We conducted our audits in accordance with publicthe standards of the Public Company Accounting Oversight Board (United States).  Those standards require that we plan and private companies,perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement.  The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audits included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion.  An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as his experience serving onevaluating the boardoverall 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 directorsFriendFinder Networks Inc. and subsidiaries as of several public companies, enables him to provide valuable business, leadership,December 31, 2012 and management advice2011, and the consolidated results of their operations and their cash flows for each of the three years in the period ended December 31, 2012, in conformity with accounting principles generally accepted in the United States of America. Also, in our opinion, the related financial statement schedule, when considered in relation to the Boardbasic financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein.

The accompanying financial statements have been prepared assuming that the Company will continue as a going concern.  As more fully described in Note B to the financial statements, the Company’s New First Lien Notes and Cash Pay Second Lien Notes, absent a restructuring or refinancing, mature on September 30, 2013 and further are subject to maturity date acceleration by the lenders as a result of Directors.events of default upon the expiration or termination of forbearance agreements currently in place. In addition, the Company has failed to comply with certain covenants related to its Non-Cash Pay Second Lien Notes which mature on April 30, 2014.  Accordingly, all such debt has been classified as current liabilities as of December 31, 2012 and cannot be satisfied with available funds which raises substantial doubt about the Company’s ability to continue as a going concern. Management’s plans in regard to this matter are also described in Note B.  The financial statements do not include any adjustments that might result from the outcome of this uncertainty.

We entered intoFriendFinder Networks Inc. (“FriendFinder”), together with Various, Inc. and its other wholly-owned subsidiaries (hereinafter referred to as the “Company”), is an amendedinternet and restated employment agreement with Mr. Shashouatechnology company providing services in the social networking and web-based video sharing markets.  The business consists of creating and operating technology platforms which run several websites throughout the world appealing to users of diverse cultures and interest groups.  The Company is also engaged in entertainment activities consisting of publishing, licensing and studio production and distribution.  The Company publishes PENTHOUSE and other adult-oriented magazines and digests.  Additionally, the Company licenses the PENTHOUSE name for international publication of adult magazines and for use on May 15, 2012 pursuant to which Mr. Shashoua would continue to receive a base salaryvarious products and provides various adult-oriented multimedia entertainment products and services, including content for pay-per-view programming.

On October 5, 2012, we27, 2010, the Company completed a debt restructuring which consolidated substantially all of its debt into three tranches with maturities on September 30, 2013 and Messrs. Bell and Staton agreed to terminate their respective amended and restated employment agreements, at which point we entered into consulting agreements with each of Mr. Bell and Mr. Staton. These agreements areApril 30, 2014.  As described in greater detail below under the section "— Executive Employment Agreements."

Commencing on March 31, 2012 and for each quarter end thereafter, the Company was not in compliance with certain covenants contained in the indenture governing the Non-Cash Pay Second Lien Notes. The Trustee of the effortsNon-Cash Pay Second Lien Notes and the Required Holders thereof waived compliance with these covenants for the periods ended March 31 and June 30, 2012 but did not waive compliance as of Messrs. PreviteSeptember 30 or December 31, 2012.  However, neither the Trustee of the Non-Cash Pay Second Lien indenture nor the holders of the Non-Cash Pay Second Lien Notes may accelerate such Notes or take any other enforcement action until the New First Lien Notes are paid in full.    As the Non-Cash Pay Second Lien Notes are in default at December 31, 2012 and Shashouathe New First Lien Notes and Cash Pay Second Lien Notes mature no later than September 30, 2013, the Non-Cash Pay Second Lien Notes can be accelerated thereafter assuming repayment upon maturity and, accordingly, have been classified as a current liability in the successful consummationaccompanying 2012 consolidated balance sheet.

As described above, the New First Lien Notes and Cash Pay Second Lien Notes mature on September 30, 2013 or may be subject to accelerated maturity prior thereto upon the expiration or termination of the forbearance agreements currently in place.  In addition, events of default have occurred under the Non-Cash Pay Second Lien Notes and, accordingly, such notes are also subject to accelerated maturity upon repayment of the New Financing, they were each grantedFirst Lien Notes.  All such debt is classified as current liabilities in the accompanying consolidated balance sheet at December 31, 2012 and cannot be satisfied by available funds which raises substantial doubt about the Company’s ability to continue as a discretionary bonusgoing concern.  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 the outcome this uncertainty.

Management is attempting to restructure or refinance the Company’s debt prior to maturity.  Based on cash provided from operating activities (after interest payments on debt) during the past several years, a substantial percentage of $150,000 by our former Chief Executive Officerwhich has been used to make principal payments on debt and our former Chairmanits forecasts of future operating cash flow, the Company anticipates that it will be able to either restructure or refinance the notes; however there is no assurance that the Company will be able to accomplish such transactions on acceptable terms, or at all.  Continuation of the Board. In January 2011, Mr. Shashoua received a discretionary bonus of $233,333. We determined that half of this bonus was earned in 2010 and half was earned in 2011. We did not pay any other discretionary bonuses during 2011.  Pursuant to the amended and restated employment agreement we entered into with Mr. Shashoua on May 15, 2012, Mr. Shashoua was eligible to receive a discretionary annual bonus up to 100% of his base salary upon achievement of specific goals and objectives under the 2012 Cash Bonus Plan (as defined below), however, the Compensation Committee determined in March 2013 that a bonus would not be granted for 2012 as the Adjusted EBITDA targets had not been met.

The consolidated financial statements include the Compensation Committeeaccounts of FriendFinder and its subsidiaries, all of which are wholly owned. Intercompany accounts and transactions have been eliminated in March 2013 that it thought it was prudent to refrain from awarding any annual restricted stock and/or stock option grants, except those required byconsolidation.

On January 25, 2010, the Company's consulting agreements with Messrs. BellCompany effected 1-for-20 reverse splits of each class and Staton and the annual stock option grants to the directors that is partseries of the directors' annual compensation.  The Compensation Committee agreed with management's recommendationCompany’s authorized capital stock, including all designated classes and asseries of common and preferred stock, and a result, no awardscorresponding and proportionate decrease in the number of restricted stock and/or stock option grants were made in March 2013, except as disclosed above.  Theoutstanding shares of each such class and series. In addition, following is a summarythe effectiveness of the 2008 Stock Option Plan,reverse stock splits, the 2009 Restricted Stock Plan and the 2012 Stock Incentive Plan and awardCompany’s articles of grants of stock options and restricted stock made to the Named Executive Officers under these plans during 2012.

Incremental costs incurred in connection with an IPO of the Company’s common stock filed with the Securities and Exchange Commission (“SEC”) were classified as deferred offering costs in the consolidated balance sheets. In May 2011 upon completion of the eventCompany’s IPO approximately $19.9 million of these costs were charged to capital in excess of par.

Cost of stock-based compensation arrangements, including stock options, 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 recognizes deferred tax assets and liabilities for the expected future tax consequences of events that hehave been included in the financial statements or she holdstax returns. Under this method, deferred tax assets and liabilities are recorded for net operating loss carry forwards 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.

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, certain cash balances 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 statements of operations.

JigoCity was acquired in 2011 and sold in 2012 (see Note I).  Operations of JigoCity’s foreign subsidiaries were conducted in local currencies which represented their functional currencies.  Balance sheet accounts of such subsidiaries were translated from foreign currencies into U.S. dollars at the exchange rate in effect at each balance sheet date his or her service terminates will be exercisable untiland income statement accounts were translated at the options expire. If a non-employee Director dies while servingaverage rate of exchange prevailing during the period.  Translation adjustments resulting from this process, were included in accumulated other comprehensive loss on our Boardthe consolidated balance sheet and reclassified to operations upon sale of Directors,JigoCity.

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 vested stock options that he or she holdsU.S. and internationally. At December 31, 2012 and 2011, accounts receivable balances are due principally from credit card processors and are settled upon processing of credit card transactions. As of December 31, 2012, two credit card processors each accounted for approximately 16.0% of accounts receivable and, as of December 31, 2011, one credit card processor accounted for 14% of accounts receivable. At December 31, 2012 and 2011, no other credit card processors accounted for more than 10% of the dateaccounts receivable. During the years ended December 31, 2012, 2011 and 2010, no customer accounted for more than 10% of death will be exercisable for one year following death, but no later than the date the stock options expire.net revenue.

 

The fair value hierarchy, established under authoritative accounting guidance, ranks the eventquality and reliability of certain non-recurring changesthe information used to determine fair values.  Financial assets and liabilities carried at fair value are classified and disclosed in our capitalization or corporation transactions,one of the Compensation Committee,following three categories:

Basic and diluted net loss per common 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 $0.0002 per share. Convertible participating securities are included in the computation of basic earnings per share using the two-class method. Inasmuch as the administratorSeries B common stock participated in any dividends and shared 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. Weighted average shares outstanding — basic and diluted are comprised of the plan, may determine the appropriate adjustment to be madefollowing (in thousands):

In computing diluted loss per share, no effect has been given to the stock options granted pursuant tocommon shares issuable at the plan.end of the period upon conversion or exercise of the following anti-dilutive securities that could potentially dilute basic earnings per share in future periods (in thousands):

The Series A and Series B preferred stock were convertible participating securities which were converted into common stock in 2011; however, as there was no contractual obligation for the holders of our Named Executive Officers will be eligiblesuch shares to receive additional awardsshare in the future under our 2008 Stock Option Plan orlosses of the Company, the preferred shares were not included in the computation of basic and diluted net loss per share (see Note M).

For the year ended December 31, 2012 and 2011, the above table of anti-dilutive securities includes 2,325,000 and 6,436,851 warrants exercisable into shares of common stock granted in connection  with employment terms or agreements. Additional grantsthe acquisition of JigoCity in 2011 (see Note M).  In addition, the 2012 and 2011 table each include 8,310,763 shares of common stock issuable on conversion of Non-Cash Pay Second Lien Notes, and 1,134,000 and 590,000 shares of common stock underlying outstanding 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 Compensation Committee. To date, we have not established any formal option granting policies.

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. The fair value of each reporting unit was determined at December 31, 2012, 2011 and 2010 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.  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 100,000price paid.  No impairments were indicated as a result of the annual impairment tests referred to above.

Concurrently with entering into the merger agreement, FriendFinder entered into an equity put agreement with the former shareholders of JigoCity pursuant to which such shareholders have the option to sell all of their shares of common stock and Robert Brackett – optionswarrants received as consideration in the merger back to purchase 100,000FriendFinder in exchange for the return of 70% of the equity in JigoCity if the volume-weighted average price of FriendFinder's common stock fails to equal or exceed $12.00 per share during any 10 trading day period between the closing date of the merger and the later of June 30, 2014 and the date upon which FriendFinder current indentures are fully discharged, or if an "indenture modification" is made, as defined under the equity put agreement, the later of June 30, 2014 and the date that the indenture modification takes place (the later date hereinafter referred to as the “Vesting Date”).  The equity put agreement provides that the put right shall become exercisable at the sole discretion of the shareholders’ appointed representative during the period commencing on the Vesting Date and expiring sixty days thereafter.  Additionally, pursuant to the equity put agreement, if the shareholders exercise the put right, FriendFinder has a right to pay them in common stock and/or cash, having a combined value as of the later of the above dates equal to the product of (i) 2,209,414 shares of common stock.  In eachstock (subject to dilutive adjustment) and (ii) the difference between the highest 10 day volume-weighted average price attained by FriendFinder common stock during such period and $12.00, in which case the put right terminates.

The total acquisition date fair value of the consideration transferred is estimated at $7.5 million, which includes the estimated fair value of acquisition-related contingent consideration which may be paid to JigoCity shareholders if the put option award has an exercisereferred to above is exercised by such shareholders.  In addition, legal and other acquisition-related costs of approximately $0.4 million were incurred and charged to general and administrative expense.  The total acquisition date fair value of consideration transferred is estimated as follows:

The estimated fair value for the 1,555,555 shares of FriendFinder’s common stock issued to JigoCity shareholders was based on $2.87 per share, representing the closing price of $1.41the common stock on the NASDAQ Global Market on the date of the acquisition.

The estimated fair value of the warrants to acquire 6,436,851 shares of FriendFinder’s common stock issued to JigoCity shareholders was determined based on the Black-Scholes option pricing model using the following valuation inputs:  (a) market price of $2.87 per share, which was the closing price of FriendFinder’s common stock on the acquisition date, (b) exercise prices of the warrants ranging from $5.00 to $18.00 per share, (c) contractual term of the warrants of approximately 10 years (d) risk-free interest rate of 2.05% (e) expected volatility of 35% and (f) no dividend yield.  Based on the length of time FriendFinder’s shares have been traded, volatility was based on the average of historical and implied volatilities for a period comparable to the contractual term of the warrants of certain individual entities considered to be similar to FriendFinder.  The risk-free interest rate is based on yields on U.S. government securities with a maturity which approximates the contractual term of the warrants.

A liability was recognized for an estimate of the acquisition date fair value of the acquisition-related contingent consideration which may be paid.  The liability was measured as the present value of the put option award vests 20%determined based on estimated future trading prices of FriendFinder's common stock between September 7, 2011 and June 30, 2014 and on the estimated future equity value of JigoCity during such period calculated on multiple scenarios using a Monte Carlo simulation methodology.  The fair value measurement of the acquisition-related contingent consideration is based on unobservable inputs that are supported by little or no market activity and reflect FriendFinder’s own assumptions.  Key assumptions include expected volatility in both the value of JigoCity and in FriendFinder’s common stock during the above period.  Changes in the fair value of the contingent consideration subsequent to the acquisition date will be recognized in earnings until the liability is eliminated or settled.  Such change through December 31, 2011 amounted to a $920,000 increase in the liability.

As of December 31, 2012, there were 2,325,451 outstanding warrants to purchase voting common stock of the Company, issued in connection with the acquisition of JigoCity. These warrants have an expiration date of March 26, 2022. December 2021 and exercise prices between $5.00 and $18.00.

On April 3, 2012, we granted awards2008, the Company’s Board of options to purchase 2,000 shares of common stock under ourDirectors adopted the 2008 Stock Option Plan (the “Plan”), which was amended and restated and approved by our stockholders on February 1, 2010.  The maximum number of shares for which stock options may be granted under the Plan is 1,343,997 shares, subject to eachadjustment.  Stock options may be issued to employees, directors and consultants, selected by the compensation committee of our directors, except for Messrs. Marc Bellthe Board of Directors.  Under the terms of the Plan, the options granted will expire no later than 10 years from the date of grant and Daniel Staton, who were each granted awards of options to purchase 8,334 shares of common stock on April 24, 2012 pursuant to their consulting agreements.  The 2,000 option awards granted to each of our directors have an exercise price of $1.40 per share, the option awardswill vest 20% on the first anniversary of the grant date and 20% on each anniversary thereafter, until fully vested, and have an expiration date of April 2, 2022. The 8,334 option awards granted to each of Messrs. Bell and Staton have an exercise price of $1.13 per share, the option awards vest 20% on the first anniversarysucceeding four anniversaries of the grant date and on each anniversary thereafter, until fullyprovided, however, that an optionee may exercise the vested and have an expirationportion of a stock option only after that date which is 18 months after May 16, 2011 the date of April 23, 2022. On April 3, 2013, each of our directors were granted awards of options to purchase 10,000 shares of common stock under our 2008 Stock Option Plan, except for Messrs. Bell and Staton, who were each granted awards of options to purchase 4,167 shares of common stock pursuant to their consulting agreements.the Company’s IPO.  The 10,000 shares of common stock granted to each of our directors have an exercise price of $0.53an option shall be the closing price of the common stock on a national exchange immediately preceding the date of grant.  The exercise price per share of any stock option agreement issued prior to May 16, 2011 was set at $10.00 per share, representing the option awards vest 20%price per share that the Company’s common stock was sold to the public pursuant to the IPO.

Upon the successful completion of the IPO on May 16, 2011, compensation cost was accrued for each vesting tranche over the requisite service period commencing on the first anniversarydate the options were granted and ending on the later of the vesting date or 18 months after the date of the IPO.  Accordingly, in the quarter ended June 30, 2011, a cumulative adjustment of approximately $2 million was made to record compensation cost which accrued prior to May 16, 2011, based on the fair value of the options on the IPO date. From the IPO date to December 31, 2011, additional compensation cost of approximately $1.7 million related to stock options was recorded.  For the year ended December 31, 2012, compensation cost related to options amounted to $637,000.

The grant date fair value for options outstanding at January 1, 2012 was estimated on the IPO date using the Black-Scholes option pricing model using the following assumptions: dividend yield of 0%; expected volatility of 106%; a risk-free interest rate of 2.31%, and expected life of 6.5 years.  For the options granted in the year ended December 31, 2012 the following assumptions were used: dividend yield of 0%; expected volatility of 63.89%; a risk-free interest rate of 1.49%, and expected life of 6.5 years. The expected dividend yield is based on the Company’s historical dividend yield. The expected volatility was based on the average of historical and implied volatilities for a period comparable to the expected life of the options of certain entities considered to be similar to the Company.  The expected life is based on the simplified expected term calculation permitted by the SEC which defines the expected life as the average of the contractual term of the options and the weighted-average vesting period for all option tranches. The risk-free interest rate is based on the annual yield on the grant date and on each anniversary thereafter, until fully vested, and have an expiration date of April 2, 2023. The 4,167 option awards granted to eacha zero-coupon U.S. Treasury bond the maturity of Messrs. Bell and Staton have an exercise price of $0.53 per share,which equals the option awards vest 20% on the first anniversary of the grant date and on each anniversary thereafter, until fully vested, and have an expiration date of April 23, 2023.option’s expected life.

On March 23, 2009, in order to attract and retain key personnel, including our Named Executive Officers, and compensate them for services provided and to be provided in the future, ourCompany’s Board of Directors approved our 2009 Restricted Stock Plan.

On March 29, 2012, ourthe Company’s Board of Directors adopted ourthe FriendFinder Networks Inc. 2012 Stock Incentive Plan (the "2012 Stock Incentive Plan"), which was approved by our stockholdersthe Stockholders of the Company on May 30, 2012. The 2012 Stock Incentive Plan authorizes ourthe Compensation Committee of the Board to grant common stock, stock options, performance shares, performance units, restricted stock stock appreciation rights and other awards (collectively,"Awards") that are valued in whole or in part by reference to, or otherwise based on, ourthe Company's common stock for up to 2,000,000 shares of common stock to our employees, officers, consultants and directors. Stock granted under the 2012 Stock Incentive Plan will generally vest between the third and fifth anniversary of the grant date, subject to the recipient’s continued service.  The purpose ofIn the year ended December 31, 2012, Stock Incentive Plan is to enable us to attract, retain, reward500,000 restricted shares and motivate employees, officers, directors (employee or non-employee) or consultants of our company (collectively, "Eligible Individuals") by providing them with an opportunity to acquire or increase a proprietary interest in our company and to incentivize them to expend maximum effort for the growth and success of our company, so as to strengthen the mutuality of the interests between the Eligible Individuals and our stockholders.  As of April 15, 2013, 944,000250,000 unrestricted shares remain available for grantwere granted under the 2012 Stock Incentive Plan.