Form 10-Q

U.S. SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549


Form 10-Q

x    QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the quarterly period ended................................................ June 30, 2003
 
OR
 
o   TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the transition period from_________________to__________________

Commission file number 000-25067


PRIVATE MEDIA GROUP, INC.
(Exact Name of Registrant as Specified in its Charter)

Nevada   87-0365673
(State or other jurisdiction of   (I.R.S. Employer Identification Number)
incorporation or organization)    

3230 Flamingo Road, Suite 156, Las Vegas, Nevada 89121
(Registered office)

Carretera de Rubí 22-26, 08190 Sant Cugat del Vallès, Barcelona, Spain
(European headquarters and address of principal executive offices)

                                   34-93-590-7070  
 
 
                     Registrant’s telephone number  


                    Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the past 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes  x    No  o

                    Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act):

Yes  o    No  x

         State the number of shares outstanding of each of the issuer’s classes of common equity, as of the latest practicable date

Class   Outstanding at August 8, 2003

 
Common Stock, par value $.001   49,854,934


PART I.

Item 1.  Financial Statements

PRIVATE MEDIA GROUP, INC.
CONSOLIDATED BALANCE SHEETS

               
December 31,
June 30,
(Unaudited)

  2002

2003

2003

  EUR EUR USD
(in thousands)
ASSETS        
Cash and cash equivalents   1,694   1,142   1,298  
Short-term investment   2,850   2,850   3,239  
Trade accounts receivable   12,472   12,514   14,220  
Related party receivable   4,228   4,488   5,100  
Inventories - net (Note 4)   8,808   10,698   12,156  
Deferred income tax asset   396   396   450  
Prepaid expenses and other current assets   3,630   4,624   5,254  



TOTAL CURRENT ASSETS   34,078   36,712   41,718  
               
Library of photographs and videos - net   16,929   17,682   20,093  
Property, plant and equipment - net   14,890   15,448   17,554  
Goodwill and other intangible assets (Note 5)   2,851   3,560   4,045  
Other assets   240   239   271  



TOTAL ASSETS   68,989   73,640   83,682  



LIABILITIES AND SHAREHOLDERS’ EQUITY              
Short-term borrowings   9,739   2,850   3,238  
Accounts payable trade   6,929   9,972   11,331  
Income taxes payable   753   387   440  
Deferred income taxes   31   31   35  
Accrued other liabilities   1,339   1,494   1,698  



TOTAL CURRENT LIABILITIES   18,791   14,733   16,742  
               
Long-term borrowings   178   9,642   10,957  
Related party payable   6,569   4,920   5,591  



TOTAL LIABILITIES   25,538   29,295   33,289  
SHAREHOLDERS’ EQUITY              
$4.00 Series A Convertible Preferred Stock 10,000,000 shares authorized, 7,000,000 and 1,650,000 issued and outstanding at December 31, 2002 and June 30, 2003, respectively
       
Common Stock, $.001 par value, 100,000,000 shares authorized, 28,608,609 and 44,904,934 issued and outstanding at December 31, 2002 and June 30, 2003, respectively
  863   878   998  
Additional paid-in capital   15,668   16,359   18,590  
Stock dividends to be distributed   692   148   168  
Retained earnings   28,695   29,080   33,046  
Accumulated other comprehensive loss   (2,467 ) (2,120 ) (2,409



TOTAL SHAREHOLDERS’ EQUITY   43,451   44,345   50,392  



TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY   68,989   73,640   83,682  




PRIVATE MEDIA GROUP, INC.
CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME

  Three-months ended
June 30,
(unaudited)

Six-months ended
June 30,
(unaudited)

  2002
2003

2002

2003

2003
  EUR EUR EUR EUR USD
(in thousands)
Net sales   11,027   10,078   20,289   19,669   22,351  
Cost of sales   4,592   4,880   8,109   9,179   10,430  





Gross profit   6,435   5,198   12,180   10,490   11,921  
Selling, general and administrative expenses   4,457   4,907   10,226   9,966   11,325  
Offering expenses       1,401      





Operating profit (loss)   1,978   291   553   524   596  
Interest expense   74   204   353   406   461  
Interest income   13   37   175   80   91  





Income before income tax   1,917   124   375   198   225  
Income taxes (benefit)   (47 ) (155 ) (372 ) (337 ) (383 )





Net income   1,964   279   746   535   608  





Other comprehensive income:                      
   Foreign currency adjustments   (257 ) 262   1,343   347   395  





   Comprehensive income   1,707   542   2,089   883   1,003  





Income applicable to common shares   1,611   207   (7 ) 387   440  





Net income per share:                      
Basic   0.06   0.00   0.00   0.01   0.01  





Diluted   0.04   0.00   0.00   0.01   0.01  





See accompanying notes to consolidated statements.

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PRIVATE MEDIA GROUP, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS

  Six-months ended
June 30,
(unaudited)

  2002

2003

2003

   
EUR
 
EUR
 
USD
 
    (in thousands)  
       
Cash flows from operating activities:              
Net income   746   535   608  
Adjustment to reconcile net income to net cash flows from operating activities:              
   Depreciation   309   515   585  
  Bad debt provision   686   150   170  
  Provision for offering expenses   134      
  Amortization of other intangible assets     25   28  
  Amortization of photographs and videos   2,808   3,474   3,948  
Effects of changes in operating assets and liabilities:              
  Trade accounts receivable   (329 ) (926 ) (1,052 )
  Related party receivable   (3,251 ) (260 ) (296 )
  Inventories   (902 ) (1,889 ) (2,147 )
  Prepaid expenses and other current assets   (732 ) (993 ) (1,129 )
  Accounts payable trade   1,619   3,043   3,458  
  Income taxes payable   (1,047 ) (366 ) (416 )
  Accrued other liabilities   34   155   176  


 
 
Net cash provided by operating activities   77   3,462   3,934  
Cash flows from investing activities:              
Investment in library of photographs and videos   5,304   4,228   4,804  
Capital expenditures   869   1,060   1,204  
Investments in (sale of) other assets   (11 ) (2 ) (2 )


 
 
Net cash used in investing activities   6,163   5,286   6,006  
Cash flow from financing activities:              
Conversion of warrants   232      
Related party note payable     (1,649 ) (1,874 )
Long-term loan (repayments on loan)   (12 ) 9,464   10,755  
Short-term borrowings (repayments)   (494 ) (6,890 ) (7,829 )


 
 
Net cash (used in) provided by financing activities   (274 ) 925   1,051  
Foreign currency translation adjustment   1,343   347   395  


 
 
Net (decrease) increase in cash and cash equivalents   (5,017 ) (551 ) (626 )
Cash and cash equivalents at beginning of the period   6,408   1,694   1,925  


 
 
Cash and cash equivalents at end of the period   1,391   1,142   1,298  


 
 
Cash paid for interest   247   219   249  


 
 
Cash paid for taxes   675   320   364  


 
 

See accompanying notes to consolidated statements.

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PRIVATE MEDIA GROUP, INC.
CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY

  Common stock
  Preferred stock
  Addi-
tional
paid-in
Stock
dividends
to be
Retained
Accu-
mulated
other
compre-
hensive
Total
share-
holder's
  Shares
Amounts
Shares
Amounts
capital
distributed
earnings
income
equity
    EUR   EUR EUR EUR EUR EUR EUR
Balance at January 1, 2002   28,370,857   863   7,000,000     14,285   396   29,802   (3,066 ) 42,280  
Translation Adjustment                 666   666  
Unrealized loss on short-term investment                 (67 ) (67 )
Conversion of warrants and options   55,295         232         232  
Stock dividends   182,457         1,150   (1,150 )      
Stock dividends to be distributed             1,446   (1,446 )    
Net income               340     340  





 
 
 
 
 
Balance at December 31, 2002   28,608,609   863   7,000,000     15,668   692   28,695   (2,467 ) 43,450  
Translation Adjustment                 348   348  
Conversion of preferred stock to common stock   16,050,000   15   (5,350,000 )           15  
Stock dividends   246,325         692   (692 )      
Stock dividends to be distributed             148   (148 )    
Net income               533     533  





 
 
 
 
 
Balance at June 30, 2003   44,904,934   878   1,650,000     16,359   148   29,080   (2,120 ) 44,345  





 
 
 
 
 

See accompanying notes to consolidated statements.

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PRIVATE MEDIA GROUP, INC.
NOTES TO THE CONSOLIDATED INTERIM FINANCIAL STATEMENTS
(UNAUDITED)

1.     Basis of Presentation

         The accompanying unaudited consolidated financial statements have been prepared in accordance with United States generally accepted accounting principles (“U.S. GAAP”) for interim financial information. Accordingly they do not include all of the information and footnotes required by U.S. GAAP for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation of financial position and results of operations have been included. Operating results for the six months period ended June 30, 2003 are not necessarily indicative of the results that may be expected for the year ended December 31, 2003. For further information, refer to the consolidated financial statements and footnotes thereto included in the Company’s annual report on form 10-K for the year ended December 31, 2002.

         Solely for the convenience of the reader, the accompanying consolidated financial statements as of June 30, 2003 and for the six months then ended have been translated into United States dollars (“USD”) at the rate of EUR 0.88 per USD 1.00 the Interbank Exchange Rate on June 30, 2003. The translations should not be construed as a representation that the amounts shown could have been, or could be, converted into US dollars at that or any other rate.

2.     Conversion of Preferred Stock

         We are authorized to issue up to 10,000,000 shares of preferred stock under our Articles of Incorporation, of which 7,000,000 million have been issued as Series A Preferred Stock.. On March 18, 2003 Slingsby Enterprises Limited, the record owner of the outstanding Series A Preferred Stock, converted 5,350,000 of the 7,000,000 shares of $4.00 Series A Preferred Stock into 16,050,000 shares of common stock in accordance with the terms of the Series A Preferred Stock. Accordingly, as of March 18, 2003, 1,650,000 shares of Series A Preferred Stock remained outstanding.

3.     Stock-Based Compensation

         As permitted by Statement of Financial Accounting Standards No. 123 (“SFAS No. 123”), “Accounting for Stock-Based Compensation,” the Company has elected to continue following Accounting Principles Board Opinion No. 25 (“APB 25”), Accounting for Stock Issued to Employees, and related Interpretations for measurement and recognition of stock-based transactions with employees and adopted the disclosure-only provisions of SFAS No. 123. Under APB 25, generally no compensation expense is recognized because the exercise price of the options equals the fair value of the stock at the vesting date.

         Had compensation cost for the Company’s stock based compensation issued to employees been determined based upon the fair value at the grant date consistent with the methodology prescribed under SFAS 123, the Company’s pro forma net income (loss) for 2002 and 2003 would have been as per the following table:

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PRIVATE MEDIA GROUP, INC.
NOTES TO THE CONSOLIDATED INTERIM FINANCIAL STATEMENTS
(UNAUDITED)

  Three-months ended
June 30,
(unaudited)

Six-months ended
June 30,
(unaudited)

  2002
2003
2002
2003
  EUR EUR EUR EUR
  (in thousands) (in thousands)
Net income, as reported   1,964   279   746   535  
 



     Deduct: Total stock based employee compensation expense determined under fair value based method for all awards net of related tax effects
  (417 ) (1,606 ) (678 ) (2,321 )
 



Pro forma net income   1,547   (1,327 ) 68   (1,786 )
 



Net income applicable to common shares, as reported
  1,611   207   (7 ) 387  
   
 
 
 
 
     Deduct: Total stock based employee compensation expense determined under fair value based method for all awards net of related tax effects
  (417 ) (1,606 ) (678 ) (2,321 )
 



Pro forma net income applicable to common shares   1,194   (1,399 ) (685 ) (1,934 )
 



Earnings (loss) per share:                  
     Basic – as reported   0.06   0.00   0.00   0.01  
 



     Basic – pro forma   0.04   (0.03 ) (0.02 ) (0.05 )
 



     Diluted – as reported   0.04   0.00   0.00   0.01  
 



     Diluted – pro forma   0.03   (0.03 ) (0.02 ) (0.05 )
 



4.     Inventories

         Inventories consist of the following:

  December 31,
June 30,
  2002
2003
  EUR EUR
  (in thousands)
Magazines for sale and resale   2,634   2,970
Video cassettes   2,874   3,002
DVDs   3,231   4,651
Other   69   75
 

    8,808   10,698
 

5.     Goodwill and Other Intangible Assets

         On May 30, 2003 the Company entered into an Asset Purchase Agreement to acquire certain assets, including governmental film board approvals and distribution rights from its former Canadian distributor, Software Entertainment Ltd. The transaction closed on May 30, 2003. The consideration for the transaction was EUR 734,091 and the transaction has been accounted for as the acquisition of an intangible asset which is being amortized on a straight line basis over 10 years.

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PRIVATE MEDIA GROUP, INC.
NOTES TO THE CONSOLIDATED INTERIM FINANCIAL STATEMENTS
(UNAUDITED)

6.     Earnings per share

         The following table sets forth the computation of basic and diluted earnings per share:

  Three-months ended
June 30,

Six-months ended
June 30,

  2002
2003
2002
2003
Numerator: (EUR in thousands)        
Net income (numerator diluted EPS)   1,964   279   746   535
 



Less: Dividends on preferred stock   353   72   754   148
 



Income applicable to common shares (numerator basic EPS)
  1,611   207   (7 ) 387
 



Denominator:                
Denominator for basic earnings per share – Weighted average shares
  28,566,982   44,983,761   28,535,966   38,153,326
Effect of dilutive securities:                
     Preferred stock   21,000,000   N/A   N/A   11,726,667
     Common stock warrants and options   166,533   N/A   N/A   331,376
Denominator for diluted earnings per share – weighted average shares and assumed conversions
  49,733,515   N/A   N/A   50,211,369
 



Earnings per share (EUR)                
     Basic   0.06   0.00   0.00   0.01
 



     Diluted   0.04   0.00   0.00   0.01
 



         For the six month period ended June 30, 2002 and the three month period ended June 30, 2003 the impact of potentially dilutive securities (convertible preferred shares and outstanding options and warrants for common shares) is anti-dilutive therefore reported diluted and basic income (loss) per share are EUR 0.00.

7.     Contingent Liability

         In December 1999 the Company received final notification from the Swedish Tax Authority assessing its subsidiary in Cyprus for the tax years 1995-1998 for a total amount of SEK 42,000,000 (approx. EUR 4.5 million) plus fines amounting to SEK 16,800,000 (approx. EUR 1.8 million) plus interest. The Swedish Tax Authority has taken the position that the subsidiary carried on business in Sweden from a permanent establishment during the period in question and should therefore be taxed on the income attributable to the permanent establishment. The case is under litigation and the Company believes the circumstances supporting

-8-


PRIVATE MEDIA GROUP, INC.
NOTES TO THE CONSOLIDATED INTERIM FINANCIAL STATEMENTS
(UNAUDITED)

the Tax Authority’s claim are without merit. However, the County Court has decided that a permanent establishment is at hand. The Court has only made a principle statement and the question how to calculate any eventual profit that can be allocated to the permanent establishment is not decided by the Court at this stage. The Company has appealed against the decision. The final outcome of this litigation will not be known for several years. Due to the early stages of this matter and the uncertainty regarding the ultimate decision, no amounts have been provided in the Company’s financial statements for this dispute.

8.     Subsequent Event

         On August 8, 2003 Slingsby Enterprises Limited, the record owner of the outstanding Series A Preferred Stock, see Note 2, converted the remaining 1,650,000 of the 7,000,000 shares of $4.00 Series A Preferred Stock into 4,950,000 shares of common stock in accordance with the terms of the Series A Preferred Stock. Accordingly, as of August 8, 2003, no shares of Series A Preferred Stock remained outstanding.

-9-


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

         You should read this section together with the consolidated financial statements and the notes and the other financial data in this Report. 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. 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.

         The following discussion should be read in conjunction with the consolidated financial statements and related notes included elsewhere in this Report.

Critical Accounting Policies

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 bad debt, 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.

         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

         Revenues from the sale of magazines, videocassettes, DVD’s and other related products where distributors are not granted rights-of-return are recognized upon transfer of title, which generally occurs upon delivery.

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Revenues from the sale of magazines 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 magazines. Revenues from the sale of videocassette and DVD products under consignment agreements with distributors are recognized based upon reported sales by the Company’s distributors. Revenues from the sale of subscriptions to the Company’s internet website are deferred and recognized ratably over the subscription period. Revenues from licensing of broadcasting rights to the Company’s video and film library 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.

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, videocassettes 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 projected by management, additional write-downs may be required.

Impairment of Long-Lived Assets

         The Company periodically evaluates the carrying value of long-lived assets including its library of photographs and videos for potential impairment. Upon indication of impairment, the company will record a loss on its long-lived assets if the undiscounted cash flows that are estimated to be generated by those assets are less than the related carrying value of the assets. An impairment loss is then measured as the amount by which the carrying value of the asset exceeds the estimated discounted future cash flows. Management’s estimated future revenues are based upon assumptions about future demand and market conditions and additional write downs may be required if actual conditions are less favorable than those assumed.

Accounts receivable

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

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Results of Operations

         Three months ended June 30, 2003 compared to the three months ended June 30, 2002

         Net sales. For the three months ended June 30, 2003, we had net sales of EUR 10.1 million compared to net sales of EUR 11.0 million for the three months ended June 30, 2002, a decrease of EUR 0.9 million, or 9%. We attribute this change to a decrease in Video and Magazine, Internet and Broadcasting sales. Video and Magazine sales decreased 18% to EUR 3.5 million, primarily as a result of DVD taking over from video in the marketplace. Internet sales decreased 32% to EUR 1.1 million as a result of a weaker US dollar and lower license sales. Broadcasting sales decreased 61% to EUR 0.6 million as a result of a decrease in license sales. The reduction in Broadcasting license sales is a result of the Company’s strategy to start operating its own TV channel in the United States. The launch of this channel requires the Company to refrain from selling its broadcast rights to third parties for the period leading up to the launch. The decrease in Video and Magazine, Internet and Broadcasting sales was offset by a increase in DVD sales of 33% to EUR 4.9 million. We attribute the growth in sales of DVDs to the increasing number of DVD players being sold in all of our markets. We believe that the growth in DVD sales will continue through the remainder of 2003.

         Net sales in general were affected by unfavorable changes in exchange rates.

         Cost of Sales. Our cost of sales was EUR 4.9 million for the three months ended June 30, 2003 compared to EUR 4.6 million for the three months ended June 30, 2002, an increase of EUR 0.3 million, or 6%. Cost of sales as a percentage of sales was 48% for the three months ended June 30, 2003, compared to 42% for the three months ended June 30, 2002. The increase in cost of sales as a percentage of sales was primarily the result of sales mix, see Gross Profit.

         Gross Profit. In the three months ended June 30, 2003, we realized a gross profit of EUR 5.2 million, or 52% of net sales compared to EUR 6.4 million, or 58% of net sales for the three months ended June 30, 2002, a decrease of EUR 1.2 million, or 19%. The decrease in gross profit was primarily the result of sales mix, with higher sales volume in products generating cost of sales, such as Videos, Magazines and DVDs combined, and lower sales in products not generating cost of sales, such as Internet and Broadcasting sales.

         Selling, general and administrative expenses. Our selling, general and administrative expenses were EUR 4.9 million for the three months ended June 30, 2003 compared to EUR 4.5 million for the three months ended June 30, 2002, an increase of EUR 0.4 million, or 10%. The increase is primarily the result of increased marketing efforts and EUR 0.15 million in increased bad debt provision.

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         Operating profit. We reported an operating profit of EUR 0.3 million for the three months ended June 30, 2003 compared to an operating profit of EUR 2.0 million for the three months ended June 30, 2002, a decrease of EUR 1.7 million, or 85%. The decrease was primarily the result of lower gross profit.

         Interest expense. We reported interest expense of EUR 0.2 million for the three months ended June 30, 2003, compared to EUR 0.1 million for the three months ended June 30, 2002, an increase of EUR 0.1 million. We attribute this increase to higher short-term and long-term borrowings outstanding during the three months ended June 30, 2003, compared to the three months ended June 30, 2002.

         Income tax expense/benefit. We reported income tax benefit of EUR 0.2 million for the three months ended June 30, 2003, compared to no income tax for the three months ended June 30, 2002.

         Net income. We reported net income of EUR 0.3 million for the three months ended June 30, 2003, compared to net income of EUR 2.0 million for the three months ended June 30, 2002. We attribute the decrease in net income in 2003 of EUR 1.7 million to lower operating profit.

Six months ended June 30, 2003 compared to the six months ended June 30, 2002

         Net sales. For the six months ended June 30, 2003, we had net sales of EUR 19.7 million compared to net sales of EUR 20.3 million for the six months ended June 30, 2002, a decrease of EUR 0.6 million, or 3%. We attribute this change to a decrease in Video and Magazine, Internet and Broadcasting sales. Video and Magazine sales decreased 14% to EUR 6.5 million, primarily as a result of DVD taking over from video in the marketplace. Internet sales decreased 25% to EUR 2.4 million as a result of a weaker US dollar and lower license sales. Broadcasting sales decreased 43% to EUR 1.3 million as a result of a decrease in license sales. The reduction in Broadcasting license sales is a result of the Company’s strategy to start operating its own TV channel in the United States. The launch of this channel requires the Company to refrain from selling its broadcast rights to third parties for the period leading up to the launch. The decrease in Video and Magazine, Internet and Broadcasting sales was offset by a increase in DVD sales of 30% to EUR 9.5 million. We attribute the growth in sales of DVDs to the increasing number of DVD players being sold in all of our markets. We believe that the growth in DVD sales will continue through the remainder of 2003.

         Net sales in general were affected by unfavorable changes in exchange rates.

         Cost of Sales. Our cost of sales was EUR 9.2 million for the six months ended June 30, 2003 compared to EUR 8.1 million for the six months ended June 30, 2002, an increase of EUR 1.1 million, or 13%. Cost of sales as a percentage of sales was 47% for the six months ended June 30, 2003, compared to 40% for the six months

-13-


ended June 30, 2002. The increase in cost of sales as a percentage of sales was primarily the result of sales mix, see Gross Profit.

         Gross Profit. In the six months ended June 30, 2003, we realized a gross profit of EUR 10.5 million, or 53% of net sales compared to EUR 12.2 million, or 60% of net sales for the six months ended June 30, 2002, a decrease of EUR 1.7 million, or 14%. The decrease in gross profit was primarily the result of sales mix, with higher sales volume in products generating cost of sales, such as Videos, Magazines and DVDs combined, and lower sales in products not generating cost of sales, such as Internet and Broadcasting sales.

         Selling, general and administrative expenses. Our selling, general and administrative expenses were EUR 10.0 million for the six months ended June 30, 2003 compared to EUR 10.2 million for the six months ended June 30, 2002, a decrease of EUR 0.2 million, or 3%. Discounting non-recurring charges of EUR 0.7 million made in 2002, our selling, general and administrative expenses have increased by EUR 0.5 million which is primarily the result of increased marketing efforts and EUR 0.15 million in increased bad debt provision.

         Operating profit. We reported an operating profit of EUR 0.5 million for the six months ended June 30, 2003 compared to an operating profit of EUR 0.6 million for the six months ended June 30, 2002, a decrease of EUR 0.1 million, or 5%. Discounting non-recurring charges of EUR 1.4 million in offering expenses made in 2002, the decrease was EUR 1.5 million. The decrease was primarily the result of lower gross profit.

         Interest expense. We reported interest expense of EUR 0.4 million for the six months ended June 30, 2003, compared to EUR 0.4 million for the six months ended June 30, 2002.

         Income tax expense/benefit. We reported income tax benefit of EUR 0.3 million for the six months ended June 30, 2003, compared to income tax benefit of EUR 0.4 million for the six months ended June 30, 2002.

         Net income. We reported net income of EUR 0.5 million for the six months ended June 30, 2003, compared to net income of EUR 0.7 million for the six months ended June 30, 2002.

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Liquidity and Capital Resources

         We reported a working capital surplus of EUR 22.0 million at June 30, 2003, an increase of EUR 6.7 million compared to the year ended December 31, 2002. The increase is principally attributable to reductions in short-term borrowings.

Operating Activities

         Net cash provided by operating activities was EUR 3.5 million for the six months ended June 30, 2003, and was primarily the result of adjustments to reconcile net income to net cash flows from operating activities. The net income of EUR 0.5 million was adjusted to reconcile net income to net cash flows from operating activities, representing depreciation of EUR 0.5 million, bad debt provision of EUR 0.15 million and amortization of photographs and videos of EUR 3.5 million provided a total of EUR 4.7 million. The total of EUR 4.7 million was then added to by changes in accounts payable trade and accrued other liabilities totaling EUR 3.2 million offset by EUR 4.4 million from trade accounts receivable, related party receivable, inventories, prepaid expenses and other current assets and income taxes payable. There was no net cash provided by operating activities for the six months ended June 30, 2002. The increase in cash provided by operating activities for the six months ended June 30, 2003 compared to the same period last year is primarily the result of changes in operating assets and liabilities.

Investing Activities

         Net cash used in investing activities for the six months ended June 30, 2003 was EUR 5.3 million. The investing activities were principally investment in library of photographs and videos of EUR 4.2 million, which was carried out in order to maintain the 2003 and 2004 release schedules for both magazines, video and DVD, and EUR 1.1 million invested in capital expenditures. The decrease over the comparable six-month 2002 period is principally due to decreased investments in library of photographs and videos.

Financing Activities

         Net cash provided by financing activities for the six months ended June 30, 2003 was EUR 0.9 million, represented primarily by a loan from an institutional lender in the principal amount of EUR 4.2 million of which EUR 1.75 million was received in March 2003. The loan bears interest at the rate of EURIBOR + 1.5%, repayable over 12 years, including an initial period of 18 months during which only interest is payable. The loan was obtained for the purposes of financing the construction of an office building and is secured by a mortgage on the building. The balance of the loan will be paid out over the remaining period of construction of the building, which is expected to be completed in 2004. The increase over the comparable six-month 2002 period is primarily due to the initial amount received from the loan.

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         In December 2001 we borrowed USD $ 4.0 million from Commerzbank AG pursuant to a Note originally due on December 20, 2002. The Note bore interest at an annual rate of 7%, payable quarterly, with the entire principal amount and accrued interest originally due on December 20, 2002. In December 2002 Commerzbank AG agreed to extend the maturity date of the Note from December 20, 2002 to March 20, 2003.

         In April 2003 the Note was acquired by Consipio Holding b.v. from Commerzbank AG, and the maturity of the Note was extended for five years, with interest on the Note being increased to 9.9% per annum. In addition, Consipio acquired a USD $3.0 million note from the Company to Beate Uhse AG, which Note was due on December 13, 2003, and bore interest at the rate of 5% per annum. This Note has now been restructured to provide for the extension of the maturity date by five years and an interest rate of 9.9% per annum.

         In May 2003 Euro 1.65 million of the approximately Euro 6.6 million related party payable to Luthares was re-financed by BPA Bank at the same interest rate as on the Note Payable, EURIBOR + 1%. The loan is repayable in equal monthly installments over a four year period starting June 29, 2004. Thus the remaining balance on the Note Payable to Luthares is Euro 4.9 million.

         We 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. However, we may need to raise additional funds to support more rapid expansion or respond to unanticipated requirements. If additional funds are raised through the issuance of equity securities, our shareholders’ percentage 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 our current shareholders. 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 or respond to competitive pressures or unanticipated requirements, which could harm our business.

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Item 3.  Quantitative and Qualitative Disclosures about Market Risk.

         We do not use derivative financial instruments for trading purposes and were never a party to any derivative, swap or option contracts. We do not hedge our interest rate or foreign currency exchange rate exposures.

         As our cash and cash equivalent and short-term investments consist principally of money market securities and investments in short-term debt or equity securities and our borrowings are primarily at fixed rates of interest our market risk related to fluctuations in interest rates is limited. Accordingly, a one percentage change in market interest rates would not have a material impact on our results of operations.

         We transact our business in various currencies, principally the Euro and the U.S dollar and certain other European Union currencies. We generally attempt to limit exposure to currency rate fluctuations by matching transaction currencies (revenues/expenses) to the functional currency of its operating subsidiaries. Our exposure to market risk for fluctuations in foreign currency exchange rates relates primarily to fluctuations in the Euro versus the U.S dollar. We translate our consolidated subsidiaries whose functional currency is not the euro into the euro for reporting purposes. Income statement amounts are translated into euros using the average exchange rate for the fiscal year. The balance sheet is translated at the year-end exchange rate. Due to the significance of the results reported in dollars the impact of the euro/dollar exchange rate on our major categories of revenue and expense can be material.

Item 4.  Controls and Procedures

         As required by SEC Rule 13a-15(b), an evaluation was performed under the supervision and with the participation of our management, including our Chief Executive Officer and our Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Rules 13a - 15(e) and 15d - 15(e) under the Securities Exchange Act of 1934) as of the end of the period covered by this report. There are inherent limitations to the effectiveness of any system of disclosure controls and procedures, including cost limitations, judgments used in decision making, assumptions regarding the likelihood of future events, soundness of internal controls, fraud, the possibility of human error and the circumvention or overriding of the controls and procedures. Accordingly, even effective disclosure controls and procedures can provide only reasonable, and not absolute, assurance of achieving their control objectives. Based upon and as of the date of the evaluation, our Chief Executive Officer and our Chief Financial Officer concluded that our disclosure controls and procedures were effective, in all material respects, with respect to the recordings, processing, summarizing and reporting, within the time periods specified in the SEC’s rules and forms, of information required to be disclosed by us in the reports that we file or submit under the Securities Exchange Act of 1934.

         There have been no significant changes in our internal controls or in other factors that could significantly affect internal controls subsequent to the date of the evaluation described above.

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PART II. OTHER INFORMATION

Item 2.  Changes in Securities and Use of Proceeds

     Conversion of Preferred Stock

             We are authorized to issue up to 10,000,000 shares of preferred stock under our Articles of Incorporation, of which 7,000,000 million have been issued as Series A Preferred Stock.. On March 18, 2003 Slingsby Enterprises Limited, the record owner of the outstanding Series A Preferred Stock, converted 5,350,000 of the 7,000,000 shares of $4.00 Series A Preferred Stock into 16,050,000 shares of common stock in accordance with the terms of the Series A Preferred Stock. On August 8, 2003, the remaining outstanding 1,650,000 shares of Series A Preferred Stock were converted into 4,950,000 shares of common stock. Accordingly, as of August 8, 2003, no shares of Series A Preferred Stock remained outstanding.

Item 6.  Exhibits and Reports on Form 8-K

  a. Exhibits:
     
  Exhibit 31.1 - Certifications pursuant to Rule 13a-14 under the Securities Exchange Act of 1934
  Exhibit 31.2 - Certifications pursuant to Rule 13a-14 under the Securities Exchange Act of 1934
  Exhibit 32.1 - Certification of CEO and CFO Pursuant to 18 U.S.C. § 1350, as Adopted Pursuant to § 906 of the Sarbanes-Oxley Act of 2002.
     
  b. Reports on Form 8-K:
     
  No reports on Form 8-K were filed during the quarter for which this Quarterly Report on Form 10-Q is filed.

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SIGNATURES

         Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this Report to be signed on its behalf by the undersigned thereunto duly authorized.

    PRIVATE MEDIA GROUP, INC.
                     (Registrant)
     
Date:  August 12, 2003   /s/  JOHAN GILLBORG
    Johan Gillborg, Chief Financial Officer

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