-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, WbRV3WKMx0d/P7hwSBGsy0lT3C7uWfmL9t0e66G/6QRiL/81duOndYvGIwgVDp1B SdK7M6kKJdk0v96Cs48e2A== 0000944209-99-000558.txt : 19990416 0000944209-99-000558.hdr.sgml : 19990416 ACCESSION NUMBER: 0000944209-99-000558 CONFORMED SUBMISSION TYPE: 10KSB PUBLIC DOCUMENT COUNT: 7 CONFORMED PERIOD OF REPORT: 19981231 FILED AS OF DATE: 19990415 FILER: COMPANY DATA: COMPANY CONFORMED NAME: PRIVATE MEDIA GROUP INC CENTRAL INDEX KEY: 0001068084 STANDARD INDUSTRIAL CLASSIFICATION: PERIODICALS: PUBLISHING OR PUBLISHING AND PRINTING [2721] IRS NUMBER: 870365673 STATE OF INCORPORATION: NV FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10KSB SEC ACT: SEC FILE NUMBER: 000-25067 FILM NUMBER: 99594658 BUSINESS ADDRESS: STREET 1: 3230 FLAMINGO ROAD STREET 2: SUITE 156 CITY: LAS VEGAS STATE: NV ZIP: 89121 BUSINESS PHONE: 8012729370 MAIL ADDRESS: STREET 1: 3230 FLAMINGO ROAD STREET 2: SUITE 156 CITY: LAS VEGAS STATE: NV ZIP: 89121 10KSB 1 FORM 10-KSB ================================================================================ U.S. SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-KSB [X] ANNUAL REPORT UNDER SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 [FEE REQUIRED] For the fiscal year ended..................................December 31, 1998 OR [_] TRANSITION REPORT UNDER SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 [NO FEE REQUIRED] For the transition period from................to...................... Commission file number 000-25067 PRIVATE MEDIA GROUP, INC. (Name of Small Business Issuer in its Charter) NEVADA 87-0365673 (State or other jurisdiction of (I.R.S. Employer Identification Number) incorporation or organization) CARRETTERA DE RUBI 22-26, 08190 SANT CUGAT DEL VALLES, BARCELONA, SPAIN (Address of principal executive offices) 34-93-590-7070 -------------- Issuer's telephone number Securities registered pursuant to Section 12(b) of the Exchange Act: None Securities registered pursuant to Section 12(g) of the Exchange Act: Common Stock Check whether the issuer (1) filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act 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_______ --- Check if no disclosure of delinquent filers in response to Item 405 of Regulation S-B is not contained herein, and no disclosure will be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-KSB or any amendment to this Form 10-KSB. [_] The issuer's revenues for the fiscal year ended December 31, 1998 were $20,484,000 At April 12, 1999, the aggregate market value of the voting stock and non- voting common equity held by non-affiliates of the registrant was $92,277,145. The aggregate market value has been computed by reference to the average bid and asked price of the common stock on April 12, 1999. On such date the registrant had 8,155,788 shares of Common Stock outstanding. Transitional Small Business Disclosure Format: Yes______ No X --- ================================================================================ PART I ITEM 1. DESCRIPTION OF BUSINESS This Report contains forward-looking statements that involve risk and uncertainties. The Company's actual results could differ materially from those anticipated in such forward looking statements as a result of certain factors, including those set forth elsewhere in this Report. THE COMPANY PRIVATE MEDIA GROUP, INC. (the "Company" or "Private") is engaged in the acquisition, refinement and delivery of adult feature products, including magazines, books, home videos, CD-Roms, laserdiscs, digital versatile discs ("DVDs"), and other products, all oriented to the adult entertainment market. The Company's primary business activities include: (i) creation, publishing and distribution of unrated and adult feature magazines, books, CD-Roms, videos, laserdiscs and DVDs, (ii) distribution and licensing of Private's proprietary products on the Internet, including magazines, videos, interactive services and novelty products, and the Private Circle fashion line and (iii) TV Home Shopping for Private's proprietary and licensed products. The Company is the publisher of Private, an internationally popular X-rated magazine. Private was founded 34 years ago in Sweden, and was the first full color, hard-core sex publication in the world. Today the Company produces four X-rated magazines: Private, Pirate, Triple X and Private Sex. In addition, a book, The Best of Private, is released annually. The X-rated magazines are distributed in a network that presently covers approximately 200,000 points of sale in over 35 countries throughout the world, with the potential to reach nearly 500,000 points of sale through its existing distribution network. Since 1992, Private has also acquired and distributed adult motion picture entertainment. As of December 31, 1998, the Company's film library contained 219 titles, and it expects to add approximately 58 additional titles in 1999. In the last few years, Private films, Private magazines and Private CD- Roms, have won a number of industry awards, including Best European Film (Hot d'Or 1998), Best Screenplay (Hot d'Or 1998), Best Foreign Director (AVN 1999), Best Foreign Release (AVN 1997, 1998, 1999), Special Achievement Awards (AVN 1997, Venus 1998), Best Production Company (Golden X 95), and Best Director (AVN 1998). The Company's films recently received 17 nominations in nine categories for the Hot d'Or Awards to be presented at Cannes, France in May 1999. Since 1997 the Company has aggressively expanded its business activities on the Internet by investing heavily in its initial Web site, www.private.com and by licensing its trademarks and proprietary media to other Web sites. In the first quarter of 1999 the Company opened two new Web sites, www.privatecinema.com and www. privatelive.com, to provide Internet access to proprietary videos and live adult entertainment, and continued to implement its program to expand its Internet licensing activities. The Company continues to invest in state-of-the-art Internet hardware and software in order to maintain the highest level of Internet service and to maximize revenue potential. The Company believes it is uniquely well positioned to exploit the growing adult entertainment Internet -1- market in view of a number of factors, including (i) an extensive library of high quality media content developed over the past 34 years, to which it retains exclusive worldwide rights, (ii) the ability to generate new, high quality, media content, (iii) its established industry position in the adult entertainment market, and (iv) the Company's financial ability to maintain and upgrade its Internet infrastructure. In the Fall of 1998 the Company entered the TV Home Shopping market, engaging in the sale of proprietary products on Swedish television. This new area has been well received, and the Company intends to expand TV Home Shopping to other territories in 1999. The Company operates in a regulated environment, requiring the Company to be socially aware and sensitive to government strictures. Private takes great care to comply with all applicable governmental laws and regulations in the jurisdictions where it operates, including laws and regulations designed to protect minors or which prohibit the distribution of obscene material. Moreover, Private will not knowingly engage the services of businesses or individuals that do not adhere to the same standards. In the 34 years that Private has conducted business it has never been held to have violated any laws or regulations regarding obscenity or the protection of minors. Private continually strives to maintain the highest standards in the presentation of its media and other products, as is evidenced by the numerous industry awards which have been bestowed upon Private and its management over the years. The Private/Milcap Group currently distributes its products in the following countries: Sweden, Denmark, Estonia, Latvia, Poland, Russia, the United Kingdom, Germany, the Netherlands, Belgium, the Czech Republic, Slovenia, Austria, Switzerland, Italy, Greece, France, Spain, Portugal, Canada, the U.S.A., Mexico, Chile, Brazil, Paraguay, Uruguay, Argentina, South Africa, Zimbabwe, Malawi, Botswana, Namibia, the Seychelles, Japan, Australia and New Zealand. The distribution in these countries is conducted primarily by the leading national independent distributors. The Company was organized in 1980 as a Utah corporation for the purpose of acquiring or merging with an established business, and had no material business activity prior to its acquisition of Milcap Media Limited ("MML"), Cinecraft Limited and their subsidiaries in June 1998. See "Business-History." HISTORY The parent company, Private Media Group, Inc., was originally incorporated in 1980 as a Utah corporation under the name Glacier Investment Company, Inc. for the purpose of acquiring or merging with an established company. In 1990, the Company changed its domicile to the State of Nevada. In February 1997 the Company entered into a Letter of Intent with Electric Entertainment Corp. ("EEC") to acquire EEC in exchange for stock of the Company and the Company subsequently changed its name to Electric Entertainment International, Inc. The transaction was consummated in June 1997 and was rescinded in November 1997 based upon the Company's belief that financial information furnished by EEC was false and misleading. In December 1997 the Company changed its corporate name to Private Media Group, Inc. and declared a one for five reverse split of its Common Stock. On December 19, 1997 the Company entered into acquisition agreements with Milcap Media Limited (the "Milcap Acquisition Agreement") and Cinecraft Limited (the "Cinecraft Acquisition Agreement") to acquire all of their outstanding capital stock in exchange for 7,500,000 shares of Common Stock, 7,000,000 shares of the $4.00 Series A Preferred Stock, and 875,000 Common Stock purchase warrants. These acquisitions were completed on June 12, 1998. -2- The "Company" is sometimes referred to herein as Private Media Group, Inc., Milcap, Private, the Milcap Media Group, or the Private/Milcap Group, and includes Private Media Group, Inc. and its subsidiaries, including: Milcap Media Limited (Cyprus) ("MML"), Cinecraft Limited (Gibraltar), Milcap Publishing Group AB (Sweden) ("MPG"), Milcap Media Group S.L. (Spain) ("MMG"), Milcap Publishing Group Italy Srl (Italy), Normcard AB (Sweden), Private Circle, Inc., Symbolic Productions S.L., and Private France S.A. MAGAZINE PUBLICATIONS The Private/Milcap Group is the publisher of Private, an internationally popular X-rated magazine. Private was founded 34 years ago, and was the first full color, hard-core sex publication in the world. Today the Company produces four X-rated magazines: Private, Pirate, Triple X and Private Sex. In addition, a book, The Best of Private, is released annually. The X-rated magazines are distributed on a network that covers approximately 200,000 points of sale in over 35 countries throughout the world. The Company's two newest magazines are Private Style and Private Life, which are produced by licensees of Private with the same first-class quality as its older sisters, but are significantly different when compared with the other four highly successful magazines, as they are the first "soft-core" magazines in the Private/Milcap Group. VIDEO AND FILM PRODUCTIONS Since 1992, the Private/Milcap Group has acquired and distributed adult motion picture entertainment. These productions generally feature men and women in a variety of erotic and adult sexual situations, generally in both hardcore and softcore versions. The Company's activity includes the acquisition and commissioning of feature videos (full length motion pictures produced on videotape) and to some extent feature films (full length motion pictures produced on film). Their distribution is organized primarily on videocassettes (licensing or sale) and alternatively through pay television and cable programming. The Company always maintains the ownership, copyrights and administration of every film it finances and produces. Currently, the Company produces approximately 60 X-rated and 8-12 R-rated movies per year and the distribution is through a world-wide network that covers approximately 60,000 sales points, with the potential to reach more than 155,000. The first two monthly video labels released were Private Film and Private Video Magazine. Both labels quickly received critical acclaim in leading international magazines as well as numerous prestigious awards from industry associations and major adult entertainment film festivals, including AVN, Impulse d'Oro and Golden X. The next three monthly video labels successfully introduced were Triple X, Private Stories and Private Gold. In May 1997, the Company introduced Gaia, a new label released bi-monthly. Earlier this year, the Company introduced the labels Pirate, Casting X, Private Special Edition and Triple X Files, which are released monthly, and Private Black Label, which is released bi-monthly. As of December 31, 1998, the Company owned a total of 219 movie titles, and by the end of 1999 the total is expected to increase to 289 titles. Titles are available mainly on videocassette and are sold by distributors, primarily to retail stores and wholesalers worldwide. Some of the original motion picture programs have also been re-edited and licensed to cable television operators. The Company owns perpetual distribution rights, and thus far has not sold any third party distribution rights. The Company continues to expand the marketing of its production into new international markets, including the United States, generally by entering into national license agreements with local distributors. During fiscal 1999, Management intends to continue to expand its video and film operations by (i) -3- distributing new videos and films with an aggressive release schedule, (ii) increasing its efforts to distribute its library and new titles into cable and satellite television markets, e-commerce, TV Home Shopping, and other new international markets, and (iii) actively seeking to acquire distribution rights to additional titles produced by third parties. INTERNET The Company's Internet team has combined the Private quality of its extensive media library with the newest technology to create what it believes to be one of the best adult Web sites: www.private.com. The Company sources and owns worldwide proprietary rights to its library. The burgeoning growth of the e-commerce market and increased access to the Internet by end-users has created a unique opportunity for Private to leverage its proprietary assets through marketing and distribution on the Web. Since March 1998, Private's WWW Club members have been able to view every Private magazine published by the Company since 1965 and over 180 clips from over 60 films. In addition, this site contains new games, chat rooms with models, previews of new releases and more. The Company's initial Web site contains more than 16,000 Web pages and is generating traffic of approximately 900,000 visitors per month and 54,000,000 requested pages per month. Private currently maintains a staff of 12 full time Internet employees and has invested heavily in state-of-the-art computer and communications infrastructure. In the first quarter of 1999 the Company opened two new Web sites, www.privatecinema.com and www. privatelive.com, to provide Internet access to proprietary videos and live adult entertainment, and continued to implement its program to expand its Internet licensing activities. The Company believes that as of today it has the capacity and the best technology available to distribute movies via satellite link in this fast growing market . The system transmission for privatecinema.com provides users with all of the Company's video and film titles available. These videos are edited and cut into 10 and 12 minute stories. The prices range from $19.95 for a monthly membership to $49.95 for a quarterly membership. Privatelive.com sells access to live adult entertainment at a billing rate of $9.95 for 10 minutes in blocks of 10, 30 and 60 minutes. The Company is also licensing the right to use its trademarks and media library on the Internet to third parties with independent Web sites, which is beginning to generate significant royalty income. Private also markets its products on the Internet through distributor sites and shopping sites. TV HOME SHOPPING In the November 1998 the Company entered the TV Home Shopping market, engaging in the sale of proprietary products, including videos, magazines and proprietary adult pleasure products under the brand "The Private Collection," on Swedish television This new area has been well received, and the Company intends to expand TV Home Shopping to other territories and formats in 1999. OTHER MARKETS CD-ROM/DVD. Although the adult CD-Rom market has been leveling out for the last few years, Private PC Games, Interactive Adventures and CD-Rom Magazines have increased sales due to high gaming and media qualities. During 1999, the Company expects to initially release CD-Roms at the rate of approximately three per month, and to increase the release rate later in 1999. In 1998 Company also started to release its movie titles on DVD. Sales of DVD titles are expected to add to the already established sales per title. DVD releases are currently at the rate of one per month and this rate is expected to increase to three per month by September 1999. -4- Licensed Products. In April 1996, the Company launched a line of adult pleasure products called Private Collection. In 1998 the Company commenced marketing of a line of clothing under the brand name Private Circle through its subsidiary, Private Circle, Inc. In the near future the Company plans to extend the product range with various additional lines of clothes, nutritional supplements, energy soft drinks and personal skin care. For these new markets, the Company is generally planning to earn royalties through the licensing of its major trademarks. Channels of distribution for licensed products include conventional distribution channels, e-commerce and TV Home Shopping. THE ADULT ENTERTAINMENT INDUSTRY Despite nearly two decades of intense political campaigning against the adult industry, consumer purchases of adult entertainment products have increased dramatically. The industry that has come to be known broadly as adult entertainment began its transformation two decades ago, with the advent of home videos and the VCR. That revolution marked the beginning of the end of red-light districts in cities, where adult book-stores, X-rated theatres, peep shows, dingy strip joints and street prostitution once flourished. During the 1980s, the availability of adult movies on videocassette and on cable television helped to legitimize the consumption of explicit material by putting it in the home setting. The result has been the legitimization of industry products by other businesses not traditionally associated with the adult entertainment industry. Video stores, long distance telephone carriers, satellite providers, cable companies, and even mutual funds, earn significant returns by supplying or investing in adult entertainment either directly or indirectly. The availability of adult-oriented media has accelerated in the 1990s as a result of growth in the Internet, resulting in increased accessibility of adult-oriented media in the privacy of a person's home. The distribution of sexually explicit material is intensely competitive. Hundreds of companies now produce and distribute films to wholesalers and retailers, as well as directly to the consumer. The low cost of videotape and the introduction of low cost video tape recorders, along with the minimal production budgets of many adult films, has resulted in much lower barriers for entry in the adult entertainment industry, while the availability of adult films on videocassette has virtually destroyed the adult theatre business. The Internet has further intensified competition due to the relatively low cost to establish a presence on the Internet, which can be as low as $5,000-$10,000. However, because of the large number of adult-oriented Web sites on the Internet, this has in turn fueled an ongoing demand for the creation and licensing of fresh adult-oriented media. According to industry sources, in 1978 some 100 hard-core feature films were produced at a typical cost in today's dollars of approximately $350,000, while in 1998 over 8,000 new hard-core videos were released, some costing as little as a few thousand dollars to produce. The bulk of this production is represented by amateurish tapes and compilations. The Company is competing with the portion of the market which involves the production of professionally produced films with high production value. -5- As of today, the U.S. and worldwide revenues of the adult entertainment market have been estimated and broken down by the Company, as follows:
- ---------------------------------------------------------------------------------------------------------- Market Segment World Est. Sales 1999 U.S. Est. 1999 Comments - ---------------------------------------------------------------------------------------------------------- Adult Videos $ 20.0 billion $ 5.0 billion Retail Sales Strip Clubs $ 5.0 billion $ 3.5 billion (1) Magazines $ 7.5 billion $ 1.5 billion (2) Phone Sex $ 4.5 billion $ 1.5 billion Escort Services $ 11.0 billion $ 1.5 billion Cable/Satellite/Pay-Per-View TV $ 2.5 billion $ 1.0 billion (3) CD-Rom $ 1.5 billion $ 1.0 billion Internet (sales and memberships) $ 1.5 billion $ 1.0 billion Novelties $ 1.0 billion $ 0.5 billion Others $ 1.5 billion $ 0.5 billion TOTAL $ 56.0 BILLION $17.0 BILLION (4)
- -------------------------------------------------------------------------------- Notes (1) It is mainly a U.S. market (approximately 2,500 clubs in the U.S. only) (2) Including softcore magazines such as Playboy, Penthouse or Hustler (U.S.) (3) i.e. The Playboy Channel, Spice and Adam & Eve in the U.S. (including hotel's pay-per-view) (4) Illicit markets not included. - -------------------------------------------------------------------------------- According to an industry report which appeared in US News and World Report (released on February 10, 1997), Americans spent over $8 billion in 1996 on hard-core videos, peep-shows, live sex acts, adult cable programming, sexual devices, computer porn and sex magazines. This amount is much larger than Hollywood's domestic box office receipts and larger than all the revenues generated by rock and country music recordings. The mainstream Hollywood film industry collected some $6 billion per year, the recorded music industry $8 billion; theater, opera and ballet $1.7 billion. Only the magazine industry with its $11 billion in U.S. sales is still competing with the adult industry for the same fraction of the entertainment budget. The Company expects the adult entertainment market to continue to grow, fueled in part by the growth of the Internet. VIDEO SALES & RENTAL The Los Angeles Times (November 22, 1997) confirmed that sales and rental of adult videos have increased 100% in the last five years. It added that "seventy percent of VCR buyers in the first three years during which the devices were on the market said that being able to view adult movies at home was a primary reason they bought a VCR." The Video Software Dealers Association (VSDA), the trade association for the entire home video industry, estimated that more than 60,000 retail outlets in the United States carry home videos; adult videocassettes are carried in more than 25,000 of these retail outlets, including such major chains as The Wherehouse, Tower Video, Palmer Video, Movies Unlimited, West Coast Video and others. In addition, hundreds of small boutiques and large mail order companies sell adult tapes directly to consumers. On the other hand, the 5,000-store Blockbuster Video, which accounts for 30% of the rental marketplace, like many other -6- large retail chains, has opted not to carry adult videos. AVN (Adult Video News), the world's largest adult entertainment industry trade publication which releases an annual poll of approximately 19,000 U.S. retailers who subscribe to the AVN magazine, estimates that in 1997 hard-core tapes generated over $828 million in adult video sales, while rental and sales volume in video stores and adult stores, excluding mail orders, represented a volume of $4.2 billion. Overall, for 1998 AVN reported that adult products represent 19.7% of the U.S. video market (all stores, whether stocking adult or not). More than 33% of the U.S.'s rental and sales transactions involving adult tapes took place on the West Coast; the average store on the West Coast stocks over 700 different adult tapes for rental. According to AVN's poll, 71% of adult videos are rented by men, 19% are rented by male/female couples, 7% are rented by male couples, 2% are rented by women and 1% by women couples. Approximately 20 major producers, such as Private, Vivid, VCA and Metro release the lion's share of adult high budget videos; approximately 80 smaller firms fill in the gaps. See "Business-Competition." INTERNET On a worldwide basis, it is estimated that over 150 million people currently have access to the Internet; by the year 2000 there are expected to be over 450 million users of the Internet. An estimated 200 million HTML pages can now be viewed on the Internet, with 500 million projected by the year 2000; the worldwide median user income for Web surfers is over $65,000 per year. Inter@ctive Week evaluated the adult entertainment business at $1 billion in 1998 for banner advertising, subscriptions, videoconferencing and products. A more conservative figure from Forrester Research Inc. was $185 million in adult online entertainment in 1998, up from $101 million in 1996 and $137 million in 1997. Forrester now estimates the adult online market at between $750 million and one billion dollars per year. Estimates of the number of sex sites are as diverse as estimates for traffic and revenue. Current estimates indicate that there may be as many as 30,000 sex sites, half commercial, the other half hobby sites. Adult Chamber of Commerce's Kraft guesses there are 20,000 distinct owners, with many more sites. According to daily estimates by www.hitbox.com, in April 1999 there were more than 12,000 sites listed, averaging over 16 million visitors per day. Pay sites have most of the adult content on the Internet, but free sites abound for obvious reasons: advertising from pay sites supports most of them. Free sites get a few cents for each viewer who "clicks" on an advertising banner; the banner transports these viewers to a site that tries to entice them into surrendering their credit card numbers. Some sites offer commissions rather than flat fees for customer referrals. Though this sounds like small change, some free sites do well. One of the largest hosts of adult sites is Globix Corporation (formerly known as Bell Technologies Group of New York), a public entity started in 1989, which claims to be the largest provider of adult hosting on the Internet. Unlike Globix, many information service providers ("ISP's") do not want adult operators for a variety of reasons. Some say they reject the traffic because adult sites use enormous bandwidth just a few hours a day. That means providers would need to invest heavily for largely unused capacity. Others have ideological objections to this type of business. The tremendous growth of the Internet, including chat rooms and Web sites dedicated to adult entertainment, has resulted in millions of potential customers accessing these sites from the relative privacy of their personal computers, worldwide. -7- Web porn has become a topical issue that interests everyone, from the religious right to anti-censorship liberals. It sparks debates about free speech vs. child protection; free enterprise vs. social good; and free markets vs. fair business practices. Parents, politicians, preachers and providers are all struggling with how to best protect children while allowing grown-ups to set their own standards of behavior and taste. The access to most of the Web sites is far from being regulated. At the user's discretion, the following Web locations provide information about blocking adult material, mainly for child protection: cyberpatrol, solidoak, netnanny, shepherd, safesurf and/or netpart. CABLE AND SATELLITE TV BROADCASTING The adult entertainment industry has continued to grow as technological advances allow easier and more private access to products. Most major hotel chains, including Sheraton, Marriott, Hyatt, Holiday Inn and Hilton, offer in- room non-explicit adult programming through video services such as Spectravision and On Command, which in 1997, according to US News and World Report, represented over $175 million in sales in the U.S. alone. On Command is the largest of the hotel pay-per-view companies and in 1998 was in more than 3,150 hotels comprising 916,000 individual rooms. This means that patrons can choose from a selection of as many as 50 general and adult features, with the requested feature starting upon the guest's request, rather than waiting for a scheduled start time. Softcore adult is a mainstay of hotel pay-per-view systems, primarily because companies can buy unlimited rights to titles for a specified period of time. Outside the U.S., except for more restrictive countries such as Japan and the United Kingdom, guests can often gain access to hard-core pay-per-view as well. Cable companies such as Time Warner, TeleCommunications, Inc., and Cablevision Systems offer softcore services like the Playboy Channel. Other cable companies like American Cable Entertainment, Comcast Corporation and Greater Media offer explicit adult programming, such as that available from Spice and Exxxtasy Networks. The Big Four U.S. cable providers are: TCI (Tele-Communications, Inc.), Time Warner Cable, MediaOne and Comcast. TCI is the largest U.S. cable provider, with over 16 million subscribers in 49 states. Besides the softcore adult- oriented channels such as Playboy TV, AdulTVision, Spice Channel and The Adam & Eve Channel, there are seven hardcore video channels available in the U.S. exclusively on the C-Band dishes, which are: Eurotica, Exotica, Exxxtasy, True Blue, X!, Xxxcite and XXXplore. Exotica, Exxxtasy and True Blue (New Frontier Media, Inc.) offer uncensored hardcore material. Exxxtasy is the only U.S. hardcore adult channel being beamed to Australia and the Pacific Rim. During 1998 Playboy Enterprises, Inc. and Spice Entertainment Companies, Inc. entered into an agreement resulting in the combination of the two companies. The Company believes that this merger reflects a trend towards the consolidation of a fragmented industry. Less explicit material routinely available on a variety of cable television networks heightens public acceptability and increases consumer demand. The Company believes that the adult entertainment industry in general will continue to experience significant growth in the coming years, particularly as advances in technology and increasing access to the Internet will allow more private and secure adult access to adult themed material. CD-ROMS -8- CD-Roms burst onto the scene during the past few years and is now estimated at $300 million per year. This includes films and sexually oriented interactive games. According to others, toning down the packaging will make it possible to expand sales while tapping music store chains, as well. The Company continues to do well in this segment, reflecting the proliferation of CD-Rom players in PCs and the preference of some customers to purchase a CD-Rom rather than accessing the same product on the Internet. Private released 60 new titles on CD-Roms in 1998 and plans to release 78 new titles on CD-Rom in 1999. PHONE SEX The Company estimates that phone sex represents a $1.5 billion dollar industry in the U.S. alone. AT&T is one of the biggest carriers of phone sex. Many in the industry believe phone sex will be outpaced by computer video- conferencing, video streaming or live streaming. For the time being we observe the dual co-existence of phone sex and live Internet sex, where Web surfers communicate by telephone while simultaneously accessing live sites. The Company earns royalties on approximately 20 phone lines operated by a third party licensee. -9- THE COMPANY'S NUMBERS The following table indicates the Company's production for 1997 and 1998 and estimates for 1999. - -------------------------------------------------------------------------------- THE PRIVATE LIBRARY - --------------------------------------------------------------------------------
- -------------------------------------------------------------------------------------------------------------------- MAGAZINES AS OF DECEMBER 31, 1997 AS OF DECEMBER 31, 1998 AS OF DECEMBER 31, 1999 (EST.) - --------- ----------------------- ------------------------ ------------------------------ Titles No of Issues No of Issues Yearly No of Issues Yearly Private 144 150 + 6 156 + 6 Pirate 46 52 + 6 58 + 6 Triple-X 20 26 + 6 32 + 6 Sex 11 19 + 6 25 + 6 Special editions (Private Dynamite) 1 3 + 2 Book Best of Private 10 11 + 1 TOTAL 221 245 24 NEW 27 NEW RELEASES RELEASES - --------------------------------------------------------------------------------------------------------------------
- -------------------------------------------------------------------------------------------------------------------- VIDEOS AS OF DECEMBER 31, 1997 AS OF DECEMBER 31, 1998 AS OF DECEMBER 31, 1999 (EST.) - ------ ----------------------- ----------------------- ------------------------------ Labels No of Titles No of Titles No of Titles Private Video Magazine 26 26 26 No more in production. Private Film 28 28 28 No more in production. Triple-X Video 32 32 32 No more in production. Private Video Stories 27 27 27 No more in production. Private Gold 25 33 39 + 6 Gaia 4 6 No more in production. Pirate Video 12 12 No more in production. Triple-X Files 12 12 No more in production. Casting-X 3 13 19 + 6 Best of Private 6 8 10 + 2 Private Black Label 4 10 + 6 Pirate Video Deluxe 10 New from 1999. Private XXX 6 New from 1999. Special Compitalations 10 16 + 6 Amanda's Diary 1 7 + 6 Peep Show Special 6 New from 1999. Horny Housewives 4 New from 1999 The Matador Series 2 New from 1999. The Story 2 New from 1999. Erotica (soft line) 7 19 + 12 TOTAL 151 219 289 70 NEW RELEASES IN 1999 - ----------------------------------------------------------------------------------------------------------------------
-10- MAGAZINE PUBLICATIONS THE BUSINESS The Company's publishing operations include the publication of the above mentioned adult magazines, and occasionally the publication of newsstand specials, calendars and paperback books. All these magazines, together with all local editions, are printed under various trade names and are distributed in approximately 35 countries worldwide. The Company publishes several editions of the main magazines; all editions contain the same editorial material but provide locally targeted content, in full cognizance of local governmental regulation regarding explicit adult publications. Most of the Company's magazines feature pictures of men and women engaged in erotic and sexually explicit situations; the Company's most popular publications include Private, Pirate, Sex and Triple X. Private Style, published in South Africa since 1997, and Private Life, published in Greece in 1998, are currently the only softcore magazines. These publications are not yet published on a regular basis.
- ------------------------------------------------------------------------------------------- QUANTITIES OF MAGAZINES PRODUCED (1997) PRODUCED (1998) ESTIMATED (1999) Private 702,450 681,710 750,000 Pirate 521,450 482,550 570,000 Triple X 504,350 493,820 570,000 Sex 327,500 359,060 450,000 Best of Private 44,830 73,400 75,000 Private Dynamite 56,000 Two new titles 44,830 180,000 - -------------------------------------------------------------------------------------------
The Company's publications offer a balanced variety of features and have all gained a loyal customer base and a reputation for excellence by providing a quality standard to the adult market industry, while maintaining circulation leadership as the best-selling hardcore magazine. All publications have long been known for their graphic excellence and features, and publish the work of top artists and photographers. They are also renowned for their pictorials of beautiful people. Because of the Company's high quality standards, its magazines are among the highest priced magazines in the industry. All of the Company's publications are printed by independent third parties. The Company has had a longstanding relationship with a printer in Spain, and two other printers in the U.S. and in the U.K. respectively; these latter two are also printers of other adult magazines that compete with the Company's products; nonetheless, Management believes that generally there is an adequate supply of printing services available to the Company at competitive prices, should the need arise. All of the Company's production and printing activities are coordinated through its operating facility, Milcap Media Group S.L., located in Barcelona, Spain. CIRCULATION The Company's magazines have historically generated most of their revenues from firm sales distribution to national distributors. Distributors with rights to return and retail circulation represent less than 25% of the current production. The Company has contracted national licensing agreements in over 35 countries -11- and normally deals with a magazine distributor for every local distribution of its publications. Single copy retail sales normally occur in adult book stores and similar establishments. Newsstand retail sales are legally allowed only in countries such as France, Italy, Spain, Germany and Portugal. Distribution of the magazine to newsstands and other public retail outlets is accomplished through a network of national distributors, who maintain a local network of several wholesale distributors and licensors. Copies of the magazine are shipped in bulk to the wholesalers, who are responsible for local retail distribution. Wholesalers of Back Catalogue are normally allowed to handle returns from National Newsstand Networks on firm sales; this practice is only allowed for magazines, while almost no return practice is allowed for videos and CD-Roms. The distribution of the Company's magazines is handled exclusively by a distributor pursuant to individual distribution agreements. Such agreements are normally subject to yearly automatic extensions unless either party delivers a termination notice. Normally, distributors also provide the Company with other services, including management information and promotional and specialty marketing services, and their marketing representatives usually solicit national, regional and local retailers in an effort to expand the number of retail outlets for the Company titles. The Company recognizes revenue from distributors' sales based on estimated copy sales at the time each issue is delivered. Provisions for expected returns are taken into consideration. The historical patterns of distribution have changed as a result of the ongoing consolidation and the relationship with each distributor, which due to the success of the publications and better terms and conditions, tend to prefer a firm sale agreement as well. For a few years, the Company has been seeking to expand the use of its magazines' editorial content and other assets across different media formats, in order to capitalize on their existing brand names at a lower cost. The process started in 1995 with the production of CD-Roms, but the main development has been the re-editing of every Private magazine since 1965, which became available on the Company's Web site in May 1998, and more recently on the Company's TV Home Shopping. PRODUCTION, DISTRIBUTION AND FULFILLMENT Four independent printers in Spain currently print most of the Company's magazines, books, brochures, video, and CD covers. Prices are subject to the alteration of the price of raw materials (paper, ink, etc.). Any alteration on printing prices must be by notification to the Company at least three months in advance. Terms of payment are 60/90 days from date of invoice. With respect to color separation, pre-press and related services, the Company is currently using its own color separation facilities and has the support of two independent suppliers using the latest technologies in this field such as digital imposition and implementing the computer to plate process. The Company believes that there is generally an adequate supply of alternative color separation services available at competitive prices, should the need arise. All proprietary magazines are printed and shipped from Barcelona, Spain with the exception of the U.K. distributor which receives all the magazines in digital format, and prepares its own layout and color separations before printing locally adapted softer editions of all the magazine titles. -12- To some extent, the actual print run varies each month and different amounts are printed for each publication. The amount of printed publications is determined bi-monthly with the input from each of the Company's national distributors. The principal raw material necessary for the publication of the Company's magazines are coated and uncoated paper. The Company's printers have a number of paper supply arrangements and believe that those supply contracts provide an adequate supply of paper for its needs and that, in any event, alternative sources are available at competitive prices. Paper prices are affected by a variety of factors, including demand, capacity, pulp supply, and by general economic conditions. Most of the Company's products are packaged and delivered directly by the printer or supplier, but fulfillment, warehousing, customer service and payment processing are conducted principally by Milcap Media Group S.L. Milcap Media Group S.L. employs a staff of professionals to manage the production and to oversee the printing, distribution and fulfillment of its magazines. The Company is able to effectively produce and distribute all of its publications, through the use of state-of-the-art design and production technology, economies of scale and, in printing contracts, efficiencies in subscription solicitation and fulfillment. Production systems for both graphics and editing utilizes an integrated publishing environment that is networked with satellite offices. Approximately 20 employees of the Company are engaged in the production and distribution of the Company's publications. LICENSED PUBLISHING The Private Style publication is owned by JT Publishing Pty, the South African distributor, who will start paying a royalty as soon as the final distribution of the magazine will be up an running. There have been three issues of Private Style on the market so far. A final royalty agreement is expected to be finalized in 1999. The Private Life publication is owned by D&L First Publishing Group Ltd., the Greek distributor, who will start paying a royalty as soon as final distribution of the magazine will be up and running. There have been two issues on the market so far. A final royalty agreement is expected to be finalized in 1999. Local publishing licensees will tailor their editions by mixing the work of the Company's editors with their own editorial and pictorial material. The Company will monitor the content of the licensed editions so that they retain the distinctive style, look and quality of the other editions, while meeting the needs of their respective markets. -13- VIDEO AND FILM PRODUCTIONS THE BUSINESS In fiscal 1992, the Company began releasing feature videos and films under the Private label. Due to the recent success of titles such as The Pyramid, The Fugitive and Tatiana, there has been a great consumer expectation for new releases. The retail success of the Company's production can easily be checked by consulting ratings and sales on some of the industry's monthly publications such as AVN (for the U.S. market), Hot Video (for the French market) and Video Impulse (for the Italian market). The Company's adult video or film products are in genres similar to its general magazines and books. Because of the strong demand for this genre of productions, the Company is able to fairly evaluate the international distribution of every production and earn a quick return on its investment. Normally, the Company's acquisition costs range between $25,000 and $125,000 per movie, prior to the computation of the post-production, duplication and distribution costs. Generally, Milcap Media Group S.L. creates and designs all artwork for promotional items and packaging and contracts for printing services. Since 1997, all videocassettes have been duplicated by independent laboratories. The Company and several of the Company's original programs have recently won awards of excellence, including a Special Achievement Award (AVN 1997) and Innovation Award (Venus 1998). The Company continues to expand its video operations in international markets and is presently marketing video products in over 35 countries worldwide. The Company finances all of its adult films and videos, and arrangements with video and film producers are done on a flat fee basis; all producers generally take care of all production costs and obligations, including among other things, the delivery of models' releases. The principal source of financing for all the motion pictures derives from the cash flow generated by previous productions. To date, the Company has not solicited any external financing for any of its acquisitions. Distribution rights may be limited to specified territories, specified media and/or particular periods of time. Most of the Company's original programs have been licensed to cable television networks and adult pay-per-view channels. In these circumstances, the Company generally grants the TV channel owner a specific right of transmission and always retains the intellectual property rights of every production. The Company is currently engaged in negotiations regarding several potential strategic alliances in order to expand its presence and revenue base into cable TV, pay-per-view and satellite adult TV. Additionally, new technology, primarily digital set-top converters, will dramatically increase channel capacity, and is expected to contribute to the sales of adult video. The Company has developed a video streaming software to allow pay-per-view of its productions through it Web site. See "Business-Internet." Motion pictures shot on film generally offer better production quality, utilize more elaborate production techniques and incur higher acquisition costs than motion pictures shot on videotape. Many of the Company's new feature video and film releases are edited into several versions depending on the media through which they are distributed. In general, versions of the videos or films edited for cable or pay-per-view television are less sexually explicit than the versions edited for home video distribution. The Company has experienced significant competition from lower cost competitors with respect to film and video. While there can be no assurance that the Company will be able to maintain its current market share, it believes that the strong brand recognition and the quality of its titles will result in the ability to appeal more -14- effectively to a broader range of adult audiences. The format of Private videos is consistent with the style, quality and focus of the Private brand. The Company believes that the quality of content and production will continue to differentiate the Company from its competitors. DISTRIBUTION The Company distributes its productions worldwide via Beta masters, videocassettes, laserdiscs and DVD's that are sold or rented in video stores, sex shops, newsstands and other retail outlets, and occasionally, where allowed, through direct mail. The Company's Web site recently contributed to boosting video sales and Management expects this new medium, together with TV Home Shopping, to become significant distribution channels in the future. During the last six years, the Company entered into several distributorship agreements in approximately 35 countries worldwide. Pursuant to these distributorship agreements, either Milcap Publishing Group or occasionally Milcap Media Group, provides monthly a minimum number of new titles during the term of the agreement, and a licensee normally serves as the exclusive distributor throughout its own country or language territory. Under the various distributorship agreements, licensees are normally required to purchase a minimum number of units for each monthly period during the term of the agreement. Typically the licensees then customize, dub or subtitle the movie, as appropriate, to meet the needs of individual markets. In countries such as the U.S. and Germany, the Company has expanded its relationships with its national distributor by entering into exclusive multi-year multi-product output agreements. Private USA, Inc., for instance, coordinated the incorporation of PCI Private Collection International, Inc. which in 1995 became the worldwide distributor of the Company's novelties collection. In another case, VPS Film Entertainment GmbH, Munich, recently contributed to the launching of the Company's contact magazine. In countries such as France and Italy, the Company established local subsidiaries for the purpose of owning or controlling the local distribution. In the near future, the Company intends to renegotiate some of its national distributorship agreements in order to vertically integrate the Company into its chain of distribution. In general, national distribution agreements enable the Company to have an ongoing branded presence in international markets and generate higher and more consistent revenues, rather than selling on a direct basis. VIDEO DUPLICATION/PRODUCTION TECHNIQUES Betacam masters are produced by Milcap Media Group S.L. and Milcap Publishing Group and, from there, they are sent to the different distributors and duplication centers. Certain distributors receive a master directly and do their own duplication. All artwork to print the video covers is created at Milcap Media Group S.L. Most of countries receive their own ready printed covers from Spain and some countries print their own covers. Body labels for the videocassettes are printed in Spain, and then mailed to the different distributors. All of the body labels have a golden stamping for the control of pirate copies. -15- INTERNET SERVICES THE PRESENT The Company believes it is uniquely well positioned to exploit the growing adult entertainment Internet market in view of a number of factors, including (i) an extensive library of high quality Internet media content developed over the past 34 years, to which it retains exclusive worldwide rights, (ii) the ability to generate new, high quality, media content on an ongoing basis, (iii) its established industry position in the adult entertainment market, and (iv) the Company's financial ability to maintain and upgrade its Internet infrastructure. In particular, the Company sources and owns the worldwide rights to its extensive media library, with an archive of high quality media content built up over the past 34 years and new material added each month. This factor alone distinguishes Private from most of its competitors on the Internet, who have to regularly buy or license content from third parties to maintain and grow their revenue base. The Company is also able to offer a wide range of other proprietary products, such as DVDs, CD-Roms, magazines, videos, energy drinks and supplements, adult pleasure products and the Private Circle fashion line. In view of the Company's strategic position, Private launched its initial site on the Internet at www.private.com in 1997. This site is now one of the Internet's most visited destination sites, with approximately 900,000 visitors per month. Taking full advantage of the technological capabilities of the medium, the private.com site contains several editorial features from the Company's magazines and select photos from various pictorials. The Company's site also promotes and sells the product range: magazines, videos, CD-Roms and collections. The Company recently implemented its Internet division by adding new hardware and a satellite connection to the backbone of the Internet in the U.S. in order to administer increased traffic to the private.com site. The new hardware and software are of the latest technology, which may also help attract additional advertisers to this site and its two new proprietary sites, privatecinema.com and privatelive.com, by providing an opportunity to target a focused market from underdeveloped related sites. Private.com, which represents over 16,000 Web pages, is currently generating a traffic of approximately 900,000 unique visitors per month and more than 54,000,000 requested pages per month. Currently, the members' area is yielding up to 30 new members every day paying a yearly fee of $100 and as of March 31, 1999 there were over 4,500 active members of private.com. The mailing list of the WWW Club exceeds 65,000 addresses and there are approximately 1,000 new addresses per day added to the list. Private WWW Club members are allowed to view thousands of pictures on the site. Major attractions include x-files, pictures designed in new formats, such as photo sets with pictures never shown before, slide shows and search engines. The site is constantly updated with new material and the full archive of every Private magazine that has been published and clips from all Private videos ever edited. The Company estimates that Club membership enables it to give its customers $5,000 of product value for a $100 membership fee. In the first quarter of 1999 the Company opened two new Web sites, www.privatecinema.com and www. privatelive.com, to provide on-line Internet access to proprietary videos and live adult entertainment. The Company believes that as of today it has the capacity and the best technology available to distribute movies via satellite link in this fast growing market . The system transmission for privatecinema.com provides users with all of the Company's video and film titles available. These videos are edited and cut into 10 and 12 minute stories. The prices range from $19.95 for a monthly subscription to $49.95 for a quarterly subscription. Privatelive.com sells access to live adult entertainment at a billing rate of $9.95 for 10 minutes in -16- blocks of 10, 30 and 60 minutes. Using a statistically established standard purchase rate of 0.1% to 0.6% and an average purchase time of 30 minutes, the Company anticipates up to 250 customers per day by June 1999 and expects this rate to double over the next 12 months. The Company's two newest proprietary sites, www.privatelive.com and www.privatecinema.com,are the culmination of the Company's development of a user-friendly streaming video application which is fully browser compatible and does not require any plug-in applications. Offering high quality video-on- demand, this software gives the Company a distinct competitive advantage. The Webcam software behind these sites can serve more than 1,000 customers simultaneously at 50% capacity, generating up to $1,000 per minute. As with private.com, this is achieved by servers connected to a full optic redundant DS3 connection into the Internet's MaeEast backbone in Washington, D.C. Private utilizes direct marketing of all of its products by e-mail, with a current e-mailing list of 65,000 addresses. The Company also has direct links from its DVD and CD-Rom products to its Internet sites, where such products can quickly be updated. The Company utilizes a SecureWebPay application which, in conjunction with Web 800, allows the processing of credit card transactions whereby the credit card is checked on the fly while sharing databases with financial institutions. Being socially aware and sensitive to government strictures, the Company has in place a well known protection program for minors which can be controlled by adults to limit access to the Company's Web sites. LICENSEES The Company licenses the right to use its trademarks and photo and video library to third parties, such as the owners of the following Web sites: privategold.com, sex.se, privateusa.com, private.com.ar, private.com.au, maxs.se and clubx.com.au, which are either licensees or independent distributors. In December 1997, Milcap Media Limited entered into an Internet license agreement with Cyber Entertainment Network, Fort Lauderdale, Florida (CEN), whereby CEN, which is in the business of developing and operating various Web adult sites, was granted use of the Web site privategold.com. The Company provides the site with adult images and videos and is entitled to receive a percentage of the gross revenues from fees collected with the sale of memberships to the site. The current revenue stream to Private exceeds $40,000 per month, an increase of 340% over 1998, with the number of unique visitors per day as of January 1999 estimated at 60,000. As of January 1999 two other licensed sites, privateshops.com and sex.se, achieved 10,000 and 15,000 unique visitors per day, respectively. In addition, 20 other licensed sites, including www.maxs.se, maxs.dk, culbx.com.au, privateusa.com, private.com.br and private.com.ar, together receive an estimated 15,000 unique visitors per day. Further, an additional 100 virtual shops selling the Company's licensed products, including gatas.com.br, adultcatalog.com, adultzine.com, sextoys.com, sexmachine.ch, dragon.ca and adultvideos-cd.com, are estimated to reach 250,000 unique visitors per day. In the Summer of 1998, the Company launched its Reseller Program, initially providing the other Web sites with promotional material designed to sell Private's product range. Late in the first quarter of 1999, the Program continued its aim of attracting adult industry and on-adult industry Web site owners and potential Web site owners to sell Private's products by means of a 25% commission program, which is supported by -17- fulfillment from the Company's networks of worldwide local distributors. THE FUTURE The Company believes that Internet sales and marketing programs presently in place or expected to be implemented in the near future will allow Private to expose its products to an estimated 1,000,000 unique visitors per day by the end of 1999. Private will continue to develop and implement new product and marketing innovations designed to make Private the leading purveyor of adult entertainment on the Internet. Private intends to continue to capitalize on its extensive library and brand loyalty established over many years. In addition, the Company is evaluating strategic alliances and potential acquisitions of Internet related companies to augment internal growth. Because the Internet is uniquely suited for the sales and marketing of Private's adult entertainment products in the privacy of the customer's home, Private anticipates that the Internet market will provide a significant source of revenue in 1999 and beyond. CD-ROMS AND INTERACTIVE GAMES THE CD-ROM MARKET The Software Publisher's Association estimated that the number of CD-Rom households by the end of calendar 1997 was 45 million worldwide (30 million in the U.S. market alone), growing approximately 50% from the previous year. This growth has been primarily fueled by the availability of multimedia computer systems. Typically, most new computers purchased are being shipped with built-in CD-Rom drives. CD-Rom products enable viewers to enjoy full-screen, full-motion CD-Rom visual display. In the last few years, the Company entered into partnerships with companies to create multimedia products, such as Video CD-Rom titles and several kinds of Video Photo Discs and Interactive Games. Management has determined that it is more efficient and cost effective to engage independent contractors to digitize and convert the Company's motion pictures into the CD-Rom format and to acquire proprietary distribution rights to CD-Rom interactive games authorized by independent software developers. Accordingly, since 1997, the Company has reduced its Swedish in-house technical workforce and has contracted the product development and distribution process to outside specialists. The product development process includes design, prototyping, programming, computer graphic design, animation, sound and video recordings and quality assurance. The Company has and expects to continue to utilize third-party designers, artists and programmers to introduce creative and technically superior products. Due to the technological complexity, inherent uncertainty in anticipating technological developments, the need for coordinated efforts of numerous technical personnel in such development, and the difficulties in identifying and eliminating errors prior to product release, the success of software product development is unpredictable. The Company has and intends to continue to digitize and convert selected titles from the Company's existing film library to the CD-Rom format under the trade name Private. It has financed and it will continue to finance the development of technically sophisticated products on the most popular personal computer platforms, currently Microsoft Windows 98 and the hybrid Windows/Macintosh platform, primarily for use in home personal computers. PRODUCTION, DISTRIBUTION AND FULFILLMENT -18- Preparation of master CD-Rom discs, user manuals and promotional materials, as well as duplication of the CD-Rom discs and printing of the user manuals and packaging, has been and will continue to be performed by outside developers. Management does not anticipate experiencing any material difficulties or delays in the manufacture and packaging of its products. Distribution of CD-Rom disc products is accomplished through the same distribution network of wholesalers and retailers through which the Company distributes its magazines and adult video products. Sales of consumer software are highly dependent on the availability of relatively inexpensive personal computers. Major computer manufacturers have continued to enhance their lower-end product offer to consumers by increasing the power and speed of these machines without significantly increasing the price. As indicated above, the inclusion of CD-Rom technology in home personal computers and the decline in prices for CD-Rom hardware is expected to contribute to the demand for CD-Rom software products that can utilize the graphics, sound and data capabilities of the latest hardware technology. The Company has no way of accurately assessing the amount of capital resources that will be required to develop these future projects, or the amount and extent of financing that will be available to meet these requirements. The development of these kinds of products incurred minimal operating costs during fiscal 1998 and have been financed through the cash flow generated by the various operations. CD-ROM LIBRARY Although the Company intends to focus on digitizing selected titles from its existing film library for the foreseeable future, it will continue to be engaged in the development and distribution of other adult-theme digital multimedia projects such as interactive games. Presently, the Company's CD-Rom library can be described as follows: Private Photo CD-Rom Discs This includes Private Collection (Vol. 1-4) and other similar CD-Roms. The program's floating control panel makes it easy to browse through more than 2,000 color-pictures included on each CD-Rom. This type of CD-Rom is easy to use and has graphical interfaces including interactive menus and slide shows with background music. CD-Rom Interactive Adventures and PC Games This includes CD Sampler, Hard Core Gallery and Private CD-Rom Magazine. These types of CD-Rom's are digitally encoded in MPEG/Quick Time Format to ensure the highest available quality, integrated with sound, and at the touch of a fingertip, users can find a vast selection of the Company's films and magazines. Private CD-Rom Magazines are hybrids that play both on PC/Windows and on Macintosh computers. The user of these interactive CD-Roms interacts and decides what will or will not happen on the screen and has total control over the actual events. Private Pleasure Park 1 & 2, Private Investigator (awarded 1996 Best Interactive Game at the AMEE Award Show in Las Vegas), Private Prison and Private Castle are examples of this type of production. The Company's PC games incorporate state-of-the-art technology in advanced arcade PC games. The -19- games combine exciting and challenging top level computer games with hard-core or R-rated movies and pictures. The PC games run in a PC/Windows environment and are compatible with Windows 98. Pornmania and Porntris, which has been the best selling adult PC-Game in Europe since 1994, are just two examples of this kind of production. The Company is competing with other CD-Rom producers such as VCA Interactive, Disk Magic, Arcus Media Group, Digital Playground, PIXIS Interactive, Venus Interactive and New Machine Publishing. Future product releases by the Company will be dependent on the continued market acceptance of its initial product releases, which, for the time being, is very positive. OTHER ANCILLARY PRODUCTS AND SERVICES THE LASERDISC MARKET According to the LaserDisc Association, more than 2.0 million U.S. households own a laserdisc player. The worldwide laserdisc household figure is estimated to be in excess of 12.0 million with the heaviest concentrations in Japan, Taiwan, Hong Kong, Singapore, Malaysia and Indonesia. The LaserDisc Association estimates that the installed base of laserdisc households in the U.S. will grow at a rate of 25% per year for the next year or two, and then see little or no growth as the next Video Disc technology takes hold (see "DVD Markets"). Laserdisc is primarily a sell-through business (not much rental activity) and caters to upper-income households with home-theater installations. Laserdisc employs an analog video technology along with a digital sound technology to deliver twice the resolution of ordinary home video cassettes. Laserdisc's popularity has grown over the past ten years among movie enthusiasts for its "instant access" capabilities (similar to audio CD) and its durability as a movie playback medium. Laserdisc's disadvantages include its size (12 inches in diameter), high retail price, and the limited amount of information that can be placed on a single side of a disc (60 minutes maximum). Presently, the Company has only released approximately six of its titles on laserdisc format. Due to the structure of its current network of distributors, the Company is not emphasizing the production of laserdiscs, which represents some sales in the U.S. and a quite small market in Japan. Private Video Magazine 2, 3, and 4 and Private Film 6 (Lady in Spain) are still available on laserdisc format. Since December 1997, most of the new releases are now edited on DVD as a complement to the classic video format. THE DIGITAL VERSATILE DISC MARKET ("DVD") The market for Digital Versatile Disc ("DVD") started to grow dramatically beginning in the fourth quarter of 1998. In October 1996 a unified, single standard was finalized for the mastering (with copy protection) and replication of DVDs. It is widely believed that this unified DVD format will make serious inroads into the market shares currently held by laserdisc and, to a much greater extent, the video cassette recorder. DVD has several major advantages over competing home video delivery technologies: 1) A single 5 1/4" DVD can hold up to 135 minutes per side of high resolution digital full-motion video and audio; 2) Instant access is available to a favorite scene; 3) DVD contains significantly higher image and audio quality than laserdisc and video tape; 4) Multiple language tracks can be incorporated on one disc; 5) Since DVD is 100% digital, the cost of replication is comparable to CD-Rom or audio CD; and 6) A relatively low replication cost will translate to a retail price for a motion picture of under $20.00, giving this medium tremendous mass-market potential. Experts at Toshiba estimate that the market for DVD software could exceed $20 billion by the year 2005. The next evolution of the CD-Rom drive, now standard equipment for all multimedia computer systems, will be the DVD-Rom. Similar to a CD-Rom in most respects, the DVD-Rom will be -20- capable of holding more than ten times more information than a CD-Rom. Management believes that the market for feature-film and video on DVD will initially consist of computer users with DVD-Rom drives. The Company's DVDs are produced, encoded and programmed in the U.S. Replications for the U.S. market are made in the U.S., while worldwide replication and distribution is arranged by the Spanish operation. There are currently only a few of the Company's DVD titles available on the market. The best selling of them is the Pyramid Trilogy and Tatiana, and the Company plans 20 new releases in 1999. THE PRIVATE COLLECTION THE MARKET The Company, together with some of its licensees, are currently working on the development, marketing and distribution of high-quality branded merchandise. The Company's licensed product lines include clothing, novelties, accessories, fragrances, leather goods, eyewear, nutritional supplements, aphrodisiacs and condoms. These products have been marketed principally through mail-order and retail outlets, including department and specialty stores. In the November 1998 the Company entered the TV Home Shopping market, engaging in the sale of proprietary products, including videos, magazines and proprietary adult pleasure products under the brand "The Private Collection," on Swedish television This new area has been well received, and the Company intends to expand TV Home Shopping to other territories and formats in 1999. THE PRIVATE COLLECTION On November 30, 1995, Milcap Media Limited entered into a license agreement with Private Collection International, Inc. ("PCI") in Los Angeles, California, and granted the licensee the worldwide rights to own, operate, distribute, subcontract, market, advertise and promote merchandise including, rubber goods, vibrating products, pumps, electric items, lotions, lubricants, potions, aphrodisiacs, realistic rubber and latex productions, condoms, dolls, jelly products, massagers, playing cards and all other items that fall into these product groups, except the rights to greeting and trading cards, leather and other apparels and lingerie which have been licensed on a non-exclusive basis. The term of the agreement is seven years. In consideration for the rights granted, the licensee agreed to pay a royalty equal to ten percent of the gross product receipts. The licensee agreed, among other things, to pay a guaranteed minimum royalty of $100,000 for the first year of the term, $200,000 for the second year of the term and $400,000 for the third year of the term. In March 1998 the Company agreed to amend the original license agreement accepting, among other things, a flat $175,000 fee for the 1997 calendar year and a modification in the royalty calculation. Payment of this amount has been personally guaranteed by the owners of PCI and is payable on or before July 30, 1999. Sales of PCI in 1996 were $769,266; sales of PCI for 1997 were $1,492,044; and sales of PCI in 1998 were $2,278,908. PCI continues to seek to identify the best possible selling goods in a very sensitive market, which is currently represented by some 5,000 to 6,000 different items available to consumers. The Company expects these sales to increase in 1999 as TV Home Shopping and Internet sales increase. The Company believes that customer anonymity in these distribution channels will result in growing product sales. NUTRITIONAL SUPPLEMENTS, DRINKS AND OTHER SIMILAR PRODUCTS In October 1997 the Company entered into a licensing agreement with RH- Patent & Original AB of Hagersten Sweden, an international agency of St. Raphael, Inc., a U.S. production entity, with the intent to -21- expand the market for nutritional supplements such as Private Passion, Private Kick, Cold Relief, Metabolize 2000, Sleep Eeze, Maxi Charge, and personal care products such as Brazilian Bronze, Waistline Management, Cellulite Regulator Gel and Tight Factor. The licensee has labeled existing government approved products such as guarana-based energy drinks and aphrodisiacs, with Private, Private Passion and Private Kick, to be distributed within the current distribution network as well as in new markets. These products are also promoted for mail order and on the Internet. In consideration for the rights granted, the Company is entitled to receive a percentage of the product's gross receipts, i.e. 15% up to 10,000 total items, 20% on direct sales (mail order via licensor) and 15% on every gross sale by distributors. Minimum sales for automatic renewal of the contract are $100,000 for 1998, $200,000 for 1999, and $400,000 for 2000. The Company agreed to provide the licensee with a minimum advertising space on its Web site. The Company is currently negotiating with an Austrian producer of energy drinks and a final agreement is expected to be signed in 1999. So far, DYNAMITE Getrankevertriebbesellschaft m.b.H. of Graz, Austria, has delivered a first order of 100,000 prototype cans of a new energy drink named Private Dynamite. The Company created the design which includes the Private logo and non-explicit pictures of models labeled on the can. This drink is similar to the original Dynamite currently on the market, but the recipe has been changed by adding ginseng and other ingredients. This first order was delivered for approximately $0.31 per can. Larger orders on better conditions, together with distribution agreements, may be finalized if the drink is well received by the markets under review. The priority markets are Spain and Germany. The rest of Europe and the U.S. are expected to follow during 1999. PRIVATE CIRCLE, INC. During the last few years, the Company invested in the production and distribution of promotional casual clothing such as: T-shirts, sweat shirts, rugby shirts, polo shirts, pique shirts, shorts, wind breakers, beach towels, swim suits, training suits, sunglasses, belts, shirts, bath robes, sweaters, trousers and baseball caps. Some of the production was sold by the Company's distributors, but most of it was given away as marketing tools. In May 1998 the Company entered into a Letter of Intent with Mr. Danny Cook and Ms. Quamilla Carlsson, two fashion designers d/b/a Zabata Clothing, Los Angeles, California. Subject to the terms and conditions of a definitive agreement, the Company was to grant to the designers, the non-transferable and exclusive license to use the trademarks in connection with the manufacturing, distribution and marketing of their collection. At the same time, the Company was to acquire all of the assets of Zabata Clothing and enter into a joint venture to form a new entity to pursue a new clothing business. Subsequent to the end of 1998 a definitive agreement was concluded among the parties, which instead provided for Private Circle, Inc. to be formed as a wholly-owned subsidiary of the Company, with the designers maintaining responsibility for its day to day operations and design and creative issues. A catalogue and a video introducing the first Private Circle Collection was distributed at the Cannes Festival in May 1998. Subsequently, the Private Circle Collection has been exhibited at several trade shows in the U.S., with the commencement of the distribution of the Collection in 1998. -22- STRATEGIES GENERAL To capitalize on its international name recognition and extensive high quality media library, the Company continues to increase its international product marketing activities, specifically targeting growth for its licensing business and several other activities. The Company's marketing strategy is to license and/or distribute its high-quality publications and adult home videos worldwide, both through the expansion of traditional distribution channels, and by aggressively exploiting the Internet and Home TV Shopping markets. Additionally, the Company licenses its trademarks for use on various consumer products, such as apparel, trendy streetwear and accessories, cosmetics and beverages. The Company's business and operating strategy is designed to provide strong revenue growth and increase profitability by improving the performance of existing titles, launching and/or acquiring additional publications and developing other ancillary revenue streams, either proprietary or under license agreements, in order to better capitalize on its internationally-recognized brands, an extensive high quality media library and efficient operations. In addition, the Company is planning to achieve growth through acquisitions of existing business enterprises. The structure of the adult entertainment industry is such that there are just a few large corporations, and the Company believes that none of them have an international presence as the Company does in the markets where Private competes. In addition, just a few of these corporations are publicly traded, and the Company believes that none of these publicly traded companies which compete directly with the Company have the financial capability and the market liquidity necessary to attract other businesses under merger or acquisition agreements. Management believes that because its Common Stock is publicly traded and the Company has an international presence, it will be in a position to acquire many of the hundreds of privately-owned adult entertainment businesses, which typically have limited financing and personnel, and who often, as a result of limited capital resources, have no other alternative but to continue their business as it is. Management believes that, as a public company, it will be able to attract privately-held acquisition candidates at a much lower price/earning multiple than that of the Company. -23- MARKETING By using its core publications as platforms for launching new "spin-off" publications, the Company has efficiently developed and produced a diverse and profitable portfolio of highly-specialized adult publications. The Company believes that it has a competitive advantage as a result of its editorial staff's ability to identify potential markets for new publications, and the Company's ability to gain access to newsstand distribution channels has enabled its new publications to become better established in several new markets. In relation to the video distribution the strategy is to increase sales of sell- through cassettes on a worldwide basis and to launch additional labels in order to increase profits. All of the titles in the Video Library will also become available on DVD and this is expected to add to the already established sales per title. Furthermore, the Company is currently negotiating to commence TV broadcasting of material adapted to what is legally accepted in each territory. INTERNET Recently the Company has deployed substantial human and financial resources into developing and implementing its Internet operations. For this purpose the Company hired highly qualified people and set up a separate division. The prime objective of this division is to offer the most unique services available on the Web, including the recently launched video-on-demand (privatecinema.com) and live-sex (privatelive.com). The Internet division offers products and services both for the Company and for other companies in the Internet marketplace. The Company believes that the Internet division will be a strong revenue provider and that the Internet will ultimately compete with home video viewing in the future. See "Internet Services." OPERATIONS Management has identified and implemented operating improvements that have resulted in significant cost savings through personnel reductions, lower lease costs, tighter purchasing procedures and controls and restructuring the Company's relationships with its principal vendors. In addition, the Company adopted a new operating policy that provides for one or more of the following actions if any of its publications generate continued losses: (i) discontinue or sell such magazine; (ii) merge such magazine with the Company's existing magazines; or (iii) enter into strategic partnerships with third parties. The Company will remain focused on identifying additional operating improvements to further increase its operating efficiencies and profit margins. MISCELLANEOUS The Company believes that there are numerous opportunities to increase ancillary revenues by leveraging the editorial content and the internationally- recognized brands of the Company's existing publications through worldwide licensing arrangements, strategic joint ventures, retail alliances, affinity group marketing, electronic software and games. -24- DISTRIBUTION METHODS, PRICE POLICIES AND PIRACY PROBLEMS DISTRIBUTION METHODS AND PRICE POLICIES A. NATIONAL NEWSSTAND NETWORKS The distribution of magazines, videos and CD-Roms is based on an agreed allocation, VAT excluded, based upon the cover price between the Company and the National Newsstand Network. Advantages These distributors are very easy to deal with as they manage themselves most of the time; they have solid companies and are most reliable; they also generally pay on time. This distribution method is also a very good instrument when the Company wants to run statistics on sales, as it can get a good input on the situation regarding every local market. As far as magazines are concerned, this type of agreement can allow the distribution of the highest volume of copies in a specific market. As a result of reaching many local retailers and sales points throughout the territories, it also brings the best margin per copy. Disadvantages Magazine distributors with a right to return the products can create some problems for the Company, but on the other end, returns do not really go wasted, as these are purchased by distributors who only handle old issues of the product (See: Wholesalers of Back Catalogue). As far as video distributors are concerned, a right to return the products is not beneficial for the Company, as it is not always easy to sell the returns (custom made, per language and layout). The end-user price obtainable for CD-Rom products through this distribution channel is 30-50% lower than for traditional CD-Rom channels (the maximum end-user price obtainable is 150-200% of a magazine cover price distributed through the same channels). This market is most suited for some older products (12-36 month), where the consumer cut price will not affect the market price in the other distribution channels. There is still not the same market for CD-Rom return products as there is for traditional magazines, i.e. distributors who only deal with old issues of the magazines (See: Wholesalers of Back Catalogue/Magazines). The duplication price of a CD-Rom combined with the extra packaging costs for adding the CD- Rom to the cover of a magazine or similar product carrier (needed in most countries for distributive/regulative purposes), adds to the total cost of each product; CD-Roms are in this case more sensitive for damages from transportation and need to be handled with care throughout the return process. For all products, a common disadvantage of this distribution method is that the conditions of payment are in general quite long, i.e. between 90 and 180 days. B. WHOLESALERS Advantages For magazines, videos and CD-Roms, this is the traditional way of distribution and in some territories also the only possible way of distribution; it is a satisfactory form of sale from a cash flow point of view, because the conditions of payment are 0-30 days. Another advantage, as far as magazines are concerned, in comparison with the National Newsstand Networks, is that the Company does not get any returns with this kind of distribution. As for CD-Roms, this is the best system to ensure the highest possible end-user price. -25- Disadvantages As far as magazines and videos are concerned, this method gives the Company less control of the distribution within the territories, resulting in overflow into other territories; it also gives it a low margin per copy, in comparison with the National Newsstand Networks. In the case of CD-Roms, since it is very expensive for the wholesalers to finance their stock, it is important for the Company to keep a good inventory for timely deliveries on short notice. C. LICENSEES The sale of magazines to licensees is based on an agreed allocation of the cover price, after the distributors' variable costs, such as printing and color separations. Videos are sold to licensees on an agreed allocation after the distributors industrial costs. Advantages For magazines, this is a very cost effective way of distributing, as the distributors take all the costs for printing, etc. and the Company only collects the royalties, generally producing good cash flow. Logistics are very simple and uncomplicated. As far as videos are concerned, licensees know their market very well as they have their own sales force that efficiently work up all the shops in the territory and in this way maximize the sales. This is also in many cases the only way to reach the video rental stores. As for CD-Roms, having a licensor (i.e. territorial distributor) who acts as a wholesaler for CD-Rom products with a stock on consignment is financially smart. The financial burden of the stock is moved from the wholesaler to the Company, where the actual invested money into the products is substantially less than to the wholesaler. In some cases the wholesaler is charged half or full duplication costs to minimize the Company's cash exposure. This enables the wholesaler to always keep plenty of products in stock to service his customers who order very frequently and need delivery within one or two days. Disadvantages As far as magazines are concerned, a negative effect of this method is that the Company has less control over the printing when it comes to volumes and quality, as this is controlled by the distributors themselves; it gives the Company the lowest margin of all the different distribution methods. In regards to videos, this method is more labor intensive, and it takes longer for the distributors to pay. In regards to CD-Roms, allowing the licensor to keep products on consignment means that the Company has to have a good financial trust in each licensor to guarantee at least the duplication and transportation costs, against any licensee's default. -26- D. WHOLESALERS OF BACK CATALOGUE Advantages With this distribution method, the Company has the possibility to sell all the returned products received from the distributors in the National Newsstand Networks. As the Company can use a different price policy on the Back Catalogue, it is able to sell the magazines at a lower price, enabling the marketing division to operate in territories with a lesser economy, i.e. opening new markets. Disadvantages As many of these distributors can often be found in developing and unstructured countries, they can be labor intensive to work with; these distributors seldom pay on time. E. INTERNET Advantages This way of distributing increases the total sales points in every area as a result of the customer accessing the products easier. It creates an in-house customer base, and gives the Company a high margin per product sold, averaging 60% in 1998. This is the ultimate way of distributing the Company's products.. Apart from sales of the products via mail order, there is an opportunity to sell parts of the videos for the customer's demand, i.e. pay- per-view. The customer gets an option to preview samples of the videos, and then purchase the actual video. See "Internet Services." As far as CD-Roms and DVDs are concerned, this a rapidly growing market, as consumers on the Internet are very likely to have CD-Rom and/or DVD capabilities. Disadvantages The Internet distribution provides a great tool of marketing cross borders. However, it is important to take advantage of the current infrastructure in terms of culture, language, package and handling issues. F. MAIL ORDER Advantages For magazines and videos, this distribution channel gives the Company the possibility to get extra sales in forms of Back Catalogue products on a Firm Sale basis (See: Wholesalers of magazines). Buyers often order high volumes and are well established companies; logistics are simple as the products have already been produced and prepared before. As far as videos are concerned, the requests for compilation tapes put together from old material, such as The Best of Private, are one way of creating extra sales at very low cost. Disadvantages The Company doesn't get a very high average price per copy for magazines and videos. PIRACY PROBLEMS According to figures from the Motion Picture Association of America, annual losses from video piracy -27- are an estimated $250 million in the U.S. alone, and close to $2.5 billion worldwide; adult video represents approximately 14% of the video business. The biggest piracy problem concerns the business done on markets where pornography is illegal or in countries with a poor economic situation. This is the situation mainly in the eastern states of Europe, such as Russia, Poland, Rumania, etc. Many of these eastern markets are so destroyed with piracy that it is more or less impossible to distribute the Company's products there. The piracy causes such a disturbed price structure that it does not leave any margins for the Company to sell its products in these territories. It is also very difficult to claim rights with reference to the copyright laws. This is a problem for everyone doing business in these markets. Another upcoming piracy problem that the Company will have to face regularly concerns the Internet. The question is how to confirm that all the different mail order sites selling Private products actually sell the original products, and not pirated copies. The problem lies in the distribution procedures, which in the case of Internet, is straight from the Internet provider's order page to the end consumer. Another problem connected with the Internet is fast advancing video streaming where the possibilities to control the origin of what is shown are almost none. Very unfortunately, when it comes to the piracy problems in the Eastern States of Europe there is not much that can be done, except for acceptance of the situation. Also in regards to mail order, it is very difficult to control what is actually happening. Most of these piracy situations are handled by the Company's legal counsel who attempt to resolve them or litigate, on a case-by- case basis. When it comes to the Internet, one solution could be the appointment of so called "Web Police", one for each territory. Private believes that it faces less piracy than other competitors. Piracy activity is most pervasive with regard to the distribution of videos. However, Private's distributors distribute a vast array of products, including CD-Roms, DVDs and adult novelty products. Private believes that its distributors are less likely to engage in video piracy as this would jeopardize their distribution of the entire line of distributed Private products. In July 1998 the Company launched a new program which it hopes will reduce piracy. The program allows any person to sell the Company's products online on the Internet through a "Private Online Shop." By agreeing to link the independent representative's website to the Company's homepage, the independent representative will be allowed to offer Private products for sale directly to its customers. In turn, the independent representative is required to purchase merchandise directly from the national distributor. This marketing arrangement is expected to allow the Company to increase its points of sale throughout the world for a very low cost. PROPRIETARY RIGHTS The Company believes that it has developed strong brand awareness within each of its magazines' and videos' targeted markets. As a result, the Company regards its branded magazine titles and logos to be valuable assets and believes that its trademarks are vital to the success and future growth of all of the Company's businesses. The Company has filed trademark registration applications with respect to most of its trade names and logos. The Company believes that the name recognition and image that it has developed in each of its markets significantly enhance customer response to its sales promotions. Accordingly, trademarks and copyrights are important to the Company's business and the Company intends to aggressively defend them throughout the world as it constantly monitors the marketplace for counterfeit products. Consequently, it initiates legal -28- proceedings from time to time to prevent unauthorized use of the trademarks. COMPETITION GENERAL CONSIDERATIONS Nearly all of the Company's products compete with other products and services that utilize leisure time or disposable income. The businesses in which the Company competes are in general, highly competitive and service-oriented. The Company has few long-term or exclusive service agreements with its customers. Business generation is based primarily on customer satisfaction with reliability, timeliness, quality and price. The Company believes that the extensive and longstanding international operations, its name, its image and reputation, as well as the quality of its distributors, provide a significant competitive advantage over many other competitors seeking to establish a similar business. Although its magazines and videos are well established and high quality products in the adult industry, the Company is in competition with entities selling similar products at retail as well as by direct marketing, regardless of whether the products being offered are similar to the Company's products. MAGAZINES The Company meets with minimal direct competition from other publishers of adult magazines and paperback books as well as all other forms of print media adult entertainment. The Company's publications are in general unique in their style and format and it is almost impossible to name any major competitor in this field. As far as magazines are concerned, the only similar business is represented by Rodox N.V. a Dutch/Danish corporation printing approximately 20,000 copies of monthly hardcore magazines. Magazines such as Playboy, Penthouse, Hustler or similar editorial publications do not compete with the Company's publication, since they are considered to be soft-core publications. There are several hardcore publications in each country where the Company's magazines are sold, but in general, they are printed in limited edition and lower quality than the Company's publications and therefore the Company is not fearing at present any major competition on this end of its business. As far as the U.S. market is concerned, none of the competitors publishes or distributes more than 5,000 copies per month, while Private USA, Inc. currently exceeds 15,000 sold copies of each magazine per month. In addition, none of these competitors normally own any pictorials. VIDEO The production and distribution of video and cable television products are highly competitive, as each competes with the other as well as with other forms of entertainment. Furthermore, there is increased competition in the television industry evidenced by the increasing number and variety of basic cable, satellite and pay television services now available. Revenues for motion picture entertainment product depends in part upon general economic conditions, but the competitive position of a producer or distributor is still greatly affected by the quality of, and public response to, the entertainment product it makes available to the marketplace. There is strong competition throughout the adult video industry, both from adult video producers and from independent companies distributing amateurish material. The Company's primary competitors in the video industry area are adult motion picture studios, with -29- in-house production and post production capabilities. Other competitors are smaller, but locally or domestically, they are capable of quickly identifying niche markets that could compete for the Company's customers. In addition, the Company also competes with other forms of media, including broadcast and cable television, direct marketing, electronic media and adult Web sites. Management believes that none of its competitors have larger worldwide distribution or have greater financial resources than the Company. The closest competitors are U.S. producers such as VCA Pictures or Vivid Film; smaller competitors are Wicked Pictures, Evil Angel Productions or Metro Global Media Inc., but all these competitors have a distribution in the U.S. market, while they are relatively less represented worldwide. INTERNET As indicated above, the Internet market for adult oriented content is booming and the number of adult sites competing with the Company's is in excess of 30,000 http addresses, most of which are free sites and currently some of them can claim a higher daily traffic than the Company's site. Management believes that traffic on its Web site will change dramatically in 1999 as the new privatelive and privatecinema sections become established and the Company implements strategic alliances which are currently being negotiated. In addition to internal expansion of Internet activities and establishment of strategic alliances, the Company is planning to achieve growth through acquisitions of existing business enterprises. The structure of the adult entertainment industry is such that there are just a few large corporations and none of them have an international presence as the Company does. In addition, only a few of these corporations are publicly traded and among these few, the Company believes that none currently have the financial capability and the market liquidity necessary to attract other businesses under merger or acquisition agreements. CD-ROM AND INTERACTIVE GAMES There are several competitors that have already released adult CD-Rom titles and interactive games, many of whom have significantly greater technical and marketing resources than those of the Company's licensees. Management believes that new competitors are increasing their focus on the consumer software market, which will result in greater competition for this kind of product. Management is not concerned by this situation because it believes that this area of the Company's activity will never represent a significant percentage of its overall business. EMPLOYEES As of March 31, 1999, the Company (including its subsidiaries) employed 67 persons on a full-time basis. The Company's full-time editorial and post-production staff consists of an editor-in-chief, six executive editors and approximately seven editors, associate editors and assistant editors who oversee the quality and consistency of the artwork and editorial copy and manage the production schedule of each issue. The production of each issue requires the editors to coordinate over a two month period the activities of a writer, a pencil artist, an inker, a colorist and a printer. The majority of this work is performed at the Company's premises. -30- The photographers and producers consist of freelancers who generally are paid on a per-assignment basis. The Company has entered into agreements with certain photographers or movie directors and writers under which such persons have agreed to provide their services to the Company on an exclusive basis, generally for a period of one to three years. Pierre Woodman is the main movie producer currently under such exclusivity agreement. The Company's Internet division employed 12 full time persons as of March 31, 1999. The Company believes that it has good relationships with its employees. Currently, none of the Company's employees are represented by any labor union. -31- GOVERNMENT REGULATION The Company operates in a regulated environment, requiring the Company to be socially aware and sensitive to government strictures. Private takes great care to comply with all applicable governmental laws and regulations in the jurisdictions where it operates, including laws and regulations designed to protect minors or which prohibit the distribution of obscene material. Moreover, Private will not knowingly engage the services of businesses or individuals that do not adhere to the same standards. In the 34 years that Private has conducted business it has never been held to have violated any laws or regulations regarding obscenity or the protection of minors. Private continually strives to maintain the highest standards in the presentation of its media and other products, as is evidenced by the numerous industry awards which have been bestowed upon Private and its management over the years. Following is a description of some of the laws and regulations in the U.S. which impact the adult entertainment industry. It is not an exhaustive description of all such laws. Moreover, the regulatory environment is constantly changing in the geographical areas in which Private conducts business, and in some instances laws which are enacted are subsequently determined by the courts to be unconstitutional. The Classification and Rating Administration of the Motion Picture Association of America (MPAA), a motion picture industry trade association, assigns ratings for age group suitability for theatrical and home video distribution of motion pictures. Submission of a motion picture to the MPAA for rating is voluntary, and the Company does not submit its motion pictures to the MPAA for review. However, with the exception of several titles which have been re-edited for cable television, most of the films and videos distributed by the Company, if so rated, would most likely fall into the "NC-17 - No Children Under 17 Admitted" rating category because of depiction of nudity and their sexually explicit content. The right to distribute adult videocassettes, magazines and CD-Rom products is protected by the First and Fourteenth Amendments to the United States Constitution, which prohibit Congress or the various states from passing any law abridging the freedom of speech. The First and Fourteenth Amendments, however, do not protect the dissemination of obscene material, and several States and communities in which the Company's products are distributed, have enacted laws regulating the distribution of obscene material with some offenses designed as misdemeanors and others as felonies, depending on numerous factors. The consequences for violating the State statutes are as varied as the number of States enacting them. Similarly, 18 U.S.C. Sections 1460-1469 contain the Federal prohibitions with respect to the dissemination of obscene material, and the potential penalties for individuals (including Directors, Officers and Employees) violating the Federal obscenity laws include fines, community service, probation, forfeiture of assets and incarceration. The range of possible sentences require calculations under the Federal Sentencing Guidelines, and the amount of the fine and the length of the period of the incarceration under those guidelines are calculated based upon the retail value of the unprotected materials. Also taken into account in determining the amount of the fine, length of incarceration or other possible penalty are whether the person accepts responsibility for his or her actions, whether the person was a minimal or minor participant in the criminal activity, whether the person was an organizer, leader, manager or supervisor, whether multiple counts were involved, whether the person provided substantial assistance to the government, and whether the person has a prior criminal history. In addition Federal law provides for the forfeiture of: (1) any obscene material produced, transported, mailed, shipped or received in violation of the obscenity laws; (2) any property, real or personal, constituting or traceable to gross profits or other proceeds obtained from such offense; and (3) any property, real or personal, used or intended to be used to commit or to promote the commission of such offense, if the court in its discretion so determines, taking into consideration the nature, scope and proportionality of the use of the property in the offense. With respect to the realm of potential penalties facing an organization such as the Company, the forfeiture provisions detailed above apply to corporate assets falling under the statute. In addition, a fine may be imposed, the amount of which is tied to the pecuniary gain to the organization from the offense or determined by a fine table tied to the severity of the offense. Also factored into determining the amount of the fine are the number of individuals in the organization and whether an individual with substantial authority participated in, condoned, or was willfully ignorant of the offense; whether the organization had an effective program to prevent and detect violations of the law; and whether the organization cooperated in the investigation and accepted responsibility for its criminal conduct. In addition, the organization may be subject to a term of probation of up to five years. Federal and State obscenity laws define the legality or illegality of materials by reference to the United States Supreme Court's three-prong test set forth in Miller v. California, 413 U.S. 1593 (1973). This test is used to evaluate whether materials are obscene and therefore subject to regulation. Miller provides that the -32- following must be considered: (a) whether "the average person, applying contemporary community standards" would find that the work, taken as a whole, appeals to the prurient interest; (b) whether the work depicts or describes, in a patently offensive way, sexual conduct specifically defined by the applicable State law; and (c) whether the work, taken as a whole, lacks serious literary, artistic, political or scientific value. The Supreme Court has clarified the Miller test in recent years advising that the prurient interest prong and patent offensiveness prong must be measured against the standards of "an average person, applying contemporary community standards," while the value prong of the test is to be judged according to a reasonable person standard. The Company is not directly engaged in the wholesale distribution of its products to U.S. wholesalers and/or retailers. The Company believes that owners of Private USA, Inc., its U.S. distributor, have taken steps to ensure compliance with all Federal, State and local regulations regulating the content of its motion pictures and print products, by staying abreast of all legal developments in the areas in which its motion pictures and print products are distributed and by specifically avoiding distribution of its motion pictures and print products in areas where the local standards clearly or potentially prohibit these products. In addition, Private USA, Inc. often requires that all video material be reviewed by an independent advisory panel comprised of two psychologists, a certified sex therapist, licensed marriage and family therapist, a certified sex educator and a licensed independent clinical social worker. Their review is directed to aspects of serious scientific value as set forth in the Miller test, because that aspect of the test is not limited by community standards but is concerned with whether a reasonable person would find such value in the material, taken as a whole. In light of Private USA's efforts to review, regulate and restrict the distribution of its materials, Management believes that the distribution of the Company's products does not violate any statutes or regulations. Many of the communities in the areas in which Private USA, Inc. offers or intends to offer products or franchises, have enacted zoning ordinances restricting the retail sale of adult entertainment products. Management believes that Private USA, Inc. intends to supply products only in locations where the retail sale of adult entertainment products is permitted. In February 1996, U.S. Congress passed the Telecommunications Act (the "Act"), and President Clinton signed it into law. Certain provisions of the Act are directed exclusively at cable programming in general and adult cable programming in particular. In some cable systems, audio or momentary bits of video of premium or pay-per-view channels may accidentally become available to nonsubscribing cable customers. This is called "bleeding." The practical effect of Section 505 of the Act ("Section 505") is to require many existing cable systems to employ additional blocking technology in every household in every cable system that offers adult programming, whether or not customers request it or need it, to prevent any possibility of bleeding, or to restrict the period during which the programming is transmitted from 10:00 p.m. to 6:00 a.m. Penalties for violation of the Act are significant and include fines and imprisonment. Surveying of cable operators and initial results indicate that most will choose to comply with Section 505 by restricting the hours of transmission. Management believes that the Company's revenues will be marginally materially adversely affected as a result of enforcement of Section 505. In addition, as digital technology (which is unaffected by Section 505) becomes more available, the Company believes that ultimately the impact will be insignificant. The National Defense Authorization Act of 1997 was signed into law in September 1996. One section of that legislation that began as the Military Honor and Decency Act (the "Military Act") bans the sale or rental of sexually oriented written or videotaped material on property under the jurisdiction of the Department of Defense. A Federal Court has permanently enjoined enforcement of the Military Act and has prohibited the Department of Defense from changing its acquisition and stocking practices based on the Military Act. The government has filed an appeal and a decision by the Appellate Court is pending. The Military Act, if applicable -33- to the Company's products and enforceable, would prohibit the sale of the Company's magazines and videos at commissaries, PX's and ship stores, and would adversely affect a portion of the Company's sales attributable to such products. Based on preliminary estimates and current sales levels at such locations, the Company believes that any such impact would be immaterial. As discussed above, U.S. Federal and State government officials have targeted "sin industries," such as tobacco, alcohol, and adult entertainment for special tax treatment and legislation. In 1996, U.S. Congress passed the Communications Decency Act of 1996 (the "CDA"). Recently, the U.S. Supreme Court, in ACLU v. Reno, held certain substantive provisions of the CDA unconstitutional. Businesses in the adult entertainment and programming industries expended millions of dollars in legal and other fees in overturning the CDA. Investors should understand that the adult entertainment industry may continue to be a target for legislation. In the event the Company must defend itself and/or join with other companies in the adult programming business to protect its rights, the Company may incur significant expenses that could have a material adverse effect on the Company's business and operating results. CHILD PORNOGRAPHY The content of every single adult tape on the shelves of every video and adult store in the U.S. involves consenting adults. Roughly 90% of the material produced and distributed over the past 15 years contains mainstream sexual acts between consenting adults. The rest could be classified as specialty material which does not contain explicit sex, but which still involves consenting adults (i.e. fetish, bondage, etc.). Mainstream sex acts means intercourse, oral sex, anal sex, group sex, etc. The Company's adult movies do not contain any depictions, let alone actual performances of rape, sex with coercion, animals, urination, defecation, violence, incest or child pornography. Since 1990, the Free Speech Coalition has worked with the Federal government to create a workable regulatory system designated to prevent minors from working in the adult industry. Child Protection Restoration and Penalties Enhancement Act of 1990 (18 U.S.C. section 2257) requires, in essence, that no one can work without having copies of their passport or driver's license, and a declaration under perjury of their age and true name, on file with the Company's Custodian of Records, and available for inspection by law enforcement. Mrs. Gloria Leonard, an Officer of Private USA, Inc. is currently the President of the Free Speech Coalition. Child Pornography Prevention Act of 1996 goes beyond what was defined in existing law. The new law is directed for the most part at depictions where no minors are involved at all, with a few exceptions such as situations where a photo of a minor and a photo of an adult are merged by computer to create a photo of a minor engaging in sexual activities where the minor never actually did so ("appear to be" or "convey the impression" approach). This law is currently still not approved by the government and seems to be extremely questionable when it comes to enforcement and control. As indicated above, all the Company's products are all in compliance with 18 U.S.C. Section 2257 and all models performing in Company's productions are 18 of age or older. SEASONALITY The Company's businesses are generally not seasonal in nature. However, June, July and August are typically impacted by smaller orders from some European and the U.S. distributors, due to the holiday season, while November and December sales are generally higher due to the printing of special issues such as The Best of Private. -34- ITEM 2. DESCRIPTION OF PROPERTIES LEASES During 1997, the Company relocated its principal administrative and operating offices from Stockholm, Sweden to Barcelona, Spain. The Barcelona facility houses the Company's administrative, editorial and operational offices, the data center, customer service, and some of the warehouse and fulfillment facilities. With the acquisition of the French distributor at the end of 1997, the Company also inherited some office space in Paris, France. Currently, the Company leases office space in Stockholm, Barcelona and Paris. Since May 27, 1997, Milcap Media Group S.L. is lessee under an initial 5- year lease representing its operating corporate office. The lease is effective from the May 27, 1997 (2d floor), November 1st, 1997 (1st floor) and October 3rd, 1997 (roof-surface for Internet satellite antennas) and represents approximately 1,300 square meters of corporate headquarters space located at Carrettera de Rubi 22-26, 08190 Sant Cugat del Valles, Barcelona, Spain. Average monthly base rental expense is approximately $9,400. The rent expense is being charged to operations on a straight-line basis over the extended term of the lease. Additionally, the lease requires the Company to pay its proportionate share of the building's real estate taxes and operating expenses. The majority of this space is used by all of the Company's operating groups, primarily for post production. Private France S.A. is lessee under an expired term lease, which is now currently month-to-month, for approximately 50 square meters of corporate headquarters space located at 17, rue Charles de Gaulle - 78680 Epone, France. Subsequent to the term of the lease, the average monthly base rental expense is approximately $1,067. The rent expense is being charged to operations, on a monthly basis. Private France S.A. also leases space for its warehousing facilities at RD S.L., B.P 2 - 28410 Saint-Lubin-de-la-Haye, at a price of $41 per pallet per month (the quantity of pallets varies from month to month). Milcap Publishing Group A.B. maintains its headquarters in Ryssviksvagen 2A 7tr, 131 36 Nacka, Sweden and consists of approximately 3,226 square feet of office space. The lease expires on December 31, 2000 and has an average annual base rental expense of approximately $34,937; it is subject to periodic increases to reflect rising real estate taxes and operating expenses. This space is utilized by the Swedish executive and administrative personnel. Private Media Group, Inc. maintains an office in the U.S. at 3230 Flamingo Road, Suite 156, Las Vegas, Nevada 89121. Presently, no office space is rented and the above address is simply a mailing address. -35- ITEM 3. LEGAL PROCEEDINGS The Company is from time to time a defendant in suits for defamation and violation of rights of privacy, many of which allege substantial or unspecified damages, which are vigorously defended by the Company. The Company is presently engaged in litigation, most of which is generally incidental to the normal conduct of its business and is immaterial in amount. Management believes that its reserves are adequate and that no such action will have a material adverse impact on the Company's financial condition. However, there can be no assurance that the Company's ultimate liability will not exceed its reserves. ITEM 5. MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS MARKET FOR THE COMPANY'S COMMON STOCK The Common Stock of the Company has traded on the Nasdaq National Market since February 1, 1999 under the symbol "PRVT." Prior thereto the Common Stock traded on the NASD, Inc. OTC Bulletin Board since March 29, 1996. The following table sets forth the range of representative high and low bid prices for the Common Stock for the periods indicated, as reported by the NASD, Inc. Quotations represent inter-dealer prices, do not include retail markups, markdowns or commissions and may not represent actual transactions.
HIGH LOW ---- --- Fiscal 1998: First Quarter $ 11 1/2 $ 6 3/8 Second Quarter $ 12 3/4 $ 7 13/16 Third Quarter $ 13 7/8 $ 9 7/16 Fourth Quarter $ 12 1/2 $ 10 Fiscal 1997: First Quarter $ 31 7/8 $ 6 1/4 Second Quarter $ 41 9/16 $ 12 1/2 Third Quarter $ 23 3/4 $ 8 3/4 Fourth Quarter $ 11 7/8 $ 3 1/8
On April 12, 1999, the closing price of the Common Stock was $12.50 per share. On April 12, 1999 the Company had 550 holders of record of its Common Stock. All quotations prior to June 12, 1998, the date of the acquisition of Milcap Media Ltd. and CineCraft Ltd., reflect the price of the Common Stock of the inactive shell company. The Company believes that the sharp increase in the price of the Common Stock during the first three quarters of 1997 reflected the acquisition by the Company of Electric Entertainment Corp., which transaction was subsequently rescinded in November 1997. See "Business -History." -36- DIVIDEND POLICY The Company did not pay any cash dividends during its last fiscal year and the Board of Directors does not contemplate doing so in the near future. The Company currently intends to retain all earnings to finance the development and expansion of its operations, and does not anticipate paying cash dividends on its shares of Common Stock in the foreseeable future. The Company's future dividend policy will be determined by its Board of Directors on the basis of various factors, including results of operations, financial condition, business opportunities and capital requirements. The payment of dividends will also be subject to the requirements of Nevada Law, as well as restrictive financial covenants which may be required in future credit agreements. TRANSFER AGENT The transfer agent and registrar for the Common Stock is InterWest Transfer Co., Inc., 1981 East 4800 South, Suite 100, Salt Lake City, Utah 84117. -37- ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following discussion should be read in conjunction with the consolidated financial statements and related notes included elsewhere in this Report. RESULTS OF OPERATIONS 1998 compared to 1997 Net sales. The Company reported net sales of SEK 165.1 million for the years ended December 31, 1998, which, compared to net sales of SEK 144.5 million for the year ended December 31, 1997, represents an increase of SEK 20.6 million, or 14.2%. The increase was partly attributable to increased video sales due to two factors; a higher output of new video releases, 61 titles in 1998 compared to 43 titles in 1997, and an increase in the number of video titles available for back-catalogue sales. Furthermore, the increase was attributable to an increase in CD-ROM sales and the first year of sales from Internet. Sales of magazines remained approximately the same in 1998 as in 1997. Cost of Sales. The Company reported cost of sales of SEK 71.3 million for the year ended December 31, 1998, which, compared to cost of sales of SEK 75.7 million for the year ended December 31, 1997, represents a decrease of SEK 4.4 million, or 5.8%. The decrease in cost of sales is the result of lower production costs during the year. The gross profit for the year ended December 31, 1998 was SEK 93.9 million, or 56.9% of net sales, which compared to gross profit for the year ended December 31, 1997 of SEK 68.9 million, or 47.6% of net sales, represents an increase of 9.3% in the gross profit margin. The increase is the result of the aforementioned lower production costs and high margins from CD-ROM and Internet sales. Selling, general and administrative expenses. The Company reported selling, general and administrative expenses of SEK 52.4 million for the year ended December 31, 1998, which, compared to selling, general and administrative expenses of SEK 33.7 million for the year ended December 31, 1997, represents an increase of SEK 18.7 million, 55.5%. The increase was primarily attributable to non-recurring moving and organization expenses related to the relocation of several departments of the Swedish subsidiary to the subsidiary in Spain, the Company's investment in Internet related activities, and the introduction of the Company on Nasdaq National Market. The re-location which started during 1997 was completed during 1998. The investment expenses associated with Internet activities are expected to continue in 1999. Interest expense. The Company reported interest expense of SEK 0.74 million for the year ended December 31, 1998, which, compared to interest expense of SEK 0.32 million for the year ended December 31, 1997, represents an increase of SEK 0.42 million. The increase is the result of higher average short-term borrowings outstanding in 1998 compared to 1997, partially offset by reduced long-term borrowings. Income taxes. The Company reported income tax expense of SEK 1,4 million for the year ended December 31, 1998 as compared to an income tax benefit of SEK 2.1 million for the year ended December 31, -38- 1997. The increase of SEK 3.5 million is primarily attributable to more of the Company's profits being recorded in tax jurisdictions where there is corporate tax. Net income. The Company reported net income of SEK 40.0 million as compared to SEK 37.0 million for the year ended December 31, 1997. The increase in 1998 net income was primarily attributable to increased sales and reduced cost of sales, offset by higher selling, general and administrative expenses. Liquidity & Capital Resources The Company reported a working capital surplus of SEK 72.4 million for the year ended December 31, 1998, an increase of SEK 23.6 million compared to the year ended December 31, 1997. The increase is principally attributable to increased accounts receivable related to increased sales and increased inventories. Net cash provided by operating activities was SEK 36.9 million for the year ended December 31, 1998 and was primarily the result of net income and adjustments to reconcile net income to net cash flows from operating activities. The net income of SEK 40.0 million and the adjustments to reconcile net income to net cash flows from operating activities, representing amortization of photographs and videos of SEK 17.9 million, depreciation of SEK 2.3 million and deferred taxes of SEK 0.4 million, provided a total of SEK 60.6 million. The total of SEK 60.6 million was then primarily reduced by the increases in trade accounts receivable, related party receivable, prepaid expenses and other current assets and inventories totaling SEK 28.5 million, offset by SEK 4.9 million from accounts payable trade, income taxes payable and accrued other liabilities. Net cash provided by operating activities was SEK 44.7 million for the year ended December 31, 1997. The decrease in cash provided by operating activities in 1998 compared to 1997 is principally the result of changes in operating assets and liabilities in 1998. Net cash used in investing activities for the year ended December 31, 1998 was SEK 38.3 million. The investing activities was principally investment in library of photographs and videos of SEK 29.9 million which was carried out in order to maintain the 1998/1999 release. In addition to investment in library of photographs and videos, SEK 4.9 million was invested in capital expenditures and SEK 4.3 million in other assets which was reduced by SEK 0.7 million from cash acquired in reverse acquisition. The increase over the comparable twelve-month 1998 period was principally due to increased investments in library of photographs and videos to support the Company's increased sales. Net cash provided by financing activities for the year ended December 31, 1998 was SEK 1.5 million represented by SEK 1.6 million from conversion of warrants and an increase in short-term borrowings of SEK -39- 0.2 million on the line of credit offset by repayments on long-term loans of SEK 0.3 million. The increase over the comparable twelve-month 1997 period was primarily due to the absence of dividends paid and the presence of additional paid-in capital. The Company has historically relied on positive cash flows from operations to finance working capital needs and investing activities. The Company expects to have adequate working capital for the next twelve months. During this period the Company intends to rely on positive cash flows from operations to finance working capital needs and necessary investing activities. The Company's long- term expansion plans will require additional sources of funding. The Company plans to meet these funding requirements through a combination of increases in short-term credit lines, additional long-term borrowings and/or equity financing. YEAR 2000 The Company relies heavily on computers in its internal and external financial reporting systems. In addition, computers are used extensively throughout the Company to perform critical operating activities including the processing of payroll, accounts receivable and accounts payable and to perform critical analyses. The Company also makes use of computers for efficient communication with employees and customers, including extensive use of e-mail systems and the Internet, and is expected to expand its use of such technology in the future. Finally, embedded technology such as microcontrollers are commonly found in equipment used throughout the Company's operations. The complete failure of these systems could have a material negative impact on the operations of the Company. In addition, many of the Company's major suppliers and customers rely heavily on similar computer systems, and failures in such systems could disrupt their operations. -40- The Company is substantially complete in assessing and addressing Year 2000 issues in its major computer systems. Most of the Company's major systems are Year 2000 compliant or have been updated in the normal course of business with applications that are Year 2000 compliant. In addition to substantially addressing Year 2000 issues in its own critical computer systems, the Company is in the process of contacting its major customers and vendors to assess their progress in addressing their Year 2000 issues. The Company expects to have responses from these customers and vendors by the second quarter of 1999. The Company believes that in making these contacts it can minimize the risks associated with Year 2000 failures of such vendors and customers. The Company can give no assurance that the systems of other companies on which the Company's systems rely will be converted or otherwise addressed on time, or that a failure to convert by another company would not have a material adverse effect on the Company. While the Company has and will continue to make efforts to address Year 2000 issues, the Company could experience disruptions in its operations as a result of failures in its own systems and those of its major vendors or customers. To date, the total amount spent on Year 2000 issues has been less than $5,000 and has not been material to the Company's operations or financial condition. Based on current assessments, the Company expects to incur less than $5,000 in additional expenditures to address Year 2000 issues. However, these estimates are subject to revision based on future assessments and responses from vendors and customers. Estimates of the costs or consequences of incomplete or untimely resolution of Year 2000 issues would be speculative. The Company will continue to assess and address Year 2000 issues and expects to fund such efforts through operating cash flows and, if necessary, external sources of financing. -41- PART III ITEM 9. DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS IDENTIFICATION OF DIRECTORS, EXECUTIVE OFFICERS AND KEY EMPLOYEES The following table sets forth all of the current directors, executive officers and key employees of Private, their age and the office they hold with the Company. Executive officers and employees serve at the discretion of the Board of Directors. All directors hold office until the next annual meeting of stockholders of the Company and until their successors have been duly elected and qualified.
POSITION WITH THE ----------------- NAME AGE COMPANY OR SUBSIDIARY ---- --- --------------------- DIRECTORS --------- Berth H. Milton.............................. 43 Chief Executive Officer, President and Director; Administrator of MMG Alfredo M. Villa............................. 37 Director, Secretary, Private Media Group, Inc. Bo Rodebrant................................. 45 Director Robert L. Tremont............................ 54 Director OTHER EXECUTIVE OFFICERS AND KEY EMPLOYEES ------------------------------------------ Claes Henrik Marten Kull..................... 33 Chief Marketing Officer, Private Media Group, Inc.; Marketing Manager, MMG Javier Sanchez............................... 36 Chief Operating Officer, Private Media Group, Inc.; General Manager, MMG Johan Gillborg............................... 36 Chief Financial Officer, Private Media Group, Inc.; Chairman and Managing Director of Milcap Publishing Group AB Jean-Pierre Michel........................... 45 Managing Director of Private France S.A.
The following table sets forth certain information with respect to the persons who are members of the Board of Directors, executive officers or key employees of the Company: BERTH H. MILTON was appointed to the Board of Directors in February 1998 in conjunction with the beginning of the final phase of due diligence process related to the acquisition of the Milcap Group by the Company in June 1998, and was the Corporate Secretary from June 1998 until February 1999. In February 1999 -42- Mr. Milton was appointed Chairman of the Board and Chief Executive Officer of Private. Mr. Milton is one of the most well known and reputable figures in the industry, has been Administrator of MMG since its inception and has been acting as an advisor to the Milcap Group since 1991. Mr. Milton is also active in several international industry and real estate projects and developments ALFREDO M. VILLA has been a Director of the Company since December 1996, and served as the Company's President and CEO from December 1996 until February 1999. Mr. Villa holds a masters degree in economics from the University of Geneva, Switzerland and attended Bocconi University in Milan, Italy. He has over 13 years of experience with the Swiss banking industry. Mr. Villa is currently Chairman and CEO of SCF Societa di Consulenza Finanziaria S.A., a Swiss corporation specializing in asset management, mergers, acquisitions, and investment banking, where he has served since 1994. Prior to that Mr. Villa was an asset manager with several other European financial institutions. In addition, Mr. Villa was Chairman of the Board of Alma Grafiche Srl, of Milan, Italy, a leader in the high quality printing of books and magazines from 1995 until February 1998. BO RODEBRANT was appointed as a Director of the Company in August 1998. Mr. Rodebrant has operated his own accountancy and management consulting services, R&S Ekonomiservice, since 1986. Prior thereto he co-founded an ice cream business, Hemglass, which was the largest of its kind in Stockholm, Sweden. The business was sold by Mr. Rodebrant in 1986. Mr. Rodebrant holds a degree in construction engineering which he received in 1974. ROBERT L. TREMONT was appointed to the Board of Directors in September 1998. Since 1980 Mr. Tremont has owned and operated a number of businesses in the adult entertainment industry. Mr. Tremont is a principal in Sundance Associates and Private Collection International, Inc., which companies are exclusive distributors for most of the Company's products in the United States and Mexico. He has also been active in political and lobbying activities for the adult entertainment industry, serving for several years as President of the Free Speech Coalition. Mr. Tremont received a Bachelors of Arts degree from the University of Minnesota and a Masters of Arts degree from the University of the Americas in Mexico City. CLAES HENRIK MARTEN KULL joined the Milcap Group in 1992 as a sales manager, and has been Milcap Group's Marketing Manager since 1993, and was appointed Chief Marketing Officer of Private Media Group, Inc. in August 1998, with his main responsibilities being to identify and open up new markets and negotiate with distributors. Since he began working for the Milcap Group in 1992, approximately 25 new countries have been opened up. From 1991 to 1992 he operated his own business (his business partner was Johan Gillborg) which acted as a sub-contracted sales force for Securitas Direct of Sweden, which is one of Sweden's largest companies. From 1988 to 1991 he managed a private import and trading corporation, which became the start of his career as an entrepreneur and sales professional. JAVIER SANCHEZ was appointed as the Chief Operating Officer of Private Media Group, Inc. in August 1998, and has been the General Manager of MMG, member of the Board of MMG and Private France S.A., and minority shareholder of Milcap Media Group S.L. since its incorporation in 1991. He has been a member of the Board of Milcap Publishing Group AB since its incorporation in 1994 until 1997. From 1988 to 1991 he was the Operations Director of a mid-size printing company near Barcelona. From 1984 to 1987 he was the Production Manager of a major printing company in Barcelona. JOHAN GILLBORG was appointed as Chief Financial Officer of Private Media Group, Inc. in August 1998 and has been the Chairman and Managing Director of Milcap Publishing Group AB since 1994. Mr. Gillborg joined the group in 1992 as Marketing Consultant. From 1991 to 1992 he operated his own business which acted -43- as sub-contracting sales force for Securitas Direct of Sweden (together with Mr. Kull). From 1988 to 1990, Mr. Gillborg served as General Manager in the hotel business in the United Kingdom and Portugal. Mr. Gillborg holds a Bachelor's Degree in Business Administration from Schiller International University in London. JEAN-PIERRE MICHEL has been the Managing Director of Private France S.A. since 1994, when he started the distribution business which was purchased by MMG in 1997. Prior to joining the Milcap Group, Mr. Michel was the COO of Polygram France and was mainly active in the marketing division. Prior thereto he was active in the video and magazine industry and was sales manager for Antares, Sevres, France and Echo S.A., Boulogne, France. No director or executive officer serves pursuant to any arrangement or understanding between him or her and any other person. SECTION 16(A) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE Based solely upon a review of Forms 3 and 5 furnished to the Company covering its 1998 fiscal year filed under Section 16(a) of the Securities Exchange Act of 1934, each of the Company's directors, officers and beneficial owners of more than 10% of the Company's Common Stock who are identified in the table appearing in Item 11 of this Report did not file the initial Form 3 on a timely basis, and Mr. Milton did not file a Form 5 on a timely basis. -44- ITEM 11. EXECUTIVE COMPENSATION The following table summarizes all compensation paid to the Company's Chief Executive Officer and to the Company's other most highly compensated executive officer other than the Chief Executive Officer whose total annual salary and bonus exceeded $100,000 (the "Named Executive Officers"), for services rendered in all capacities to the Company during the fiscal years ended December 31, 1998, 1997 and 1996. No other executive officer of the Company earned compensation in excess of $100,000 in each of these periods. SUMMARY COMPENSATION TABLE
LONG TERM COMPENSATION AWARDS ------------- NAME AND SECURITIES PRINCIPAL POSITION DURING FISCAL ANNUAL COMPENSATION UNDERLYING ALL OTHER FISCAL 1998 YEAR SALARY($) OPTIONS (#) COMPENSATION($) - ------------------------- ------ ------------------- ------------- --------------- Alfredo M. Villa.................. 1998 --- --- --- Chief Executive Officer 1997 29,073(1) --- --- and President 1996 --- --- --- Berth H. Milton................... 1998 144,000 --- --- MMG Administrator, 1997 145,000 --- --- Corporate Secretary(2) 1996 105,500 --- --- Javier Sanchez.................... 1998 143,274 --- --- Chief Operating Officer, Private 1997 4,000 --- --- Media Group, Inc., General 1996 4,000 --- --- Manager, MMG.
- ------------ (1) Represents $20,000 of fees and $9,073 of expenses paid under a Consulting Agreement between the Company and a company affiliated with Mr. Villa. (2) Mr. Milton was appointed as the Company's CEO in February 1999. In June 1998 Mr. Milton received 175,000 Warrants to acquire Private Common Stock at $4.00 per share in connection with the Company's acquisition of Milcap Media Limited and Cinecraft Limited. See "Business -- History." No options to acquire shares of Common Stock of the Company were granted as compensation for services or exercised during the Company's fiscal year ended December 31, 1998. ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT The following table presents certain information as of March 31, 1999, regarding the beneficial ownership of Common Stock by (i) each of the directors and Named Executive Officers of the Company -45- individually, (ii) all persons known by the Company to be beneficial owners of five percent or more of the Common Stock, and (iii) all directors and executive officers of the Company as a group. Unless otherwise noted, the persons listed below have sole voting and investment power and beneficial ownership with respect to such shares.
NUMBER OF SHARES Name and Address (1) BENEFICIALLY OWNED (1) PERCENT BENEFICIALLY OWNED -------------------- ---------------------- -------------------------- Berth H. Milton (2) 7,691,049 50.7% Senate Limited (3) 3 Bell Lane, Gibraltar 1,675,000 20.5% Chiss Limited (4) 3 Bell Lane, Gibraltar 1,400,000 17.2% Bajari Properties Limited (5) 7 Myrtle Street, Douglas, Isle of Man 625,000 7.7% Pressmore Licensing Limited P.O. Box N-341, Nassau, Bahamas 625,000 7.7% Perrystone Trading Limited P.O. Box 171, Providenciales, Turks & Caicos 625,000 7.7% Solidmark (Gibraltar) Ltd. 3 Bell Lane, Gibraltar 625,000 7.7% Churchbury Limited 3 Bell Lane, Gibraltar 625,000 7.7% Kingston Finance Ltd. Wickhams Cay, Road Town, Tortola, BVI 625,000 7.7% Alfredo M. Villa (6) Lugano, Switzerland 15,000 * Marten Kull (7) 75,000 * Johan Gillborg (8) 35,000 * Javier Sanchez (9) 10,000 * Robert L. Tremont (10) 3,000 * Bo Rodebrant (11) 2,500 * All Executive Officers and Directors
-46- as a group (12) 7,816,549 [51.2%]
--------------- * Denotes less than 1% (1) Beneficial ownership is determined in accordance with rules of the Securities and Exchange Commission, and includes generally voting power and/or investment power with respect to securities. Shares of Common Stock which may be acquired upon exercise or conversion of warrants or Preferred Stock which are currently exercisable or exercisable within 60 days of March 31, 1999, are deemed outstanding for computing the beneficial ownership percentage of the person holding such securities but are not deemed outstanding for computing the beneficial ownership percentage of any other person. Except as indicated by footnote, to the knowledge of the Company, the persons named in the table above have the sole voting and investment power with respect to all shares of Common Stock shown as beneficially owned by them. (2) Includes 7,000,000 shares of Common Stock issuable upon conversion of 7,000,000 of the Company's $4.00 Series A Convertible Preferred Stock and 59,049 shares of Common Stock which have accrued as dividends on the Preferred Stock. Mr. Milton is indirectly the beneficial owner of the 7,000,000 $4.00 Series A Convertible Preferred Stock and 59,049 shares of Common Stock owned of record by Slingsby Enterprises Limited. Also includes (i) 625,000 shares of Common Stock owned by Bajari Properties Limited, of which Mr. Milton is the sole shareholder, and (ii) 7,000 shares of Common Stock issuable upon exercise of Warrants owned by Mr. Milton. His address is c/o the Company, Carrettera de Rubi 22-26, 08190 Sant Cugat del Valles, Barcelona, Spain. (3) Cornelia Strehl is the sole shareholder of Senate Limited and, therefore, may be deemed to be the beneficial owner of these shares. (4) Andrea Armas is the sole shareholder of Chiss Limited and, therefore, may be deemed to be the beneficial owner of these shares. (5) Berth Milton is the sole shareholder of Bajari Properties Limited. Therefore, these shares may be deemed to be beneficially owned by Mr. Milton and are also reflected as being beneficially owned by Mr. Milton, individually, in the above table. (6) Mr. Villa's address is Corso Elvezia 4, CH-6900 Lugano, Switzerland. (7) Includes 75,000 shares of Common Stock issuable upon exercise of Warrants owned by Mr. Kull. His address is c/o the Company, Carrettera de Rubi 22- 26, 08190 Sant Cugat del Valles, Barcelona, Spain. (8) Includes 35,000 shares of Common Stock issuable upon exercise of Warrants owned by Mr. Gillborg. His address is c/o the Company, Carrettera de Rubi 22-26, 08190 Sant Cugat del Valles, Barcelona, Spain. (9) Includes 10,000 shares of Common Stock issuable upon exercise of Warrants owned by Mr. Sanchez. His address is c/o the Company, Carrettera de Rubi 22-26, 08190 Sant Cugat del Valles, Barcelona, Spain. (10) Includes 3,000 shares of Common Stock issuable upon exercise of Warrants owned by Mr. Tremont. His address is c/o the Company, Carrettera de Rubi 22-26, 08190 Sant Cugat del Valles, Barcelona, Spain. (11) Includes 2,500 shares of Common Stock issuable upon exercise of Warrants owned by Mr. -47- Rodebrant. His address is c/o the Company, Carrettera de Rubi 22-26, 08190 Sant Cugat del Valles, Barcelona, Spain. (12) Includes 7,000,000 shares of Common Stock issuable upon conversion of the outstanding Series A Preferred Stock and 125,000 shares of Common Stock issuable upon exercise of outstanding Warrants. ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS CERTAIN RELATIONSHIPS No Director or executive officer of the Company is related to any other Director or executive officer. None of the Company's officers or Directors hold any directorships in any other public entity. There are currently two outside directors on the Company's Board of Directors. RELATED TRANSACTIONS The Company has long term borrowings of SEK 723,000 and SEK 394,000 at December 31, 1997 and 1998, respectively. The borrowings bear interest at a rate of 10% payable annually and are due to entities controlled by Berth Milton. The borrowings have no maturity date. The Company has a short term loan to an entity controlled by Mr. Milton in the amount of SEK 4,946,000 at December 31, 1998. The loan bears interest at the rate of 10% per annum and has no maturity date. On March 31, 1998, two of the Company's wholly owned subsidiaries, together with Zebra Forvaltings AB, Sweden ("Zebra"), an affiliated company of Berth Milton, purchased all of the outstanding capital stock of Viladalt S.L., Spain ("Viladalt") from its shareholders, none of whom are related to the Company or Mr. Milton, for the sum of approximately $2,685,000. It was agreed that the Company's subsidiaries would own 69% of the Viladalt shares, Zebra would own 31% of the Viladalt shares, and that each party would be responsible for its proportionate share of the purchase price. To avoid the appearance of a conflict of interest Zebra has agreed to sell its interest in Viladalt to the Company at Zebra's cost when and if the Viladalt interest is sold by the Company. The principal asset of Viladalt is a country house in the Barcelona, Spain area known as Casa Retol de la Sarra. The Viladalt property was acquired by the Company as a real estate investment and is presently being utilized as a filming location for certain of the Company's upcoming releases. Milcap Publishing Group, a wholly owned subsidiary of the Company, is a party to an exclusive Distribution Agreement with Sundance Associates, Inc. ("Sundance") which has been in effect since 1995. Robert Tremont, a Director of the Company, is the sole shareholder of Sundance. Under the terms of the Distribution Agreement Milcap granted to Sundance the exclusive rights to distribute in the United States and Mexico specified products, including magazines, videos and digital media such as CD-ROM's and laser discs. Royalties are paid by Sundance to Milcap in accordance with an agreed royalty schedule. The Distribution Agreement automatically renews for successive one year terms and is cancellable by either party prior to the end of each one year term. During the 12 month periods ended December 31, 1997 and December 31, 1998 Sundance paid royalties to Milcap of $2,156,000 and $2,362,000, respectively. Milcap Media Limited, a wholly owned subsidiary of the Company, is a party to an exclusive License Agreement with Private Collection International, Inc. ("PCI"), which has been in effect since 1995. The principal terms of this Agreement are set forth elsewhere in this Prospectus under "Business - Private Collection." Robert Tremont, a Director of the Company, is an officer and principal shareholder of PCI. -48- The foregoing transactions were approved by a majority of disinterested Directors and are believed to be on terms no less favorable to the Company than could be obtained from unaffiliated third parties on an arms-length basis. -49- ITEM 13. EXHIBITS AND REPORTS ON FORM 8-K (A) DOCUMENTS FILED AS PART OF THIS FORM 10-K 1. FINANCIAL STATEMENTS -------------------- See Consolidated Financial Statements. 2. FINANCIAL STATEMENT SCHEDULES ----------------------------- See Consolidated Financial Statements. 3. EXHIBITS -------- See Exhibit Index. (B) REPORTS ON FORM 8-K: There were no reports on Form 8-K filed by the Registrant in the last quarter of Fiscal 1998. -50- INDEX TO EXHIBITS -----------------
EXHIBIT No. DESCRIPTION OF DOCUMENT - --- ----------------------- *3.1 Articles of Incorporation 3.2 Amended and Restated Bylaws *4.1 Specimen Common Stock Certificate *4.3 Certificate of Designation re Preferred Stock *10.1 Milcap Acquisition Agreement dated December 19, 1997 *10.2 Cinecraft Acquisition Agreement dated December 19, 1997 *10.3 Distribution Agreement between Sundance Associates and the Registrant *10.4 License Agreement between PCI, Inc. and Milcap Media Ltd. *10.5 Letter of Intent dated May 5, 1998, by and between Max's Film AB and Milcap Media Limited as amended on August 20, 1998, and October 12, 1998 *10.7 Agreement dated March 31, 1998, by and between Milcap Media Ltd. and certain shareholders of Viladalt, S.L. *10.8 Agreement dated March 31, 1998, by and between Zebra Forvaltnings, AB and certain shareholders of Viladalt, S.L. *10.9 Agreement dated March 31, 1998, by and between Milcap Media Ltd. and certain shareholders of Viladalt, S.L. *10.10 Agreement dated March 31, 1998, by and between Milcap Media Ltd. and certain shareholders of Viladalt, S.L. 10.11 1999 Employee Stock Option Plan. 10.12 Production Agreement dated as of March 29, 1999, by and between Milcap Media Ltd. And Pierre Woodman. 10.13 Final Agreement dated as of March 22, 1999, by and among Private Media Group, Inc., Danny Cook and Qamilla Carlsson. 21 Subsidiaries of the Registrant
-51- 27.1 Financial Data Schedule _________________ *Incorporated by reference from the registrant's Registration Statement on Form SB-2 (SEC File No. 333-62075). -52- SIGNATURES In accordance with the requirements of Section 13 or 15(d) of the Exchange Act, the registrant has caused this Report to be signed on its behalf by the undersigned, thereunto duly authorized. Dated: April 13, 1999 PRIVATE MEDIA GROUP, INC. By: /s/ Berth H. Milton ------------------------------------- Berth H. Milton, Chief Executive Officer In accordance with the requirements of the Exchange Act, the Report has been signed below by the following persons on behalf of the registrant in the capacities and on the dates indicated. NAME TITLE DATE ---- ----- ---- /s/ Berth H. Milton Chairman of the Board, Chief April 13, 1999 - --------------------- Berth H. Milton Executive Officer and Director /s/ Alfredo M. Villa Director April 13, 1999 - --------------------- Alfredo M. Villa /s/ Johan Gillborg Chief Financial Officer, Chief April 13, 1999 - --------------------- Johan Gillborg Accounting Officer /s/ Bo Rodebrant Director April 13, 1999 - --------------------- Bo Rodebrant /s/ Robert L. Tremont Director April 13, 1999 - --------------------- Robert L. Tremont -53- REPORT OF INDEPENDENT AUDITORS To the Board of Directors and Shareholders of Private Media Group Inc. We have audited the accompanying consolidated balance sheet of Private Media Group, Inc, and its subsidiaries as of December 31, 1998 and the related consolidated statements of income and comprehensive income, shareholders' equity and cash flows for each of the two years in the period ended December 31, 1998. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with auditing standards generally accepted in Sweden and in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of Private Media Group, Inc, and its subsidiaries as of December 31, 1998 and the consolidated results of their operations and their cash flows for each of the two years in the period ended December 31, 1998, in conformity with generally accepted accounting principles in the United States of America. Stockholm, Sweden April 12, 1999 Ernst & Young AB - ---------------- /s/ Tom Bjorklund - ----------------- Tom Bjorklund F-1 PRIVATE MEDIA GROUP, INC. CONSOLIDATED BALANCE SHEETS
December 31, ------------------------------- 1998 1998 ------------- ------------- SEK USD (in thousands) ASSETS Cash and cash equivalents..................................................... 4,165 517 Trade accounts receivable - (Note 4).......................................... 55,650 6,904 Related party receivable (Note 12)............................................ 5,178 642 Inventories - net (Note 5).................................................... 30,888 3,832 Prepaid expenses and other current assets..................................... 9,096 1,129 ---------- ---------- TOTAL CURRENT ASSETS.......................................................... 104,978 13,025 Library of photographs and videos - net (Note 7).............................. 79,564 9,871 Property, plant and equipment - net (Note 8).................................. 9,546 1,184 Other assets (Note 6)......................................................... 16,391 2,034 ---------- ---------- TOTAL ASSETS.................................................................. 210,479 26,114 ========== ========== LIABILITIES AND SHAREHOLDERS' EQUITY Short-term borrowings (Note 9)................................................ 1,802 224 Accounts payable trade........................................................ 20,389 2,530 Income taxes payable.......................................................... 1,011 125 Deferred tax liability (Note 11).............................................. 630 78 Accrued other liabilities (Note 10)........................................... 8,741 1,085 ---------- ---------- TOTAL CURRENT LIABILITIES..................................................... 32,573 4,041 Long-term borrowings (Note 12)................................................ 394 49 SHAREHOLDERS' EQUITY (Note 13) $4.00 Series A Convertible Preferred Stock.................................... - - 10,000,000 shares authorized, 7,000,000 shares issued and outstanding Common Stock, $.001 par value, 50,000,000..................................... 7,997 992 shares authorized 8,131,669 issued and outstanding Additional paid-in capital.................................................... 2,344 291 Stock dividends to be distributed............................................. 5,642 700 Retained earnings............................................................. 161,177 19,997 Accumulated other comprehensive income........................................ 353 44 ---------- ---------- TOTAL SHAREHOLDERS' EQUITY.................................................... 177,512 22,024 ---------- ---------- TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY.................................... 210,479 26,114 ========== ==========
See notes to consolidated financial statements. F-2 PRIVATE MEDIA GROUP, INC. CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME
Years ended December 31, ----------------------------------------- 1997 1998 1998 --------- --------- -------- SEK SEK USD (in thousands) Net sales....................................................... 144,543 165,104 20,484 Cost of sales................................................... 75,674 71,272 8,843 --------- --------- -------- Gross profit.................................................... 68,869 93,883 11,642 Selling, general and administrative expenses.................... 33,682 52,365 6,497 --------- --------- -------- Operating profit................................................ 35,187 41,468 5,145 Interest expense................................................ 321 745 92 Interest income................................................. 69 731 91 --------- --------- -------- Income before income tax........................................ 34,935 41,455 5,143 Income taxes.................................................... (2,052) 1,445 179 --------- --------- -------- Net income...................................................... 36,987 40,010 4,964 --------- --------- -------- Other comprehensive income: Foreign currency adjustments.................................... 365 353 44 --------- --------- -------- Comprehensive income............................................ 37,352 40,363 5,008 ========= ========= ======== Net income per share: Basic........................................................... 4.93 5.14 0.64 ========= ========= ======== Diluted......................................................... 2.43 2.60 0.32 ========= ========= ========
See notes to consolidated financial statements. F-3 PRIVATE MEDIA GROUP, INC. CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
Accumu- lated Stock other Total Common stock Preferred stock Additional Dividends compre- Share- ------------------------------------------- Paid-in to be Retained hensive holders' Shares Amounts Shares Amounts capital distributed earnings income equity --------- ------- ---------- ------- ---------- ----------- -------- ------- -------- SEK SEK SEK SEK SEK SEK SEK Balance at January 1, 7,500,000 7,992 7,000,000 - - - 96,482 (365) 104,109 1997 Exchange rate changes - - - - - - - 365 365 Dividends paid - - - - - - (6,660) - (6,660) Net income - - - - - - 36,987 - 36,987 --------- ----- --------- ---- ----- ----- ------- ---- ------- Balance at December 7,500,000 7,992 7,000,000 - - - 126,809 - 134,801 31, 1997 Shares issued in 581,669 5 - - 731 - - - 736 reverse acquisition Exchange rate changes - - - - - - - 353 353 Conversion of warrants 50,000 - - - 1,613 - - - 1,613 Stock dividends to - - - - - 5,642 (5,642) - - be distributed Net income - - - - - - 40,010 - 40,010 --------- ----- --------- ---- ----- ----- ------- ---- ------- Balance at December 31, 1998 8,131,669 7,997 7,000,000 - 2,344 5,642 161,177 353 177,513 ========= ===== ========= ==== ===== ===== ======= ==== =======
See notes to consolidated financial statements. F-4 PRIVATE MEDIA GROUP, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS
----------------------------------------------- 1997 1998 1998 ----------- ----------- --------- SEK SEK USD Cash flows from operating activities: Net income..................................................... 36,987 40,010 4,964 Adjustment to reconcile net income to net cash flows from operating activities: Deferred taxes.............................................. (2,800) 378 47 Depreciation................................................ 1,366 2,336 290 Amortization of photographs and videos...................... 20,209 17,899 2,221 Effects of changes in operating assets and liabilities: Trade accounts receivable................................... (15,936) (8,018) (995) Related party receivable.................................... - (5,178) (642) Inventories................................................. (5,985) (10,391) (1,289) Prepaid expenses and other current assets................... 4,037 (4,922) (611) Accounts payable trade...................................... 4,047 380 47 Income taxes payable........................................ 130 152 19 Accrued other liabilities................................... 2,640 4,301 534 ----------- ----------- --------- Net cash provided by operating activities...................... 44,695 36,946 4,584 Cash flows from investing activities: Investment in library of photographs and videos................ 25,864 29,886 3,708 Capital expenditures........................................... 1,541 4,884 606 Investments in other assets.................................... 11,121 4,279 531 Cash acquired in reverse acquisition........................... - (736) (91) ----------- ----------- --------- Net cash used in investing activities.......................... 38,526 38,313 4,754 Cash flow from financing activities: Dividends paid................................................. (6,660) - - Conversion of warrants......................................... - 1,613 200 Repayments on long-term loan................................... (409) (329) (41) Short-term borrowings.......................................... 788 198 25 ----------- ----------- --------- Net cash (used in) provided by financing activities............ (6,281) 1,482 184 Foreign currency translation adjustment........................ 365 ----------- ----------- --------- Net (decrease) increase in cash and cash equivalents........... 253 353 44 Cash and cash equivalents at beginning of the period........... 3,445 467 58 ----------- ----------- --------- Cash and cash equivalents at end of the period................. 3,698 3,698 459 =========== =========== ========= 4,165 517 Cash paid for interest......................................... 310 =========== =========== ========= 544 67 Cash paid for taxes............................................ 367 332 41 =========== =========== =========
See notes to consolidated financial statements. F-5 PRIVATE MEDIA GROUP, INC. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS 1. Basis of Presentation Private Media Group, Inc. ("the Company") was originally incorporated on September 23, 1980 as Glacier Investment Company, Inc. under the laws of the State of Utah and, effective November 24, 1997, after a series of interim name changes, changed its name to Private Media Group Inc. Effective June 12, 1998 the Company acquired Cine Craft Limited ("Cine Craft"), a Gibraltar corporation and Milcap Media Limited ("Milcap"), a Republic of Cyprus corporation. Prior to the acquisitions the Company was a holding company with no operations. Milcap and its subsidiaries and Cine Craft operate under common control and are engaged in the acquisition, refinement and distribution of video and photo rights for adult feature magazines and movies. The acquisition has been accounted for as a reverse acquisition whereby the Company is considered to be the acquiree even though legally it is the acquiror. Accordingly, the accompanying financial statements present the historical combined financial statements of Cine Craft and Milcap from January 1, 1997 through the acquisition date of June 12, 1998 and the consolidated financial statements of the Company, Cine Craft and Milcap since that date. Since the fair value of the net assets of the Company were equal to their net book value on June 12, 1998, the assets and liabilities of the Company remained at their historical cost following the acquisition. The accompanying financial statements have been presented in Swedish Kronor ("SEK") which is the principal currency in which Cine Craft and Milcap generate their cash flows. Solely for the convenience of the reader, the accompanying consolidated financial statements as of December 31, 1998 and for the twelve months then ended have been translated into United States dollars ("USD") at the rate of SEK 8.06 per USD 1.00 the exchange rate of the Swedish Riksbank on December 31, 1998. The translations should not be construed as a representation that the amounts shown could have been, our could be, converted into US dollars at that or any other rate. 2. Summary of Significant Accounting Policies Principles of Consolidation The accompanying consolidated financial statements include the accounts of the Company and its subsidiaries. All significant intercompany transactions and balances have been eliminated. F-6 PRIVATE MEDIA GROUP, INC. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS The financial statements of the Company and its subsidiaries are measured in the currency in which that company primarily conducts its business (the functional currency). The functional currency of all the Company's foreign operations is the applicable local currency. When translating functional currency financial statements into Swedish Kronor, year-end exchange rates are applied to asset and liability accounts, while average annual rates are applied to income statement accounts. Adjustments resulting from this process are recorded in a separate component of shareholders' equity. Foreign currency transaction gains and losses resulting from the settlement of amounts receivable or payable denominated in a currency other than the functional currency are credited or charged to income. Inventories Inventories are valued at the lower of cost or market, with cost principally determined on an average basis. Inventories consists principally of video cassettes and magazines held for resale. Property, Plant and Equipment Property, plant and equipment are carried at cost and are generally depreciated using the straight-line method over the estimated useful lives of the assets. The useful lives range from 3-5 years. The Company evaluates the carrying value of property, plant and equipment for potential impairment on an ongoing basis. Recognition of Revenue Revenue from the sale of magazines and other related products is recognized upon delivery. Revenue from the sale of video products is recognized based upon reported sales to retail customers by the Company's distributors. Provisions for expected returns of product are recorded. Advertising Costs Advertising costs are charged to income as incurred. F-7 PRIVATE MEDIA GROUP, INC. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS Income Taxes The Company accounts for certain income and expense items differently for financial reporting purposes than for tax purposes. Provision for deferred taxes are made in recognition of such temporary differences, following the requirements of Financial Accounting Standards Board Statement No. 109 "Accounting for Income Taxes". It is the Company's current intention to re-invest the unremitted earnings of its non-U.S. subsidiaries indefinitely and accordingly no provision for U.S. income taxes or foreign withholding taxes has been provided. Library of Photographs & Videos The library of photographs and videos, including rights for photographs and videos as well as translation and dubbing of video material, is reflected at the lower of amortized cost or net realizable value. The cost is amortized on a straight-line basis over 3-5 years representing the estimated useful life of the asset. Estimated future revenues are periodically reviewed and, revisions may be made to amortization rates or write-downs made to the asset's net realizable value as a result of significant changes in future revenue estimates. Net realizable value is the estimated selling price in the ordinary course of business, less estimated costs to complete and exploit in a manner consistent with realization of that income. Cash Equivalents All highly liquid investments purchased with an original maturity of three months or less at the time of acquisition are considered cash equivalents. Concentration of Credit Risk Financial instruments that potentially subject the Company to concentrated credit risks consist primarily of cash and trade receivables. Credit risk on trade receivables is minimized as a result of the use of bank guarantees and credit control. The Company maintains cash and equivalents with various financial institutions. The Company policy is designed to limit exposure to any one institution. F-8 PRIVATE MEDIA GROUP, INC. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS Basic and Diluted Earnings Per Share Basic and diluted earnings per share is calculated in accordance with Financial Accounting Standards Board Statement No. 128 "Earnings per Share" (SFAS 128) (see Note 14). Fair Value of Financial Instruments The carrying value of financial instruments such as cash, accounts receivable, accounts payable and short-term borrowings approximate their fair value based on the short-term maturities of these instruments. Use of Estimates The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ from those estimates. 3. Business Acquisition On June 12, 1998, the Company acquired (a) all of the outstanding common stock of Cine Craft in exchange for the issuance of 7,500,000 shares of common stock and 700,000 common stock purchase warrants of the Company, and (b) all of the outstanding common stock of Milcap in exchange for the issuance of 7,000,000 shares $4.00 series A convertible preferred stock and 175,000 common stock purchase warrants of the Company. Generally accepted accounting principles require that the Company be considered the acquired company for financial statement purposes (a reverse acquisition) even though the entity will continue to be called Private Media Group, Inc. Therefore, the acquisition has been recorded as a recapitilization of Cine Craft and Milcap. The effects of the reverse acquisition have been reflected for all share amounts in the accompanying financial statements. The Company had no operations at the time of the reverse acquisition. The shares issued in the reverse acquisition represent the outstanding shares of the Company at the date of the reverse acquisition. F-9 PRIVATE MEDIA GROUP, INC. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS 4. Trade Accounts Receivable Trade accounts receivable consist of the following:
December 31, 1998 ---------------- SEK (in thousands) Trade accounts receivable.......................................... 57,314 Allowance for doubtful accounts.................................... (1,664) ------ Total trade accounts receivable................................... 55,650 ======
5. Inventories Inventories consist of the following:
December 31, 1998 ---------------- SEK (in thousands) Magazines.......................................................... 17,826 Video cassettes.................................................... 10,558 Other.............................................................. 2,505 ------ 30,888 ======
6. Other Assets Included in other assets at December 31, 1998, is an amount of SEK 14,784 thousand representing an investment in certain land and building. F-10 PRIVATE MEDIA GROUP, INC. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS 7. Library of photographs & videos Library of photographs & videos consist of the following:
December 31, 1998 ---------------- SEK (in thousands) Gross: Photographs........................................................ 27,569 Videos............................................................. 112,175 Translations, Sound Dubbing, & Sub-Titles for Video Library........ 24,359 ------- 164,103 ======= Less accumulated depreciation: Photographs........................................................ 18,494 Videos............................................................. 55,356 Translations, Sound Dubbing, & Sub-Titles for Video Library........ 10,689 ------- 84,539 ======= Net: Photographs........................................................ 9,075 Videos............................................................. 56,819 Translations, Sound Dubbing, & Sub-Titles for Video Library........ 13,670 ------- 79,564 =======
8. Property, Plant and Equipment Property, plant and equipment consist of the following:
December 31, 1998 ---------------- SEK (in thousands) Equipment & Furniture.............................................. 15,288 Accumulated Depreciation........................................... (5,742) ------ Total Property, Plant and Equipment, net........................... 9,546 ======
9. Short-term Borrowings The Company's Swedish subsidiary has a line of credit amounting to SEK 1,000 thousand. Use of the credit facility is charged at 9.50%, which is equal to the Swedish banks' current official interest rate, and which was the rate of interest on outstanding borrowings at December 31, 1998. The renewal date of the facility is every calendar quarter. The line of credit is guaranteed by the Company's principal shareholder. The F-11 PRIVATE MEDIA GROUP, INC. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS Company pays an annual facility fee of 2.00% on the line of credit amount. At December 31, 1998 borrowings under the line of credit was SEK 330 thousand. The Company's Swedish subsidiary also has a SEK 1,000 thousand short term loan due for repayment at April 30, 1999. Interest on the loan is 9.25%. The Company's Spanish subsidiary has a line of credit amounting to SEK 568 thousand. Use of the credit facility was charged at an average of 6.00% during 1998. At December 31, 1998 the borrowings under the line of credit of SEK was 290 thousand. The Company's Spanish subsidiary also has a SEK 182 thousand short term loan. Interest on the loan is 7.71%. 10. Accrued Other Liabilities Accrued other liabilities is comprised of the following:
December 31, 1998 ---------------- SEK (in thousands) Accrued taxes......................................... 955 Deposits.............................................. 161 Accrued salaries...................................... 23 Accrued expenses...................................... 6,161 Vacation pay.......................................... 151 Social security....................................... 392 Other................................................. 898 ----- 8,741 =====
11. Income Tax Pretax income (loss) for the years ended December 31, 1997 and 1998 was taxed in the following jurisdictions:
December 31, ------------------------ 1997 1998 ---------- ---------- (SEK in thousands) USA............................................ - (1,366) Gibraltar...................................... 41,100 37,232 Cyprus......................................... 1,184 1,424 Sweden......................................... (4,606) 2,260 Spain.......................................... (2,784) 1,565 France......................................... - 388 Other.......................................... 41 (48) ------ ------ 34,935 41,455 ====== ======
F-12 PRIVATE MEDIA GROUP, INC. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS The components of the provision for income tax (benefit) are as follows:
December 31, ---------------------------- 1997 1998 ----------- ----------- (SEK in thousands) Current Cyprus........................................... 62 65 Sweden........................................... 230 242 Spain............................................ 456 746 France........................................... - 14 Deferred Sweden........................................... (1,509) 378 Spain............................................ (1,291) - ------ ----- (2,052) 1,445 ====== =====
The Company's deferred tax liabilities relate principally to inventory. A reconciliation of income taxes determined using the Swedish statutory rate of 28% to actual income taxes provided is as follows:
December 31, -------------------------------- 1997 1998 ---------- ---------- (SEK in thousands) Income tax expenses at statutory rates.............. 9,781 11,607 Income in Gibraltar not subject to tax.............. (11,508) (10,424) Foreign tax rate differential....................... (479) (133) Losses for which no tax benefit was recorded........ - 396 Other, net.......................................... 154 (1) ------- ------- Income tax (benefit) provided....................... (2,052) 1,445 ======= =======
12. Related Party Transactions The Company has short term loans receivable of SEK 4,946 thousand at December 31, 1998. The loans bear interest at a rate of 10% payable annually and are due from entities controlled by the Company's principal shareholder. The current balance including accrued interest amounts to SEK 5,178 thousand at December 31, 1998 F-13 PRIVATE MEDIA GROUP, INC. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS The Company has long term borrowings of SEK 394 thousand at December 31, 1998. The borrowings bear interest at a rate of 10% payable annually and are due to entities controlled by the Company's principal shareholder. The borrowings have no maturity date. 13. Shareholders' Equity Retained earnings The Company is a holding company with no operations of its own. Accordingly, the retained earnings of the Company represent the accumulated earnings of its foreign subsidiaries, principally Cine Craft Ltd. The ability of the Company to pay dividends is dependent on the transfer of accumulated earnings from these subsidiaries. The Company is not currently aware of any significant restrictions that would inhibit its ability to pay dividends should it choose to do so, although the Company's current intention is to re-invest the unremitted earnings of its foreign subsidiaries. Common stock The Company is authorized to issue 50,000,000 shares of common stock. Holders of common stock are entitled to one vote per share. The common stock is not redeemable and has no conversion or pre-emptive rights. Preferred stock The Company is authorized to issue 10,000,000 shares of preferred stock with relative rights, preferences and limitations determined at the time of issuance. The Company has issued 7,000,000 shares of $4.00 Series A convertible Preferred stock. The Series A stock is non-voting and provides for a 5% annual stock dividend beginning in 1998 to be paid quarterly in common stock at the average closing price of the Company's common stock for the twenty consecutive days prior to the quarterly record date. Each preferred share is convertible at any time into common shares on a one for one basis. Additionally, at any time the common stock of the Company has a closing price of less than $4.00 per share for twenty consecutive days the preferred stock may be converted at the option of the holder thereof into common stock at a 20% discount to the five day average closing price prior to the date of conversion. 59,049 shares of common stock will be distributed in 1999 with respect to 1998 stock dividends. This amount is shown in shareholders' equity under stock dividend to be distributed. F-14 PRIVATE MEDIA GROUP, INC. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS Common stock warrants The Company has issued 875,000 common stock warrants which are exercisable at any time by the holder thereof until December 31, 2000 at an exercise price of $4.00 per share. During the year ended December 31, 1998, 50,000 warrants were exercised. 14. Earnings per Share The following table sets forth the computation of basic and diluted earnings per share:
Years ended December 31, ----------------------------- 1997 1998 ---------- ---------- Numerator: Net income (SEK in thousands) 36,987 40,010 ========== ========== Denominator: Denominator for basic earnings per share 7,500,000 7,790,835 - Weighted average shares Effect of dilutive securities: Preferred stock 7,000,000 7,000,000 Common stock warrants 712,888 523,878 Stock dividends to be distributed - 59,049 ---------- ---------- Denominator for diluted earnings per share - weighted average shares and assumed conversions 15,212,882 15,373,761 ========== ========== Earnings per share (SEK) Basic 4.93 5.14 ========== ========== Diluted 2.43 2.60 ========== ==========
F-15 PRIVATE MEDIA GROUP, INC. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS 15. Commitments and Contingent Liabilities The Company leases certain property and equipment under operating leases. The rental payments under these leases are charged to operations as incurred. Rental expense for the years ended December 31, 1997 and 1998 amounted to SEK 1,485 thousand and SEK 2,251 thousand, respectively. Future minimum payments under non-cancelable leases as of December 31, 1998 are as follows:
Year (SEK in thousands) ------------ ------------------- 1999 2,714 2000 2,221 2001 1,915 2002 1,485 2003 559 2004 30 Thereafter 0
Management is not aware of any matters that could give rise to any material liability to the Company that would have a material adverse effect on the Company's financial condition or results of operations. 16. Operations by Geographical Area The Company operates in one business segment, which is the acquisition, refinement and distribution of video and photo rights for adult feature magazines and movies. Information concerning the Company's geographic locations is summarized as follows:
December 31, --------------------------------- 1997 1998 ------------ ------------ Net Sales (SEK in thousands) USA.............................................. - - Gibraltar........................................ 41,100 37,000 Cyprus........................................... 62,410 63,317 Sweden........................................... 120,281 117,635 Spain............................................ 42,800 116,060 France........................................... - 12,027 Eliminations..................................... (122,048) (180,935) -------- -------- Total............................................... 144,543 165,104 ======== ========
Eliminations principally relates to revenue arising from trademark, license and distribution agreements between the Gibraltar, Cyprus, Sweden and Spain companies. F-16 PRIVATE MEDIA GROUP, INC. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
December 31, --------------------------------- 1997 1998 ---------- ---------- (SEK in thousands) Operating profit USA......................................... - (1,366) Gibraltar................................... 41,100 37,000 Cyprus...................................... 1,227 1,423 Sweden...................................... (4,427) 2,066 Spain....................................... (2,653) 1,884 France...................................... - 509 Other....................................... (60) (48) ------ ------- Total....................................... 35,187 41,468 Interest income (expense), net.............. (252) (14) ------ ------- Income before income taxes.................. 34,935 41,455 ====== ======= Long-lived assets USA......................................... - - Gibraltar................................... - - Cyprus...................................... 65,097 76,809 Sweden...................................... 14,208 15,225 Spain....................................... 7,256 11,531 France...................................... - 1,801 Other....................................... 126 137 ------ ------- Total....................................... 86,687 105,503 ====== =======
Export sales from Sweden to unaffiliated customers amounted to SEK 102.8 million and SEK 96.7 million for the years ended December 31, 1997 and 1998, respectively. Export sales from Spain to unaffiliated customers amounted to SEK 6.4 million and SEK 46.5 million for the years ended December 31, 1997 and 1998, respectively. Export sales from other geographic areas are insignificant. 17. Advertising Costs The total advertising costs were SEK 1,156 thousand and SEK 3,391 thousand for the years ended December 31, 1997 and 1998, respectively. 18. Recent Pronouncements In June 1998, the FASB issued Statement No. 133, Accounting for Derivitive Instruments and for Hedging Activities. Statement No. 133 is effective for fiscal years beginning after June 15, 1999. Statement No. 133 will not affect the Company as it does not enter into derivitive or hedging activities. F-17 EX-3.2 2 AMENDED AND RESTATED BYLAWS EXHIBIT 3.2 BY-LAWS OF PRIVATE MEDIA GROUP, INC. ARTICLE I. REGISTERED OFFICE. ----------------- The registered office shall be at 3230 Flamingo Rd. Suite 156, Las Vegas, Nevada 89121 or at such other location as the Board of director may determine. Private Media Group, Inc. (hereinafter called the "Corporation") may also have offices at such other places both within or without State of Nevada as the Board of Directors may from time to time determine or the business of the Corporation may require. ARTICLE II. FISCAL YEAR. ----------- The fiscal year of the Corporation shall end on the last day of December, of each year unless another date shall be fixed by resolution of the Board of Directors. After such date is fixed, it may be changed for future fiscal years at any time by further resolution of the Board of Directors. ARTICLE III. MEETING OF SHAREHOLDERS. ----------------------- 1. Meetings. -------- All meetings of the shareholders for the election of Directors shall either be by waiver of notice and consent or shall be held at such place either within or without State of Nevada as shall be designated from time to time by the Board of Directors and stated in the notice of the meeting. 2. Annual Meetings. --------------- Annual meetings of shareholders may be held by waiver of notice and consent or shall be held on such date an time as shall be designated from time to time by the Board of Directors and stated in the notice of the meeting; at which meeting the shareholders shall elect, either in person or by proxy, by a plurality vote a Board of Directors and transact such other business as may properly be brought before the meeting. 3. Special Meetings. ---------------- Special meetings of the shareholders, for any purpose or purposes, may be held by waiver of notice and consent or may be called by the President and shall be called by the President or Secretary at the request in writing of any two (2) of the Board of Directors, or at the request in writing of shareholders owning not less than ten (10%) percent of the entire common stock of the Corporation issued and outstanding and entitled to vote. -Page 1- 4. Notice. ------ When required by law, written notice of a special meeting stating the place, date and hour of the meeting and the purpose or purposes for which the meeting is called shall be given not less than ten (10) nor more than sixty (60) days before the date of the meeting, to each shareholder entitled to vote at such meeting. 5. Notice of Specific Purpose. -------------------------- Business transacted at a special meeting shall not be limited to the purpose stated in the notice so long as not more than forty (40%) percent of the shareholders present do not object to the consideration of such business. 6. Quorum. ------ Except as otherwise provided by statute or by the Articles of Incorporation, the holders of fifty (50%) percent of the shares issued and outstanding and entitled to vote at such meeting, present in person or represented by proxy, shall constitute a quorum at all meetings of the shareholders for the transaction of business. If, however, such quorum shall not be present or represented at any meeting of the shareholders, the shareholders entitled to vote at such meeting, present in person or represented by proxy, shall have power to adjourn the meeting from time to time, without notice other than announcement at the meeting, until a quorum shall be present or represented. Such adjourned meeting at which a quorum shall be present or represented shall constitute the meeting as originally notified. If the adjournment is for more than sixty (60) days, or if after the adjournment a new record date is fixed for the adjourned meeting, a notice of the adjourned meeting shall be given to each shareholder of record entitled to vote at the meeting. 7. Voting Percentage. ----------------- When a quorum is present at any meeting, the vote of the holders of a majority of the shares having the power present in person or represented by proxy shall decide any question brought before such meeting, unless the question is one upon which, by express provision of the statutes or of the Articles of Incorporation or of these By-Laws, a different vote is required, in which case such express provision shall govern and control the necessary vote for such question. 8. Voting List. ------------ The officer who has charge of the stock ledger of the Corporation shall prepare and make, at least ten (10) days before every meeting of shareholders, a complete list of the shareholders entitled to vote at the meeting, arranged in alphabetical order, and showing the address of each shareholder and the number of shares registered in the name of each shareholder. Such list shall be open to the examination of any shareholder for any purpose germane to the meeting, during the ordinary business hours, for a period of at least ten (10) days prior to the meeting, either at a place within the city where the meeting is to be held, which place shall be specified in the notice of the meeting, or, if not so specified, at the place where the meeting is to be held. The list shall also be produced and kept at the time and place of the meeting during the whole time thereof, and may be inspected by any shareholder who is present. -Page 2- 9. Votes Per Share and Proxies. --------------------------- Each shareholder shall be entitled to one vote in person or by proxy for each share of common stock having voting power held by such shareholder, but no proxy shall be voted on after three (3) months from its date, unless the proxy provides for a longer period. ARTICLE IV. DIRECTORS. --------- 1. Number. ------ The number of Directors which shall constitute the whole Board shall consist of not less than three (3) nor more than nine (9) Directors. The Directors shall be elected at the annual meeting of the shareholders, except as provided in Paragraph 2 of this Article. Each Director elected shall hold office until his successor is elected and qualified or until he is removed pursuant to statute. Directors need not be shareholders. 2. Vacancies. --------- Vacancies and newly created directorships resulting from any increase in the authorized number of Directors may be filled by a majority of the Directors then in office, though less than a quorum, or by a sole remaining Director. The Director so chosen shall hold office until the next annual election and until his successor is duly elected and shall qualify, unless sooner displaced. If there are no Directors in office, then an election of Directors shall be held in the manner provided by statute. 3. Powers. ------ The business of the Corporation shall be managed by its Board of Directors which may exercise all such powers of the Corporation and do all such lawful acts and things as are not by statute or by the Articles of Incorporation directed or required to be exercised or done by the shareholders. 4. Place of Meetings. ----------------- The Board of Directors of the Corporation may hold meetings, both regular and special, either within or without the State of Nevada. 5. First Meeting. ------------- The first meeting of each newly elected Board of Directors shall be held at such time and place as shall be fixed by the vote of the shareholders at the annual meeting and no notice of such meeting shall be necessary to the newly elected Directors in order legally to constitute the meeting, provided a quorum shall be present. In the event of the failure of the shareholders to fix the time or place of such first meeting of the newly elected Board of Directors, or in the event such meeting is not held at the time and place so fixed by the shareholders, the meeting may be held at such time an place as shall be specified in a notice given as hereinafter provided for special meetings of the Board of Directors, or as shall be specified in a written waiver signed by all of the Directors. -Page 3- 6. Regular Meetings. ---------------- Regular meetings of the Board of Directors may be held without notice at such time and at such place as shall from time to time be determined by the Board. 7. Special Meetings. ---------------- Special meetings of the Board may be called by the President on three day's notice to each Director, either personally or by mail or by telegram; special meetings shall be called by the President or Secretary in like manner and on like notice on the written request by two (2) Directors. 8. Quorum. ------ At all meetings of the Board, a majority of the Directors shall constitute a quorum for the transaction of business and the act of a majority of the Directors present at any meeting at which there is a quorum shall be the act of the Board of Directors, except as may be otherwise specifically provided by statute or by the Articles of Incorporation. If a quorum shall not be present at any meeting of the Board of Directors, the Directors present at such meeting may adjourn the meeting from time to time, without notice other than announcement at the meeting, until a quorum shall be present. 9. Consent Meetings. ---------------- Any action required or permitted to be taken at any meeting of the Board of Directors may be taken without a meeting, if all members of the Board or committee consent thereto in writing, and the writing or writings are filed with the minutes of the Board. 10. General Authorization of Board's Authority to Issue --------------------------------------------------- Stock. ----- The Board of Directors may issue, from time to time and in its discretion, any stock authorized by the Articles of Incorporation to be issued by the Corporation. ARTICLE V. NOTICES. ------- Whenever, under the provisions of the statutes or of the Articles of Incorporation or of these By-Laws, notice is required to be given to any Director or shareholder, it shall not be construed to require personal notice unless specifically stated. Rather such notice may be given in writing, by mail, addressed to such Director or shareholder, at his address as it appears on the records of the Corporation, with postage thereon prepaid, and such notice shall be deemed to be given at the time when the same shall be deposited in the United States mail. Notice to Directors may also be given by telegram, fascimile, or email. Whenever any notice is required to be given under the provisions of the statutes or of the Articles of Incorporation or of these By-Laws, a waiver thereof in writing, signed by the person or persons entitled to said notice, whether before or after the time stated therein, shall be deemed equivalent to such notice. -Page 4- ARTICLE VI. OFFICERS. -------- 1. Officers. -------- The Board of Directors, within twenty-one (21) days after the annual election of the Directors in each year, shall elect a President, a Secretary, and a Treasurer, who need not be members of the Board and who need not be shareholders. The Board at that time or from time to time may, in addition, elect a Chief Marketing Officer, Chief Operating Officer, Chief Financial Officer and more than one Vice-Presidents, Assistant Secretaries and Assistant Treasurers who may or may not be members of the Board. The same person may hold any two or more offices. The Board may also appoint such other Officers and agents as it may deem necessary for the transaction of the business of the Corporation. 2. Terms. ----- The term of office of all Officers shall be one year or until their respective successors are chosen, but any Officer may be removed from office, with or without cause, at any meeting of the Board of Directors by the affirmative vote of a majority of the Directors then in office. The Board of Directors shall have power to fill any vacancies in any offices occurring from whatever reason. 3. Salaries. -------- The salaries and other compensation of all Officers of the Corporation shall be fixed by the Board of Directors. 4. President. --------- The President shall be the chief executive officer of the Corporation and shall have the responsibility for the general and active management of the business of the Corporation, and shall see that all orders and resolutions of the Board are carried into effect. He shall execute all authorized conveyances, contracts, or other obligations in the name of the Corporation except where the signing and execution thereof shall be expressly delegated by the Board of Directors to some other officer or agent of the Corporation. He shall preside at all meetings of the shareholders and, if not a member of the Board of Directors, shall nonetheless receive notice of all meetings of the Board of Directors and shall be ex-officio a member of the Board of Directors and all standing committees of the Board of Directors. 5. Vice-President(s). ----------------- The Vice-Presidents in the order designated by the Board of Directors or, lacking such a designation, by the President, shall in the absence or disability of the President perform the duties and exercise the powers of the President and shall perform such other duties as the Board of Directors shall prescribe. 6. Secretary. --------- The Secretary shall attend all meetings of the shareholders and record all votes and the minutes of all proceedings in a book to be kept for that purpose and shall perform like duties for the Board of Directors and the standing committees when required. He shall give, or cause to be given, notice of all meetings of the shareholders and shall perform such other duties as may be prescribed by the Board of Directors of by the President, under whose supervision he shall act. He may execute all authorized conveyances, contracts or other obligations in the name of the Corporation except as otherwise directed by the Board of Directors. -Page 5- He shall keep in safe custody the seal of the Corporation and, when authorized by the Board, affix the same to any instrument requiring it and, when so affixed, it shall be attested by his signature or by the signature of the Treasurer or an Assistant Secretary. The Secretary shall keep a register of the address of each shareholder. Said address shall be furnished to the Secretary by such shareholder and the responsibility for keeping said address current shall be upon the shareholder. The Secretary shall have general charge of the stock transfer books of the Corporation. 7. Treasurer. --------- The Treasurer shall have custody of and keep account of all money, funds and property of the Corporation, unless otherwise determined by the Board of Directors, and he shall render such accounts and present such statements to the Directors and President as may be required of him. He shall deposit funds of the Corporation which may come into his hands in such bank or banks as the Board of Directors may designate. He shall keep his bank accounts in the name of the Corporation and shall exhibit his books and accounts at all reasonable times to any Director of the Corporation, upon application, at the office of the Corporation during business hours. If required by the Board of Directors, he shall give the Corporation a bond in such sum and with such surety or sureties as shall be satisfactory to the Board for faithful performance of the duties of his office and for the restoration to the Corporation in case of his death, resignation or removal from office of all books, papers, vouchers, money and other property of whatever kind in his possession or under his control belonging to the Corporation. 8. Assistants. ---------- The Assistant Secretaries and the Assistant Treasurers, if any, respectively, in the absence of the Secretary or the Treasurer, as the case may be, shall perform the duties and exercise the powers of such Secretary or Treasurer and shall perform such other duties as the Board of Directors shall prescribe. 9. Chief Operating Officer. ----------------------- The Chief Operating Officer, if appointed, shall perform all duties required in the day to day operations of the Company, as directed by the President and will report directly to the President. These duties may include, but not be limited to, hiring and firing of personnel, selection of vendors, overseeing the employees involved in the production of the Company's products, and the performance of all other duties necessary to the day to day activities of the Company. 10. Chief Financial Officer. ------------------------ The Chief Financial Officer, if appointed, will perform all financial duties as directed by the treasurer, prepare such reports as to the finances of the Company as may be required by the Board or the Treasurer, prepare such budgets and projections as required by the Board or the Treasurer, and provide all necessary services for the day to day finances of the Company. In addition, in the event no Treasurer has been appointed or during any periods of absence of the Treasurer, he shall exercise all duties of the Treasurer and assume all authority of the Treasurer. -Page 6- 11. Chief Marketing Officer. ----------------------- The Chief Marketing Officer, if appointed, shall be responsible for all day to day activities related to the marketing of the Company's products as directed by the President and the Board. He shall participate in the development of all marketing campaigns, be integrally involved in any joint venture involving marketing, and be a part of the contact group for any new product development. ARTICLE VII. CERTIFICATES. ------------ 1. Lost Certificates. ----------------- The Board of Directors may direct a new certificate or certificates to be issued in place of any certificate or certificates theretofore issued by the Corporation alleged to have been lost, stolen or destroyed, upon the making of an affidavit of that fact by the person claiming the certificate of shares to be lost, stolen or destroyed. When authorizing such issue of a new certificate or certificates, the Board of Directors may, in its discretion and as a condition precedent to the issuance thereof, require the owner of such lost, stolen or destroyed certificate or certificates, or his legal representative, to advertise the same in such manner as it shall require and/or to give the Corporation a bond in such sum as it may direct as indemnity against any claim that may be made against the Corporation with respect to the certificate alleged to have been lost, stolen or destroyed. 2. Surrender. --------- Upon surrender to the Corporation of a certificate for shares duly endorsed or accompanied by proper evidence of succession, assignment or authority to transfer, it shall be the duty of the Corporation to issue a new certificate to the person entitled thereto, cancel the old certificate and record the transaction upon its books. 3. Record Date. ----------- In order that the Corporation may determine the shareholders entitled to notice of or to vote at any meeting of shareholders or any adjournment thereof, or to express consent to corporate action in writing without a meeting, or entitled to receive payment of any dividend or other distribution or allotment of any rights, or entitled to exercise any rights in respect of any change, conversion or exchange of stock or for the purpose of any other lawful action, the Board of Directors may fix, in advance, a record date, which shall not be more than sixty (60) days nor less than ten (10) days before the date of such meeting, nor more than sixty (60) days prior to any other action. A determination of shareholders of record entitled to notice of or to vote at a meeting of shareholders shall apply to any adjournment of the meeting; provided, however, that the Board of Directors may fix a new record date for the adjourned meeting. Absent Board of Directors action, the record date shall be ten (10) days before the date of such meeting. 4. Voting. ------ The Corporation shall be entitled to recognize the exclusive right of a person registered on its books as the owner of shares to receive dividends, and to vote as such owner, a person registered on its books as the owner of shares, and shall not be bound to recognize any equitable or other claim to interest in such share -Page 7- or shares on the part of any other person, whether or not it shall have express or other notice thereof, except as otherwise provided by the laws of the State of Nevada. ARTICLE VIII. NONAPPLICABILITY OF NRS 78.378 THROUGH 78.3793 AS AMENDED. --------------------------------------------------------- The provisions of NRS 78.378 through 78.3793 entitled "Acquisition of Controlling Interest" shall not apply to this corporation and shall have no force or effect on the activities of this corporation or its shareholders. ARTICLE IX. AMENDMENTS ---------- These By-Laws may be altered, amended or repealed or new By-Laws may be adopted by the shareholders or by the Board of Directors at any regular meeting of the shareholders or of the Board of Directors or at any special meeting of the shareholders or of the Board of Directors if notice of such alteration, amendment, repeal or adoption of new By-Laws be contained in the notice of such special meeting. - --------------------------------- Secretary -Page 8- EX-10.11 3 1999 EMPLOYEE STOCK OPTION PLAN EXHIBIT 10.11 PRIVATE MEDIA GROUP, INC. 1999 EMPLOYEE STOCK OPTION PLAN 1. Purpose. ------- This Employee Stock Option Plan (the "Plan") is intended to allow designated employees, executive officers, directors, consultants, advisors and other corporate and divisional officers (all of whom are sometimes collectively referred to herein as "Employees") of Private Media Group, Inc., a Nevada corporation ("Private"), and its subsidiaries which it may have from time to time (Private and such subsidiaries being together referred to herein as the "Company") to receive certain options ("Stock Options") to purchase Private's common stock, $.001 par value ("Common Stock"), as herein provided. The purpose of the Plan is to provide Employees with additional incentives to make significant and extraordinary contributions to the long-term performance and growth of the Company and to attract and retain Employees of exceptional ability. 2. Administration. -------------- (a) The Plan shall be administered by a Committee of three or more persons ("Committee") established by the Board of Directors of Private (the "Board") from time to time, which may consist of the Compensation Committee, the full Board of Directors or such persons as the Board shall designate. A majority of its members shall constitute a quorum. The Committee shall be governed by the provisions of Private's By-Laws and of Nevada law applicable to the Board, except as otherwise provided herein or determined by the Board. (b) The Committee shall have full and complete authority, in its discretion, but subject to the express provisions of the Plan: to approve the Employees nominated by the management of the Company to be granted Stock Options; to determine the number of Stock Options to be granted to an Employee; to determine the time or times at which Stock Options shall be granted; to establish the terms and conditions upon which Stock Options may be exercised; to remove or adjust any restrictions and conditions upon Stock Options; to specify, at the time of grant, provisions relating to the exercisability of Stock Options and to accelerate or otherwise modify the exercisability of any Stock Options; and to adopt such rules and regulations and to make all other determinations deemed necessary or desirable for the administration of the Plan. All interpretations and constructions of the Plan by the Committee, and all of its actions hereunder, shall be binding and conclusive on all persons for all purposes. (c) The Company hereby agrees to indemnify and hold harmless each Committee member and each employee of the Company, and the estate and heirs of such Committee member or employee, against all claims, liabilities, expenses, penalties, damages or other pecuniary losses, including legal fees, which such Committee member or employee or his or her estate or heirs may suffer as a result of his or her responsibilities, obligations or duties in connection with the Plan, to the extent that insurance, if any, does not cover the payment of such items. 3. Eligibility and Participation. ----------------------------- Employees eligible under the Plan shall be approved by the Committee from those Employees who, in the opinion of the management of the Company, are in positions which enable them to make significant and extraordinary contributions to the long-term performance and growth of the Company. In selecting Employees to whom Stock Options may be granted, consideration shall be given to factors such as employment position, duties and responsibilities, ability, productivity, length of service, morale, interest in the Company and recommendations of supervisors. 4. Grants. ------ The Committee may grant Stock Options in such amounts, at such times, and to such Employees nominated by the management of the Company as the Committee, in its discretion, may determine. Stock Options granted under the Plan shall constitute non-statutory stock options. Subject to the provisions of paragraph 11 hereof, the number of shares of Common Stock issued and issuable pursuant to the exercise of Stock Options granted hereunder shall not exceed One Million Two Hundred Thousand (1,200,000). Each Stock Option shall be evidenced by a written agreement (the "Option Agreement") in a form approved by the Committee, which shall be executed on behalf of the Company and by the Employee to whom the Stock Option is granted. If a Stock Option expires, terminates or is cancelled for any reason without having been exercised in full, the shares of Common Stock not purchased thereunder shall again be available for purposes of the Plan. 5. Purchase Price. -------------- The purchase price (the "Exercise Price") of shares of Common Stock subject to each Stock Option ("Option Shares") shall be determined by the Committee at the time of the grant of the Stock Option and shall be equal to or greater than the fair market value ("Fair Market Value") of such shares on the date of grant of such Stock Option (which date of grant may be the date the Committee approves the issuance of the Stock Option or such later date or dates as the Committee may specify. The Fair Market Value of a share of Common Stock on any date shall be equal to the closing bid price of the Common Stock for the last preceding day on which Private's shares were traded, and the method for determining the closing bid price shall be determined by the Committee. 6. Option Period. ------------- The Stock Option period (the "Term") shall commence on the date of grant of the Stock Option and shall be five (5) years or such shorter period as is determined by the Committee. Notwithstanding the foregoing, but subject to the provisions of paragraphs 2(b) and 11(c), Stock Options granted to Employees who are subject to the reporting requirements of Section 16(a) of the U.S. Securities Exchange Act of 1934 ("Section 16 Reporting Persons") shall not be exercisable until at least six months and one day from the date the Stock Option is granted, or, if later, from the date of stockholder approval of the Plan. If an Employee shall not in any period -2- purchase all of the Option Shares which the Employee is entitled to purchase in such period, the Employee may purchase all or any part of such Option Shares at any time prior to the expiration of the Stock Option. 7. Exercise of Options. ------------------- (a) Each Stock Option may be exercised in whole or in part (but not as to fractional shares) by delivering it for surrender or endorsement to the Company, attention of the Corporate Secretary, at the principal office of the Company, together with payment of the Exercise Price and an executed Notice and Agreement of Exercise in the form prescribed by paragraph 7(b). Payment may be made in cash, by cashier's or certified check. (b) The exercise of each Stock Option is conditioned upon the agreement of the Employee to the terms and conditions of this Plan and of such Stock Option as evidenced by the Employee's execution and delivery of a Notice and Agreement of Exercise in a form to be determined by the Committee in its discretion. Such Notice and Agreement of Exercise shall set forth the agreement of the Employee that: (a) no Option Shares will be sold or otherwise distributed in violation of the Securities Act of 1933 (the "Securities Act") or any other applicable federal or state securities laws, (b) each Option Share certificate may be imprinted with legends reflecting any applicable federal and state securities law restrictions and conditions, (c) the Company may comply with said securities law restrictions and issue "stop transfer" instructions to its Transfer Agent and Registrar without liability, (d) if the Employee is a Section 16 Reporting Person, the Employee will furnish to the Company a copy of each Form 4 or Form 5 filed by said Employee and will timely file all reports required under federal securities laws, and (e) the Employee will report all sales of Option Shares to the Company in writing on a form prescribed by the Company. (b) No Stock Option shall be exercisable unless and until any applicable registration or qualification requirements of federal and state securities laws, and all other legal requirements, have been fully complied with The Company will use reasonable efforts to maintain the effectiveness of a Registration Statement under the Securities Act for the issuance of Stock Options and shares acquired thereunder, but there may be times when no such Registration Statement will be currently effective. The exercise of Stock Options may be temporarily suspended without liability to the Company during times when no such Registration Statement is currently effective, or during times when, in the reasonable opinion of the Committee, such suspension is necessary to preclude violation of any requirements of applicable law or regulatory bodies having jurisdiction over the Company. If any Stock Option would expire for any reason, then if the exercise of such Stock Option is duly tendered before its expiration, such Stock Option shall be exercisable and exercised (unless the attempted exercise is withdrawn) as of the first day after the end of such suspension. The Company shall have no obligation to file any Registration Statement covering resales of Option Shares. -3- 8. Continuous Employment. --------------------- Except as provided in paragraph 10 below or unless otherwise provided by the Committee, an Employee may not exercise a Stock Option unless from the date of grant to the date of exercise such Employee remains continuously in the employ of the Company. For purposes of this paragraph 8, the period of continuous employment of an Employee with the Company shall be deemed to include (without extending the term of the Stock Option) any period during which such Employee is on leave of absence with the consent of the Company, provided that such leave of absence shall not exceed three (3) months and that such Employee returns to the employ of the Company at the expiration of such leave of absence. If such Employee fails to return to the employ of the Company at the expiration of such leave of absence, such Employee's employment with the Company shall be deemed terminated as of the date such leave of absence commenced. The continuous employment of an Employee with the Company shall also be deemed to include any period during which such Employee is a member of the military, provided that such Employee returns to the employ of the Company within ninety (90) days (or such longer period as may be prescribed by law) from the date such Employee first becomes entitled to discharge. If an Employee does not return to the employ of the Company within ninety (90) days (or such longer period as may be prescribed by law) from the date such Employee first becomes entitled to discharge, such Employee's employment with the Company shall be deemed to have terminated as of the date such Employee's military service ended. 9. Restrictions on Transfer. ------------------------ Options granted under this Plan shall be transferable only by will or the laws of descent and distribution unless otherwise determined by the Committee at any time at or after the date of grant of the Option, provided such transfer does not conflict with applicable securities laws or render the Company ineligible to use Form S-8 or any successor form to register the Options. No interest of any Employee under the Plan shall be subject to attachment, execution, garnishment, sequestration, the laws of bankruptcy or any other legal or equitable process. Each Stock Option granted under this Plan shall be exercisable during an Employee's lifetime (or in the event of the death of Employee, by his or her legal representative) only by such Employee or such Employee's permitted transferees or legal representative. 10. Termination of Employment. ------------------------- (a) Upon an Employee's Retirement, Disability or death: (a) all Stock Options to the extent then presently exercisable shall remain in full force and effect and may be exercised pursuant to the provisions thereof, including expiration at the end of the fixed term thereof, and (b) unless otherwise provided by the Committee, all Stock Options to the extent not then presently exercisable by such Employee shall terminate as of the date of such termination of employment and shall not be exercisable thereafter. (b) Upon the termination of the employment of an Employee with the Company for any -4- reason other than the reasons set forth in paragraph 10(a) hereof, unless otherwise provided by the Committee, (a) all Stock Options to the extent then presently exercisable by such Employee shall remain exercisable only for a period of ninety (90) days after the date of such termination of employment (except that the ninety (90) day period shall be extended to twelve (12) months if the Employee shall die during such ninety (90) day period), and may be exercised pursuant to the provisions thereof, including expiration at the end of the fixed term thereof, and (b) all Stock Options to the extent not then presently exercisable by such Employee shall terminate as of the date of such termination of employment and shall not be exercisable thereafter. (c) For purposes of this Plan: (i) "Retirement" shall mean an Employee's retirement from the employ of the Company on or after the date on which such Employee attains the age of sixty-five (65) years; and (ii) "Disability" shall mean total and permanent incapacity of an Employee, due to physical impairment or legally established mental incompetence, to perform the usual duties of such Employee's employment with the Company, which disability shall be determined on medical evidence by a licensed physician designated by the Committee. 11. Adjustments Upon Change in Capitalization. ----------------------------------------- (a) The number and class of shares subject to each outstanding Stock Option, the Exercise Price thereof (but not the total price) and the maximum number of Stock Options that may be granted under the Plan shall be proportionately adjusted in the event of any increase or decrease in the number of the issued shares of Common Stock which results from a split-up or consolidation of shares, payment of a stock dividend or dividends exceeding a total of two and one-half percent (2.5%) for which the record dates occur in any one fiscal year, a recapitalization (other than the conversion of convertible securities according to their terms), a combination of shares or other like capital adjustment, so that upon exercise of the Stock Option, the Employee shall receive the number and class of shares such Employee would have received had such Employee been the holder of the number of shares of Common Stock for which the Stock Option is being exercised upon the date of such change or increase or decrease in the number of issued shares of the Company. (b) Upon a reorganization, merger or consolidation of the Company with one or more corporations as a result of which Private is not the surviving corporation or in which Private survives as a wholly-owned subsidiary of another corporation, or upon a sale of all or substantially all of the property of the Company to another corporation, or any dividend or distribution to shareholders of more than ten percent (10%) of the Company's assets, adequate adjustment or other provisions shall be made by the Company or other party to such transaction so that there shall remain and/or be substituted for the Option Shares provided for herein, the shares, securities or assets which would have been issuable or payable in respect of or in exchange for such Option Shares then remaining, as if the Employee had been the owner of such Option Shares as of the applicable date. Any securities so substituted shall be subject to similar successive -5- adjustments. (c) In the sole discretion of the Committee, Stock Options may include provisions, on terms authorized by the Committee in its sole discretion, that accelerate the Employees' rights to exercise Stock Options upon a sale of substantially all of the Company's assets, the dissolution of Private or upon a change in the controlling shareholder interest in Private resulting from a tender offer, reorganization, merger or consolidation or from any other transaction or occurrence, whether or not similar to the foregoing (each, a "Change in Control"). 12. Withholding Taxes. ----------------- The Company shall have the right at the time of exercise of any Stock Option to make adequate provision for any federal, state, local or foreign taxes which it believes are or may be required by law to be withheld with respect to such exercise ("Tax Liability"), to ensure the payment of any such Tax Liability. The Company may provide for the payment of any Tax Liability by any of the following means or a combination of such means, as determined by the Committee in its sole and absolute discretion in the particular case: (i) by requiring the Employee to tender a cash payment to the Company, (ii) by withholding from the Employee's salary, (iii) by withholding from the Option Shares which would otherwise be issuable upon exercise of the Stock Option that number of Option Shares having an aggregate Fair Market Value as of the date the withholding tax obligation arises that is equal to the Employee's Tax Liability or (iv) by any other method deemed appropriate by the Committee. Satisfaction of the Tax Liability of a Section 16 Reporting Person may be made by the method of payment specified in clause (iii) above upon satisfaction of such additional conditions as the Committee shall deem in its sole and absolute discretion as appropriate in order for such withholding of Option Shares to qualify for the exemption provided for in Section 16b-3 of the Exchange Act. 13. Relationship to Other Employee Benefit Plans. -------------------------------------------- Stock Options granted hereunder shall not be deemed to be salary or other compensation to any Employee for purposes of any pension, thrift, profit- sharing, stock purchase or any other employee benefit plan now maintained or hereafter adopted by the Company. 14. Amendments and Termination. -------------------------- The Board of Directors may at any time suspend, amend or terminate this Plan. No amendment or modification of this Plan may be adopted, except subject to shareholder approval, which would: (a) materially increase the benefits accruing to Employees under this Plan, (b) materially increase the number of securities which may be issued under this Plan or (c) materially modify the requirements as to eligibility for participation in the Plan. -6- 15. Successors in Interest. ---------------------- The provisions of this Plan and the actions of the Committee shall be binding upon all heirs, successors and assigns of the Company and of Employees. 16. Other Documents. --------------- All documents prepared, executed or delivered in connection with this Plan shall be, in substance and form, as established and modified by the Committee or by persons under its direction and supervision; provided, however, that all such documents shall be subject in every respect to the provisions of this Plan, and in the event of any conflict between the terms of any such document and this Plan, the provisions of this Plan shall prevail. All Stock Options granted under the Plan shall be evidenced by written agreements executed by the Company and the Employees to whom the Stock Options have been granted. 17. No Obligation to Continue Employment. ------------------------------------ This Plan and grants hereunder shall not impose any obligation on the Company to continue to employ any Employee. Moreover, no provision of this Plan or any document executed or delivered pursuant to this Plan shall be deemed modified in any way by any employment contract between an Employee (or other employee) and the Company. 18. Term of Plan. ------------ This Plan was adopted by the Board effective March 1, 1999. No Stock Options may be granted under this Plan after March 1, 2004. 19. Governing Law. ------------- This Plan shall be construed in accordance with, and governed by, the laws of the State of Nevada. 20. Stockholder Approval. -------------------- No Stock Option shall be exercisable unless and until the stockholders of the Company have approved this Plan and all other legal requirements have been fully complied with. -7- 21. Privileges of Stock Ownership. ----------------------------- The holder of a Stock Option shall not be entitled to the privileges of stock ownership as to any shares of the Company common stock not actually issued to such holder. IN WITNESS WHEREOF, this Plan has been executed effective as of the first day of March, 1999. PRIVATE MEDIA GROUP, INC. By_________________________ Berth Milton, President -8- EX-10.12 4 PRODUCTION AGREEMENT DATED AS OF MARCH 29, 1999 EXHIBIT 10.12 MILCAP MEDIA LIMITED Nicolaou Pentradromos Centre Office 908, Block A P.O. Box 123 Limassol CYPRUS PRODUCTION AGREEMENT THIS AGREEMENT is made and entered into this 29/th/ day of March, 1999, by and between: Of the one party, MILCAP MEDIA LIMITED, with registered address at Nicolaou Pentradromos Centre, Office 908, Block A, P.O. Box 123, Limassol (Cyprus), and correspondence office at Carrerera de Rubi, 22, 08190 Sant Cugat de Valles, Barcelona, Spain. Represented by Claes Henrik Marten Kull. Hereinafter, "MML." Of the other, PIERRE ANDRE GERBIER, artistically known as Pierre Woodman, residing at 35 Quai de Grenelle, Paris 15 eme, with French passport number 75-15-98-183982. Hereinafter "the Director." Correspondence address: Carrerera de Rubi, 22-26, 08190 Sant Cugat de Valles Tf. +34.3.59072.96 -- Fax +34.3.589.54.00 Barcelona, SPAIN WITNESSETH Whereas, MML issues, produces and distributes all around the world, magazines, videos and other audio-visual adult products under different Private Group's labels and brands, and works on the Internet, providing its clients with material under those labels and brands; Whereas, the Director is an independent producer, who produces and works in the production, as Director, of adult films, audio-visuals and additional adult material, and is interested in working for MML, for its products to be distributed under the Private Group's labels and brands. NOW, THEREFORE, in consideration of the mutual covenants and undertakings set forth herein, both Parties agree as follows: 1. Co-Operation. ------------ Both Parties agree that Pierre Gerbier is going to work for the Private Group, producing video and photographic productions, to be used under any format for distribution all around the world through any media, even the Internet, and for promotional activities, during the period of two years from April the 1/st/, 1999, to April the 1/st/, 2001. -1- The productions done by the Director as per this Agreement will be six per year of each label Private Gold in two versions hard and soft-, and Private Casting by Pierre Woodman-, in one version hard-, and will be done and delivered to MML according to Attachment I and Attachment II "Technical Specification" to this Agreement. Although the co-operation hereby agreed would not be exclusive, the Director will promote only Private production, and his image but not his name, will only be linked to Private and the production under this label, during the whole period of this Agreement. Therefore, the Director hereby warrants that [he] is not bound by any other contract or otherwise to any other company or studio, during the period above- mentioned, for promotional and advertising activities of any kind related to the adult industry, and is free to grant herein to MML, the sole and exclusive right to use his productions obtained in execution of the contract. The Director hereby warrants that the productions related to this Agreement will be in a similar level of quality and contents that the one done previously by Pierre Woodman for MML. MML warrants that his artistic name PIERRE WOODMAN will appear on the cover of the above-mentioned titles. The Director warrants that [he] shall provide MML with all the Model releases and additional documentation regarding performers required by MML and commonly used in its productions. The Director warrants that [he] is not going to work with actors under the age of 18 years old and the productions will not contain crud immoral contents (i.e. buggery, glorification of violence, or pornography with infants or animals). The Director shall inform MML in writing of any and all the productions done during the validity period of this contract, different from the ones hereby agreed. MML shall have first refusal rights regarding any other adult productions done by Pierre Gerbier during the period mentioned in paragraph 1, point 1, hereby. 2. Remuneration. ------------ MML shall pay to the Director per each production the price agreed in Attachments I and II "Technical Specifications" to this Agreement. This payment shall grant to MML the whole and entire rights over the productions. MML shall not pay any additional fee, as the delivery of masters and traveling expenses to MML or related companies offices are included in the agreed fees. The above mentioned amounts per production will be invoiced to MML and paid to the Director according to the following schedule: 70% of the total amount at the date of the starting of the shooting, the additional 30%, once the edited masters and agreed additional material has been delivered to MML in suitable technical conditions. The Director shall provide MML with the name and address of its bank and the number of accounts. 3. Licence of Rights: ----------------- Pierre Gerbier hereby irrevocably grants and assigns to MML, the sole and exclusive right, license and privilege to exhibit, distribute, market, transmit, perform and otherwise deal in and exploit the productions, all around the world. Therefore, MML shall be the first owner of the entire copyright and all other rights in and to the productions issued and done as per this Agreement, and shall have the absolute and exclusive perpetuity right to exhibit, exploit, duplicate, dub, distribute, market, transmit, perform, reproduce, sub-license and use anyhow the productions throughout the world by all existing and any as yet undiscovered methods and formats, and the Director hereby grants MML all consent necessary to enable MML to exploit the productions and their additional materials at its convenience. -2- As a consequence, the Director shall not be entitled to use the productions or part of them hereby sold to MML, without MML's prior written consent. The Director shall, at all times, at its own expense, indemnify, defend and hold harmless MML and its related companies, employees and sub-licensees, from and against any reasonable damages, liabilities, losses, costs and expenses (including reasonable legal fees and costs), directly arising out of any breach by the Director of any of the warranties, representations, agreements, covenants or obligations as stated hereby, or concerning the use of the productions and their contents, even if such an action is brought by a third party. MML shall be granted the rights over the actors and model performances, and shall be entitled to use their name and image in relations to the productions hereby. 4. Promotion. --------- The Director will be exclusively available for promotional activities organized by MML and will take part in any and all Private group's promotion activities at MML's request. The expenses of these promotion activities will be borne by MML. At MML's request, the Director shall obtain the performers cooperation to promote the productions or productions in which they have been involved. MML shall be entitled to promote, design, create and operate a "Private Woodman" Internet Web Site, to promote exclusively adult products under the Private or related trademarks, brands, or labels, or other products produced by the PRIVATE/MILCAP Group, which is its sole owner, even those directed by Pierre Woodman. The worldwide web site, whatever its names would be, as well as the materials published in it, shall be the property of MML, even after the termination of the Agreement. Pierre Woodman shall be entitled to have his own Internet Web Site, but warrants hereby that [he] will not use or publish in it any of the adult materials produced by MML, including all the materials (e.g. slides, backstage pictures), linked to MML productions, even those materials directed by the Director which are property of MML, as established hereby. 5. Recognisance of Debt. -------------------- The Director hereby recognises to owe to MML, the amount of US$43,400.00, (forty three thousand, four hundred dollars). This amount shall be paid to MML monthly, during the validity period of this Agreement, according to point 1, paragraph 1, hereby. The monthly amount of US$1,808.00 (one-thousand, eight hundred and eight dollars), shall be reduced of the amounts to be paid to the Director as per this Agreement, starting on April 1, 1999. 6. Termination. ----------- After this Agreement's termination, the Director will be free to contract and work with and by any other party, as well as to promote any other company or promotion. MML shall keep the sole and exclusive right over the productions as stated in point 3 above. Notwithstanding the foregoing, this Agreement may be renewed after termination provided an agreement of both Parties. 7. Entire Agreement. ---------------- The terms and provisions contained in this contract, together with the Attachment I "Technical Specifications," and the "Performer Agreements and Model Releases" and related documents to be signed between the Director and the performers of each production, constitute the entire Agreement between the Parties. -3- Nothing herein contained, shall be considered or constitute a partnership or joint venture between the Parties. None of the Parties shall ve considered the agent of the other. 8. Disputes and Governing Law. -------------------------- The Courts of the City of Barcelona (country of Spain), shall finally and exclusively settle any dispute out of or in connection with this Agreement. The Parties waive to have their disputes settled by their own competent courts, in case they were different from the ones of Barcelona. This Agreement shall be construed in accordance with and governed by Spanish law. MILCAP MEDIA LIMITED By:_________________________________________ Name:____________________________________ Title:___________________________________ ____________________________________________ PIERRE ANDRE GERBIER a.k.a. Pierre Woodman -4- ATTACHMENT I TO THE PRODUCTION AGREEMENT DATED 29/TH/ DAY OF MARCH, 1999 TECHNICAL SPECIFICATIONS PRIVATE GOLD LINE The Director shall deliver to MML, as per the Production Agreement dated the 4/th/ day of March, 1999; 6 Movies a year -- one every 2/nd/ month, at 110,000, US$ each, starting with the masters of the first film Private Gold nr. 38 according to the following schedule: Private Gold 38: first day of shooting - 15/th/ April, 1999 delivery of cover pictures - 15/th/ May, 1999 delivery of masters hard and soft - 15/th/ June, 1999 Private Gold 39: first day of shooting - 15/th/ June, 1999 delivery of cover pictures - 15/th/ July, 1999 delivery of masters hard and soft - 15/th/ August, 1999 Private Gold 40: first day of shooting - 15/th/ August, 1999 delivery of cover pictures - 15/th/ September, 1999 delivery of masters hard and soft - 15/th/ October, 1999 Private Gold 41: first day of shooting - 15/th/ October, 1999 delivery of cover pictures - 15/th/ November, 1999 delivery of masters hard and soft - 15/th/ December, 1999 Private Gold 42: first day of shooting - 15/th/ December, 1999 delivery of cover pictures - 15/th/ January, 2000 delivery of masters hard and soft - 15/th/ February, 2000 Private Gold 43: first day of shooting - 15/th/ February, 2000 delivery of cover pictures - 15/th/ March, 2000 delivery of masters hard and soft - 15/th/ April, 2000 Private Gold 44: first day of shooting - 15/th/ April, 2000 delivery of cover pictures - 15/th/ May, 2000 delivery of masters hard and soft - 15/th/ June, 2000 Private Gold 45: first day of shooting - 15/th/ June, 2000 delivery of cover pictures - 15/th/ July, 2000 delivery of masters hard and soft - 15/th/ August, 2000 Private Gold 46: first day of shooting - 15/th/ August, 2000 delivery of cover pictures - 15/th/ September, 2000 delivery of masters hard and soft - 15/th/ October, 2000 Private Gold 47: first day of shooting - 15/th/ October, 2000 delivery of cover pictures - 15/th/ November, 2000 delivery of masters hard and soft - 15/th/ December, 2000
Attachment I Page 1 Private Gold 48: first day of shooting - 15/th/ December, 2000 delivery of cover pictures - 15/th/ January, 2001 delivery of masters hard and soft - 15/th/ February, 2001 Private Gold 49: first day of shooting - 15/th/ February, 2001 delivery of cover pictures - 15/th/ March, 2001 delivery of masters hard and soft - 15/th/ April, 2001 Private Gold 50: first day of shooting - 15/th/ April, 2001 delivery of cover pictures - 15/th/ May, 2001 delivery of masters hard and soft - 15/th/ June, 2001
Including editing. Each film shall be delivered in two versions: hard & Soft. Each version will be edited on a separate BETACAM DIGITAL TAPE. Length: No less than 90 minutes per Film. Format: BETACAM DIGITAL. Payment: 70% at the starting of the shooting, 30% upon receipt of masters. The payment includes high quality front cover photographs in different versions, for MML's different markets. The payment includes high quality back cover photographs in different versions for MML's different markets. Includes also backstage photographs. includes also backstage video material, and interviews with the actors. All original tapes from camera must be sent to MML. This attachment is signed and agreed this 29/th/ day of March, 1999, by and between: MILCAP MEDIA LIMITED By:_________________________________________ Name:____________________________________ Title:___________________________________ ____________________________________________ PIERRE ANDRE GERBIER a.k.a. Pierre Woodman Attachment I Page 2 ATTACHMENT II TO THE PRODUCTION AGREEMENT DATED 29/TH/ MARCH, 1999 TECHNICAL SPECIFICATIONS PRIVATE CASTING BY PIERRE WOODMAN The Director shall deliver to MML, as per the Production Agreement dated 4/th/ March, 1999: 6 Movies a year -- one every 2/nd/ month, at 27,500, US$ each, starting with the masters of the first film Private Casting nr. 18 according to the following schedule: Private Casting 18: first day of shooting - 15/th/ May, 1999 delivery of cover pictures - 15/th/ June, 1999 delivery of masters hard and soft - 15/th/ July, 1999 Private Casting 19: first day of shooting - 15/th/ July, 1999 delivery of cover pictures - 15/th/ August, 1999 delivery of masters hard and soft - 15/th/ September, 1999 Private Casting 20: first day of shooting - 15/th/ September, 1999 delivery of cover pictures - 15/th/ October, 1999 delivery of masters hard and soft - 15/th/ November, 1999 Private Casting 21: first day of shooting - 15/th/ November, 1999 delivery of cover pictures - 15/th/ December, 1999 delivery of masters hard and soft - 15/th/ January, 2000 Private Casting 22: first day of shooting - 15/th/ January, 2000 delivery of cover pictures - 15/th/ February, 2000 delivery of masters hard and soft - 15/th/ March, 2000 Private Casting 23: first day of shooting - 15/th/ March, 2000 delivery of cover pictures - 15/th/ April, 2000 delivery of masters hard and soft - 15/th/ May, 2000 Private Casting 24: first day of shooting - 15/th/ May. 2000 delivery of cover pictures - 15/th/ June, 2000 delivery of masters hard and soft - 15/th/ July, 2000 Private Casting 25: first day of shooting - 15/th/ July, 2000 delivery of cover pictures - 15/th/ August, 2000 delivery of masters hard and soft - 15/th/ September, 2000 Private Casting 26: first day of shooting - 15/th/ September, 2000 delivery of cover pictures - 15/th/ October, 2000 delivery of masters hard and soft - 15/th/ November, 2000 Private Casting 27: first day of shooting - 15/th/ November, 2000 delivery of cover pictures - 15/th/ December, 2000 delivery of masters hard and soft - 15/th/ January 2001
Attachment II Page 1 Private Casting 28: first day of shooting - 15/th/ January, 2001 delivery of cover pictures - 15/th/ February, 2001 delivery of masters hard and soft - 15/th/ March, 2001 Private Casting 29: first day of shooting - 15/th/ March, 2001 delivery of cover pictures - 15/th/ April, 2001 delivery of masters hard and soft - 15/th/ May, 2001 Private Casting 30: first day of shooting - 15/th/ May, 2001 delivery of cover pictures - 15/th/ June, 2001 delivery of masters hard and soft - 15/th/ July, 2001
Including editing and soundtrack (original sound). Length: No less than 90 minutes per Film. Format: BETACAM DIGITAL. Payment: 70% at the starting of the shooting, 30% upon receipt of masters. The payment includes high quality front cover photographs in different versions, for MML's different markets. The payment includes high quality back cover photographs in different versions for MML's different markets. Includes also backstage photographs. includes also backstage video material, and interviews with the actors. All original tapes from camera must be sent to MML. All photographs taken during shooting must be sent to MML. This attachment is signed and agreed this 29/th/ day of March, 1999, by and between: MILCAP MEDIA LIMITED By:_________________________________________ Name:____________________________________ Title:___________________________________ ____________________________________________ PIERRE ANDRE GERBIER a.k.a. Pierre Woodman Attachment II Page 2 EX-10.13 5 FINAL AGREEMENT DATED AS OF MARCH 22, 1999 EXHIBIT 10.13 FINAL AGREEMENT This Letter of Understanding is entered into on the 22/nd/ day of March, 1999, by and between Private Media Group, Inc. ("Private") and Danny Cook ("Cook") and Qamilla ("Carlsson") (Cook and Carlsson collectively "Designers"). WHEREAS, Private and Designers, on May 5, 1998, entered into a Letter of Understanding which provided generally that the Parties would form a corporation to be known as Private Circle, Inc. ("PCI"), that Private would contribute $115,000 to the capital of PCI, that Designers would contribute the assets of DQ Collections and Zapata Clothing to the capital of PCI if PCI paid $15,000 to Designers, that ownership of PCI would be 80% to Private and 20% to Designers, and that Private would issue to each of Designers 7,500 common stock purchase warrants at $10.00 per share; and WHEREAS, said Letter of Understanding was to expire on July 13, 19998, if no formal agreement had been reached; and WHEREAS, said Letter of Understanding was extended first to October 1, 1998, and then to December 31, 1998; and WHEREAS, no formal agreement has been reached to date and the May 5/th/, 1998, Letter of Understanding has expired on its own terms; and WHEREAS, the $115,000 capital was never contributed to PCI and no stock was issued to the Parties, however, approximately $450,000 has been loaned to PCI by Private through its subsidiaries and $15,000 was paid to Designers for the DQ Collections and Zapata Clothing assets; and WHEREAS, the Parties desire to enter into a new agreement for PCI with some of the terms contained in the May 5/th/, 1998, Letter of Understanding, and some new terms; NOW, THEREFORE, the Parties agree as follows: 1. The Parties acknowledge: a. that PCI was formed on June 2, 1998; b. that Danny Cook was appointed President, Secretary and Treasurer of PCI; c. that no capital stock of PCI was ever issued; d. that $15,000 was paid to Designers towards the purchase of the DQ -1- Collections and Zapata Clothing assets; e. that PCI has borrowed approximately $450,000 from Private through its subsidiaries; and f. that Designers have received from PCI agreed upon salaries or consulting fees since approximately May 5, 1998. 2. Because the amount loaned by Private is far in excess of its anticipated capital contribution of $115,000, Private wishes to restructure Designers' originally proposed equity interests, salaries, and consulting fee arrangements, and profit sharing arrangement in the following manner: a. PCI will be 100% owned by Private, or one of its subsidiaries; b. PCI will enter into written employment or consulting agreements, acceptable to Designers, which shall have a length of two (2) years, monthly compensation of $4,000, and normal employment benefits (such as health insurance, vacation pay, etc); c. In addition, each of Designers shall be entitled to an annual bonus equal to 5% of the net profits before taxes and an additional bonus of 5% of net profits before taxes for each year in which the ratio of net profits before taxes divided by sales is over 10%; d. Private will issue to each Designer warrants to purchase up to 7,500 shares of the common stock of Private at $10.00 per share at any time before October 1, 2000; said shares to be "investment shares" as the term is normally understood under the Securities Act of 1933, and each Designer will be enrolled in the Private Employees Option Plan at the management level-Class A; e. Cook will continue to act as President of PCI and Secretary and/or Treasurer, if needed; and f. During the aforementioned period of employment, and all extensions thereto, Designers will continue to manage the day-to-day activities of PCI, and Designers shall retain 100% control over design and creative issue, and no garment shall bear the PCI logo unless it is designed or approved of by Designers. 3. Designers, and each of them, accept and agree to the above-terms, -2- subject to approval of the employment and/or consulting agreements to be provided [to Designers]. 4. This Agreement shall be governed by the State of Nevada, and all Parties agree that any dispute hereunder shall be settled by arbitration in, or litigation before any Court of competent jurisdiction in the State of Nevada. Dated: _______________________ Private Media Group, Inc. By:_______________________ Berth Milton, President Dated: ________________________ __________________________ Danny Cook Dated: _______________________ __________________________ Qamilla Carlsson -3- EX-21 6 SUBSIDIARIES OF THE REGISTRANT EXHIBIT 21 Private Media Group, Inc., Subsidiaries
Name of Subsidiary Place of Incorporation Owner Percent Owner - ------------------ ---------------------- ----- ------------- Cine Craft, Ltd. GIBRALTAR Private Media Group, Inc. 100% Milcap Media, Ltd. CYPRUS Private Media Group, Inc. 100% Milcap Publishing Group AB SWEDEN Milcap Media, Ltd. 100% Milcap Publishing Group Italy Sri ITALY Milcap Publishing Group AB 100% Normcard AB SWEDEN Milcap Publishing Group AB 100% Milcap Media Group SA SPAIN Milcap Publishing Group AB 100% Private France SA FRANCE Milcap Media Group SA 98% Symbolic Productions S.L. SPAIN Milcap Media Group, S.L. 98% Private Circle, Inc. NEVADA Private Media Group, Inc. 100%
EX-27.1 7 FINANCIAL DATA SCHEDULE
5 1,000 SWEDISH YEAR YEAR DEC-31-1997 DEC-31-1998 JAN-01-1997 JAN-01-1998 DEC-31-1997 DEC-31-1998 .1356 .1240 0 4,165 0 0 0 60,828 0 0 0 30,888 0 104,978 0 9,546 0 0 0 210,479 0 32,573 0 0 0 0 0 7,997 0 2,344 0 0 0 210,479 144,543 165,104 144,543 165,104 75,674 71,272 75,674 71,272 0 0 0 0 321 745 34,935 41,455 (2,052) 1,445 0 0 0 0 0 0 0 0 36,987 40,010 4.93 5.14 2.43 2.60
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