 million which amount is included in general and administrative expenses for each of the years ended December 31, 2008, 2007 and 2006. The fee is subject to increase at the rate of 10% of EBITDA of our business, exclusive of EBITDA attributable to the acquisition of Various, but annual compensation cannot exceed $1.0 million. We have yet to increase the fee as the EBITDA hurdles have not been attained. In addition, the agreement provides that the managers may participate in our future bonus pool and stock option plans. On August 17, 2005, the management agreement was amended to limit the total bonus to be paid to the managers to a maximum of $500,000 so long as any of the 2005 Notes or any guaranty thereof remained outstanding and to prohibit the payment of the bonus as long as there is a default occurring on the 2005 Notes. On August 23, 2006, the management agreement was further amended to provide that no management fee, other than reimbursement of expenses, shall be paid to the managers so long as there is a default or an event of default occurring on the 2006 Notes. On December 9, 2008, our board of directors approved forms of employment agreements for each of Messrs. Bell and Staton, which will become effective upon the consummation of this offering, the extinguishment or waiver of the defaults under the existing debt instruments and the obtainment of any other third party consents required. For each of the years ended December 31, 2008 and 2007, Bell & Staton Inc. was paid $500,000. These payments were in violation of the covenant in the management agreement prohibiting the payment of fees if there is a default of the 2006 Notes or 2005 Notes and violated the restricted payment covenant in our First Lien Senior Secured Notes and Second Lien Subordinated Secured Notes.
Effective January 1, 2005, we entered into a lease with 6800 Broken Sound LLC, an affiliate of Marc H. Bell, and currently lease 3,533 square feet of space in an office building in Boca Raton, Florida. The lease currently provides for an annual base rent of $57,909, payable in equal monthly installments, increasing to an annual base rent of $59,646 in the final year of the lease. We are also responsible for certain costs, including property taxes, utilities, repairs, maintenance, alterations, cleaning and insurance currently estimated to be $49,956 per annum, increasing to an estimated $52,999 per annum in the final year of the lease. Total rent expense under this lease agreement was approximately $117,500, $111,000 and $159,000 for the years ended December 31, 2008, 2007, and 2006, respectively.
In August 2005, we entered into a Security Holders Agreement, or the 2005 Security Holders Agreement, with PET Capital Partners LLC, PET Capital Partners II LLC, Messrs. Bell and Staton and certain other investors in our Series A Convertible Preferred Stock whereby, among other things, a specified group of funds may propose a board designee who shall be reasonably acceptable to the Majority Equity Sponsor as defined in the agreement pursuant to which the Series A Convertible Preferred Stock was purchased and each of the security holders party to the 2005 Security Holders Agreement agreed to vote all voting securities then held or thereafter acquired by such security holder to elect such board designee as a director during the term of the 2005 Security Holders Agreement. The group of funds has yet to designate a board designee. In addition, the security holders party to the 2005 Security Holders Agreement have agreed not to vote for certain changes in our capitalization or corporate governance without
the written consent of certain stockholders, so long as certain stockholders collectively own at least twenty percent of the Series A Convertible Preferred Stock originally issued to such investors pursuant to the purchase agreement whereby the 2005 Notes were issued. These provisions of the 2005 Security Holders Agreement will terminate immediately upon the consummation of this offering.
In August 2005, in connection with our offering of Series A Convertible Preferred Stock and 2005 Notes, PET Capital Partners II, LLC, whose members consist of Messrs. Bell, Florescue and Staton or their affiliates, purchased 8,412,700 shares of Series A Convertible Preferred Stock for an aggregate purchase price of $5.0 million, or approximately $0.5943 per share. In addition, one of our existing stockholders purchased 5,047,600 shares of Series A Convertible Preferred Stock for an aggregate purchase price of $3.0 million, or approximately $0.5943 per share.
In August 2006, PET Capital Partners II, LLC purchased an additional 7,571,934 shares of Series A Convertible Preferred Stock for an aggregate purchase price of $4.5 million, or approximately $0.5943 per share and one of our existing stockholders purchased an additional 2,523,977 shares of Series A Convertible Preferred Stock for an aggregate purchase price of $1.5 million, or approximately $0.5943 per share.
In October 2004, PET and one of our existing stockholders participated in our issuance of $35.8 million in aggregate principal amount of Term Loan Notes. In August 2005, concurrent with the completion of our offerings of the 2005 Notes and the Series A Convertible Preferred Stock, we used a portion of the net proceeds from those offerings to repay $11.8 million of the Term Loan Notes plus accrued interest. The Term Loan Notes held by PET and such shareholder were not repaid, but exchanged for Subordinated Term Loan Notes with a principal amount of approximately $21.5 million. Messrs. Bell and Staton indirectly own PET. In October 2006, PET, purchased an additional $0.9 million in principal amount of Subordinated Term Loan Notes. We used the proceeds to fund part of the purchase price consideration for the Danni.com business. Interest on the Subordinated Term Loan Notes is payable in arrears annually at the rate of 13% per annum. As we are restricted from paying cash on the Subordinated Term Loan Notes until we have maintained consolidated EBITDA of at least $25.0 million for the prior four consecutive fiscal quarters and attain an interest coverage ratio of at least 3:1, all interest on our Subordinated Term Loan Notes has been paid in kind. In 2008, 2007 and 2006, PET received additional Subordinated Term Loan Notes in the amount of approximately $3.7 million, $3.3 million and $2.8 million, respectively, and our existing stockholder received additional Subordinated Term Loan Notes in the amount of approximately $338,504, $299,561 and $265,098, respectively, as payment of interest for those years. As of December 31, 2008, PET owns approximately $32.2 million in principal amount of our Subordinated Term Loan Notes, which is the largest principal amount outstanding to date and none of which has been paid. Mr. Bell and Mr. Staton have interests in approximately $13.9 million and $15.9 million, respectively, of the principal amount outstanding on the Subordinated Term Loan Notes owned by PET. As of December 31, 2008, our existing stockholder owns approximately $2.9 million in principal amount of our Subordinated Term Loan Notes, which is the largest principal amount outstanding to date and none of which has been paid.
In August 2006, Florescue Family Corporation purchased approximately $0.9 million in principal amount of our Subordinated Term Loan Notes. Barry Florescue, one of our directors, is the president and a majority shareholder of Florescue Family Corporation and has beneficial interest over all the Subordinated Term Loan Notes owned by the Florescue Family Corporation. In 2008, 2007 and 2006 the Florescue Family Corporation received additional Subordinated Term Loan Notes in the amount of $148,898, $131,768 and $116,609, respectively, as payment of interest for those years. As of December 31, 2008, the Florescue Family Corporation owns approximately $1.3 million in principal amount of our Subordinated Term Loan Notes, which is the largest principal amount outstanding to date and none of which has been paid.
As of December 31, 2008 there was $36.4 million aggregate principal amount outstanding of Subordinated Term Loan Notes. We have not repaid any principal of this loan. We have accrued $1.1 million and $1.0 million in interest for the years ended December 31, 2008 and 2007, respectively, on the Subordinated Term Loan Notes.
On September 21, 2007, in connection with the Various acquisition, we entered into a consulting agreement with Hinok Media Inc., an entity controlled by Andrew B. Conru, one of the founders of Various. In exchange for consulting services, we agreed to pay Hinok Media Inc. the sum of $9,615.38 twice per month for the term of the agreement, which was originally one year and which automatically renews every month until either party terminates the agreement. On December 6, 2007, the agreement was amended as part of the amendment to the Various Stock
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Purchase Agreement to provide for additional payments to Hinok Media Inc. of $1.0 million on the first anniversary of the closing of the Various acquisition, $1.0 million on the second anniversary and $3.0 million on the third anniversary. On May 12, 2008, the parties signed a letter agreement confirming the amendment and clarifying that the additional payments would be made on the dates specified in the amendment regardless of whether the original consulting agreement is still in effect at the time. In the year ended December 31, 2008, we paid a total of $1,230,769 to Hinok Media Inc., $230,769 pursuant to the original consulting agreement and $1.0 million pursuant to the December 6, 2007 amendment.
On September 21, 2007, in connection with the Various acquisition, we entered into a consulting agreement with Legendary Technology Inc., an entity controlled by Lars Mapstead, one of the founders of Various. In exchange for consulting services, we agreed to pay Legendary Technology Inc. the sum of $9,615.38 twice per month for the term of the agreement, which was originally one year and which automatically renews every month until either party terminates the agreement. In the year ended December 31, 2008, we paid a total of $230,769 to Legendary Technology Inc.
In December 2007, certain of our existing stockholders, including Messrs. Bell and Staton and the Florescue Family Corporation, purchased an aggregate of 168,897,005 shares of Series B Convertible Preferred Stock at a purchase price of $0.029604 per share. The aggregate proceeds of $5.0 million were used to help fund the acquisition of Various and for general corporate purposes.
In December 2007, Mr. Bell purchased approximately $5.2 million in principal amount of our subsidiary’s First Lien Senior Secured Notes. This is the largest principal amount outstanding on the First Lien Senior Secured Notes owned by Mr. Bell to date. In December 2007, Staton Family Investments, Ltd., of which Mr. Staton is president, also purchased approximately $5.2 million in principal amount of our subsidiary’s First Lien Senior Secured Notes. Mr. Staton is president of Staton Family Investments, Ltd. and has beneficial interest over all the First Lien Senior Secured Notes owned by Staton Family Investments, Ltd. This is the largest principal amount outstanding on the First Lien Senior Secured Notes owned by Staton Family Investments, Ltd. to date. In December 2007, one of our existing stockholders and debtholders purchased approximately $100 million in principal amount of our subsidiary’s First Lien Senior Secured Notes. This is the largest principal amount outstanding on the First Lien Senior Secured Notes owned by such securityholder to date. Interest on the First Lien Senior Secured Notes accrues at a rate per annum equal to 8% plus the greater of (a) 4.5% or (b) the three-month LIBOR, as further defined in the securities purchase agreement governing the First Lien Senior Secured Notes for the applicable interest period. In 2008, Mr. Bell received $0.7 million in interest payments and $0.5 million in principal payments, Staton Family Investments, Ltd. received $0.7 million in interest payments and $0.5 million in principal payments, and our existing securityholder received $12.1 million in interest payments and $8.6 million in principal payments on the First Lien Senior Secured Notes. As of December 31, 2008, Mr. Bell owns approximately $4.7 million, Staton Family Investments, Ltd. owns approximately $4.7 million, and our existing securityholder owns approximately $74.2 million in principal amount of the First Lien Senior Secured Notes. In connection with its purchase of our subsidiary’s First Lien Senior Secured Notes, our existing securityholder also received warrants for 32,724,439 shares of our common stock valued at approximately $9.1 million.
In December 2007, we entered into a Security Holders Agreement dated December 6, 2007, or the 2007 Security Holders Agreement, pursuant to which the holders of warrants issued in connection with the sale of the First Lien Senior Secured Notes and the Second Lien Subordinated Secured Notes, as well as PET, an existing stockholder and Messrs. Bell and Staton have agreed, among other things, to vote all voting securities then held or thereafter acquired by such holder in favor of the board designees allowed to be appointed by noteholders holding the required number of notes as prescribed by the securities purchase agreements pursuant to which the First Lien Senior Secured Notes and the Second Lien Subordinated Secured Notes were sold, respectively, during the term of the 2007 Security Holders Agreement. The 2007 Security Holders Agreement will terminate immediately upon the consummation of this offering.
At the closing of the Various acquisition on December 6, 2007, PET Capital Partners LLC, Staton Family Investments, LLC, Staton Media, LLC, Staton Family Perpetual Trust and Marc H. Bell, collectively referred to as the principals, entered into an agreement with the Andrew B. Conru Trust Agreement and the Mapstead Trust, created on April 16, 2002, collectively referred to as the sellers, pursuant to which the principals and sellers agreed, among other things, that:
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| • | | the principals granted the sellers an option to purchase from time to time from the principals, shares of our common stock and Series B Convertible Preferred Stock at the exercise price of $0.01 per share, at any time until the consummation of an initial public offering. The option was subject to a vesting schedule pursuant to which the option vested in part immediately, and in part after each of six, nine and twelve months. However, this vesting schedule was subsequently amended as described below. |
| • | | in the event (i) there is a default under the letter agreement; (ii) the outstanding balance of the First Lien Senior Secured Notes held by the sellers is greater than or equal to $50.0 million, and there is an interest or principal payment default under the securities purchase agreement governing the First Lien Senior Secured Notes, which is not cured at least two days prior to the applicable time frame within which cure is permitted under such Securities Purchase Agreement; (iii) the outstanding balance of the notes is less than $50.0 million, and there is an interest or principal payment default under such securities purchase agreement that has been called for immediate payment by the Required Holders (as defined in the securities purchase agreement) pursuant to the terms of such securities purchase agreement; or (iv) the First Lien Senior Secured Notes are not paid in full within 3.5 years after issuance, the sellers shall have the right to require the principals to purchase their outstanding First Lien Senior Secured Notes, in whole or in part, together with the related warrants to purchase shares of our common stock that are then still outstanding, and the principals will purchase such First Lien Senior Secured Notes and related outstanding warrants, at a purchase price equal to the then outstanding principal amount of the First Lien Senior Secured Notes required to be purchased, plus accrued and unpaid interest on such First Lien Senior Secured Notes through the date of purchase. This provision was subsequently deleted by amendment as described below; |
| • | | the principals granted the sellers a security interest in all our equity securities owned by the principals to secure the performance of the principals’ obligations referenced in the foregoing item. This provision was subsequently deleted by amendment as described below; |
| • | | in the event that, at any time and from time to time, after the issuance of the First Lien Senior Secured Notes to sellers, any seller receives a bid price equal to or greater than 97% of par plus accrued and unpaid interest to purchase such seller’s First Lien Senior Secured Notes and related outstanding warrants, in whole or in part, such seller shall sell its First Lien Senior Secured Notes and the related outstanding warrants pursuant to such bid; and (ii) each seller shall, at all times for so long as it owns any First Lien Senior Secured Notes, maintain with Imperial Capital, LLC and/or such other broker as the principals shall designate an offer price not greater than par plus accrued and unpaid interest to sell its First Lien Senior Secured Notes and related outstanding warrants. This provision was subsequently deleted by amendment as described below; and |
| • | | for so long as any First Lien Senior Secured Notes owned by any seller remain outstanding, the principals are restricted from selling, transferring or otherwise disposing of their First Lien Senior Secured Notes except subject to certain exceptions. This provision was subsequently revised by amendment as described below. |
The letter agreement terminates upon the (i) sale, transfer or other disposition of all First Lien Senior Secured Notes owned by the sellers to an unrelated third party, (ii) the repayment in full of such First Lien Senior Secured Notes, or (iii) the consummation of this offering.
On May 14, 2008, the letter agreement was amended to reflect the sellers’ decision to retain their outstanding First Lien Senior Secured Notes, instead of selling them, as contemplated by the original letter agreement. The principals and the sellers agreed, among other things, to the following amendments which remain in effect to date:
| • | | the principals no longer have an obligation to purchase the sellers’ First Lien Senior Secured Notes or to grant a security interest in any equity securities owned by the principals; |
| • | | the sellers no longer have an obligation to sell their First Lien Senior Secured Notes at a certain bid price; |
| • | | the principals granted the sellers an immediately exercisable option to purchase from time to time from the principals, an aggregate of approximately 20,000,000 shares of our common stock at the exercise price of $0.01 per share, at any time until the consummation of an initial public offering; |
| • | | the principals are no longer restricted from selling their First Lien Senior Secured Notes. Instead, until the later of (i) the repayment in full of the First Lien Senior Secured Notes owned by any seller and (ii) the |
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| | consummation of an initial public offering, no principal may sell, transfer or otherwise dispose of any of our securities subject to the purchase option or permit them to become subject to any liens; and |
| • | | the letter agreement terminates upon the consummation of this offering and the completion of transfer of any equity securities required by the amendment to be transferred. |
In 2004, PET Capital Partners LLC sold a minority position of non-voting Series B common stock to IBD. In connection with the purchase agreement relating to this transaction, IBD was entitled to certain rights under the Shareholders’ Agreement (to which we are a party), including the right to receive notice of and to participate on a pro rata basis in, any issuance or sale of securities to a related party. IBD has claimed that the 2007 issuance of Series B Convertible Preferred Stock by us was a violation of the Shareholders’ Agreement.
On December 31, 2008, Strategic Media I LLC, or Strategic, a Delaware limited liability company, purchased 25,483,300 shares of our non-voting Series B common stock from IBD. Staton Family Investments, Ltd., which is managed by Mr. Staton, our Chairman of the Board and Treasurer, owns 25.0% of the membership interests of Strategic and, as the sole manager of Strategic, Staton Family Investments, Ltd. has sole dispositive and voting power over the shares purchased by Strategic. Bell Family 2000 Trust Agreement, an affiliate of Mr. Bell, our Chief Executive Officer and President, owns 25.0% of the membership interests of Strategic; however, Mr. Bell disclaims beneficial ownership over the membership interests held by this trust. Mr. LaChance, one of our directors, and his spouse own 6.25% of the membership interests of Strategic as tenants by the entirety.
The purchase price for the shares purchased by Strategic was $36.7 million, all of which is payable to the creditors of IBD. The approximate dollar value of each of the interests held by the Staton Family Investments, Ltd., the Bell Family 2000 Trust and Mr. LaChance’s is $9.18 million, $9.18 million and $2.29 million, respectively.
A non-refundable initial payment in the amount of $3.7 million was paid at the closing of the stock purchase. The balance of the purchase price is due on December 31, 2011, except that such balance is subject to pre-payment upon the occurrence of certain events, including upon consummation of this initial public offering. If the balance is not paid in full by its due date and the shares purchased by Strategic are not delivered to IBD’s creditors within five business days after the due date, the balance of the purchase price will start to accrue interest, at a rate per annum equal to 10% of the unpaid principal balance, until either the balance is paid or the shares are delivered. Strategic pledged the shares as security for payment of the balance of the purchase price. The shares are subject to lock-up arrangements as described under “Underwriting.”
As a result of this transaction, we delivered general releases to, and received general releases from, IBD, certain of its current and former directors, officers and shareholders, as well as substantially all of IBD’s creditors. The general release from IBD released us from, among other things, allegations raised in a July 30, 2007 letter from IBD that we, as well as certain of our officers and directors, had violated the Nevada Revised Statutes, federal securities laws, state common law and breached the terms of the 2004 Shareholders’ Agreement in connection with our offering of shares of Series B Convertible Preferred Stock in December 2007.
In 2008 we paid a total of $42,598 to Cyberzine Publishing, Inc., which is owned by Lars Mapstead, one of the founders of Various. These payments were made in consideration for traffic sent to our websites from domain names owned by Cyberzine Publishing, Inc.
Quantitative and Qualitative Disclosures about Market Risk
We are exposed to market risk attributed to interest and foreign currency exchange rates.
Interest Rate Risk
We are exposed to interest rate fluctuations, primarily as a result of our First Lien Senior Secured Notes issued in connection with the acquisition of Various on which the interest rate is subject to market fluctuations. We do not currently use derivative instruments to fix the interest rates of any of our floating rate debt. Our First Lien Senior Secured Notes accrue interest at a rate per annum equal to the sum of the greater of three month LIBOR (1.4% at December 31, 2008) or 4.5%, plus 8.0%. A hypothetical 1.0% or 100 basis point increase in interest rates would not result in a material impact on our earnings due to the three-month LIBOR rate at April 23, 2009 of 1.1% being substantially lower than the floor of 4.5%.
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Foreign Currency Exchange Risk
Our exposure to foreign currency exchange risk is primarily due to our international operations. As of December 31, 2008, we had a $82.0 million liability for VAT denominated in Euros and British Pounds, which represents substantially all of our foreign currency exchange rate exposure. In addition, revenue derived from international websites are paid in advance primarily with credit cards and are denominated in local currencies. Substantially all such currencies are converted into U.S. dollars on the dates of the transactions at rates of exchange in effect on such dates and remitted to us and accordingly, is recorded based on the U.S. dollars received by us. As a result, our foreign currency exchange risk exposure is not material and is limited to the amount of foreign exchange rate changes on any individual day on the portion of our net revenue received in other currencies. Accounts receivable due from restricted cash held by foreign credit card processors and VAT liabilities denominated in foreign currencies are converted into U.S. dollars using current exchange rates in effect as of the balance sheet date. Gains and losses resulting from transactions denominated in foreign currencies are recorded in the statement of operations. The potential loss resulting from a hypothetical 10.0% adverse change in quoted foreign currency exchange rates is approximately $8.2 million. We do not utilize any currency hedging strategies.
Inflation
We are subject to the effects of changing prices. We have, however, generally been able to pass along inflationary increases in our costs by increasing the prices of our products and subscriptions.
Sarbanes-Oxley Compliance and Corporate Governance
As a public company, we will be subject to the reporting requirement of the Sarbanes-Oxley Act of 2002. Beginning immediately, we will be required to establish and regularly evaluate the effectiveness of internal controls over financial reporting. In order to maintain and improve the effectiveness of disclosure controls and procedures and internal control over financial reporting, significant resources and management oversight will be required. We also must comply with all corporate governance requirements of the New York Stock Exchange, including independence of our audit committee and independence of the majority of our board of directors.
We plan to timely satisfy all requirements of the Sarbanes-Oxley Act and the New York Stock Exchange applicable to us. We have taken, and will continue to take, actions designed to enhance our disclosure controls and procedures. We have adopted a Code of Business Conduct and Ethics applicable to all of our directors, officers and employees. We will establish a confidential and anonymous reporting process for the receipt of concerns regarding questionable accounting, auditing or other business matters from our employees. We intend for our General Counsel to assist us in the continued enhancement of our disclosure controls and procedures. In addition, we intend to put additional personnel and systems in place which we expect will provide us the necessary resources to be able to timely file the required periodic reports with the SEC as a publicly traded company. We intend for our Chief Financial Officer, Controller and other financial personnel to lead our existing staff in the performance of the required accounting and reporting functions. In addition, we plan to install a new accounting system and implement additional controls and procedures designed to improve our financial reporting capabilities and improve reporting efficiencies.
On an ongoing basis we intend to conduct a controls evaluation to identify control deficiencies and to confirm that appropriate corrective action, including process improvements, are being undertaken. We expect to conduct this type of evaluation on a quarterly basis so that the conclusions concerning the effectiveness of our controls can be reported in our periodic reports. The overall goals of these evaluation activities will be to monitor our internal controls for financial reporting and our disclosure controls and procedures and to make modifications as necessary. Our intent in this regard is that our internal controls for financial reporting and our disclosure controls and procedures will be maintained as dynamic systems that change, including with improvements and corrections, as conditions warrant.
Our ability to enhance our disclosure controls and procedures, to conduct controls evaluations and to modify controls and procedures on an ongoing basis may be limited by the current state of our staffing, accounting system and internal controls since any enhancements and modifications may require additional staffing and improved systems and controls.
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Recent Accounting Pronouncements
In September 2006, the Financial Accounting Standards Board, or FASB, issued SFAS No. 157,Fair Value Measurements. SFAS No. 157 clarifies the definition of fair value, establishes a framework for measuring fair value, and expands the disclosures on fair value measurements. SFAS No. 157 is effective for fiscal years beginning after November 15, 2007. On February 12, 2008, the FASB issued FASB Staff Position, or FSP, No. FAS 157-2 which delays the effective date of SFAS No. 157 for fair value measurements for all non-financial assets and non-financial liabilities, except those that are recognized or disclosed at fair value in the financial statements on a recurring basis (that is at least annually). The FSP defers the effective date of SFAS No. 157 to fiscal years beginning after November 15, 2008. Effective January 1, 2008, we adopted SFAS No. 157 with respect to our financial assets and liabilities. The adoption of this standard had no impact on our consolidated financial statements for the year ended December 31, 2008. We are currently evaluating the impact, if any, of the adoption of this statement on our financial statements as it relates to non-financial assets and liabilities.
In February 2007, the FASB issued SFAS No. 159,The Fair Value Option for Financial Assets and Financial Liabilities. SFAS No. 159 provides companies with an option to report selected financial assets and liabilities at fair value and establishes presentation and disclosure requirements designed to facilitate comparisons between companies that choose different measurement attributes for similar types of assets and liabilities. SFAS No. 159 became effective for us on January 1, 2008 and had no effect on our financial statements for the year ended December 31, 2008, as we did not elect to apply the provisions of SFAS No. 159.
In December 2007, the FASB issued SFAS No. 141(R), Business Combinations. SFAS No.141(R) establishes principles and requirements for how an acquirer in a business combination (i) recognizes and measures in its financial statements the identifiable assets acquired, the liabilities assumed, and any noncontrolling interest in the acquiree, (ii) recognizes and measures the goodwill acquired in a business combination or a gain from a bargain purchase and (iii) determines what information to disclose to enable users of financial statements to evaluate the nature and financial effects of the business combination. Adoption of SFAS No. 141(R) is required for combinations after December 15, 2008. Early adoption and retroactive application of SFAS No. 141(R) to fiscal years preceding the effective date are not permitted. The impact, if any, of the implementation of SFAS No. 141(R) will have on our financial statements is dependent on our future acquisitions.
In April 2008, the FASB issued FSP FAS No. 142-3,Determination of the Useful Life of Intangible Assets. FSP FAS No. 142-3, which is effective for fiscal years beginning after December 15, 2008, amends the factors that should be considered in developing renewal or extension assumptions used to determine the useful life of a recognized intangible asset acquired after the effective date. The intent of this FSP is to improve the consistency between the useful life of a recognized intangible asset and the period of expected cash flows used to measure the fair value of the asset under SFAS No. 141(R), Business Combinations, and other U.S. GAAP. We adopted FSP FAS No. 142-3 on January 1, 2009 and do not expect this standard to have a material impact on our financial statements.
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OUR INDUSTRY
Greater worldwide availability and affordability of internet and broadband access has led to the global growth of internet users and their time spent online with the internet becoming an increasingly significant communication and entertainment medium. As part of this trend, social networking has become one of the most popular services on the internet as individuals seek to combine the exchange of information, content and entertainment within an online community environment. In this sphere, adult social networking services have experienced considerable appeal by allowing individuals to search for and communicate online with a large number of potential partners before interacting in face-to-face meetings. Since adult content is mostly a paid service online, the continued increase in worldwide credit card penetration and alternative online payment mechanisms are expected to drive significant growth in the online adult industry. Additionally, given the internet’s interactive nature, reach and ability to target niche audiences, we expect the social networking space to create new opportunities for advertisers to target customers online.
The Growth of the Internet and Broadband Adoption
In recent years the rapid growth of the internet has continued, with the number of internet users worldwide reaching approximately 1.6 billion in December 2008 according to Internet World Statistics, having grown by approximately 336% since 2000. In North America and Europe the number of internet users grew to approximately 247 and 390 million, respectively, in December 2008, having grown by approximately 128% and 271% since 2000. Major Asian markets have grown at an even greater rate, achieving a total growth rate of approximately 469% since 2000, with the total number of users reaching 650 million in December 2008. Notably, broadband internet is the fastest growing segment of the internet allowing for faster delivery of complex content, such as photos and video. According to the Economist Intelligence Unit, in 2008 broadband penetration in North America rose to 27% of the population and is expected to reach over 29% by 2010. As seen in the chart below, similar trends in increased broadband adoption are expected worldwide.
Broadband Penetration (as a percentage of population)
| |
|---|
| | | | 2004
| | 2005
| | 2006
| | 2007
| | 2008
| | 2009E
| | 2010E
|
|---|
| Worldwide | | | | | 3 | % | | | 4 | % | | | 6 | % | | | 7 | % | | | 8 | % | | | 9 | % | | | 10 | % |
| North America | | | | | 15 | % | | | 19 | % | | | 22 | % | | | 25 | % | | | 27 | % | | | 28 | % | | | 29 | % |
| Europe | | | | | 9 | % | | | 13 | % | | | 17 | % | | | 21 | % | | | 24 | % | | | 27 | % | | | 29 | % |
| Asia-Pacific | | | | | 2 | % | | | 3 | % | | | 3 | % | | | 4 | % | | | 5 | % | | | 5 | % | | | 6 | % |
| Middle East & Africa | | | | | 0 | % | | | 1 | % | | | 1 | % | | | 1 | % | | | 2 | % | | | 2 | % | | | 2 | % |
| Latin America | | | | | 1 | % | | | 2 | % | | | 3 | % | | | 4 | % | | | 6 | % | | | 8 | % | | | 9 | % |
Source: Economist Intelligence Unit, March 2009
We believe the increase in broadband penetration will have a positive effect on e-commerce transactions, including the purchase of content and services online as broadband connections provide faster, more convenient transaction experiences.
The Growth of Traditional Social Networking
We participate in the online social networking industry in the adult online communities category. Social networking is a communications and personal expression medium that has become one of the most popular services in internet history. In general, traditional online social networking is an online activity in which internet users link personal websites about themselves and their interests to those of their friends or individuals with similar interests. Users engage in a number of activities within social networking environments, including communication, such as e-mailing and instant messaging, content sharing, such as photos and videos, and publishing, such as blogging, to establish a network of social relationships with friends, colleagues and acquaintances and meet other individuals with like interests. Much of the growth in social networking can be explained by its general appeal, as it allows users to communicate in a highly interactive fashion.
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According to comScore, social networking has recently been marked by rapid growth: in December 2007, worldwide social networking accounted for 9% of time spent online and increased to 11% by December 2008. In terms of actual visitors, in December 2008, out of 1,008 million unique worldwide visitors to internet websites, approximately 706 million visited social networking websites. Worldwide social networking visitors have grown at a faster rate than internet visitors as a whole. Although social networking growth in North America is starting to level off, the medium is still growing very rapidly in other regions around the world, as shown in the chart below.
Growth of Social Networks and Internet (Unique Visitors), December 2007 – December 2008
| |
|---|
| | | | Social Networks
| | Internet
|
|---|
| Worldwide | | | | | 37 | % | | | 24 | % |
| Middle East & Africa | | | | | 57 | % | | | 25 | % |
| Asia-Pacific | | | | | 41 | % | | | 36 | % |
| Europe | | | | | 50 | % | | | 22 | % |
| Latin America | | | | | 44 | % | | | 29 | % |
| North America | | | | | 10 | % | | | 2 | % |
Source: comScore, February 2009
Growth in Adult Online Communities
Within the social networking sphere, we are focused on adult online communities. According to comScore, over 43% of worldwide internet users accessed adult websites in December 2008 and worldwide users accessing adult websites grew 23% from December 2007 to December 2008. In particular, according to comScore, the number of adult visitors (defined as users over 18 years of age) to social networks have increased by 37% from December 2007 to December 2008. Adults as a group have also become more actively engaged over the same time period, spending 47% more total minutes on social networks than in December 2007. Additionally, within the adult segment, social networking in the United States is still under penetrated. According to eMarketer, the number of adult users of social networks in the United States will increase by 47% from 57 million in 2007 to 84 million in 2011, as shown in the chart below.
United States Adult Online Social Networking Users
| |
|---|
| | | | 2007
| | 2008
| | 2009E
| | 2010E
| | 2011E
|
|---|
| Number of adult social networking users (in millions) | | | | | 57 | | | | 63 | | | | 71 | | | | 78 | | | | 84 | |
| Percentage of adult internet users | | | | | 37 | % | | | 40 | % | | | 44 | % | | | 47 | % | | | 49 | % |
Source: eMarketer, February 2009
Adult community websites such as ours offer a similar suite of applications and communications tools as general interest social networking websites. The distinction lies in the user’s purpose for accessing the website. Whereas most general interest social networking users log on to remain generally connected to their friends and interest groups, adult community website members log on specifically to meet a companion or date who they do not know. Adult communities facilitate interaction between individuals by allowing them to search for and communicate with a large number of potential partners at their convenience and afford them the ability to initially meet people in a more secure online setting before meeting face-to-face.
Growth of Online Spending on Adult Services and Entertainment
Adult content dominates the paid online content market, which includes subscription and pay-on-demand services. The main drivers of purchasing adult services online are payment mechanisms, including credit cards and the emergence of alternative online payment methods in emerging markets. According to Euromonitor, by 2010 about 40% of the world’s population is expected to own a credit card, allowing for significant increases in online spending for goods and services. The chart below shows significant increases are expected in credit card penetration across all regions worldwide.
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Credit Card Penetration
| |
|---|
| | | | 2004
| | 2005
| | 2006
| | 2007
| | 2008
| | 2009E
| | 2010E
|
|---|
| Worldwide | | | | | 22 | % | | | 24 | % | | | 25 | % | | | 28 | % | | | 31 | % | | | 35 | % | | | 40 | % |
| North America | | | | | 212 | % | | | 222 | % | | | 229 | % | | | 242 | % | | | 249 | % | | | 262 | % | | | 275 | % |
| Europe | | | | | 20 | % | | | 22 | % | | | 25 | % | | | 28 | % | | | 33 | % | | | 40 | % | | | 50 | % |
| Middle East & Africa | | | | | 22 | % | | | 23 | % | | | 28 | % | | | 32 | % | | | 35 | % | | | 39 | % | | | 43 | % |
| Latin America | | | | | 22 | % | | | 28 | % | | | 35 | % | | | 44 | % | | | 51 | % | | | 58 | % | | | 64 | % |
| Asia-Pacific | | | | | 15 | % | | | 16 | % | | | 17 | % | | | 19 | % | | | 23 | % | | | 27 | % | | | 33 | % |
Source: Euromonitor, March 2009
In developing economies access to credit cards is currently limited due to a less developed banking sector, limited credit histories for customers and customer aversion to debt. For example, in China as of 2008 only 12% of the population held a credit card, according to Euromonitor. However, as illustrated in the table above, credit cards are expected to grow rapidly in emerging markets. Additionally, a number of alternative payment systems, such as prepaid cards, mobile phone payments, cash payments and bank transfers, are becoming more and more prevalent for online payments in these markets.
Growth in Online Advertising
Since internet users share a wealth of personal information, such as age, location, occupation and hobbies, the social networking websites are highly attractive to advertisers who are able to target advertisements to specific demographic groups.
Despite the current unenthusiastic outlook for the United States and the global economies, internet advertising spending is expected to grow at a solid pace, maintaining significantly higher growth rates than other advertising mediums, as shown in the chart below. According to ZenithOptimedia, internet advertising worldwide is expected to grow at a compounded annual growth rate of 13% between 2007 and 2010.
Worldwide Advertising Spending Growth
| |
|---|
| | | | 2004
| | 2005
| | 2006
| | 2007
| | 2008
| | 2009E
| | 2010E
|
|---|
| Total advertising expense | | | | | 7 | % | | | 6 | % | | | 7 | % | | | 7 | % | | | 1 | % | | | –7 | % | | | 1 | % |
| Internet | | | | | 26 | % | | | 43 | % | | | 38 | % | | | 36 | % | | | 21 | % | | | 9 | % | | | 11 | % |
| Print | | | | | 5 | % | | | 4 | % | | | 4 | % | | | 2 | % | | | –5 | % | | | –12 | % | | | –4 | % |
| TV | | | | | 9 | % | | | 5 | % | | | 7 | % | | | 6 | % | | | 3 | % | | | –6 | % | | | 3 | % |
| Cinema | | | | | 9 | % | | | 11 | % | | | 6 | % | | | 13 | % | | | 6 | % | | | –4 | % | | | 6 | % |
| Radio | | | | | 6 | % | | | 4 | % | | | 4 | % | | | 4 | % | | | –2 | % | | | –10 | % | | | –1 | % |
| Outdoor | | | | | 8 | % | | | 12 | % | | | 10 | % | | | 10 | % | | | 3 | % | | | –7 | % | | | 2 | % |
Source: ZenithOptimedia, March 2009
Furthermore, eMarketer forecasts that worldwide online social networking advertising spending will reach $2.6 billion by 2010 compared to the $1.4 billion in 2007, as shown in the chart below:
Worldwide Online Social Networking Advertising Spending
| |
|---|
| | | | 2007 | | 2008 | | 2009E | | 2010E | | 2011E |
|---|
| Advertising spending (in millions) | | | | | $1,366 | | | | $2,000 | | | | $2,350 | | | | $2,600 | | | | $2,870 | |
| Percent change | | | | | N/A | | | | 46 | % | | | 17 | % | | | 11 | % | | | 10 | % |
Source: eMarketer, March 2009
Overall, we believe our industry offers the potential for substantial further growth for a number of reasons, including:
| • | | internet penetration, particularly broadband penetration, continues to grow, expanding our potential client base and permitting us to offer more services and a better user experience to our customers; |
| • | | the adoption of adult social networking is increasing worldwide, and people are spending more and more time on websites; |
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| • | | the increase in credit card penetration and other online payment mechanisms in emerging markets, coupled with growing broadband adoption, are increasing the ease of transacting online; and |
| • | | worldwide internet advertising spending is expected to increase despite the progressively unenthusiastic current outlook on the United States and global economies. |
We believe that we are well-positioned to capitalize on these growth trends and lead as a social network in both the adult and non-adult or general audience segments.
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BUSINESS
Company Overview
We are a leading internet-based social networking and multimedia entertainment company operating several of the most heavily visited social networking websites in the world, including AdultFriendFinder.com and FriendFinder.com as well as several entertainment websites. Through our extensive network of websites, since our inception, we have built a base of over 285 million members in approximately 170 countries. Our websites are intended to appeal to members of diverse cultures and interest groups and include social networking, live interactive video and premium content websites. Our revenue to date has been primarily derived from subscription and paid-usage adult-oriented products and services. We believe that our broad and diverse membership base also represents a valuable asset that will provide opportunities for growth. In addition to our online products and services, we also produce and distribute original pictorial and video content, license the globally-recognized Penthouse brand and publish branded men’s lifestyle magazines.
We categorize our users into four categories: visitors, members, subscribers and paid users and focus on the following key business metrics to evaluate the effectiveness of our operating strategies.
| • | | Visitors. Visitors are users who visit our websites but do not necessarily register. We believe we achieve large numbers of unique visitors because of our focus on continuously enhancing the user experience and expanding the breadth of our services. For the year ended December 31, 2008, we averaged 59 million unique worldwide visitors per month according to comScore. |
| • | | Members. Members are users who complete a free registration form on one of our websites. Members are able to complete their personal profile and access our searchable database of members but do not have the same full access rights as subscribers. For the year ended December 31, 2008, we averaged more than four million new member registrations on our websites each month. |
| • | | Subscribers. Subscribers are members who purchase subscriptions for one or more of our websites. Subscribers have full access to our websites and may access special features including premium content during the term of their subscription. For the year ended December 31, 2008, we had a monthly average of over one million paying subscribers from whom we derived approximately 80.7% of our internet revenues. |
| • | | Paid Users. Paid users are members who purchase products or services on a paid-by-usage basis. For the year ended December 31, 2008, we averaged approximately 1.6 million purchased minutes by paid users each month from whom we derived approximately 18.5% of our internet revenue from paid users. |
| • | | Average Monthly Net Revenue per Subscriber. ARPU is calculated by dividing adjusted non-GAAP net revenue for the period by the number of average subscribers in the period. For the year ended December 31, 2008, our ARPU was approximately $21.78. For more information regarding our adjusted non-GAAP net revenue, see “Prospectus Summary — Non-GAAP Financial Results” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations — Results of Operations — FriendFinder Networks Inc. and Subsidiaries — Year Ended December 31, 2008 as Compared to Pro Forma Year Ended December 31, 2007.” |
| • | | Churn. Churn is calculated by dividing terminations of subscriptions during the period by the total number of subscribers at the beginning of that period. Our historic average monthly churn rate, which measures the rate of loss of subscribers, has decreased from approximately 19.6% per month for the year ended December 31, 2007 to approximately 17.8% per month for the year ended December 31, 2008. |
| • | | Marketing Affiliates. Our marketing affiliates are companies that operate websites that market our services on their websites and direct visitor traffic to our websites by placing banners or links on their websites to one or more of our websites. As of December 31, 2008, we had over 150,000 participants in our marketing affiliate program from which we derive a substantial portion of our new members and approximately 43.0% of our revenue. For the year ended December 31, 2008, we made payments to marketing affiliates of approximately $62.3 million. |
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Our Competitive Strengths
We believe that we have the following competitive strengths that we can leverage to implement our strategy:
• | | Paid Subscriber-Based Social Networking Model. |
We operate social networking websites that allow our members to make connections with other members who they may or may not already know but with whom they share common interests. Our members are able to post their profiles and other content of interest for free and our subscribers are then able to access this content for a fee. We believe the content posted by our members creates a compelling value proposition for which people are willing to pay. Our paid subscriber-based model is distinctly different from other social networking websites whose users can access the websites for free to remain connected to their pre-existing friends and interest groups. Our subscribers and paid users purchase our products and services in advance using various payment methods, including credit card and non-credit card payments, such as preauthorized bank account debiting and mobile phone payments. Because our customers pay in advance, we have limited exposure to credit risk. The majority of our subscription-based websites offer multi-tiered subscriptions that allow subscribers to access greater or enhanced services and content depending upon their subscription levels. We also have users who pay-by-usage basis, where minutes are purchased in advance of use and there is a deduction of the available funds as minutes are used.
• | | Large and Diverse Membership Base Attractive to Members. |
We operate some of the most heavily visited social networking websites in the world. Since our inception, over 285 million members have registered on our websites, and for the year ended December 31, 2008 we added on average more than four million new members each month, which we believe represents a substantial barrier to entry to potential competitors. Our websites are designed to appeal to individuals with a diversity of interests and backgrounds. We believe potential members are attracted to the opportunity to interact with other individuals by having access to our large, diverse membership base. During the registration process, we collect valuable demographic information about our members and our technology allows us to then target specific demographics and interest groups within our member base via e-mail, which in turn allows us to develop diverse features and websites tailored for these demographics and interest groups. We believe this is a valuable asset that will attract advertisers seeking to advertise on our websites.
• | | Large and Difficult to Replicate Affiliate Network. |
Through a network of over 150,000 affiliates, we are able to further promote our flagship brands. By collaborating with other companies who market our services on their websites, our marketing affiliate program generates approximately 43.0% of our revenue from attracting and referring visitors who become members and subscribers of our websites. We believe potential affiliates are drawn to our program by the size of our online communities and by our distinctive business model, which results in attractive compensation for our affiliates. We also provide our affiliates a variety of payment options and value-added features, such as private labeling, a feature that is currently used to power more than 15,000 websites. Private labeling allows our affiliates to preserve the look and feel of their websites while generating revenue for us. We believe our program’s ability to direct a large number of visitors to our websites is a key component of our past success and future growth. In addition, we believe that the difficulty in building an affiliate network of this large size presents a significant barrier to entry for potential competitors.
• | | Proprietary and Scalable Technology Platform and Business Model. |
Over the last ten years we have developed a robust, highly scalable technology platform for the websites we operate built on open-source technology and inexpensive commodity hardware, and augmented by a customizable template interface that allows us to add new features and launch additional websites at a relatively low incremental cost. We also have developed a wide array of custom applications technologies to support our affiliate program, our billing processes and for business analytics. Our
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technology platform enables us to collect and sort a large variety of data in order to monitor all areas of our business and increase the traffic and revenue to our websites.
• | | Brand Recognition and Compelling Adult Content. |
The strength and wide recognition of our AdultFriendFinder, FriendFinder and Penthouse brands provides us with a competitive advantage. Our websites are offered in 12 languages to users who reside in approximately 170 countries. We produce original mature video and pictorial content and own a library of over 650 films, over 10,000 hours of video content and over one million images that are frequently updated. Due to our ability to offer a wide variety of both member-generated and professionally-produced content, we believe our websites appeal to adult internet users worldwide.
Our Strategy
As one of the world’s leading internet-based social networking and multimedia entertainment companies, our goal is to enhance revenue opportunities while improving our profitability. We plan to achieve these goals using the following strategies:
• | | Increase Conversion of Members to Subscribers. |
Our business model to date has been subscriber-based, resulting in our internet business revenue being principally generated from our subscribers. We continually seek to improve the websites we operate with the goals of encouraging visitors to become members and members to become subscribers. Currently, we have approximately one million subscribers, which is less than 1.0% of our total members. We continually evaluate, add and enhance features on our websites to improve our members’ experience. New features and designs are tested on a statistically significant sample of our membership base, and features and designs are released to the entire membership base only after satisfactory results are achieved. We believe the release of new features and designs creates real value for the subscription fee, generating increased member and subscriber loyalty, prompting the purchase of additional services and increasing the number of visits and utilization of our products and services. A small increase in the conversion ratio or a decline in the loss of a subscriber, or churn, has significant effects on our revenue and profitability.
• | | Generate Advertising Revenue. |
To date, advertising revenues have represented less than 1.0% of our revenue, averaging approximately $0.2 million per month in the year ended December 31, 2008. However, we believe that our large social networking membership base represents a significant advertising opportunity. In particular, we believe that some of our websites with lower conversion rates and with relatively lower ARPU, which are predominantly the non-adult, or general audience, websites, can benefit from the addition of an advertising-based revenue model. Our technology allows us to target specific demographics and interest groups within our member base. We believe that our large membership base will provide advertisers an opportunity to achieve superior results through well-targeted campaigns aimed at their preferred demographic and interest group. The soft launch of our advertising platform in 2008 has allowed our ad sales team to sell, track and optimize the ad inventory we currently have. In 2009, we expect to roll out our advertising platform and we plan to continue developing technology designed to integrate advertising sales into our websites, assemble a larger sales force and create marketing material for potential advertisers.
• | | Penetrate New Communities of Interest and Monetize Current Foreign Markets. |
We are constantly seeking to identify groups of sufficient size who share a common interest in order to create an online community intended to appeal to their interests. Within our extensive membership database, we have an existing list of users who could potentially be members of new websites we may create based on the demographic information we have previously collected. By leveraging our extensive membership database together with our scalable technology platform, we are able to quickly create and launch additional websites without substantial additional capital investment. The creation of new websites would allow us to attract new members and different interest groups, as we have done for a variety of
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groups, including BigChurch.com and SeniorFriendFinder.com. We also plan to expand in selected geographic markets, including southeast Europe, South America and Asia, and we plan to offer our social networking websites and services in additional languages, including Hindi and Russian. In markets in which we already have a presence, we plan to leverage our technology platform in order to make culturally relevant enhancements to our websites, such as expanding language translation as well as adjusting prices based on geography to enhance revenues from countries where we already have a large member base. In certain of the markets where we operate, there are domestic issues that preclude members in these countries from becoming paid subscribers including limited availability of credit cards. As credit cards and other payment mechanism become more readily available and accessible in these foreign jurisdictions we expect our revenue to grow.
• | | Pursue Targeted Acquisitions. |
We believe there is a significant opportunity to expand our business by acquiring and integrating other companies. We have identified three general types of acquisition candidates:
| • | | additional social networking websites which will strengthen our existing business; |
| • | | owners, creators and distributors of content which will expand our products and services; and |
| • | | payment processing and advertising businesses which will expand our existing technology and infrastructure. |
After successfully closing and integrating the $401 million acquisition of Various, we assembled an experienced team to identify, examine and proactively pursue accretive acquisition opportunities. In addition, our team continues to evaluate the numerous potential candidates that have contacted us to determine if the candidates meet our strategic criteria. A majority of these companies are smaller than we are and have limited financial and human resources. Most of these candidates are in industries that are highly fragmented, and we believe there are a limited number of potential purchasers for these acquisition opportunities.
Our Products and Services
Our products and services consist of our social networking, live interactive video and premium content websites and, to a lesser extent, the licensing of our Penthouse brand, the publishing of branded men’s lifestyle magazines and the production and distribution of original video and pictorial content. For a discussion of our financial information for specific geographic areas, see “Note N — Segment Information” in our consolidated financial statements and related notes.
Social Networking Websites
The social networking aspect of our business is a cornerstone of our business model and is our largest source of revenue. We believe we are a leading provider of social networking websites in the world. The largest of our communities, AdultFriendFinder.com, is ranked in the top 75 in the world by Amazon.com’s Alexa ratings system, which ranks the most highly-visited websites in the world.
We provide social networking and online personals services for members of diverse cultures, ethnicities and interest groups. Each website is built around a central theme, which often relates to the ethnicity or social interests of its members. These online communities are delivered in the language appropriate to the group targeted by the website, including:
| • English | | | | • German | | • Portuguese |
| • Chinese | | | | • Italian | | • Spanish |
| • Dutch | | | | • Japanese | | • Swedish |
| • French | | | | • Korean | | • Tagalog |
Membership on our social networking websites generally includes access to member-generated content including the ability to post a personal profile and photographs, create a social network, chat and instant message
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with other members, and search our database of member profiles as well as company-generated features and content such as contests, newsletters and articles as well as the loyalty program we administer. We believe that this variety of revenue-enhancing features encourages visitors to join as members. The ability to initiate communication with other members and subscribers via our e-mail communications platform and view the full profiles of the members in our database requires payment of a subscription fee. Depending on the specific website, subscribers also have access to additional functionality and increased or enhanced levels of services and content. Described below are several of the features that are accessible on many of our websites.
| • | | Blogs — Blogs are a simple way to create a regularly updated home page where members can express themselves, learn about others, get more noticed and attract new friends. There are numerous blogs, grouped by subject. |
| • | | Chatrooms — Chatrooms are areas where members can discuss a specific topic or join rooms established by region. A private chatroom lets a member host a chat party by invitation only. |
| • | | Contests — Contests are a means of engaging our members by offering rewards for member-generated content. Examples include Best Holiday Greeting Card, Silly Photos with Clever Captions and many more. Prizes include upgraded memberships, free points, DVDs, T-shirts and mugs. |
| • | | Cupid Reports — Once a member has described an ideal match, the member is automatically notified by e-mail when a person matching that description becomes a member. |
| • | | Friends Network — A member can invite specified members into a personal group, keep track of them, share private photos and send personalized bulletins. |
| • | | Get Local — Websites list local events that are geographically targeted according to a member’s location. |
| • | | Groups — Groups are the place to find people who share interests and to develop new friendships. Members search for groups by topics, names or keywords and correspond, exchanging ideas. All groups have their own discussion boards and chatrooms, which facilitate communication and relationship building. Popular groups include “Single again? Let’s get together!,” “Dancing” and “Adventures, Romantic Getaways.” |
| • | | Instant Messaging — Two different types of our instant messaging system are available: a standard service and a faster Flash system, which offers extra options such as live video and sound. |
| • | | Loyalty Program — Our point based loyalty program is designed to increase participation in our websites membership activities, such as participating in blogs and online magazines and creating video introductions. Points can be redeemed for other membership services such as upgraded memberships or more prominence of member profiles in online searches. |
| • | | Newsletters — Our most popular websites periodically send newsletters to members, including photos and brief descriptions of other members, advice on enhancing one’s profile to attract more responses from other members and practical tips on dating and relationships. |
| • | | Online Magazine — At magazine pages, members can participate in many ways: read articles with expert advice on dating and relationships, enjoy fiction serials, submit their own articles, vote and comment on their reading, post original polls they have created, give advice and exchange opinions on various subjects, and view archives of articles. |
| • | | Photo, Video and Voice Sharing — Members can post their photographs and create webcam video introductions and voice introductions of themselves, which generates member-to-member contact. |
| • | | Posting Profiles — Members include personal details, such as city of residence and birthday, physical information, such as height and hair color, personal information, such as education, and occupation as well as other information. They describe themselves, specifying hobbies, the type of person they are seeking for a friend or for dating and can present up to 20 photographs. Members are encouraged to make their profiles as unique as possible by including personal details. |
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| • | | Search — Members can conduct searches for compatible members according to a substantial list of criteria, including gender, geographical proximity, availability of photos and interests. Search criteria can be saved for repeated use. |
Website Data
Below is a list of each of our websites that had over 100,000 members since its inception as of December 31, 2008. For the year ended December 31, 2008, we have approximately one million subscribers.
Website
| | | | Description
| | Members
Since Inception
|
|---|
| AdultFriendFinder.com | | | | Our most popular adult social networking and dating website. | | | 138,532,860 | |
| Amigos.com | | | | Spanish version of FriendFinder.com, translated into Spanish, Portuguese and English. | | | 34,433,758 | |
| Cams.com | | | | Adult content live interactive video website where members pay per minute to chat with models who broadcast on the website via their webcams. | | | 31,574,172 | |
| AsiaFriendFinder.com | | | | Chinese version of FriendFinder.com, features traditional and simplified Chinese character sets as well as an English interface. | | | 31,297,006 | |
| FriendFinder.com | | | | Website targeted toward singles looking for love, romance and marriage. Also includes many social networking aspects. | | | 11,811,393 | |
| ALT.com | | | | Alternative lifestyle personals website, catering to users with fetish, role-playing and other alternative sexuality interests. | | | 11,639,957 | |
| OutPersonals.com | | | | Adult-oriented dating website for gay men. | | | 5,616,302 | |
| GradFinder.com | | | | Alumni directory where members can contact friends from elementary school through college. | | | 3,405,783 | |
| IndianFriendFinder.com | | | | Indian version of FriendFinder.com, where users can narrow their searches by specific criteria, including language, religion, diet, and caste. | | | 2,513,543 | |
| FastCupid.com | | | | Social networking and personals website for dating, romance and friendship. | | | 2,040,834 | |
| BigChurch.com | | | | Christian dating website with searchable bible passages and daily bible chapter e-mails. | | | 1,988,362 | |
| SeniorFriendFinder.com | | | | Website targeted toward people over 40 years of age. | | | 1,690,746 | |
| GayFriendFinder.com | | | | Dating website for gay men. | | | 1,675,978 | |
| FilipinoFriendFinder.com | | | | Filipino version of FriendFinder.com, translated into Tagalog and English. | | | 1,608,233 | |
| FrenchFriendFinder.com | | | | French version of FriendFinder.com, translated into French and English. | | | 1,531,766 | |
| ItalianFriendFinder.com | | | | Italian version of FriendFinder.com, translated into Italian and English. | | | 998,602 | |
| GermanFriendFinder.com | | | | German version of FriendFinder.com, translated into German and English. | | | 983,324 | |
| KoreanFriendFinder.com | | | | Korean version of FriendFinder.com, translated into Korean and English. | | | 813,112 | |
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Website
| | | | Description
| | Members
Since Inception
|
|---|
| Millionairemate.com | | | | Dating website targeted toward like-minded people who understand that intelligence, success and drive are key elements to attraction. | | | 549,253 | |
| Penthouse.com | | | | Content-based website with varying levels of access to Penthouse pictorials, articles, videos and live webcams shows with Penthouse Pets. | | | 540,996 | |
| JewishFriendFinder.com | | | | Jewish dating website. | | | 532,409 | |
| Slim.com | | | | Health and wellness website. | | | 116,464 | |
Internet Privacy
Our privacy principles represent the continuing evolution of our long-standing commitment to consumer privacy. Our privacy principles related to our internet websites and services provide for robust consumer notice, choice and data security. Our privacy principles include:
| • | | Notice. Members are provided meaningful notice about the information collected and used for internet related advertising. Members visiting our websites are provided notice via links to our privacy policies usually located on every one of our web pages and other methods of the types of individual information collected for advertising purposes, the technologies employed to collect such information, and how such information is used, including if applicable that other companies operate on the website and may collect such information. |
| • | | Choice.Members are provided with a choice on how certain information is used. We provide for an opt-out mechanism for e-mail advertising and members of our social networking websites have access to a control panel that allows them to make choices on the type of data that is stored on our servers or made available to the public or other members using our websites. |
| • | | Security.We strive to provide reasonable security for consumer data. Our security methods are based on the sensitivity of the data, the nature of the services provided, the types of risks related to such data and the reasonable protections available to us for practical implementation. We require our business service providers, such as credit card processors, to contractually maintain appropriate information security procedures based upon the sensitivity of the data and industry practices. We also ask members to verify their age and we review all member-generated content prior to its appearing on our websites. |
| • | | Responsiveness.Members have a readily accessible means to contact us to express concerns and complaints regarding privacy matters and we have a team associated with handling such concerns and complaints. Most of our web pages have a link directly to a web based form for providing complaints to us for processing. |
Live Interactive Video Websites
Our live interactive video websites, such as Cams.com, are a broadcast platform that enables models with a camera and a broadband internet connection to broadcast to an audience of users of any size. These websites represented approximately 18.5% of our adjusted non-GAAP revenue in the year ended December 31, 2008. For more information regarding our adjusted non-GAAP net revenue, see “Prospectus Summary — Non-GAAP Financial Results” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations — Results of Operations — FriendFinder Networks Inc. and Subsidiaries — Year Ended December 31, 2008 as Compared to Pro Forma Year Ended December 31, 2007.” On these websites we offer an interactive webcam service where users can contact models, visually see them and communicate via on-screen text messaging. The models broadcast from independent studios throughout the world to a group of our users. The models interact with a group of users until an individual user requests a private one-on-one experience at which time the per-minute usage charge begins and the screen is blocked to all but the user who is being charged. In some cases, other users are permitted to view the private session for a fee but not interact with the model. In addition to the pay-by-usage service, we
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offer subscription-based payment options that provide discounts on the pay-per-usage services. The majority of the revenues we generate from these websites are from users who may not be subscribers but provide a credit card for payment under the pay-by-usage plan. We pay approximately 30.0% of the revenues derived from these websites to the studios that employ the models.
Premium Content Websites
We operate a number of websites with premium content, such as Penthouse.com and HotBox.com. Premium content is professionally-generated content as opposed to member-generated content. These websites provide subscribers and paid users access to our collection of over 10,000 hours of professional video, which includes our library of over 650 standard and high-definition full-length feature films. Our subscribers also have access to our collection of over one million professionally produced images. Additionally, subscribers have access to editorial content, chat rooms and other interactive features.
We believe that we are one of the few companies that produce high quality, high definition video productions available on the internet. In 2008, we averaged 15 high definition productions per calendar quarter using a combination of freelance and contract directors. PenthouseTV is available in the United States and its territories and reaches over 30 million homes in North America. Our programming is also available in Latin America, Europe and Asia.
We derive revenue through third party license agreements for the distribution of our programming in which we may receive a percentage of the subscription fee paid by the customer, a percentage of the single program or title fee purchased by the customer, a fixed fee for the licensed program, or a combination of the above. Our fixed fee contracts may receive a fixed amount of revenue per title, group of titles or for a certain amount of programming during a period of time. Our studio group also realizes revenue through the sale of DVDs. We sell our productions in the retail DVD marketplace through retail outlets, internet stores, including PenthouseStore.com, and mail order. We release an average of one new DVD title every week to the retail marketplace.
Licensing of Penthouse Brand
We license the Penthouse name, logos, trademarks and artwork for the manufacture, sale and distribution of consumer products. We work with our U.S. and international licensees to develop, market and distribute Penthouse-branded products, including books, apparel, accessories, lingerie, shoes, novelties and swimwear. We have 14 international editions of Penthouse magazine and its associated magazines and digests available in over 16 countries. We continually seek to expand our licenses and products in new markets and retail categories both domestically and internationally.
We also license our Penthouse brand to 10 upscale gentlemen’s clubs and nightclubs. We actively seek to expand our location-based entertainment business, and we are in negotiations on a number of other locations in the United States, Europe and Asia. Our licensing arrangements require limited capital investment or expense on our part.
Magazine Publishing
Penthouse magazine and its related publications are our branded men’s lifestyle publications offering a combination of pictorials, editorial content and humor. We also publish several other adult-oriented magazines and digests. We believe that Penthouse magazine plays a key role in driving the continued popularity and recognition of the Penthouse brand. Accordingly, in the past few years we made significant changes to Penthouse magazine in order to appeal to a wider customer base. We softened the magazine’s pictorial content to improve newsstand positioning and attract a wider national advertising base, and we added editorial content covering sports, music, video and gaming in order to attract additional categories of advertisers and new readers, primarily targeting 21 to 39 year old males. This resulted in the magazine re-entering sales channels in retail establishments. Our advertising base has expanded to now include tobacco, liquor, apparel, footwear, toiletries, men’s grooming, consumer products and direct-response companies.
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Original Video and Pictorial Content
We produce professionally generated original mature video and pictorial content in high-definition format, which in addition to providing superior quality resolution on our websites, gives us the flexibility to convert the content into different media and market it through a wide range of distribution channels including broadcast, cable, satellite, internet protocol television, or IPTV, DVDs and mobile devices.
Payment for Our Internet Products and Services
We derive our revenue primarily from subscriptions. Our users can purchase daily, three-day, weekly, monthly, quarterly, annual or lifetime subscriptions that give them access to all members’ full profile information and the ability to contact other members in one-on-one e-mail correspondence. During the year ended December 31, 2008, our monthly ARPU across our subscriber base was $21.78. Monthly subscription fees and ARPU tend to be lower on our non-adult-oriented or general interest websites. All subscriptions are charged in advance and we recognize the revenue over the terms of such subscriptions. Subscribers on a majority of our websites can upgrade their subscription level for an additional cost in order to have access to additional features and content. On average, our subscribers maintain their subscriptions for approximately five months.
On our live interactive video websites, our users are primarily paid users who purchase products and services on a pay-by-usage basis, and some users pay a monthly fee for access to the websites. During the year ended December 31, 2008, these websites averaged a usage fee of $3.03 per minute, but can be as high as $9.99 per minute, as determined by the studio producing the video. The paid users purchase minutes in advance of their use and draw down on the available funds as the minutes are used.
Our internet-based business does not carry customer receivables on the balance sheet since our products and services are paid for in advance. Subscribers pay for products and services on our websites using several payment methods including credit card and non-credit card payments, such as preauthorized bank account debiting, regular bank transfers, e-money and mobile phone payments. As of March 31, 2009, credit card payments represented approximately 95% of our total payments while other payment methods represented 5% of our total payments, which we consider to present a significant opportunity for growth. We have maintained long-standing relationships with merchant banks and have more than 20 merchant bank accounts. Our technology platform includes proprietary anti-fraud measures to protect us against unauthorized use of credit cards and fraudulent activity on our websites. As a result, our credit card charge back rate is currently less than 1.0% of the transactions processed and the reserves the banks require us to maintain are less than 1.0% of our total revenue.
Internet Product and Feature Development
We are at the leading-edge of creating, implementing and commercializing advanced features and product enhancements to our websites. We continually evaluate and add features to our websites to improve our members’ experience. New features and designs are tested on a statistically significant sample of our membership base, and features and designs are released to the entire membership base only after satisfactory results are achieved. We believe the release of new features and designs results in new members, increased member loyalty, the purchase of additional services on our websites, and increased visitation and utilization of our other websites and services.
Technology Platform
We have developed a robust, highly scalable technology platform over the last ten years, which is supported by approximately 120 architects, programmers and designers. We release new codes on a bi-monthly basis, having released over 300 codes to date. Our proprietary technology platform operates on more than 2,000 devices and allows us to add new members and additional websites at a very low incremental cost. In addition, we have developed a wide array of technologies to support our affiliate program, our billing processes, content management and translation, and for business analytics.
Our technology platform allows us to collect and sort a variety of data which permits us to monitor all areas of our business and increase the traffic and revenue to our websites. We collect and evaluate information related to the activity of the visitors on our websites, the nature of our visitors and the processing of information on our servers.
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The data we collect concerning our visitors’ activities on our websites includes:
| • number of visitors | | | | • number of visitors completing registration |
| • number of paid subscriptions | | | | • number of messages sent |
| • number of images uploaded | | | | • number of customer service requests |
| • number of blogs created | | | | • number of videos uploaded and viewed |
The data we collect concerning the nature of our visitors includes:
| • referring link/domain | | | | • referring affiliate/ad buy/traffic source |
| • country | | | | • language |
| • gender | | | | • e-mail domain |
Statistics monitored on a per-server basis include:
| • number of requests served | | | | • time spent per request |
| • central processing unit utilization | | | | • memory utilization |
| • disc utilization | | | | | | |
We have developed a substantial portfolio of technology-related intellectual property assets. Almost every aspect of our technology, including software code and network architecture, is developed in-house and designed to help optimize our website performance. For example, our content management system enables translation of our websites into a dozen languages or rebranding to address certain target or niche audiences, and our billing software quickly allows the addition of new billing sources.
With respect to marketing technologies, our in-house monitoring systems provide analytical tools during every stage of the “sales funnel” and help us to react quickly to changes in user or potential member behavior. Sophisticated live A-B testing in which we run controlled blind tests in different control groups enables us to determine how a website design element affects conversion rates.
Finally, our in-house developed and maintained software also allows us to provide our third-party advertisers and affiliates with near real-time statistics so that they can monitor their traffic conversion and quickly make necessary adjustments. Similarly, we can provide these advertisers with a variety of improved business models based upon the efficiency of their traffic source.
Marketing
Our marketing primarily consists of our marketing affiliates program and online advertising.
Marketing Affiliates Program
Our marketing affiliates are companies that operate websites that market our services on their websites. Our affiliates’ websites cover a wide range of content and interests. Our affiliates direct visitor traffic to our websites by using our technology to place banners or links on their websites to one or more of our websites. When a visitor to an affiliate’s website clicks on the banner or link, the visitor will be directed to one of our websites. In addition, for over 15,000 of our affiliates, we maintain private label websites that provide a seamless, turnkey outsourced solution using our technology platform for social networking and live interactive video websites. These websites have the look and feel of the affiliate’s website with the affiliate’s logo and website name but are operated by us. Users who click through the affiliate’s website are tagged with the affiliate’s identifier that tracks the user to calculate the payment due to the affiliate. Private labeling allows our affiliates to preserve their brand while generating revenue for us. Generally our websites have different programs from which our affiliates may derive revenue.
Our affiliates may derive revenue based on:
| • | | a percentage of revenue generated and collected; |
| • | | per member who registers, confirms their e-mail address and whose profile is approved; and |
With over 150,000 affiliates registered in our affiliate marketing program, we believe our affiliate network is one of the largest in the world and one of the highest paying programs in the industry. We do not typically have
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exclusive arrangements with our affiliates and some of our affiliates may also be affiliates for our competitors. We provide our affiliates with daily updated statistics, bi-monthly payments and technical support. Our affiliates are required to comply with a strict code of conduct, including a strict prohibition on spam and spyware and mandated compliance with our regulatory restrictions. We believe that as a result of these policies, the quality of our visitor traffic is enhanced.
Online Advertising
Another method we use for marketing our websites is by purchasing prepaid advertising, or ad buys, which consists primarily of pay-per-click keyword advertising on major search engines and advertising on third party websites via banner advertisements and ad networks. Through the use of our technology, we analyze returns and estimate the long-term revenue that a particular advertising program will generate after only a few days of monitoring traffic. This allows us to test different text, formats, placements and graphics relating to marketing programs on a cost effective basis, where we are able to analyze activity, estimate results and quickly and efficiently make changes to the program if necessary.
Competition
As an internet-based social networking and multimedia entertainment company we operate in several submarkets within a highly competitive but fragmented industry. We compete with a number of large and small companies that provide a range of internet products and services including adult-oriented communities and adult content websites, general audience communities and internet personals websites. We believe that the primary competitive factors in social networking and online communities are functionality, brand recognition, member affinity and loyalty, ease-of-use, quality of service, reliability and critical mass. We believe the primary competitive factors in our entertainment segment is brand recognition, video and pictorial content. While our management does not believe there is another company with whom we compete across all the areas of our business, we tend to compete with companies in four categories, with some overlap among these categories:
| • | | Social Networking Websites —Unlike most other social networking websites which are free, we have a paid subscription-based business model, which we believe is a significant competitive advantage. Our adult-themed community websites from which the majority of our revenue and earnings are derived, including AdultFriendFinder.com, do not directly compete with other general interest social networking websites because of the adult nature of the content. Our general audience websites, which contribute substantially less of our revenue and earnings, compete with other companies offering social networking websites such as MySpace, Inc., Facebook, Inc. and Friendster, Inc. Our general audience websites provide a wide range of social networking tools including blogs, chatrooms and messaging similar to our competitors. We also believe that a significant advantage to our websites is the ease with which members meet other members who were not known to them prior to joining our network. |
| • | | Internet Personals Websites —We compete with certain elements of the internet personals business provided by companies including Match.com, L.L.C., Yahoo!Personals, a website owned and operated by Yahoo! Inc., eHarmony, Inc., Lavalife Corp., Plentyoffish Media Inc. and Spark Networks Limited websites, including jdate.com, americansingles.com and relationships.com, as well as companies offering adult-oriented internet personals websites such as Cytek Ltd., the operator of SexSearch.com, and Fling Incorporated. |
| • | | Adult Audience Websites —We compete with many adult-oriented and live interactive video websites, such as Playboy.com and LiveJasmin.com, respectively. These websites are largely distinguished by the quality of the video and the quantity and caliber of the video content. We continue to seek to be at the forefront of video technology by seeking to offer our users the best available experience. As adult content receives wider mainstream acceptance, we expect our websites to benefit from an increased volume of member-generated content that will enhance our large library of adult content which is frequently updated and refreshed. |
| • | | Adult Entertainment Providers —We compete with other publishers of branded men’s lifestyle magazines, such as Maxim and Playboy, and we compete with other producers of adult pictorial and video content, such as Playboy Enterprises Inc., tmc Content Group AG and Total Media Agency. |
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Intellectual Property
Our Penthouse mark has been in use since 1965 and is a globally recognized brand in the adult entertainment industry. Through continuous and widespread use, we have developed strong trademark rights in numerous trademarks, including Penthouse Forum, Penthouse Variations, Penthouse Letters, the One Key Logo and Three Key Logo, Pet Of The Year, Pet Of The Month and Penthouse Pet, as well as the AdultFriendFinder, FriendFinder, ALT.com, Bondage.com, OutPersonals.com and FriendFinder trademarks used in our internet social networking and online personals business. We have developed the “FriendFinder” service mark and its many variations, including AdultFriendFinder, SeniorFriendFinder and FrenchFriendFinder.
We currently own and maintain approximately 100 U.S. trademark registrations and applications and over 900 foreign trademark registrations and applications. We have generated very large volumes of written, visual and audiovisual content, including over one million photographic images. We own and maintain hundreds of U.S. copyright registrations covering our magazines and videos. As our intellectual property assets are one of the keys to our continued growth and success, we enforce our rights against infringers as is reasonably prudent. We regularly evaluate and grant requests to license our brands and content and participate in other commercial ventures by contributing trademark and content licenses.
We devote substantial resources to the establishment, protection and enforcement of our trademarks and other proprietary rights. However, our actions to establish, protect and enforce our trademarks and other proprietary rights may not prevent imitation of our products, services or brands or control piracy by others or prevent others from claiming violations of their trademarks and other proprietary rights by us. There are factors outside of our control that pose a threat to our intellectual property rights. For example, effective intellectual property protection may not be available in every country in which our products and services are distributed or made available through the internet. Any infringement or related claims, even if not meritorious, may be costly and time-consuming to litigate, may distract our management from other tasks of operating the business and may result in the loss of significant financial and managerial resources, which could harm our business, financial condition or operating results. If we are not successful in defending against such claims, our financial condition or operating results would be materially adversely affected.
Successful claims against us could also result in us having to seek a license to continue our practices, which may significantly increase our operating burden and expenses, potentially resulting in a negative effect on our business, financial condition and results of operations.
Employees
As of March 9, 2009, we had approximately 428 full-time employees and two part-time employees, none of whom is represented by a collective bargaining agreement. We believe we maintain a satisfactory relationship with our employees.
Properties
Our headquarters are in Boca Raton, Florida. As of December 31, 2008, our principal offices consisted of the following properties:
Location/Principal Use
| | | | Square Feet
| | Lease Expiration Date
|
|---|
| Los Angeles, California — entertainment | | | | | 10,196 | | | April 30, 2009 |
| Sunnyvale, California — internet | | | | | 50,112 | | | October 31, 2015 |
| Boca Raton, Florida — corporate administrative offices | | | | | 3,533 | | | December 31, 2009 |
| Las Vegas, Nevada — internet | | | | | 5,440 | | | October 31, 2009 |
| New York, New York — entertainment | | | | | 16,431 | | | May 6, 2018 |
We believe that our properties are in good operating condition and adequately serve our current business operations. We also anticipate that suitable additional or alternative space, including those under lease options, will be available at commercially reasonable terms for future expansion.
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Government Regulation
We are subject to a number of foreign and domestic laws that affect companies conducting business on the internet. In addition, laws relating to user privacy, freedom of expression, content, advertising, information security, internet obscenity and intellectual property rights are being considered for adoption by many countries throughout the world. We face risks from some of this proposed legislation that could be passed in the future.
In the United States, laws relating to the liability of providers of online services for activities of their users and other third parties are currently being tested by a number of claims, which include actions for libel, slander, invasion of privacy and other tort claims, unlawful activity, copyright and trademark infringement and other theories based on the nature and content of the materials searched, the ads posted or the content generated by users. Certain foreign jurisdictions are also testing the liability of providers of online services for activities of their users and other third parties. Any court ruling that imposes liability on providers of online services for activities of their users and other third parties could expose us to liability.
A range of other laws and new interpretations of existing laws could have an impact on our business. For example, the Digital Millennium Copyright Act has provisions that limit, but do not necessarily eliminate, our liability for listing, linking or hosting third-party content that includes materials that infringe copyrights. Portions of the Communications Decency Act are intended to provide statutory protections to online service providers who distribute third-party content. We rely on the protections provided by both the Digital Millennium Copyright Act and Communications Decency Act in conducting our business. Any changes in these laws or judicial interpretations narrowing their protections will subject us to greater risk of liability and may increase our costs of compliance with these laws or limit our ability to operate certain lines of business. The Children’s Online Privacy Protection Act restricts the ability of online services to collect information from children under 13. In the area of data protection, many states have passed laws requiring notification to users when there is a security breach for personal data, such as California’s Information Practices Act. The costs of compliance with these laws may increase in the future as interpretations change. Furthermore, any failure on our part to comply with these laws may subject us to significant liabilities.
Similarly, the application of existing laws prohibiting, regulating or requiring licenses for certain businesses of our advertisers, including, for example, online gambling, distribution of pharmaceuticals, adult content, financial services, alcohol or firearms, can be unclear. Application of these laws in an unanticipated manner could expose us to substantial liability and restrict our ability to deliver services to our users.
We also face risks related to investigations and prosecutions involving our adult content. Current or future government officials may choose to increase enforcement of obscenity laws and government officials could also change or interpret current laws in a manner that is unfavorable to our business. U.S. government officials could amend or construe and seek to enforce more broadly or aggressively the adult content recordkeeping and labeling requirements set forth in 18 U.S.C. Section 2257 and its implementing regulations in a manner that is unfavorable to our business. In addition, court rulings may place additional restrictions on adult content affecting how people interact on the internet, such as mandatory web labeling.
We also face risks relating to government failure to preserve the internet’s basic neutrality as to the services and websites that users can access through their broadband service providers, as governments can arbitrarily choose to block websites. Such a failure to enforce network neutrality could limit the internet’s pace of innovation and the ability of large competitors, small businesses and entrepreneurs to develop and deliver new products, features and services, which could harm our business.
We are also subject to federal, state and foreign laws regarding privacy and protection of user data. We post on our website our privacy policies and practices concerning the use and disclosure of user data. Any failure by us to comply with our posted privacy policies or privacy-related laws and regulations could result in proceedings against us by governmental authorities or others, which could potentially harm our business. In addition, the interpretation of data protection laws, and their application to the internet, in the United States, Europe and other foreign jurisdictions is unclear and in a state of flux. There is a risk that these laws may be interpreted and applied in conflicting ways from country to country and in a manner that is not consistent with our current data protection practices. Complying with these varying international requirements could cause us to incur additional costs and change our business practices. Further, any failure by us to protect our users’ privacy and data could result in a loss of user confidence in our services and ultimately in a loss of users, which could adversely affect our business.
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In addition, because our services are accessible worldwide, certain foreign jurisdictions may claim that we are required to comply with their laws, even where we have no local entity, employees or infrastructure.
Legal Proceedings
We are currently a party to several legal proceedings, including the ones discussed below. Management presently believes that the ultimate outcome of these pending proceedings will be favorable to us. However, litigation is subject to inherent uncertainties and unfavorable rulings could occur. An unfavorable ruling could include monetary damages or, in cases for which injunctive relief is sought, an injunction prohibiting us from selling one or more services or conducting enjoined activities. Were an unfavorable ruling to occur, there exists the possibility of a material adverse impact on the business or results of operations for the period in which the ruling occurs or future periods.
On December 28, 2007, Broadstream Capital Partners, Inc., or Broadstream, filed a lawsuit against us in the State Superior Court of California, County of Los Angeles, Central District, and we subsequently removed the case to the Federal District Court for the Central District of California. The complaint alleged breach of contract, breach of covenant of good faith and fair dealing, breach of fiduciary duty and constructive fraud arising out of a Non-Disclosure Agreement. The complaint alleged, among other things, that Broadstream entered into a Non-Disclosure Agreement with us that required Broadstream’s prior written consent for us to knowingly acquire Various or any of its subsidiaries and that such consent was not obtained. On April 7, 2008, Broadstream filed its first amended complaint, which added a new cause of action for intentional interference with prospective economic advantage. On February 4, 2009, Broadstream filed its third amended complaint which dismisses the allegations of breach of fiduciary duty and constructive fraud. The complaint seeks damages which plaintiff alleges to be in excess of $20.0 million, plus interest, costs and punitive damages. Broadstream later served supplemental disclosures asserting between $100 million and $500 million in damages plus punitive damages. We responded with a motion for summary judgment dated March 12, 2009, which was denied. The plaintiff withdrew its claim for breach of covenant of good faith and fair dealing. The trial is set for May 12, 2009. We dispute all of Broadstream’s claims and intend to defend the lawsuit vigorously.
On December 23, 2005, Robert Guccione, our former president, filed an action against us and some of our officers, among other defendants, in New York State Court for breach of contract, fraud, unjust enrichment, promissory estoppel, failure to pay severance and conspiracy to defraud. The amount of damages requested in the complaint against us is approximately $9.0 million and against the officers is in excess of $10.0 million. Some of the counts in the complaint also demand an unspecified amount of damages. Mr. Guccione filed an amended complaint on June 5, 2007 to include additional claims relating to ownership of certain United Kingdom, Jersey and Guernsey trademarks and add as a party Penthouse Publications Limited, an entity with no current affiliation with us, as party plaintiff. Mr. Guccione agreed to dismiss the count for conspiracy to defraud only. Mr. Guccione filed a second amended complaint on December 20, 2007 adding General Media International, Inc. an entity with no current affiliation with us, as party plaintiff and a new claim for inducement to breach a contract. We filed our motion to dismiss the second amended complaint on January 31, 2008, which was granted in part and denied in part. The court dismissed the claims for unjust enrichment and promissory estoppel. On August 14, 2008, Mr. Guccione filed a voluntary petition for Chapter 7 bankruptcy. We filed a proof of claim on January 13, 2009. We and our officers believe that we have meritorious defenses to all claims and intend to vigorously defend the lawsuit.
On November 28, 2006, Antor Media Corporation, or Antor, filed a complaint against us, our subsidiary, General Media Communications, Inc., and several non-affiliate media/entertainment defendants in the U.S. District Court for the Eastern District of Texas, Texarkana Division, for infringement of a patent titled “Method and Apparatus for Transmitting Information Recorded on Information Storage Means from a Central Server to Subscribers via a High Data Rate Digital Telecommunications Network.” No specific amount of damages has been requested. Injunctive relief is sought. We and our subsidiary filed an Answer, Affirmative Defenses and Counterclaims. The United States Patent and Trademark Office, or USPTO, issued a non-final office action rejecting Antor’s patent claims. Antor filed a response to the office action which added 83 new claims to the original 29 rejected claims. In August 2008, the USPTO issued its final office action, sustaining the rejection of plaintiff’s original 29 claims and rejecting the 83 new claims. Antor filed its Petition to Vacate Finality of Office Action, on the grounds it introduced new grounds of rejection. Based on the final office action, we filed an expedited motion
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to stay the case, which is pending. In December 2008, pursuant to an order granting a reexamination proceeding, the USPTO issued a non-final office action again rejecting the original 29 claims and the 83 new claims. In February 2009, plaintiff filed a response in which it agreed to cancel the 83 new claims previously proposed. The parties await the USPTO’s issuance of a new final office action.
On or about November 27, 2006, a claimant filed a consumer class action arbitration at Judicial Arbitration and Mediation Services, Inc., or JAMS, in San Jose, California, alleging a nationwide class against Various, under a variety of legal theories related to, among other things, representations regarding the number of active users on its internet dating websites, causing the appearance of erroneous member profiles, and a failure to adequately remove or account for alleged erroneous member profiles. The claimant is seeking unspecified damages. Various disputes the claims and intends to defend the arbitration vigorously.
In or about December 2007, Spark Network Services, Inc. served Various with a complaint for patent infringement and is seeking unspecified monetary damages as well as injunctive relief. The complaint alleges infringement of U.S. Patent No. 6,272,467 B1 titled “System for Data Collection and Matching Compatible Profiles.” Various moved for a stay of the federal case due to the USPTO’s reexamination of the patent at issue and the Federal Court granted the stay. The suit is in very early stages, and we intend to vigorously defend the claims asserted therein.
On November 4, 2008, Balthaser Online, Inc. filed a lawsuit for patent infringement against us, among other defendants, in the U.S. District Court for the Eastern District of Texas and is seeking unspecified monetary damages as well as injunctive relief. The complaint alleges infringement of U.S. Patent No. 7,000,180 titled “Methods, Systems, and Processes for the Design and Creation of Rich-Media Applications Via the Internet.” The plaintiff filed a first amended complaint naming Various, Inc., FriendFinder California Inc. and Global Alphabet, Inc. as defendants on January 15, 2009. A motion to transfer the case to the U.S. District Court for the Northern District of California has been briefed and awaits decision by the Court. This suit is in very early stages and we intend to vigorously defend the claims asserted therein.
After our acquisition of Various in December 2007, we became aware that Various had not collected VAT from subscribers in the European Union nor had Various been paying VAT to the appropriate tax jurisdictions. The resulting liability for such omissions has yet to be determined and there can be no assurance that we will reach a favorable accommodation with the tax jurisdictions. We have registered effective July 1, 2008 with the tax authorities of the applicable jurisdictions and effective July 29, 2008 have begun collecting VAT from our subscribers in the European Union. We have initiated discussions with these tax jurisdictions on resolving the liability and we have come to a resolution with respect to the liability in certain tax jurisdictions but there can be no assurance that we will reach a favorable accommodation with all of these tax jurisdictions. If we are unable to reach a favorable accommodation with these tax jurisdictions, the terms of the payment of these liabilities could adversely affect our financial condition. Our primary recourse to the sellers of Various for any losses suffered by us as a result of such liabilities (VAT-related or otherwise) is to offset the principal amount of the Subordinated Convertible Notes by the amount of any such losses. On October 14, 2008, we made an indemnity claim against these notes under the acquisition agreement for Various in the amount of $64.3 million due to working capital adjustments resulting from the VAT liability which was not disclosed at the closing of the acquisition. As of December 31, 2008, the total amount of historical uncollected VAT payments was approximately $78.3 million, including approximately $37.6 million in potential penalties and interest. The sellers have denied responsibility for the VAT liability.
On or about March 26, 2009, Kevin Cammarata filed a complaint against our subsidiary FriendFinder California, Inc. and other defendants in the State Superior Court of California, County of Los Angeles in connection with their advertising on a free adult content website run by a third party known as Bright Imperial Limited. In April 2009, Various was also added as a defendant. The complaint alleges that the defendants aided and abetted Bright Imperial Limited in engaging in below cost competition and unlawful use of “loss leaders” in violation of California law by providing free, apparently professionally produced adult content. The plaintiff is seeking $10.0 million in damages, trebled to at least $30.0 million, plus injunctive relief and attorneys’ fees. This suit is in very early stages and we intend to vigorously defend the claims asserted therein.
Other than as described above, we believe there are currently no litigation or legal or administrative proceedings pending against us that are likely to have, individually or in the aggregate, a material adverse effect on our business or our results of operations.
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MANAGEMENT
The following sets forth certain information concerning our executive officers, other key employees and directors as of April 24, 2009.
Name
| | | | Age
| | Position
|
|---|
| Marc H. Bell | | | | | 41 | | | Chief Executive Officer, President and Director |
| Daniel C. Staton | | | | | 56 | | | Chairman of the Board and Treasurer |
| Ezra Shashoua | | | | | 54 | | | Chief Financial Officer |
| Anthony Previte | | | | | 44 | | | Chief Operating Officer |
| Robert Brackett | | | | | 31 | | | President, internet group |
| Robert B. Bell | | | | | 69 | | | Director |
| Barry W. Florescue | | | | | 65 | | | Director |
| James “Jim” LaChance | | | | | 44 | | | Director |
| Toby E. Lazarus | | | | | 41 | | | Director |
| Jason Smith | | | | | 36 | | | Director |
Executive Officers and Key Employees
Marc H. Bell has been our Chief Executive Officer, President and a Director since October 2004. Mr. Bell has served as Chairman of the Board of Directors and Treasurer of Enterprise Acquisition Corp. (AMEX: EST), a blank check company formed with the purpose of effecting a merger, acquisition or other similar business combination with an operating business, since its inception in July 2007. Mr. Bell has served as Managing Director of Marc Bell Capital Partners LLC, an investment firm which invests in media and entertainment ventures, real estate and distressed assets, since 2003. Previously, Mr. Bell was the founder and President of Globix Corporation, a full-service commercial internet service provider with data centers and a private network with over 20,000 miles of fiber spanning the globe. Mr. Bell served as Chairman of the Board of Globix Corporation from 1998 to 2003 and Chief Executive Officer from 1998 to 2001. Globix, which went public in 1996 under the name Bell Technology Group, Ltd. and was renamed Globix Corporation in 1998, offered internet connectivity and sophisticated internet-based solutions to large and medium size companies through a host of vertically-integrated businesses. Globix filed a voluntary bankruptcy petition in January 2002, which included a pre-packaged plan with its creditors. The plan, which was led by Mr. Bell, was confirmed by the bankruptcy court in March 2003. Mr. Bell remained the Chairman of Globix until 2003. Globix was an initial investor in NetSat Express, a satellite communications joint venture with Globecomm Systems Inc. and Reuters Group plc, which was later sold to Globecomm Systems Inc. Mr. Bell was also a member of the Board of Directors of EDGAR Online, Inc., an internet-based provider of filings made by public companies with the SEC, from 1998 to 2000. Mr. Bell has also been a co-producer of several Broadway musicals and plays (Jersey Boys, The Wedding Singer, August: Osage County, A Catered Affair) and has been a winner of the American Theatre Wing’s Tony Award (“2008 Best Play” forAugust: Osage County and “2006 Best Musical” forJersey Boys). Mr. Bell is a member of the Board of Trustees of New York University and New York University School of Medicine and was an adjunct instructor at the Global Entrepreneurship Center of Florida International University, where he taught graduate courses in Entrepreneurship. Mr. Bell holds a B.S. degree in accounting from Babson College and an M.S. degree in real estate development and investment from New York University. Mr. Bell is the son of Robert B. Bell, one of our directors.
Daniel C. Staton has been our Chairman of the Board since October 2004 and our Treasurer since December 2008. Mr. Staton has served as President and Chief Executive Officer and as a member of the Board of Directors of Enterprise Acquisition Corp. (AMEX: EST), a blank check company formed with the purpose of effecting a merger, acquisition or other similar business combination with an operating business, since its inception in July 2007. Mr. Staton has served as Managing Director of Staton Capital LLC, a private investment firm, since 2003 and as President of The Walnut Group, a private investment firm that has made over 20 private equity and venture capital investments, from 1997 to January 2007. Prior to forming The Walnut Group, Mr. Staton served as General Manager and partner of Duke Associates from 1981 to 1993. With its initial public offering, Mr. Staton became Chief Operating Officer and a director of Duke Realty Investments, Inc. (NYSE: DRE), a real estate investment trust, from 1993 to 1997. Mr. Staton served as Chairman of the Board of Directors of Storage Trust Realty, a real estate investment trust, from 1997 to 1999 and led its merger with Public Storage (NYSE: PSA), where he has served on the Board of Directors since 1999. The Walnut Group was an initial investor and Mr. Staton served as director
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of Build-a-Bear Workshop (NYSE: BBW), a specialty retailer with over 300 stores, from 1998 until its initial public offering in 2004. The Walnut Group was an initial investor in Deal$: Nothing Over a Dollar, a specialty retailer which grew from one location to 67 locations until its sale to Supervalu Inc. in 2002. In connection with other investments by The Walnut Group, Mr. Staton served as director of Ameristop, a convenience store operator with over 140 locations, from 1998 to 2003, as a director of Skylight Financial, a credit card company for the “underbanked,” from 1998 until its sale in 2003 and as a director of Changing Paradigms, a leader in private-label household products, from 1999 until its sale in 2006. Mr. Staton also invested in and served as a director of United Sports Ventures, owner of three minor league baseball and four minor league hockey teams, from 1997 to 2002. Mr. Staton has co-produced or invested in numerous successful Broadway musicals, and plays includingThe Producers, Hairspray, Jersey Boys, andAugust: Osage County all of which won the Tony Award for “Best Musical” or “Best Play” as well asA Catered Affair andSmokey Joe’s Café, Broadway’s longest-running musical revue. Mr. Staton majored in Finance at the University of Missouri and holds a B.S. degree in specialized business from Ohio University and a B.S. degree in business (management) from California Coast University. Mr. Staton has served as Executive in Residence at both the University of Missouri and Ohio University.
Ezra Shashoua has been our Chief Financial Officer since January 2008. From September 2007 to January 2008, Mr. Shashoua served as a consultant to us. Mr. Shashoua has also served as the Chief Financial Officer of Enterprise Acquisition Corp. (AMEX: EST), a publicly held blank check company organized for the purpose of effecting a merger, acquisition or other similar business combination with an operating business, since January 2008. From June 2003 to May 2007, he was Executive Vice President and Chief Financial Officer of Cruzan International, Inc., a Florida-based publicly-held spirits company which owned the Cruzan Rum brand and several manufacturing plants. He was part of the management team that grew the Cruzan brand into a 700,000 annual case premium rum. Prior to his employment at Cruzan, Mr. Shashoua served as Executive Vice President from 2001 to June 2003 at NationsRent, Inc., a publicly-held NYSE equipment rental company. NationsRent filed a voluntary bankruptcy petition in December 2001. The plan of restructure, which was led by Mr. Shashoua, was confirmed by the bankruptcy court in May 2003. Mr. Shashoua had previously been at 7-Eleven, Inc. where he served in several roles of increasing responsibility over 18 years culminating in his appointment as Chief Financial Officer. During his tenure, 7-Eleven, Inc. went through a leveraged buyout, reorganization and sale. After reorganization, Mr. Shashoua was a leader of the management team that revitalized the 7-Eleven convenience store concept. Mr. Shashoua started his career as an attorney at the law firm of Sonnenschein Nath & Rosenthal LLP in Chicago. He holds a B.A. degree from Northwestern University and a J.D. degree from Illinois Institute of Technology-Chicago Kent College of Law.
Anthony Previte has been our Chief Operating Officer since February 2008. From March 2003 to January 2008, Mr. Previte was Managing Member of Starsmith LLC, a financial business consulting and outsourcing services company that provided consulting services to us from December 2006 until December 2007. From October 1998 to March 2003, Mr. Previte was with Globix Corporation where he served as Chief Technology Officer and Chief Operating Officer. Mr. Previte studied aerospace engineering at Polytechnic Institute of New York.
Robert Bracketthas been the President of our internet group since December 2007. Prior to that, Mr. Brackett was Interim President of Various since October 2006. From 2003 to 2006, Mr. Brackett served as Chief Technology Officer of Various. Over the last four years he has spearheaded Various’ infrastructure and software growth. From 1999 to 2001, Mr. Brackett was software developer at iPrint Technologies, the internet’s first online print shop. Mr. Brackett developed software at iPrint to allow the easy creation of custom print shops for many large businesses such as Oracle, Washington Mutual and 3M. Mr. Brackett graduated from the University of California-Santa Cruz with highest honors in computer science and honors in language studies.
Directors
Robert B. Bell has been a Director since 2005. Mr. Bell served as Executive Vice President and Chief Financial Officer of Globix Corporation for 10 years. Prior to joining Globix, Mr. Bell was a practicing attorney in New York City at the firm of Bell, Kalnick, Beckman, Klee and Green LLP, which Mr. Bell founded in the early 1970s and specialized in the law of international real estate joint ventures and investment. He is the author ofJoint Ventures in Real Estate published by John Wiley & Sons. Prior to 1994, Mr. Bell was for many years an Adjunct Professor at New York University. Mr. Bell has a B.S. degree from New York University and a Juris Doctorate degree from the University of California at Berkeley. Mr. Bell is the father of Marc H. Bell, our Chief Executive Officer and a Director.
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Barry W. Florescue has been a Director since 2005. Since 1989, Mr. Florescue has also been the Chairman of the Board, Chief Executive Officer and owner of Century Financial Group, Inc., a private holding company which owns Century Bank, a federally chartered thrift institution based in Sarasota, Florida. From 1988 to 1997, Mr. Florescue was also Chairman of the Board and Chief Executive Officer of Century Bank. Since that time, he has continued to serve as a director of Century Bank. Mr. Florescue has also been Chairman of the Board and President of BMD Management Company, Inc. since 1980. BMD is a privately-owned management services, finance and real estate investment company which has managed fast food and casual dining restaurants and now primarily manages over 20 commercial real estate properties in Florida, Colorado and New York. From 1996 to December 2004, Mr. Florescue was the major stockholder, Chairman of the Board, Chief Executive Officer and Chief Operating Officer of BFMA Holding Corporation, a private holding company which owned and operated Marietta Corporation, a company that manufactures personal care amenities for the hospitality market and provides contract manufacturing and packaging for companies in the personal care, cosmetic, over-the-counter pharmaceutical, household care and food industries. Since 2003, Mr. Florescue has been the Chairman of the Board and Chief Executive Officer of Caswell-Massey Holding Corporation, a 250 year old company that sells Caswell-Massey brand bath and beauty products through its retail stores, mail-order catalog and website, as well as through department stores and chain retailers. Mr. Florescue also served as Chairman of the Board and Chief Executive Officer of Renaissance Acquisition Corp, an American Stock Exchange listed blank check company, which completed its initial public offering in January 2007 with net proceeds of approximately $91 million and has subsequently announced its liquidation and dissolution. Mr. Florescue is on the Executive Advisory Committee of the Simon Graduate School of Business Administration and is a Trustee of the University of Rochester. Mr. Florescue received a B.S. degree from the University of Rochester and a Master of Business Administration degree from New York University Graduate School of Business. Mr. Florescue earned his CPA certification in 1970.
James “Jim” LaChance has been a Director since October 2008. Since 2004, Mr. LaChance has served as the Chairman of the Board of Northern Offshore Ltd., a drilling and production services company listed on the Oslo Stock Exchange (Oslo Børs: NOF). From July 2005 to February 2008, Mr. LaChance served as portfolio manager at Satellite Asset Management, L.P., an investment management fund in New York with approximately $7 billion assets under management. From 2002 to June 2005, he was a Partner at Post Advisory Group, LLC, an investment management firm in Los Angeles with $8 billion assets under management. Before that, he managed hedge funds for LibertyView Capital Management. He began his professional career as an audit and management consultant for Arthur Andersen & Co. Subsequent to obtaining his MBA, Mr. LaChance worked as a restructuring and merchant banker with Chase Manhattan Bank. Mr. LaChance graduated from Northeastern University in 1988 with a B.A. degree in business administration and an Master of Business Administration degree from the Stern School of Business at New York University in 1993.
Toby E. Lazarus has been a Director since March 2009. Since 2004, Dr. Lazarus has served as Vice President of Operations for Lumen Management, a multi-strategy private investment partnership focusing on small and mid-cap companies. Prior to joining Lumen Management, she served in various positions in hospitals and health centers across the United States with an emphasis on developmental psychology and psychiatry. Dr. Lazarus graduated from Johns Hopkins University, Phi Beta Kappa with honors in psychology, received her M.A. and Ph.D. in developmental psychology from the University of Chicago with a focus on neuropsychology and has presented her work at various conferences in the United States.
Jason H. Smith has been a Director since 2005. Since 1994, Mr. Smith has been the Chief Operating Officer at Hopper Radio of Florida Inc., a consumer electronics distribution business which, among other things, sources and distributes the Memorex brand of consumer electronics and media. Mr. Smith has succeeded in helping to grow the business over the last 11 years. Mr. Smith spearheaded the Disney Electronics line of consumer electronics which debuted in 2003 through a partnership with Disney Consumer Products. Mr. Smith graduated from the University of Florida in 1994 with a B.Sc. degree in business administration, with a major in marketing.
Composition of the Board of Directors
All of our directors serve until the next annual meeting of stockholders and their successors are elected or appointed, or until their earlier death, retirement, disqualification, resignation or removal. Our bylaws set the authorized number of directors at not less than two but not more than fifteen, with the actual number fixed by our
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board of directors or by a majority vote of our stockholders. The size of our board of directors is currently set at seven. Our bylaws authorize the board of directors to designate one or more committees, as it deems desirable, each consisting of one or more of the directors, and alternate members thereof, with such powers and authority (to the extent permitted by law and the bylaws) as may be provided in the board resolution establishing the committee.
Pursuant to a voting agreement dated as of July 6, 2005, which we refer to as the 2005 Voting Agreement, Mr. Florescue is entitled to nominate a designee for election to our board of directors and Messrs. Bell and Staton have agreed to vote in favor of the election of such designee. Mr. Florescue nominated himself as such nominee and was elected to our board of directors.
Under the 2005 Security Holders Agreement dated as of August 17, 2005, Messrs. Bell and Staton, among others, have agreed to vote in favor of the election of a designee of one of the holders of our Series A Convertible Preferred Stock to the board of directors who shall be reasonably acceptable to the Majority Equity Sponsor as defined in the agreement under which the Series A Convertible Preferred Stock was purchased. To date, that holder has not designated anyone reasonably acceptable for election.
Pursuant to the terms of the sellers’ securities agreement governing the Second Lien Subordinated Secured Notes and the 2007 Security Holders Agreement, Andrew Conru and Lars Mapstead, Various’ founders, collectively have the right to nominate a designee for election to the board of directors. Messrs. Bell and Staton have agreed to vote in favor of the election of such designee. To date, Messrs. Conru and Mapstead have not nominated anyone for election.
Pursuant to the terms of the First Lien Senior Secured Notes Securities Purchase Agreement and the 2007 Security Holders Agreement, the holders of the First Lien Senior Secured Notes are entitled to nominate a designee for election to our board of directors. Messrs. Bell and Staton have agreed to vote in favor of the election of such designee. To date, the holders of the First Lien Senior Secured Notes have not nominated anyone for election.
The election of any of the designees of the foregoing would result in an increase in the number of directors on the board of directors. The obligations of the Messrs. Bell and Staton and the other security holders to vote in favor of election of any of the foregoing nominees terminate upon the consummation of this offering.
Board Committees and Independence
We currently have a compensation committee comprised of Marc Bell and Daniel Staton, the sole purpose of which is to grant a limited number of stock options to new employees.
Effective upon consummation of this offering, we will establish an audit committee and a nominating and corporate governance committee and we will reconstitute our compensation committee so that it complies with the applicable rules and regulations of the SEC and the New York Stock Exchange. The audit committee will consist of Messrs. Florescue, LaChance and Smith, the compensation committee will consist of Messrs. Florescue and LaChance and Dr. Lazarus and the nominating and corporate governance committee will consist of Messrs. LaChance and Smith and Dr. Lazarus. Our board of directors has determined that each of these directors is “independent” within the meaning of the applicable rules and regulations of the SEC and the New York Stock Exchange.
In addition, we believe Mr. Florescue, one of our independent directors, qualifies as an “audit committee financial expert” as the term is defined by the applicable SEC rules and regulations and New York Stock Exchange listing standards, which we believe is consistent with his experience.
Audit Committee
The audit committee will be responsible for, among other things:
| • | | appointing, replacing and overseeing the work of the registered independent public accounting firm; |
| • | | reviewing and discussing with management and registered independent accounting firm our quarterly and annual financial statements and discussing with management our earnings releases; |
| • | | pre-approving all auditing services and permissible non-audit services provided by our registered independent public accounting firm; |
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| • | | engaging in a dialogue with the registered independent public accounting firm regarding relationships that may adversely affect the independence of the registered independent public accounting firm and, based on such review, assessing the independence of the registered independent public accounting firm; |
| • | | providing the audit committee report to be filed with the SEC in our annual proxy statement; |
| • | | establishing procedures for the receipt, retention and treatment of complaints regarding accounting, internal accounting controls or auditing matters, including the confidential anonymous submission by our employees of concerns regarding questionable accounting or auditing matters; |
| • | | reviewing and discussing with management and registered independent accounting firm management’s annual assessment of the effectiveness of the internal controls and registered independent accounting firm’s attestation and report about management’s assessment as required by the SEC; |
| • | | reviewing and discussing with management and registered independent accounting firm the adequacy and effectiveness of our internal controls over our financial reporting including any significant deficiencies in the design or operation of our internal controls or material weaknesses and the adequacy and effectiveness of our disclosure controls and procedures; and |
| • | | reviewing and assessing annually the adequacy of the audit committee charter. |
| | Mr. Florescue will serve as chairman of this committee. |
Compensation Committee
The principal responsibilities of the compensation committee will be, among others:
| • | | reviewing and determining annually the compensation of our Chief Executive Officer; |
| • | | providing the annual report on executive compensation to be filed with the SEC in our annual proxy statement; |
| • | | making recommendations to our board of directors with respect to employment contracts, severance arrangements, change in control provisions and other compensatory arrangements with executive officers; |
| • | | approving compensation programs and grants involving the use of our common stock and other equity securities; and |
| • | | reviewing and assessing annually the compensation committee’s performance. |
| | Mr. LaChance will serve as the chairman of this committee. |
Nominating and Corporate Governance Committee
The nominating and corporate governance committee will be responsible for, among other things:
| • | | recommending to the board of directors the slate of nominees of directors to be proposed for election by the stockholders and individuals to be considered by the board of directors to fill vacancies; |
| • | | reviewing periodically the criteria for the selection of new directors and recommending any proposed changes to our board of directors; |
| • | | developing and recommending to our board of directors a set of corporate governance guidelines applicable to us; and |
| • | | reviewing and assessing annually the performance of the nominating and corporate governance committee. |
| | Mr. Smith will serve as the chairman of this committee. |
Compensation Committee Interlocks and Insider Participation
None of our executive officers serves, or in the past year has served, as a member of the board of directors or compensation committee of any entity that has an executive officer serving as a member of our board of directors.
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Code of Ethics and Code of Conduct
We have adopted a code of ethics that applies to our chief executive officer and senior financial officers, including our chief financial officer and principal accounting officer. We have also adopted a code of business conduct and ethics, or code of conduct, that applies to all of our officers, directors and employees. Our code of ethics and code of conduct codify the business and ethical principles that govern all aspects of our business. These documents will be made available in print, free of charge, to any stockholder requesting a copy in writing from our Secretary at our headquarters in Boca Raton, Florida. Copies of our code of ethics and code of conduct will be available on our website at www.ffn.com, under “About us: Corporate Governance” upon the consummation of this offering. The inclusion of our website address in this prospectus does not include or incorporate by reference the information on our website into this prospectus.
Executive Compensation
Compensation Discussion and Analysis
The following compensation discussion and analysis provides information regarding the objectives and elements of our compensation philosophy and policies for the compensation of our executive officers that appear in the “Summary Compensation Table” below (referred to throughout this section collectively as our “named executive officers”). Our named executive officers for the fiscal year ended December 31, 2008 were:
| • | | Marc H. Bell, Chief Executive Officer and President |
| • | | Daniel C. Staton, Chairman of the Board and Treasurer |
| • | | Ezra Shashoua, Chief Financial Officer |
| • | | Anthony Previte, Chief Operating Officer |
| • | | Robert Brackett, President, internet group |
| • | | James Sullivan, President, licensing and publishing group |
| • | | Diane Silberstein, President and Publisher, publishing group |
Mr. Bell served in the role of Chief Executive Officer during 2008. Mr. Shashoua served in the role of Chief Financial Officer during 2008 and, in addition to serving as Chairman of the Board and Treasurer, Mr. Staton served in a similar capacity as our Chief Financial Officer in 2008. Each of these persons is included in the “Summary Compensation Table” below because of his position, together with Messrs. Previte, Brackett, Sullivan and Ms. Silberstein, who are included based on compensation earned in 2008.
Ms. Silberstein’s employment terminated effective as of April 15, 2008 and she is no longer with our company.
Compensation Committee
Our compensation committee is currently comprised of Messrs. Bell and Staton and was established for the sole purpose of granting a limited number of stock options to new employees. Upon the completion of this offering, we will have reconstituted our compensation committee in accordance with the rules and regulations of the SEC and the New York Stock Exchange. Effective upon the consummation of this offering, our compensation committee will be responsible for establishing, implementing and monitoring adherence to our compensation philosophy. Historically, this has been the responsibility of our board of directors and our Chief Executive Officer and Chairman of the Board. Except as otherwise noted, references in this section to the board of directors will, upon the reconstitution of our compensation committee, be references to such committee. The board of directors, in conjunction with our Chief Executive Officer and our Chairman of the Board, strives to ensure that the total compensation paid to our executive officers is fair, reasonable and competitive.
Compensation Philosophy and Objectives
To date, we have not established a formal compensation philosophy. Rather, compensation decisions have been made on a case-by-case basis by our Chief Executive Officer, our Chairman of the Board and our board of directors with the goal of hiring and retaining individuals with proven ability and compensating them in a manner that is
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commensurate with the nature of their contributions to our company. Our Chief Executive Officer, Chairman of the Board and board of directors consider a variety of factors in determining the compensation of our executives, including our named executive officers. Such factors include, but are not limited to, prior training, prior relevant work experience and the extent to which an executive officer possesses such skills or knowledge that render him or her essential to our business or difficult to replace.
Our overall compensation philosophy and objectives did not change between 2007 and 2008, and decisions have continued to be made on a case by case basis. After this offering, our compensation committee will be responsible for overseeing our executive compensation plans, policies and programs, determining and approving the compensation of our Chief Executive Officer and for making recommendations to our board of directors with respect to the compensation of our other executive officers. We expect that our compensation committee will continue to follow the general approach to executive compensation that we have followed to date, rewarding superior individual and company performance, such as meeting certain revenue targets, with commensurate compensation as part of a comprehensive compensation policy.
Role of Executive Officers in Compensation Decisions
Decisions as to the compensation of our executive officers are made primarily by our Chief Executive Officer and Chairman of the Board and, in the case of the compensation of our Chief Executive Officer and Chairman of the Board, our board of directors. Executive officers who are also board members participate in the discussion of their compensation but abstain from the determination of their compensation. Our Chief Executive Officer and Chairman of the Board review the performance of each of our named executive officers (other than their own performance which is reviewed by our board of directors) periodically but not in accordance with any specific schedule. The conclusions reached and recommendations based on these reviews, including with respect to salary adjustments and bonus payout amounts, are presented to our board of directors, which has the discretion to modify any recommended adjustments or awards to executives. Effective upon the consummation of this offering, our newly reconstituted compensation committee will assume primary responsibility for compensation decisions.
After completion of this offering, our compensation committee will determine each element of compensation for each of our executive officers annually. We anticipate that our Chief Executive Officer and Chairman of the Board will continue to review the compensation and performance of each executive officer other than himself annually and make recommendations to the compensation committee regarding each executive officer’s total compensation package for the following year. We also anticipate that the chairman of the compensation committee will review the compensation and performance of our Chief Executive Officer and Chairman of the Board and will make recommendations to the compensation committee regarding our Chief Executive Officer’s and Chairman of the Board’s total compensation package for the following year.
Our board of directors approves recommendations regarding equity awards. In 2008, our board of directors approved the adoption of our 2008 Stock Option Plan and agreements to grant options to purchase shares of our common stock to all of our officers under the plan. Our interim compensation committee, comprised of Messrs. Bell and Staton, has the authority to approve grants of options to purchase less than 20,000 shares of common stock to new employees without the approval of our board of directors.
Setting Executive Compensation
Due to the unique nature of each named executive officer’s duties, our criteria for assessing executive performance and determining compensation in any given year are inherently subjective and are not based upon specific formulas or weighing of factors. While our board of directors has a general understanding of the compensation practices of other similar companies and does consider general marketplace information when making compensation decisions, we have not, to date, felt it necessary to utilize the services of a compensation consultant or to do any formal benchmarking.
Executive Compensation Components
The principal components of compensation for our executive officers, including our named executive officers, are:
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| • | | long-term equity incentive compensation in the form of stock options under our 2008 Stock Option Plan and, subject to the approval of our compensation committee, restricted stock following the consummation of this offering; and |
In 2008, Messrs. Bell and Staton were compensated pursuant to the terms of a management agreement entered into with Bell & Staton, Inc. which contemplates their performance of certain management services. In December 2008, our board of directors approved new forms of employment agreements for Messrs. Bell and Staton which will become effective upon the consummation of this offering. Our board of directors approved these employment agreements in order to compensate Messrs. Bell and Staton for their efforts in consummating an initial public offering and for the increased responsibility associated with public companies. Messrs. Shashoua and Brackett and Ms. Silberstein also had employment agreements in place in 2008. Mr. Previte’s compensation was previously determined in accordance with a consulting agreement but since he was retained as our Chief Operating Officer in February 2008, we have not entered into a formal employment agreement with him. We did not have a formal employment agreement in place with Mr. Sullivan during 2008.
Base Salary
We provide our executive officers and other employees with base salary to compensate them for services rendered during the year. Base salary ranges for named executive officers are determined for each executive based on his or her position and scope of responsibility. The initial base salary for most of our named executive officers was established in their initial service agreements with us.
Salary levels are reviewed occasionally upon a promotion, a material change concerning the company or other material change in job responsibility. Merit based increases are based on our Chief Executive Officer’s and our Chairman of the Board’s assessment of the individual’s performance.
In reviewing base salaries for our executive officers, our Chief Executive Officer and our Chairman of the Board primarily consider:
| • | | the executive officer’s total compensation package, both individually and relative to other executive officers; and |
| • | | the individual performance of the executive officer. |
Our Chief Executive Officer and Chairman of the Board review these criteria collectively but do not assign a weight to each criterion when setting base salaries. Each base salary adjustment is made by our Chief Executive Officer and our Chairman of the Board subjectively based upon the foregoing.
While we do not have a practice of re-evaluating the base salaries of our executives each year, base salaries may be reviewed and adjustments may be made in connection with promotions or other changes in an executive’s responsibilities. Messrs. Bell and Staton each received compensation through the management agreement of $250,000 in 2008, the same compensation they received in 2007. Pursuant to the terms of their new employment agreements, upon the consummation of this offering, the annual base salaries of Messrs. Bell and Staton will increase to $1,000,000 per year in recognition of their leadership roles within our new public company. Effective as of July 8, 2008, our Chief Executive Officer and Chairman of the Board approved an increase in the annual base salary of Mr. Shashoua from $200,00 per year to $400,000 per year and authorized an annual base salary of $500,000 for Mr. Previte, which is in excess of his previous consulting fees. In each case, these increases reflect increased responsibilities resulting from the expansion of our business and, in the case of Mr. Previte, his retention as an executive officer of our company. As Mr. Brackett was retained by us at the end of 2007, our Chief Executive Officer and Chairman of the Board took into account his 2008 compensation when considering his offer letter and thus no change to his base salary was made in 2008. Neither Ms. Silberstein nor Mr. Sullivan received salary increases in 2008.
Bonuses
We use bonuses to reward individual and company performance, however, these bonuses vary from executive to executive as we have not established a comprehensive bonus plan. While the management agreement covering the
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compensation of Messrs. Bell and Staton contemplates their participation in a bonus pool, no such pool was established with respect to 2008. Following the consummation of this offering, Messrs. Bell and Staton will be eligible for annual bonuses of up to 100% of their annual base salaries. To incentivize Mr. Shashoua to stay with us through our initial public offering, Mr. Shashoua’s employment agreement also contemplates a bonus of up to 50% of annual base salary, contingent upon his continued employment upon the completion of this offering. Mr. Shashoua did not receive any bonus with respect to 2008. We have not entered into any bonus arrangement with Mr. Previte. On November 13, 2007, in light of Mr. Brackett’s role as a key executive of Various, and in order to secure his continued service in the event of a sale of Various, Various entered into a special bonus award agreement with Mr. Brackett pursuant to which he was entitled to (i) a transaction bonus of $207,143 if the contemplated sale of Various to our company closed on or before December 31, 2007 and Mr. Brackett remained in full-time employment until the closing date and (ii) a post-closing bonus of $517,857 payable on or before the one-month anniversary of the closing date. These bonus amounts were paid to Mr. Brackett in 2007. In addition, Various agreed to pay Mr. Brackett a retention bonus of $725,000, payable in three annual installments of $241,667 on each of the first three anniversaries of the closing date, subject to his continued full-time employment on such dates. Mr. Brackett received the first installment of $241,667 of this retention bonus in 2008. In addition, Mr. Brackett’s offer letter contemplated quarterly bonuses tied to Various’ performance for 2007. For 2008, Mr. Brackett had no contractual right to a bonus. However, consistent with Various’ past practices, we elected to continue to pay Mr. Brackett discretionary quarterly bonuses during 2008. Mr. Brackett’s 2008 bonuses amounts were allocated to him from certain quarterly bonus pools which were established based on the EBITDA of INI and its subsidiaries for the quarter which exceeded the amount of EBITDA for INI and its subsidiaries required by our financial covenants and budgets. The bonus amounts allocated to Mr. Brackett during 2008 were determined by our Chief Operating Officer, in his discretion, taking into account Mr. Brackett’s performance as well as internal equities. None of our other named executive officers were eligible to receive allocations from these quarterly bonus pools. We have not entered into any bonus arrangement with Mr. Sullivan. As Ms. Silberstein was hired to run our publishing business and increase our revenues through a comprehensive print advertising campaign, Ms. Silberstein’s employment agreement provides for an annual bonus based on incremental increases in revenues earned and collected for advertising insertions in our print publications each year or, advertising revenues. For 2008, to the extent that advertising revenues exceeded advertising revenues for 2007, Ms. Silberstein was entitled to 20% of the first $3.0 million above 2007 amounts, 15% of the next $3.0 million above 2007 amounts and 10% of all additional advertising revenues above 2007 amounts. Ms. Silberstein’s employment agreement does not provide for a target bonus amount. While Ms. Silberstein did not receive a bonus based on increased revenues in 2008, as a result of negotiations at the time her agreement was entered into, her employment agreement provides for an annual $200,000 non-refundable advance which is paid quarterly, subject to Ms. Silberstein’s continued employment at the end of the applicable quarter. Ms. Silberstein received $50,000 (one quarter of the total advance) on March 31, 2008, prior to her termination of employment on April 15, 2008.
Long-Term Equity Incentive Compensation
In April 2008, we adopted our 2008 Stock Option Plan in order to provide certain of our employees, directors and consultants with equity-based compensation and align their interests with those of our shareholders. The plan allows us to grant stock options qualified under the Internal Revenue Code of 1986, as amended, or the Code, or incentive stock options, and options that are not qualified under the Code, or nonqualified stock options. Our compensation committee or board of directors may administer the plan and both have the authority to prescribe rules and regulations relating to the plan, interpret the plan and awards and make all other determinations necessary for the administration of the plan. We may amend or terminate the plan at any time, subject to stockholder approval in certain cases, but we may not materially impair the rights of an existing option holder without his or her consent. Unless it is terminated earlier, the plan will terminate on December 31, 2017.
The exercise price of the stock options will not be less than the fair market value of one share of our common stock on the date of grant. Notwithstanding the foregoing, the exercise price of any stock options granted before an initial public offering of our common stock will be the price per share of our common stock to be sold pursuant to the initial public offering. In general, stock options granted pursuant to the plan have a term of ten years and vest ratably over five years, unless otherwise specified by the administrator. However, the stock options may be exercised only after eighteen months after the date of an initial public offering of our common stock. An option holder may exercise his or her options by delivering written notice to our Secretary or Treasurer and paying the exercise price in cash, shares of our common stock already owned by the option holder, or by cashless exercise using a broker.
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In the event of a change in control (defined as any sale or conveyance of all or substantially all of our property and assets or any consolidation or merger of us or any acceptance of a tender offer for a controlling number of our shares), our board of directors may accelerate the vesting of options or notify option holders that their vested stock options may only be exercised within thirty days after they are notified.
Stock options generally may not be transferred by an option holder, other than by will or by the laws of descent or distribution, and may only be exercised by an option holder, his or her legal representative or by a permitted transferee during the option holder’s lifetime.
In the event of an option holder’s termination of employment with us for any reason other than due to his or her death or permanent and total disability, the option holder will have the ability to exercise his or her options that were vested at the time of termination within three months of the termination of employment, but no later than the expiration of the options. However, if the option holder’s employment is terminated for cause or due to his or her resignation, the option holder’s stock options will terminate on the date his or her employment terminates.
In the event that a non-employee director has served his or her full term, any vested stock options that he or she holds as of the date his or her service terminates will be exercisable until the options expire. If a non-employee director dies while serving on our board of directors, the vested stock options that he or she holds as of the date of death will be exercisable for one year following death, but no later than the date the stock options expire.
In the event of certain non-recurring changes in our capitalization or corporation transactions, the administrator may determine the appropriate adjustment to be made to the stock options granted pursuant to the plan.
On July 7, 2008, in order to incentivize our executives to use best efforts to effectuate our initial public offering, to aid in retention and to remain competitive with the market, we entered into agreements with certain of our executives, including our named executive officers, to grant options as of the consummation of the offering to purchase shares of our common stock with an exercise price equal to the offering price of the shares of our common stock pursuant to the offering. With respect to our named executive officers, Messrs. Bell, Staton and Shashoua will receive options to purchase 1,000,000 shares, Mr. Previte will receive options to purchase 750,000 shares, Mr. Brackett will receive options to purchase 500,000 shares, and Mr. Sullivan will receive options to purchase 250,000 shares. The exercise price of these options will be the share price offered to the public at the time of our initial public offering. The number of options granted to each of our named executive officers depends on the individual’s position and ability to influence our financial performance and, in the case of options to be granted in connection with this offering, the extraordinary efforts of Messrs. Bell, Staton and Shashoua. Those with the most responsibility are accordingly granted a larger number of options and our named executive officers will receive a proportionately larger grant than our other executives because our board of directors recognizes that their continued retention and motivation is critical to our future success. We have subsequently agreed to grant additional options to purchase shares of our common stock at the initial public offering price to other high-level employees.
Effective upon the pricing of this offering, we may enter into agreements to award additional nonqualified stock options to our named executive officers in recognition of their extraordinary efforts with respect to this offering and as an incentive for service during the vesting period. Each option will have an exercise price equal to the offering price as adjusted for underwriting discounts and commissions, and will vest ratably over the five years following the date of the agreement. The exercise of these options will be contingent upon the closing of this offering. Each of our named executive officers will be eligible to receive additional awards under our 2008 Stock Option Plan periodically thereafter or in connection with employment terms or agreements. Additional grants of stock options under our 2008 Stock Option Plan will be made both pursuant to employment agreements and ad hoc as to be determined by our Chief Executive Officer and Chairman of the Board or our compensation committee, as applicable. To date, we have not established any formal option granting policies.
On March 23, 2009, in order to retain key personnel, including our named executive officers, and further align their interests with those of our stockholders, our board of directors approved our 2009 Restricted Stock Plan which becomes effective upon the consummation of this offering. Restricted shares granted under our 2009 Restricted Stock Plan will generally vest on the third anniversary of the grant date, subject to the individual’s continued service with us. Going forward, it is anticipated that both stock options and restricted stock will be used to aid in the retention of our named executive officers.
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Retirement Benefits
Currently, we operate two 401(k) plans. We have historically administered the Penthouse Media Group Inc. 401(k) Plan, which has a discretionary matching component. We have historically elected not to make matching contributions. As a result of our December 6, 2007 acquisition of Various, we also operate the Various 401(k) Plan, which does contain a matching component. Other than as mentioned above, we do not provide any company sponsored retirement benefits to any employee, including to our named executive officers.
Tax and Accounting Implications
Deductibility of Executive Compensation/Internal Revenue Code Section 162(m)
Internal Revenue Code Section 162(m) (as interpreted by IRS Notice 2007-49) denies a federal income tax deduction for certain compensation in excess of $1 million per year paid to the Chief Executive Officer and the three other most highly-paid executive officers (other than the company’s Chief Executive Officer and Chief Financial Officer) of a publicly-traded corporation. Certain types of compensation, including compensation based on performance criteria that are approved in advance by stockholders, are excluded from the deduction limit. In addition, “grandfather” provisions may apply to certain compensation arrangements that were entered into by a corporation before it was publicly held. In view of these grandfather provisions, we believe that Section 162(m) of the Code will not limit our tax deductions for executive compensation for fiscal year 2008. The board of directors’ policy is to qualify compensation paid to our executive officers for deductibility for federal income tax purposes to the extent feasible. However, to retain highly skilled executives and remain competitive with other employers, the board of directors has the right to authorize compensation that would not otherwise be deductible under Section 162(m) or otherwise.
Accounting for Stock-Based Compensation
We account for stock-based payments under the 2008 Stock Option Plan in accordance with the requirements of FASB Statement 123(R).
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Summary Compensation Table
The following table summarizes the total compensation paid to or earned by each of our named executive officers in the fiscal years ended December 31, 2007 and December 31, 2008.
Name and Principal Position
| | | | Year
| | Salary
($)
| | Bonus
($)
| | All Other
Compensation
($)
| | Total
($)
|
|---|
Marc H. Bell,
Chief Executive Officer and President | | | | | 2008 | | | | 250,000 | (1) | | | — | | | | — | | | | 250,000 | |
| | | | | | 2007 | | | | 250,000 | | | | — | | | | — | | | | 250,000 | |
Daniel C. Staton,
Chairman of the Board and Treasurer | | | | | 2008 | | | | 250,000 | (2) | | | — | | | | 10,912 | (3) | | | 260,912 | |
| | | | | | 2007 | | | | 250,000 | | | | — | | | | — | | | | 250,000 | |
Ezra Shashoua,
Chief Financial Officer(4) | | | | | 2008 | | | | 300,000 | | | | — | | | | — | | | | 300,000 | |
| | | | | | 2007 | | | | 65,902 | (5) | | | — | | | | — | | | | 65,902 | |
Anthony Previte, Chief Operating
Officer(6) | | | | | 2008 | | | | 475,000 | (7) | | | — | | | | 39,149 | (8) | | | 514,149 | |
| | | | | | 2007 | | | | 300,000 | | | | — | | | | — | | | | 300,000 | |
Robert Brackett, President,
internet group(9) | | | | | 2008 | | | | 328,326 | | | | 413,167 | (10) | | | — | | | | 741,493 | |
James Sullivan,
President, licensing and publishing group | | | | | 2008 | | | | 300,000 | | | | — | | | | — | | | | 300,000 | |
| | | | | | 2007 | | | | 300,000 | | | | 60,000 | | | | — | | | | 360,000 | |
Diane Silberstein, President and
Publisher, magazine group(11) | | | | | 2008 | | | | 145,831 | | | | 50,000 | (12) | | | 343,125 | (13) | | | 538,956 | |
| | | | | | 2007 | | | | 500,000 | | | | 200,000 | | | | — | | | | 700,000 | |
| (1) | | This amount reflects the portion of the $500,000 payment to Bell & Staton, Inc., pursuant to the management agreement, that is attributable to Mr. Bell. |
| (2) | | This amount reflects the portion of the $500,000 payment to Bell & Staton, Inc., pursuant to the management agreement, that is attributable to Mr. Staton. |
| (3) | | This amount represents reimbursement for car lease expenses. |
| (4) | | Beginning in September 2007, we engaged Mr. Shashoua’s services as Acting Chief Financial Officer. Mr. Shashoua became employed by us on January 1, 2008 as our Chief Financial Officer. |
| (5) | | This amount reflects payments under a consulting agreement pursuant to which Mr. Shashoua was retained as our Acting Chief Financial Officer prior to becoming employed as our Chief Financial Officer. Under the terms of the consulting agreement dated September 11, 2007, Mr. Shashoua received $200,000 annually, or $8,333.33 semi-monthly, in consulting fees. |
| (6) | | On December 11, 2006, we engaged Mr. Previte’s services, through Starsmith, LLC, as a consultant to head our entertainment group. Mr. Previte became employed by us on February 26, 2008 and now serves as our Chief Operating Officer. |
| (7) | | This amount reflects $50,000 in consulting fees paid under a consulting agreement pursuant to which Mr. Previte served as head of our entertainment group prior to becoming our Chief Operating Officer on February 26, 2008 as well as $425,000 in salary related to his service as our Chief Operating Officer. |
| (8) | | This amount represents relocation expenses for Mr. Previte from Los Angeles, California to Sunnyvale, California. |
| (9) | | We retained Mr. Brackett on October 25, 2007 pursuant to an offer letter. Mr. Brackett was not a named executive officer during 2007 but became a named executive officer during 2008. |
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| (10) | | This amount reflects bonus payments with respect to each fiscal quarter of 2008 as follows: $43,750 for the first quarter, $48,125 for the second quarter, $48,125 for the third quarter and $31,500 for the fourth quarter, plus a $241,667 retention bonus. |
| (11) | | Ms. Silberstein’s employment terminated as of April 15, 2008 and she is no longer employed by us. |
| (12) | | This amount represents a non-refundable advance against a 2008 bonus for which Ms. Silberstein was eligible based on pre-established performance criteria set forth in her employment agreement. Due to her termination of employment on April 15, 2008 , Ms. Silberstein did not ultimately earn the remaining $150,000 portion of such bonus advance. |
| (13) | | This amount represents severance payments and health care coverage reimbursements to which Ms. Silberstein became entitled in connection with her April 15, 2008 termination of employment that were earned in 2008. Because Ms. Silberstein is subject to restrictive covenants during her severance period, her remaining severance amounts will be earned in 2009. |
Executive Employment Agreements
Management Agreement. In October 2004, we entered into a management agreement with Bell & Staton, Inc., a Florida corporation controlled by Messrs. Bell and Staton, or the managers, whereby certain management services are to be performed by the managers as designated by our board of directors. The agreement is for a term of five years with an annual fee of $500,000 per year. The management agreement originally provided for a potential fee increase at the rate of 10% of our EBITDA, exclusive of EBITDA contributable to Various, but annual compensation cannot exceed $1.0 million. In addition, the agreement provides that the managers may participate in our future bonus pool and stock option plans. On August 17, 2005, the management agreement was amended to limit the total bonus to be paid to the managers to a maximum of $500,000 so long as any of the 2005 Notes or any guaranty thereof remained outstanding and to prohibit the payment of the bonus as long as there is a default occurring on the 2005 Notes. On August 23, 2006, the management agreement was further amended to provide that no management fee, other than reimbursement of expenses, shall be paid to the managers so long as there is a default or an event of default occurring on the 2006 Notes.
On December 9, 2008, our board of directors approved forms of employment agreements for each of Messrs. Bell and Staton, which will become effective upon the consummation of this offering, the extinguishment or waiver of the defaults under the existing debt instruments and the obtainment of any other third party consents required. These employment agreements will replace the management agreement with Bell and Staton, Inc. and each agreement will provide for a term of employment of five years at a base salary of $1,000,000 per year. This base salary may be increased each year by 10% of the then current base salary. Each agreement provides for an annual bonus of up to 100% of base salary, based on our board of directors’ objective evaluation of our performance and our board of directors’ subjective evaluation of the individual executive officer’s performance. Such performance will be evaluated based on consultation with the executive within sixty days following the end of the year. Messrs. Bell and Staton will each be entitled to receive 83,333 options to purchase our common stock upon the effective date of the agreement and each anniversary date thereafter, as well as beginning at the first anniversary of the agreement, annual grants of 50,000 shares of restricted stock under the terms of these agreements until such executive is no longer employed by us. If the executive ceases to be employed by us, except under certain circumstances, we may repurchase the restricted stock issued to the executive less than three years prior to the executive’s date of termination at a price of $0.01 per share. Pursuant to these employment agreements, if we undergo a change in control (which is defined as (i) an acquisition of 50% or more of the then issued and outstanding stock of the company, (ii) a merger or consolidation resulting in the transfer of the voting power of more than 50% of the issued and outstanding shares or (iii) a sale or disposition of all or substantially all of the company’s assets) or if the executive’s employment is terminated by us without cause or by him for good reason, we will become obligated to pay him severance of the lesser of 2.99 times the base salary year in the year of such termination or the amount of base salary owed to the executive for the remainder of the year; an amount equal to 100% of the greater of the executives’ bonus for the year of termination or bonus actually earned for the year prior to the year of termination; and the same level of health coverage and benefits as in effect on the day immediately prior to termination until the earlier to occur of the date that such executive is no longer eligible for continued coverage under the Consolidated Omnibus Budget Reconciliation Act of 1985 or twelve months from the executive’s termination date. In addition the vesting of the executive’s stock options will accelerate to that number of shares
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that would have become vested if the executive had remained employed by us until the date twelve months following the termination date.
Ezra Shashoua. On September 6, 2007, we entered into an employment agreement with Mr. Shashoua, effective January 1, 2008, pursuant to which Mr. Shashoua would receive a base salary of $200,000 per year with an increase to $400,000 per year upon the consummation of an initial public offering. The employment agreement provides that Mr. Shashoua is an at-will employee, and thus his employment may be terminated at any time. The employment agreement provides for Mr. Shashoua to be eligible to receive an annual performance based bonus of up to 50% of his then current annual base salary, which bonus is contingent upon his continued employment through the completion of an initial public offering and the achievement of certain goals and objectives as agreed to between Mr. Shashoua and senior management. The employment agreement also provides for Mr. Shashoua to be eligible to receive options upon pricing of an initial public offering equal to 0.6% of our total outstanding equity, with an exercise price equal to the initial public offering stock price. On July 8, 2008, Mr. Shashoua’s employment agreement was amended and restated, increasing his base salary to $400,000 per year and identifying that he would be eligible for a grant of options to purchase 1,000,000 shares of common stock in lieu of an amount equal to 0.6% of our then outstanding equity, or in an amount equal to other top tier senior executives. In addition, upon the consummation of an initial public offering, Mr. Shashoua will become entitled to receive a bonus of up to 50% of his then current annual base salary and will become eligible to receive restricted stock from time to time. Mr. Shashoua is subject to a confidentiality provision during the term of his employment.
Anthony Previte. On December 11, 2006, we entered into a consulting agreement with Starsmith LLC, a New York limited liability company controlled by Mr. Previte, retaining it to act in the capacity as the head of our entertainment group. The term of this consulting agreement ended on December 28, 2007 and on February 26, 2008, we hired Mr. Previte as our Chief Operating Officer but did not enter into a formal employment agreement.
Robert Brackett. On October 25, 2007, we retained Mr. Brackett pursuant to an offer letter. He initially served as the President of Various and now serves as the President of our internet group. The offer letter provides for a term of three years from Mr. Brackett’s start date. Pursuant to his offer letter, Mr. Brackett is entitled to a base salary of $315,000 annually and is eligible to receive equity-based compensation and health and 401(k) plan benefits. Mr. Brackett’s offer letter also contains a bonus plan that ended on December 31, 2007, pursuant to which Mr. Brackett would have been awarded a bonus on a quarterly basis, based on top-line revenue and bottom-line profit growth rates. Mr. Brackett’s offer letter contains one year post-termination covenants not to solicit our employees or customers.
In addition to his offer letter, Mr. Brackett executed an Employee Proprietary Information Agreement upon the commencement of his employment with us, pursuant to which he agreed to hold confidential information he learns about us, our work, and invention. Mr. Brackett also agreed that any works produced during the scope of his employment will be our property.
Mr. Brackett also entered into a Bonus Award Agreement with us on November 13, 2007, which was amended on December 5, 2007, pursuant to which he became entitled to receive certain bonuses upon the closing of the sale of Various to Penthouse Media Group, Inc. on or before December 31, 2007. Mr. Brackett received $207,143 as a transaction bonus on the closing date of the Various transaction, $517,857 as a post-closing bonus on or before the one-month anniversary of the closing date, and he also become entitled to receive payment of $241,667 on each of the first three anniversaries of the closing date as retention bonuses, assuming Mr. Brackett’s continued employment.
James Sullivan. We have not entered into any employment agreement or other compensation arrangement with Mr. Sullivan.
Diane Silberstein. On January 3, 2006, we entered into an employment agreement with Ms. Silberstein retaining her to act as President and Publisher of our magazine group. Ms. Silberstein’s employment was terminated effective as of April 15, 2008. Ms. Silberstein was entitled to a base salary of $500,000 per year and a bonus based on incremental increases in the company’s print publication advertising revenue each year during her employment. Ms. Silberstein was entitled to a non-refundable advance of her bonus in the amount of $200,000 payable in quarterly installments subject to her continued employment on each payment date. In addition, Ms. Silberstein was entitled
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to receive 300,000 stock options exercisable at $1.00 per share. These stock options were not granted as no stock option plan was in effect at any time during Ms. Silberstein’s employment. In addition, Ms. Silberstein was entitled to be reimbursed for certain business expenses. Pursuant to the terms of a severance agreement and release she became entitled to severance payments equal to 15 months of continued base salary and reimbursement for 15 months of COBRA coverage. Ms. Silberstein is subject to a non-compete agreement and a non-solicitation provision through April 15, 2009 and a perpetual confidentiality agreement.
Potential Payments Upon Termination or Change in Control
Assuming a termination or change in control as of December 31, 2008, Messrs. Shashoua and Brackett and Ms. Silberstein would have become entitled to receive severance payments.
Ezra Shashoua. If we terminated Mr. Shashoua’s employment without cause (as defined below), or if he terminated his employment for good reason (as defined below) Mr. Shashoua would have become entitled to receive an amount equal to $400,000, payable in a lump sum within thirty days of termination.
For purposes of Mr. Shashoua’s employment agreement, “good reason” means (i) the occurrence of a change of control within one year of the Various acquisition, (ii) the relocation of the geographical base of his employment out of Boca Raton, Florida or (iii) the failure of an initial public offering to occur within one year of the Various acquisition.
For purposes of Mr. Shashoua’s employment agreement, “cause” means his (i) willful failure or refusal to perform his duties; (ii) willful failure or refusal to carry out the lawful directions of his supervisors; (ii) willful gross misconduct, including but not limited to theft, violent work-related behavior, violation of our sexual or other lawful workplace harassment policies or repeated acts of gross insubordination; (iii) willful dishonesty or fraud in connection with his employment, regardless of whether it results in economic harm to us; (iv) indictment or conviction of a crime other than a minor traffic infraction; or (v) material breach of his employment agreement.
Termination
| | | | Severance
|
|---|
| Without Cause/For Good Reason | | | | $ | 400,000 | |
Robert Brackett. If we had terminated Mr. Brackett’s employment other than for cause (as defined below) or if he had terminated his employment for good reason (as defined below), Mr. Brackett would have become entitled to receive his base salary from the date his employment terminated until the date that is three years from his start date (the closing of the Various acquisition), subject to his execution of a release of claims.
Pursuant to Mr. Brackett’s offer letter, “cause” means (i) Mr. Brackett’s willful failure to substantially perform his duties under his offer letter, the Employee Proprietary Information Agreement, or pursuant to our stated policies and procedures; (ii) his willful failure or refusal to carry out lawful directions of his superiors; or (iii) his willful gross misconduct, including but not limited to theft, violent work-related behavior, violation of our anti-discrimination and anti-harassment policies or repeated acts of gross insubordination; willful dishonesty or fraud in connection with his employment, regardless or whether it results in economic harm to us or our subsidiaries or affiliates; or indictment or conviction of a crime other than a minor traffic infraction. Pursuant to his offer letter, “good reason” means (i) any reduction of Mr. Brackett’s base salary; (ii) relocation of his base office more than 50 miles from the location of his base office as of the start date; or (iii) our failure to obtain from any successor its agreement to assume and perform the terms of the offer letter.
Termination
| | | | Severance
|
|---|
| Without Cause/For Good Reason | | | | $ | 596,683 | |
Diane Silberstein. Ms. Silberstein’s employment actually terminated effective April 15, 2008 pursuant to a severance and release agreement dated April 30, 2008. Pursuant to the agreement, Ms. Silberstein became entitled to receive fifteen months continued payment of her then current base salary, less deductions and withholdings, in semi-monthly installments. She also became entitled to reimbursement for the cost of COBRA coverage during the fifteen-month severance period. Ms. Silberstein’s receipt of the above amounts is contingent upon her execution of the severance agreement and release and her continued compliance with the restrictive covenants contained in her employment agreement.
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| | | | Severance
| | COBRA
Reimbursements
| Total
| |
|---|
| Termination on April 15, 2008 | | | | $ | 625,000 | | | $ | 16, 394 | | $641,394 | |
The following information is with respect to our 2008 Stock Option Plan for the fiscal year 2008. For more information regarding the accounting treatment of our 2008 Stock Option Plan see “Note L — Stock Options” in our consolidated financial statements and related notes.
Equity Compensation Plan Information Table
| Plan Category | | | | Number of securities to
be issued upon exercise
of outstanding options,
warrants and rights | | Weighted-average
exercise price of
outstanding options,
warrants and
rights | | Number of securities
remaining available for future
issuance under equity
compensation plans (excluding
securities reflected in column (a)) |
|---|
| | | | (a) | | (b) | | (c) |
|---|
| Equity compensation plans approved by security holders | | | | | — | | | | — | | | | — | |
| Equity compensation plans not approved by security holders | | | | | 13,910,000 | | | | (1 | ) | | | 12,969,946 | |
| Total | | | | | 13,910,000 | | | | (1 | ) | | | 12,969,946 | |
| (1) | | Each option will have an exercise price equal to the price per share of our common stock offered in our initial public offering. |
Compensation of Directors
Commencing January 1, 2008, our non-employee directors receive a quarterly fee of $7,500, payable at the beginning of each quarter.
In April 2008, we entered into agreements to grant options to purchase 25,000 shares of our common stock to each of our then current non-employee directors as well as to one board advisor. In October 2008, we entered into agreements to grant stock options to purchase 25,000 shares of our common stock to Mr. LaChance in connection with his appointment to our board of directors. Future grants of stock options will be made at the discretion of our Chief Executive Officer and Chairman of the Board until a formal plan for compensating our directors is established. In addition, our non-employee directors and board advisor will receive additional options to purchase 5,000 shares of common stock on each subsequent April 3 anniversary so long as such director is serving on the board. The stock options will vest ratably over the five years following the grant date. However, a non-employee director may exercise the vested portion of a stock option only after that date which is 18 months after the date of the consummation of this offering. Each option will expire no more than ten years from its date of grant, except in the event of death in which case the options will expire six months from the date of death. The exercise price of the option will be the fair market value of our common stock on the date immediately preceding the date on which such option is granted or, in the case of options granted in connection with this offering, the per share offering price in this offering. Options are non-transferable except by will or by the laws of descent and distribution. Each such option granted will be evidenced by a written agreement.
We plan to reimburse each non-employee director for reasonable travel and related expenses incurred in connection with attendance at board and committee meetings.
Employees who also serve as directors receive no additional compensation for their services as a director.
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DIRECTOR COMPENSATION AS OF DECEMBER 31, 2008
Name
| | | | Fees
Earned
or Paid
in Cash
($)
| | Total
($)
|
|---|
| Jason Smith | | | | $ | 30,000 | | | $ | 30,000 | |
| Robert Bell | | | | | 30,000 | | | | 30,000 | |
| Barry Florescue | | | | | 30,000 | | | | 30,000 | |
James LaChance(1) | | | | | 5,725 | | | | 5,725 | |
| (1) | | Mr. LaChance was appointed to our board of directors in October 2008. |
Indemnification Agreements with Directors and Officers
We will be entering into indemnification agreements with our directors and executive officers, a form of which will be filed as an exhibit to the registration statement of which this prospectus is a part. Under the terms of the indemnification agreements, we will be required to indemnify the directors against specified liabilities arising out of their services to us. The indemnification agreements will require us to indemnify each director and executive officer to the fullest extent permitted by law and to advance certain expenses incurred by the director. The indemnification agreements will provide limitations on the directors’ and officers’ rights to indemnification in certain circumstances.
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PRINCIPAL STOCKHOLDERS
The following table sets forth information known to us about the beneficial ownership of our common stock as of April 20, 2009:
| • | | each person or entity who is known to beneficially own 5% or more of the outstanding shares of common stock; |
| • | | each named executive officer as of December 31, 2008; |
| • | | all of our named executive officers, current executive officers and directors as a group. |
Beneficial ownership of shares is determined under the rules of the SEC and generally includes any shares over which a person exercises sole or shared voting or investment power. Except as indicated by footnote, and subject to applicable community property laws, each person identified in the table possesses sole voting and investment power with respect to all common stock held by them. Common stock subject to options and warrants currently exercisable or exercisable within 60 days of April 20, 2009, and not subject to repurchase as of that date, are deemed to be outstanding for calculating the percentage of outstanding shares of the person holding these options, but are not deemed to be outstanding for calculating the percentage of any other person and includes our Series A and Series B convertible preferred stock which is convertible at any time at the holder’s option. The applicable percentage of ownership is based on 104,956,481 shares voting of common stock outstanding on April 20, 2009. Unless otherwise indicated, the address for those listed below is c/o FriendFinder Networks Inc., 6800 Broken Sound Parkway, Boca Raton, Florida 33487.
| | | | | | Percentage of Common
Stock Beneficially Owned
| |
|---|
Name, Address
and Title of Beneficial Holder
| | | | Number of Shares
of Common Stock
Beneficially Owned
| | Prior to Offering
Common Stock
| | After Offering
Common Stock
|
|---|
Named executive officers and directors:
| | | | | | | | | | | | | | |
Daniel C. Staton, Chairman of the Board and Treasurer(1) | | | | | 130,496,675 | | | | 63.55 | % | | | % | |
Marc H. Bell, Chief Executive Officer, President
and Director(2) | | | | | 101,329,586 | | | | 56.34 | % | | | % | |
| Robert Brackett, President, Internet Group | | | | | — | | | | — | | | | * | |
| Anthony Previte, Chief Operating Officer | | | | | — | | | | — | | | | * | |
| Ezra Shashoua, Chief Financial Officer | | | | | — | | | | — | | | | * | |
| Diane Silberstein, former President and Publisher, Magazine Group | | | | | — | | | | — | | | | * | |
| James Sullivan, President, Licensing and Publishing Group | | | | | — | | | | — | | | | * | |
| Robert B. Bell, Director | | | | | — | | | | — | | | | * | |
Barry Florescue, Director(3) | | | | | 14,354,211 | | | | 12.03 | % | | | % | |
| Jim LaChance, Director | | | | | — | | | | — | | | | * | |
| Toby E. Lazarus, Director | | | | | — | | | | — | | | | * | |
| Jason H. Smith, Director | | | | | — | | | | — | | | | * | |
All named executive officers, executive officers and directors as a group (12 persons) | | | | | 246,180,472 | | | | 91.48 | % | | | % | |
| |
Five percent stockholders:
| | | | | | | | | | | | | | |
Andrew B. Conru Trust Agreement(4) | | | | | 67,617,570 | | | | 47.66 | % | | | % | |
Florescue Family Corporation (5) | | | | | 9,306,487 | | | | 8.14 | % | | | % | |
Mapstead Trust(6) | | | | | 10,259,834 | | | | 9.15 | % | | | % | |
PET Capital Partners II LLC(7) | | | | | 15,984,634 | | | | 13.22 | % | | | % | |
Staton Family Investments, Ltd.(8) | | | | | 88,248,920 | | | | 53.47 | % | | | % | |
Staton Family Perpetual Trust(9) | | | | | 33,779,400 | | | | 24.35 | % | | | % | |
Other five percent stockholders:
| | | | | | | | | | | | | | |
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| * | | Represents less than 1% of the outstanding common stock. |
| (1) | | Shares beneficially owned include 28,155,160 shares of common stock, 32,923,633 shares issuable upon conversion of Series B Convertible Preferred Stock and 1,686,827 shares issuable upon exercise of warrants, owned by Staton Family Investments, Ltd. as well as 25,483,300 shares of Series B common stock purchased from IBD over which Staton Family Investments, Ltd., holds sole dispositive and voting power; 1,958,500 shares of common stock and 1,041,400 shares of Series B common stock owned by Staton Media LLC; 5,468,455 shares issuable upon conversion of Series A Convertible Preferred Stock owned by PET Capital Partners II LLC and 33,779,400 issuable upon conversion of Series B Convertible Preferred Stock, owned by Staton Family Perpetual Trust. Mr. Staton is a member of Staton Family Investments, Ltd. and has voting and investment power over its shares. Mr. Staton is a member and the manager of Staton Media LLC and has voting and investment power over its shares. Mr. Staton is a member of PET Capital Partners II LLC and has voting and investment power over his percentage interest in its shares. Mr. Staton disclaims beneficial ownership over the shares held by PET Capital Partners II LLC for which he does not have voting and investment power. Mr. Staton is also the trustee of Staton Family Perpetual Trust and has voting and investment power over its shares, which are held in trust for the benefit of his minor children. |
| (2) | | Shares beneficially owned include 1,041,400 shares of Series B common stock, 66,703,033 shares issuable upon conversion of Series B Convertible Preferred Stock and 1,686,827 shares issuable upon exercise of warrants as well as 5,468,455 shares issuable upon conversion of Series A Convertible Preferred Stock owned by PET Capital Partners II LLC. Mr. Bell is a member of PET Capital Partners II LLC and has voting and investment power over his percentage interest in its shares. Mr. Bell disclaims beneficial ownership over the shares held by PET Capital Partners II LLC for which he does not have voting and investment power. The amount does not include 3,683,789 shares held by the Bell Family 2003 Charitable Lead Annuity Trust for which Mr. Bell does not hold voting or dispositive power. Mr. Bell disclaims beneficial ownership over the shares held by the Bell Family 2003 Charitable Lead Annuity Trust. |
| (3) | | Shares beneficially owned include 5,047,724 shares issuable upon conversion of Series A Convertible Preferred Stock owned by PET Capital Partners II LLC and 9,306,487 shares of Series B Convertible Preferred Stock owned by Florescue Family Corporation. Mr. Florescue is a member of PET Capital Partners II LLC and has voting and investment power over his percentage interest in its shares. Mr. Florescue disclaims beneficial ownership over the shares held by PET Capital Partners II LLC for which he does not have voting and investment power. Mr. Florescue is also President of Florescue Family Corporation and has voting and investment power over its shares. |
| (4) | | Shares beneficially owned include 21,626,613 shares issuable upon exercise of warrants and 15,285,957 shares issuable upon exercise of its right to purchase shares from Marc H. Bell, Daniel C. Staton, or related entities. Shares beneficially owned do not include shares of common stock issuable upon the conversion of his Subordinated Convertible Note. To the best of our knowledge, Andrew Conru holds investment and voting power over the securities held by the Andrew B. Conru Trust Agreement. The address of the Andrew B. Conru Trust Agreement is 116 El Nido, Portola Valley, CA 94028. |
| (5) | | Shares beneficially owned consist of 9,306,487 shares issuable upon conversion of Series B Convertible Preferred Stock. The address of Florescue Family Corporation is 50 E. Sample Rd, Suite 400, Pompano Beach, FL 30064. |
| (6) | | Shares beneficially owned include 2,135,515 shares issuable upon exercise of warrants and 5,095,319 shares issuable upon exercise of its right to purchase shares from Marc H. Bell, Daniel C. Staton, or related entities. Shares beneficially owned do not include shares of common stock issuable upon the conversion of its Subordinated Term Loan Note. Lars Mapstead is a trustee of the Mapstead Trust and has voting and investment power over its shares. The address of Mapstead Trust is c/o Lars Mapstead, 180 Horizon Way, Aptos, CA 95003. |
| (7) | | Shares beneficially owned consist of 15,984,634 shares issuable upon conversion of Series A Convertible Preferred Stock. Messrs. Bell, Staton and Florescue each disclaim beneficial ownership of these shares except with respect to their percentage ownership of Pet Capital Partners II LLC. |
| (8) | | Shares beneficially owned include 32,923,633 shares of Series B Convertible Preferred Stock and 1,686,827 shares issuable upon exercise of warrants. |
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| (9) | | Shares beneficially owned consist of 33,779,400 shares issuable upon conversion of Series B Convertible Preferred Stock. |
Pursuant to the 2005 Voting Agreement by and among Barry Florescue, Marc Bell and Daniel Staton, each of Messrs. Bell and Staton agreed to vote all of his voting securities in favor of one board member designated by Mr. Florescue. Mr. Florescue nominated himself as such nominee and was elected to our board of directors. The 2005 Voting Agreement terminates on the earlier of the date on which Mr. Florescue and/or his affiliated entities ceases to hold more than fifty percent of the units of PET Capital Partners II LLC originally purchased by Mr. Florescue and affiliated entities and the consummation of this offering. Pursuant to the 2005 Security Holders Agreement, the holders of Series A Convertible Preferred Stock as well as certain holders of common stock and Series B common stock, have agreed, among other things, to vote all voting securities then held or thereafter acquired by such holder for the board designee allowed to be appointed pursuant to the 2005 Security Holders Agreement during the term of the 2005 Security Holders Agreement and have agreed not to vote for certain changes in our capitalization or corporate governance without the written consent of certain stockholders, so long as certain ownership levels are maintained by a certain group of stockholders. The holders of the warrants issued in connection with the 2006 Notes as well as the holders of the Series B Convertible Preferred Stock subsequently became party to this agreement and are subject to the voting requirements therein. The voting provisions of the 2005 Security Holders Agreement shall terminate upon the consummation of this offering. Pursuant to the 2007 Security Holders Agreement, the holders of warrants issued in connection with the sale of the First Lien Senior Secured Notes and the Second Lien Subordinated Secured Notes, as well as PET an existing stockholder and Messrs. Bell and Staton have agreed, among other things, to vote all voting securities then held or thereafter acquired by such holder in favor of the board designees allowed to be appointed by noteholders holding the required number of notes as prescribed by the securities purchase agreements pursuant to which the First Lien Senior Secured Notes and the Second Lien Subordinated Secured Notes were sold, respectively, during the term of the 2007 Security Holders Agreement. The 2007 Security Holders Agreement will terminate immediately upon the consummation of this offering.
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CERTAIN RELATIONSHIPS AND RELATED PARTY TRANSACTIONS
Except as described below, there has not been, nor is there any proposed transaction where we were or will be a party in which the amount involved exceeded or will exceed $120,000 and in which any director, executive officer, holder of more than 5% of any class of our voting securities, or any member of the immediate family of any of the foregoing persons had or will have a direct or indirect material interest, other than the employment agreements described in “Management.” These related party transactions were each negotiated at an arm’s length basis and were on no less favorable terms to us than would have been given to a third party.
General Media, Inc. Transaction
General Media, Inc., or GMI, a Delaware corporation formed in 1993, filed for bankruptcy on August 12, 2003. In November 2003, Marc Bell and Daniel Staton formed PET Capital Partners LLC to acquire GMI’s secured notes and preferred stock. On October 5, 2004, GMI emerged from Chapter 11 protection with new equity distributed entirely to the holders of the GMI secured notes. The reorganized capital structure also included approximately $35.8 million of Term Loan Notes distributed to former secured and unsecured creditors and a credit facility for up to $20.0 million funded by NAFT Ventures I LLC, or NAFT, an affiliate of Messrs. Bell and Staton. An unaffiliated fund also participated in the exit financing facility. Concurrently with the plan closing, we changed our name to Penthouse Media Group Inc. and PET Capital Partners LLC sold a minority position of non-voting Series B common stock to IBD. This transaction was part of a broader settlement agreement, which ended all litigation among the parties to the transaction and allowed the company to emerge from bankruptcy without further delay. Within a year, all of the unsecured creditors with valid claims were paid in full.
Boca Raton Lease
Effective January 1, 2005, we entered into a lease with 6800 Broken Sound LLC, an affiliate of Marc H. Bell, and currently lease 3,533 square feet of space in an office building in Boca Raton, Florida. The lease currently provides for an annual base rent of $57,909, payable in equal monthly installments, increasing to an annual base rent of $59,646 in the final year of the lease. We are also responsible for the certain costs, including property taxes, utilities, repairs, maintenance, alterations, cleaning and insurance currently estimated to be $49,956 per annum, increasing to an estimated $52,999 per annum in the final year of the lease. Total rent expense under this lease agreement was approximately $117,500, $111,000 and $159,000 for the years ended December 31, 2008, 2007 and 2006, respectively.
Management Agreement
In October 2004, we entered into a management agreement with Bell & Staton, Inc., a Florida corporation controlled by Marc H. Bell and Daniel C. Staton, or the managers, whereby certain management services are to be performed by these managers as designated by our board of directors. The agreement is for a term of five years with an annual fee of $0.5 million, which amount is included in general administrative expenses for each of the years ended December 31, 2008, 2007 and 2006. The fee is subject to increase at the rate of 10% of EBITDA of our business, exclusive of EBITDA attributable to the acquisition of Various, but annual compensation cannot exceed $1.0 million. We have yet to increase the fee as the EBITDA hurdles have not yet been attained. In addition, the agreement provides that the managers may participate in our future bonus pool and stock option plans. On August 17, 2005, the management agreement was amended to limit the total bonus to be paid to the managers to a maximum of $500,000 so long as any of the 2005 Notes or any guaranty thereof remained outstanding and to prohibit the payment of the bonus as long as there is a default occurring on the 2005 Notes. On August 23, 2006, the management agreement was further amended to provide that no management fee, other than reimbursement of expenses, shall be paid to the managers so long as there is a default or an event of default occurring on the 2006 Notes. On December 9, 2008, our board of directors approved forms of employment agreement with each of Messrs. Bell and Staton to become effective upon the consummation of this offering, the extinguishment or waiver of the existing debt instruments and the obtainment of any other third party consents required, as described above. For each of the years ended December 31, 2008 and 2007, Bell & Staton Inc. was paid $500,000. These payments were in violation of the covenant in the management agreement prohibiting the payment of fees if there is a default on the 2006 Notes or 2005 Notes and violated the restricted payment covenant in our First Lien Senior Secured Notes and Second Lien Subordinated Secured Notes.
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Security Holders Agreements
In August 2005, we entered into the 2005 Security Holders Agreement with PET Capital Partners LLC, PET Capital Partners II LLC, Messrs. Bell and Staton and certain other investors in our Series A Convertible Preferred Stock whereby, among other things, a specified group of funds may propose a board designee and who shall be reasonably acceptable to the Majority Equity Sponsor as defined in the agreement pursuant to which the Series A Convertible Preferred Stock was purchased and each of the security holders party to the 2005 Security Holders Agreement agreed to vote all voting securities then held or thereafter acquired by such security holder to elect such board designee as a director during the term of the 2005 Security Holders Agreement. The group of funds has yet to designate a board designee. In addition, the security holders party to the 2005 Security Holders Agreement have agreed not to vote for certain changes in our capitalization or corporate governance without the written consent of certain stockholders, so long as certain stockholders collectively own at least twenty percent of the Series A Convertible Preferred Stock originally issued to such investors pursuant to the purchase agreement whereby the 2005 Notes were issued. These provisions of the 2005 Security Holders Agreement will terminate immediately upon the consummation of this offering.
In December 2007, we entered into the 2007 Security Holders Agreement, pursuant to which the holders of warrants issued in connection with the sale of the First Lien Senior Secured Notes and the Second Lien Subordinated Secured Notes, as well as PET, an existing stockholder and Messrs. Bell and Staton have agreed, among other things, to vote all voting securities then held or thereafter acquired by such holder in favor of the board designees allowed to be appointed by noteholders holding the required number of notes as prescribed by the securities purchase agreements pursuant to which the First Lien Senior Secured Notes and the Second Lien Subordinated Secured Notes were sold, respectively, during the term of the 2007 Security Holders Agreement. The 2007 Security Holders Agreement will terminate immediately upon the consummation of this offering.
August 2005 Purchase of Series A Convertible Preferred Stock
In August 2005, in connection with our offering of Series A Convertible Preferred Stock and 2005 Notes, PET Capital Partners II, LLC, whose members consist of Messrs. Bell, Florescue and Staton or their affiliates, purchased 8,412,700 shares of Series A Convertible Preferred Stock for an aggregate purchase price of $5.0 million, or approximately $0.5943 per share. In addition, an existing stockholder purchased 5,047,600 shares of Series A Convertible Preferred Stock for an aggregate purchase price of $3.0 million, or approximately $0.5943 per share.
August 2006 Purchase of Series A Convertible Preferred Stock
In August 2006, PET Capital Partners II, LLC purchased an additional 7,571,934 shares of Series A Convertible Preferred Stock for an aggregate purchase price of $4.5 million, or approximately $0.5943 per share and one of our existing stockholders purchased an additional 2,523,977 shares of Series A Convertible Preferred Stock for an aggregate purchase price of $1.5 million, or approximately $0.5943 per share.
Purchase of Subordinated Term Loan Notes
In October 2004, PET and one of our existing stockholders participated in our issuance of $35.8 million in aggregate principal amount of Term Loan Notes. In August 2005, concurrent with the completion of our offerings of the 2005 Notes and the Series A Convertible Preferred Stock, we used a portion of the net proceeds from those offerings to repay $11.8 million of the Term Loan Notes plus accrued interest. The Term Loan Notes held by PET and such shareholder were not repaid, but exchanged for Subordinated Term Loan Notes with a principal amount of approximately $21.5 million. Messrs. Bell and Staton indirectly own PET. In October 2006, PET, purchased an additional $0.9 million in principal amount of Subordinated Term Loan Notes. We used the proceeds to fund part of the purchase price consideration for the Danni.com business. Interest on the Subordinated Term Loan Notes is payable in arrears annually at the rate of 13% per annum. As we are restricted from paying cash on the Subordinated Term Loan Notes until we reach have maintained consolidated EBITDA of at least $25.0 million for the prior four consecutive fiscal quarters and attain an interest coverage ratio of at least 3:1, all interest on our Subordinated Term Loan Notes has been paid in kind. In 2008, 2007 and 2006 PET received additional Subordinated Term Loan Notes in the amount of approximately $3.7 million, $3.3 million and $2.8 million, respectively, and our existing stockholder received additional Subordinated Term Loan Notes in the amount of approximately $338,504, $299,561 and $265,098, respectively, as payment of interest for those years. As of December 31, 2008, PET owns
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approximately $32.2 million in principal amount of our Subordinated Term Loan Notes, which is the largest principal amount outstanding to date and none of which has been paid. Mr. Bell and Mr. Staton have interests in approximately $13.9 and $15.9, respectively, of the principal amount outstanding on the Subordinated Term Loan Notes owned by PET. As of December 31, 2008, our existing stockholder owns approximately $2.9 million in principal amount of our Subordinated Term Loan Notes, which is the largest principal amount outstanding to date and none of which has been paid.
In August 2006, Florescue Family Corporation purchased approximately $0.9 million in principal amount of our Subordinated Term Loan Notes. Barry Florescue, one of our directors, is the president and a majority shareholder of Florescue Family Corporation and has beneficial interest over all the Subordinated Term Loan Notes owned by the Florescue Family Corporation. In 2008, 2007 and 2006 the Florescue Family Corporation received additional Subordinated Term Loan Notes in the amount of $148,898, $131,768 and $116,609, respectively, as payment of interest for those years. As of December 31, 2008, the Florescue Family Corporation owns approximately $1.3 million in principal amount of our Subordinated Term Loan Notes, which is the largest principal amount outstanding to date and none of which has been paid.
As of December 31, 2008 there was $36.4 million aggregate principal amount outstanding of Subordinated Term Loan Notes. We have not repaid any principal of this loan. We have accrued interest of $1.1 million and $1.0 million for the years ended December 31, 2008 and 2007, respectively on the Subordinated Term Loan Notes.
Series B Convertible Preferred Stock Offering
In December 2007, certain of our existing stockholders, including Messrs. Bell and Staton and the Florescue Family Corporation, purchased an aggregate of 168,897,005 shares of Series B Convertible Preferred Stock at a purchase price of $0.029604 per share. The aggregate proceeds of $5.0 million were used to help fund the acquisition of Various and for general corporate purposes.
Purchase of First Lien Senior Secured Notes by Marc H. Bell, Staton Family Investments, Ltd. and an existing noteholder
In December 2007, Mr. Bell purchased approximately $5.2 million in principal amount of our subsidiary’s First Lien Senior Secured Notes. This is the largest principal amount outstanding on the First Lien Senior Secured Notes owned by Mr. Bell to date. In December 2007, Staton Family Investments, Ltd., of which Mr. Staton is president, also purchased approximately $5.2 million in principal amount of our subsidiary’s First Lien Senior Secured Notes. Mr. Staton is president of Staton Family Investments, Ltd. and has beneficial interest over all the First Lien Senior Secured Notes owned by Staton Family Investments, Ltd. This is the largest principal amount outstanding on the First Lien Senior Secured Notes owned by Staton Family Investments, Ltd. to date. In December 2007, one of our existing stockholders and debtholders purchased approximately $100 million in principal amount of our subsidiary’s First Lien Senior Secured Notes. This is the largest principal amount outstanding on the First Lien Senior Secured Notes owned by such securityholder to date. Interest on the First Lien Senior Secured Notes accrues at a rate per annum equal to 8% plus the greater of (a) 4.5% or (b) the three-month LIBOR, as further defined in the securities purchase agreement governing the First Lien Senior Secured Notes for the applicable interest period. In 2008, Mr. Bell received $0.7 million in interest payments and $0.5 million in principal payments, Staton Family Investments, Ltd. received $0.7 million in interest payments and $0.5 million in principal payments, and our existing securityholder received $12.1 million in interest payments and $8.6 million in principal payments on the First Lien Senior Secured Notes. As of December 31, 2008, Mr. Bell owns approximately $4.7 million, Staton Family Investments, Ltd. owns approximately $4.7 million, and our existing securityholder owns approximately $74.2 million in principal amount of the First Lien Senior Secured Notes. In connection with its purchase of our subsidiary’s First Lien Senior Secured Notes, our existing securityholder also received warrants for 32,724,439 shares of our common stock valued at approximately $9.1 million.
Letter Agreement with Sellers of Various
At the closing of the Various acquisition on December 6, 2007, PET Capital Partners LLC, Staton Family Investments, LLC, Staton Media, LLC, Staton Family Perpetual Trust and Marc H. Bell, collectively referred to as the principals, entered into an agreement with the Andrew B. Conru Trust Agreement and the Mapstead Trust,
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created on April 16, 2002, collectively referred to as the sellers, pursuant to which the principals and sellers agreed, among other things, that:
| • | | the principals granted the sellers an option to purchase from time to time from the principals, shares of our common stock and Series B Convertible Preferred Stock at the exercise price of $0.01 per share, at any time until the consummation of an initial public offering. The option was subject to a vesting schedule pursuant to which the option vested in part immediately, and in part after each of six, nine and twelve months. However, this vesting schedule was subsequently amended as described below; |
| • | | in the event (i) there is a default under the letter agreement; (ii) the outstanding balance of the First Lien Senior Secured Notes held by the sellers is greater than or equal to $50.0 million, and there is an interest or principal payment default under the securities purchase agreement governing the First Lien Senior Secured Notes, which is not cured at least two days prior to the applicable time frame within which cure is permitted under such Securities Purchase Agreement; (iii) the outstanding balance of the notes is less than $50.0 million, and there is an interest or principal payment default under such securities purchase agreement that has been called for immediate payment by the Required Holders (as defined in the securities purchase agreement) pursuant to the terms of such securities purchase agreement; or (iv) the First Lien Senior Secured Notes are not paid in full within 3.5 years after issuance, the sellers shall have the right to require the principals to purchase their outstanding First Lien Senior Secured Notes, in whole or in part, together with the related warrants to purchase shares of our common stock that are then still outstanding, and the principals will purchase such First Lien Senior Secured Notes and related outstanding warrants, at a purchase price equal to the then outstanding principal amount of the First Lien Senior Secured Notes required to be purchased, plus accrued and unpaid interest on such First Lien Senior Secured Notes through the date of purchase. This provision was subsequently deleted by amendment as described below; |
| • | | the principals granted the sellers a security interest in all our equity securities owned by the principals to secure the performance of the principals’ obligations referenced in the foregoing item. This provision was subsequently deleted by amendment as described below; |
| • | | in the event that, at any time and from time to time, after the issuance of the First Lien Senior Secured Notes to sellers, any seller receives a bid price equal to or greater than 97% of par plus accrued and unpaid interest to purchase such seller’s First Lien Senior Secured Notes and related outstanding warrants, in whole or in part, such seller shall sell its First Lien Senior Secured Notes and the related outstanding warrants pursuant to such bid; and (ii) each seller shall, at all times for so long as it owns any First Lien Senior Secured Notes, maintain with Imperial Capital, LLC and/or such other broker as the principals shall designate an offer price not greater than par plus accrued and unpaid interest to sell its First Lien Senior Secured Notes and related outstanding warrants. This provision was subsequently deleted by amendment as described below; and |
| • | | for so long as any First Lien Senior Secured Notes owned by any seller remain outstanding, the principals are restricted from selling, transferring or otherwise disposing of their First Lien Senior Secured Notes except subject to certain exceptions. This provision was subsequently revised by amendment as described below. |
The letter agreement terminates upon the (i) sale, transfer or other disposition of all First Lien Senior Secured Notes owned by the sellers to an unrelated third party, (ii) the repayment in full of such First Lien Senior Secured Notes, or (iii) the consummation of this offering.
On May 14, 2008, the letter agreement was amended to reflect the sellers’ decision to retain their outstanding First Lien Senior Secured Notes, instead of selling them, as contemplated by the original letter agreement. The principals and the sellers agreed, among other things, to the following amendments, which remain in effect to date:
| • | | the principals no longer have an obligation to purchase the sellers’ First Lien Senior Secured Notes or to grant a security interest in any equity securities owned by the principals; |
| • | | the sellers no longer have an obligation to sell their First Lien Senior Secured Notes at a certain bid price; |
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| • | | the principals granted the sellers an immediately exercisable option to purchase from time to time from the principals, an aggregate of approximately 20,000,000 shares of our common stock at the exercise price of $0.01 per share, at any time until the consummation of an initial public offering; |
| • | | the principals are no longer restricted from selling their First Lien Senior Secured Notes. Instead, until the later of (i) the repayment in full of the First Lien Senior Secured Notes owned by any seller and (ii) the consummation of an initial public offering, no principal may sell, transfer or otherwise dispose of any of our securities subject to the purchase option or permit them to become subject to any liens; and |
| • | | the letter agreement terminates upon the consummation of this offering and the completion of transfer of any equity securities required by the amendment to be transferred. |
Purchase of Series B Common Stock by Strategic Media I LLC
In 2004, PET Capital Partners LLC sold a minority position of non-voting Series B common stock to IBD. In connection with the purchase agreement relating to this transaction, IBD was entitled to certain rights under the Shareholders’ Agreement (to which we are a party), including the right to receive notice of and to participate on a pro rata basis in, any issuance or sale of securities to a related party. IBD has claimed that the 2007 issuance of Series B Convertible Preferred Stock by us was a violation of the Shareholders’ Agreement.
On December 31, 2008, Strategic Media I LLC, or Strategic, a Delaware limited liability company, purchased 25,483,300 shares of our non-voting Series B common stock from IBD. Staton Family Investments, Ltd., which is managed by Mr. Staton, our Chairman of the Board and Treasurer, owns 25.0% of the membership interests of Strategic and, as the sole manager of Strategic, Staton Family Investments, Ltd. has sole dispositive and voting power over the shares purchased by Strategic. Bell Family 2000 Trust Agreement, an affiliate of Mr. Bell, our Chief Executive Officer and President, owns 25.0% of the membership interests of Strategic; however, Mr. Bell disclaims beneficial ownership over the membership interests held by this trust. Mr. LaChance, one of our directors, and his spouse own 6.25% of the membership interests of Strategic as tenants by the entirety.
The purchase price for the shares purchased by Strategic was $36.7 million, all of which is payable to the creditors of IBD. The approximate dollar value of each of the interests held by the Staton Family Investments, Ltd., the Bell Family 2000 Trust and Mr. LaChance’s is $9.18 million, $9.18 million and $2.29 million, respectively.
A non-refundable initial payment in the amount of $3.7 million was paid at the closing of the stock purchase. The balance of the purchase price is due on December 31, 2011, except that such balance is subject to pre-payment upon the occurrence of certain events, including upon consummation of this initial public offering. If the balance is not paid in full by its due date and the shares purchased by Strategic are not delivered to IBD’s creditors within five business days after the due date, the balance of the purchase price will start to accrue interest, at a rate per annum equal to 10% of the unpaid principal balance, until either the balance is paid or the shares are delivered. Strategic pledged the shares as security for payment of the balance of the purchase price. The shares are subject to lock-up arrangements as described under “Underwriting.”
As a result of this transaction, we delivered general releases to, and received general releases from, IBD, certain of its current and former directors, officers and shareholders, as well as substantially all of IBD’s creditors. The general release from IBD released us from, among other things, allegations raised in a July 30, 2007 letter from IBD that we, as well as certain of our officers and directors, had violated the Nevada Revised Statutes, federal securities laws, state common law and breached the terms of the 2004 Shareholders’ Agreement in connection with our offering of shares of Series B Convertible Preferred Stock in December 2007.
Consulting Agreements
On September 21, 2007, in connection with the Various acquisition, we entered into a consulting agreement with Hinok Media Inc., an entity controlled by Andrew B. Conru, one of the founders of Various. In exchange for consulting services, we agreed to pay Hinok Media Inc. the sum of $9,615.38 twice per month for the term of the agreement, which was originally one year and which automatically renews every month until either party terminates the agreement. On December 6, 2007, the agreement was amended as part of the amendment to the Various Stock Purchase Agreement to provide for additional payments to Hinok Media Inc. of $1.0 million on the first anniversary
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of the closing of the Various acquisition, $1.0 million on the second anniversary and $3.0 million on the third anniversary. On May 12, 2008, the parties signed a letter agreement confirming the amendment and clarifying that the additional payments would be made on the dates specified in the amendment regardless of whether the original consulting agreement is still in effect at the time. In the year ended December 31, 2008, we paid a total of $1,230,769 to Hinok Media Inc., $230,769 pursuant to the original consulting agreement and $1.0 million pursuant to the December 6, 2007 amendment.
On September 21, 2007, in connection with the Various acquisition, we entered into a consulting agreement with Legendary Technology Inc., an entity controlled by Lars Mapstead, one of the founders of Various. In exchange for consulting services, we agreed to pay Legendary Technology Inc. the sum of $9,615.38 twice per month for the term of the agreement, which was originally one year and which automatically renews every month until either party terminates the agreement. In the year ended December 31, 2008, we paid a total of $230,769 to Legendary Technology Inc.
Certain Affiliate Payments
In 2008 we paid a total of $42,598 to Cyberzine Publishing, Inc., which is owned by Lars Mapstead, one of the founders of Various. These payments were made in consideration for traffic sent to our websites from domain names owned by Cyberzine Publishing, Inc.
Family Relationships
Marc H. Bell, our Chief Executive Officer, President and a director is the son of Robert B. Bell, one of our directors.
Related Party Policy and Audit Committee Charter
We have established a related party transaction policy, which will become effective upon the consummation of this offering, which provides procedures for the review of transactions with a value in excess of $120,000 in any year between us and any covered person having a direct or indirect material interest with certain exceptions. Covered persons include any director, executive officer, director nominee, a holder of more than 5% of any class of our voting securities or any of the immediate family members of the foregoing. Any such related party transactions will require advance approval by a majority of our independent directors or a majority of the members of a committee constituted solely of our independent directors as such approval may be delegated by the board of directors from time to time.
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DESCRIPTION OF CAPITAL STOCK
General
The following is a summary of the rights of our common stock and preferred stock and related provisions of our articles of incorporation and bylaws, as they will be in effect upon the closing of this offering. For more detailed information, see the articles of incorporation and the form of amended and restated articles of incorporation and form of amended and restated bylaws, which are filed as exhibits to the registration statement of which this prospectus forms a part.
Our authorized capital stock consists of 1,250,000,000 shares of common stock, $0.001 par value per share, 250,000,000 of which are designated Series B common stock, and 450,000,000 shares of preferred stock, $0.001 par value per share, 50,000,000 shares of which are designated Series A Convertible Preferred Stock and 200,000,000 shares of which are designated Series B Convertible Preferred Stock.
Common Stock
Common Stock
As of December 31, 2008, there were 104,956,481 shares of common stock outstanding, excluding Series B common stock, which is non-voting.
Except as otherwise provided by our articles of incorporation or Nevada law, the holders of common stock are entitled to one vote per share on all matters to be voted upon by the stockholders and any corporate action, other than the election of directors, requires a majority of the votes cast by holders entitled to vote. Subject to preferences that may be applicable to any outstanding preferred stock and except as otherwise provided by our articles of incorporation or Nevada law, the holders of common stock are entitled to receive ratably such dividends, if any, as may be declared from time to time by the board of directors out of funds legally available for that purpose. In the event of our liquidation, dissolution or winding up, the holders of common stock are entitled to share ratably in all assets remaining after payment of liabilities, subject to prior distribution rights of preferred stock, if any, then outstanding. The common stock has no preemptive rights, redemption, conversion or other subscription rights under Nevada law. The outstanding shares of common stock are fully paid and non-assessable. The rights, preferences and privileges of holders of common stock are subject to the rights of the holders of shares of our preferred stock.
Series B Common Stock
As of December 31, 2008, there were 36,796,500 shares of Series B common stock outstanding. The holders of the Series B common stock have the same rights, preferences and privileges as the holders of the common stock, except that the holders of the Series B common stock do not have the right to vote on matters that come before the stockholders, unless otherwise required by Nevada law. The outstanding shares of Series B common stock are fully paid and non-assessable. Under our articles of incorporation, holders of Series B common stock have the right to exchange all shares of Series B common stock for a like number of shares of common stock commencing immediately prior to the occurrence of:
| • | | our consummation of a sale of all or substantially all of our assets or capital stock to any unaffiliated third party or our merger, consolidation or combination with any unaffiliated third party, or |
| • | | our consummation of an underwritten initial public offering of securities or our “reverse merger” with or into a publicly traded company. |
Preferred Stock
Series A Convertible Preferred Stock
As of December 31, 2008, there were 35,334,011 shares of Series A Convertible Preferred Stock outstanding.
Our Series A Convertible Preferred Stock ranks senior to our common stock and on parity with our Series B Convertible Preferred Stock. Series A Convertible Preferred Stock may be converted at the holder’s option at
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any time into shares of our common stock at the initial rate of one share of common stock for each share of Series A Convertible Preferred Stock, subject to adjustment for certain dilution events. Shares of Series A Convertible Preferred Stock carry voting rights on all matters to be voted upon by our stockholders, and on any particular matter each holder of Series A Convertible Preferred Stock is entitled to the number of votes equal to the number of whole shares of common stock into which such holder’s Series A Convertible Preferred Stock shares would be convertible as of the record date for determining the stockholders entitled to vote on the matter. Under certain circumstances, the written consent of the holders of Series A Convertible Preferred Stock is required to take certain actions, including, for example, to amend our articles of incorporation, effect a change of control, and declare any dividend or make any distribution on any of our capital stock. Shares of our Series A Convertible Preferred Stock are entitled to receive ratably such dividends, if any, as may be declared by the board of directors. Each share of Series A Convertible Preferred Stock has a liquidation preference equal to the greater of (x) the original issue price for such share ($0.5943 per share), plus declared and accrued but unpaid dividends, and (y) such amount as would have been payable had such share been converted into common stock immediately prior to the liquidation, dissolution or winding up. The Series A Convertible Preferred Stock provides that, under certain circumstances, the holders of the Series A Convertible Preferred Stock have preemptive rights with respect to the offering by us of any shares of, or any securities convertible into or exercisable for any shares of, any class of our capital stock. These rights terminate immediately prior to the closing of certain public offerings of our common stock, which we expect will include this offering.
Series B Convertible Preferred Stock
As of December 31, 2008, there were 168,897,006 shares of Series B Convertible Preferred stock outstanding.
Our Series B Convertible Preferred Stock ranks senior to our common stock and on parity with our Series A Convertible Preferred Stock. Series B Convertible Preferred Stock may be converted at the holder’s option at any time into shares of our common stock at the initial rate of one share of common stock for each share of Series B Convertible Preferred Stock, subject to adjustment for certain dilution events. Shares of Series B Convertible Preferred Stock carry voting rights on all matters to be voted upon by stockholders, and on any particular matter each holder of Series B Convertible Preferred Stock is entitled to the number of votes equal to the number of whole shares of common stock into which such holder’s Series B Convertible Preferred Stock shares would be convertible as of the record date for determining the stockholders entitled to vote on the matter. Shares of our Series B Convertible Preferred Stock are entitled to receive ratably such dividends, if any, as may be declared by the board of directors. Each share of Series B Convertible Preferred Stock has a liquidation preference equal to the greater of (x) the original issue price for such share ($0.029604 per share), plus declared and accrued but unpaid dividends, and (y) such amount as would have been payable had such share been converted into common stock immediately prior to the liquidation, dissolution or winding up. The Series B Convertible Preferred Stock provides that, under certain circumstances, the holders of the Series B Convertible Preferred Stock have preemptive rights with respect to the offering by us of any shares of, or any securities convertible into or exercisable for any shares of, any class of our capital stock. These rights terminate immediately prior to the closing of certain public offerings of our common stock, which we expect will include this offering.
Undesignated Preferred Stock
Subject to certain approval rights of the holders of our preferred stock, our board of directors has the authority, without action by the holders of the common stock, to designate and issue preferred stock in one or more series and to designate the rights, preferences and privileges of each series, which may be greater than the rights of the common stock. It is not possible to state the actual effect of the issuance of any shares of preferred stock upon the rights of holders of the common stock until the board of directors determines the specific rights of the holders of such preferred stock. However, the effects might include, among other things:
| • | | restricting dividends on the common stock; |
| • | | diluting the voting power of the common stock; |
| • | | impairing the liquidation rights of the common stock; or |
| • | | delaying or preventing a change in control of us without further action by the stockholders. |
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Warrants
As of December 31, 2008, there were a total of 142,733,364 warrants to purchase shares of our common stock outstanding.
In August 2005, we issued 14,646,202 warrants (including 501,800 warrants issued as part of the placement agent’s fee) pursuant to the transactions under the Securities Purchase Agreement dated as of August 17, 2005. The holders of these warrants are entitled to purchase one share of our common stock at a purchase price of $0.318147111224 per share at any time prior to August 16, 2015 or our consummation of this offering of our common stock pursuant to a registration statement under the Securities Act. The number of shares which may be purchased upon the exercise of these warrants and the purchase price for these shares are subject to adjustment in certain events. In August 2006, as consideration for the waiver by the holders of the warrants of certain defaults by us under such Securities Purchase Agreement, we amended the terms of 4,865,619 of these warrants to reduce the exercise price to $0.00001 per share.
In August 2006, we issued 8,829,359 warrants in connection with our offering of $5.0 million in principal amount of our 2006 Notes. The holders of these warrants are entitled to purchase one share of our common stock at a purchase price of $0.00001 per share at any time prior to the earlier to occur of August 27, 2016 or the consummation of this offering.
In November 2007, we issued 45,019,915 warrants to 15 holders of our Series A Convertible Preferred Stock and to the holder of the warrants issued as part of the placement agent’s fee in August 2005 in lieu of the application of anti-dilution provisions contained in the Series A Convertible Preferred Stock and certain warrants held by such holders in connection with our issuance of the Series B Convertible Preferred Stock. The holders of these warrants are entitled to purchase one share of our common stock at a purchase price of $0.00001 per share at any time prior to the earlier to occur of December 6, 2017 or the consummation of this offering.
In December 2007, in connection with the issuance by INI of (i) $257.3 million in First Lien Senior Secured Notes, we issued an aggregate of 84,212,295 detachable warrants to the holders of the First Lien Senior Secured Notes, 50,478,295 of which remain outstanding as of December 31, 2008, and (ii) $80.0 million in Second Lien Subordinated Secured Notes to the sellers, we issued 23,759,593 detachable warrants to the holders of the Second Lien Subordinated Secured Notes. The holders of these warrants are entitled to purchase one share of our common stock at a purchase price of $0.00001 per share at any time prior to the earlier to occur of December 6, 2017 or the consummation of this offering.
On May 18, 2008, certain holders of warrants issued in connection with the First Lien Senior Secured Notes exercised an aggregate of 33,734,000 warrants.
All of the warrants are subject to adjustment immediately prior to the closing of this offering in the event that we have issued fewer than 26,879,946 shares (or options, warrants or rights) pursuant to an equity incentive or benefits plan prior to the occurrence of this offering. The number of shares of common stock for which each warrant is exercisable will be adjusted such that one such share will represent upon the offering the same proportion of the fully-diluted equity of the company that such share would have represented on the date of issuance of the warrant had the actual number of shares (or options, warrants or rights) issued under an equity plan (rather than 26,879,946 shares) been deemed issued on the date of issuance of the warrant.
The warrants issued in December 2007 to the holders of the First Lien Senior Secured Notes and the holders of the Second Lien Subordinated Secured Notes are also subject to adjustment immediately prior to the closing of this offering, such that the number of shares for which each such warrant is exercisable will be increased to account for the dilutive effect caused by that number of shares into which the Subordinated Convertible Notes are convertible based on the offering price of our common stock in this offering.
Given the nominal exercise price and that after the completion of this offering any unexercised warrants will have expired, we anticipate that the holders of these warrants will exercise all of their warrants prior to, or concurrently with, the consummation of this offering.
Registration Rights
Pursuant to the 2005 Security Holders Agreement, the holders of the Series A Convertible Preferred Stock are entitled to piggyback registration rights for registration under the Securities Act of the shares of common stock
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issuable upon the conversion of the Series A Convertible Preferred Stock or the exercise of the warrants held by such security holders. Additionally, beginning six months after the consummation of this offering, a specified entity, for so long as funds affiliated with such entity collectively own at least 20% of the Series A Convertible Preferred Stock issued to them, or, in any other case, the holders of a majority of the shares of our common stock owned by certain of our stockholders (including common stock issuable upon the conversion of the Series A Convertible Preferred Stock or the exercise of the warrants), are entitled to demand registration rights on behalf of such funds for the shares of common stock issuable upon the conversion of the Series A Convertible Preferred Stock or the exercise of the warrants. We are not required to effect more than three registrations pursuant to the demand registration rights. The piggyback and demand rights are subject to conditions and limitations, among them the right of an underwriter of an offering to limit the number of shares of common stock underlying the Series A Convertible Preferred Stock and the warrants for inclusion in the registration. The warrants issued in connection with the 2005 Notes and the 2006 Notes are also subject to this agreement and have registration rights thereunder. We are generally required to bear all of the expenses of all such registrations except for underwriting discounts and commissions.
On December 6, 2007, we entered into a Registration Rights Agreement with the sellers of the Various stock granting the holders of the warrants issued along with the First Lien Senior Secured Notes certain piggyback registration rights for the registration under the Securities Act of the shares of our common stock issuable upon the conversion of the warrants. Additionally, beginning six months after the consummation of this offering, holders of the warrants representing at least 51% of the total common stock issuable upon conversion of all such warrants are entitled to demand registration rights for the shares of common stock issuable upon the conversion of the warrants. We are not required to effect more than three registrations pursuant to the demand registration rights. The piggyback and demand rights are subject to conditions and limitations, among them the right of an underwriter of an offering to limit the number of shares of common stock underlying the warrants for inclusion in the registration. We are generally required to bear all of the expenses of all such registrations except for underwriting discounts and commissions.
On December 6, 2007, we entered into a Registration Rights Agreement with the sellers of the Various stock granting the holders of the Subordinated Convertible Notes certain piggyback registration rights for the registration under the Securities Act of the shares of our common stock issuable upon the conversion of the Subordinated Convertible Notes. Additionally, beginning six months after the consummation of this offering, holders of the Subordinated Convertible Notes are also entitled to demand registration rights for the shares of our common stock issuable upon the conversion of their notes, so long as the shares to be registered represent at least 30% of the registrable securities (as defined in the registration rights agreement) outstanding or would result in an aggregate anticipated offering price of at least $10.0 million. We are not required to effect more than two registrations pursuant to the demand registration rights. The piggyback and demand rights are subject to conditions and limitations, among them the right of an underwriter of an offering to limit the number of shares of common stock underlying the notes for inclusion in the registration. We are generally required to bear all of the expenses of all such registrations except for underwriting discounts and commissions.
Transfer agent and registrar
Upon the closing of this offering, the transfer agent and registrar for our common stock will be American Stock Transfer & Trust Company. The address of the transfer agent is 59 Maiden Lane, Plaza Level, New York, New York 10038.
We expect that as of the date of this prospectus our common stock will be approved for quotation on the New York Stock Exchange under the symbol “FFN.”
Nevada Anti-Takeover Laws and Certain Articles and Bylaws Provisions
Provisions of Nevada law and our articles of incorporation and bylaws could make the following more difficult:
| • | | acquisition of us by means of a tender offer; |
| • | | acquisition of us by means of a proxy contest or otherwise; or |
| • | | removal of our incumbent officers and directors. |
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These provisions, summarized below, are expected to discourage certain types of coercive takeover practices and inadequate takeover bids. These provisions are also designed to encourage persons seeking to acquire control of us to first negotiate with our board of directors.
Requirements for Advance Notification of Stockholder Nominations and Proposals. Our bylaws establish advance notice procedures with respect to stockholder proposals and the nomination of candidates for election as directors, other than nominations made by or at the direction of the board of directors or a committee of the board of directors.
Consent of Holders of Preferred Stock. Under certain circumstances, the written consent of certain holders of our preferred stock is required before certain action can be taken, including, for example, effecting a change of control of the company or amending our articles of incorporation.
Stockholder Meetings. Our bylaws provide that special meetings of the stockholders may be called by our Chairman of the Board or our President, and must be called by certain of our officers upon the written request of the holders of not less than 75% of the voting power of our capital stock.
No Action by Written Consent.Our bylaws provide that stockholders may only take action at an annual or special meeting of stockholders and may not act by written consent, except as specifically required by our articles of incorporation or the Nevada Revised Statutes.
No Cumulative Voting.Our articles of incorporation and bylaws do not provide for cumulative voting in the election of directors.
Undesignated Preferred Stock.The authorization of undesignated preferred stock in our articles of incorporation makes it possible for our board of directors to issue preferred stock with voting or other rights or preferences that could impede the success of any attempt to change control of us. These and other provisions may have the effect of deferring hostile takeovers or delaying changes in control or management of us.
In addition, the Nevada Revised Statutes contain provisions governing the acquisition of a controlling interest in certain Nevada corporations. These laws provide generally that any person that acquires 20% or more of the outstanding voting shares of certain Nevada corporations in the secondary public or private market must follow certain formalities before such acquisition or they may be denied voting rights, unless a majority of the disinterested stockholders of the corporation elects to restore such voting rights in whole or in part. These laws will apply to us if we have 200 or more stockholders of record, at least 100 of whom have addresses in Nevada, unless our articles of incorporation or bylaws in effect on the tenth day after the acquisition of a controlling interest provide otherwise. These laws provide that a person acquires a “controlling interest” whenever a person acquires shares of a subject corporation that, but for the application of these provisions of the Nevada Revised Statutes, would enable that person to exercise (1) one-fifth or more, but less than one-third, (2) one-third or more, but less than a majority or (3) a majority or more, of all of the voting power of the corporation in the election of directors. Once an acquirer crosses one of these thresholds, shares which it acquired in the transaction taking it over the threshold and within the 90 days immediately preceding the date when the acquiring person acquired or offered to acquire a controlling interest become “control shares” to which the voting restrictions described above apply. These laws may have a chilling effect on certain transactions if our articles of incorporation or bylaws are not amended to provide that these provisions do not apply to us or to an acquisition of a controlling interest, or if our disinterested stockholders do not confer voting rights in the control shares.
Nevada law also provides that if a person is the “beneficial owner” of 10% or more of the voting power of certain Nevada corporations, such person is an “interested stockholder” and may not engage in any “combination” with the corporation for a period of three years from the date such person first became an interested stockholder, unless the combination or the transaction by which the person first became an interested stockholder is approved by the board of directors of the corporation before the person first became an interested stockholder. Another exception to this prohibition is if the combination is approved by the affirmative vote of the holders of stock representing a majority of the outstanding voting power not beneficially owned by the interested stockholder at a meeting, no earlier than three years after the date that the person first became an interested stockholder. These laws generally apply to Nevada corporations with 200 or more stockholders of record, but a Nevada corporation may elect in its articles of incorporation not to be governed by these particular laws. We have made such an election in our articles of incorporation which will be effective upon the consummation of this offering.
Nevada law also provides that directors may resist a change or potential change in control if the directors determine that the change is opposed to, or not in the best interest of, the corporation.
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DESCRIPTION OF INDEBTEDNESS
2006 Notes
As of December 31, 2008, we had approximately $6.1 million in principal amount of our 2006 Notes outstanding. In August 2006, we issued $5.0 million in principal amount of 2006 Notes. Since August 2006, we have issued $1.0 million in principal amount of 2006 Notes in payment of accrued interest on the outstanding notes. In December 2007, we also issued an additional $140,000 in principal amount of 2006 Notes pro rata to the holders of outstanding 2006 Notes in consideration for their waiver of certain defaults and consent to the incurrence of additional debt in connection with our acquisition of Various.
The 2006 Notes mature on July 31, 2010. Interest on the 2006 Notes accrues at a rate of 15% per annum, and is payable quarterly in cash after February 1, 2008 in arrears, on February 15, May 15, August 15 and November 15 of each year.
The 2006 Notes are pari passu with our 2005 Notes, and are secured by a first-priority security interest in all of our assets and the assets of our subsidiaries other than those of INI, including trademarks and other intellectual property, provided that the assets of INI are subject to a security interest in favor of the 2006 Notes that is subordinate to that of the First Lien Senior Secured Notes and the Second Lien Subordinated Secured Notes. Our obligations under the 2006 Notes are guaranteed by each of our subsidiaries.
We may redeem all or part of the 2006 Notes after the second anniversary of their issuance at:
| • | | 101.5% of the principal amount, if after August 17, 2008 but on or before August 17, 2009; and |
| • | | 100.0% of the principal amount if after August 17, 2009, plus accrued and unpaid interest. |
The securities purchase agreement governing the 2006 Notes contains covenants applicable to us and our subsidiaries, including covenants relating to limitations and requirements with respect to indebtedness, restricted payments, dividends and other payments affecting our subsidiaries, sale-leaseback transactions, consolidations and mergers and provision of financial statements and reports.
We are currently in breach of several of these covenants which has resulted in events of default. Specifically, we have failed to timely deliver certified annual financial statements, provide notice before changing our corporate name, deliver bank account control agreements for certain subsidiaries acquired in the Various acquisition and cause those subsidiaries to join as guarantors, meet certain sales and net revenue targets from the production and distribution of films, and hold quarterly board meetings in 2008. We are not in compliance with minimum consolidated EBITDA and consolidated coverage ratios, and have not kept senior debt below certain levels. In addition, due to the VAT liability of Various, we are in breach of certain covenants related to compliance with laws. Finally, we made certain payments of fees under a management agreement with Bell & Staton, Inc. that were in violation of a covenant in the management agreement prohibiting the payment of fees if there is a default on the 2006 Notes. The securities purchase agreement governing the 2006 Notes prohibits such payments if they are not permitted under the management agreement. As a result of these events of default, holders of 51% of the outstanding principal amount of our 2006 Notes and 2005 Notes may request acceleration and immediate payment of all outstanding 2006 Notes and 2005 Notes, including all accrued and unpaid interest. The defaults on our 2006 Notes also triggered defaults of our 2005 Notes, Subordinated Term Loan Notes, First Lien Senior Secured Notes and Second Lien Subordinated Secured Notes.
2005 Notes
As of December 31, 2008, we had approximately $38.4 million in principal amount of our 2005 Notes outstanding.
We originally issued $33.0 million in principal amount of the 2005 Notes in August 2005 as 11% Senior Notes due 2010 along with 11,777,800 shares of Series A Convertible Preferred Stock. Since August 2005, we have issued $4.5 million in principal amount of 2005 Notes in payment of accrued interest on the outstanding notes. In December 2007, we also issued an additional approximately $0.9 million in principal amount of 2005 Notes pro rata to the
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holders of outstanding 2005 Notes in consideration for their waiver of certain defaults and consent to the incurrence of additional debt in connection with our acquisition of Various.
In August 2006, in connection with our offering of the 2006 Notes and as consideration for the waiver of certain defaults under the securities purchase agreement governing the 2005 Notes, we amended the terms of the 2005 Notes to provide, among other matters, that interest on the 2005 Notes would accrue at a rate of 14% per annum and would be paid-in-kind.
In December 2007, in connection with our acquisition of Various and as consideration for the waiver of certain defaults under the securities purchase agreement governing the 2005 Notes, we amended the terms of the 2005 Notes to provide that interest on the 2005 Notes would accrue at a rate of 15% per annum, payable quarterly in arrears, on February 15, May 15, August 15 and November 15 of each year.
The 2005 Notes mature on July 31, 2010. The 2005 Notes are pari passu with the 2006 Notes and are secured by a first-priority security interest in all of our assets and the assets of our subsidiaries other than INI and its subsidiaries, including trademarks and other intellectual property, provided that the assets of INI are subject to a security interest in favor of the 2005 Notes that is subordinate to that of the First Lien Senior Secured Notes and the Second Lien Subordinated Secured Notes. Our obligations under the 2005 Notes are guaranteed by each of our subsidiaries.
We may redeem all or part of the 2005 Notes after the second anniversary of their issuance at:
| • | | 101.5% of the principal amount, if after the third anniversary but on or prior to the fourth anniversary of their issuance; and |
| • | | 100.0% of the principal amount if after the fourth anniversary of their issuance, plus accrued and unpaid interest. |
The securities purchase agreement governing the 2005 Notes contains covenants applicable to us and our subsidiaries, including covenants relating to limitations and requirements with respect to indebtedness, restricted payments, dividends and other payments affecting our subsidiaries, sale-leaseback transactions, consolidations and mergers and provision of financial statements and reports.
We are currently in breach of several of these covenants which has resulted in events of default. Specifically, we have failed to timely deliver certified annual financial statements, provide notice before changing our corporate name, deliver bank account control agreements for certain subsidiaries acquired in the Various acquisition and cause those subsidiaries to join as guarantors, meet certain sales and net revenue targets from the production and distribution of films, and hold quarterly board meetings in 2008. We are not in compliance with minimum consolidated EBITDA and consolidated coverage ratios, and have not kept senior debt below certain levels. In addition, due to the VAT liability of Various, we are in breach of certain covenants related to compliance with laws. Finally, we made certain payments of fees under a management agreement with Bell & Staton, Inc. that were in violation of a covenant in the management agreement prohibiting the payment of fees if there is a default on the 2005 Notes. The securities purchase agreement governing the 2005 Notes prohibits such payments if they are not permitted under the management agreement. As a result of these events of default, holders of 51% of the outstanding principal amount of our 2006 Notes and 2005 Notes may request acceleration and immediate payment of all outstanding 2006 Notes and 2005 Notes, including all accrued and unpaid interest. The defaults on our 2005 Notes also triggered defaults of our 2006 Notes, Subordinated Term Loan Notes, First Lien Senior Secured Notes and Second Lien Subordinated Secured Notes.
Subordinated Term Loan Notes
As of December 31, 2008, we had approximately $36.4 million in principal amount of our Subordinated Term Loan Notes outstanding.
In October 2004, we issued $35.8 million in aggregate principal amount of Term Loan Notes. In August 2005, concurrent with the completion of our offerings of the 2005 Notes and the Series A Convertible Preferred stock, we used a portion of the net proceeds from those offerings to repay $11.8 million of the Term Loan Notes plus accrued interest. The remaining $24.0 million in principal amount of the Term Loan Notes are held by PET, the
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Florescue Family Corporation and one other stockholder and were reissued as Subordinated Term Loan Notes. From October 2005 to December 31, 2008, we have issued $11.5 million in principal amount of Subordinated Term Loan Notes in payment of accrued interest on the outstanding notes. In October 2006, we issued an additional $0.9 million in principal amount of Subordinated Term Loan Notes to fund part of the purchase price consideration for the Danni.com business.
Interest on the Subordinated Term Loan Notes is payable in arrears annually on October 5 in each year, commencing October 5, 2005 at the rate of 13% per annum. For the three-year period following October 5, 2004, interest is payable in cash or in kind by the issuance of additional Subordinated Term Loan Notes (other than with respect to the date of issuance) in such principal amount as shall equal the interest payment that is then due, or any combination thereof, at our election; and thereafter until the principal is paid or made available for payment, payable in cash.
The terms of the Subordinated Term Loan Notes provide that, among other things:
| • | | they are subordinated to the 2006 Notes, the 2005 Notes, the First Lien Senior Secured Notes and the Second Lien Subordinated Secured Notes; |
| • | | we may not redeem the Subordinated Term Loan Notes while the 2006 Notes, the 2005 Notes, the First Lien Senior Secured Notes and the Second Lien Subordinated Secured Notes remain outstanding; |
| • | | we are restricted from paying cash interest on the Subordinated Term Loan Notes until we have maintained consolidated EBITDA of at least $25.0 million for the prior four consecutive fiscal quarters and attain an interest coverage ratio of at least 3:1; and |
| • | | upon the occurrence of a change of control, the holders of the Subordinated Term Loan Notes will have the right to require us to concurrently purchase their notes at 100.0% of the face value thereof, plus accrued and unpaid interest, if any, provided, however, that such right shall only be exercisable if the holders of the 2006 Notes and the 2005 Notes have exercised their repurchase right. |
In the event that the maturity on our 2006 Notes, 2005 Notes, First Lien Senior Secured Notes or Second Lien Subordinated Secured Notes is accelerated, the holders of 25% of the outstanding principal amount of our Subordinated Term Loan Notes may request acceleration and immediate payment of all outstanding principal and accrued and unpaid interest on the Subordinated Term Loan Notes, due to a cross-default provision. We were also in breach of certain covenants requiring the delivery of financial statements and accountants statements, prohibiting investments other than permitted investments and requiring all subsidiaries to be joined as guarantors. In addition, due solely to the VAT liability of Various, we were in breach of a covenant requiring the payment of all taxes before they become due. However, on December 6, 2007, December 19, 2008 and March 20, 2009, the holders of the Subordinated Term Loan Notes waived the cross-default provision as well as all other defaults resulting from covenants which we were in breach of.
First Lien Senior Secured Notes
As of December 31, 2008, we had $233.0 million of First Lien Senior Secured Notes outstanding. In connection with our acquisition of Various on December 6, 2007, INI issued approximately $257.3 million in principal amount of First Lien Senior Secured Notes.
The First Lien Senior Secured Notes mature on June 30, 2011. Interest on the First Lien Senior Secured Notes will accrue at a rate per annum equal to 8% plus the greater of (a) 4.5% or (b) the three-month LIBOR, as further defined in the securities purchase agreement governing the First Lien Senior Secured Notes for the applicable interest period. Interest on the First Lien Senior Secured Notes is payable quarterly in arrears on each March 31, June 30, September 30 and December 31.
The First Lien Senior Secured Notes are secured by a first-priority lien on all of INI’s assets and are guaranteed by each of INI’s subsidiaries. These guarantees are the senior secured obligations of each such subsidiary guarantor.
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We and each of our other direct subsidiaries have guaranteed INI’s obligations under the First Lien Senior Secured Notes. Our guarantee and the guarantees of our other direct subsidiaries are also our respective secured obligations, but are subordinate to our respective obligations under our 2006 Notes and 2005 Notes.
INI may, at its option, redeem the First Lien Senior Secured Notes, in whole but not in part, at the redemption prices (expressed as percentages of principal amount thereof) set forth below plus accrued and unpaid interest, on the First Lien Senior Secured Notes redeemed, to the applicable redemption date:
| • | | 105.0%, if redeemed on or before December 6, 2009; |
| • | | 102.0%, if redeemed on or before December 6, 2010; and |
| • | | 100.0%, if redeemed after December 6, 2010. |
Commencing the fiscal quarter ending March 31, 2008, INI was required to make principal payments on the First Lien Senior Secured Notes, in an aggregate amount equal to 90% of the Excess Cash Flow (as defined in the securities purchase agreement governing the First Lien Senior Secured Notes) (if any) of INI and its subsidiaries for such quarterly period. Through December 31, 2008, we have made $24.3 million of such payments.
Commencing December 31, 2008, INI is required to make principal payments on the First Lien Senior Secured Notes in annual installments on the 45th day following the date set forth below, in an aggregate amount equal to the greater of (x) 90% of the Excess Cash Flow (if any) of INI and its subsidiaries for the fiscal quarter most recently ended on December 31 and (y) the amount specified below for each such date, less, the aggregate amount of all repayments, if any, made in the immediately preceding three fiscal quarters:
| • | | December 31, 2009, an installment amount of approximately $38.6 million; |
| • | | December 31, 2010, an installment amount of approximately $51.5 million; and |
| • | | June 30, 2011, an installment amount of approximately $141.5 million. |
The securities purchase agreement governing the First Lien Senior Secured Notes contains covenants applicable to us and our subsidiaries, including covenants relating to limitations and requirements with respect to indebtedness, restricted payments, dividends and other payments affecting our subsidiaries, sale-leaseback transactions, consolidations and mergers and provision of financial statements and reports. The restrictive payments covenant prohibits dividends or other cash distributions from Various and INI to us subject to certain limited exceptions including our exception that permits INI to dividend to us up to 10% of Excess Cash Flow of INI as defined solely for interest payments on the First Lien Senior Secured Notes, plus not more than $6 million during the first quarter of fiscal 2008 ($5 million of which was to be used for general corporate purposes), plus $1.0 million per quarter through December 31, 2008 solely for third party expenses related to our initial public offering.
We are currently in breach of several of these covenants which has resulted in events of default. Specifically, we have failed to deliver on a timely basis certified annual financial statements, provide notice before changing our corporate name, deliver bank account control agreements and perfection certificates for us and all of our subsidiaries, cause those subsidiaries to join as guarantors, deliver our credit card processing agreements, deliver landlord consents and letter agreements from counterparties to service agreements, provide notice of the change in location of collateral, create a back-up data center, and hold quarterly board meetings in 2008. INI also made non-permitted investments and restricted payments to us, our affiliates and others in breach of covenants limiting restricted payments and investments. In addition, as a result of the VAT liability of Various and the reduction in net revenue due to purchase accounting, certain of our representations and warranties were materially incorrect when made and we are in breach of covenants related to compliance with laws, maintaining minimum consolidated EBITDA and consolidated coverage ratios, and keeping senior debt below certain levels. As a result of these events of default, holders of 51% of the outstanding principal balance of First Lien Senior Secured Notes other than those held by the former stockholders of Various may request acceleration and immediate payment of all outstanding First Lien Senior Secured Notes, including all accrued and unpaid interest. The defaults on our First Lien Senior Secured Notes also triggered defaults of our 2005 Notes, 2006 Notes, Subordinated Term Loan Notes, Second Lien Subordinated Secured Notes and Subordinated Convertible Notes.
We are required to use 50% of the net cash proceeds from an initial public offering of our common stock to prepay the First Lien Senior Secured Notes at a redemption price of 115.0% of the principal amount redeemed,
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plus accrued and unpaid interest thereon to such redemption date. The balance of the First Lien Senior Secured Notes will be redeemed at a redemption price of 105.0% of the principal amount redeemed plus accrued and unpaid interest.
Second Lien Subordinated Secured Notes
As of December 31, 2008, we had $80.0 million of Second Lien Subordinated Secured Notes outstanding. In connection with our acquisition of Various on December 6, 2007, INI issued to the sellers of Various, $80.0 million in principal amount of Second Lien Subordinated Secured Notes in partial payment of the purchase price for Various. The Second Lien Subordinated Secured Notes will mature on December 6, 2011. Interest on the Second Lien Subordinated Secured Notes accrues at a rate of 15% per annum and is payable quarterly in arrears on each March 31, June 30, September 30 and December 31.
The Second Lien Subordinated Secured Notes are secured by a second-priority lien on all of INI’s assets and are guaranteed by each of INI’s subsidiaries, including Various. These guarantees are the senior secured obligations of each such subsidiary guarantor subordinate only to the first-priority lien granted to the purchasers of the First Lien Senior Secured Notes. We and each of our other direct subsidiaries have guaranteed INI’s obligations under the Second Lien Subordinated Secured Notes. Our guarantee and the guarantees of our other direct subsidiaries are also our respective secured obligations, but are subordinate to our respective obligations under our 2006 Notes and 2005 Notes and the First Lien Senior Secured Notes.
We may redeem the Second Lien Subordinated Secured Notes, in whole or in part, at any time subject to the rights of the holders of the First Lien Senior Secured Notes under the intercreditor agreement between the holders of the First Lien Senior Secured Notes and the holders of the Second Lien Subordinated Secured Notes. This agreement provides that no redemption of the Second Lien Subordinated Secured Notes may occur until the First Lien Senior Secured Notes are repaid in full after which principal on the Second Lien Subordinated Secured Notes is payable quarterly to the extent of 90% of Excess Cash Flow. The redemption price for the Second Lien Subordinated Secured Notes will be 100.0% of the outstanding principal amount plus accrued and unpaid interest, if any, on the Second Lien Subordinated Secured Notes to the redemption date.
The sellers’ securities agreement governing the Second Lien Subordinated Secured Notes contains covenants applicable to us and our subsidiaries, including covenants relating to limitations and requirements with respect to indebtedness, restricted payments, dividends and other payments affecting our subsidiaries, sale-leaseback transactions, consolidations and mergers and provision of financial statements and reports. These covenants are substantially identical to those contained in the First Lien Senior Secured Notes.
The holders of the Second Lien Subordinated Secured Notes have the option of requiring INI to repay the Second Lien Subordinated Secured Notes in full upon a Liquidity Event (defined as a liquidation, winding up, change of control (other than resulting from an initial public offering), merger, or a sale of all or substantially all of our assets or the assets of INI). Subject to the prior payment in full of the First Lien Senior Secured Notes, upon an initial public offering, we will cause INI to redeem the Second Lien Subordinated Secured Notes using the proceeds from such initial public offering, net of any amounts required to pay fees and expenses related to such initial public offering for working capital purposes or for strategic acquisitions. Any such repayment of the Second Lien Subordinated Secured Notes will be at a price equal to 100.0% of the outstanding principal amount plus accrued and unpaid interest, if any, on the Second Lien Subordinated Secured Notes to the repayment date.
We are currently in breach of several of these covenants which has resulted in events of default. Specifically, we have failed to deliver on a timely basis certified annual financial statements, provide notice before changing our corporate name, deliver bank account control agreements and perfection certificates for us and all of our subsidiaries, cause those subsidiaries to join as guarantors, deliver our credit card processing agreements, deliver landlord consents and letter agreements from counterparties to service agreements, provide notice of the change in location of collateral, create a back-up data center, and hold quarterly board meetings in 2008. INI also made non-permitted investments and restricted payments to us, our affiliates and others in breach of covenants limiting restricted payments and investments. In addition, as a result of the VAT liability of Various and the reduction in net revenue due to purchase accounting, certain of our representations and warranties were materially incorrect when made and we are in breach of covenants relating to compliance with laws, maintaining minimum consolidated
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EBITDA and consolidated coverage ratios, and keeping senior debt below certain levels. As a result of these events of default, holders of 51% of the outstanding principal balance of Second Lien Subordinated Secured Notes may request acceleration and immediate payment of all outstanding Second Lien Subordinated Secured Notes, including all accrued and unpaid interest. The defaults on our Second Lien Subordinated Secured Notes also triggered defaults of our 2005 Notes, 2006 Notes, Subordinated Term Loan Notes, First Lien Senior Secured Notes and Subordinated Convertible Notes.
Subordinated Convertible Notes
As of December 31, 2008, we had $111.2 million in principal amount of Subordinated Convertible Notes outstanding reflecting to reductions of $64.3 million and $1.4 million and an increase of $6.9 million as described below. On December 6, 2007, INI issued Subordinated Convertible Notes in the original aggregate principal amount of $170.0 million in partial payment of the purchase price for Various. The Subordinated Convertible Notes will mature on December 6, 2011. Interest on the Subordinated Convertible Notes is payable at a rate of 6% per annum and until the 2006 Notes, 2005 Notes, First Lien Senior Secured Notes and the Second Lien Subordinated Secured Notes are repaid in full such interest may only be paid in additional Subordinated Convertible Notes. Thereafter, interest may be paid in additional Subordinated Convertible Notes at INI’s option, and may be prepaid at INI’s option, in whole or in part, at 100.0% principal plus accrued and unpaid interest. The Subordinated Convertible Notes are the unsecured obligation of INI and we have guaranteed INI’s obligations under the Subordinated Convertible Notes. The Subordinated Convertible Notes are subordinate in right of payment to INI’s First Lien Senior Secured Notes and Second Lien Subordinated Secured Notes. Our guarantee is subordinated to the prior payment of our 2006 Notes and our 2005 Notes and our guarantee of the First Lien Senior Secured Notes and Second Lien Subordinated Secured Notes and pari passu in right of payment with the 13% Subordinated Term Loan Notes described above.
The Subordinated Convertible Notes are convertible, at our or the holder’s option, into shares of our common stock, in whole or in part, at any time through and including the maturity date of such notes after the later to occur of (i) the one-year anniversary of the date of issuance of such notes and (ii) the consummation of an initial public offering. The conversion price will be equal to the per share offering price in this offering. If the notes are converted at the holder’s option, the aggregate number of shares issuable upon the conversion of the notes will be limited in number to the number of shares equal to 17% of our fully diluted equity calculated at the time of the first such conversion. The Subordinated Convertible Notes are being held in escrow to secure indemnity obligations of the sellers of Various stock to INI. On October 14, 2008, we made an indemnity claim against these notes under the acquisition agreement for Various in the amount of $64.3 million due to working capital adjustments resulting from the VAT liability which was not disclosed at the closing of the acquisition. The Subordinated Convertible Notes are also subject to reduction to the extent certain post closing bonuses of up to $3.5 million are paid by Various for a three year period. During 2008, as a result of payment of $1.1 million in bonuses, the Subordinated Convertible Notes were reduced by $1.4 million. On June 30, 2008, INI issued additional Subordinated Convertible Notes in the amount of $5.8 million as payment in kind for its interest obligation. On December 31, 2008, INI issued additional Subordinated Convertible Notes in the amount of $1.1 million as payment in kind for its interest obligation.
We have granted the holders of such notes piggyback registration rights and up to two demand registration rights to register the shares of common stock issuable upon the conversion of such notes. The demand rights may be exercised by the holders of the Subordinated Convertible Notes, so long as the shares to be registered represent at least 30% of the shares issued or issuable upon the conversion of the Subordinated Convertible Notes or would result in an aggregate offering price of at least $10.0 million, at any time commencing 180 days after this offering. The piggyback and demand rights are subject to conditions and limitations, among them the right of an underwriter of an offering to limit the number of shares of common stock underlying the Subordinated Convertible Notes for inclusion in the registration and the subordination of the right of inclusion of such shares to the prior inclusion of shares requested to be included in such registration by holders of common stock issued as a result of the conversion of Series A Convertible Preferred Stock or the exercise of warrants. We are generally required to bear all of the expenses of all such registrations except underwriting discounts and commissions.
In the event that the maturity on our First Lien Senior Secured Notes and Second Lien Subordinated Secured Notes is accelerated, the maturity of the outstanding principal balance of the Subordinated Convertible Notes would also be accelerated due to a cross-default provision. No maturity has been accelerated on any of our debt.
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SHARES ELIGIBLE FOR FUTURE SALE
Prior to this offering, there has been no public market for our common stock. We cannot predict the effect, if any, that market sales of shares or the availability of shares for sale will have on the market price prevailing from time to time. Sales of our common stock in the public market after the restrictions lapse as described below, or the perception that those sales may occur, could cause the prevailing market price to decrease or to be lower than it might be in the absence of those sales or perceptions.
Upon completion of this offering, we will have outstanding shares of common stock. Of these shares, shares of common stock sold in this offering will be freely tradable in the public market without restriction or further registration under the Securities Act, unless these shares are held by persons who may be deemed to be our “affiliates,” as that term is defined in Rule 144 under the Securities Act who will be subject to the restrictions described below. An aggregate of shares of our common stock held by our existing stockholders upon closing of this offering will be “restricted securities,” as that term is defined in Rule 144 under the Securities Act. These restricted securities are eligible for public sale only if their resale is registered under the Securities Act or qualifies for an exemption from registration under Rule 144 or 701 under the Securities Act, which are summarized below.
Subject to the lock-up agreements described below and the provisions of Rules 144 and 701 under the Securities Act, these restricted securities will be available for sale in the public market as follows:
Days After the Date of this Prospectus
| | | | Additional Shares
Eligible for Public Sale
|
|---|
| On the date of this prospectus | | | | | | |
| Between 90 and 180 days after the date of this prospectus | | | | | | |
| At various times beginning more than 180 days after the date of this prospectus | | | | | | |
Lock-Up Arrangements
We, our executive officers and directors and all of the holders of our common stock or securities exchangeable or convertible for common stock have entered into lock-up agreements with the underwriters. Under these agreements, subject to certain exceptions, we and each of these persons may not, without the prior written approval of the representative of the underwriters, offer, sell, contact to sell or otherwise dispose of, directly or indirectly, or hedge our common stock or securities convertible into or exchangeable for our common stock. These restrictions will be in effect for a period of 180 days after the date of this prospectus. At any time and without public notice, the representative of the underwriters may, in its sole discretion, release some or all of the securities from these lock-up agreements. These agreements are subject to extension as set forth in “Underwriting.”
Rule 144
Generally, the shares of our common stock sold in this offering will be freely transferable without restriction or further registration under the Securities Act, except that any shares of our common stock held by an “affiliate” of ours may not be resold publicly except in compliance with the registration requirements of the Securities Act or under an exemption under Rule 144 or otherwise. Rule 144 permits common stock of an issuer that has been acquired by a person who is an affiliate of the issuer, or has been an affiliate of the issuer within the past three months, to be sold in an amount that does not exceed, during any three-month period, the greater of:
| • | | 1.0% of the total number of shares of our common stock outstanding; or |
| • | | the average weekly reported trading volume of our common stock for the four calendar weeks prior to the sale. |
Such sales are also subject to specific manner of sale provisions, a six-month holding period, notice requirements and the availability of current public information about us.
Rule 144 also provides that a person who is not deemed to have been an affiliate of ours at any time during the three months preceding a sale, and who has beneficially owned shares of our common stock that are restricted securities for at least six months, will be entitled to freely sell such shares of stock subject only to the availability of current public information about us. A person who is not deemed to have been an affiliate of ours at any time during
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the three months preceding a sale, and who has beneficially owned for at least one year shares of our common stock that are restricted securities, will be entitled to freely sell such shares under Rule 144 without regard to the current public information requirements of Rule 144.
Equity Plans
We intend to file a registration statement on Form S-8 under the Securities Act for shares of our common stock subject to options outstanding or reserved for issuance under our stock plans and shares of our common stock issued upon the exercise of options by employees. We expect to file this registration statement as soon as practicable after this offering and as soon as permitted under the Securities Act.
Registration Rights
The holders of shares of our common stock, assuming the exercise of outstanding warrants to purchase registrable securities and the conversion of outstanding Convertible Preferred Stock and Subordinated Convertible Notes, may demand that we register their shares under the Securities Act or, if we file another registration statement under the Securities Act, may elect to include their shares in such registration. If these shares are registered, they will be freely tradable without restriction under the Securities Act. For more information regarding our outstanding registration rights, see “Description of Capital Stock—Registration Rights.”
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CERTAIN MATERIAL U.S. TAX CONSIDERATIONS
The following is a summary of certain U.S. federal income tax consequences relating to the acquisition, ownership and disposition of our common stock by Non-U.S. Holders (defined below), but does not purport to be a complete analysis of all the potential tax considerations. This summary is based upon the Internal Revenue Code of 1986, as amended or “Code,” the Treasury Regulations or the “Regulations” promulgated or proposed thereunder and administrative and judicial interpretations thereof, all as of the date hereof and all of which are subject to change, possibly on a retroactive basis. This summary is limited to the tax consequences of persons who hold shares of our common stock as capital assets within the meaning of Section 1221 of the Code.
This summary does not purport to deal with all aspects of U.S. federal income taxation that might be relevant to particular Non-U.S. Holders in light of their particular investment circumstances or status, nor does it address specific tax consequences that may be relevant to particular persons (including, for example, financial institutions, broker-dealers, insurance companies, partnerships or other pass-through entities, expatriates, banks, real estate investment trusts, regulated investment companies, tax-exempt organizations, or persons in special situations, such as those who have elected to mark securities to market or those who hold shares of our common stock as part of a straddle, hedge, conversion transaction or other integrated investment or Non-U.S. Holders that own (or owned during the relevant period) actually or constructively, more than 5% of our common stock). In addition, this summary does not address U.S. federal alternative minimum tax consequences or consequences under the tax laws of any state, local or foreign jurisdiction. We have not sought any ruling from the Internal Revenue Service, or the IRS, with respect to the statements made and the conclusions reached in this summary, and we cannot assure you that the IRS will agree with such statements and conclusions.
This summary is for general information only. Prospective purchasers of shares of our common stock are urged to consult their tax advisors concerning the U.S. federal income taxation and other tax consequences to them of acquiring, owning and disposing of shares of our common stock, as well as the application of state, local and foreign income and other tax laws.
For purposes of the following summary, a “Non-U.S. Holder” is a holder of our common stock that, for U.S. federal income tax purposes, is not (i) a citizen or individual resident of the U.S.; (ii) a corporation or other entity taxable as a corporation created or organized under the laws of the U.S., any state thereof, or the District of Columbia; (iii) an estate the income of which is subject to U.S. federal income tax regardless of the source; or (iv) a trust, if a court within the U.S. is able to exercise primary supervision over the trust’s administration and one or more U.S. persons have the authority to control all its substantial decisions or if a valid election to be treated as a U.S. person is in effect with respect to such trust.
If a Non-U.S. Holder is a partner in a partnership, or an entity treated as a partnership for U.S. federal income tax purposes, that holds shares of our common stock, the tax treatment of such Non-U.S. Holder generally will depend upon its U.S. tax status and upon the activities of the partnership. If a Non-U.S. Holder is a partner of a partnership acquiring shares of our common stock, such Non-U.S. Holder is urged to consult its tax advisor about the U.S. tax consequences of holding and disposing of the shares of our common stock.
The description set forth above may not be applicable depending on a Non-U.S. Holder’s particular situation. Prospective Non-U.S. Holders of our common stock should consult their tax advisors with respect to the particular tax consequence to them of owning and disposing of our common stock, including the consequences under the laws of any state, local or foreign jurisdiction or under any applicable tax treaty.
Dividends
We do not expect to declare or pay any dividends on shares of our common stock in the foreseeable future. However, if we do pay dividends on shares of our common stock, such distributions will constitute dividends for U.S. federal income tax purposes to the extent paid from our current or accumulated earnings and profits, as determined under U.S. federal income tax principles. Distributions in excess of earnings and profits will constitute a return of capital that is applied against and reduces the Non-U.S. Holder’s adjusted tax basis in shares of our common stock. Any remaining excess will be treated as gain realized on the sale or other disposition of shares of our common stock and will be treated as described under “—Gain on Disposition of Common Stock” below. Any dividend paid to a Non-U.S. Holder of shares of our common stock ordinarily will, except as described in the following paragraph, be
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subject to withholding of U.S. federal income tax at a rate of 30%, or such lower rate as may be specified under an applicable income tax treaty. In order to receive a reduced treaty rate, a Non-U.S. Holder must provide an IRS Form W-8BEN or other appropriate version of Form W-8 certifying eligibility for the reduced rate.
Dividends paid to a Non-U.S. Holder that are effectively connected with a trade or business conducted by the Non-U.S. Holder in the United States generally will be exempt from the withholding tax described above (if the Non-U.S. Holder complies with applicable certification and disclosure requirements) and instead generally will be subject to U.S. federal income tax on a net income basis at the regular graduated U.S. federal income tax rates in much the same manner as if the Non-U.S. Holder were a U.S. person (unless, where an income tax treaty applies, the dividend is not attributable to a permanent establishment maintained by the Non-U.S. Holder in the United States). In order to obtain this exemption from withholding tax, a Non-U.S. Holder must provide an IRS Form W-8ECI properly certifying eligibility for such exemption. Dividends received by a corporate Non-U.S. Holder that are effectively connected with a trade or business conducted by such corporate Non-U.S. Holder in the United States may also be subject to an additional branch profits tax at a rate of 30% or such lower rate as may be specified by an applicable income tax treaty.
Gain on Disposition of Common Stock
A Non-U.S. Holder generally will not be subject to U.S. federal income tax on any gain realized on a disposition of shares of our common stock, provided that (i) the gain is not otherwise effectively connected with a trade or business conducted by the Non-U.S. Holder in the U.S. (and, in the case of an applicable tax treaty, is not attributable to a permanent establishment maintained by the Non-U.S. Holder in the United States), and (ii) in the case of a Non-U.S. Holder who is an individual and who holds the shares of our common stock as a capital asset, such Non-U.S. Holder is not present in the United States for 183 or more days in the taxable year of the sale or other disposition and certain other conditions are met. Additional special rules would apply if our stock were considered to be a U.S. real property interest, which we do not expect to be the case. Non-U.S. Holders should consult their tax advisors with respect to the application of the foregoing rules to their ownership and disposition of shares of our common stock.
Common stock owned or treated as owned by an individual who is not a citizen or resident (as specially defined for U.S. federal estate tax purposes) of the United States at the time of death may be included in the individual’s gross estate for U.S. federal estate tax purposes, unless an applicable estate tax or other treaty provides otherwise and, therefore, may be subject to U.S. federal estate tax.
Information Reporting and Backup Withholding
U.S. backup withholding tax will not apply to payments of dividends to a Non-U.S. Holder if the certification described above in “—Dividends” is duly provided by such Non-U.S. Holder or the Non-U.S. Holder otherwise establishes an exemption, provided that the payor does not have actual knowledge or reason to know that such holder is a U.S. person or that the conditions of any claimed exemption are not satisfied.
Certain payments may be subject to information reporting even if a Non-U.S. Holder establishes an exemption from backup withholding. Copies of information returns reporting dividend payments and any withholding may also be made available to the tax authorities in the country in which a Non-U.S. Holder resides under the provisions of an applicable income tax treaty.
Any amounts withheld under the backup withholding tax rules from a payment to a Non-U.S. Holder will be allowed as a refund, or a credit against such Non-U.S. Holder’s U.S. federal income tax liability, provided that the requisite procedures are followed.
Non-U.S. Holders are urged to consult their tax advisors regarding their particular circumstances and the availability of and procedure for obtaining an exemption from backup withholding.
The foregoing discussion of U.S. federal income tax considerations is not tax advice. Accordingly, each prospective Non-U.S. Holder of our common stock should consult that holder’s own tax advisor with respect to the federal, state, local, estate and non-U.S. tax consequences of the acquisition, ownership and disposition of our common stock.
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UNDERWRITING
We are offering the shares of our common stock described in this prospectus through the underwriters named below. Renaissance Securities (Cyprus) Limited is the representative of the underwriters. We have entered into an underwriting agreement with the representative. Subject to the terms and conditions of the underwriting agreement, each of the underwriters has severally agreed to purchase the number of shares of common stock listed next to its name in the following table:
Underwriters
| | | | Number of shares
|
|---|
| Renaissance Securities (Cyprus) Limited | | | | | | |
| |
| | | | | | | |
| | | | | | | |
| |
| Total | | | | | | |
The underwriting agreement provides that the underwriters must buy all of the shares if they buy any of them. However, the underwriters are not required to take or pay for the shares covered by the underwriters’ over-allotment option described below.
Our common stock is offered subject to a number of conditions, including:
| • | | receipt and acceptance of the common stock by the underwriters; and |
| • | | the underwriters’ right to reject orders in whole or in part. |
The representative has advised us that the underwriters intend to make a market in our common stock but that they are not obligated to do so and may discontinue making a market at any time without notice.
In connection with this offering, certain of the underwriters or securities dealers may distribute prospectuses electronically.
The underwriters are expected to make offers and sales both inside and outside of the United States through their respective selling agents. Any offers or sales in the United States will be conducted by broker-dealers registered with the SEC and Financial Industry Regulatory Authority Inc., including RenCap Securities, Inc.
Over-Allotment Option
We have granted the underwriters an option to buy up to additional shares of our common stock. The underwriters may exercise this option solely for the purpose of covering over-allotments, if any, made in connection with this offering. The underwriters have 30 days from the date of this prospectus to exercise this option. If the underwriters exercise this option, they will each purchase additional shares approximately in proportion to the amounts specified in the table above.
Commissions and Discounts
Shares sold by the underwriters to the public will initially be offered at the offering price set forth on the cover of this prospectus. Any shares sold by the underwriters to securities dealers may be sold at a discount of up to $ per share from the initial public offering price. Any of these securities dealers may resell any shares purchased from the underwriters to other brokers or dealers at a discount of up to $ per share from the initial public offering price. If all the shares are not sold at the initial public offering price, the representative may change the offering price and the other selling terms. Upon execution of the underwriting agreement, the underwriters will be obligated to purchase the shares at the prices and upon the terms stated therein and, as a result, will thereafter bear any risk associated with changing the offering price to the public or other selling terms. The underwriters have informed us that they do not expect discretionary sales to exceed % of the shares of common stock to be offered.
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The following table shows the per share and total underwriting discounts and commissions we will pay to the underwriters, assuming both no exercise and full exercise of the underwriters’ option to purchase up to an additional shares:
| | | | No exercise
| | Full exercise
|
|---|
| Per share | | | | $ | | | | $ | | |
| Total | | | | $ | | | | $ | | |
We estimate that the total expenses of this offering payable by us, not including the underwriting discounts and commissions, will be approximately $ million.
No Sales of Similar Securities
We, our executive officers and directors and all of the holders of our common stock or securities exchangeable or convertible for common stock have entered into lock-up agreements with the underwriters. Under these agreements, subject to certain exceptions, we and each of these persons may not, without the prior written approval of the representative of the underwriters, offer, sell, contact to sell or otherwise dispose of, directly or indirectly, or hedge our common stock or securities convertible into or exchangeable for our common stock. These restrictions will be in effect for a period of 180 days after the date of this prospectus. At any time and without public notice, the representative of the underwriters may, in its sole discretion, release some or all of the securities from these lock-up agreements.
The 180-day restricted period described in the preceding paragraph will be automatically extended if: (1) during the last 17 days of the 180-day restricted period we issue an earnings release or announce material news or a material event; or (2) prior to the expiration of the 180-day restricted period, we announce that we will release earnings results during the 16-day period following the last day of the 180-day period, in which case the restrictions described in the preceding paragraph will continue to apply until the expiration of the 18-day period beginning on the issuance of the earnings release of the announcement of the material news or material event.
Indemnification and Contribution
We have agreed to indemnify the underwriters and their controlling persons against certain liabilities, including liabilities under the Securities Act. If we are unable to provide this indemnification, we have agreed to contribute to payments the underwriters and their controlling persons may be required to make in respect of those liabilities.
Listing
We intend to apply to have our common stock quoted on The New York Stock Exchange under the symbol “FFN.”
Price Stabilization, Short Positions
In connection with this offering, the underwriters may engage in activities that stabilize, maintain or otherwise affect the price of our common stock, including: stabilizing transactions, short sales, purchases to cover positions created by short sales, imposition of penalty bids and syndicate covering transactions.
Stabilizing transactions consist of bids or purchases made for the purpose of preventing or retarding a decline in the market price of our common stock while this offering is in progress. These transactions may also include making short sales of our common stock, which involve the sale by the underwriters of a greater number of shares of common stock than they are required to purchase in this offering. Short sales may be “covered short sales,” which are short positions in an amount not greater than the underwriters’ over-allotment option referred to above, or may be “naked short sales,” which are short positions in excess of that amount.
The underwriters may close out any covered short position either by exercising their over-allotment option, in whole or in part, or by purchasing shares in the open market. In making this determination, the underwriters will consider, among other things, the price of shares available for purchase in the open market compared to the price at which they may purchase shares through the over-allotment option.
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Naked short sales are sales in excess of the over-allotment option. The underwriters must close out any naked short position by purchasing shares in the open market. A naked short position is more likely to be created if the underwriters are concerned that there may be downward pressure on the price of the common stock in the open market that could adversely affect investors who purchased in this offering.
The underwriters also may impose a penalty bid. This occurs when a particular underwriter repays to the underwriters a portion of the underwriting discount received by it because the representative has repurchased shares sold by or for the account of that underwriter in stabilizing or short covering transactions.
As a result of these activities, the price of our common stock may be higher than the price that otherwise might exist in the open market. If these activities are commenced, they may be discontinued by the underwriters at any time. The underwriters may carry out these transactions on The New York Stock Exchange, in the over-the-counter market or otherwise.
Determination of Offering Price
Prior to this offering, there was no public market for our common stock. The initial public offering price will be determined by negotiation by us and the representative of the underwriters. The principal factors to be considered in determining the initial public offering price include: the information set forth in this prospectus and otherwise available to the representative, our history and prospects and the history of, and prospects for, the industry in which we compete, our past and present financial performance and an assessment of our management, our prospects for future earnings and the present state of our development, the general condition of the securities markets at the time of this offering, the recent market prices of, and the demand for, publicly traded common stock of generally comparable companies and other factors deemed relevant by the underwriters and us.
Affiliations
Certain of the underwriters and their affiliates have entered into an agreement with us to provide certain strategy and financial planning services for us for which they are entitled to receive fees. Certain of the underwriters and their affiliates may from time to time provide certain other commercial banking, financial advisory, investment banking and other services for us for which they will be entitled to receive separate fees.
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LEGAL MATTERS
The validity of the securities offered pursuant to this prospectus will be passed upon for us by Brownstein Hyatt Farber Schreck, LLP, Las Vegas, Nevada, our Nevada counsel. Akin Gump Strauss Hauer & Feld LLP, New York, New York, our special counsel, will pass upon certain matters for us. Skadden, Arps, Slate, Meagher & Flom LLP, New York, New York, will pass upon certain matters for the underwriters named in this prospectus in connection with this offering.
INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
Our financial statements as of December 31, 2008 and 2007, and for the years ended December 31, 2008, 2007 and 2006 included in this prospectus and in the registration statement have been audited by Eisner LLP, independent registered public accounting firm, as stated in their report which included an explanatory paragraph concerning conditions that raise substantial doubt about our ability to continue as a going concern as described in Note A to our consolidated financial statements, appearing in this prospectus and in the registration statement and are so included in reliance upon the report of such firm given upon its authority as experts in accounting and auditing.
WHERE YOU CAN FIND MORE INFORMATION
We have filed a registration statement on Form S-1 with the SEC relating to the common stock offered by this prospectus. This prospectus does not contain all of the information set forth in the registration statement and the exhibits and schedules to the registration statement. Statements contained in this prospectus as to the contents of any contract or other document referred to are not necessarily complete and in each instance we refer you to the copy of the contract or other document filed as an exhibit to the registration statement, each such statement being qualified in all respects by such reference. For further information with respect to our company and the common stock offered by this prospectus, we refer you to the registration statement, exhibits, and schedules.
We are not currently subject to the informational requirements of the Securities Exchange Act of 1934, or the Exchange Act. As a result of the consummation of this offering, we will become subject to the informational requirements of the Exchange Act and, in accordance with the Exchange Act, will be required to file reports and other information with the SEC. Anyone may inspect a copy of the registration statement, such reports and other information without charge at the public reference facility maintained by the SEC in Room 1580, 100 F Street, N.E., Washington, D.C. 20549. Copies of all or any part of the registration statement may be obtained from that facility upon payment of the prescribed fees. The public may obtain information on the operation of the public reference room by calling the SEC at 1-800-SEC-0330. The SEC maintains a website at http://www.sec.gov that contains reports, proxy and information statements, and other information regarding registrants that file electronically with the SEC.
145
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
FriendFinder Networks Inc. and Subsidiaries
| | | | | | |
Audited Financial Statements as of December 31, 2008 and 2007 and the years ended December 31, 2008, 2007 and 2006
| | | | | | |
| Report of Independent Registered Public Accounting Firm | | | | | F-2 | |
| Consolidated Balance Sheets as of December 31, 2008 and 2007 | | | | | F-3 | |
| Consolidated Statements of Operations for the years ended December 31, 2008, 2007 and 2006 | | | | | F-4 | |
| Consolidated Statements of Changes in Stockholders’ Equity (Deficiency) for the years ended December 31, 2008, 2007 and 2006 | | | | | F-5 | |
| Consolidated Statements of Cash Flows for the years ended December 31, 2008, 2007 and 2006 | | | | | F-6 | |
| Notes to Consolidated Financial Statements | | | | | F-7 | |
Various, Inc. and Subsidiaries and Affiliates
| | | | | | |
Audited Financial Statements as of December 6, 2007 and December 31, 2006, and for the period from January 1, 2007 through December 6, 2007 and the years ended December 31, 2006 and 2005
| | | | | | |
| Report of Independent Registered Public Accounting Firm | | | | | F-37 | |
| Combined Balance Sheets as of December 6, 2007 and December 31, 2006 | | | | | F-38 | |
| Combined Statements of Operations for the period from January 1, 2007 through December 6, 2007 and for the years ended December 31, 2006 and 2005 | | | | | F-39 | |
| Combined Statements of Changes in Shareholders’ Deficit for the period from January 1, 2007 through December 6, 2007 and for the years ended December 31, 2006 and 2005 | | | | | F-40 | |
| Combined Statements of Cash Flows for the period from January 1, 2007 through December 6, 2007 and for the years ended December 31, 2006 and 2005 | | | | | F-41 | |
| Notes to Combined Financial Statements | | | | | F-42 | |
F-1
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
The Board of Directors and Stockholders
FriendFinder Networks Inc.
We have audited the accompanying consolidated balance sheets of FriendFinder Networks Inc. (formerly known as Penthouse Media Group, Inc.) and subsidiaries (the “Company”) as of December 31, 2008 and 2007, and the related consolidated statements of operations, changes in stockholders’ equity (deficiency), and cash flows for each of the three years in the period ended December 31, 2008. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of FriendFinder Networks Inc. and subsidiaries at December 31, 2008 and 2007 and the consolidated results of their operations and their cash flows for each of the three years in the period ended December 31, 2008, in conformity with United States generally accepted accounting principles.
The accompanying financial statements have been prepared assuming that the Company will continue as a going concern. As more fully described in Note A, events of default have occurred under certain debt agreements allowing the noteholders to declare a default and to demand repayment of the notes. Accordingly, such debt has been classified as a current liability in the accompanying balance sheet as of December 31, 2008, resulting in a substantial working capital deficiency at such date. These conditions raise substantial doubt about the Company’s ability to continue as a going concern. Management’s plans in regard to these matters are also described in Note A. The financial statements do not include any adjustments that might result from the outcome of this uncertainty.
/s/ Eisner LLP
New York, New York
March 20, 2009
F-2
FRIENDFINDER NETWORKS INC. (FORMERLY KNOWN AS PENTHOUSE MEDIA GROUP INC.)
AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS)
| | | | December 31,
|
|
|---|
| | | | 2008
| | 2007
|
|---|
ASSETS
| | | | | | | | | | |
Current assets:
| | | | | | | | | | |
| Cash | | | | $ | 23,704 | | | $ | 7,381 | |
| Restricted cash | | | | | 7,861 | | | | 16,341 | |
| Accounts receivable, less allowance for doubtful accounts of $2,510 and $1,368, respectively | | | | | 9,341 | | | | 15,947 | |
| Inventories | | | | | 1,627 | | | | 1,715 | |
| Prepaid expenses | | | | | 9,236 | | | | 4,515 | |
| Deferred tax asset | | | | | 21,571 | | | | 20,927 | |
| Total current assets | | | | | 73,340 | | | | 66,826 | |
| Film costs, net | | | | | 4,822 | | | | 4,260 | |
| Property and equipment, net | | | | | 21,184 | | | | 22,320 | |
| Goodwill | | | | | 334,037 | | | | 344,682 | |
| Domain names | | | | | 55,127 | | | | 55,000 | |
| Trademarks | | | | | 17,873 | | | | 32,735 | |
| Other intangible assets, net | | | | | 77,746 | | | | 108,326 | |
| Unamortized debt issuance costs | | | | | 3,230 | | | | 4,204 | |
| Receivable from escrow fund | | | | | 10,000 | | | | 10,000 | |
| Other assets | | | | | 2,554 | | | | 1,515 | |
| | | | | $ | 599,913 | | | $ | 649,868 | |
| |
LIABILITIES
| | | | | | | | | | |
Current liabilities:
| | | | | | | | | | |
| Long-term debt classified as current due to events of default, net of unamortized discount of $51,736 and $70,275, respectively | | | | $ | 415,606 | | | $ | 417,310 | |
| Current installment of long-term debt, net of unamortized discount of $246 and $503, respectively | | | | | 2,152 | | | | 497 | |
| Accounts payable | | | | | 9,033 | | | | 11,806 | |
| Accrued expenses and other liabilities | | | | | 100,262 | | | | 102,512 | |
| Deferred revenue | | | | | 42,814 | | | | 27,214 | |
| Total current liabilities | | | | | 569,867 | | | | 559,339 | |
| Deferred tax liability | | | | | 49,363 | | | | 67,269 | |
| Long-term debt, net of unamortized discount of $661 and $862, respectively | | | | | 38,768 | | | | 35,379 | |
| Total liabilities | | | | | 657,998 | | | | 661,987 | |
Commitments and contingencies (Notes O and P)
| | | | | | | | | | |
| |
STOCKHOLDERS’ DEFICIENCY
| | | | | | | | | | |
Preferred stock, $0.01 par value — authorized 250,000,000 shares
| | | | | | | | | | |
| Series A Convertible Preferred Stock — authorized 50,000,000 shares; issued and outstanding 35,334,011 shares in 2008 and 2007 (liquidation preference $21,000) | | | | | 353 | | | | 353 | |
| Series B Convertible Preferred Stock — authorized 200,000,000 shares; issued and outstanding 168,897,005 shares in 2008 and 2007 (liquidation preference $5,000) | | | | | 1,689 | | | | 1,689 | |
Common stock, $0.01 par value — authorized 1,250,000,000 shares in 2008 and 2007
| | | | | | | | | | |
| Common stock voting — authorized 1,000,000,000 shares, issued and outstanding 104,956,481 and 71,222,481 shares at December 31, 2008 and 2007, respectively | | | | | 1,050 | | | | 712 | |
| Series B common stock non-voting — authorized 250,000,000 shares; issued and outstanding 36,796,500 shares in 2008 and 2007 | | | | | 368 | | | | 368 | |
| Capital in excess of par value | | | | | 83,122 | | | | 83,460 | |
| Accumulated deficit | | | | | (144,667 | ) | | | (98,701 | ) |
| Total stockholders’ deficiency | | | | | (58,085 | ) | | | (12,119 | ) |
| | | | | $ | 599,913 | | | $ | 649,868 | |
See notes to consolidated financial statements
F-3
FRIENDFINDER NETWORKS INC. (FORMERLY KNOWN AS PENTHOUSE MEDIA GROUP INC.)
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
| | | | Year Ended December 31,
| |
|---|
| | | | 2008
| | 2007
| | 2006
|
|---|
Net revenue
| | | | | | | | | | | | | | |
| Service | | | | | 309,388 | | | | 24,321 | | | | 9,522 | |
| Product | | | | | 21,629 | | | | 23,752 | | | | 20,443 | |
| Total | | | | $ | 331,017 | | | $ | 48,703 | | | $ | 29,965 | |
Cost of revenue
| | | | | | | | | | | | | | |
| Service | | | | | 81,815 | | | | 8,479 | | | | 1,398 | |
| Product | | | | | 14,699 | | | | 14,851 | | | | 14,529 | |
| Total | | | | $ | 96,514 | | | $ | 23,330 | | | $ | 15,927 | |
| |
| Gross profit | | | | | 234,503 | | | | 24,743 | | | | 14,038 | |
| |
Operating expenses:
| | | | | | | | | | | | | | |
| Product development | | | | | 14,553 | | | | 1,002 | | | | — | |
| Selling and marketing | | | | | 59,281 | | | | 7,595 | | | | 1,430 | |
| General and administrative | | | | | 88,280 | | | | 24,466 | | | | 24,354 | |
| Depreciation and amortization | | | | | 40,849 | | | | 5,091 | | | | 3,322 | |
| Impairment of goodwill | | | | | 9,571 | | | | 925 | | | | 22,824 | |
| Impairment of other intangible assets | | | | | 14,860 | | | | 5,131 | | | | — | |
| |
| Total operating expenses | | | | | 227,394 | | | | 44,210 | | | | 51,930 | |
| |
| Income (loss) from operations | | | | | 7,109 | | | | (19,467 | ) | | | (37,892 | ) |
| |
| Interest expense, net of interest income | | | | | (80,510 | ) | | | (15,953 | ) | | | (7,918 | ) |
| Interest and penalties related to VAT | | | | | (8,429 | ) | | | (1,592 | ) | | | — | |
| Loss on modification of debt | | | | | — | | | | — | | | | (3,799 | ) |
| Foreign exchange gain | | | | | 15,195 | | | | 546 | | | | — | |
| Gain on settlement of VAT liability | | | | | 2,690 | | | | — | | | | — | |
| Other (expense) income, net | | | | | (197 | ) | | | 119 | | | | (332 | ) |
| |
| Loss before income tax benefit | | | | | (64,142 | ) | | | (36,347 | ) | | | (49,941 | ) |
| Income tax benefit | | | | | (18,176 | ) | | | (6,430 | ) | | | — | |
| |
Net loss | | | | $ | (45,966 | ) | | $ | (29,917 | ) | | $ | (49,941 | ) |
| |
Net loss per common share — basic and diluted | | | | $ | (0.17 | ) | | $ | (0.23 | ) | | $ | (0.45 | ) |
| |
Weighted average shares outstanding — basic and diluted | | | | | 274,706 | | | | 132,193 | | | | 111,088 | |
See notes to consolidated financial statements
F-4
FRIENDFINDER NETWORKS INC. (FORMERLY KNOWN AS PENTHOUSE MEDIA GROUP INC.)
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY (DEFICIENCY)
YEARS ENDED DECEMBER 31, 2008, 2007, AND 2006
(IN THOUSANDS, EXCEPT SHARE DATA)
| | | | Preferred Stock
| | Common Stock
| |
|---|
| | | | Series A Convertible
| | Series B Convertible
| | Voting
| | Series B Non-Voting
| |
|---|
| | | | Shares
| | Amount
| | Shares
| | Amount
| | Shares
| | Amount
| | Shares
| | Amount
| | Capital in
Excess
of Par
Value
| | Accumulated
Deficit
| | Total
|
|---|
Balance at January 1, 2006 | | | | | 25,238,000 | | | $ | 252 | | | | | | | | | | | | 69,203,300 | | | $ | 692 | | | | 36,796,500 | | | $ | 368 | | | $ | 36,693 | | | $ | (18,843 | ) | | $ | 19,162 | |
| Issuance of preferred stock | | | | | 10,096,011 | | | | 101 | | | | | | | | | | | | | | | | | | | | | | | | | | | | 5,899 | | | | | | | | 6,000 | |
| Common stock issued in connection with acquisition | | | | | | | | | | | | | | | | | | | | | 2,019,181 | | | | 20 | | | | | | | | | | | | 1,200 | | | | | | | | 1,220 | |
| Warrants issued in connection with Senior Secured Notes | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | 2,536 | | | | | | | | 2,536 | |
| Repricing of warrants | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | 461 | | | | | | | | 461 | |
| Preferred stock issuance costs | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | (184 | ) | | | | | | | (184 | ) |
| Net loss | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | (49,941 | ) | | | (49,941 | ) |
Balance at December 31, 2006 | | | | | 35,334,011 | | | | 353 | | | | | | | | | | | | 71,222,481 | | | | 712 | | | | 36,796,500 | | | | 368 | | | | 46,605 | | | | (68,784 | ) | | | (20,746 | ) |
| Series B Convertible Preferred Stock issued | | | | | | | | | | | | | 168,897,005 | | | $ | 1,689 | | | | | | | | | | | | | | | | | | | | 3,311 | | | | | | | | 5,000 | |
| Non-cash stock dividend on Series A Convertible Preferred Stock in connection with issuance of warrants | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | (447 | ) | | | | | | | (447 | ) |
| Distributions to warrant holders in connection with issuance of additional warrants | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | (886 | ) | | | | | | | (886 | ) |
| Warrants issued in connection with anti-dilutive adjustments | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | 1,333 | | | | | | | | 1,333 | |
| Warrants issued with notes which financed the Various, Inc. acquisition | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | 30,120 | | | | | | | | 30,120 | |
| Options granted by the Company’s principal stockholders to former stockholders of Various, Inc., net of related deferred tax of $2,282 | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | 3,424 | | | | | | | | 3,424 | |
| Net loss | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | (29,917 | ) | | | (29,917 | ) |
Balance at December 31, 2007 | | | | | 35,334,011 | | | | 353 | | | | 168,897,005 | | | | 1,689 | | | | 71,222,481 | | | | 712 | | | | 36,796,500 | | | | 368 | | | | 83,460 | | | | (98,701 | ) | | | (12,119 | ) |
| Exercise of warrants | | | | | | | | | | | | | | | | | | | | | 33,734,000 | | | | 338 | | | | | | | | | | | | (338 | ) | | | | | | | | |
| Net loss | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | (45,966 | ) | | | (45,966 | ) | | |
Balance at December 31, 2008 | | | | | 35,334,011 | | | $ | 353 | | | | 168,897,005 | | | $ | 1,689 | | | | 104,956,481 | | | $ | 1,050 | | | | 36,796,500 | | | $ | 368 | | | $ | 83,122 | | | $ | (144,667 | ) | | $ | (58,085 | ) |
See notes to consolidated financial statements
F-5
FRIENDFINDER NETWORKS INC. (FORMERLY KNOWN AS PENTHOUSE MEDIA GROUP INC.)
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
| | | | Year Ended December 31,
| |
|---|
| | | | 2008
| | 2007
| | 2006
|
|---|
Cash flows from operating activities:
| | | | | | | | | | | | | | |
| Net loss | | | | $ | (45,966 | ) | | $ | (29,917 | ) | | $ | (49,941 | ) |
Adjustments to reconcile net loss to net cash provided by (used in) operating activities:
| | | | | | | | | | | | | | |
| Deferred income tax benefit | | | | | (18,550 | ) | | | (6,430 | ) | | | — | |
| Impairment of intangibles | | | | | 24,431 | | | | 6,056 | | | | 22,824 | |
| Loss on modification of debt | | | | | — | | | | — | | | | 3,799 | |
| Depreciation and amortization | | | | | 40,849 | | | | 5,091 | | | | 3,322 | |
| Amortization of film costs | | | | | 3,899 | | | | 2,217 | | | | 305 | |
| Non-cash interest, including amortization of discount | | | | | 30,725 | | | | 10,635 | | | | 4,021 | |
| Provision for doubtful accounts | | | | | (1,505 | ) | | | 505 | | | | 424 | |
| Gain on settlement of VAT liability | | | | | (2,690 | ) | | | — | | | | — | |
| Deferred rent | | | | | — | | | | (108 | ) | | | (107 | ) |
| Loss on lease abandonment | | | | | — | | | | — | | | | 643 | |
| Other | | | | | 32 | | | | 32 | | | | 264 | |
Changes in operating assets and liabilities, net of effects of acquisitions:
| | | | | | | | | | | | | | |
| Restricted cash | | | | | 8,480 | | | | 153 | | | | — | |
| Accounts receivable | | | | | 8,111 | | | | (4,753 | ) | | | (2,262 | ) |
| Inventories | | | | | 88 | | | | (259 | ) | | | 139 | |
| Prepaid expenses | | | | | (4,896 | ) | | | 3,547 | | | | (743 | ) |
| Film costs | | | | | (4,461 | ) | | | (3,227 | ) | | | (1,803 | ) |
| Other assets | | | | | (864 | ) | | | (548 | ) | | | 416 | |
| Accounts payable | | | | | (2,775 | ) | | | 2,906 | | | | 233 | |
| Accrued expenses and other liabilities | | | | | 440 | | | | 11,204 | | | | 661 | |
| Deferred revenue | | | | | 15,600 | | | | 7,640 | | | | 1,205 | |
| Net cash provided by (used in) operating activities | | | | | 50,948 | | | | 4,744 | | | | (16,600 | ) |
Cash flows from investing activities:
| | | | | | | | | | | | | | |
| Cash paid for acquisitions, net of cash acquired | | | | | — | | | | (139,296 | ) | | | (2,571 | ) |
| Cash paid into escrow in connection with acquisition | | | | | — | | | | (10,000 | ) | | | — | |
| Purchases of property and equipment | | | | | (9,161 | ) | | | (86 | ) | | | (769 | ) |
| Additions to trademarks | | | | | — | | | | (42 | ) | | | (117 | ) |
| Other | | | | | (128 | ) | | | 102 | | | | 43 | |
| Net cash used in investing activities | | | | | (9,289 | ) | | | (149,322 | ) | | | (3,414 | ) |
Cash flows from financing activities:
| | | | | | | | | | | | | | |
| Issuance of senior secured notes and warrants | | | | | — | | | | — | | | | 5,000 | |
| Issuance of preferred stock | | | | | — | | | | 5,000 | | | | 6,000 | |
| Repayment of long-term debt | | | | | (25,336 | ) | | | (322 | ) | | | (1,083 | ) |
| Issuance of first lien secured notes and warrants | | | | | — | | | | 148,486 | | | | — | |
| Issuance of other long-term debt | | | | | — | | | | — | | | | 917 | |
| Offering costs—preferred stock and senior secured notes | | | | | — | | | | (4,203 | ) | | | (265 | ) |
| Net cash (used in) provided by financing activities | | | | | (25,336 | ) | | | 148,961 | | | | 10,569 | |
Net increase (decrease) in cash | | | | | 16,323 | | | | 4,383 | | | | (9,445 | ) |
| Cash at beginning of period | | | | | 7,381 | | | | 2,998 | | | | 12,443 | |
Cash at end of period | | | | $ | 23,704 | | | $ | 7,381 | | | $ | 2,998 | |
Supplemental disclosures of cash flow information:
| | | | | | | | | | | | | | |
| Interest paid | | | | $ | 53,592 | | | | — | | | $ | 1,739 | |
| Non-cash items: | | | | | | | | | | | | | | |
| Reduction of Subordinated Convertible Notes and goodwill for bonus indemnification from former stockholders of Various, Inc. | | | | $ | 1,074 | | | | — | | | | — | |
| Notes and warrants issued to sellers in connection with acquisition of Various, Inc. | | | | | — | | | $ | 264,000 | | | | — | |
| Issuance of note and warrants for payment of debt issuance costs | | | | | — | | | $ | 907 | | | | — | |
| Common stock issued in connection with acquisition | | | | | — | | | | — | | | $ | 1,220 | |
See notes to consolidated financial statements
F-6
FRIENDFINDER NETWORKS INC. (FORMERLY KNOWN AS PENTHOUSE MEDIA GROUP INC.)
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE A — DESCRIPTION OF BUSINESS AND BASIS OF PRESENTATION
On July 1, 2008, Penthouse Media Group Inc. changed its name to FriendFinder Networks Inc. (“FriendFinder”). FriendFinder together with its subsidiaries (hereinafter referred to as the “Company”) is an international multimedia company that operates interactive social networking and other adult websites and is also engaged in entertainment activities consisting of publishing, licensing and studio production and distribution. The Company publishes PENTHOUSE magazine and four other adult-oriented publications. Additionally, the Company licenses the PENTHOUSE name for international publication of adult magazines and for use on various products and provides various adult-oriented multimedia entertainment products and services, including DVD and VHS videos, pay-per-view programming and telephone services.
Since emerging from bankruptcy protection in October 2004, FriendFinder has incurred substantial net losses and used substantial amounts of cash in its operating activities. On December 6, 2007, FriendFinder acquired Various, Inc. (“Various”), an operator of interactive multimedia websites, which has provided the cash flow necessary to fund FriendFinder’s operations (see Note J(a)).
As described in Note J, events of default have occurred with respect to the secured notes issued to finance the acquisition allowing the noteholders and, as a result of cross-default provisions, holders of subordinated convertible notes issued in connection with the acquisition and FriendFinder’s existing Senior Secured Notes to declare a default and demand repayment of the notes. Accordingly, such debt has been classified as current obligations in the accompanying balance sheet as of December 31, 2008, resulting in a substantial working capital deficiency at such date.
The above conditions raise substantial doubt about the Company’s ability to continue as a going concern. Management has held discussions with the noteholders, and is attempting to obtain waivers of, or obtain modifications of debt agreements that would cure, such events of default. Further, the Company is attempting to obtain funds through the sale of common stock in an initial public offering (“IPO”) and use the net proceeds to repay its debt. However, there can be no assurance that the events of default will be waived or cured or that the public offering will be successful. Continuation of the Company as a going concern is dependent upon the retirement of debt through successful completion of the public offering, or if not successful, finding alternative sources of financing to repay such debt in the event the noteholders demand repayment. The accompanying financial statements have been prepared assuming that the Company will continue as a going concern and do not include any adjustments that may result from this outcome of the uncertainty.
NOTE B — SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
1. | | Principles of consolidation: |
The consolidated financial statements include the accounts of FriendFinder and its subsidiaries, all of which are wholly owned. Intercompany accounts and transactions have been eliminated in consolidation. The accounts of Various are included in the consolidated financial statements from its date of acquisition in December 2007.
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.
3. | | Cash and cash equivalents: |
Cash and cash equivalents include all cash balances and highly liquid investments having original maturities of three months or less when purchased. As of December 31, 2008 and 2007, there were no cash equivalents.
F-7
FRIENDFINDER NETWORKS INC. (FORMERLY KNOWN AS PENTHOUSE MEDIA GROUP INC.)
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE B — SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
The credit card processors used by Various regularly withhold deposits and maintain balances which are recorded as restricted cash.
Accounts receivable is principally comprised of credit card payments owed to Various for membership fees, which are pending collection from the credit card processors. An allowance for doubtful accounts is estimated based on past experience. In addition, an estimated liability is recorded by Various based on historical trends of chargeback levels and credits. The chargeback and credit liability as of December 31, 2008 and 2007, which is included in accrued expenses and other liabilities, was approximately $530,000 and $463,000, respectively. Chargebacks and credits charged to revenue for the year ended December 31, 2008 and for the period from December 7, 2007 through December 31, 2007 were approximately $11,916,000 and $866,000, respectively.
Inventories, which consist principally of paper and printing costs, are valued at the lower of cost (first-in, first-out method) or market.
7. | | Property and equipment: |
Property and equipment are stated at cost less accumulated depreciation and amortization. Depreciation and amortization are computed using the straight-line method over the estimated useful lives of the related assets. Computer hardware and software are depreciated over three years and leasehold improvements are amortized over the shorter of the life of the lease or the estimated useful life of the improvements.
Costs related to developing or obtaining internal-use software are expensed as incurred or capitalized into property and equipment in accordance with Statement of Position (“SOP”) 98-1, “Accounting for the Costs of Computer Software Developed or Obtained for Internal Use.” SOP 98-1 requires that costs incurred in the preliminary project and post-implementation stages of an internal use software project be expensed as incurred and that certain costs incurred in the application development stage of a project be capitalized.
Internal-use software acquired in the acquisition of Various, which was valued at $17,300,000, is included in property and equipment and is being amortized over an estimated useful life of three years.
In accordance with Emerging Issues Task Force (“EITF”) 00-2, “Accounting for Website Development Costs,” the Company expenses costs related to the planning and operating stages of the website. Direct costs incurred in the development stage are capitalized. Costs associated with minor enhancements and maintenance for the website are included in expenses as incurred.
Film costs consist of direct costs of production of adult entertainment video content. Such costs are being amortized using the straight-line method over thirty-six months, which represents the estimated period during which substantially all revenue from the content will be realized. Film cost amortization is included in cost of revenue.
F-8
FRIENDFINDER NETWORKS INC. (FORMERLY KNOWN AS PENTHOUSE MEDIA GROUP INC.)
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE B — SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
10. | | Goodwill, trademarks and other intangibles: |
Goodwill and trademarks, which are deemed to have an indefinite useful life, were recorded in connection with the adoption of fresh start reporting upon the Company’s emergence from bankruptcy proceedings. Additionally, goodwill was recorded in connection with the acquisition of Various and other business combinations, representing the excess of the purchase price over the fair value of the identifiable net assets acquired. These assets, together with domain names that were recorded in the Various acquisition and were also deemed to have an indefinite useful life based primarily on the Company’s plans for continued indefinite use, are not amortized, but are tested for impairment annually or more frequently if events or changes in circumstances indicate that the asset might be impaired. The impairment test for indefinite-lived trademarks and domain names consists of a comparison of their fair value with their carrying amount. See Notes G and H with respect to impairment of goodwill and trademarks, respectively.
Other intangible assets are deemed to have finite useful lives and are amortized over periods ranging from two to six years. The Company evaluates the recoverability of such assets by comparing their carrying amount to the expected future undiscounted cash flows to be generated from such assets when events or circumstances indicate that impairment may have occurred. If the carrying amount exceeds such cash flow, an impairment loss would be recognized to the extent such carrying amount exceeds the fair value of the impaired assets based upon their discounted future cash flows.
Revenues from subscription fees are recognized ratably over the subscription period, including periods for which no additional amounts are charged, beginning when there is persuasive evidence of an arrangement, delivery has occurred (access has been granted) and the fees are fixed and determinable. Collection is reasonably assured as subscribers pay in advance, primarily by using a credit card, and all purchases are final and nonrefundable. Fees collected in advance are deferred and recognized as revenue using the straight-line method over the term of the subscription, which ranges from one to eighteen months.
Revenues on a pay-by-usage basis are recognized when access has been granted. Revenues for banner advertising on websites are recognized ratably over the period that the advertising appears. Commission revenue from the shipment of products (i.e., adult novelty items and videos) from online stores, which are operated by a third party, are recognized upon receipt of notification of the commission owed the Company from the online store operator.
The Company estimates the amount of chargebacks that will occur in future periods to offset current revenue. The Company’s revenue is primarily collected through online credit card transactions. As such, the Company is subject to chargebacks by consumers generally up to 90 days subsequent to the original sale date. The Company accrues chargebacks based on historical trends relative to sales levels by website.
Revenues from the sale of magazines at newsstands are recognized on the on-sale date of each issue based on an estimate of the total sell through, net of estimated returns. The amount of estimated revenue is adjusted in subsequent periods as sales and returns information becomes available. Revenues from the sale of magazine subscriptions are recognized ratably over their respective terms which range from one to two years.
The unrecognized portion of magazine subscriptions is shown as deferred revenue. Revenues from advertising in magazines are recognized on the on-sale date of each issue in which the advertising is included.
F-9
FRIENDFINDER NETWORKS INC. (FORMERLY KNOWN AS PENTHOUSE MEDIA GROUP INC.)
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE B — SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
11. | | Revenue recognition: (Continued) |
b) Entertainment: (Continued)
Revenues from the third party sale of content produced by the Company including DVDs and videocassettes are recognized upon receipt of notification of sale from the third parties. Revenues from subscription fees for television programming channels are recognized ratably over the subscription period. Revenues from pay-per-view broadcasts are recognized when the films are aired.
Revenues from the licensing of the PENTHOUSE name for use (i) in the publication of magazines in foreign countries and the sale of consumer products are recognized in the period of sale as reported by the licensee and (ii) in connection with licensed nightclubs are recognized ratably over the term of the license agreement for up-front payments and in the period of sale as reported by the licensee on food, beverages and other sales.
Cost of internet revenue includes commissions paid to websites having direct links to the Company’s websites resulting in new subscribers, costs for online models and studios and amortization of capitalized website development costs.
Publishing costs include the costs of printing and distributing of magazines. Shipping and handling costs are also included and amounted to approximately $3,256,000, $3,336,000 and $3,102,000 for the years ended December 31, 2008, 2007 and 2006, respectively.
Studio costs principally consist of amortization of production costs of videos containing adult entertainment content.
Costs related to the planning and post-implementation stages of the Company’s website development efforts are recorded as product development expense. Direct costs incurred in the development stage are capitalized and amortized over the website’s estimated useful life of three years as charges to cost of revenue.
14. | | Retail display allowances: |
Payments made to retail outlets as an incentive to carry and sell the Company’s publications are recognized as a reduction of revenue on the on-sale date of such issue.
Advertising costs are expensed as incurred. For the years ended December 31, 2008, 2007 and 2006, the Company incurred advertising costs, included in selling and marketing expense, amounting to approximately $52,619,000, $3,758,000 and $156,000, respectively. Costs for 2008 and 2007 include payments to internet search engines for key words searches to generate traffic to Various’ websites.
Various operates a point-based loyalty program designed to increase participation in its assorted membership activities. These points are earned through activities such as, but not limited to, participating in sponsored blogs and online magazines, as well as by increasing the uniqueness of a member profile through the addition of photographs and other assorted items. Points may be redeemed for other membership services such as upgraded
F-10
FRIENDFINDER NETWORKS INC. (FORMERLY KNOWN AS PENTHOUSE MEDIA GROUP INC.)
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE B — SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
16. | | Loyalty program: (Continued) |
memberships or highlighting of member profiles in online searches. As the incremental cost of providing these additional membership services is minimal, no liabilities are recorded in connection with point redemptions.
17. | | Stock-based compensation: |
In December 2004, the Financial Accounting Standards Board (the “FASB”) issued Statement of Financial Accounting Standards (“SFAS”) No. 123 (revised), “Share-Based Payment” (“SFAS 123R”), which replaces SFAS No. 123, “Accounting for Stock-Based Compensation,” and supersedes Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees” (“APB 25”). SFAS 123R covers a wide range of share-based compensation arrangements and requires that the compensation cost related to these types of payment transactions, including stock options, be recognized in the financial statements. Cost is measured based on the fair value of the equity instrument issued at the date of grant and is expensed over the vesting period.
The Company adopted SFAS 123R effective January 1, 2006, as required, using the modified prospective application method. Under such method, SFAS 123R applies to all awards granted, modified, repurchased or cancelled by the Company since January 1, 2006 and to unvested awards at the date of adoption. The adoption of SFAS 123R did not have any impact on the Company’s 2006 results of operations as there were no unvested awards at the date of adoption and there was no stock option activity during such year.
The Company accounts for income taxes under the provisions of SFAS No. 109, “Accounting for Income Taxes.” SFAS No. 109 requires that the Company recognize deferred tax assets and liabilities for the expected future tax consequences of events that have been included in the financial statements or tax returns. Under this method, deferred tax assets and liabilities are recorded for net operating loss carryforwards and for the difference between the tax bases of assets and liabilities and their respective financial reporting amounts at enacted tax rates in effect for the years in which the temporary differences are expected to reverse. A valuation allowance is recorded if it is more likely than not that some portion or all of the deferred tax assets will not be realized in future periods.
Value added taxes are presented on a net basis and are excluded from revenue.
20. | | Foreign Currency Transactions: |
Revenue derived from international websites is paid in advance primarily with credit cards and is denominated in local currencies. Substantially all such currencies are converted into U.S. dollars on the dates of the transactions at rates of exchange in effect on such dates and remitted to the Company. Accordingly, foreign currency revenue is recorded based on the U.S. dollars received by the Company. Accounts receivable due from, and restricted cash held by, foreign credit card processors and VAT liabilities denominated in foreign currencies are translated into U.S. dollars using current exchange rates in effect as of the balance sheet date. Gains and losses resulting from transactions denominated in foreign currencies are recorded in the statement of operations.
21. | | Concentration of credit risk: |
The Company’s cash, cash equivalents, and accounts receivable are potentially subject to concentrations of credit risk. Cash and cash equivalents are placed with financial institutions that management believes are of high credit quality. The Company’s accounts receivable are derived from revenue earned from customers
F-11
FRIENDFINDER NETWORKS INC. (FORMERLY KNOWN AS PENTHOUSE MEDIA GROUP INC.)
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE B — SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
21. | | Concentration of credit risk: (Continued) |
located in the U.S. and internationally. At December 31, 2008 and 2007, accounts receivable balances are due principally from credit card processors and are settled upon processing of credit card transactions. As of December 31, 2008, three credit card processors accounted for 30%, 24% and 21% of accounts receivable and as of December 31, 2007, one credit card processor accounted for 62% of accounts receivable. During the years ended December 31, 2008, 2007 and 2006, no customers accounted for more than 10% of net revenue.
22. | | Fair value of financial instruments: |
The carrying amounts of cash, receivables and payables approximate their fair values due to the short-term nature of these financial instruments. As of December 31, 2008, the carrying value of long-term debt, including amounts classified as current due to events of default was $456,526,000 compared to its estimated fair value of $434,720,349. As of December 31, 2007, the carrying amount of long-term debt classified as current due to events of default on the notes issued in connection with the acquisition of Various in December 2007 ($379,152,000), which consists of both variable and fixed term debt, is considered to approximate its fair value. The estimated fair value of the balance of long-term debt, all of which bears interest at fixed rates, was $73,538,184 compared to its carrying value of $74,034,953 (of which $38,158,000 is classified as current due to events of default). The fair value is estimated by discounting the projected cash flows using the estimated rates at which similar amounts of debt could be borrowed at such date.
Basic and diluted loss per share is based on the weighted average number of shares of outstanding common stock and Series B common stock including shares underlying common stock purchase warrants which are exercisable at the nominal price of $0.00001 per share. Pursuant to Issue 7 of EITF 03-6, a consensus was reached that convertible participating securities should be included in the computation of basic earnings per share using the two-class method. Inasmuch as the Series B common stock participates in any dividends and shares in the net loss on a pro rata basis with the common stock based on the total number of common shares outstanding, the net loss per common share, basic and diluted, as presented in the Company’s statements of operations is consistent with the two-class method.
In computing diluted loss per share, no effect has been given to the common shares issuable upon conversion or exercise of the following anti-dilutive securities (in thousands):
| | | | December 31,
| |
|---|
| | | | 2008
| | 2007
| | 2006
|
|---|
| Series A Convertible Preferred Stock | | | | | 35,334 | | | | 35,334 | | | | 35,334 | |
| Series B Convertible Preferred Stock | | | | | 168,897 | | | | 168,897 | | | | — | |
| Warrants | | | | | 9,780 | | | | 9,780 | | | | 9,780 | |
| Total common shares issuable | | | | | 214,011 | | | | 214,011 | | | | 45,114 | |
The Series A and Series B preferred stock are convertible participating securities; however, as there is no contractual obligation for the holders of such shares to share in the losses of the Company, the preferred shares are not included in the computation of basic and diluted net loss per share.
No shares are included in the above table with respect to the conversion of the Subordinated Convertible Notes as the number of common shares into which the notes are convertible is based upon an IPO price which is not presently determinable. In addition, the number of shares issuable upon conversion is dependent upon whether the conversion option is exercised by the noteholder or the Company (see Note J(b)). Further, no shares are included in the above table with respect to options to acquire 13.9 million shares of common stock outstanding at December 31, 2008, granted under the 2008 Stock Option Plan as, for accounting purposes, the grant date will occur upon consummation of an IPO (see Note L).
F-12
FRIENDFINDER NETWORKS INC. (FORMERLY KNOWN AS PENTHOUSE MEDIA GROUP INC.)
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE B — SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
24. | | Accounting pronouncements adopted in 2008: |
In September 2006, the FASB issued SFAS No. 157, “Fair Value Measurements.” SFAS No. 157 clarifies the definition of fair value, establishes a framework for measuring fair value, and expands the disclosures on fair value measurements. SFAS No. 157 is effective for fiscal years beginning after November 15, 2007. On February 12, 2008, the FASB issued FASB Staff Position (“FSP”) FAS No. 157-2 which delays the effective date of SFAS No. 157 for fair value measurements for all non-financial assets and non-financial liabilities, except those that are recognized or disclosed at fair value in the financial statements on a recurring basis (that is, at least annually). The FSP defers the effective date of SFAS No. 157 to fiscal years beginning after November 15, 2008. Effective January 1, 2008, the Company adopted SFAS No. 157 with respect to its financial assets and liabilities. The adoption of this standard had no impact on the Company’s financial statements for the year ended December 31, 2008. The Company is currently evaluating the impact, if any, of the adoption of this statement on its financial statements as its relates to non-financial assets and liabilities.
In February 2007, the FASB issued SFAS No. 159 “The Fair Value Option for Financial Assets and Liabilities.” SFAS No. 159 provides companies with an option to report selected financial assets and liabilities at fair value and establishes presentation and disclosure requirements designed to facilitate comparisons between companies that choose different measurement attributes for similar types of assets and liabilities. SFAS No. 159 became effective for the Company on January 1, 2008 and had no effect on the Company’s financial statements as the Company did not elect to apply the provisions of SFAS No. 159.
25. | | New accounting pronouncements: |
In December 2007, the FASB issued SFAS No. 141(R), “Business Combinations.” SFAS No.141(R) establishes principles and requirements for how an acquirer in a business combination (i) recognizes and measures in its financial statements the identifiable assets acquired, the liabilities assumed, and any noncontrolling interest in the acquiree, (ii) recognizes and measures the goodwill acquired in a business combination or a gain from a bargain purchase, and (iii) determines what information to disclose to enable users of financial statements to evaluate the nature and financial effects of the business combination. Adoption of SFAS No. 141(R) is required for combinations after December 15, 2008. Early adoption and retroactive application of SFAS No. 141(R) to fiscal years preceding the effective date are not permitted. The impact, if any, the implementation of SFAS No. 141(R) will have on the Company’s financial statements is dependent on future acquisitions.
In April 2008, the FASB issued FSP FAS No. 142-3,Determination of the Useful Life of Intangible Assets. FSP FAS No. 142-3, which is effective for fiscal years beginning after December 15, 2008, amends the factors that should be considered in developing renewal or extension assumptions used to determine the useful life of a recognized intangible asset acquired after the effective date. The intent of this FSP is to improve the consistency between the useful life of a recognized intangible asset and the period of expected cash flows used to measure the fair value of the asset under SFAS No. 141(R), Business Combinations, and other U.S. GAAP. The Company adopted FSP FAS No. 142-3 on January 1, 2009 and does not expect this standard to have a material impact on the Company’s financial statements.
NOTE C — ACQUISITIONS
1. | | Acquisition of Various: |
On December 6, 2007, pursuant to a stock purchase agreement, Interactive Network, Inc. (“INI”), a newly-formed wholly owned subsidiary of FriendFinder, purchased all of the stock of Various and certain affiliated companies. Various and affiliates are engaged in the operation of social networking services and other
F-13
FRIENDFINDER NETWORKS INC. (FORMERLY KNOWN AS PENTHOUSE MEDIA GROUP INC.)
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE C — ACQUISITIONS (Continued)
1. | | Acquisition of Various: (Continued) |
interactive websites, online photo-sharing and storage, online publishing and broadcast of user-generated media content and adult materials and online adult retail services. The sellers of Various were paid approximately $137 million in cash and issued notes valued at approximately $248 million, together with related warrants to acquire approximately 57.5 million shares of common stock, valued at approximately $16 million (or $.28 each, see Note J) comprising a total purchase price of approximately $401 million. The notes issued consist of $91 million of First Lien Senior Secured Notes, $73 million of Second Lien Subordinated Secured Notes, $80 million of Subordinated Convertible Notes and $4 million of other notes, (see Notes J(a), (b), (c) and (d)). The purchase price gives effect to a $61 million reduction attributable to a post-closing working capital adjustment that resulted in a $51 million reduction in the value of notes issued and a $10 million reduction in cash paid which is being held in escrow. In addition, legal and other acquisition costs totaling approximately $4 million were incurred. The cash portion of the purchase price was obtained through issuance of notes and warrants, including approximately $110 million from the Company’s stockholders (see Note J).
The working capital adjustment, which principally relates to unrecorded value added tax liability (see Note I), has been computed and submitted by the Company to the former stockholders of Various. On February 6, 2009, the former stockholders of Various submitted their objection to the working capital adjustment. In the event that the parties cannot resolve the issues, the dispute is required to be settled through binding resolution by an accounting firm mutually acceptable to the Company and the former stockholders of Various.
The acquisition was made due to Various’ strategic fit, enabling the Company to enter a new line of business, its dominant position on the web and ability to leverage its technological strength. The combination of these factors contributed to the excess of purchase price paid over the fair value of identifiable net assets acquired (“goodwill”).
The following table summarizes the estimated fair values of the assets acquired and liabilities assumed at the date of acquisition (in thousands):
| Current assets (including cash of $2,132) | | | | $ | 30,065 | |
| Property and equipment | | | | | 22,033 | |
| Other assets | | | | | 122 | |
| Identifiable intangible assets | | | | | 165,200 | |
| Goodwill | | | | | 330,994 | |
| |
| Total assets acquired | | | | | 548,414 | |
| |
| Liability related to VAT (see Note I) | | | | | 78,090 | |
| Other current liabilities (including deferred revenue of $12,600) | | | | | 27,307 | |
| Deferred tax liability | | | | | 37,247 | |
| |
| Total liabilities assumed | | | | | 142,644 | |
| |
| Net assets acquired | | | | $ | 405,770 | |
Of the $165.2 million of acquired identifiable intangible assets, $55.0 million was assigned to domain names, $23.5 million was assigned to customer lists, $76.1 million was assigned to service and studio contracts and $10.6 million was assigned to non-compete agreements. Domain names, which have an indefinite life, are not subject to amortization. The remaining acquired intangible assets have a weighted-average useful life of approximately 3.9 years (see Note H). The goodwill was assigned to the internet segment.
An election under Section 338(h)(10) of the Internal Revenue Code was not made by September 15, 2008, the deadline for making the election. Such election treats the acquisition of stock as an acquisition of assets and, accordingly, would result in the tax basis of the assets acquired being increased to reflect the purchase
F-14
FRIENDFINDER NETWORKS INC. (FORMERLY KNOWN AS PENTHOUSE MEDIA GROUP INC.)
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE C — ACQUISITIONS (Continued)
1. | | Acquisition of Various: (Continued) |
price of Various stock. As a result of no election having been made, no portion of the goodwill will be deductible for tax purposes. The deferred tax liability shown in the above table reflects no such election having been made and primarily relates to the excess of the financial statement basis over the tax basis of the identifiable intangible assets and property and equipment, net of a deferred tax asset related to the VAT liability (see Note M).
The following unaudited pro forma financial information presents the combined results of the Company and Various as if the acquisition had occurred as of January 1 for each of the fiscal years shown below (in thousands):
| | | | 2007
| | 2006
|
|---|
Net revenue(1) | | | | $ | 307,120 | | | $ | 283,349 | |
Net loss (2) | | | | $ | (79,559 | ) | | $ | (86,936 | ) |
| (1) | | Differs from the $332,907 revenue reflected in the pro forma consolidated statement of operations on page 41 of the prospectus as such statement does not reflect a non-recurring $25.8 million reduction in net revenue resulting from the reduction in deferred revenue at January 1, 2007 to reflect the purchase price allocation. |
| (2) | | Differs from the $53,606 net loss reflected in the pro forma consolidated statement of operations on page 41 of the prospectus as such statement does not include $7.1 million of bonuses paid to Various employees relating to the acquisition and includes $0.6 million of additional compensation related to new employment agreements and does not reflect a $25.8 million reduction in net revenue referred to above, net of the tax effects on the aforementioned items. |
| | The pro forma results give effect to increased depreciation and amortization and decreased revenue to reflect the purchase price allocation and also give effect to interest (approximately $67 million) on debt incurred to finance the acquisition in addition to a related deferred tax benefit. Such results are not necessarily indicative of what actually would have occurred had the acquisition been made as of such date and is not indicative of future period results. The pro forma net loss for the year ended December 31, 2007 includes approximately $7.1 million of bonuses paid to Various employees relating to the acquisition. |
2. | | Acquisition of Video Bliss Inc. and Danni Ashe, Inc.: |
On October 20, 2006, the Company purchased the stock of Video Bliss Inc. (“VBI”) and Danni Ashe, Inc. (“DAI”), adult video and internet production companies, for $1,416,000 in cash and 2,523,977 shares of the Company’s common stock valued at $1,500,000 ($0.5943 per share). The value of the common stock was based on the most recent sale of the Company’s Series A Preferred Stock (see Note K). Of the total consideration, $1,116,000 in cash and 2,019,181 common shares valued at $1,220,000 were paid at closing; 50% of the remaining $300,000 in cash and 504,796 common shares will be paid when the six continuous months aggregate revenue for the VBI and the DAI subsidiaries subsequent to the closing date reach $3,100,000; the remaining 50% will be paid on the attainment of continuous six months aggregate revenue of $3,300,000. As of December 31, 2008, the revenue targets had not been attained. The obligation to make earn-out payments terminates on December 31, 2009. Such contingent consideration aggregating $580,000 will be recorded as additional purchase price if and when the revenue targets are attained.
The non-contingent portion of the purchase price was allocated as follows (in thousands):
| Cash | | | | $ | 265 | |
| Other current assets | | | | | 510 | |
| Property and equipment | | | | | 200 | |
| Other assets | | | | | 136 | |
| Goodwill | | | | | 2,169 | |
| |
| Total assets acquired | | | | | 3,280 | |
F-15
FRIENDFINDER NETWORKS INC. (FORMERLY KNOWN AS PENTHOUSE MEDIA GROUP INC.)
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE C — ACQUISITIONS (Continued)
2. | | Acquisition of Video Bliss Inc. and Danni Ashe, Inc.: (Continued) |
| |
| Current liabilities | | | | | (490 | ) |
| Notes payable | | | | | (454 | ) |
| |
| Total liabilities assumed | | | | | (944 | ) |
| |
| Net assets acquired | | | | $ | 2,336 | |
The $2,169 of goodwill, none of which is deductible for tax purposes, was assigned to the Internet segment.
Unaudited pro forma financial information as if the acquisitions of VBI and DAI had occurred as of January 1, 2006 has not been presented based on materiality.
3. | | Acquisition of Jill Kelly Productions: |
On September 11, 2006, the Company acquired assets for $1,720,000 in cash and $100,000 in assumed liabilities from the debtor estate of Jill Kelly Productions Inc., an adult entertainment production company which had ceased operations and was being liquidated in bankruptcy proceedings. The purchase price was allocated to accounts receivable ($277,000), DVD and a content library ($770,000), property and equipment ($43,000) and trademarks ($730,000). This transaction was accounted for as a purchase of assets.
NOTE D — INVENTORY
The components of inventory were as follows (in thousands):
| | | | December 31,
| |
|---|
| | | | 2008
| | 2007
|
|---|
| Paper and printing costs | | | | $ | 1,035 | | | $ | 1,249 | |
| Editorials and pictorials | | | | | 592 | | | | 466 | |
| | | | | $ | 1,627 | | | $ | 1,715 | |
NOTE E — FILM COSTS
Film costs activity consists of the following (in thousands):
| | | | Year Ended December 31,
| |
|---|
| | | | 2008
| | 2007
| | 2006
|
|---|
| Opening balance | | | | $ | 4,260 | | | $ | 3,250 | | | $ | 982 | |
| Content produced | | | | | 4,461 | | | | 3,227 | | | | 1,803 | |
| Acquired library | | | | | — | | | | — | | | | 770 | |
| Amortization | | | | | (3,899 | ) | | | (2,217 | ) | | | (305 | ) |
| Ending balance | | | | $ | 4,822 | | | $ | 4,260 | | | $ | 3,250 | |
Substantially all of the capitalized film costs at December 31, 2008 and 2007 represent completed and released content. Management estimates that amortization charges for the completed and released content, as of December 31, 2008, will be $2,771,000, $1,584,000 and $467,000 for the years ending December 31, 2009, 2010 and 2011, respectively.
F-16
FRIENDFINDER NETWORKS INC. (FORMERLY KNOWN AS PENTHOUSE MEDIA GROUP INC.)
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE F — PROPERTY AND EQUIPMENT
Property and equipment consists of the following (in thousands):
| | | | December 31,
| |
|---|
| | | | 2008
| | 2007
|
|---|
Property and equipment:
| | | | | | | | | | |
| Leasehold improvements | | | | $ | 125 | | | $ | 144 | |
| Computer hardware and software | | | | | 33,124 | | | | 24,308 | |
| | | | | | 33,249 | | | | 24,452 | |
| Less accumulated depreciation and amortization | | | | | 12,065 | | | | 2,132 | |
| | | | | $ | 21,184 | | | $ | 22,320 | |
Depreciation and amortization expense amounted to approximately $10,255,000, $1,254,000 and $696,000 for the years ended December 31, 2008, 2007 and 2006, respectively.
NOTE G — GOODWILL
Changes in the carrying amount of goodwill by segment for the years ended December 31, 2008 and 2007 are as follows (in thousands):
| | | | Internet
| | Entertainment
| | Total
|
|---|
| Balance as of January 1, 2007 | | | | $ | 10,946 | | | $ | 3,667 | | | $ | 14,613 | |
| Acquisition of Various | | | | | 330,994 | | | | — | | | | 330,994 | |
| Impairment | | | | | — | | | | (925 | ) | | | (925 | ) |
| Balance as of December 31, 2007 | | | | $ | 341,940 | | | $ | 2,742 | | | $ | 344,682 | |
Reduction for indemnification from sellers of Various, Inc.
(see Note J(b)) | | | | | (1,074 | ) | | | — | | | | (1,074 | ) |
| Impairment | | | | | (6,829 | ) | | | (2,742 | ) | | | (9,571 | ) |
| Balance as of December 31, 2008 | | | | $ | 334,037 | | | $ | — | | | $ | 334,037 | |
Impairment of goodwill is required to be tested at least annually. Impairment is tested by comparing the fair values of the applicable reporting units with the carrying amount of their net assets, including goodwill. If the carrying amount of the reporting unit’s net assets exceeds the unit’s fair value, an impairment loss would be recognized in an amount equal to the excess of the carrying amount of goodwill over its implied fair value. The implied fair value of goodwill is determined in the same manner as the amount of goodwill recognized in a business combination with the fair value of the reporting unit deemed to be the purchase price paid.
The fair value of each reporting unit was determined at December 31, 2008, 2007 and 2006 by weighting a combination of the present value of the Company’s discounted anticipated future operating cash flows and values based on market multiples of revenue and earnings before interest, taxes, depreciation and amortization (“EBITDA”) of comparable companies. Such valuations resulted in the Company recording a goodwill impairment loss of approximately $9.6 million, $0.9 million and $23.0 million for the years ended December 31, 2008, 2007 and 2006, respectively. Such losses were attributable to downward revisions of earnings forecasted for future years and an increase in the discount rate due to operating results that were worse than anticipated.
The impairment charge with respect to the Internet segment was solely due to impairment in the online reporting unit of the Internet segment. The online reporting unit, launched in 1995, consists of branded websites, including Penthouse.com and Danni.com. It does not contain any of the assets acquired in the Various transaction, which are contained in the dating reporting unit and the Streamray reporting unit of the Internet segment. Due to a significant reduction in the Company’s forecasts of revenue and profitability for the online reporting unit, the fair value of the unit was determined to be less than its carrying value. Discounted anticipated future operating cash flows used to determine the fair value of the reporting unit were based upon assumptions with respect to future growth and
F-17
FRIENDFINDER NETWORKS INC. (FORMERLY KNOWN AS PENTHOUSE MEDIA GROUP INC.)
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE G — GOODWILL (Continued)
trends, discount rates and other variables. Key assumptions used were a discount rate of 16%, and an expected long-term growth rate of 3%. In addition, in calculating the implied fair value of goodwill, a royalty rate of 7% was derived from analysis of comparable companies in order to determine the value of trademarks utilized by the unit.
Management believes that the assumptions used in performing the impairment analysis are reasonable; however, they are inherently uncertain. A 1% change in any of the above three key assumptions could result in an impairment charge ranging from $6,231 to $7,527.
NOTE H — INTANGIBLE ASSETS
Other intangible assets consist of the following (in thousands):
| | | | December 31,
| |
|---|
| | | | 2008
| | 2007
| |
|---|
| | | | Gross
Amount
| | Accumulated
Amortization
| | Gross
Amount
| | Accumulated
Amortization
| | Estimated
Useful Lives
(Years)
| |
|---|
Amortizable intangible assets:
| | | | | | | | | | | | | | | | | | | | | | | | | | |
| Non-compete agreements | | | | $ | 10,600 | | | $ | 3,771 | | | $ | 10,600 | | | $ | 231 | | | | 3 | | | | | |
| Customer lists | | | | | 28,540 | | | | 17,259 | | | | 28,540 | | | | 5,835 | | | | 2–4 | | | | | |
| Service contracts | | | | | 72,800 | | | | 15,583 | | | | 72,800 | | | | 804 | | | | 3–5 | | | | | |
| Studio contracts | | | | | 3,300 | | | | 881 | | | | 3,300 | | | | 44 | | | | 4 | | | | | |
| Other | | | | | 2,840 | | | | 2,840 | | | | 2,840 | | | | 2,840 | | | | 3 | | | | | |
| | | | | $ | 118,080 | | | $ | 40,334 | | | $ | 118,080 | | | $ | 9,754 | | | | | | | | | |
For the years ended December 31, 2008, 2007 and 2006, aggregate amortization expense amounted to $30,581,000, $3,837,000 and $2,626,000, respectively. Estimated future amortization expense is as follows: $29,662,000 (2009), $19,017,000 (2010), $15,580,000 (2011) and $13,487,000 (2012).
Trademarks relate to publishing, licensing and studio operations which are included in the Entertainment segment. For the years ended December 31, 2008 and 2007, a trademark impairment loss of $14,860,000 and $5,131,000 was recognized. Such loss resulted due to the estimated fair value of the trademarks being less than their carrying value. The fair value of trademarks related to publishing is estimated based on an income approach using the relief-from-royalty method. This methodology assumes that, in lieu of ownership, a firm would be willing to pay a royalty in order to exploit the related benefits of these types of assets. This approach is dependent on a number of factors, including estimates of future growth and trends, royalty rates in the category of intellectual property, discount rates and other variables. The fair value of trademarks related to licensing is based on an income approach using the present value of discounted anticipated operating cash flows. The Company bases its fair value estimates on assumptions it believes to be reasonable, but which are unpredictable and inherently uncertain. The impairment of trademarks mainly resulted from declines in projected operating results and cash flows related to publishing and licensing.
F-18
FRIENDFINDER NETWORKS INC. (FORMERLY KNOWN AS PENTHOUSE MEDIA GROUP INC.)
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE I — ACCRUED EXPENSES AND OTHER LIABILITIES
Accrued expenses and other liabilities consist of the following (in thousands):
| | | | December 31,
| |
|---|
| | | | 2008
| | 2007
|
|---|
| Accrued liability related to VAT | | | | $ | 81,954 | | | $ | 81,002 | |
| Chargeback reserve | | | | | 530 | | | | 463 | |
| Compensation and benefits | | | | | 1,733 | | | | 1,866 | |
| Accrued marketing | | | | | 1,972 | | | | 1,700 | |
| Legal and related expenses | | | | | 1,158 | | | | 4,819 | |
| Accrued interest | | | | | 1,966 | | | | 5,190 | |
| Accrued commissions to third party websites | | | | | 4,496 | | | | 3,272 | |
| Other | | | | | 6,453 | | | | 4,200 | |
| | | | | $ | 100,262 | | | $ | 102,512 | |
Effective July 1, 2003, as a result of a change in the law in the European Union, Various was required to collect value added tax (“VAT”) from customers in connection with their use of internet services in the European Union provided by Various and remit the VAT to the taxing authorities in the various European Union countries. As Various did not separately charge its customers for, or remit, the VAT, a liability has been recorded at the date of acquisition to reflect the estimated VAT which should have been collected and remitted on Various’ revenues derived from the various European Union countries since July 1, 2003 or other local implementation date. In addition, a liability has been recorded at the date of acquisition for interest and penalties related to the unremitted VAT and failure to file tax returns. The aggregate liability recorded at the date of acquisition amounted to $78,090,000 (see Note C(1)). Effective July 2008, Various registered in the European Union and on July 29, 2008 began separately charging VAT to its customers. As of December 31, 2008 and 2007, the aggregate liability, which is denominated in pounds and Euros, amounted to $81,954,000 and $81,002,000 respectively, which includes VAT ($43,462,000 and $41,985,000), interest ($11,879,000 and $7,608,000) and penalties ($25,686,000 and $31,408,000). The aggregate liability as of December 31, 2008 includes $11,781,000 related to 2008 operations, of which $8,083,000 was incurred prior to the Company separately charging VAT to its customers, and $925,000 related to settlements with certain taxing authorities. The consolidated statements of operations for the years ended December 31, 2008 and 2007, respectively, include a foreign currency transaction gain of $15,195,000 and $545,000 primarily related to the liability, VAT of $8,083,000 and $1,865,000 (offset against net revenue) and interest and penalties related to VAT of $8,429,000 and $1,592,000. In addition, as the allocation period to determine the fair value of the VAT obligation has ended the 2008 results of operations includes a $2,690,000 gain related to settlement of a pre-acquisition VAT liability with certain of the European Union countries.
Various has been notified that the German tax authorities and the Office of the District Attorney in Bonn have been investigating Various’ former Chief Executive Officer for alleged intentional evasion of VAT on revenues collected from customers located in Germany commencing in 2003. Various has also negotiated a settlement with the German authorities to drop criminal charges against a current officer by payment of approximately $2.3 million, which represents a portion of the total amount owed of the historical uncollected German VAT liability. In connection with the settlement, the Company will pay a fine of e25,000 to a charitable organization. The $2.3 million is payable in equal monthly installments of approximately $380,000 commencing April 1, 2009. On April 18, 2008, a court in Germany granted authorities a search and seizure order that allowed them to seize documents from Various’ office located in Germany in order to determine the amount of revenue subject to VAT. In addition, the German court also issued an order authorizing the freezing of Various’ funds, in the amount of e610,343, held by Various’ credit card processors located in the Netherlands and Germany to secure the VAT estimated by the tax authorities to be due from Various from revenue from internet websites in Germany. At December 31, 2008, the frozen Euros are included in restricted cash in the amount of $850,000.
F-19
FRIENDFINDER NETWORKS INC. (FORMERLY KNOWN AS PENTHOUSE MEDIA GROUP INC.)
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE J — LONG-TERM DEBT
Long-term debt consists of the following (in thousands):
| | | | December 31,
| |
|---|
| | | | 2008
| | 2007
| |
|---|
| | | | Principal
| | Unamortized
Discount
| | Principal
| | Unamortized
Discount
|
|---|
Debt issued by INI in connection with the acquisition of Various:
| | | | | | | | | | | | | | | | | | |
| First Lien Senior Secured Notes due 2009–2011, including principal of $93,343 and $103,338 ($83,589 and $90,554 net of discount) issued to selling stockholders, respectively (a) | | | | $ | 233,001 | | | $ | 24,387 | | | $ | 257,338 | | | $ | 36,378 | |
Second Lien Subordinated Secured Notes due 2011 issued to selling stockholders (a)
| | | | | 80,000 | | | | 5,058 | | | | 80,000 | | | | 6,492 | |
| Subordinated Convertible Notes due 2011 issued to selling stockholders (b) | | | | | 111,206 | | | | 20,454 | | | | 105,720 | | | | 24,672 | |
| Other (c) | | | | | 4,000 | | | | 776 | | | | 5,000 | | | | 1,365 | |
| Senior Secured Notes of FriendFinder due 2010 (d) | | | | | 44,530 | | | | 1,968 | | | | 44,530 | | | | 2,733 | |
| Subordinated Term Notes of FriendFinder due 2011 (e) | | | | | 36,432 | | | | — | | | | 32,238 | | | | — | |
| | | | | $ | 509,169 | | | $ | 52,643 | | | $ | 524,826 | | | $ | 71,640 | |
| Less unamortized discount | | | | | (52,643 | ) | | | | | | | (71,640 | ) | | | | |
| Long-term debt classified as current due to events of default, net of unamortized discount of $52,397 and $70,275, respectively | | | | | (415,606 | ) | | | | | | | (417,310 | ) | | | | |
| Less current installment of long-term debt, net of unamortized discount of $246 and $503, respectively | | | | | (2,152 | ) | | | | | | | (497 | ) | | | | |
| | | | | $ | 38,768 | | | | | | | $ | 35,379 | | | | | |
| (a) | | The First Lien Senior Secured Notes (“First Lien Notes”), of which approximately $110,000,000 principal amount were issued to the Company’s stockholders including $10,000,000 to entities controlled by certain officers and directors, were issued with an original issue discount of $7,720,000 or approximately 3.0%, mature on June 30, 2011, and accrue interest at a rate per annum equal to the sum of the greater of three month LIBOR (1.4% at December 31, 2008) or 4.5%, plus 8.0%. Interest on the notes is payable quarterly on March 31, June 30, September 30 and December 31 of each year. Principal on the First Lien Notes is payable quarterly to the extent of 90% of Excess Cash Flow, as defined, subject to minimum amounts. Minimum principal amortization is payable as follows (in thousands): $1,398 (2009), $38,601 (2010), and $193,003 (2011). The 2009 minimum amount has been reduced by principal payments of $24,336 made by the Company in 2008 as a result of the excess cash flow requirements. |
The First Lien Notes are guaranteed by Various and its subsidiaries and are collateralized by a first-priority lien on all of their assets as well as a pledge of the Various stock and a lien on any rights to indemnification and other rights under the purchase agreement with the former stockholders of Various. In addition, FriendFinder and each of FriendFinder’s subsidiaries guaranteed INI’s obligations under the notes. The guarantees are collateralized by the assets of the guarantors; however, such security interest is subordinate to the security interest of holders of FriendFinder’s Senior Notes.
F-20
FRIENDFINDER NETWORKS INC. (FORMERLY KNOWN AS PENTHOUSE MEDIA GROUP INC.)
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE J — LONG-TERM DEBT (Continued)
The First Lien Notes are redeemable at the option of INI, in whole but not in part, at 105% of principal through December 6, 2009 and at 102% of principal thereafter through December 6, 2010 and at principal thereafter through maturity on June 30, 2011, plus accrued and unpaid interest. In the event of an IPO, at least 50% of the net proceeds must be used to redeem the First Lien Notes at 115% of principal plus accrued and unpaid interest. In addition, note holders have the option of requiring INI to repay the First Lien Notes in full upon a Liquidity Event (defined as liquidation, winding up, change of control (other than an IPO), merger, or a sale of all or substantially all of the assets of INI or of FriendFinder).
The Second Lien Subordinated Secured Notes (“Second Lien Notes”) mature on December 6, 2011, bear interest at 15% payable quarterly in cash, are guaranteed by Various and its subsidiaries and are collateralized by a second-priority lien on all of their assets and a pledge of the Various stock. The notes are also guaranteed by FriendFinder and its subsidiaries which guarantees are collateralized by the assets of the guarantors; however, such security interest is subordinate to those holders of FriendFinder’s Senior Notes and the First Lien Notes. The Second Lien Notes are redeemable, at the option of INI, in whole or in part, at 100% of principal plus accrued and unpaid interest. Upon the payment in full of the First Lien Notes, principal on the Second Lien Notes is payable quarterly to the extent of 90% of Excess Cash Flow, as defined. In addition, the Second Lien Notes are payable out of a portion of the net proceeds of an IPO or upon a Liquidity Event.
The First and Second Lien Notes require INI and its subsidiaries to maintain specified levels of EBITDA and other financial ratios and limits their capital expenditures and indebtedness. In addition, the First and Second Lien Notes provide that INI can distribute to FriendFinder up to 10% of INI’s Excess Cash Flow, as defined, each quarter for the purpose of making interest payments on FriendFinder’s Senior Notes provided no defaults exist or would result therefrom. INI was also allowed to distribute to FriendFinder not more than $6 million ($5 million of which is to be used for general corporate purposes) during the first quarter of fiscal 2008 and an additional $3 million during fiscal 2008, at the rate of $1 million each subsequent quarter, which was limited to actual fees and expenses of third parties incurred in connection with an IPO. The Company would require a modification of the note agreements or waivers thereof to receive additional distributions for IPO expenses or general corporate purposes for periods subsequent to December 31, 2008. During 2008 amounts distributed from INI for payment of IPO expenses were used for general corporate purposes. In addition, in January 2009, INI distributed additional funds to pay expenses to be incurred during the first quarter of 2009. These transactions constituted a breach of covenants under the note agreements.
FriendFinder issued to the purchasers of the First and Second Lien Notes, detachable warrants to purchase 84,212,295 and 23,759,593 shares of FriendFinder’s common stock, respectively, at an exercise price of $0.00001 per share. The warrants expire in December 2017, or, if earlier, upon the consummation of an underwritten public offering of FriendFinder common stock. The warrants were valued at $0.28 each based upon the estimated fair value of a share of the Company’s common stock. Such fair value was determined using the discounted future operating cash flows, comparable company multiples and guideline transaction valuation methodologies. The valuation, which was performed on a retrospective basis, considered four scenarios, three where an IPO would occur and one where it would not. Probabilities were assigned to these outcomes, with the non-IPO scenario weighted at 80%. Applying these weights arrived at the value noted above. The aggregate warrant value of $30,120,000, which was credited to capital in excess of par value, was recorded as a discount of $23,492,000 on the First Lien Notes and $6,628,000 on the Second Lien Notes and is being amortized as interest expense (by use of the interest method) over the term of the respective notes. FriendFinder has granted the holders of the warrants piggyback and up to three demand registration rights to register the shares of common stock issuable upon exercise of the warrants.
Certain principal stockholders of the Company granted to former owners of Various in connection with their holdings of First Lien Notes fully vested options to purchase 20,381,276 shares of the Company’s common stock owned by the principal stockholders at an exercise price of $0.01 per share. The options are exercisable at any time until the consummation of a Qualified IPO, as defined. The fair value of the options, amounting
F-21
FRIENDFINDER NETWORKS INC. (FORMERLY KNOWN AS PENTHOUSE MEDIA GROUP INC.)
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE J — LONG-TERM DEBT (Continued)
to $5,706,000, has been credited to capital in excess of par value and recorded as a discount on the First Lien Notes. In addition, a related deferred tax liability of $2,282,000, resulting from the difference between the carrying value of the notes and their tax basis attributable to recording of the discount, has been charged to capital in excess of par value.
Events of default have occurred with respect to the First and Second Lien Notes relating to certain representations and warranties having been materially incorrect when made. In addition, during 2008, the Company has not performed or complied with certain conditions, covenants and agreements, including the restricted payment covenant referred to above, a financial covenant to achieve a minimum consolidated annualized EBITDA and other affirmative and negative covenants during each of the quarters ended March 31, June 30, and September 30, 2008. As a result, noteholders holding 51% of the outstanding principal balance of First Lien Notes other than those held by the former stockholders of Various and holders of 51% of the outstanding principal balance of the Second Lien Notes may declare a default and demand repayment of the notes, in which event the maturity of the notes will be accelerated. Accordingly, the First Lien and Second Lien Notes have been classified as current obligations on the accompanying balance sheets at December 31, 2008 and 2007.
| (b) | | The Subordinated Convertible Notes (“Convertible Notes”) mature on December 6, 2011 and bear interest at 6% which may be paid in additional Convertible Notes at INI’s option. The notes have been recorded at estimated fair value at the date of issuance, resulting in an effective interest rate of approximately 13% and discount of $24,977,000, which is being amortized as interest expense (by use of the interest method) over the term of the notes. During 2008, interest amounting to $6,892,000 was paid through issuance of additional Convertible Notes. The notes are the unsecured obligation of INI and are guaranteed by FriendFinder. The notes are subordinate in right of payment to the First and Second Lien Notes. The guarantee is subordinate to the prior payment of FriendFinder’s Senior Notes and the guarantee of the First and Second Lien Notes and pari passu in right of payment with FriendFinder’s Subordinated Term Notes. The notes which had an original principal amount of $170,000,000 are subject to reduction to the extent certain post-closing bonuses of up to $3.5 million are paid by Various over a three-year period and for a post-closing working capital adjustment. During 2008, as a result of payment of $1.4 million in bonuses which was charged to expense, the principal amount of the notes was reduced and the carrying value of the notes was reduced by $1.1 million with a corresponding reduction in goodwill. The post-closing working capital adjustment determined by the Company resulted in an indemnity claim which has been reflected as a reduction of $64,279,357 in the principal amount of the notes and a $10,000,000 receivable from an escrow fund set up in connection with the acquisition (see the second to last paragraph of Note P). |
Until the First and Second Lien Notes and FriendFinder’s Senior Notes are repaid in full, no payments of principal or interest (other than interest payable through issuance of additional notes) may be made on the Convertible Notes. Thereafter, the Convertible Notes may be prepaid at the option of INI, in whole or in part, at 100% of principal plus accrued and unpaid interest and are convertible into shares of FriendFinder’s common stock, in whole or in part, at either the holder’s or the Company’s option, at any time after the later to occur of (i) the one-year anniversary of the date of their issuance and (ii) the consummation of an IPO. The conversion price will be the per share offering price in the IPO. If converted at the holder’s option, the aggregate number of shares issuable upon the conversion of the notes will be the number of shares not to exceed 17% of the fully diluted equity of FriendFinder calculated at the time of the first such conversion. FriendFinder has granted the holders of the Convertible Notes piggyback and up to two demand registration rights to register the shares of common stock issuable upon conversion of the notes.
As described in (a) above, as of December 31, 2008 and 2007, events of default existed under the First and Second Lien Notes issued by INI which could result in the potential acceleration of the maturity of such notes. In such event, the maturity of the Convertible Notes would also be accelerated pursuant to cross-default
F-22
FRIENDFINDER NETWORKS INC. (FORMERLY KNOWN AS PENTHOUSE MEDIA GROUP INC.)
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE J — LONG-TERM DEBT (Continued)
provisions. Accordingly, the Convertible Notes have been classified as a current liability in the accompanying balance sheets as of December 31, 2008 and 2007.
| (c) | | In connection with the acquisition of Various, INI issued a non-interest bearing obligation with a principal balance of $5.0 million to a former owner. In 2008, $1.0 million of the notes were paid. Remaining principal payments are $1.0 million in 2009 and $3.0 million in 2010. The obligation was recorded at a present value of $3.6 million using a discount rate of 15%. |
For the year ended December 31, 2008 and for the period from December 7, 2007 through December 31, 2007, interest expense, including amortization of discount, related to the debt issued in connection with the acquisition of Various amounted to approximately $67,678,000 and $4,800,000, respectively.
| (d) | | On August 17, 2005, the Company issued $33,000,000 of 11% Senior Secured Notes due July 31, 2010 (“Notes”). Interest on the Notes, which was increased to 15% effective December 6, 2007, is payable quarterly. The Notes are collateralized by a first-priority security interest in all of the Company’s assets, other than those of INI and its subsidiaries for which a third-priority security interest has been granted. The Notes are redeemable by the Company, in whole or in part, at 101.5% of principal through August 17, 2009, and 100% of principal thereafter through maturity, plus accrued and unpaid interest. |
On August 28, 2006, in connection with the issuance of the New Notes referred to below, the agreement pursuant to which the notes were issued was modified to, among other matters, increase the interest rate on the Notes to 14% and conform the covenants and restrictions to those of the New Notes. In addition, the exercise price of warrants to purchase 4,865,619 common shares issued to the holders of the Notes was changed to $0.00001 per share from $0.32 per share. The excess of the fair value of the modified warrants over their fair value immediately prior to the modification amounted to $461,000. In accordance with EITF 96-19, the increase in interest rate was considered to be a substantial modification of terms and, accordingly, the modification was accounted for like an extinguishment of debt and the creation of new debt, resulting in a loss of $3,799,000, attributable to the expensing of unamortized debt discount and issuance costs related to the Notes and the increase in value of the modified warrants. The new debt was valued at $32,049,000, net of discount of $951,000 based on an effective interest rate of 15%.
On August 28, 2006, the Company issued $5,000,000 of 15% Senior Secured Notes due July 31, 2010 (the “New Notes” and together with the Notes, the “Senior Secured Notes”) to certain holders of the original Notes described above. In addition, the holders of the New Notes were granted warrants to purchase 8,829,359 shares of voting common stock, at an exercise price of $0.00001 per share which are exercisable, in whole or in part, at any time through August 2016, provided that the warrants terminate if not exercised in full concurrently with the consummation of a qualified IPO, as defined. The proceeds of the offering, which were allocated to the New Notes ($2,414,000) and warrants ($2,536,000) based on their relative fair value, were used to pay interest due on the original Notes of approximately $1,827,000, to acquire the assets of Jill Kelly Productions, Inc. for approximately $1,665,000 (see Note C(3)), and the balance of approximately $1,458,000 was used to pay transaction fees and expenses and for general corporate purposes. Interest on the New Notes, as amended, is payable quarterly. For the year ended December 31, 2007, approximately $1,018,000 of interest on the New Notes was paid through the issuance of New Notes. Interest may be paid by issuing additional notes through January 31, 2008. Interest is payable in cash thereafter. The New Notes are collateralized by a first-priority security interest in all of the Company’s assets, other than those of INI and its subsidiaries for which a third-priority security interest has been granted. The Company may redeem all or part of the New Notes at 101.5% of principal through August 28, 2009 and 100% thereafter through maturity, plus accrued and unpaid interest.
The agreements pursuant to which the Senior Secured Notes were issued require the Company to maintain specified minimum levels of EBITDA and other financial ratios and limits sales of assets, capital expenditures
F-23
FRIENDFINDER NETWORKS INC. (FORMERLY KNOWN AS PENTHOUSE MEDIA GROUP INC.)
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE J — LONG-TERM DEBT (Continued)
and indebtedness. In addition, the agreements restrict the payment of dividends and limits changes in the Company’s business. As of December 31, 2006, events of default had occurred under the Senior Secured Note agreements, including noncompliance with certain financial covenants. On December 6, 2007, in connection with the acquisition of Various, the holders of the Senior Secured Notes waived such events of default, including those related to quarterly financial covenants, through March 31, 2008. In addition, the interest rate on the Notes issued in 2005 was increased to 15%, interest payments were changed from a semi-annual to a quarterly basis, and the senior noteholders were paid a $1,000,000 fee together with $5,530,000 of accrued interest through the issuance of additional Senior Secured Notes. As described in (a) above, as of December 31, 2008 and 2007, events of default exist under the First and Second Lien Notes issued by INI which could result in a potential acceleration of the maturity of such notes. In such event, the maturity of the senior notes would also be accelerated pursuant to cross default provisions. In addition, absent the waiver the Company would not have been in compliance with certain of the quarterly financial covenants at December 31, 2007 and it was probable that the Company would not be able to comply with such covenants during the fiscal quarters ending in 2008. During 2008, the Company was not in compliance with certain of the quarterly financial covenants. Accordingly, the Senior Secured Notes have been classified as a current liability in the accompanying balance sheets at December 31, 2008 and 2007.
| (e) | | In October 2004, as part of the plan of reorganization pursuant to which the Company emerged from bankruptcy proceedings, the Company issued $32,546,000 of term notes. In connection with the issuance of Senior Secured Notes in August 2005, the Company redeemed $8,513,000 of term notes payable to unrelated creditors in order to receive their consent to borrow funds from holders of the Senior Secured Notes. The remaining outstanding balance of $24,033,000 (“Subordinated Term Notes”) payable to the term noteholders was subordinated to the interests of the holders of the Senior Secured Notes. The Subordinated Term Notes, which are held by entities controlled by certain principal stockholders of the Company who are also officers and directors, mature on October 1, 2011, are redeemable by the Company at 100% of principal plus accrued and unpaid interest, and bear interest at a rate of 13% payable annually in arrears beginning October 5, 2005. Beginning in October 2005 through October 2007, interest is payable in cash or “in-kind” by issuing additional subordinated notes at the Company’s discretion; thereafter, interest is payable in kind unless the Company achieves minimum EBITDA, as defined, and an interest coverage ratio, as defined, of at least 3 to 1. |
Interest expense on term notes amounted to $4,321,000, $3,822,000, and $3,301,000 for the years ended December 31, 2008, 2007 and 2006, respectively, of which $4,191,000, $3,703,000 and $3,177,000 was paid through issuance of additional subordinated notes. On October 14, 2006, subordinated noteholders advanced $916,000 to the Company to fund a portion of the purchase price of two adult entertainment production companies (see Note C(2)). Subordinated Term Notes payable were increased by the advance.
The Subordinated Term Notes are collateralized by a second priority security interest in all assets of the Company other than those held by INI and its subsidiaries and are subordinate to the notes issued by INI as well as the Senior Secured Notes issued by FriendFinder and may not be redeemed while any of such notes remain outstanding.
The indenture governing the Subordinated Term Notes significantly restricts the Company’s ability to sell assets and incur debt and prohibits the Company from paying dividends. Further, the indenture requires the noteholders’ approval for the Company to enter into new lines of business or to sell or otherwise convey the Penthouse trademark, other than in the ordinary course of business, or to sell other assets for net proceeds in excess of $10 million.
On December 19, 2008, the holders of the Subordinated Term Notes waived the cross-default provisions with respect to existing events of default with the Senior Secured Notes and the First and Second Lien Notes issued by INI. Accordingly, the Subordinated Term Notes are classified as long-term debt in the accompanying balance sheets at December 31, 2008 and 2007.
F-24
FRIENDFINDER NETWORKS INC. (FORMERLY KNOWN AS PENTHOUSE MEDIA GROUP INC.)
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE J — LONG-TERM DEBT (Continued)
Principal of long-term debt matures as follows (in thousands):
Year
| | | | Amount
|
|---|
| 2009 | | | | $ | 2,398 | |
| 2010 | | | | | 86,131 | |
| 2011 | | | | | 420,640 | |
| | | | | $ | 509,169 | |
The above table excludes the effect of existing events of default which may result in the acceleration of the maturity of the related notes and reflects the required minimum principal amortization due. As described above, principal payments on the First and Second Lien Notes may be accelerated depending on the cash flows of Various.
NOTE K — STOCKHOLDERS’ EQUITY
On March 31, 2006, FriendFinder, previously a Delaware corporation, merged into one of its wholly-owned subsidiaries organized in the State of Nevada. The purpose of the merger was to change FriendFinder’s jurisdiction of incorporation from Delaware to Nevada. In the merger, a 100-for-1 stock split was effected, whereby each share of the Delaware corporation’s capital stock was converted into the right to receive 100 shares of the surviving Nevada corporation’s capital stock, in the same class or series, and possessing identical rights, privileges and preferences, as the share of the Delaware corporation being converted. Numbers of shares and per share amounts have been adjusted to give retroactive effect to such split in the accompanying consolidated financial statements and notes. Following the merger, FriendFinder’s authorized share capital was 500,000,000 shares of common stock having a par value of $0.01 per share, of which 250,000,000 shares were each designated as common stock voting and Series B common stock non-voting, and 100,000,000 shares of preferred stock having a par value of $0.01 per share, of which 50,000,000 shares were designated Series A Convertible Preferred Stock. Other than voting, the rights of the common stock and Series B common stock are identical. The Series B common stock can be exchanged for a like number of shares of common stock immediately prior to the earliest to occur of (i) a consummation of a sale of all or substantially all of the assets or capital stock of the Company to any unaffiliated third party or the merger, consolidation or combination of the Company with any unaffiliated third party or (ii) the consummation of an underwritten IPO of securities of the Company or the reverse merger of the Company with or into a publicly traded company.
On November 13, 2007, FriendFinder’s articles of incorporation were amended to authorize it to issue 1.25 billion shares of common stock having a par value of $0.01 per share, of which 250,000,000 shares are designated as Series B common stock non-voting, and 250,000,000 shares of preferred stock having a par value of $0.01 per share of which 50,000,000 shares are designated as Series A Convertible Preferred Stock (“Series A Preferred”) and 200,000,000 shares are designated as Series B Convertible Preferred Stock (“Series B Preferred”).
From June through November 2007, FriendFinder received an aggregate of $5 million to fund its operations principally from certain of its principal stockholders in exchange for 168,897,005 shares of newly authorized Series B Preferred at a price of $0.029604 per share. In connection therewith, FriendFinder issued warrants to purchase a total of 45,019,915 shares of common stock at an exercise price of $0.00001 per share to holders of Series A Preferred and existing warrants in exchange for the holders waiving the anti-dilution provisions under these instruments. FriendFinder recorded a deemed non-cash preferred stock dividend of $447,000 on the Series A Preferred with respect to the warrants issued to the Series A holders and a distribution of $886,000 to warrant holders for the warrants issued to them.
Series B Preferred ranks senior to FriendFinder’s common stock and on parity with the Series A Preferred. Series B Preferred may be converted at the holder’s option at any time into shares of FriendFinder’s voting common stock at the initial rate of one share of voting common stock for each share of Series B Preferred, subject to adjustment
F-25
FRIENDFINDER NETWORKS INC. (FORMERLY KNOWN AS PENTHOUSE MEDIA GROUP INC.)
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE K — STOCKHOLDERS’ EQUITY (Continued)
for certain dilutive events. Series B Preferred shares carry voting rights on all matters to be voted upon by the stockholders, and on any particular matter each holder of Series B Preferred is entitled to the number of votes equal to the number of whole shares of voting common stock into which such holder’s Series B Preferred shares would be convertible as of the record date for determining the stockholders entitled to vote on the matter. Series B Preferred shares are entitled to receive ratably such dividends, if any, as may be declared by the board of directors. Dividends are not cumulative. Each share of Series B Preferred has a liquidation preference equal to the greater of (x) the original issue price for such share ($0.029604 per share), plus declared and accrued but unpaid dividends, and (y) such amount as would have been payable had such share been converted into voting common stock immediately prior to the liquidation, dissolution or winding up. Subject to certain conditions, the holders of the Series B Preferred have preemptive rights on any sale by FriendFinder of any shares of, or any securities convertible into or exercisable for shares of, any class of FriendFinder’s capital stock. Such preemptive rights expire immediately prior to an IPO.
Concurrent with the issuance of notes in August 2006, an entity controlled by the Company’s majority stockholders and affiliated entities purchased 10,096,011 shares of Series A Preferred at $0.5943 per share for a total consideration of $6,000,000.
Series A Preferred ranks senior to FriendFinder’s common stock and on parity with the Series B Preferred. Series A Preferred may be converted at the holder’s option at any time into shares of FriendFinder’s voting common stock at the initial rate of one share of voting common stock for each share of Series A Preferred, subject to adjustment for certain anti-dilutive events. Series A Preferred shares carry voting rights on all matters to be voted upon by the stockholders, and on any particular matter each holder of Series A Preferred is entitled to the number of votes equal to the number of whole shares of voting common stock into which such holder’s Series A Preferred shares would be convertible as of the record date for determining the stockholders entitled to vote on the matter. Under certain circumstances, the written consent of the holders of Series A Preferred is required to take certain actions, including, for example, to amend FriendFinder’s articles of incorporation, effect a change of control, and declare any dividend or make any distribution on any of FriendFinder’s capital stock. Series A Preferred shares are entitled to receive ratably such dividends, if any, as may be declared by the board of directors. Dividends are not cumulative. Each share of Series A Preferred has a liquidation preference equal to the greater of (x) the original issue price for such share ($0.5943 per share), plus declared and accrued but unpaid dividends, and (y) such amount as would have been payable had such share been converted into voting common stock immediately prior to the liquidation, dissolution or winding up. Subject to certain conditions, the holders of the Series A Preferred have preemptive rights on any sale by FriendFinder of any shares of, or any securities convertible into or exercisable for shares of, any class of FriendFinder’s capital stock. Such preemptive rights expire immediately prior to an IPO.
No dividend may be declared or paid on shares of common stock unless holders of Series A Preferred and Series B Preferred first or simultaneously receive a per share dividend equivalent to that payable on common shares into which the Series A and Series B Preferred are then convertible. All accrued but unpaid dividends must be included in the liquidation preference of the preferred stock payable upon a liquidation, dissolution or winding up of the Company.
Subject to certain conditions and limitations, FriendFinder has granted the holders of Series A Preferred piggyback and demand registration rights to register the shares of common stock issuable upon conversion of the Series A Preferred or the exercise of related warrants.
F-26
FRIENDFINDER NETWORKS INC. (FORMERLY KNOWN AS PENTHOUSE MEDIA GROUP INC.)
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE K — STOCKHOLDERS’ EQUITY (Continued)
As of December 31, 2008, outstanding warrants to purchase voting common stock of the Company are as follows:
Expiration Date(1)
| | | | Exercise Price
| | Number of Shares(2)
|
|---|
| August 2015 | | | | $ | 0.32 | | | | 9,278,783 | |
| August 2015 | | | | $ | 0.59 | | | | 501,800 | |
| August 2015 | | | | $ | 0.00001 | | | | 4,865,619 | |
| August 2016 | | | | $ | 0.00001 | | | | 8,829,359 | |
| December 2017 | | | | $ | 0.00001 | | | | 119,257,803 | |
| | | | | | | | | | 142,733,364 | |
(1) | | Warrants terminate if not exercised concurrently with the consummation of an IPO, if earlier than their stated expiration date. |
(2) | | The number of shares of common stock for which each warrant is exercisable will be decreased immediately prior to the closing of an IPO in the event that the Company has issued prior to such IPO fewer than 26,879,946 shares or options pursuant to an equity incentive or benefit plan. |
On May 18, 2008, certain of the Company’s stockholders exercised warrants issued in connection with the First Lien Notes having an exercise price of $0.00001 (see Note J(a)) for an aggregate of 33,734,000 shares of its voting common stock, resulting in a transfer of $338,000 from capital in excess of par value to common stock for the par value of the shares.
NOTE L — STOCK OPTIONS
On April 3, 2008, the Company’s board of directors adopted and the stockholders approved the 2008 Stock Option Plan (the “Plan”). The maximum number of shares for which stock options may be granted under the Plan is 26,879,946 shares, subject to adjustment. Stock options may be issued to employees, directors, and consultants, selected by a committee of the board of directors. Under the terms of the Plan, the options granted shall expire no later than 10 years from the date of grant and will vest 20% on the first anniversary of the grant date and 20% on each succeeding four anniversaries of the grant date, provided, however, that an optionee may exercise the vested portion of a stock option only after that date which is 18 months after the date of an IPO of the Company’s common stock. The exercise price of an option shall be the closing price of the common stock on a national securities exchange on the date immediately preceding the date of grant or if the common stock is not traded on a national securities exchange, its fair value as determined in good faith by the board of directors.
From April through October 2008, the Company granted options to purchase a total of 13,910,000 shares of the Company’s common stock to employees, non-employee directors as well as to one board advisor under the Plan. The options, all of which are outstanding at December 31, 2008, vest ratably over the five years following the grant date, however the vested portion of a stock option may be exercised only after that date which is 18 months after the date of the consummation of an IPO. Each option will expire no more than ten years from its date of grant, except in the event of death in which case the options will expire six months from the date of death. The exercise price of these options will be set at the price per share that the Company’s common stock is sold to the public pursuant to an IPO. As a successful completion of an IPO is necessary in order for an option to be exercised, no compensation cost will be recognized until the occurrence of such event. Consequently, the Company has not recognized any compensation related to these options during the year ended December 31, 2008.
Upon successful completion of an IPO, compensation cost will be accrued for each vesting tranche over the requisite service period commencing on the date the options were granted and ending on the later of the vesting date or 18 months after the date of the IPO. Accordingly, the date the IPO is completed, a cumulative adjustment will be made to record compensation cost which accrued prior to such date, based on the fair value of the options on the IPO date.
F-27
FRIENDFINDER NETWORKS INC. (FORMERLY KNOWN AS PENTHOUSE MEDIA GROUP INC.)
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE M — INCOME TAXES
FriendFinder and its subsidiaries file a consolidated federal income tax return.
The components of the income tax benefit are as follows (in thousands):
| | | | Year Ended December 31,
| |
|---|
| | | | 2008
| | 2007
|
|---|
Current:
| | | | | | | | | | |
| Federal | | | | $ | 374 | | | $ | — | |
| State | | | | | — | | | | — | |
| | | | | $ | 374 | | | $ | — | |
Deferred:
| | | | | | | | | | |
| Federal | | | | $ | (13,615 | ) | | $ | (5,194 | ) |
| State | | | | | (4,935 | ) | | | (1,236 | ) |
| | | | | $ | (18,550 | ) | | $ | (6,430 | ) |
| Total tax benefit | | | | $ | (18,176 | ) | | $ | (6,430 | ) |
A reconciliation between the benefit computed at the U.S. federal statutory rate on the pre-tax loss to the tax benefit included in the consolidated statements of operations follows (in thousands):
| | | | Year Ended December 31,
| |
|---|
| | | | 2008
| | 2007
| | 2006
|
|---|
| Tax benefit at federal statutory rate (35%) | | | | $ | 22,450 | | | $ | 12,721 | | | $ | 17,479 | |
| State taxes, net of federal effect | | | | | 3,208 | | | | 804 | | | | — | |
| Impairment of goodwill | | | | | (3,350 | ) | | | (324 | ) | | | (7,988 | ) |
| Net operating loss for which no tax benefit is recognized | | | | | (4,842 | ) | | | — | | | | (9,491 | ) |
| Tax benefit recognized as a reduction of goodwill arising in the Various acquisition | | | | | — | | | | (6,530 | ) | | | — | |
| Non-deductible penalties including related foreign exchange gain | | | | | 1,119 | | | | (177 | ) | | | — | |
| Other | | | | | (409 | ) | | | (64 | ) | | | — | |
| Tax benefit | | | | $ | 18,176 | | | $ | 6,430 | | | $ | — | |
F-28
FRIENDFINDER NETWORKS INC. (FORMERLY KNOWN AS PENTHOUSE MEDIA GROUP INC.)
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE M — INCOME TAXES (Continued)
The components of deferred tax assets and liabilities are as follows (in thousands):
| | | | December 31,
| |
|---|
| | | | 2008
| | 2007
|
|---|
Deferred tax assets:
| | | | | | | | | | |
| Net operating loss carryforwards | | | | $ | 32,005 | | | $ | 39,488 | |
| Allowance for doubtful accounts | | | | | 1,004 | | | | 450 | |
| Accrued expenses | | | | | — | | | | 640 | |
| Accrued liability related to VAT | | | | | 20,568 | | | | 19,837 | |
| Other | | | | | 388 | | | | — | |
| Gross deferred tax assets | | | | | 53,965 | | | | 60,415 | |
| Less valuation allowance | | | | | (9,624 | ) | | | (4,782 | ) |
| Net deferred tax assets | | | | | 44,341 | | | | 55,633 | |
| |
Deferred tax liabilities:
| | | | | | | | | | |
| Trademarks and domain names not subject to amortization | | | | | (27,244 | ) | | | (33,188 | ) |
| Intangible assets subject to amortization | | | | | (31,098 | ) | | | (43,330 | ) |
| Long-term debt | | | | | (8,821 | ) | | | (11,012 | ) |
| Property and equipment | | | | | (4,458 | ) | | | (6,765 | ) |
| Deferred revenue | | | | | — | | | | (7,680 | ) |
| Other | | | | | (512 | ) | | | — | |
| | | | | | (72,133 | ) | | | (101,975 | ) |
| Net deferred tax liabilities | | | | $ | (27,792 | ) | | $ | (46,342 | ) |
Amounts recognized in the consolidated balance sheets consist of (in thousands):
| | | | December 31,
| |
|---|
| | | | 2008
| | 2007
|
|---|
| Deferred tax asset — current | | | | $ | 21,571 | | | $ | 20,927 | |
| Deferred tax liability — non-current | | | | | (49,363 | ) | | | (67,269 | ) |
| Net deferred tax liability | | | | $ | (27,792 | ) | | $ | (46,342 | ) |
At December 31, 2008, the Company had net operating loss carryforwards for federal income tax purposes of approximately $77.2 million available to offset future taxable income which expire at various dates from 2024 through 2027. The Company’s ability to utilize approximately $9.1 million of such carryforwards related to the periods prior to the Company’s exit from Chapter 11 reorganization proceedings is limited due to changes in the Company’s ownership, as defined by federal tax regulations. Realization of the deferred tax assets is dependent on the existence of sufficient taxable income within the carryforward period, including future reversals of taxable temporary differences. The taxable temporary difference related to indefinite-lived trademarks and domain names, which have no tax basis, will reverse when such assets are disposed of or impaired. Because such period is not determinable and, based on available evidence, management was unable to determine that realization of the deferred tax assets was more likely than not, the Company has recorded a valuation allowance against a portion of its deferred tax assets at December 31, 2008.
In connection with the acquisition of Various, deferred tax liabilities were recorded which relate to amortizable intangibles and property and equipment having no tax basis and deferred revenue and certain long-term debt having a higher tax basis than financial reporting basis. As such taxable temporary differences will reverse during the carryforward period, the valuation allowance at the date of acquisition which offset the Company’s deferred tax assets has been reduced by approximately $26 million and accounted for as a reduction of goodwill recorded in connection with the acquisition (see Note C).
F-29
FRIENDFINDER NETWORKS INC. (FORMERLY KNOWN AS PENTHOUSE MEDIA GROUP INC.)
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE M — INCOME TAXES (Continued)
The valuation allowance at December 31, 2007 relates to a portion of pre-reorganization and acquired C corporation entities’ net operating loss carryforwards. There was no utilization of such carryforwards during 2008 and accordingly, as of December 31, 2008, $4.8 million of the valuation allowance relates to pre-reorganization and acquired C corporation entities net operating loss carryforwards. In accordance with SFAS No. 141(R), utilization of such benefits will reduce future income tax expense.
The valuation allowance increased $4.8 million in 2008, decreased $16.8 million in 2007 and increased $10.7 million in 2006.
On January 1, 2007, the Company adopted FASB Interpretation No. 48, “Accounting for Uncertainty in Income Taxes” (“FIN 48”). FIN 48 clarifies the criteria for recognizing tax benefits related to uncertain tax positions under SFAS No. 109, “Accounting for Income Taxes,” and requires additional financial statement disclosure. As required by FIN 48, the Company applied the “more-likely-than-not” recognition threshold to all tax positions commencing at the adoption date which resulted in no unrecognized tax benefits as of such date or at December 31, 2007. As at December 31, 2008, unrecognized tax benefits were not material.
To the extent incurred, the Company classifies interest and penalties accrued on the underpayment of income taxes as interest expense and other expense, respectively.
The Company is no longer subject to federal, state, and local income tax examinations by tax authorities for years before 2005. However, to the extent utilized in the future, the Company’s net operating loss carryforwards originating in such years remain subject to examination.
NOTE N — SEGMENT INFORMATION
Prior to the acquisition of Various, the Company’s reportable segments consisted of Internet, Publishing, Studio and Licensing. Subsequent to the acquisition, for the year ended December 31, 2008, the Internet segment constituted more than 75% of consolidated revenue and was the only segment which constituted at least 10% of the consolidated revenue, profit or assets of all the operating segments and, accordingly, in accordance with SFAS No. 131 “Disclosures about Segments of an Enterprise and Related Information,” the Company combined the Publishing, Studio, and Licensing segments and reported them as “Entertainment” for such period. In addition, the Company reported its segment information for the years ended December 31, 2007 and 2006 in a similar manner. In 2008, the Entertainment segment recorded revenue of $616,000 from advertising services provided to the Internet segment. Additionally, the Entertainment segment provided the Internet segment with video and pictorial content for which no intersegment revenue is recorded. Certain corporate expenses and interest expense are not allocated to segments. Segment assets include intangible, fixed, and all others identified with each segment. Unallocated corporate assets consist primarily of cash, certain prepaid items related to indebtedness, and deferred tax assets not assigned to one of the segments. Information for the Company’s segments is as follows:
F-30
FRIENDFINDER NETWORKS INC. (FORMERLY KNOWN AS PENTHOUSE MEDIA GROUP INC.)
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE N — SEGMENT INFORMATION (Continued)
| | | | Year Ended December 31,
| |
|---|
| | | | 2008
| | 2007
| | 2006
|
|---|
Assets:
| | | | | | | | | | | | | | |
| Internet | | | | $ | 568,999 | | | $ | 592,105 | | | $ | 8,581 | |
| Entertainment | | | | | 26,724 | | | | 44,733 | | | | 56,491 | |
| Unallocated corporate | | | | | 4,190 | | | | 13,030 | | | | 5,698 | |
| Total | | | | $ | 599,913 | | | $ | 649,868 | | | $ | 70,770 | |
Net revenue from external customers:
| | | | | | | | | | | | | | |
| Internet | | | | $ | 306,129 | | | $ | 20,961 | | | $ | 6,623 | |
| Entertainment | | | | | 24,888 | | | | 27,112 | | | | 23,342 | |
| Total | | | | $ | 331,017 | | | $ | 48,073 | | | $ | 29,965 | |
Income (loss) from operations:
| | | | | | | | | | | | | | |
| Internet | | | | $ | 34,345 | | | $ | (964 | ) | | $ | 4,088 | |
| Entertainment | | | | | (17,748 | ) | | | (7,811 | ) | | | (28,043 | ) |
| Unallocated corporate | | | | | (9,488 | ) | | | (10,692 | ) | | | (13,937 | ) |
| Total | | | | $ | 7,109 | | | $ | (19,467 | ) | | $ | (37,892 | ) |
Depreciation and amortization (included in loss from operations):
| | | | | | | | | | | | | | |
| Internet | | | | $ | 40,399 | | | $ | 2,594 | | | $ | 17 | |
| Entertainment | | | | | 450 | | | | 539 | | | | 575 | |
| Unallocated corporate | | | | | — | | | | 1,958 | | | | 2,730 | |
| Total | | | | $ | 40,849 | | | $ | 5,091 | | | $ | 3,322 | |
Impairment of goodwill and other assets:
| | | | | | | | | | | | | | |
| Internet | | | | $ | 6,829 | | | $ | — | | | $ | — | |
| Entertainment | | | | | 17,602 | | | | 6,056 | | | | 22,824 | |
| Total | | | | $ | 24,431 | | | $ | 6,056 | | | $ | 22,824 | |
Net revenues by service and product is as follows (in thousands):
| | | | Year Ended December 31,
| |
|---|
| | | | 2008
| | 2007
| | 2006
|
|---|
Internet
| | | | | | | | | | | | | | |
| Subscription based service | | | | $ | 246,978 | | | $ | 16,895 | | | $ | 6,623 | |
| Pay by usage service | | | | | 56,729 | | | | 4,066 | | | | | |
| Advertising | | | | | 2,422 | | | | | | | | | |
| | | | | | 306,129 | | | | 20,961 | | | | 6,623 | |
Entertainment
| | | | | | | | | | | | | | |
| Magazine | | | | | 15,581 | | | | 18,303 | | | | 18,754 | |
| Video entertainment | | | | | 6,048 | | | | 5,449 | | | | 1,689 | |
| Licensing | | | | | 3,259 | | | | 3,360 | | | | 2,899 | |
| | | | | | 24,888 | | | | 27,112 | | | | 23,342 | |
| Total revenues | | | | $ | 331,017 | | | $ | 48,073 | | | $ | 29,965 | |
F-31
FRIENDFINDER NETWORKS INC. (FORMERLY KNOWN AS PENTHOUSE MEDIA GROUP INC.)
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE N — SEGMENT INFORMATION (Continued)
The Company derives revenue from international websites and other foreign sources. Revenues by geographical area based on where the customer is located or the subscription originates are as follows (in thousands):
| | | | Year Ended December 31,
| |
|---|
| | | | 2008
| | 2007
| | 2006
|
|---|
Net revenue:
| | | | | | | | | | | | | | |
| United States | | | | $ | 192,102 | | | $ | 35,689 | | | $ | 24,497 | |
| Europe | | | | | 86,797 | | | | 4,092 | | | | 2,659 | |
| Canada | | | | | 16,381 | | | | 4,840 | | | | 1,743 | |
| Other | | | | | 35,737 | | | | 3,452 | | | | 1,066 | |
| Total | | | | $ | 331,017 | | | $ | 48,073 | | | $ | 29,965 | |
Principally all long-lived assets are located in the United States.
NOTE O — COMMITMENTS
Future minimum rental commitments for noncancellable operating leases of office space as of December 31, 2008, are as follows (in thousands):
Year
| | | | Operating
Leases
|
|---|
| 2009 | | | | $ | 1,762 | |
| 2010 | | | | | 1,676 | |
| 2011 | | | | | 1,712 | |
| 2012 | | | | | 1,751 | |
| 2013 | | | | | 1,797 | |
| Thereafter | | | | | 5,859 | |
| Total | | | | $ | 14,557 | |
The above amounts do not include taxes and property operating costs on certain leases. Rent expense amounted to approximately $2,226,000, $1,569,000 and $1,493,000 for the years ended December 31, 2008, 2007 and 2006, respectively.
NOTE P — CONTINGENCIES
In November 2005, a subsidiary of FriendFinder entered into a 10 year lease for a production facility in Los Angeles, California. The lease, which began in March 2006, provided for an annual base rental of $452,000 plus a share of the common area operating expenses. In November 2006, the subsidiary determined that the foundation would not support the heavy equipment necessary to operate a film studio and therefore the premises were not suitable for their intended use. The subsidiary notified the landlord, vacated the premises and ceased making lease payments. In 2006, the Company recorded a charge of $697,000 resulting from this lease abandonment, which primarily represented a write-off of leasehold improvements and a security deposit. In connection with a lawsuit filed by a construction contractor against the landlord for breach of contract pertaining to improvements to the premises, the landlord, on December 11, 2007, filed a cross-claim against the subsidiary seeking unspecified damages for breach of lease and for indemnity of the construction contractor’s claim. In October 2008, the landlord served its Amended Cross-Complaint which alleged breach of contract and fraud against the Company, the subsidiary and an officer of the subsidiary as defendants. On February 18, 2009, a settlement and general release agreement was entered into pursuant to which the Company agreed to pay an amount in settlement of the litigation for which a liability has been accrued at December 31, 2008. The accrual did not have a material effect on the accompanying financial statements. Pursuant to this settlement agreement, the action was dismissed with prejudice.
F-32
FRIENDFINDER NETWORKS INC. (FORMERLY KNOWN AS PENTHOUSE MEDIA GROUP INC.)
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE P — CONTINGENCIES (Continued)
On July 30, 2007, the Company received a demand letter from a minority stockholder of the Company alleging that the Company as well as certain of its officers and directors have violated the Nevada Revised Statutes, federal securities laws, state common law and breached the term of a Shareholder’s Agreement dated September 21, 2004. The claim arises out of the Company offering of shares of Series B Convertible Preferred Stock, which the minority stockholder alleged was made in the self-interest of a few officers and directors of the Company and wrongfully diluted its equity interest in the Company. The minority stockholder further alleged that the Company failed to disclose and make available certain documents and failed to elect a minority interest member to the board, and breach of fiduciary duty owed by the Company’s officers and directors. The minority stockholder requested the Company withdraw and cancel the offering. In August 2007, the Company replied, denying any wrongdoing and refusing to withdraw and cancel the offering. The Company also subsequently provided the minority stockholder with the information requested, including a valuation report that confirms the Series B offering did not undervalue the shares being offered for sale. On or about December 31, 2008, the parties executed a settlement agreement resolving all outstanding claims against the Company and its officers and directors. The settlement involved the purchase of 25,483,300 shares of Series B Common Stock from the minority stockholder by an entity owned by the principal stockholders of the Company for $36.7 million. In connection therewith, the Company received general releases with respect to the allegations referred to above. No amounts were payable by the Company in connection with the settlements.
On or about August 9, 2007, Intelsat USA Sales Corp. (“Intelsat”) sued West Coast Facilities Inc. (“WCF”), a wholly owned subsidiary of the Company, in the United States District Court in Washington DC for anticipatory breach of a contract and unjust enrichment concerning the termination of a Non-Exclusive Service Agreement dated December 2005. The complaint sought approximately $7.4 million in damages together with interest, costs and attorneys’ fees. On October 23, 2008, WCF settled the matter with Intelsat for an immaterial amount, which has been charged to 2008 operations. The action was dismissed with prejudice.
On December 28, 2007, Broadstream Capital Partners, Inc. (“Broadstream”) filed a lawsuit against the Company in the State Superior Court of California, County of Los Angeles, Central District, and the Company subsequently removed the case to the Federal District Court for the Central District of California. The complaint alleged breach of contract, breach of covenant of good faith and fair dealing, breach of fiduciary duty and constructive fraud arising out of a document entitled a Non-Disclosure Agreement. The complaint alleged, among other things, that Broadstream entered into a Non-Disclosure Agreement with the Company that required Broadstream’s prior written consent for the Company to knowingly acquire Various or any of its subsidiaries and that such consent was not obtained. On April 7, 2008, Broadstream filed its First Amended Complaint, which added a new cause of action for intentional interference with prospective economic advantage. On February 4, 2009, Broadstream filed its Third Amended Complaint, which dismisses the allegations of breach of fiduciary duty and constructive fraud. The complaint seeks damages which plaintiff alleges to be in excess of $20 million, plus interest, costs and punitive damages. Broadstream later served supplemental disclosures asserting between $100 million and $500 million in damages plus punitive damages. The Company responded with a motion for summary judgement dated March 12, 2009, which was denied. The plaintiff withdrew its claim for breach of contract of good faith and fair dealing. The trial is set for May 12, 2009. The Company disputes all of Broadstream’s claims and intends to defend the lawsuit vigorously.
On December 23, 2005, Robert Guccione, former president of FriendFinder, filed an action against the Company and some of its officers, among other defendants, in New York State Court for breach of contract, fraud, unjust enrichment, promissory estoppel, failure to pay severance and conspiracy to defraud. The amount of damages requested in the complaint against the Company is approximately $9 million and against the officers is in excess of $10 million. Some of the counts in the complaint also demand an unspecified amount of damages. Guccione filed an amended complaint on June 5, 2007 to include additional claims relating to ownership of certain United Kingdom, Jersey and Guernsey trademarks and add as a party Penthouse Publications Limited, an entity with no current affiliation with the Company, as party plaintiff. Guccione agreed to dismiss the count for conspiracy to
F-33
FRIENDFINDER NETWORKS INC. (FORMERLY KNOWN AS PENTHOUSE MEDIA GROUP INC.)
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE P — CONTINGENCIES (Continued)
defraud only. Guccione filed a Second Amended Complaint adding General Media International, Inc. (an entity with no current affiliation with the Company) as party plaintiff and a new claim for inducement to breach of contract. The Company filed its motion to dismiss the Second Amended Complaint on January 31, 2008, which was granted in part and denied in part. The court dismissed the claims for unjust enrichment and promissory estoppel. The Company believes that it has meritorious defenses to all claims and intends to vigorously defend the lawsuit.
On November 28, 2006, Antor Media Corporation (“Antor”) filed a complaint against the Company, its subsidiary, General Media Communications, Inc. (“GMCI”), and several non-affiliate media/entertainment defendants in the U.S. District Court for the Eastern District of Texas, Texarkana Division, for infringement of a patent titled “Method and Apparatus for Transmitting Information Recorded on Information Storage Means from a Central Server to Subscribers via a High Data Rate Digital Telecommunications Network.” No specific amount of damages has been requested. The Company and its subsidiary filed an Answer, Affirmative Defenses and Counterclaims. The United States Patent and Trademark Office (“USPTO”) issued a non-final office action rejecting Antor’s patent claims. Antor filed a response to the office action which added 83 new claims to the original 29 rejected claims. In August 2008, the USPTO issued its final office action sustaining its rejection of the original 29 claims and rejecting the 83 new claims. Antor filed its Petition to Vacate Finality of Office Action on the grounds it introduced new grounds for rejection. Based on the final office action, the Company, GMCI and all other defendants filed an expedited motion to stay the case, which is pending. In December 2008, pursuant to an order granting a reexamination proceeding, the USPTO issued a non-final office action again rejecting the original 29 claims and the new 83 claims. In February 2009, Antor filed a response in which it agreed to cancel the new claims previously proposed. The parties await the USPTO’s issuance of a new final office action.
In May 2005, Parallel Networks, LLC (“Parallel”), formerly known as Epic Realm, Inc., a patent holding company, filed a complaint in the United States District Court for the Eastern District of Texas alleging that a subsidiary of FriendFinder, FriendFinder California, Inc., engaged in various actions that infringed on two patents related to dynamic webpage generation. Parallel filed a second action against Various, Inc., alleging similar acts of infringement. The two cases were subsequently consolidated. In August 2008 the jury returned a verdict for Parallel and awarded damages of approximately $1.3 million. A liability for $1.6 million related to the litigation, including estimated interest and costs, is included in the accompanying balance sheet at December 31, 2007. This case was settled on December 21, 2008 without a material impact to the financial statements.
On or about November 27, 2006, a claimant filed a consumer class action arbitration at JAMS in San Jose, California, alleging a nationwide class against Various, under a variety of legal theories related to, among other things, representations regarding the number of active users on its internet dating websites, causing the appearance of erroneous member profiles, and a failure to adequately remove or account for alleged erroneous member profiles. The claimant is seeking unspecified damages. Various disputes the claims and intends to defend the arbitration vigorously.
In or about December 2007, Spark Network Services, Inc. served Various with a complaint for patent infringement and is seeking unspecified monetary damages as well as injunctive relief. Various moved for a stay of the federal case due to the USPTO’s reexamination of the patent at issue and the Federal Court granted the stay. The suit is in very early stages, and the Company intends to vigorously defend the claims asserted therein.
On November 4, 2008, Balthaser Online, Inc. filed a lawsuit for patent infringement against the Company among other defendants, in the U.S. District Court for the Eastern District of Texas, Texarkana Division, and is seeking unspecified monetary damages as well as injunctive relief. The plaintiff filed a first amended complaint naming Various, Inc., FriendFinder California Inc. and Global Alphabet, Inc. as defendants on January 15, 2009. This suit is in very early stages and the Company intends to vigorously defend the claims asserted therein. A motion to transfer the case to the U.S. District Court for the Northern District of California has been briefed and awaits decision by the Court.
In March 2009, Kevin Cammarata filed a complaint against our subsidiary FriendFinder California, Inc. and other defendants in the State Superior Court of California, County of Los Angeles in connection with their advertising
F-34
FRIENDFINDER NETWORKS INC. (FORMERLY KNOWN AS PENTHOUSE MEDIA GROUP INC.)
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE P — CONTINGENCIES (Continued)
on a free adult content website run by a third party known as Bright Imperial Limited. The complaint alleges that the defendants aided and abetted Bright Imperial Limited in engaging in below cost competition and unlawful use of “loss leaders” in violation of California law by providing free, apparently professionally produced adult content. The plaintiff is seeking $10.0 million in damages, trebled to at least $30.0 million, plus injunctive relief and attorneys’ fees. This suit is in very early stages and we intend to vigorously defend the claims asserted therein.
The Company currently is a party to other legal proceedings and claims. While management presently believes that the ultimate outcome of these proceedings, including the ones discussed above, individually and in the aggregate, will not have a material adverse effect on the Company’s financial position, cash flows, or overall trends in results of operations, litigation is subject to inherent uncertainties and unfavorable rulings could occur. An unfavorable ruling could include monetary damages or, in cases for which injunctive relief is sought, an injunction prohibiting the Company from selling one or more products or services. Were an unfavorable ruling to occur, there exists the possibility of a material adverse impact on the business or results of operations for the period in which the ruling occurs or future periods. Other than as disclosed above, the Company is unable to make an estimate of the possible loss or range of loss which may result from pending legal proceedings or claims.
In connection with the acquisition of Various, a purchase price reduction determined by the Company, resulting from a post-closing working capital adjustment is subject to arbitration (see Note C(1)). In the event an adverse determination is rendered in any arbitration proceedings, the recorded value of convertible notes issued to the former owners of Various and goodwill recorded in connection with the acquisition may be increased (see Note J(b)).
Effective July 1, 2008, Various registered in the European Union and on July 29, 2008 began separately charging VAT to its customers. For periods prior thereto, Various recorded a liability for VAT and related interest and penalties in connection with revenue from internet services derived from its customers in the various European Union countries. Various is attempting to negotiate settlements of the liabilities related to VAT for periods prior to July 1, 2008, with the taxing authority in each of the various European Union countries (see Note I).
NOTE Q — RELATED PARTY TRANSACTIONS
In October 2004, the Company entered into a separate management agreement with an entity controlled by the Company’s principal stockholders whereby certain management services are to be performed by these principal stockholders as designated by the board of directors of the Company. The agreement is for a term of 5 years with an annual fee of $500,000 which amount is included in general and administrative expenses for each of the years ended December 31, 2008, 2007 and 2006. The fee is subject to increase at the rate of 10% of EBITDA, but cannot exceed $1,000,000. In addition, the agreement provides that the managers may participate in the Company’s future bonus pool and stock option plans. The payment of fees under the management agreement is a violation of a covenant in the management agreement prohibiting the payment of fees if there is an event of default under the Company’s debt agreements. The agreements governing certain of the Company’s indebtedness prohibit such payments if they are not permitted in the management agreement. Payments made in violation of such agreement accordingly resulted in an event of default under certain of the Company’s debt agreements.
The Company has also entered into a lease agreement for rental of office space from a company controlled by the Company’s principal stockholders who were former owners of Various. The lease, which commenced on January 1, 2005, is for a period of five years and provides for annual rent of approximately $58,000 plus operating expenses. Total rent expense under this lease agreement was approximately $118,000, $111,000 and $159,000 for the years ended December 31, 2008, 2007 and 2006, respectively.
In September 2007, the Company entered into consulting agreements with two entities controlled by two of the Company’s stockholders who were former owners of Various. The agreements specify payments of approximately $19,000 per month to each entity. Both agreements are for one year and thereafter renew automatically each month until either party terminates the agreement. For the year ended December 31, 2008, the Company paid an aggregate of approximately $462,000 under such agreements which is included in general and administrative expenses.
F-35
FRIENDFINDER NETWORKS INC. (FORMERLY KNOWN AS PENTHOUSE MEDIA GROUP INC.)
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE Q — RELATED PARTY TRANSACTIONS (Continued)
During 2008, the Company paid approximately $43,000 in commissions to websites owned by a stockholder who was a former owner of Various.
NOTE R — EMPLOYEE BENEFIT PLAN
FriendFinder has a defined contribution plan that combines an employee deferred compensation 401(k) plan with a profit-sharing plan under which FriendFinder may make contributions solely at its own discretion. Substantially all employees may participate in the plan. FriendFinder did not make any contributions to the plan for the years ended December 31, 2008, 2007 and 2006.
Various has a defined contribution plan under Section 401(k) of the Internal Revenue Code covering all full-time employees which provides for matching contributions by Various, as defined in the plan. Contributions made by Various to the plan for the year ended December 31, 2008 and for the period from December 7, 2007 through December 31, 2007 were approximately $491,000 and $66,000, respectively.
F-36
INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM REPORT
To the Shareholders of
Various, Inc. and Affiliates
We have audited the accompanying combined balance sheets of Various, Inc. and subsidiaries and affiliates (collectively, the “Company”) as of December 6, 2007 and December 31, 2006, and the related combined statements of operations, changes in shareholders’ deficit, and cash flows for the period from January 1, 2007 through December 6, 2007 and for the years ended December 31, 2006 and 2005. These combined financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these combined financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing standards as established by the Auditing Standards Board (United States) and in accordance with the auditing standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the combined financial position of Various, Inc. and subsidiaries and affiliates as of December 6, 2007 and December 31, 2006, and the combined results of their operations and their cash flows for the period from January 1, 2007 through December 6, 2007 and for the years ended December 31, 2006 and 2005 in conformity with accounting principles generally accepted in the United States of America.
As discussed in Note N to the combined financial statements, the 2006 and 2005 financial statements have been restated to correct a misstatement.
As described in Note A to the combined financial statements, on December 6, 2007, the stock of the Company was sold to Interactive Network, Inc., a wholly owned subsidiary of FriendFinder Networks Inc. (formerly known as Penthouse Media Group, Inc.) and the 2007 combined financial statements reflect the financial position, results of operations and cash flows of the Company prior to the sale.
/s/ Eisner LLP
New York, New York
November 6, 2008
F-37
VARIOUS, INC. AND SUBSIDIARIES AND AFFILIATES
COMBINED BALANCE SHEETS
| | | | December 6,
2007
| | December 31,
2006
|
|---|
| | | | | | (Restated –
Note N) |
|---|
ASSETS
| | | | | | | | | | |
Current assets:
| | | | | | | | | | |
| Cash | | | | $ | 2,132,130 | | | $ | 15,895,840 | |
| Restricted cash | | | | | 16,493,119 | | | | 16,084,140 | |
| Accounts receivable | | | | | 7,330,250 | | | | 11,359,713 | |
| Prepaid expenses | | | | | 2,242,669 | | | | 1,074,603 | |
| Deferred tax asset | | | | | 1,583,626 | | | | 667,705 | |
| Other. | | | | | 1,868,493 | | | | 108,234 | |
| Total current assets | | | | | 31,650,287 | | | | 45,190,235 | |
| |
| Property and equipment, net | | | | | 4,733,475 | | | | 6,300,213 | |
| Goodwill | | | | | 20,645,831 | | | | 19,189,129 | |
| Intangible assets, net | | | | | 8,732,777 | | | | 6,342,061 | |
| Deposits and other assets | | | | | 122,095 | | | | 121,823 | |
| | | | | $ | 65,884,465 | | | $ | 77,143,461 | |
LIABILITIES AND SHAREHOLDERS’ DEFICIT
| | | | | | | | | | |
Current liabilities:
| | | | | | | | | | |
| Accounts payable | | | | $ | 6,505,550 | | | $ | 10,109,708 | |
| Accrued expenses and other liabilities | | | | | 88,791,543 | | | | 55,763,658 | |
| Deferred revenue | | | | | 40,260,512 | | | | 36,706,036 | |
| Total current liabilities | | | | | 135,557,605 | | | | 102,579,402 | |
| |
| Deferred tax liability | | | | | 294,131 | | | | 66,989 | |
| Deferred revenue | | | | | | | | | 828,126 | |
| Total liabilities | | | | | 135,851,736 | | | | 103,474,517 | |
| |
Commitments and contingencies (Note K)
| | | | | | | | | | |
| |
Shareholders’ deficit:
| | | | | | | | | | |
| Common stock, no par value; 20,000,000 shares authorized at December 6, 2007 and December 31, 2006; 10,931,948 shares issued and outstanding at December 6, 2007 and December 31, 2006 | | | | | 10,000 | | | | 10,000 | |
| Common stock of affiliates | | | | | 62,750 | | | | 62,750 | |
| Additional paid-in capital | | | | | 26,135,156 | | | | 26,135,156 | |
| Accumulated other comprehensive income | | | | | 2,452 | | | | 1,730 | |
| Accumulated deficit | | | | | (96,177,629 | ) | | | (52,540,692 | ) |
| Total shareholders’ deficit | | | | | (69,967,271 | ) | | | (26,331,056 | ) |
| | | | | $ | 65,884,465 | | | $ | 77,143,461 | |
See notes to combined financial statements
F-38
VARIOUS, INC. AND SUBSIDIARIES AND AFFILIATES
COMBINED STATEMENTS OF OPERATIONS
| | | | | | Year Ended December 31,
| |
|---|
| | | | Period From
January 1,
2007 Through
December 6,
2007
| | 2006
| | 2005
|
|---|
| | | | | | (Restated –
Note N) | | (Restated –
Note N) |
|---|
| Net revenue | | | | $ | 289,480,028 | | | $ | 289,675,229 | | | $ | 214,373,549 | |
| Cost of revenue | | | | | 75,603,044 | | | | 76,111,625 | | | | 56,116,057 | |
| Gross profit | | | | | 213,876,984 | | | | 213,563,604 | | | | 158,257,492 | |
| |
Operating expenses:
| | | | | | | | | | | | | | |
| Product development | | | | | 10,326,899 | | | | 10,666,178 | | | | 6,379,703 | |
| Sales and marketing | | | | | 63,888,452 | | | | 58,528,455 | | | | 42,161,198 | |
| General and administrative | | | | | 57,786,879 | | | | 51,370,838 | | | | 36,144,376 | |
| VAT expense | | | | | 13,105,655 | | | | 11,988,515 | | | | 7,483,480 | |
| Depreciation and amortization | | | | | 3,634,186 | | | | 4,178,285 | | | | 3,047,070 | |
| Total operating expenses | | | | | 148,742,071 | | | | 136,732,271 | | | | 95,215,827 | |
| |
| Operating income | | | | | 65,134,913 | | | | 76,831,333 | | | | 63,041,665 | |
| Interest and penalties related to VAT | | | | | (11,736,269 | ) | | | (10,911,513 | ) | | | (7,317,007 | ) |
| Foreign exchange (loss)/gain | | | | | (5,118,385 | ) | | | (4,035,901 | ) | | | 1,682,274 | |
| Interest income and other expenses, net | | | | | 860,375 | | | | 308,622 | | | | 56,181 | |
| |
| Income before income taxes and preacquisition earnings | | | | | 49,140,634 | | | | 62,192,541 | | | | 57,463,113 | |
| Provision for income taxes | | | | | 576,571 | | | | 1,075,180 | | | | 885,533 | |
| |
| Income before preacquisition earnings | | | | | 48,564,063 | | | | 61,117,361 | | | | 56,577,580 | |
| Preacquisition earnings | | | | | | | | | | | | | (813,420 | ) |
| |
| Net income | | | | $ | 48,564,063 | | | $ | 61,117,361 | | | $ | 55,764,160 | |
See notes to combined financial statements
F-39
VARIOUS, INC. AND SUBSIDIARIES AND AFFILIATES
COMBINED STATEMENTS OF CHANGES IN SHAREHOLDERS’ DEFICIT
| | | | Common Stock
| |
|---|
| | | | Shares
| | Amount
| | Common
Stock of
Affiliates
| | Additional
Paid-in
Capital
| | Accumulated
Other
Comprehensive
Income
| | Accumulated
Deficit
| | Total
Shareholders’
(Deficit)
|
|---|
| | | | | | | | | | | | | | (Restated –
Note N) | | (Restated –
Note N) |
|---|
Balance at January 1, 2005:
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Previously reported | | | | | 10,000,000 | | | $ | 10,000 | | | $ | 62,750 | | | $ | 481,830 | | | $ | 25,729 | | | $ | (8,291,255 | ) | | $ | (7,710,946 | ) |
| Restatement | | | | | | | | | | | | | | | | | | | | | | | | | (7,873,310 | ) | | | (7,873,310 | ) |
| As restated | | | | | 10,000,000 | | | | 10,000 | | | | 62,750 | | | | 481,830 | | | | 25,729 | | | | (16,164,565 | ) | | | (15,584,256 | ) |
| Shares issued for Streamray, Inc. acquisition | | | | | 931,948 | | | | | | | | | | | | 25,653,326 | | | | | | | | | | | | 25,653,326 | |
| Foreign translation adjustments | | | | | | | | | | | | | | | | | | | | | (12,140 | ) | | | | | | | (12,140 | ) |
| Net income | | | | | | | | | | | | | | | | | | | | | | | | | 55,764,160 | | | | 55,764,160 | |
| Comprehensive income | | | | | | | | | | | | | | | | | | | | | | | | | | | | | 55,752,020 | |
| Shareholder distributions | | | | | | | | | | | | | | | | | | | | | | | | | (72,257,448 | ) | | | (72,257,448 | ) |
| |
Balance at December 31, 2005
| | | | | 10,931,948 | | | | 10,000 | | | | 62,750 | | | | 26,135,156 | | | | 13,589 | | | | (32,657,853 | ) | | | (6,436,358 | ) |
| Foreign translation adjustments | | | | | | | | | | | | | | | | | | | | | (11,859 | ) | | | | | | | (11,859 | ) |
| Net Income | | | | | | | | | | | | | | | | | | | | | | | | | 61,117,361 | | | | 61,117,361 | |
| Comprehensive income | | | | | | | | | | | | | | | | | | | | | | | | | | | | | 61,105,502 | |
| Shareholder distributions | | | | | | | | | | | | | | | | | | | | | | | | | (81,000,200 | ) | | | (81,000,200 | ) |
| |
Balance at December 31, 2006
| | | | | 10,931,948 | | | | 10,000 | | | | 62,750 | | | | 26,135,156 | | | | 1,730 | | | | (52,540,692 | ) | | | (26,331,056 | ) |
| Foreign translation adjustments | | | | | | | | | | | | | | | | | | | | | 722 | | | | | | | | 722 | |
| Net income | | | | | | | | | | | | | | | | | | | | | | | | | 48,564,063 | | | | 48,564,063 | |
| Comprehensive income | | | | | | | | | | | | | | | | | | | | | | | | | | | | | 48,564,785 | |
| Shareholder distributions | | | | | | | | | | | | | | | | | | | | | | | | | (92,201,000 | ) | | | (92,201,000 | ) |
Balance at December 6, 2007 | | | | | 10,931,948 | | | $ | 10,000 | | | $ | 62,750 | | | $ | 26,135,156 | | | $ | 2,452 | | | $ | (96,177,629 | ) | | $ | (69,967,271 | ) |
See notes to combined financial statements
F-40
VARIOUS, INC. AND SUBSIDIARIES AND AFFILIATES
COMBINED STATEMENTS OF CASH FLOWS
| | | | | | Year Ended December 31,
| |
|---|
| | | | Period From
January 1,
2007 Through
December 6,
2007
| | 2006
| | 2005
|
|---|
| | | | | | (Restated –
Note N) | | (Restated –
Note N) |
|---|
Cash flows from operating activities:
| | | | | | | | | | | | | | |
| Net Income | | | | $ | 48,564,063 | | | $ | 61,117,361 | | | $ | 55,764,160 | |
Adjustments to reconcile net income to net cash provided by operating activities:
| | | | | | | | | | | | | | |
| Depreciation and amortization | | | | | 4,160,418 | | | | 4,839,151 | | | | 3,547,964 | |
| Deferred revenue | | | | | 2,726,350 | | | | 1,641,304 | | | | 12,694,609 | |
| Deferred income taxes | | | | | (688,779 | ) | | | (350,903 | ) | | | 4,901 | |
| Provision for doubtful accounts | | | | | 52,533 | | | | 160,000 | | | | | |
Changes in operating assets and liabilities:
| | | | | | | | | | | | | | |
| Restricted cash | | | | | (408,978 | ) | | | (4,356,676 | ) | | | (3,857,672 | ) |
| Accounts receivable | | | | | 3,976,930 | | | | (1,945,254 | ) | | | (5,757,717 | ) |
| Prepaid expenses | | | | | (1,170,662 | ) | | | 946,225 | | | | (667,565 | ) |
| Deposits and other assets | | | | | (1,760,530 | ) | | | (168,203 | ) | | | (44,903 | ) |
| Accounts payable | | | | | (3,613,805 | ) | | | 3,192,683 | | | | 1,765,579 | |
| Accrued expenses and other liabilities | | | | | 33,037,532 | | | | 29,996,401 | | | | 14,427,708 | |
| Net cash provided by operating activities | | | | | 84,875,072 | | | | 95,072,089 | | | | 77,877,064 | |
| |
Cash flows from investing activities:
| | | | | | | | | | | | | | |
| Purchases of property and equipment | | | | | (2,231,105 | ) | | | (3,157,034 | ) | | | (5,257,076 | ) |
| Acquisition of businesses, net of cash acquired | | | | | (1,731,275 | ) | | | | | | | (211,716 | ) |
| Purchase of intangible assets | | | | | (2,476,124 | ) | | | (60,914 | ) | | | (2,111 | ) |
| Net cash used in investing activities | | | | | (6,438,504 | ) | | | (3,217,948 | ) | | | (5,470,903 | ) |
| |
Cash flows used in financing activities:
| | | | | | | | | | | | | | |
| Shareholder distributions | | | | | (92,201,000 | ) | | | (81,000,200 | ) | | | (72,257,448 | ) |
| Effect of exchange rate changes on cash | | | | | 722 | | | | (11,859 | ) | | | (12,140 | ) |
| |
Net (decrease) increase in cash | | | | | (13,763,710 | ) | | | 10,842,082 | | | | 136,573 | |
Cash at beginning of period | | | | | 15,895,840 | | | | 5,053,758 | | | | 4,917,185 | |
Cash at end of period | | | | $ | 2,132,130 | | | $ | 15,895,840 | | | $ | 5,053,758 | |
| |
Supplemental disclosure of cash flow information
| | | | | | | | | | | | | | |
Cash paid during the year for:
| | | | | | | | | | | | | | |
| Income taxes | | | | $ | 1,092,118 | | | $ | 1,227,875 | | | $ | 999,904 | |
| |
Noncash investing activities:
| | | | | | | | | | | | | | |
| Issuance of common stock in connection with the acquisition of Streamray, Inc | | | | $ | — | | | $ | — | | | $ | 25,653,326 | |
See notes to combined financial statements
F-41
VARIOUS, INC. AND SUBSIDIARIES AND AFFILIATES
NOTES TO COMBINED FINANCIAL STATEMENTS
NOTE A — DESCRIPTION OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
1. | | Description of business: |
Various, Inc. (formerly known as FriendFinder, Inc.) and its subsidiaries and affiliates (the “Company”) provide internet personals services in the United States and internationally whereby adults are able to post information about themselves (“profiles”) on the Company’s websites and search and contact other individuals who have posted profiles. Online services also include publishing and broadcast of user-generated media content and adult materials. Additionally, the Company operates webcams which provide online adult services.
Membership on the Company’s online services, which includes the posting of a personal profile and photos, and access to its database of profiles requires a subscription fee. The Company charges a subscription fee for one, three, six and twelve-month subscriptions to members allowing them to initiate communication with other members and subscribers via the Company’s e-mail communications platform. Prior to July 2007, the Company granted three and twelve-month subscriptions an additional one and three months, respectively, for no additional charge, upon purchasing a subscription. Subsequent to July 2007, three and twelve-month subscriptions were granted an additional one and six-months, respectively, for no additional charge if the member is active in certain areas of the website over the life of their subscription. Two-way communications through the Company’s e-mail platform can only take place between paying subscribers. The Company also offers a webcam service, on a pay by usage basis, whereby members can contact models, view the models via the model’s webcam, and communicate via typing text.
2. | | Principles of combination: |
The accompanying combined financial statements include the accounts of Various, Inc. and its subsidiaries, all of which are wholly owned, and three affiliated companies that are under common ownership, control and management. All significant intercompany transactions and balances have been eliminated in combination.
On December 6, 2007, the shareholders of the Company sold the outstanding stock of the Company to Interactive Network, Inc., a wholly owned subsidiary of FriendFinder Networks, Inc. (formerly known as Penthouse Media Group, Inc.), an international multimedia entertainment company. The accompanying 2007 combined financial statements reflect the combined financial position, results of operations and cash flows of the Company prior to the sale.
3. | | Revenue recognition and deferred revenue: |
Substantially all of the Company’s revenues are derived from subscription fees, and pay by usage. Revenues are presented net of credits and credit card chargebacks. The Company recognizes revenue ratably over the subscription period, including periods for which no additional amounts are charged, beginning when there is persuasive evidence of an arrangement, delivery has occurred (access has been granted) and the fees are fixed and determinable. Collection is reasonably assured as subscribers pay in advance, primarily by using a credit card, and all purchases are final and nonrefundable. Fees collected in advance are deferred and recognized as revenue using the straight-line method over the term of the subscription.
Advertising costs are expensed as incurred. For the period from January 1, 2007 through December 6, 2007 and for the years ended December 31, 2006 and 2005, the Company incurred advertising costs, included in sales and marketing expense, amounting to approximately $57.1 million, $55.3 million and $39.3 million, respectively.
5. | | Cash and cash equivalents: |
All highly liquid instruments with an original maturity of three months or less are considered cash equivalents. At December 6, 2007 and December 31, 2006, there were no cash equivalents.
F-42
VARIOUS, INC. AND SUBSIDIARIES AND AFFILIATES
NOTES TO COMBINED FINANCIAL STATEMENTS
NOTE A — DESCRIPTION OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
5. | | Cash and cash equivalents: (Continued) |
The credit card processors that the Company uses regularly withhold deposits and maintain balances which are recorded as restricted cash.
6. | | Accounts receivable and reserves: |
Accounts receivable is primarily comprised of credit card payments for membership fees pending collection from the credit card processors. The allowance for doubtful accounts as of December 6, 2007 and December 31, 2006 was approximately $212,000 and $160,000, respectively. Such allowance related to a foreign credit card processor with whom the Company is no longer transacting business. The Company records a reserve based on historical chargeback levels and credits experienced over the preceding year. The chargeback and credit reserve as of December 6, 2007 and December 31, 2006, which is included in accrued expenses and other liabilities, was approximately $475,000 and $447,000, respectively. Amounts charged to revenue for chargebacks and credits for 2007, 2006, and 2005 were approximately $13.0 million, $12.5 million and $9.4 million, respectively.
7. | | Website and software development costs: |
The Company capitalizes costs related to developing or obtaining internal-use software. Product development costs are expensed as incurred or capitalized into property and equipment in accordance with Statement of Position (“SOP”) 98-1, “Accounting for the Costs of Computer Software Developed or Obtained for Internal Use.” SOP 98-1 requires that costs incurred in the preliminary project and post-implementation stages of an internal-use software project be expensed as incurred and that certain costs incurred in the application development stage of a project be capitalized.
In accordance with Emerging Issues Task Force (“EITF”) 00-2, “Accounting for Website Development Costs,” the Company expenses costs related to the planning and operating stages of the website. Direct costs incurred in the development stage are capitalized. Costs associated with minor enhancements and maintenance for the website are included in expenses as incurred.
Capitalized development costs are included in property and equipment and amortized over the estimated useful life of the products, which is usually three years. The following table summarizes capitalized development costs for the period from January 1, 2007 through December 6, 2007 and for the years ended December 31, 2006 and 2005 (in thousands):
| | | | 2007
| | 2006
| | 2005
|
|---|
| Capitalized | | | | $ | 69 | | | $ | 283 | | | $ | 776 | |
| Amortization expense | | | | $ | 526 | | | $ | 661 | | | $ | 501 | |
| Unamortized balance | | | | $ | 454 | | | $ | 912 | | | $ | 1,290 | |
8. | | Property and equipment: |
Property and equipment are stated at cost, net of accumulated depreciation and amortization, which is provided using the straight-line method over the estimated useful life of the asset. Upon the sale or retirement of property or equipment, the cost and related accumulated depreciation and amortization are removed from the Company’s combined financial statements with the resulting gain or loss, if any, reflected in the Company’s combined results of operations.
Intangible assets, which resulted from business acquisitions in 2005 and 2007, were recorded at estimated fair value at date of acquisition. Identifiable intangible assets are comprised mainly of studio and service contracts, domain names, customer lists and a non-compete agreement. Domain names were determined to have indefinite
F-43
VARIOUS, INC. AND SUBSIDIARIES AND AFFILIATES
NOTES TO COMBINED FINANCIAL STATEMENTS
NOTE A — DESCRIPTION OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
9. | | Intangible assets: (Continued) |
useful lives, and therefore are not amortized, but are subject to annual impairment testing. Intangible assets with finite useful lives are amortized using the straight-line method over their estimated useful lives (see Note E).
10. | | Impairment of long-lived assets: |
The Company assesses the impairment of assets, which include property and equipment and identifiable intangible assets, whenever events or changes in circumstances indicate that such assets might be impaired and the carrying value may not be recoverable.
If events and circumstances indicate that the carrying amount of an asset may not be recoverable and the expected undiscounted future cash flows attributable to the asset are less than the carrying amount of the asset, an impairment loss equal to the excess of the asset’s carrying value over its fair value is recorded. Fair value is determined based on the present value of estimated expected future cash flows using a discount rate commensurate with the risk involved, quoted market prices or appraised values, depending on the nature of the assets.
Various, Inc. and several of its subsidiaries as well as its affiliates operate as S corporations, and are thus subject only to California state income tax at a 1.5 percent rate. For these S corporations, no provision for federal income tax is included in the accompanying combined financial statements as the results of operations of these corporations are reportable on the tax returns of the shareholders of Various, Inc. The remainder of the subsidiaries and affiliates operate as C corporations and are therefore subject to both federal and state income tax. In addition, international subsidiaries are subject to foreign income taxes.
Deferred income tax assets and liabilities are recognized for future tax consequences attributable to differences between financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. Valuation allowances are established when necessary to reduce deferred tax assets to the amount expected to be realized.
Cost of revenue consists of commissions, which are expensed as incurred, paid to websites having direct links to the Company’s websites which result in new subscribers, costs for online models and studios and amortization of capitalized website development costs.
Costs related to the planning and post-implementation stages of the Company’s website development efforts are recorded as product development expense. Direct costs incurred in the development stage are capitalized and amortized over the product’s estimated useful life of three years as charges to cost of revenue.
Sales and marketing expenses consists principally of advertising costs, which the Company pays internet search engines for key words to generate traffic to its websites. In addition, sales and marketing expenses includes salaries for sales and marketing personnel and other associated costs such as public relations.
F-44
VARIOUS, INC. AND SUBSIDIARIES AND AFFILIATES
NOTES TO COMBINED FINANCIAL STATEMENTS
NOTE A — DESCRIPTION OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
15. | | General and administrative: |
General and administrative expenses relate primarily to corporate personnel related costs, professional fees, occupancy, credit card collection fees and other overhead costs.
16. | | Comprehensive income: |
Comprehensive income is defined as the change in equity of a business enterprise during a period from transactions and other events and circumstances from non-owner sources. For the Company, comprehensive income consists of its reported net income and translation adjustments. Accumulated other comprehensive income consists of the foreign currency translation adjustments.
The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the 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.
18. | | Concentrations of credit risk: |
The Company’s cash and accounts receivable are potentially subject to concentrations of credit risk. Cash is placed with financial institutions that management believes are of high credit quality. The Company’s accounts receivable are derived from revenue earned from customers located in the U.S. and internationally. Accounts receivable balances are due principally from credit card processors and are settled upon processing of credit card transactions. During the period from January 1, 2007 through December 6, 2007 and for the years ended December 31, 2006 and 2005, no customers accounted for more than 10% of net revenues. As of December 6, 2007 and December 31, 2006, one credit card processor accounted for 68% and 86% of accounts receivable, respectively.
19. | | Foreign currency translation: |
The functional currency of the Company’s international subsidiaries is generally the local currency. The financial statements of these subsidiaries are translated into United States dollars using period-end rates of exchange for assets and liabilities and average rates of exchange for the period for revenues and expenses. Translation gains (losses) are recorded in accumulated other comprehensive income as a component of shareholders’ equity.
Gains and losses related to the Company’s foreign currency transactions are recorded in income (see Note N).
The Company operates a point-based loyalty program designed to increase participation in its assorted membership activities. These points are earned through activities such as, but not limited to, participating in sponsored blogs and online magazines, as well as by increasing the uniqueness of a member profile through the addition of photographs and other assorted items. Points may be redeemed for other membership services such as upgraded memberships or highlighting of member profiles in online searches. As the incremental cost of providing these additional membership services is minimal, no liabilities are recorded in connection with point redemptions.
F-45
VARIOUS, INC. AND SUBSIDIARIES AND AFFILIATES
NOTES TO COMBINED FINANCIAL STATEMENTS
NOTE B — ACQUISITIONS OF BUSINESSES
1. | | FRNK Technology Group: |
On January 19, 2007, the Company acquired 100% of the common stock of FRNK Technology Group (“FRNK”), an online adult website, in exchange for cash of $1,800,000. The purchase price was allocated $1,456,000 to goodwill, $216,000 to domain name, $62,000 to fixed assets and $66,000 to net current assets. FRNK’s results of operations, which are included in the FriendFinder segment, are included in the 2007 combined financial statements from the date of acquisition. As the FRNK acquisition was not considered material to the Company’s combined financial statements, disclosures of pro forma results of operations for 2006 are not presented.
On July 21, 2005, the Company purchased certain assets of Spring Street Networks, Inc. (“Spring Street”) which runs third-party websites in exchange for cash of $750,000. In connection with the acquisition, $100,000 was paid directly to a customer of Spring Street for the purpose of retaining the customer. The Company subsequently renamed the acquired business FastCupid, Inc. The purchase price and payment to the customer was allocated $127,000 to service contracts, $594,000 to goodwill (included in the FriendFinder segment), $124,000 to fixed assets and $5,000 to domain name. The results of Spring Street’s operations have been included in the combined financial statements from the date of acquisition.
On March 22, 2005, the Company completed the purchase of Streamray, Inc. (“Streamray”), a company that operates adult webcams. The acquisition of Streamray fits with the Company’s strategy of expanding its online experience for its members. The Company expects that the purchase of Streamray will allow for numerous cost savings and revenue synergies which are reflected in the amount of goodwill included in the purchase price. The purchase price for the acquisition was $26.7 million, which was comprised of 931,948 shares of the Company’s common stock valued at approximately $25.7 million, and a cash payment in the amount of $1 million.
The following table summarizes the estimated fair values of the assets acquired and liabilities assumed at the date of acquisition (in thousands):
| | | | March 22,
2005
|
|---|
| Current assets (including cash acquired of $1,638,000) | | | | $ | 2,349 | |
| Property and equipment | | | | | 452 | |
| Restricted cash | | | | | 186 | |
| Identifiable intangibles | | | | | 7,379 | |
| Goodwill | | | | | 18,596 | * |
| Total assets acquired | | | | | 28,962 | |
| Current liabilities | | | | | (1,401 | )* |
| Deferred revenue | | | | | (908 | ) |
| Net assets acquired | | | | $ | 26,653 | |
Of the $7.4 million of acquired identifiable intangible assets, $1.4 million was assigned to a non-compete agreement, $545,500 was assigned to customer lists, $242,400 was assigned to studio contracts and $5.2 million was assigned to the domain name.
F-46
VARIOUS, INC. AND SUBSIDIARIES AND AFFILIATES
NOTES TO COMBINED FINANCIAL STATEMENTS
NOTE B — ACQUISITIONS OF BUSINESSES (Continued)
3. | | Streamray, Inc.: (Continued) |
The acquisition agreement provides in the event that more than 90% of the issued shares of Various, Inc. are sold or in any other way transferred to a third-party, the former owner of Streamray will receive in addition to its other existing rights and equity an amount equal to 0.5% of the proceeds received as the result of the sale. As a result of the sale to Penthouse, the former owner of Streamray became entitled to $2.5 million, which has been recorded as compensation (included in general and administrative expenses) with a corresponding amount included in accrued expenses and other liabilities in the accompanying 2007 combined financial statements.
As permitted by Accounting Research Bulletin No. 51, “Consolidated Financial Statements,” Streamray’s results of operations are included in the 2005 combined statement of operations as though Streamray had been acquired by the Company at the beginning of such year and, accordingly, revenues, cost of revenues and expenses are included for the twelve months ended December 31, 2005. Streamray’s pre-acquisition earnings for the period from January 1, 2005 through March 21, 2005 amounting to $813,420 (as restated see Note N) are shown as a separate deduction. This method presents results which are more indicative of the current status of the Company, and facilitates future comparison with subsequent years.
NOTE C — PROPERTY AND EQUIPMENT
Property and equipment consists of the following (in thousands):
| | | | December 6,
2007
| | December 31,
2006
|
|---|
| Computer equipment and software | | | | $ | 18,207 | | | $ | 15,754 | |
| Furniture, fixtures and equipment | | | | | 63 | | | | 63 | |
| | | | | | 18,270 | | | | 15,817 | |
| Less: Accumulated depreciation and amortization | | | | | 13,537 | | | | 9,517 | |
| | | | | $ | 4,733 | | | $ | 6,300 | |
Depreciation and amortization expense for the period from January 1, 2007 through December 6, 2007 and for the years ended December 31, 2006 and 2005 was approximately $4.1 million, $4.0 million and $2.9 million, respectively. Computer equipment and software is depreciated on the straight-line basis over three years, while furniture, fixtures and equipment are depreciated on the straight-line basis over five years.
NOTE D — GOODWILL
Goodwill represents the excess of the purchase price over the fair value of the identifiable net assets acquired resulting from business acquisitions in 2005 and 2007 (see Note B).
Changes in the carrying amount of goodwill by segment for the period from January 1, 2007 to December 6, 2007 and for the year ended December 31, 2006 is as follows (in thousands):
| | | | FriendFinder
| | Streamray
| | Total
|
|---|
| Balance as of January 1, 2006 and December 31, 2006 (as restated) | | | | $ | 594 | | | $ | 18,596 | | | $ | 19,190 | |
| Acquisition of FRNK (Note B1) | | | | | 1,456 | | | | — | | | | 1,456 | |
| Balance — December 6, 2007 | | | | $ | 2,050 | | | $ | 18,596 | | | $ | 20,646 | |
Statement of Financial Accounting Standards (“SFAS”) No. 142, “Goodwill and Other Intangible Assets”, requires goodwill to be tested for impairment at least annually. Impairment is tested by comparing the fair values of the applicable reporting units with the carrying amount of their net assets, including goodwill. If the carrying
F-47
VARIOUS, INC. AND SUBSIDIARIES AND AFFILIATES
NOTES TO COMBINED FINANCIAL STATEMENTS
NOTE D — GOODWILL (Continued)
amount of the reporting unit’s net assets exceeds the unit’s fair value, an impairment loss would be recognized in an amount equal to the excess of the carrying amount of goodwill over its implied fair value. The implied fair value of goodwill is determined in the same manner as the amount of goodwill recognized in a business combination with the fair value of the reporting unit deemed to be the purchase price paid.
Goodwill attributable to the acquisition of Streamray has been increased by $454,000 from amounts previously reported to reflect the estimated unrecorded liability incurred by Streamray prior to acquisition for unrecorded value-added tax. See Note N.
The Company has determined that no impairment was indicated for the period from January 1, 2007 through December 6, 2007 and for the years ended December 31, 2006 and 2005.
NOTE E — INTANGIBLE ASSETS
Intangible assets consist of the following (in thousands):
| | | | December 6, 2007
| | December 31, 2006
| |
|---|
| | | | Gross
Amount
| | Accumulated
Amortization
| | Gross
Amount
| | Accumulated
Amortization
| | Estimated
Useful Lives
(Years)
|
|---|
| Domain names | | | | $ | 8,229 | | | $ | — | | | $ | 5,535 | | | $ | — | | | | Indefinite | |
| Non-compete agreement | | | | | 1,356 | | | | 1,356 | | | | 1,356 | | | | 1,186 | | | | 2 | |
| Customer lists | | | | | 546 | | | | 242 | | | | 546 | | | | 159 | | | | 6 | |
| Service contracts | | | | | 127 | | | | 76 | | | | 127 | | | | 58 | | | | 7 | |
| Studio contracts | | | | | 242 | | | | 93 | | | | 242 | | | | 61 | | | | 7 | |
| | | | | $ | 10,500 | | | $ | 1,767 | | | $ | 7,806 | | | $ | 1,464 | | | | | |
During the period from January 1, 2007 through December 6, 2007, the Company purchased several domain names through auctions for approximately $2.5 million. The purchases were made of similar niche domain names that will be used to either redirect internet traffic to the Company’s current websites or for further development similar to the Company’s current websites. The Company also allocated $216,000 from the purchase of FRNK Technology Group to domain names (see Note B).
Amortization expense for finite-lived intangible assets for the period from January 1, 2007 through December 6, 2007 and for the years ended December 31, 2006 and 2005 was $302,000, $843,000 and $622,000, respectively. Amortization expense is expected to be approximately $165,000 for each of the years ending December 31, 2008, 2009 and 2010, respectively.
NOTE F — ACCRUED EXPENSES AND OTHER LIABILITIES
Accrued expenses and other liabilities consist of the following (in thousands):
Affiliate
| | | | December 6,
2007
| | December 31,
2006
|
|---|
| Accrued liability related to VAT (Note N) | | | | $ | 78,091 | | | $ | 48,131 | |
| Accrued marketing | | | | | 3,067 | | | | — | |
| Chargeback reserve | | | | | 475 | | | | 447 | |
| Compensation and benefits (Note B) | | | | | 3,949 | | | | 1,838 | |
| Legal and related expenses | | | | | 2,409 | | | | 5,117 | |
| Other | | | | | 801 | | | | 231 | |
| | | | | $ | 88,792 | | | $ | 55,764 | |
F-48
VARIOUS, INC. AND SUBSIDIARIES AND AFFILIATES
NOTES TO COMBINED FINANCIAL STATEMENTS
NOTE G — COMMON STOCK OF AFFILIATES
Common stock of affiliates at December 6, 2007 and December 31, 2006 consists of:
| | | | Common Stock
| |
|---|
Affiliate
| | | | Outstanding
Shares
| | Par or
Stated Value
|
|---|
| Global Alphabet, Inc. | | | | | 1,000 | | | $ | 2,750 | |
| Sharkfish, Inc. | | | | | 1,000 | | | | 30,000 | |
| Traffic Cat, Inc. | | | | | 1,000 | | | | 30,000 | |
| | | | | | | | | $ | 62,750 | |
NOTE H — INCOME TAXES
The Company’s provision for income taxes consists of the following (in thousands):
| | | | | | Year Ended December 31,
| |
|---|
| | | | Period From
January 1,
2007 Through
December 6,
2007
| | 2006
| | 2005
|
|---|
| | | | | | (Restated –
Note N) | | (Restated –
Note N) |
|---|
Current:
| | | | | | | | | | | | | | |
| Federal | | | | $ | 32 | | | $ | 4 | | | $ | — | |
| State | | | | | 1,234 | | | | 1,422 | | | | 881 | |
| Total | | | | | 1,266 | | | | 1,426 | | | | 881 | |
| |
Deferred:
| | | | | | | | | | | | | | |
| State | | | | | (689 | ) | | | (351 | ) | | | 5 | |
| Total | | | | | (689 | ) | | | (351 | ) | | | 5 | |
| Total provision for income taxes | | | | $ | 577 | | | $ | 1,075 | | | $ | 886 | |
No provision for federal income tax is included in the accompanying combined financial statements for Various, Inc. and certain of its subsidiaries and affiliates which operate as S corporations.
Various, Inc. and its subsidiaries and affiliates file income tax returns using the cash basis of accounting. The income tax effects of temporary differences that give rise to deferred tax assets and liabilities are as follows (in thousands):
F-49
VARIOUS, INC. AND SUBSIDIARIES AND AFFILIATES
NOTES TO COMBINED FINANCIAL STATEMENTS
NOTE H — INCOME TAXES (Continued)
| | | | December 6,
2007
| | December 31,
2006
|
|---|
| | | | | | (Restated –
Note N) |
|---|
Deferred tax assets:
| | | | | | | | | | |
| Deferred revenue | | | | $ | 1,604 | | | $ | 1,993 | |
| Accrued expenses and other liabilities | | | | | 2,696 | | | | 1,796 | |
| Accounts payable | | | | | 361 | | | | 114 | |
| Property and equipment | | | | | 109 | | | | 60 | |
| Operating loss carryforwards | | | | | 866 | | | | 595 | |
| Total deferred tax assets | | | | | 5,636 | | | | 4,558 | |
Deferred tax liabilities:
| | | | | | | | | | |
| Restricted cash | | | | | 247 | | | | 241 | |
| Accounts receivable | | | | | 109 | | | | 170 | |
| Other assets | | | | | 74 | | | | 149 | |
| Total deferred tax liabilities | | | | | 430 | | | | 560 | |
| Deferred tax asset | | | | | 5,206 | | | | 3,998 | |
| Valuation allowance | | | | | (3,916 | ) | | | (3,397 | ) |
| Net deferred tax asset | | | | $ | 1,290 | | | $ | 601 | |
Amounts recognized in the combined balance sheets:
| | | | | | | | | | |
| Deferred tax asset — current | | | | $ | 1,584 | | | $ | 668 | |
| Deferred tax liability — non-current | | | | | (294 | ) | | | (67 | ) |
| | | | | $ | 1,290 | | | $ | 601 | |
Management establishes a valuation allowance for net operating loss carryforwards and deductible temporary differences when it is more likely than not that the benefit of such deferred tax assets will not be recognized. The ultimate realization of deferred tax assets is dependent upon the Company’s ability to generate taxable income during the periods in which the carryforwards and temporary differences become deductible. Management considers the historical level of taxable income, projections for future taxable income and tax planning strategies in making this assessment.
As a result of historical cumulative losses of C corporation subsidiaries and affiliates, management has established a valuation allowance on the deferred tax assets of these entities as of December 6, 2007 and December 31, 2006. The net changes in the valuation allowance for the period from January 1, 2007 through December 6, 2007 and for the years ended December 31, 2006 and 2005 were increases of approximately $519,000, $903,000 and $797,000, respectively.
At December 6, 2007, certain subsidiaries and affiliates of Various, Inc. which are taxable as C corporations had federal and state net operating loss carryforwards of approximately $2.2 million and $2.6 million, respectively. The federal net operating loss carryforwards begin to expire in 2020 and state net operating loss carryforwards begin to expire in 2010, if not utilized.
On January 1, 2007, the Company adopted Financial Accounting Standards Board Interpretation No. 48, “Accounting for Uncertainty in Income Taxes (“FIN 48”). FIN 48 clarifies the criteria for recognizing tax benefits related to uncertain tax positions under SFAS No. 109, “Accounting for Income Taxes,” and requires additional financial statement disclosure. As required by FIN 48, the Company applied the “more-likely-than-not” recognition threshold to all tax positions commencing at the adoption date which resulted in no unrecognized tax benefits as of such date or December 6, 2007. Accordingly, the adoption of FIN 48 had no effect on the Company’s 2007 combined financial statements.
F-50
VARIOUS, INC. AND SUBSIDIARIES AND AFFILIATES
NOTES TO COMBINED FINANCIAL STATEMENTS
NOTE H — INCOME TAXES (Continued)
To the extent incurred, the Company classifies interest and penalties incurred on the underpayment of income taxes as general and administrative expenses.
NOTE I — SEGMENT INFORMATION
The Company operates several online websites that have been aggregated into two reportable segments: FriendFinder.com website and its co-branded websites which provide internet personals services and certain adult materials, and Streamray, which consists of the Company’s adult webcam website and its co-branded websites. Information for the Company’s segments is as follows (in thousands):
| | | | | | Year Ended December 31,
| |
|---|
| | | | Period From
January 1,
2007 Through
December 6,
2007
| | 2006
| | 2005
|
|---|
Net revenues:
| | | | | | | | | | | | | | |
| FriendFinder | | | | $ | 230,970 | | | $ | 237,008 | | | $ | 184,664 | |
| Streamray | | | | | 58,510 | | | | 52,667 | | | | 29,710 | |
| Total | | | | $ | 289,480 | | | $ | 289,675 | | | $ | 214,374 | |
Cost of revenues:
| | | | | | | | | | | | | | |
| FriendFinder | | | | $ | 49,776 | | | $ | 49,205 | | | $ | 39,433 | |
| Streamray | | | | | 25,827 | | | | 26,907 | | | | 16,683 | |
| Total | | | | $ | 75,603 | | | $ | 76,112 | | | $ | 56,116 | |
Gross profit:
| | | | | | | | | | | | | | |
| FriendFinder | | | | $ | 181,194 | | | $ | 187,803 | | | $ | 145,231 | |
| Streamray | | | | | 32,683 | | | | 25,760 | | | | 13,026 | |
| Total | | | | $ | 213,877 | | | $ | 213,563 | | | $ | 158,257 | |
Assets:
| | | | | | | | | | | | | | |
| FriendFinder | | | | $ | 37,440 | | | $ | 44,637 | | | $ | 33,694 | |
| Streamray | | | | | 28,444 | | | | 32,506 | | | | 28,548 | |
| Total | | | | $ | 65,884 | | | $ | 77,143 | * | | $ | 62,242 | * |
Due to the Company’s integrated business structure, operating expenses are not allocated to the individual reporting segments. As such, the Company does not measure operating profit or loss by segment for internal reporting purposes.
F-51
VARIOUS, INC. AND SUBSIDIARIES AND AFFILIATES
NOTES TO COMBINED FINANCIAL STATEMENTS
NOTE I — SEGMENT INFORMATION (Continued)
The Company operates several international websites, however, all of them are operated and managed by the Company’s U.S. operations. Revenues by geographical area (based on where the subscription originated) are as follows (in thousands):
| | | | | | Year Ended December 31,
| |
|---|
| | | | Period From
January 1,
2007 Through
December 6,
2007
| | 2006
| | 2005
|
|---|
Net revenues:
| | | | | | | | | | | | | | |
| United States | | | | $ | 169,558 | | | $ | 177,803 | | | $ | 143,392 | |
| Europe | | | | | 83,084 | | | | 76,197 | | | | 47,979 | |
| Canada | | | | | 13,830 | | | | 12,706 | | | | 8,507 | |
| Other | | | | | 23,008 | | | | 22,969 | | | | 14,496 | |
| Total | | | | $ | 289,480 | | | $ | 289,675 | | | $ | 214,374 | |
Principally all long-lived assets are located in the United States.
NOTE J — EMPLOYEE BENEFIT PLAN
The Company has a defined contribution plan under Section 401(k) of the Internal Revenue Code covering all full-time employees, which provides for matching contributions by the Company. Participants in the plan may direct the investment of their personal accounts to a choice of mutual funds consisting of various portfolios of stocks, bonds or cash instruments. Contributions made by the Company to the plan for the period ended December 6, 2007 and for the years ended December 31, 2006 and 2005 were approximately $421,000, $324,000 and $193,000, respectively.
NOTE K — COMMITMENTS AND CONTINGENCIES
The Company leases its office facilities under operating lease agreements effective through 2009, providing for annual minimum lease payments of $601,000 for 2008 and $123,000 for 2009.
The Company recognized rent expense under operating leases of $698,100, $698,800 and $433,700 for the period from January 1, 2007 through December 6, 2007 and for the years ended December 31, 2006 and 2005, respectively.
In May 2005, Parallel Networks, LLC (“Parallel”), formerly know as Epic Realm, Inc., a patent holding company, filed a complaint in the United States District Court for the Eastern District of Texas alleging that a subsidiary, FriendFinder Network, Inc., engaged in various actions that infringed on numerous patents related to dynamic webpage generation. Parallel filed a second action against Various, Inc., alleging similar acts of infringement. The two cases were subsequently consolidated. In August 2008 the jury returned a verdict for Parallel, and awarded damages of approximately $1.3 million, which is subject to further post-trial motions. Such judgment has not been confirmed by the judge, and both parties will have the opportunity to further appeal or bring similar motions which may affect the damage award. A liability for $1.6 million related to the litigation, including estimated interest and costs, is included in the accompanying balance sheet at December 6, 2007.
On or about November 27, 2006, a claimant filed a consumer class action arbitration at JAMS in San Jose, California, alleging a nationwide class against Various Inc., under a variety of legal theories related to, among other things, representations regarding the number of active users on its internet dating websites, causing the appearance of erroneous member profiles, and a failure to adequately remove or account for alleged erroneous member profiles.
F-52
VARIOUS, INC. AND SUBSIDIARIES AND AFFILIATES
NOTES TO COMBINED FINANCIAL STATEMENTS
NOTE K — COMMITMENTS AND CONTINGENCIES (Continued)
2. | | Legal proceedings: (Continued) |
The claimant is seeking unspecified damages. Various Inc. disputes the claims and intends to defend the arbitration vigorously.
In or about January 2008, Spark Network Services, Inc. served Various Inc., with a complaint for patent infringement and is seeking unspecified monetary damages as well as injunctive relief. Various Inc. moved for a stay of the Federal case due to the Patent and Trademark Office reexamination of the patent at issue and the Federal Court granted the stay. Various Inc. believes that it has meritorious defenses to the claims and intends to vigorously defend them.
The Company currently is a party to assorted other legal proceedings. While management presently believes that the ultimate outcome of these proceedings, including those discussed above, individually and in the aggregate, will not have a material adverse effect on the Company’s combined financial position, cash flows, or overall trends in results of operations, litigation is subject to inherent uncertainties, and unfavorable rulings could occur. An unfavorable ruling could include monetary damages or, in cases for which injunctive relief is sought, an injunction prohibiting the Company from selling one or more services. Were an unfavorable ruling to occur, there exists the possibility of a material adverse impact on the business or results of operations for the period in which the ruling occurs or future periods.
NOTE L — COMPENSATION AGREEMENTS
The Company had an agreement with an employee, whereby in the event that a majority of the Company is sold, or in any other way transferred by the founder of the Company to a third party, the employee will receive a distribution equal to 15,000 shares of the Company (adjusted for stock splits, reverse stock splits, etc.), prior to the sale minus an assessment equal to $.10 per share (adjusted for stock splits, reverse stock splits, etc.). As a result of the sale of the Company, a payment of $422,668 was made to the employee which is recorded in general and administrative expenses.
Coincident with the sale of the Company, agreements were entered into with certain employees pursuant to which the Company recorded compensation of approximately $3.7 million (included in general and administrative expenses) for services rendered by the employees prior to the closing of the sale. The Company is also committed to pay up to a maximum of $3.4 million over the three-year period beginning with the date of the closing for services to be rendered by these employees. At the closing, the Company also agreed to pay certain consultants approximately $0.4 million, which is also recorded in general and administrative expenses.
NOTE M — RELATED PARTY TRANSACTIONS
On October 27, 2006, the Company purchased an automobile from the founder of the Company for $125,000. The amount is classified in other current assets since it is currently being held for sale and in 2006 was written down to its estimated net realizable value of $95,000.
In 2007, 2006 and 2005, the Company made payments in the amounts of approximately $77,000, $500,000 and $862,000, respectively, to Cyberzine Publishing, Inc., (“Cyberzine”) which is owned by the former owner of Streamray who, prior to the sale, was a shareholder of the Company. The payments were consideration for traffic sent to the Company’s websites from domain names owned by Cyberzine.
NOTE N — RESTATEMENT
Effective July 1, 2003, as a result of a change in the law in the European Union, the Company was required to collect value added tax (“VAT”) from customers in connection with their use of internet services in the European Union provided by the Company and remit the VAT to the taxing authorities in the various European Union countries. As the Company did not separately charge its customers for, or remit, the VAT, an expense and a related liability have been recorded in the accompanying financial statements to reflect the estimated VAT which should
F-53
VARIOUS, INC. AND SUBSIDIARIES AND AFFILIATES
NOTES TO COMBINED FINANCIAL STATEMENTS
NOTE N — RESTATEMENT (Continued)
have been collected and remitted on the Company’s revenues derived from the various European Union countries since July 1, 2003 or other local implementation date. In addition, a provision and related liability have been recorded for interest and penalties related to the unremitted VAT and failure to file tax returns. In connection therewith, the Company’s prior years’ financial statements have been restated from amounts previously reported to reflect the VAT, the related interest and penalties, the foreign exchange (loss) gain related to the resulting liability denominated in Euros and pounds, and the related deferred income tax effect applicable to each year as follows:
| | | | Year Ended December 31,
| |
|---|
| | | | 2006
| | 2005
| | As of January 1,
2005
|
|---|
| Net income as previously reported | | | | $ | 87,801,290 | | | $ | 68,477,417 | | | $ | — | |
| Accumulated deficit as previously reported | | | | | — | | | | — | | | | (8,291,255 | ) |
| VAT expense | | | | | (11,988,515 | ) | | | (7,483,480 | ) | | | (3,480,224 | ) |
| Interest and penalties(a) | | | | | (10,911,513 | ) | | | (7,317,007 | ) | | | (3,782,373 | ) |
| Foreign exchange (loss)/gain | | | | | (4,035,901 | ) | | | 1,682,274 | | | | (671,713 | ) |
| Deferred state income tax benefit | | | | | 252,000 | | | | 93,000 | | | | 61,000 | |
| Preacquisition earnings | | | | | — | | | | 311,956 | | | | — | |
| As restated | | | | $ | 61,117,361 | | | $ | 55,764,160 | | | $ | (16,164,565 | ) |
| (a) | | Includes penalties of $8,961,769 (2006), $6,042,016 (2005) and $3,130,706 (January 1, 2005). |
In addition, the balance sheet at December 31, 2006 has been restated to reflect a liability for VAT together with related interest and penalties aggregating $48,131,000 with corresponding adjustments consisting of increases in goodwill (relating to unremitted VAT of Streamray prior to acquisition), deferred tax assets and accumulated deficit as follows:
| | | | As Previously
Reported
| | Restatement
| | As Restated
|
|---|
| Deferred tax assets | | | | $ | 261,705 | | | $ | 406,000 | | | $ | 667,705 | |
| Total current assets | | | | | 44,784,235 | | | | 406,000 | | | | 45,190,235 | |
| Goodwill | | | | | 18,735,162 | | | | 453,967 | | | | 19,189,129 | |
| Total assets | | | | | 76,283,494 | | | | 859,967 | | | | 77,143,461 | |
| Accrued expenses and other liabilities | | | | | 7,633,195 | | | | 48,130,463 | | | | 55,763,658 | |
| Total current liabilities | | | | | 54,448,939 | | | | 48,130,463 | | | | 102,579,402 | |
| Total liabilities | | | | | 55,344,054 | | | | 48,130,463 | | | | 103,474,517 | |
| Accumulated deficit | | | | | (5,270,196 | ) | | | (47,270,496 | ) | | | (52,540,692 | ) |
| Total shareholders’ equity (deficit) | | | | | 20,939,440 | | | | (47,270,496 | ) | | | (26,331,056 | ) |
The financial statements for the period ended December 6, 2007 reflect a VAT expense of $13,105,655, a provision of $11,736,265 for related interest ($9,545,853) and penalties ($2,190,416), together with a foreign exchange loss of $5,118,385 and a related liability of $78,090,772 at such date.
The Company has been notified that the German tax authorities and the Office of the District Attorney in Bonn have been investigating the Company’s former Chief Executive Officer for alleged intentional evasion of VAT on revenues collected from customers located in Germany commencing in 2003. The Company has also learned that German authorities are investigating a current officer of the Company in connection with the VAT matter. In connection therewith, on April 18, 2008, a court in Germany granted authorities a search and seizure order that allowed them to seize documents from the Company’s office located in Germany in order to determine the amount of revenue subject to VAT. In addition, the German court also issued an order authorizing the freezing of the Company’s funds, in the amount of E610,343 ($879,000), held by the Company’s credit card processors located in the Netherlands and Germany to secure the VAT estimated by the Revenue tax authorities to be due from the Company from revenue from internet websites in Germany.
F-54
Common Stock
PROSPECTUS
, 2009
Renaissance Securities (Cyprus) Limited
Until , 2009 (the first business day following the 25th day after the date of this prospectus), all dealers that buy, sell or trade these securities, whether or not participating in the offering, may be required to deliver a prospectus. This is in addition to the dealers’ obligation to deliver a prospectus when acting as underwriters and with respect to their unsold allotments or subscriptions.
PART II
INFORMATION NOT REQUIRED IN PROSPECTUS
Item 13. Other Expenses of Issuance and Distribution
The following table sets forth the expenses in connection with this Registration Statement. We will pay all expenses of the offering. All such expenses are estimates, other than the filing fees payable to the Securities and Exchange Commission, and are subject to future contingencies.
| Securities and Exchange Commission registration fee | | | | $ | 18,078 | |
| Financial Industry Regulatory Authority filing fee | | | | | 46,500 | |
| New York Stock Exchange listing fee | | | | | * | |
| Printing expenses | | | | | * | |
| Legal fees and expenses | | | | | * | |
| Accounting fees and expenses | | | | | * | |
| Transfer agent fees | | | | | * | |
| Blue sky fees and expenses | | | | | * | |
| Miscellaneous | | | | | * | |
| Total | | | | $ | * | |
| * | | To be completed by amendment. Each of the amounts set forth above, other than the Securities and Exchange Commission registration fee and the Financial Industry Regulatory Authority filing fee, is an estimate. |
Item 14. Indemnification of Directors and Officers
Section 78.7502 of the Nevada Revised Statutes empowers a Nevada corporation to indemnify any person who was or is a party or is threatened to be made a party to any threatened, pending or completed action, suit or proceeding, whether civil, criminal, administrative or investigative (other than an action by or in the right of such corporation), by reason of the fact that such person is or was a director, officer, employee or agent of such corporation, or is or was serving at the request of such corporation as a director, officer, employee or agent of another corporation or enterprise. The indemnity may include expenses (including attorneys’ fees), judgments, fines and amounts paid in settlement actually and reasonably incurred by such person in connection with such action, suit or proceeding, provided that such person (i) is not liable for breaching his or her duties as a director or officer of the corporation, where such breach involved intentional misconduct, fraud or a knowing violation of law and (ii) acted in good faith and in a manner he or she reasonably believed to be in or not opposed to the corporation’s best interests, and, for criminal proceedings, had no reasonable cause to believe his or her conduct was unlawful. A Nevada corporation may indemnify any person against expenses (including attorneys’ fees) in connection with the defense or settlement of an action by or in the right of the corporation under the same conditions, except that no indemnification is permitted without judicial approval if the officer or director is adjudged to be liable to the corporation. Where a director, officer, employee or agent is successful on the merits or otherwise in the defense of any action referred to above, the corporation must indemnify him or her against the expenses which such officer or director actually and reasonably incurred in connection with the defense.
Our amended and restated bylaws contain a provision providing for indemnification of our officers and directors. Our amended and restated bylaws further require us to pay advance expenses as incurred by an officer or director in connection with proceedings against them for which they may be indemnified.
We intend to enter into indemnification agreements with our directors and executive officers, a form of which has been filed as an exhibit to the registration statement. Under the terms of the indemnification agreements, we will be required to indemnify the directors against specified liabilities arising out of their services to us. The indemnification agreements will require us to indemnify each director and executive officer to the fullest extent permitted by law and to advance certain expenses incurred by the director. The indemnification agreements will provide limitations on the directors’ and officers’ rights to indemnification in certain circumstances.
In addition, we have obtained directors’ and officers’ insurance that covers our directors and officers for specific liabilities, including for coverage for public securities matters.
II-1
Pursuant to the Underwriting Agreement filed as Exhibit 1.1 to this registration statement, we have agreed to indemnify the underwriters and the underwriters have agreed to indemnify us against certain civil liabilities that may be incurred in connection with this offering, including certain liabilities under the Securities Act of 1933, as amended.
Item 15. Recent Sales of Unregistered Securities
During the three years preceding the filing of this registration statement, we sold the following securities which were not registered under the Securities Act of 1933, as amended.
On August 23, 2006, we issued $24,441,056 in principal amount to the holders of the outstanding Subordinated Term Loan Notes to PET Capital Partners LLC to replace the then outstanding Subordinated Term Loan Note of $24,033,160 in the principal amount issued on August 17, 2005 and the Subordinated Term Loan Note of $407,896 issued on October 5, 2005. The notes were issued in reliance upon Section 4(2) of the Securities Act of 1933 as a transaction by an issuer not involving a public offering.
On August 28, 2006, we issued $5.0 million of our 2006 Notes, and $6.0 million of additional Series A Convertible Preferred Stock and warrants to purchase an aggregate of 8,829,359 shares of common stock at an exercise price of $0.00001, to fund the acquisition of substantially all of the assets of the debtor estate of Jill Kelly Productions, Inc. and for general corporate purposes. All of these securities were issued in reliance upon Section 4(2) of the Securities Act of 1933 as a transaction by an issuer not involving a public offering and Regulation D promulgated thereunder.
On October 5, 2006, we issued $3,177,337 in principal amount of Subordinated Term Loan Notes to the holders of the outstanding Subordinated Term Loan Notes in lieu of payment of cash interest due under such notes. These notes were issued in reliance upon Section 4(2) of the Securities Act of 1933 as a transaction by an issuer not involving a public offering.
On October 25, 2006, we issued $0.9 million of Subordinated Term Loan Notes to PET Capital Partners LLC. These notes were issued in reliance upon Section 4(2) of the Securities Act of 1933 as a transaction by an issuer not involving a public offering. No commissions or underwriting expenses were paid in connection with the transaction.
Also in October 2006, in connection with the purchase of Video Bliss, Inc., Danni Ashe, Inc. and Snapshot Productions LLC, we issued 1,009,600 shares of common stock to the seller at the closing. These shares were issued in reliance upon Section 4(2) of the Securities Act of 1933 as a transaction by an issuer not involving a public offering.
On October 5, 2007, we issued $3,702,907 in principal amount of Subordinated Term Loan Notes to the holders of the outstanding Subordinated Term Loan Notes in lieu of payment of cash interest due under such notes. These notes were issued in reliance upon Section 4(2) of the Securities Act of 1933 as a transaction by an issuer not involving a public offering.
In December 2007, we issued 84,448,505 shares of Series B Convertible Preferred Stock, at $0.029604 per share for a total of $5.0 million to Messrs. Staton and Bell, the Florescue Family Corporation and an existing stockholder. These shares were issued in reliance upon Section 4(2) of the Securities Act of 1933 as a transaction by an issuer not involving a public offering. No commissions or underwriting expenses were paid in connection with the transaction.
In December 2007, we issued $1,838,141 in principal amount of 2005 Notes in lieu of cash interest due under the provisions of the 2005 Notes. We also issued $862,152 in principal amount of 2005 Notes and $137,848 in principal amount of 2006 Notes pro rata to the holders of such notes in consideration for their waivers of certain defaults and consents to the incurrence of additional debt in connection with our acquisition of Various, Inc. Additionally, we issued warrants to purchase a total of 22,280,190 shares of our common stock at an exercise price of $0.00001 per share, to 15 holders of our Series A Convertible Preferred Stock in lieu of the application of anti-dilution provisions of the Series A Convertible Preferred Stock in connection with our issuance of the Series B Convertible Preferred Stock. These notes and warrants were issued in reliance upon Section 4(2) of the Securities
II-2
Act of 1933 as a transaction by an issuer not involving a public offering. No commissions or underwriting expenses were paid in connection with these transactions.
In December 2007, INI issued $257.3 million in principal amount of Senior Secured Notes due 2011 with detachable warrants to purchase an aggregate of 42,106,153 shares of our common stock at a purchase price of $0.00001 per share to 15 accredited investors. The proceeds from the sale of these notes were used to pay part of the purchase price for the stock of Various, Inc. These notes were issued in reliance upon Section 4(2) of the Securities Act of 1933 as a transaction by an issuer not involving a public offering and Regulation D promulgated thereunder.
INI also issued $80.0 million in principal amount of Second Lien Subordinated Secured Notes with detachable warrants to purchase 1,189,980 shares of our common stock at a purchase price of $0.00001 per share and $170.0 million in principal amount of Subordinated Convertible Notes in payment of the balance of the purchase price for the stock of Various, Inc. These securities were issued in reliance upon Section 4(2) of the Securities Act of 1933 as a transaction by an issuer not involving a public offering. No commissions or underwriting expenses were paid in connection with the transaction.
On June 30, 2008 we issued $5,808,333 in principal amount of Subordinated Convertible Notes to the holders of the outstanding Subordinated Convertible Notes in lieu of payment of cash interest under such notes. These notes were issued in reliance upon Section 4(2) of the Securities Act of 1933 as a transaction by an issuer not involving a public offering.
On October 5, 2008 we issued $4,190,903 in principal amount of Subordinated Term Loan Notes to the holders of the outstanding Subordinated Term Loan Notes in lieu of payment of cash interest on such notes. These notes were issued in reliance upon Section 4(2) of the Securities Act of 1933 as a transaction by an issuer not involving a public offering.
On December 31, 2008, INI issued additional Subordinated Convertible Notes in the amount of $1.1 million as payment in kind for its interest obligation. These notes were issued in reliance upon Section 4(2) of the Securities Act of 1933 as a transaction by an issuer not involving a public offering.
Item 16. Exhibits and Financial Statement Schedules.
A list of exhibits filed herewith is contained in the exhibit index that immediately follows the signature page and is incorporated herein by reference.
(b) Financial Statement Schedules.
Description of Financial Statement Schedules
| | | | Page Number
|
|---|
| Report of Independent Registered Public Accounting Firm | | | | | II-4 | |
| Schedule II — Valuation and Qualifying Accounts | | | | | II-5 | |
II-3
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
The Board of Directors and Stockholders
FriendFinder Networks Inc.
We have audited the accompanying consolidated financial statements of FriendFinder Networks Inc. and subsidiaries (the “Company”) as of December 31, 2008 and 2007, and for each of the three years in the period ended December 31, 2008 and have issued our report thereon dated March 20, 2009 (included elsewhere in this Registration Statement). Our audits also included the financial statement schedule listed in Item 16(b) of Form S-1 of this Registration Statement. This schedule is the responsibility of the Company’s management. Our responsibility is to express an opinion on this schedule based on our audits.
In our opinion, the financial statement schedule referred to above when considered in relation to the basic financial statements taken as a whole presents fairly, in all material respects, the information set forth therein. The financial statement schedule does not include any adjustments to reflect the possible future effects on the recoverability and classification that may result from the outcome of the uncertainty regarding the Company’s ability to continue as a going concern.
/s/ Eisner LLP
New York, New York
March 20, 2009
II-4
FRIENDFINDER NETWORKS INC.
YEARS ENDED DECEMBER 31, 2008, 2007, AND 2006
VALUATION AND QUALIFYING ACCOUNTS
(IN THOUSANDS)
| | | | Balance at
Beginning of
Period
| | Additions
Charged to
Costs and
Expenses
| | Additions
Charged to
Other
Accounts
| | Deductions
| | Balance at
End of
Period
|
|---|
Description
| | | | | | | | | | | | | | | | | | | | | | |
Year Ended December 31, 2006
| | | | | | | | | | | | | | | | | | | | | | |
| Allowance for doubtful accounts | | | | $ | 475 | | | $ | 424 | | | $ | 164 | (a) | | $ | 360 | (c) | | $ | 703 | |
| Deferred tax asset valuation allowance | | | | | 10,908 | | | | 10,734 | | | | — | | | | — | | | | 21,642 | |
Year Ended December 31, 2007
| | | | | | | | | | | | | | | | | | | | | | |
| Allowance for doubtful accounts | | | | $ | 703 | | | $ | 505 | | | $ | 212 | (b) | | $ | 52 | (c) | | $ | 1,368 | |
| Deferred tax asset valuation allowance | | | | | 21,642 | | | | 7,970 | | | | 1,143 | (d) | | | 25,973 | (e) | | | 4,782 | |
Year Ended December 31, 2008
| | | | | | | | | | | | | | | | | | | | | | |
| Allowance for doubtful accounts | | | | $ | 1,368 | | | $ | 1,505 | | | $ | — | | | $ | 363 | (c) | | $ | 2,510 | |
| Deferred tax asset valuation allowance | | | | | 4,782 | | | | 4,842 | | | | — | | | | — | | | | 9,624 | |
Notes:
| (a) | | Balance at acquisition of Jill Kelly Productions assets. |
| (b) | | Balance at acquisition of Various, Inc. |
| (c) | | Accounts receivable amounts considered uncollectible and removed from accounts receivable by reducing the allowance for doubtful accounts. |
| (d) | | Deferred tax assets valuation allowance acquired from Various, Inc. |
| (e) | | Reduction of deferred tax asset valuation allowance due to taxable temporary differences from deferred tax liabilities recorded in connection with the acquisition of Various, Inc. which reverse in future periods. The reduction in the deferred tax valuation allowance has been accounted for as a reduction of goodwill at the date of acquisition. |
Other financial statement schedules have been omitted because the required information is either not applicable, not deemed material or is shown in the respective financial statements or in the notes thereto.
Item 17. Undertakings
The undersigned registrant hereby undertakes to provide to the underwriter, at the closing specified in the underwriting agreement, certificates in such denominations and registered in such names as required by the underwriter to permit prompt delivery to each purchaser.
Insofar as indemnification for liabilities arising under the Securities Act of 1933 may be permitted to directors, officers, and controlling persons of the registrant pursuant to the provisions described in Item 17, or otherwise, the registrant has been advised that in the opinion of the Securities and Exchange Commission such indemnification is against public policy as expressed in the Act and is, therefore, unenforceable. In the event that a claim for indemnification against such liabilities (other than the payment by the registrant of expenses incurred or paid by a director, officer, or controlling person of the registrant in the successful defense of any action, suit, or proceeding) is asserted by such director, officer, or controlling person in connection with the securities being registered, the registrant will, unless in the opinion of its counsel the matter has been settled by controlling precedent, submit to a court of appropriate jurisdiction the question whether such indemnification by it is against public policy as expressed in the Act and will be governed by the final adjudication of such issue.
II-5
The undersigned registrant hereby undertakes that:
(1) For purposes of determining any liability under the Securities Act of 1933, the information omitted from the form of prospectus filed as part of this registration statement in reliance upon Rule 430A and contained in a form of prospectus filed by the registrant pursuant to Rule 424(b)(1) or (4) or 497(h) under the Securities Act shall be deemed to be part of this registration statement as of the time it was declared effective.
(2) For the purpose of determining any liability under the Securities Act of 1933, each post-effective amendment that contains a form of prospectus shall be deemed to be a new registration statement relating to the securities offered therein, and the offering of such securities at that time shall be deemed to be the initial bona fide offering thereof.
II-6
SIGNATURES
Pursuant to the requirements of the Securities Act of 1933, the Registrant has duly caused this Registration Statement to be signed on its behalf by the undersigned, thereunto duly authorized, in the City of Boca Raton, State of Florida, on the 24th day of April, 2009.
FRIENDFINDER NETWORKS INC.
| By: | | /s/ Marc H. Bell
Marc H. Bell
Chief Executive Officer and President |
Pursuant to the requirements of the Securities Act of 1933, this Registration Statement has been signed by the following persons in the capacities and on the dates indicated.
Signature
| | | | Title
| | Date
|
|---|
/s/ Marc H. Bell
Marc H. Bell | | | | Chief Executive Officer,
President and Director
(Principal Executive Officer) | | April 24, 2009 |
/s/ Ezra Shashoua
Ezra Shashoua | | | | Chief Financial Officer (Principal Financial
Officer and Principal Accounting Officer) | | April 24, 2009 |
/s/ Daniel C. Staton
Daniel C. Staton | | | | Chairman of the Board and Treasurer | | April 24, 2009 |
*
Robert B. Bell | | | | Director | | April 24, 2009 |
*
Barry Florescue | | | | Director | | April 24, 2009 |
*
James LaChance | | | | Director | | April 24, 2009 |
*
Toby E. Lazarus | | | | Director | | April 24, 2009 |
*
Jason H. Smith | | | | Director | | April 24, 2009 |
* By: /s/ Ezra Shashoua
Ezra Shashoua
Attorney-in-fact | | | | | | April 24, 2009 |
II-7
EXHIBIT INDEX
In reviewing the agreements included as exhibits to this registration statement, please remember they are included to provide you with information regarding their terms and are not intended to provide any other factual or disclosure information about us or the other parties to the agreements. The agreements contain representations and warranties by each of the parties to the applicable agreement. These representations and warranties have been made solely for the benefit of the other parties to the applicable agreement and:
| • | | should not in all instances be treated as categorical statements of fact, but rather as a way of allocating the risk to one of the parties if those statements prove to be inaccurate; |
| • | | have been qualified by disclosures that were made to the other party in connection with the negotiation of the applicable agreement, which disclosures are not necessarily reflected in the agreement; |
| • | | may apply standards of materiality in a way that is different from what may be viewed as material to you or other investors; and |
| • | | were made only as of the date of the applicable agreement or such other date or dates as may be specified in the agreement and are subject to more recent developments. |
Accordingly, these representations and warranties may not describe the actual state of affairs as of the date they were made or at any other time.
Exhibit
Number
| | | | Description
|
|---|
| 1.1* | | | | Underwriting Agreement |
| 3.1** | | | | Articles of Incorporation of FriendFinder Networks Inc. |
| 3.2** | | | | Certificates of Amendment to Articles of Incorporation of FriendFinder Networks Inc. dated March 30, 2006, November 13, 2007 and July 1, 2008 |
| 3.3** | | | | Amended and Restated Bylaws of FriendFinder Networks Inc. |
| 3.4* | | | | Form of Amended and Restated Articles of Incorporation of FriendFinder Networks Inc. to be effective upon the closing of this offering |
| 3.5* | | | | Form of Amended and Restated Bylaws of FriendFinder Networks Inc. to be effective upon the closing of this offering |
| 4.1* | | | | Specimen of Common Stock Certificate |
| 4.2* | | | | Specimen of Series B Common Stock Certificate |
| 4.3* | | | | Specimen of Series A Convertible Preferred Stock Certificate |
| 4.4* | | | | Specimen of Series B Convertible Preferred Stock Certificate |
| 4.5* | | | | Certificate of Designation of Series A Convertible Preferred Stock |
| 4.6* | | | | Certificate of Designation of Series B Convertible Preferred Stock |
| 4.7 | | | | Form of Detachable Warrant for the Purchase of Securities of Penthouse Media Group Inc. |
| 4.8* | | | | Registration Rights Agreement dated December 6, 2007 (Detachable Warrants) |
| 4.9 | | | | Registration Rights Agreement dated December 6, 2007 (6% Subordinated Convertible Notes) |
| 4.10 | | | | Amendment to Registration Rights Agreement dated May 14, 2008 (6% Subordinated Convertible Notes) |
| 4.11* | | | | Intercreditor and Subordination Agreement dated December 6, 2007 (Interactive Network, Inc. First Lien/Second Lien Notes) |
| 4.12* | | | | Intercreditor and Subordination Agreement dated December 6, 2007 (Penthouse Media Group Inc. Senior Lien Notes/Subordinated Guaranty by Penthouse Media Group Inc. of Interactive Network, Inc. Notes/Marc Bell Notes/Various Seller Notes) |
| 4.13* | | | | Intercreditor and Subordination Agreement dated December 6, 2007 (Subordinated Secured Guaranty of Penthouse Media Group Inc. Notes from Interactive Network, Inc.) |
II-8
Exhibit
Number
| | | | Description
|
|---|
| 4.14* | | | | Seller Note Subordination Agreement dated December 6, 2007 |
| 4.15* | | | | Intercreditor Agreement dated December 6, 2007 (PET Notes/Seller Notes Guaranty) |
| 4.16* | | | | Security Holders Agreement dated August 17, 2005, by and among Penthouse Media Group Inc. and Holders of Equity Securities of Penthouse Media Group Inc. |
| 4.17* | | | | Security Holders Agreement dated December 6, 2007, by and among Penthouse Media Group Inc. and Holders of Equity Securities of Penthouse Media Group Inc. |
| 4.18* | | | | Shareholders’ Agreement dated September 21, 2004, by and among PET Capital Partners, LLC, Marc H. Bell, Daniel C. Staton, certain other investors and Penthouse Media Group Inc. |
| 4.19 | | | | Form of 13% Subordinated Term Loan Note due 2011 |
| 4.20 | | | | Form of 15% Senior Secured Note Due 2010 |
| 4.21 | | | | Form of Senior Secured Class A Note Due 2011 |
| 4.22 | | | | Form of Sellers’ Subordinated Secured Note Due 2011 |
| 4.23 | | | | Form of Senior Secured Class B Note Due 2011 |
| 4.24 | | | | Form of 6% Subordinated Convertible Note Due 2011 |
| 4.25 | | | | Guaranty of 6% Subordinated Convertible Note due 2011 |
| 5.1* | | | | Opinion of Brownstein Hyatt Farber Schreck, LLP |
| 9.1 | | | | Voting Agreement dated July 6, 2005, by and among Barry Florescue, Marc H. Bell and Daniel C. Staton |
| 10.1* | | | | Form of Indemnification Agreement between FriendFinder Networks Inc. and its Directors and Officers |
10.2
| | | | Management Agreement dated as of October 5, 2004, by and between Penthouse Media Group Inc. and Bell & Staton, Inc. |
10.3
| | | | Amendment No. 1 to Management Agreement dated as of August 17, 2005, by and between Penthouse Media Group Inc. and Bell & Staton, Inc. |
| 10.4* | | | | Amendment No. 2 to Management Agreement dated as of August 23, 2006, by and between Penthouse Media Group Inc. and Bell & Staton, Inc. |
10.5**
| | | | Form of Employment Agreement by and between FriendFinder Networks Inc. and Daniel C. Staton to be effective upon closing of this offering |
10.6**
| | | | Form of Employment Agreement by and between FriendFinder Networks Inc. and Marc H. Bell to be effective upon closing of this offering |
10.7*
| | | | Securities Purchase Agreement dated July 6, 2005, by and among Penthouse Media Group Inc., PET Capital Partners II LLC and an existing stockholder |
10.8*
| | | | Note Exchange Agreement dated August 17, 2005, by and among Penthouse Media Group Inc., PET Capital Partners LLC and an existing stockholder |
| 10.9* | | | | Securities Purchase Agreement dated August 17, 2005, by and among Penthouse Media Group Inc., each Subsidiary of Penthouse Media Group Inc. acting as a Guarantor, the Security Holders named therein and U.S. Bank National Association |
| 10.10* | | | | Amendment No. 1 to Securities Purchase Agreement dated August 28, 2006, by and among Penthouse Media Group Inc., each Subsidiary of Penthouse Media Group Inc. acting as a Guarantor, the Security Holders named therein and U.S. Bank National Association |
| 10.11* | | | | Amendment No. 2 to Securities Purchase Agreement dated December 6, 2007, by and among Penthouse Media Group Inc., each Subsidiary of Penthouse Media Group Inc. acting as a Guarantor, the Security Holders named therein and U.S. Bank National Association |
| 10.12* | | | | Issuer Security and Pledge Agreement dated August 17, 2005, by and between Penthouse Media Group Inc. and U.S. Bank National Association, as collateral agent for the Security Holders party to the Securities Purchase Agreement dated August 17, 2005 |
II-9
Exhibit
Number
| | | | Description
|
|---|
| 10.13* | | | | First Amendment to Issuer Security and Pledge Agreement dated August 28, 2006, by and between Penthouse Media Group Inc. and U.S. Bank National Association, as collateral agent for the Security Holders party to the Securities Purchase Agreement dated August 17, 2005 |
| 10.14* | | | | Form of Guarantor Security and Pledge Agreement dated August 17, 2005, by and between each Guarantor and U.S. Bank National Association, as collateral agent for the Security Holders party to the Securities Purchase Agreement dated August 17, 2005 |
| 10.15* | | | | Form of First Amendment to Guarantor Security and Pledge Agreement dated August 28, 2006, by and between each Guarantor and U.S. Bank National Association, as collateral agent for the Security Holders party to the Securities Purchase Agreement dated August 17, 2005 |
10.16*
| | | | Securities Purchase Agreement dated August 10, 2006, by and between Penthouse Media Group Inc. and PET Capital Partners II LLC |
| 10.17* | | | | Securities Purchase Agreement dated August 28, 2006, by and among Penthouse Media Group Inc., each Subsidiary of Penthouse Media Group Inc. acting as a Guarantor, the Security Holders named therein and U.S. Bank National Association |
10.18*
| | | | Securities Purchase Agreement dated July 23, 2007, by and among Penthouse Media Group Inc. and the Investors named therein |
| 10.19* | | | | Securities Purchase Agreement dated December 6, 2007, by and among Interactive Network, Inc., each Subsidiary of Penthouse Media Group Inc. acting as a Guarantor, the Security Holders named therein and U.S. Bank National Association |
| 10.20* | | | | Amendment to Securities Purchase Agreement dated January 14, 2008, by and among Interactive Network, Inc., each Subsidiary of Penthouse Media Group Inc. acting as a Guarantor, the Security Holders named therein and U.S. Bank National Association |
| 10.21* | | | | Issuer Security and Pledge Agreement dated December 6, 2007, by and between Interactive Network, Inc. and U.S. Bank National Association, as collateral agent for the Security Holders party to the Securities Purchase Agreement dated December 6, 2007 |
| 10.22* | | | | Parent Security and Pledge Agreement dated December 6, 2007, by and between Penthouse Media Group Inc. and U.S. Bank National Association, as collateral agent for the Security Holders party to the Securities Purchase Agreement dated December 6, 2007 |
| 10.23* | | | | Sellers’ Securities Agreement dated December 6, 2007, by and among Interactive Network, Inc., each Subsidiary of Penthouse Media Group Inc. acting as a Guarantor, the Security Holders named therein and U.S. Bank National Association |
| 10.24* | | | | Amendment to Sellers’ Securities Agreement dated as of December 6, 2008, by and among Interactive Network, Inc., each Subsidiary of Penthouse Media Group Inc. acting as a Guarantor, the Security Holders named therein and U.S. Bank National Association |
| 10.25* | | | | Issuer Security and Pledge Agreement dated December 6, 2007, by and between Interactive Network, Inc. and U.S. Bank National Association, as collateral agent for the Security Holders party to the Sellers’ Securities Agreement dated December 6, 2007 |
| 10.26* | | | | Parent Security and Pledge Agreement dated December 6, 2007, by and between Penthouse Media Group Inc. and U.S. Bank National Association, as collateral agent for the Security Holders party to the Sellers’ Securities Agreement dated December 6, 2007 |
| 10.27 | | | | Stock Purchase Agreement dated September 21, 2007, by and among Various, Inc., The Andrew B. Conru Trust Agreement, The Lars Mapstead Trust, Andrew B. Conru, Lars Mapstead and Penthouse Media Group Inc. |
| 10.28 | | | | Amendment to Stock Purchase Agreement dated December 6, 2007, by and among Various, Inc., The Andrew B. Conru Trust Agreement, The Lars Mapstead Trust, Andrew B. Conru, Lars Mapstead and Penthouse Media Group Inc. |
II-10
Exhibit
Number
| | | | Description
|
|---|
| 10.29 | | | | Assignment Agreement dated December 6, 2007, concerning Stock Purchase Agreement dated September 21, 2007 |
10.30*
| | | | Limited Waiver dated December 6, 2007, by and between FriendFinder Networks Inc. and PET Capital Partners LLC, as agent for the Holders of the 13% Subordinated Term Loan Notes due 2011 |
10.31*
| | | | Limited Waiver dated December 19, 2008, by and between FriendFinder Networks Inc. and PET Capital Partners LLC, as agent for the Holders of the 13% Subordinated Term Loan notes due 2011 |
10.32*
| | | | Limited Waiver dated March 20, 2009, by and between FriendFinder Networks Inc. and PET Capital Partners LLC, as agent for the Holders of the 13% Subordinated Term Loan Notes due 2011 |
| 10.33** | | | | Independent Contractor Agreement dated September 21, 2007, by and between Andrew B. Conru and Various, Inc. |
| 10.34** | | | | Amendment to Independent Contractor Agreement dated May 12, 2008, by and between Andrew B. Conru and Various, Inc. |
| 10.35** | | | | Employee Proprietary Information Agreement dated September 21, 2007, by and between Andrew B. Conru and Various, Inc. |
| 10.36** | | | | Independent Contractor Agreement dated September 21, 2007, by and between Lars Mapstead and Various, Inc. |
| 10.37** | | | | Employee Proprietary Information Agreement dated September 21, 2007, by and between Lars Mapstead and Various, Inc. |
10.38
| | | | Employment Agreement dated September 6, 2007, by and between Penthouse Media Group Inc. and Ezra Shashoua |
10.39
| | | | Consulting Agreement dated September 11, 2007, by and between Penthouse Media Group Inc. and Ezra Shashoua |
| 10.40** | | | | Amended and Restated Employment Agreement, dated July 8, 2008, by and between Penthouse Media Group Inc. and Ezra Shashoua |
| 10.41** | | | | Employment Agreement, dated October 25, 2007, by and between Penthouse Media Group Inc. and Robert Brackett |
10.42
| | | | Bonus Award Agreement dated November 13, 2007 by and between Various, Inc. and Robert Brackett |
10.43
| | | | Amendment to Bonus Award Agreement dated December 5, 2007, by and between Various, Inc. and Robert Brackett |
10.44
| | | | Employee Proprietary Information Agreement dated November 9, 2007, by and between Various, Inc. and Robert Brackett |
10.45
| | | | Consulting Agreement dated December 11, 2006, by and between Penthouse Media Group Inc. and Starsmith LLC |
10.46
| | | | Employment Agreement dated January 3, 2006, by and between Penthouse Media Group Inc. and Diane Silberstein |
10.47
| | | | Agreement and General Release dated April 30, 2008, by and between Penthouse Media Group Inc. and Diane Silberstein |
| 10.48** | | | | Lease dated November 2, 2004, by and between 6800 Broken Sound LLC and Penthouse Media Group Inc. |
| 10.49** | | | | Amendment to Lease dated June 14, 2006, by and between 6800 Broken Sound LLC and Penthouse Media Group Inc. |
| 10.50** | | | | Lease dated May 6, 2008 by and between 20 Broad Company LLC and Penthouse Media Group Inc. |
| 10.51* | | | | Lease dated August 22, 2003, between Rader Properties Group VII, LLC and Video Bliss, Inc. |
| 10.52* | | | | First Amendment of Lease dated November 21, 2008, by and between Rader Properties Group VII, LLC and Video Bliss, Inc. |
II-11
Exhibit
Number
| | | | Description
|
|---|
| 10.53 | | | | Lease dated April 21, 2005 by and between KNK Properties, LLC and Streamray Inc. |
| 10.54 | | | | Modification of Lease, dated September 1, 2005, by and between KNK Properties, LLC and Streamray Inc. |
| 10.55 | | | | Modification of Lease, dated April 1, 2007, by and between KNK Properties, LLC and Streamray Inc. |
| 10.56** | | | | Lease dated May 9, 2008, between Batton Associates, LLC, Lessor and Various, Inc., Lessee |
| 10.57** | | | | Penthouse Media Group Inc. 2008 Stock Option Plan |
| 10.58* | | | | FriendFinder Networks Inc. 2009 Restricted Stock Plan |
| 14.1** | | | | Code of Ethics |
| 14.2** | | | | Code of Business Conduct and Ethics |
| 21.1** | | | | List of Subsidiaries |
| 23.1* | | | | Consent of Brownstein Hyatt Farber Schreck, LLP (included in Exhibit 5.1) |
| 23.2 | | | | Consent of Eisner LLP |
| 24.1** | | | | Power of Attorney (included in signature page) |
| 99.1** | | | | Form of Audit Committee charter |
| 99.2** | | | | Form of Compensation Committee charter |
| 99.3** | | | | Form of Nominating and Corporate Governance Committee charter |
| * | | To be filed by amendment. |
II-12
