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PRVT > SEC Filings for PRVT > Form 10-Q on 28-Jun-2013All Recent SEC Filings

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Form 10-Q for PRIVATE MEDIA GROUP INC


28-Jun-2013

Quarterly Report


Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations

In this section, unless the context indicates otherwise, all references herein to "Private Media," "the Company," "we," "our" or "us" refer collectively to Private Media Group, Inc. and its subsidiaries.

You should read this section together with the consolidated financial statements and the notes and the other financial data in this Quarterly Report and in conjunction with management's discussion and analysis of financial condition and results of operations included in our Annual Report on Form 10-K for the year ended December 31, 2012. The matters that we discuss in this section, with the exception of historical information, are forward-looking statements within the meaning of the Private Securities Reform Act of 1995. These statements include forward-looking statements both with respect to us, specifically, and the adult entertainment industry, in general. In some cases, forward-looking statements can be identified by the use of terminology such as "may," "will," "expects," "plans," "anticipates," "estimates," "potential" or "could" or the negative thereof or other comparable terminology. Such forward-looking statements are subject to risks, uncertainties and other factors which could cause our actual results to differ materially from those expressed or implied by such forward-looking statements. Potential risks and uncertainties relate to factors such as: (1) the timing of the introduction of new products and services and the extent of their acceptance in the market; (2) our expectations of growth in demand for our products and services; (3) our ability to successfully implement expansion and acquisition plans; (4) the impact of expansion on our revenue, cost basis and margins; (5) our ability to respond to changing technology and market conditions; (6) the effects of regulatory developments and legal proceedings with respect to our business; (7) the impact of exchange rate fluctuations; and (8) our ability to obtain additional financing. For a more complete list of factors that may cause results to differ materially from our expectations, please refer to the Risk Factors section of our Annual Report for 2012 filed on Form 10-K. We caution investors not to place significant reliance on the forward-looking statements contained in this Quarterly Report. These statements, like all statements in this Quarterly Report, speak only as of the date of this Quarterly Report (unless another date is indicated) and we undertake no obligation to update or revise forward-looking statements.

Overview

We acquire worldwide rights to adult media produced for us by independent producers and then process this content into products suitable for popular physical media formats such as print publications, DVDs, digital media platforms (such as internet websites, mobile telephony and transactional television), and broadcasting (which includes cable, satellite and IPTV). Our branded adult media is available at physical retail locations and through electronic retailers as well as on mobile devices, transaction television platforms and over the Internet. In addition, we provide adult entertainment films to thousands of major hotels around the world. To a lesser extent, in addition to branded adult media products, we also market and distribute branded leisure and novelty products oriented to the adult entertainment lifestyle and generate additional sales through the licensing of our Private trademark to third parties.

We operate in a highly competitive market that is subject to numerous new and on-going changes in business, economic and competitive conditions. Although we believe our brand and our products are well-established in the adult entertainment industry, we compete with numerous entities selling adult-oriented products via any type of distribution network, including the Internet. Over the past few years, the adult entertainment industry and the media formats in which adult content is disseminated have undergone significant change. The introduction of a large number of free content internet sites that allow users to access large libraries of content free of charge has created an even more challenging environment where both sales volume and margins have decreased substantially. In addition, the recent recession has shown that the adult industry is not immune to economic cycles.

We generate revenues primarily through:

subscriptions by end consumers to our internet websites, primarily private.com (e-commerce) and sales of our branded media to 3rd party on-line content aggregators;

sales of VOD content to television distribution platforms including cable television, direct broadcast satellite and IPTV (Internet Protocol Television) operators;

sales of content and revenue participations in the two Private branded adult entertainment PPV networks;

sales of DVDs and magazines;

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sales of Private branded media to wireless providers (wireless); and

license fees and revenue share agreements for the use of our brand.

Over time, we expect net sales from DVDs and magazines to continue to decline as a percentage of net sales in relation to total net sales from the Internet, broadcasting and wireless. We expect net sales from Internet and direct-to-consumer digital sales to be the principal area of growth during the coming years.

We generally provide extended payment terms to our established distributors of between 90 and 180 days. Although our extended payment terms increase our exposure to accounts receivable write-offs, we believe our risk is minimized by our generally long-term relationships with our distributors.

Our primary expenses include:

web page development costs;

acquisition and licensing of content for our library of photographs and videos;

printing, processing and duplication costs; and

selling, general and administrative expenses.

Over the years, our cost of sales has fluctuated relative to net sales due to our use of new mediums for the dissemination of our products, such as the Internet, broadcasting and wireless and the different cost structure of those new mediums. We also incur significant web page development expenses annually in connection with the amortization of our library of photographs and movies and capitalized development costs. We amortize these assets on a straight-line basis for periods of between three and five years.

Critical Accounting Estimates

General

Our discussion and analysis of our financial condition and results of operations are based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amount of assets and liabilities revenues and expenses. On an ongoing basis, we evaluate our estimates, including those related to impairment of the library of photographs and videos and other long lived assets, allowances for doubtful debts, income taxes and contingencies and litigation. Accounts receivable and sales related to certain products are, in accordance with industry practice, subject to distributors' right of return to unsold items. We base our estimates on historical experience and on various assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily available from other sources. Management periodically reviews such estimates. Actual results may differ from these estimates as a result of unexpected changes in trends.

We believe the following critical accounting policies are significantly affected by judgments and estimates used in the preparation of our consolidated financial statements.

Recognition of Revenue

The Company's primary sources of revenue are the sale of content delivered via the Internet, broadcasting, DVD and magazines and mobile phones.

Internet video-on-demand offerings are sold directly via the Company's websites and are paid for almost exclusively by credit card. The Company recognizes revenue from video-on-demand when the service is rendered and collectability is reasonably assured, specifically, when the customer's credit card is charged, which is, in most cases, simultaneous with delivery of the on-demand video. Credit card payments accelerate cash flow and reduce the Company's collection risk, subject to the merchant bank's right to hold back cash pending settlement of the transactions.

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Revenues from the sale of subscriptions to the Company's internet website are deferred and recognized ratably over the subscription period.

IPTV and satellite and cable broadcasting revenues are recognized upon delivery when the following conditions have been met (i) license period of the arrangement has begun and the customer can begin its exploitation, exhibition, or sale (ii) the arrangement fee is fixed or determinable and (iii) collection of the arrangement fee is reasonably assured. Such revenues may be generated by either a fixed license fee or as an agreed percentage of sales, based on sales reported each month by the Company's IPTV, cable and satellite affiliates. The affiliates do not report actual monthly sales for each of their systems to the Company until several months after the month of service ends. This practice requires management to make monthly revenue estimates based on historical experience for each affiliated system. Revenue is subsequently adjusted to reflect the actual amount earned upon receipt. Adjustments made to adjust revenue from estimated to actual have historically been immaterial.

DVDs and magazines (physical products) are sold both to wholesalers, on firm sale basis, and via national newsstand distributors, with the right to return. Our physical products are generally produced in multiple languages and the principal market is in Europe. Revenues from the sale of physical products where distributors are not granted rights-of-return are recognized upon transfer of title, which generally occurs upon delivery. Revenues from the sale of physical products under consignment agreements with distributors are recognized based upon reported sales by the Company's distributors. Revenues from the sale of physical products under agreements that grant distributors rights-of-return are recognized upon transfer of title, which generally occurs on delivery, net of an allowance for returned product. Distributors with the right to return are primarily national newsstand distributors. Most of our products are bi-monthly (six issues per year) and remain on sale at a newsstand for a period of several months. Normally, all unsolds are reported to us within a period of four to six months from delivery. There are normally two to four national newsstand distributors for all newspapers and periodicals operating in each country. The Company uses specific return percentages per title and distributor based on estimates and historical data. The percentages vary up to 80%. Percentages are reviewed on an on-going basis. In view of the high retail price, the margin and the physical quality of the magazines and the fact that the content has a very long "shelf-life" since it is not particularly linked to time, trends, fashion or current events, the Company historically has collected the returns from newsstands, repackaged them, and then made them available for sale again. The Company operates scheduled re-distribution of returned magazines, via national newsstand distributors, together with DVDs as magazine/DVD packs as a way of increasing DVD distribution. Since the national newsstand distributors have the right to return, the DVD packs are returned in order to be sold via an additional scheduled re-distribution. Magazine returns not re-distributed as per above are sold on a firm sale basis to wholesalers as back issues at a lower price than new issues. The Company has historically sold all returned copies at an average price higher than, or equal, to cost.

Revenues from mobile content (wireless) sales are recognized based on sales reported each month by mobile operators via aggregators. The aggregators do not report actual monthly sales for each of their operators to the Company for several months after the month of service ends. This practice requires management to make monthly revenue estimates based on historical experience for each affiliated system. Revenue is subsequently adjusted to reflect the actual amount earned upon receipt. Adjustments made to adjust revenue from estimated to actual have historically been immaterial.

Accounts receivable

We are required to estimate the collectability of our trade receivables and notes receivable. A considerable amount of judgment is required in assessing the ultimate realizable value of these receivables including the current credit-worthiness of each customer. Significant changes in required reserves have been recorded in the past and may occur in the future due to the current market environment.

Management reviews the allowance for doubtful accounts on at least a quarterly basis and adjusts the balance based on their estimate of the collectability of specific accounts as well as a reserve for a portion of other accounts which have been outstanding for more than six months. This estimate is based on historical losses and information about specific customers. After collection attempts have failed, the Company writes off the specific account.

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Inventories

Inventories are valued at the lower of cost or market, with cost principally determined on an average basis. Inventories principally consist of DVD's and magazines held for sale or resale. The inventory is written down to the estimated market value based upon assumptions about future demand and market conditions. If actual market conditions are less favorable than those anticipated by management, write-downs may be required.

Results of Operations

Three months ended March 31, 2013 compared to the three months ended March 31, 2012

Net sales. Net sales for the three months ended March 31, 2013 ("the fiscal 2013 quarter") decreased by EUR 206,000, or by 12%, compared to net sales for the three months ended March 31, 2012 ("the fiscal 2012 quarter"). This was a result of decreased sales from each of our four principal revenue sources (broadcast, mobile/wireless, DVD/magazines, and Internet/e-commerce). The decrease in net sales was attributable both trends in the adult entertainment industry and the amount of new video and print content that we released during the fiscal 2013 quarter and prior periods. We believe that revenues in the segment of the adult entertainment industry that we compete in have been decreasing due to the proliferation of free adult content that is now available the Internet. This free, or low cost, alternate source of content has reduced the demand for our paid products, which has reduced our Internet sales, broadcast, DVD and magazine sales. We believe that the continuous release of new, high quality print and video products may retain our traditional customers and attract new customers. However, because of the change in management in 2012, the large amount of liabilities our new management inherited in 2012, and our lack of funding, we did not produce and release enough new video products during 2012 and the fiscal 2013 quarter. We have recently completed a number of new products that we will be releasing in 2013, which new products are expected to generate additional revenues in the future. However, the longer term effects of the easy availability to our customers of free, or low cost, adult content over the Internet on our revenues and business are uncertain and cannot be predicted.

Cost of Sales. Our cost of sales consisted primarily of the cost of operating our Internet, broadcasting and wireless businesses, the cost of printing, processing and duplication, and the amortization of our library and websites. Cost of sales decreased by EUR 215,000 in the fiscal 2013 quarter due to the decrease in net sales and lower amortization costs of the library. Cost of sales as a percentage of net sales for the three months ended March 31, 2013 decreased (from 76% for the three months ended March 31, 2012 to 72% in the 2013 quarter), due to the decrease in amortization of our library and websites in the fiscal 2013 quarter. Amortization of our library does not vary with sales since it reflects the amortization of our investments in content which has been available for sale for a period of three to five years.

Gross Profit. In the three months ended March 31, 2013, our gross profit increased slightly by EUR 9,000 compared to our gross profit for the three months ended March 31, 2012. Gross profits increased despite the decrease in net sales because of the decrease in the cost of sales (and the increase in gross margins as described above).

Selling, general and administrative expenses. Our selling, general and administrative expenses for the three months ended March 31, 2013 decreased by EUR 506,000 compared to the fiscal 2012 quarter. The decrease was the result of continued emphasis by new management to control costs (including lower payroll costs), lower legal and other professional fees, and positive foreign exchange fluctuations (EUR 181,000) during the fiscal 2013 quarter. Legal and other professional fees decreased in the fiscal 2013 quarter compared to the 2012 fiscal quarter as a result of lower legal fees following new management's settlement of legacy legal claims during 2012. As a percentage of net sales, selling, general and administrative expenses decreased from 74% of net sales in the fiscal 2012 quarter to 63%, after giving effect for the foreign exchange gain, in the fiscal 2012 quarter.

Operating profit/loss. We reported an operating loss of EUR 851,000 for the three months ended March 31, 2012 compared to an operating loss of EUR 336,000 for the three months ended March 31, 2013. Our operating loss for the three month period ended March 31, 2013 was less than the loss in the prior year's period due to the slight increase in gross profits and the significant reduction in selling, general and administrative expenses.

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Interest expense. Interest expense represented interest on the institutional line of credit and bank borrowings (including the Commerzbank promissory note held by Consipio Holding bv). Interest expense in the fiscal 2013 quarter decreased by EUR 27,000 compared to the fiscal 2012 quarter primarily because the Commerzbank promissory note was repaid on December 28, 2012. The decrease in interest was partially offset by interest accrued on the new EUR 800,000 loan we obtained in February 2013.

Net Income/loss. We reported a net loss of EUR 921,000 for the three months ended March 31, 2012, compared to a net loss of EUR 379,000 for the three months ended March 31, 2013. Our net loss decreased in the fiscal 2013 quarter despite lower net sales due to the improvement in gross margins and the significant reduction in selling, general and administrative expenses.

Liquidity and Capital Resources

We had a working capital deficit of EUR 2.0 million at March 31, 2013, compared to a working capital deficit of EUR 2.4 million as of December 31, 2012.

Operating Activities

For the fiscal 2013 quarter, the Company had negative cash flow of EUR 75,000 from its operating activities. Although the Company had a net loss of EUR 379,000 during this quarter, the net loss was partly attributable to non-cash expenses. The principal non-cash expenses consisted of amortization of photographs and videos (EUR 463,000), amortization of web pages (EUR 130,000), and depreciation (EUR 58,000). Excluding these non-cash expenses, the Company would have generated cash from its operations. We also generated additional cash by our increased efforts to collect accounts receivable, which resulted in our trade accounts receivable decreasing by EUR 181,000. However, these benefits were more than offset by the use of cash to pay down trade accounts payable (EUR 533,000), which trade payables were largely related to the settlement and payment of professional fees incurred by former management.

Investing Activities

The Company used EUR 386,000 of net cash in investing activities during the three months ended March 31, 2013. The investing activities were principally capital expenditures of EUR 59,000 and investment in library of photographs and videos of EUR 340,000. The Company has increased its content production activities in order to provide new content to its customers. As a result of these increased video production activities, cash used in investment activities is expected to increase in future periods.

Financing Activities

Net cash generated by financing activities for the three-month period ended March 31, 2013 was EUR 706,000, reflecting the placement of new debt net of repayments on borrowings. In February 2013, in order to settle some of the liabilities prior management accrued (including the foregoing legal fees), we borrowed a total of EUR 800,000 from three unaffiliated foreign lenders. The loans bear interest at a rate of 9.9% per annum and are due and payable on December 31, 2014.

Liquidity

In each of the past three years we have experienced losses from operations. At March 31, 2013, we had cash and cash equivalents of EUR 224,000 and a working capital deficit of EUR 1,972,000. As a result, there is substantial doubt as to our ability to continue as a going concern. Our ability to continue as a going concern will depend on our ability to generate or obtain sufficient cash to meet our obligations on a timely basis and ultimately to attain profitable operations.

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During the fiscal quarter ended March 31, 2012 we replaced most of our directors and replaced our prior senior executive officers. Since March 31, 2012, our new has implemented a number of steps to improve our cash flow, reduce our working capital deficit, and to increase our liquidity. These steps include the following:

As part of a larger settlement with Consipio Holding bv, in December 2012 we issued 800,000 shares of our newly created Series B Preferred Stock (at EUR 10.00 per share) to Consipio as payment in full for liabilities in excess of EUR 8,000,000. The liabilities that were repaid by means of this equity issuance included the entire outstanding balance of the Commerzbank promissory note, the legal fees and costs that the Nevada State Court ordered us to pay, the legal fees and costs we were required to pay Consipio because of the New York lawsuit, and amounts that we owed to third parties, which obligations were acquired by Consipio. The foregoing settlement both reduced the amount of our cash obligations and ended the litigation (which resulted in significant savings of future legal and other fees related to the litigation);

We settled $450,000 of attorneys' fees and costs that the Nevada State Court ordered us to pay to Tisbury Services Inc. by issuing to Tisbury 3,000,000 unregistered shares of Common Stock, and a five-year, contingent warrant;

We restructured a EUR 1,073,500 debt that one of our subsidiaries owed to a European bank under a defaulted loan that we had guaranteed. Under the new terms, the loan now bears interest at a rate of 3% per annum, with interest payments due annually at the end of each calendar year. The repayment dates for the unpaid principal balance have been extended, so that the outstanding principal amount must be repaid as follows: (i) EUR 350,000 is due on January 1, 2016, (ii) EUR 350,000 is due on January 1, 2017, and the balance, (iii) EUR 373,500 is due on January 1, 2018. As a result, our current cash payment obligations have been substantially reduced;

We have settled and paid certain outstanding professional fees (principally legal fees) that were incurred by prior management at a discount;

In February 2013, in order to settle some of the liabilities prior management accrued (including the foregoing legal fees), we borrowed a total of EUR 800,000 from three unaffiliated foreign lenders. The loans bear interest at a rate of 9.9% per annum and are due and payable on December 31, 2014. Interest is payable quarterly in arrears. Our obligations under the loans are secured by a lien on trademarks and certain motion pictures in our film library. These loans enabled us to repay many of prior management's debts at a discount, thereby reducing our trade accounts payable and other short-term obligations; and

We have reduced our on-going selling, general and administrative expenses by reducing the amount of office space we use in our current headquarters and by closing our redundant office in Spain. In addition, we have substantially reduced the Company's headcount.

As a result of the foregoing actions, and based on our internal forecasts of cash expected to be generated from our current operations, as of the date of this report, we currently expect that our available cash resources and cash generated from operations will be sufficient to meet our presently anticipated working capital and capital expenditure requirements for at least the next 12 months. Nevertheless, we may raise additional funds to support more rapid growth, to repay more of the legacy liabilities accrued by prior management, or to respond to unanticipated capital requirements. No assurance can be given that we will be able to raise additional funding, or that such funding will be on terms favorable to our current shareholders.

We currently have no additional availability under our existing credit facilities. The existence of a going concern exception by our auditors may make it more difficult to obtain additional bank financing if and when required. If additional funds are raised through the issuance of equity securities, our shareholders' percentage

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ownership will be reduced, they may experience additional dilution, or these newly issued equity securities may have rights, preferences, or privileges senior to those of the current holders of our common stock. Additional financing may not be available when needed on terms favorable to us, or at all. If adequate funds are not available or are not available on acceptable terms, we may be unable to develop or enhance our products and services, take advantage of future opportunities, maintain the scope of our operations or respond to competitive pressures or unanticipated requirements, which could harm our business.

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