UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 20-F
|_| REGISTRATION STATEMENT PURSUANT TO SECTION 12(b) OR (g)
OF THE SECURITIES EXCHANGE ACT OF 1934
OR
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended: August 31, 2002
Commission file number: 001-15131
PEACE ARCH ENTERTAINMENT GROUP INC.
(Exact name of registrant as specified in the charter)
BRITISH COLUMBIA, CANADA
(Jurisdiction of Incorporation or Organization)
#500, 56 EAST 2ND AVENUE, VANCOUVER, BRITISH COLUMBIA, CANADA
(Address of principal executive offices)
Securities registered or to be registered pursuant to
Section 12(b) of the Act
None
Securities to be registered pursuant to Section 12(g) of the Act:
None
Securities for which there is a reporting obligation pursuant to
Section 15(d) of the Act:
Class B Subordinate Voting Shares
The number of outstanding shares of each class of stock of PEACE ARCH
ENTERTAINMENT GROUP INC. as of August 31, 2002 was:
1,091,875 Class A Multiple Voting Shares, without par value
2,795,969 Class B Subordinate Voting Shares, without par value
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 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 ___
Indicate by check mark which financial statement item the registrant has elected
to follow. Item 17 X Item 18
TABLE OF CONTENTS
Page
----
PART I
Item 1. Identity of Directors, Senior Management and Advisors....................................................3
Item 2. Offer Statistics and Expected Timetable..................................................................3
Item 3. Key Information..........................................................................................3
Item 4. Information on the Company..............................................................................16
Item 5. Operating and Financial Review and Prospects............................................................28
Item 6. Directors, Senior Management and Employees..............................................................36
Item 7. Major Shareholders and Related Party Transactions.......................................................44
Item 8. Financial Information...................................................................................46
Item 9. The Offer and Listing...................................................................................47
Item 10. Additional Information.................................................................................50
Item 11. Qualitative and Quantitative Disclosures about Risk....................................................56
Item 12. Description of Securities Other than Equity Securities.................................................57
PART II
Item 13. Defaults, Dividends Arrearages and Delinquencies.......................................................58
Item 14. Material Modifications to the Rights of Security Holders and Use of Proceeds...........................58
Item 15. Controls and Procedures................................................................................58
Item 16. [Reserved].............................................................................................58
PART III
Item 17. Financial Statements...................................................................................59
Item 18. Financial Statements...................................................................................60
Item 19. Exhibits...............................................................................................88
2
PART I
ITEM 1. IDENTITY OF DIRECTORS, SENIOR MANAGEMENT AND ADVISERS
Not applicable.
ITEM 2. OFFER STATISTICS AND EXPECTED TIMETABLE
Not applicable.
ITEM 3. KEY INFORMATION
A. SELECTED FINANCIAL DATA
The consolidated statement of operations and deficit presented below for each of
the years in the three-year period ended August 31, 2002 and the consolidated
balance sheet data as of August 31, 2001 and 2002, are derived from the audited
consolidated financial statements included elsewhere herein. The consolidated
statement of operations and deficit for each of the years in the two-year period
ended August 31, 1999 and the consolidated balance sheet data as of each of
August 31, 2000, 1999 and 1998, are derived from our audited financial
statements which are not included or incorporated by reference herein. Each of
the financial statements from which the selected consolidated financial data and
operating data is derived was prepared in accordance with Canadian GAAP. This
selected financial data should be read in conjunction with the audited
consolidated financial statements and accompanying notes contained in this
annual report.
The selected consolidated financial and operating data set forth below is
reported in Canadian dollars. However, for the convenience of the reader, the
Canadian dollar statement of operations and deficit data for the year ended
August 31, 2002 and the Canadian dollar balance sheet data have been translated
to United States dollars using the rate in effect as of August 31, 2002. These
translations are not necessarily representative of the amounts that would have
been reported if we had historically reported our financial statements in U.S.
dollars. In addition, the rates utilized are not necessarily indicative of the
rates in effect at any other time or that may be effective in the future.
3
SELECTED CONSOLIDATED FINANCIAL AND OPERATING DATA
(IN THOUSANDS, EXCEPT PER SHARE DATA)
YEAR ENDED AUGUST 31,
-----------------------------------------------------------------------
CDN$ CDN$ CDN$ CDN$ CAN$ US$
---- ---- ---- ---- ---- ----
1998 1999 2000 2001 2002 2002
---- ---- ---- ---- ---- ----
STATEMENT OF OPERATIONS DATA:
Canadian GAAP
Revenue............................ $ 32,407 $ 51,273 $34,663 $ 54,900 $ 6,494 $ 4,167
Expenses
Amortization of programming...... 27,234 43,179 31,144 57,612 6,639 4,260
Other costs of production and
Sales.......................... 3,577 2,905 2,157 1,755 615 394
Selling, general and administra-
tion expense................... 2,201 3,049 3,668 4,521 3,101 1,990
Bad debt -- -- -- -- 1,675 1,074
Other............................ 376 484 781 748 476 305
-------- -------- ------- -------- ------- --------
Total expenses..................... 33,388 49,617 37,750 64,636 12,506 8,023
-------- -------- ------- -------- ------- --------
Net earnings (loss) from operations. (981) 1,656 (3,087) (9,736) (6,012) (3,856)
Interest income 50 274 775 499 597 383
Interest expense (589) (1,188) (963) (2,295) (2,364) (1,517)
Gain (loss) on sale of capital
assets and other................... -- 360 272 233 176 113
Loss on write-down of assets -- -- -- (2,665) (166) (107)
Provision (against) limited partner-
ship revenue interests........... -- -- -- -- -- --
Income taxes....................... (297) (631) (265) (316) 748 480
-------- -------- ------- -------- ------- -------
Net earnings (loss)................ $ (1,817) $ 471 $(3,268) $(14,280) $(7,021) $(4,504)
======== ======== ======= ======== ======= =======
Earnings (loss) per common share
(1)
Basic............................ $ (0.70) $0.15 $(0.86) $(3.71) $(1.81) $(1.16)
Diluted.......................... $ (0.70) $0.15 $(0.86) $(3.71) $(1.81) $(1.16)
Weighted average number of
common shares.................. 2,603 3,083 3,795 3,844 3,888 3,888
Diluted number of common
shares......................... 2,603 3,094 3,795 3,844 3,888 3,888
OTHER OPERATING DATA:
Cash flows provided by (used in):
Operating activities............. (6,226) (3,756) (4,244) (12,733) 20,007 12,835
Investing activities............. (632) 101 (2,103) (337) 5,395 3,461
Financing activities............. 6,990 6,234 6,351 12,588 (27,411) (17,588)
EBITDA(2).......................... 3,020 2,414 (1,531) (8,489) (4,929) (3,162)
4
YEAR ENDED AUGUST 31,
-----------------------------------------------------------------
CDN$ CDN$ CDN$ CDN$ CAN$ US$
---- ---- ---- ---- ---- ----
1998 1999 2000 2001 2002 2002
---- ---- ---- ---- ---- ----
U.S. GAAP(3)
Net earnings (loss), Canadian
GAAP............................ $(1,817) $ 471 $(3,268) $(14,280) $(7,021) $(4,504)
Compensatory value of transferred
Shares.......................... (1,224) -- -- -- -- --
Gain on sale of asset, net of income
tax............................. -- (187) 187 -- (53) (34)
Adjustment to eliminate retroactive
change in accounting film costs,
net of income tax............... 3,575 1,382 4,080 -- -- --
Stock compensation expense to
service providers............... -- -- -- (24) (44) (29)
Additional debt discount - warrants -- -- -- (60) (133) (86)
---- ---- ---- ---- ---- ----
Net earnings (loss) before
cumulative adjustment to reflect
change in accounting for film
costs, US GAAP.................. 534 1,666 999 (14,364) (7,251) (4,653)
Cumulative adjustment to reflect
change in accounting for film
costs........................... -- -- -- (10,736) -- --
---- ------ ---- -------- ------- -------
Net earnings (loss), US GAAP....... $534 $1,666 $999 $(25,100) $(7,251) $(4,653)
==== ====== ==== ======== ======= =======
Earnings (loss) per common share(1)
Basic............................ $0.23 $0.56 $0.26 $(6.53) $(1.87) $(1.20)
Diluted.......................... $0.23 $0.56 $0.26 $(6.53) $(1.87) $(1.20)
Weighted average number of
common shares.................. 2,304 2,935 3,795 3,844 3,888 3,888
Diluted number of common
Shares......................... 2,304 2,954 3,808 3,844 3,888 3,888
-------------------------------------------------------------
AS OF AUGUST 31,
-------------------------------------------------------------
CDN$ CDN$ CDN$ CDN$ CDN$ US$
---- ---- ---- ---- ---- ----
1998 1999 2000 2001 2002 2002
---- ---- ---- ---- ---- ----
BALANCE SHEET DATA:
Cash and marketable securities........ $ 1,876 $ 4,455 $ 4,459 $ 3,977 $ 1,968 $1,263
Accounts and other receivables........ 10,235 19,901 16,443 28,203 3,871 2,484
Production costs in progress.......... 11,906 3,446 15,637 3,039 1,356 870
Investments in television 2,070
programming, net.................... 358 2,560 3,667 2,332 1,496
Property and equipment, net........... 9,498 7,079 7,397 7,277 842 540
Goodwill and trademarks............... 2,544 3,185 2,913 238 -- --
Total assets.......................... 36,913 40,706 51,340 $47,270 $10,763 6,906
Debt financing(4)..................... 10,367 11,172 17,049 29,662 11,747 7,537
Deferred revenue...................... 10,770 3,980 8,338 3,191 1,197 768
Total liabilities..................... 24,454 22,340 35,715 45,729 16,030 10,286
Shareholders' equity.................. 12,459 18,366 15,625 1,541 (5,267) (3,380)
(1) Earnings per share shown above are based on the weighted average number of
shares outstanding during the period.
5
(2) EBITDA represents earnings before interest, taxes, provision against
limited partnership revenue interests, gain (loss) on capital assets,
depreciation and amortization. For purposes of EBITDA, amortization
excludes amortization of programming and excludes interest capitalized in
production costs. EBITDA has been included because we feel that some
readers will find it useful for evaluating our business. However, EBITDA
should not be considered as an alternative to net earnings, as determined
in accordance with Canadian GAAP or as an indicator of our operating
performance. In addition, it should not be considered as an alternative to
cash flows from operations, as determined in accordance with Canadian GAAP,
or as an indicator of our liquidity or available cash. To the extent that
EBITDA does represent cash generated by operations, this cash may not be
available for management's discretionary use, due to debt service
requirements, requirements to invest in television programming, and
uncertainties. EBITDA, as presented, may not be comparable to similar
computations presented by other companies.
(3) Differences to U.S. GAAP shown above reflect the transfer of 160,000
performance shares to three of our officers and directors in 1998. Under
Canadian GAAP, the transfer is a capital transaction outside of Peace Arch
and is not accounted for as compensatory to any of the individuals who
acquired the shares. For U.S. GAAP purposes only, a compensation expense of
Cdn$1.2 million was recorded in the year ended August 31, 1998. In 1999 and
2002 we sold real estate and reported partial gains under Canadian GAAP.
The consideration included notes receivable. Under US GAAP these
transactions would have been accounted for using the deposit method due to
the existence of the notes receivable and the partial gains of Cdn$187,000
in 1999 and Cdn$53,000 in 2002 would not have been realized at that time.
In fiscal 2000, under US GAAP, the partial gain would have been realized.
In fiscal 2003, under US GAAP, the partial gain of $53,000 will be
realized. Commencing with the year ended August 31, 2001, the accounting
policy for accounting for film costs was changed and applied retroactively
for Canadian GAAP purposes. For U.S. GAAP purposes, changes in accounting
policy are applied prospectively with a cumulative adjustment to the
current year's financial statements. In each of 2001 and 2002, we granted
as compensation to services providers, warrants to purchase up to 100,000
Class B shares. For U.S. GAAP purposes only, a compensation expense of
$24,000 in 2001 and $44,000 in 2002 was recorded. In connection with the
debentures issued, we issued or repriced share purchase warrants and
reported, under US GAAP only, additional amortization of debt discount of
$60,000 in 2001 and $133,000 in 2002.
(4) Debt financing shown above includes costs associated with both bank
indebtedness and long-term debt.
(5) Certain figures have been reclassified to conform with the presentation
adopted in fiscal 2002.
Exchange Rates
Peace Arch Entertainment Group Inc. (together with its subsidiaries, will also
be referred to as "Peace Arch" , "Company", "we", "our" or "us") publishes its
financial statements in Canadian dollars. In this Annual Report, references to
"dollars", "$" or "Cdn$" are to Canadian dollars, unless otherwise specified,
reference to "US$" refer to United States dollars. For your convenience, this
Annual Report contains translations of certain Canadian dollar amounts into
United States dollars at specified rates. These translations should not be read
as representations that the Canadian dollar amounts actually represent such
United States dollar amounts or could be converted into United States dollars at
the rate indicated. Unless otherwise stated, the translations of Canadian
dollars ("Cdn$") into United States dollars ("US$") have been made at Cdn$1.5585
to US$1.00, the noon buying rate in New York City for cable transfers in
Canadian dollars as certified for customs purposes by the Federal Reserve Bank
of New York (the "Noon Buying Rate") on August 31, 2002.
6
This table describes certain exchange rates based on the Noon Buying Rate. These
rates are shown as U.S. dollars per Cdn$1.00. The Noon Buying Rate on January 6,
2003 was Cdn$1.5598 per US$1.00.
PERIOD
--------------------
FROM TO AVG. HIGH LOW
-------- ------- ------ ------ ------
8/31/96 8/31/97 0.7308 0.7525 0.7139
8/31/97 8/31/98 0.6957 0.7293 0.6330
8/31/98 8/31/99 0.6635 0.6891 0.6423
8/31/99 8/31/00 0.6796 0.6973 0.6631
8/31/00 8/31/01 0.6543 0.6787 0.6334
8/31/01 8/31/02 0.6354 0.6619 0.6200
9/01/01 9/30/02 0.6349 0.6517 0.6304
10/01/02 10/31/02 0.6337 0.6406 0.6288
11/01/02 11/30/02 0.6370 0.6440 0.6308
12/01/02 12/31/02 0.6418 0.6461 0.6329
01/01/03 01/06/03 0.6381 0.6411 0.6349
B. CAPITALIZATION AND INDEBTEDNESS
Not applicable
C. REASONS FOR THE OFFER AND USE OF PROCEEDS
Not applicable
D. RISK FACTORS
There are risks and uncertainties that could impact revenues and earnings from
operations. In addition to interest rate risk and credit risk, that is referred
to in the notes to the consolidated financial statements, there are several
other risks specific to Peace Arch and our industry.
7
PROPOSED ACQUISITION AND FINANCING TRANSACTIONS
Subsequent to August 31, 2002, we entered into agreements in December 2002 with
regard to a series of transactions (referred to collectively as the "Acquisition
and Financing Transactions"). Pursuant to the Acquisition and Financing
Transactions, we would issue or reserve for issuance up to an aggregate
16,196,333 of our Class B Subordinate Voting Shares to effect the Private
Placement Financing, Asset Acquisition, Debt Restructuring and Release and
Reconstitution of Loan Guarantee Transactions, each as described below, (the
"Shares Issuances"). Each of the Share Issuances is subject to regulatory and
shareholder approval. Each of the Asset and Financing Transactions is contingent
upon the other Asset and Financing Transactions and will close concurrently.
In the event that we do not complete these Acquisition and Financing
Transactions, we believe that we will not have adequate resources to meet our
cash requirements into 2003. If the business climate does not improve so that we
may earn revenues from our library of television programming, and if we are
unable to raise capital from outside sources, we would be unable to make the
contracted payments or meet the financial covenant requirements of our debt,
causing our lenders to demand immediate repayment of our debt obligations. In
such event, if we are unable to renegotiate our debt with our creditors, it is
likely that we will be unable to continue operations.
Private Placement Financing: We have agreed to a private placement of 5,000,000
Class B Subordinate Voting Shares at a subscription price of $0.30 per share,
which price approximates the market price of the Class B Subordinate Voting
Shares at the time the private placement was negotiated, for total proceeds of
$1,500,000 (the "Private Placement Financing"). Under the Private Placement
Financing, four (4) arm's length investors subscribed for and agreed to pay an
aggregate $1,500,000, in cash, for 5,000,000 of our Class B Subordinate Voting
Shares.
Asset Acquisition: We have agreed to acquire a portfolio of assets owned and
controlled by CPC Communications Inc. ("CPC") of Toronto, Canada and/or its
subsidiaries, in consideration for the issuance of 8,333,333 of our Class B
Subordinate Voting Shares at a price of $0.30 per share (the "Asset
Acquisition"). The assets include Film Production Company Assets, the Assigned
Receivable Assets and the ongoing business activities of Greenlight Film and
Television Inc. ("Greenlight"), a wholly owned subsidiary of CPC, collectively
(the "Assets"). The Assets have been independently estimated to have a value of
not less than $2,500,000.
Greenlight, a Toronto company, has been in business since 1997 and is primarily
in the business of producing theatrical motion pictures. In the five years since
its inception, Greenlight has produced, through its wholly owned subsidiaries,
more than thirty (30) feature films for worldwide distribution. These films,
produced and/or executive produced by its President and founder, Mr. Gary
Howsam, have been licensed by entities including Lions Gate Entertainment,
Artisan Entertainment, Trimark, HBO and Blockbuster, Showtime, Hallmark
Entertainment and Encore. Greenlight focuses on films with budgets from $4
million to $25 million, designed both for theatrical release and DVD/television.
Following the Asset Acquisition, we intend to continue the future business
activities of Greenlight.
The Film Production Company Assets proposed to be acquired by us from CPC
include five films, held by single purpose companies, that qualify as Canadian
content as determined by the CRTC (Canadian Radio-television and
Telecommunications Commission), four (4) of which are being produced under tax
treaties between Canada and the UK. The films, which are presently in
production, have aggregate Canadian budgets of approximately $26.5 million. The
five companies are wholly owned by CPC or its subsidiaries and their feature
films are described as follows:
1. GFT Crime Spree Films Inc. is in production of a feature film "Crime
Spree", a caper comedy starring Gerard Depardieu and Harvey Keitel,
and directed by Brad Mirman.
8
2. GFT Absolon Films Inc. is in production of a feature film "Absolon", a
futuristic thriller starring Christopher Lambert and Lou Diamond
Philips.
3. GFT Rough Rider Films Inc. is in production of "Partners in Action",
an action thriller starring Armand Assante and directed by Sidney J.
Furie.
4. GFT Detention Films Inc. is in production of "Detention", an action
thriller starring Dolph Lundgren and directed by Sidney J. Furie.
5. GFT Limit Films Inc. is in production of "The Limit", a suspense film
starring Lauren Bacall and Claire Forlani and directed by Lewin Webb.
The above single purpose production companies (collectively the "Prodcos") own
majority copyright and certain residual rights to the above noted feature films.
Prior to closing of the Asset Acquisition, Greenlight has agreed to transfer
100% of the shares of the Prodcos to GFT Entertainment Inc., a newly
incorporated company, and, upon closing of the Asset Acquisition, we will
acquire 100% of the shares of GFT Entertainment Inc.
The Assigned Receivable Assets to be acquired are as follows:
1. Federal and Ontario tax credit receivables due to the Prodcos in the
estimated amount of $280,000;
2. Interim collateral deposit release of $300,000;
3. Ownership of loan due to a subsidiary of CPC from GFT Limit Films Inc. in
the amount of US$959,713; and
4. Assignment of $408,000 due to CPC with respect to proceeds of France
exploitation of Crime Spree (the "French Proceeds"). Provided that we
receive actual cash from the Assigned Receivable Assets and from the Film
Production Company Assets in the amount of $2,500,000, we have agreed to
remit any further cash received from these assets to CPC until an amount
equal to the French Proceeds actually received by us has been recouped by
CPC.
We retained Ellis Foster, Chartered Accountants, to provide an independent
estimate of the fair market value of the Assets. The conclusion of such estimate
was that, as at November 15, 2002, the fair market value of the Assets proposed
to be acquired by us is not less than $2,500,000.
Debt Restructuring: We have agreed to a restructuring of the debt (the "Debt
Restructuring") due to Fremantle Media Enterprises Ltd. ("Fremantle"). As at the
date of this report, we are indebted to Fremantle in the approximate aggregate
principal amount of $7.58 million, accruing interest at a rate of 10% per annum
(the "Fremantle Debt"). The Fremantle Debt is secured, providing Fremantle with
a fixed and floating charge over all of our assets and those of our subsidiaries
and a specific charge on certain assets held by us or our subsidiaries, subject
to certain other priority charges.
Pursuant to the proposed Debt Restructuring, and subject to and concurrent with
the closing of the other Acquisition and Financing Transactions, Fremantle has
agreed that the scope of the Fremantle Debt and collateral charged will be
restricted to our business, assets and undertakings as they exist immediately
prior to the closing of the Acquisition and Financing Transactions and any
proceeds derived from such pre-existing business after those closings. Fremantle
will not have any recourse, right or claim against any
9
funding, proceeds and/or assets conveyed to us as a result of the Private
Placement Financing or Asset Acquisition.
To give effect to the Debt Restructuring, upon closing of the Acquisition and
Financing Transactions, our pre-existing assets and undertakings will be
conveyed to one or more new or existing wholly-owned subsidiaries on the
condition that such conveyance will not adversely affect the Fremantle Debt. The
new subsidiary(s) will assume the Fremantle Debt and we will be released from
liability in respect of the Fremantle Debt. Payments on the Fremantle Debt shall
be made directly from the income stream of the new subsidiary(s). We will manage
the business of the new subsidiary(s), subject to Fremantle's approval of
operating budgets and business plans.
It is a term of the Debt Restructuring that we deliver, on or before the closing
of the Acquisition and Financing Transactions, an instrument in favor of
Fremantle that evidences the principal amount of the Fremantle Debt and permits
Fremantle, for a period of ninety (90) days from December 31, 2004, to convert,
subject to regulatory approval, such principal amount outstanding at December
31, 2004, into our Class B Subordinate Voting Shares at the lower price of
either (a) $5.00 per share or (b) the closing price of the Class B Subordinate
Voting Shares for the thirty (30) days prior to December 31, 2004, provided that
in no event shall the conversion price be less than $3.00 per share. If the
whole of the principal amount of the Fremantle Debt, (excluding interest),
remains outstanding at December 31, 2004 and the 30-day average closing price of
the shares is $3.00 or less, the maximum number of shares issuable on such
conversion would be 2,527,000 Class B Subordinate Voting Shares.
Release and Reconstitution of Loan Guarantee: We have also agreed to a
reconstitution of a loan guarantee (the "Release and Reconstitution of Loan
Guarantee") provided to Comerica Bank - California ("Comerica") with respect to
the guarantee of a loan from Comerica to Big Sound Productions Inc. of the
United Kingdom, an unrelated company controlled by Jamie Brown. There is
approximately US$1.075 million due to Comerica under the loan agreement, which
is currently in default. Big Sound Productions Inc. was our co-production
partner on our 22 episode television series, "Big Sound". In the event that the
loan is in default, we may at our option assume all of the co-producer's rights
and interest to the series, subject to Comerica's charge on the rights to the
proceeds from exploitation of the series in certain international territories
(the "Exploitation Rights").
Pursuant to the Release and Reconstitution of Loan Guarantee and subject to and
concurrent with the closing of the other Acquisition and Financing Transactions,
Comerica will release us from our guarantee of the loan and the guarantee shall
be reconstituted into the form of a non-interest bearing, unsecured liability
(the "Comerica Liability"). Furthermore, Comerica has agreed that, with the
exception of the Exploitation Rights, the scope of the Comerica Liability will
be restricted to our business, assets and undertakings such as they exist
immediately prior to the closing of the Acquisition and Financing Transactions
and any proceeds derived from our pre-existing business after those closings,
subject to the secured creditors and the priority of the Fremantle Debt.
Comerica will not have any recourse, right or claim against any funding,
proceeds and/or assets conveyed to us as a result of the Private Placement
Financing or Asset Acquisition.
Upon closing of the Acquisition and Financing Transactions, our pre-existing
assets and undertakings will be conveyed to one or more new or existing
wholly-owned subsidiaries as described above. The new subsidiary(s) will assume
the Comerica Liability and we will be released from liability in respect of the
guarantee. Payments of the Comerica Liability shall be made directly from the
income stream of the new subsidiary(s), subject to priority and security
interests.
10
It is a term of the Release and Reconstitution of Loan Guarantee that we deliver
on or before the closing of the Acquisition and Financing Transactions, an
instrument in favor of Comerica that evidences the principal amount of the
Comerica Liability and permits Comerica, for a period of ninety (90) days from
December 31, 2005, to convert, subject to regulatory approval, such principal
amount outstanding at December 31, 2005, into our Class B Subordinate Voting
Shares at a price of $5.00 per share. If the whole amount of the Comerica
Liability remains outstanding at December 31, 2005, then, using a conversion
rate of 1.5588, the maximum number of shares issuable on such conversion would
be 335,077.
The consummation of the Acquisition and Financing Transactions is subject to a
number of conditions, including approval of our directors, approval of the Share
Issuances by our shareholders and The Toronto Stock Exchange (the "TSX") and, in
certain cases, execution of formal documentation. We have scheduled the Annual
General Meeting of Shareholders for January 20, 2003, at which the shareholders
will be asked to approve the Share Issuances pursuant to the Acquisition and
Financing Transactions. Based on proxies received to date for the Annual General
Meeting of Shareholders, we currently expect our shareholders will approve the
Share Issuances. Based on our discussions with the TSX, we currently expect the
TSX will approve the Share Issuances pursuant to the Acquisition and Financing
Transactions.
The following table sets out the pro forma share capital (on a non-diluted
basis) prior to the Acquisition and Financing Transactions and immediately
following the Share Issuances:
-------------------------------------------------------------------------------------------------------------------------
PRO FORMA CAPITALIZATION
-------------------------------------------------------------------------------------------------------------------------
CLASS A MULTIPLE VOTING CLASS B SUBORDINATE
SHARES VOTING SHARES
-------------------------------------------------------------------- --------------------------- ------------------------
Shares issued as at January 6, 2003 1,091,875 2,795,969
Shares to be issued pursuant to the Share Issuances:
Private Placement Financing Nil 5,000,000
Asset Acquisition Nil 8,333,333
Reserved for Debt Restructuring
Nil (1)
Reserved for Release and Reconstitution of Loan Guarantee
Nil (1)
-------------------------------------------------------------------- --------------------------- ------------------------
ISSUED CAPITAL: 1,091,875 16,129,302
-------------------------------------------------------------------- --------------------------- ------------------------
(1) The proposed Debt Restructuring could result in the additional issuance
of a maximum of approximately 2,527,000 Class B Subordinate Voting
Shares during the ninety days following December 31, 2004 and the
proposed Release and Reconstitution of Loan Guarantee could result in
the additional issuance of a maximum of approximately 336,000 Class B
Subordinate Voting Shares during the ninety days following December 31,
2005.
11
(2) The 5,000,000 Class B Subordinate Voting Shares to be issued pursuant
to the Private Placement Financing will represent 31% (18% of the
voting rights), and the 8,333,333 Class B Subordinate Voting Shares to
be issued pursuant to the Asset Acquisition will represent 52% (31% of
the voting rights) of our issued Shares after giving effect to the
Private Placement Financing and Asset Acquisition.
Decrease in Revenues and Going-Concern Issues
Due to worldwide reduction in demand for programming, and reduced cash flow
available for development, we have experienced a sharp decline in production and
distribution activities for dramatic television programming, which historically
has made up the majority of our revenues. Our revenues decreased to $6.5 million
for fiscal 2002 from $54.9 million for fiscal 2001. We underwent rapid
production growth through 2001, which placed increasing demands on our financial
resources.
Major television networks around the world are faced with increasing competition
from various sources including basic and specialty cable channels, satellite,
digital stations and the Internet. This fragmentation of the market, combined
with downward price pressure due to a weak worldwide market for television
programming, has resulted in a demand for more cost-effective programming. In
order to meet market demands, we will increase the production of lower cost
reality and factual programs, will continue to take advantage of tax credits and
government incentives and will focus on programming with global market appeal.
However, the current weak worldwide market for television programming caused an
industry slowdown that is reflected in reduced production activities in the
Canadian market place. Based on this market trend, as well as on our increased
production of factual programs that result in lower revenues than drama
programs, we do not expect proprietary revenues to change significantly from
2002.
Our auditor's report for our fiscal year ended August 31, 2002 includes
additional comments for U.S. readers on Canada-U.S. reporting differences that
arise due to conditions and events that exist that cast substantial doubt on our
ability to continue as a going concern. The consolidated financial statements do
not include any adjustments as a result of that uncertainty.
In the event that we do not complete the Acquisition and Financing Transactions,
we believe that we will not have adequate resources to meet our cash
requirements into 2003. If the business climate does not improve so that we may
earn revenues from our library of television programming, and if we are unable
to raise capital from outside sources, we would be unable to make the contracted
payments or meet the financial covenant requirements of our debt, causing our
lenders, including Fremantle and Comerica, to demand immediate repayment of our
debt obligations. In such event, if we are unable to renegotiate our debt with
our creditors, it is likely that we will be unable to continue operations.
Risk of Delisting from The Toronto Stock Exchange
If the Acquisition and Financing Transactions are not completed, our shares may
be delisted from the TSX. We have been advised by the TSX that we do not
currently meet the minimum requirements for the continued listing of our common
shares on the exchange. We have been granted a 45 day extension from our
original deadline of December 27, 2002 to meet the listing criteria, but the TSX
may limit this extension if the proposed Acquisition and Financing Transactions
are not completed. We believe that we will meet the criteria subject to the
completion of the Acquisition and Financing Transactions.
12
Risks Related to the Nature of the Entertainment Industry
The business of producing and distributing television programming is highly
competitive. We face intense competition with other producers and distributors,
many of whom are substantially larger and have greater financial resources. We
compete with other companies for ideas and storylines created by third parties,
as well as for actors, directors and other personnel. Therefore, there is a risk
that television projects will not be successful, possibly resulting in a portion
of costs not being recouped or anticipated profits not being realized.
Revenues derived from the production and distribution of television programming
depend primarily upon acceptance by the public, which is difficult to predict.
Some or all of our proprietary television programs may not be commercially
successful, resulting in our failure to recoup our investment or realize our
anticipated profits.
Fluctuating Results of Operations and Financing Risks
Results of operations for any period are significantly dependent on the number
and timing of television programs and motion pictures delivered. Consequently,
results of operations may fluctuate materially from period to period and the
results of any one period are not necessarily indicative of results for future
periods. In particular, results of operations in any period depend to a large
extent upon our production and delivery schedule for television programs and
motion pictures. As a result of the production cycle, our revenues are not
recognized evenly throughout any given year. Cash flows may also fluctuate and
may not directly respond with revenue recognition.
Our ability to maintain and expand our development, production and distribution
of proprietary programming and to cover our general and administrative expenses
depends upon our ability to obtain financing through equity financing, debt
financing (including credit facilities) or the sale or syndication of some or
all of our interests in certain projects or other assets. If our access to
existing credit facilities is not available, and if other funding does not
become available, there could be a material adverse effect on our business.
Our revenues have decreased to $6.5 million for fiscal 2002 from $54.9 million
for fiscal 2001. We underwent rapid production growth through 2001, which placed
increasing demands on our financial resources. As a result, we may fail to make
the contracted payments or meet the financial covenant requirements of our debt,
causing our lenders to demand immediate repayment of our debt.
If the business climate does not improve so that we may earn revenues from our
library of television programming, if we are unable to raise capital from
outside sources, and if we do not have the continued support of our creditors,
it is likely that we will be unable to continue operations.
Our auditors' report for our fiscal year ended August 31, 2002 includes
additional comments for U.S. readers on Canada-U.S. reporting differences that
arise due to conditions and events that cast substantial doubt on our ability to
continue as a going concern. The consolidated financial statements do not
include any adjustments as a result of that uncertainty.
Potential for Budget Overruns and Other Production Risks
Actual production costs may exceed budget, perhaps significantly, due to factors
within or beyond our control. These factors may delay or prevent completion of a
production. If there are significant cost
13
overruns, we may have to seek additional financing to complete the production.
Financing on terms acceptable to us may not be available. We may be unable to
recoup the additional costs, which could have a material adverse impact on
operating results and liquidity.
Risk of Loss of Key Customers
In fiscal 2002, we derived 73% of our revenues from three customers: PAX, Life
Network, and Nelvana who each accounted for 14% or more of our revenues. We
expect that a significant amount of our revenues will continue to be derived
from a relatively small number of customers. The loss of any of these customers
could have a material adverse impact on our results of operations and financial
condition.
Risks to Operations from Union Action
The film and television industry in British Columbia operates under collective
agreements with several unions. In the event that one or more of these unions
should take strike action, we may be unable to hire the required personnel to
produce our programming. This could result in a delay or cancellation of
production, causing a reduction in revenues and operating profits.
Risk Related to Overestimation of Ultimate Revenue
Investments in television programming are amortized against revenues in the
ratio that current revenues bear to management's estimate of ultimate revenues
for each program pursuant to the Statement of Position ("SOP-002") issued by the
Accounting Standards Executive Committee of the American Institute of Certified
Public Accountants. As a result of our policy we typically amortize a minimum of
80% of the costs over a three-year period. Management periodically reviews its
estimates and adjusts the amortization of our programming accordingly. In the
event that management should determine that the capitalized costs for a program
exceed its fair value, capitalized costs would be written down in the current
period, resulting in a corresponding decrease in earnings.
Government Incentive Programs
We currently finance a significant portion of our production budgets through
Canadian government agencies and incentive programs, including federal and
provincial tax credits, as well as through similar international arrangements in
the case of our international co-productions. These tax credits combined can
represent approximately 20% of an individual production budget. During the year,
tax credits represented on average 19.7% of our production budgets. We will
continue to qualify for these tax credits if, among other things, Canadians
beneficially own or control a majority of the voting rights of Peace Arch.
Because we have no way of confirming the actual beneficial ownership of our
shares, it is possible that non-Canadians could acquire and beneficially own a
majority of our voting rights. If Canadians fail to beneficially own or control
a majority of our voting rights at any time, we could lose such tax incentives
and the costs of our productions would increase substantially. Canadian law
requires Canadian conventional, specialty, pay and pay-per-view television
services to devote a certain amount of their programming schedules, including
prime time, to Canadian productions. If we fail to qualify as a Canadian
producer, it would be more difficult to obtain time slots in Canada for our
programming, a "slot" being a broadcast time period for a program. We believe we
will continue to qualify as a Canadian producer for this purpose as long as,
among other things, Canadians beneficially own or control a majority of our
voting rights. These incentive programs, including federal and provincial tax
credit programs, may be amended or eliminated in the future, which could result
in a material increase in the
14
effective cost of our productions. The loss or elimination of these tax and
business incentives would have a material adverse effect on our results of
operations and financial condition.
Proposed Government Incentives in the U.S.
In response to the outflow of film and television production from the U.S. to
Canada and other worldwide locations, legislators in the United States have
proposed legislation to allow for government incentives to encourage filmmakers
to locate production in the U.S. In July 2001, Senator Lincoln of Arkansas
introduced the U.S. Independent Film and Television Production Incentive Act,
which would provide a wage tax credit for the production of certain theatrical
films, telefilms and movies of the week that are shot in the U.S. and fall in
the US$200,000 to US$10 million wage expense bracket. The credit would apply to
25% of the first US$25,000 in qualified wages per employee. The bill has not
passed the U.S. Congress, may not be enacted or may not pass in its current
form.
In February 2002, California Governor Davis announced a proposal for a 15%
wage-based state tax-credit, modeled after the U.S. Independent Film and
Television Production Incentive Act, for California. Called the Anti-Runaway
Production Measure, the bill would apply to employees involved in the production
of a California-based film, and would not take effect until July 1, 2004. In
March 2002, the California State Assembly passed the bill. The bill has not
passed the California State Senate. Like the U.S. federal bill, the California
bill may not be enacted or may not pass in its current form.
Because the proposals in the U.S. have not been enacted into law, we cannot
assess the impact of such proposals on our business at this time. If such
proposals were to pass or if similar proposals were to become law, such
government incentives could have an adverse effect on our business and results
of operations.
Currency Risk
We receive a portion of our revenues from U.S. and international sources in U.S.
dollars, while our costs are payable primarily in Canadian dollars. Accordingly,
operating results can be affected by fluctuations in the US dollar exchange
rate. We do not maintain US currency balances in excess of our estimated US
payables. In addition, costs may be payable in currencies other than Canadian
and US dollars. From time to time we employ derivative investments to reduce our
exposure to foreign currency risks. We had no derivative instruments outstanding
at August 31, 2002, 2001, and 2000.
We are a Canadian corporation with our principal place of business in Vancouver,
British Columbia. Substantially all of our directors and executive officers and
some of the experts named in this report are not residents of the U.S. and
virtually all of the assets of these persons and substantially all of our assets
are located outside the U.S. As a result, it may not be possible for you to
serve summons and complaints within the U.S. upon these persons or upon us.
Similarly, it may not be possible to enforce in U.S. courts, against such
persons or against us, judgments of U.S. courts based upon civil liability
provisions of the U.S. federal or state securities laws. In addition, it may be
difficult in Canadian courts for you, in original suits or in suits for the
enforcement of judgments of U.S. courts, to enforce civil liabilities based upon
U.S. federal or state securities laws against us or our directors or executive
officers, or our experts. We have appointed National Registered Agents, Inc. of
Washington, D.C., to act as agent for service of process in any action in any
U.S. federal or state court brought against us under the securities laws of the
U.S.
15
ITEM 4. INFORMATION ON THE COMPANY
A. HISTORY AND DEVELOPMENT OF THE COMPANY
We are a vertically integrated company that develops, finances, produces and
distributes high-quality, proprietary television programming for markets
worldwide. We also provide production services for third parties on a contract
basis. Our head office is based in Vancouver, British Columbia, Canada, one of
North America's major production centers. As a Canadian producer, we believe we
currently have a number of competitive advantages over producers outside of
Canada, including tax and other government incentives. With facilities in
British Columbia, we also believe we have a competitive advantage over producers
in other parts of Canada due to our proximity to Los Angeles, British Columbia's
varied geography and its temperate climate.
We were incorporated as Vidatron Enterprises Ltd. under the laws of British
Columbia on October 22, 1986 by registration of our Memorandum and Articles. On
February 13, 1992, we consolidated our share capital on a one new for five old
basis, increased our authorized share capital to 25,000,000 common shares
without par value and 25,000,000 serial preference shares without par value, and
changed our name to The Vidatron Group Inc. On February 5, 1997, we further
consolidated our share capital on a one new for four old share basis, increased
our authorized share capital to 25,000,000 common shares without par value and
25,000,000 preference shares without par value and changed our name to Vidatron
Entertainment Group Inc.
By resolution dated July 14, 1999 our share capital was reorganized by
converting our Common Shares into Class A Multiple Voting Shares and Class B
Subordinate Voting Shares, and by converting each 5 issued and outstanding
Common Shares into 1 Class A Multiple Voting Share and 1 Class B Subordinate
Voting Share. At the same time, we changed our name to "Peace Arch Entertainment
Group Inc.". All references in this document to share data refer to post
consolidated shares.
Since our incorporation in 1986, we have been involved in producing and
marketing a variety of products ranging from consumer based instructional
videos, to integrated corporate training programs, to individually contracted
corporate videos, feature films, television documentaries and television
commercials. Historically, we derived the bulk of our revenues from production
service arrangements whereby we were retained to produce a video program, film
or television commercial for a fee.
In 1996, we commenced a shift in our business toward the production of
proprietary television programming. The first steps in this process were the
production of the feature length family films Double Play and Ronnie and Julie.
Our shift into the business of proprietary television production was accelerated
through the acquisition of Peace Arch Productions Inc. (formerly Sugar
Entertainment Ltd.) in September 1996. Our principal motivation for expanding
into this business was that it offered us greater potential for growth than our
prior businesses. We also believe that the production of proprietary programming
offers us the ability to create and expand a library of programming which will
generate long term value.
As part of the Asset Acquisition of the Acquisition and Financing Transactions,
in December, 2002, subject to shareholder and regulatory approval we entered
into a series of agreements to acquire a portfolio of assets which include an
interest in five feature films and the forward business of Toronto based
Greenlight Film & Television Inc., one of Canada's largest independent producers
of theatrical motion pictures. See "Proposed Acquisition and Financing
Transactions" in Item 3D above. We believe
16
that the Asset Acquisition will add significant management expertise and will
put us in a strong position for future growth.
Our Class A Multiple Voting Shares and Class B Subordinate Voting Shares trade
on the Toronto Stock Exchange under the symbols "PAE.A" and "PAE.B",
respectively. Our Class B Subordinate Voting Shares also trade on the American
Stock Exchange under the symbol "PAE".
Our consolidated financial statements are stated in Canadian Dollars (CDN$) and
are prepared in accordance with Canadian Generally Accepted Accounting
Principles (GAAP). The application of GAAP conforms in all material respects for
the periods presented with U.S. GAAP except as explained in footnote 20 to our
fiscal 2002 consolidated financial statements included under Item 17 to this
Form 20-F.
Our head and registered office and production/distribution facility is located
in the Peace Arch Building, Suite 500, 56 East 2nd Avenue, Vancouver, B.C.
CANADA V5T 1B1. Our telephone number is (604) 681-9308 and facsimile number is
(604) 681-3299. The contact person is Juliet Jones, President, and a Director.
Our agent for service in the U.S. is National Registered Agents, Inc., 1090
Vermont Avenue, NW, Suite 910, Washington, D.C. 20005.
Capital Expenditures and Divestitures
In August 1999, we sold our Hamilton Street, Vancouver, British Columbia
property for gross proceeds of $3.27 million. We received cash in the amount of
$550,000 and a note in the amount of $817,295, bearing interest at 12% per
annum. The principal was due and repaid in the year ended August 31, 2000.
In October 2001, we sold our studio building located at 310 West 4th Avenue,
Vancouver, British Columbia for gross proceeds of $2.31 million. We realized net
cash proceeds of $1.46 million from the sale, which were utilized to pay down
our subordinated debt.
In January 2002, we sold our West 1st Avenue, Vancouver, British Columbia studio
property for gross proceeds of $4.72 million, consisting of cash in the amount
of $3.72 million and a note in the amount of $1 million. The note receivable,
which bears interest at 9% per annum, is due on January 1, 2004 and is secured
by a second mortgage on the property. We realized net cash proceeds of $1.03
million from the sale, which were utilized to pay down our subordinated debt.
In our normal course of business, we invest in television programming that we
capitalize and amortize as described in the August 31, 2002 audited financial
statements, Note 3(d) attached hereto. The amounts capitalized to investment in
television programming were $31.6 million in 2000, $52.1 million in 2001, and
$1.6 million in 2002.
In addition we incurred general capital expenditures in respect to operations of
$589,000 in 2000, $178,000 in 2001, and $44,000 in 2002.
The information in this Annual Report is stated as of January 6, 2003, unless
otherwise indicated.
B. BUSINESS OVERVIEW
17
Development
We develop programming including episodic series, movies and documentaries. The
initial stage in the process of creating programming is concept development. We
select programming concepts that we believe will have domestic and international
market appeal. We often arrange for the involvement of industry recognized
creative talent, including writers, producers, directors and actors, which makes
the programming more saleable and increases the value of our library. In some
cases, one or more of these people may already be involved when we become
involved.
Our development department receives and evaluates written concepts, scripts,
books and other literary properties from agents, writers and prospective
production partners around the world. After the selection and acquisition of the
necessary rights to source material, we generally involve broadcasters,
distributors and investors in the further development of the concept. These
activities often include the preparation of a series "bible", script writing or
the production of a promotional reel that can be used as a sales tool.
Production
The production of proprietary programming involves the assembly of a team of
production personnel, including script writers, directors, cast and crew. In the
case of larger-budget drama productions such as First Wave, The Immortal and Big
Sound, this team can include over 150 people per production who are hired either
as employees or independent contractors. For our documentary and lifestyle
productions our production team is smaller and many functions are performed
using in-house resources. We form a wholly-owned production company for each
production which retains the necessary employees and contractors.
In addition to our proprietary programming, we also produce creative works that
are directed to training, education and the information needs of third parties.
We offer domestic and foreign language production services for network
television including entertainment segments, news segments and electronic press
kits, as well as sports, entertainment and documentary all under various
contract arrangements. While these production services represent only a small
portion of current revenues, we plan to continue to pursue production service
arrangements because they provide a training ground for our creative staff,
foster our relationships with key industry participants and keep our facilities
utilized during hiatus production periods of our television series programming.
Our proprietary programming and production services offer high production values
and generally require extensive studio and on-location filming or taping,
special visual effects, music scoring, editing and post-production finishing.
Many of these activities are undertaken by our crews using facilities and
equipment that we own or rent. Other key activities, including sound mixing and
post-production finishing, are subcontracted to companies that specialize in
these areas.
Since inception, we have produced feature length films, documentaries and
various specialty programs for television. We have also produced 166 one-hour
episodes and 90 half-hour episodes of television series programming. During
fiscal 2002, we delivered one documentary and 17.5 hours of episodic
programming, including 2 hours of production services. We have completed
production of an additional 13 one-hour episodes of our series Animal Miracles
with Alan Thicke, and eight one-half hour episodes of Whistler Stories were
delivered during the first quarter of fiscal 2003.
18
Our current proprietary programming and other productions include:
First Wave. We have completed three 22-episode seasons of our science fiction
thriller television series First Wave. First Wave was produced in association
with FremantleMedia (formerly Pearson Television), Francis Ford Coppola and
Chris Brancato. Mr. Coppola is an Academy Award winner and producer and director
of "The Godfather" trilogy and co-screenwriter of "Apocalypse Now" and Mr.
Brancato is an accomplished screenwriter ("Species 2" and "Hoodlum"). We sold 66
episodes (all three seasons) of First Wave to USA Networks' Sci-Fi Channel.
FremantleMedia distributes First Wave outside of North America. CHUM Television
ordered 66 episodes for broadcast in Canada. In 2000 First Wave won a Leo Award
for best male performer. The Leos recognize excellence in British Columbia film
and television production.
The Immortal. We have completed production of 22 one-hour episodes of our
television series titled The Immortal, co-produced with Alta Productions
Limited, a Studio 8 Company, of the United Kingdom. The Immortal is based on the
short story "The Tao of the Immortal" by Cary Solomon and Chuck Konzelman. CHUM
Television premiered The Immortal nationally in Canada on SPACE: The Imagination
Station in the spring of 2001. The Immortal has been in syndication in
approximately 80% of the United States market and airs in various countries
around the world.
Big Sound. In May 2001 we completed production of 22 episodes of our 1/2-hour
comedy series, Big Sound, which is set in the music industry. Big Sound,
co-produced with Studio 8 of the United Kingdom, was produced in association
with Global Television, a CanWest company, in Canada. In 2001, Big Sound won the
following Leo Awards: Best Music, Comedy or Variety Program or Series; Best
Musical Score in a Music, Comedy or Variety Program or Series for John Mitchell;
and Best Performance or Host in a Music, Comedy or Variety Program or Series for
Deanna Milligan.
Animal Miracles with Alan Thicke. We have completed production of our third
season of 13 one-half hour episodes of Animal Miracles with Alan Thicke. Animal
Miracles tells the stories of the close relationships that humans develop with
animals. We hold the world-wide rights to the series and have presold the third
season to Life Network Inc. in Canada and PAX in the United States. We are
actively pursuing agreements to sell additional seasons of Animal Miracles with
Alan Thicke.
Whistler Stories. We have completed production of the first season of 13
one-hour episodes of Whistler Stories. Whistler Stories is a weekly series which
explores the interwoven lives of real people who work and play in the Whistler,
Canada area during the 2001/2002 winter season. The program explores the
ambitions and passions of these people, in a setting of supernatural beauty and
athletic risk-taking at one of the world's top ski and snowboarding resorts. We
hold the world-wide rights to the series and have presold the first season,
which is scheduled to premiere on January 20, 2003, to Life Network Inc. in
Canada. We are actively pursuing agreements to sell additional seasons of
Whistler Stories.
Documentaries. We have just completed production on two documentaries, Fantasy
Lands, a look at our fascination with theme parks, and the documentary on world
renowned native artist Bill Reid entitled Raven In The Sun. During fiscal 2002,
we also produced the documentary Rites of Passage for TLC, which takes a
provocative and fascinating look at contemporary male initiation rites in North
America. We have also produced two one-hour documentaries for CTV and The
Knowledge Network: Citizen Shame, about child poverty in Canada, and Harm's Way,
about youth and violence. These programs were financed through Canadian
broadcast sales and government incentive programs. We retain the right to
exploit these programs worldwide. In addition, we produced: Heroines, a dark and
thought provoking expose of the dark world of heroine addiction among women,
Cake Night, a special on substance abuse
19
and It's a Mall World, a one-hour fun filled look at the North American
phenomenon of shopping malls which has aired on the Discovery Networks TLC in
the United States and Canada. In 2002, Heroines received four Leo Award
nominations, including a win for Best Arts/Performing Arts Program, and was
nominated for three Gemini Awards, as well as receiving four awards at the
Yorkton Short Film & Video Festival, including Best of the Festival and Best
Documentary - General Subject.
Feature Length Films. In addition to our current activities, we produced
numerous feature films and documentaries. These include: Cadence, a feature
length film starring Martin Sheen and Charlie Sheen; Island of Whales, a feature
documentary narrated by Gregory Peck and commissioned by the PBS Nova Series;
Outside Chance of Maximillian Glick, an award-winning Canadian feature film and
three 90-minute made-for-television movies based on the Catherine Marshall
Christy stories. Christy tells the story of a courageous teacher who leaves the
city to teach at a mission school in the Appalatian Mountains in 1912. We have
also participated in the production of two feature length films, namely, Now &
Forever, a dramatic contemporary love story starring Mia Kirshner and Adam Beach
and directed by award winning director, Bob Clark, and The Impossible Elephant,
an endearing family story. Now & Forever won the Audience Favorite Award at the
Festival of Festivals in Palm Springs held in November 2002. The Impossible
Elephant won the YTV Silver Sprocket Award at the Toronto Children's
International Film Festival held in April 2001. The Silver Sprocket is presented
to the audience's favourite feature film. We have also produced two installments
of our Contemporary Classics youth movie series made in association with
Showtime and Hallmark Entertainment Network--Double Play and Ronnie and Julie.
Prior pictures in the series include Annie O, The Halfback of Notre Dame and
Robin of Locksley.
Major television networks around the world are faced with increasing competition
from various sources including basic and specialty cable channels, satellite,
digital stations and the Internet. This fragmentation of the market, combined
with downward price pressure due to a weak worldwide market for television
programming, has resulted in a demand for more cost-effective programming. In
order to meet market demands, we currently plan to increase the production of
lower cost reality and factual programs, will continue to take advantage of tax
credits and government incentives and will focus on programming with global
market appeal.
Library
We hold varying ownership interests in our proprietary productions. It is our
strategy to focus on increasing ownership and control over exploitation to
continue to build significant future asset value. During fiscal 2002, we added
16.5 hours of programming to our library. During fiscal 2001, we added 56.5
hours of programming to our library. At August 31, 2002, our library contained
approximately 222 hours of proprietary programming. We will continue to expand
our library as we produce more proprietary programming.
Marketing and Distribution
We market and distribute our proprietary television programming under
arrangements with worldwide distributors and agents. We also market and
distribute titles in our library to existing pay and free television, home video
and other markets worldwide, as well as through developing technologies. We
typically directly distribute our programming in North America and contract with
international distributors and sales agents, such as FremantleMedia, Oasis, and
Rive Gauche to distribute our programs in markets outside North America. This
strategy provides us with two principal benefits. We avoid the substantial costs
and financial risks of distributing our programs to markets throughout
20
the world and, in certain circumstances, allows us to secure distribution
advances to provide cash flow for the production.
Increasingly, we are reducing the use of distributors and handling certain
distribution activities in-house or through specialized sales agents. This
strategy sometimes requires more up-front capital, but can result in reduced
distribution fees and expenses in the long run. It also allows us more control
over the distribution process.
Our marketing efforts are focused on creating branded identities for our
proprietary programs. We believe that such branded identities will lead to
additional revenues from television and home video distribution and ancillary
markets such as clothing, toys, novelties, books, CDs, soundtracks and other
audio products, electronic and video games, Internet applications and other
merchandise.
This table shows the breakdown of our total revenues during our past three
fiscal years by activity and by geographical market:
Year Ended August 31,
------------------------------------------------------
2000 2001 2002
------------------ ----------------- -----------------
(Canadian dollars in millions)
REVENUES BY ACTIVITY
Proprietary programming.................................... 31.7 45.9 2.8
Production services........................................ 2.8 9.0 3.6
Other...................................................... 0.9 0.5 0.1
REVENUES BY GEOGRAPHIC MARKET
Canada..................................................... 5.3 13.0 2.4
U.S. ...................................................... 8.1 22.9 4.1
Europe and other markets................................... 22.0 19.5 0.0
Key Relationships
We believe that our relationships with domestic and international broadcasters,
distributors, financing sources and creative talent are important to the
successful expansion of our proprietary television business.
U.S. and International Broadcasters and Distributors. We have produced our
programming in association with a variety of U.S. and international broadcasters
and distributors including Buena Vista Television, FremantleMedia, Hallmark
Entertainment Network, MGM, USA Network's Sci-Fi Channel, Telmunchen, TFI,
Columbia Tristar, MTV and Showtime Networks.
Canadian Domestic Broadcasters. We have a long-standing relationship with the
Canadian broadcast community, including CHUM-City, CTV, Global, Life Network
Inc., Knowledge Network and The Family Channel. We sold the initial 22-episode
season of our 1/2-hour comedy series Big Sound to the Global Television Network.
We sold our television series The Immortal, First Wave and Dead Man's Gun to
CHUM-City. We have sold our television series, Animal Miracles with Alan Thicke
and Whistler Stories to Life Network. We have also licensed two documentaries,
Harm's Way and Citizen Shame, to CTV and Knowledge Network, licensed our
documentary Heroines to Bravo, WTN, and CBC, and licensed our television movies,
Double Play and Ronnie and Julie, to The Family Channel.
21
Canadian broadcaster relationships are an integral part of producing in Canada,
not only for the sales revenues they represent, but also because their
involvement makes it possible to take advantage of various government
incentives. See the discussion under "Regulatory Considerations--Canadian
Content Requirements" for further details of these incentives.
Producing and Writing Talent. We have worked with Francis Ford Coppola and
screenwriter Chris Brancato (Species 2 and Hoodlum), who is the creator and lead
writer on First Wave. Our first dramatic television series, Dead Man's Gun, was
created by Howard and Ed Spielman ("Kung Fu" and "Young Riders") and produced in
association with Henry Winkler (Happy Days and MacGyver). David Steinberg, whose
writing and directing credits with U.S. Network sitcoms include Mad About You,
Friends and Seinfeld, joined our creative team to assist us with the development
of our 1/2-hour sitcom Big Sound. We hire Canadian talent at all levels in the
production of our programs, including writers, directors, production designers,
editors and actors.
Industry Overview
THE TELEVISION PRODUCTION INDUSTRY
The North American television production and distribution industry serves the
largest broadcast market in the world, with a population of nearly 300 million
people. In the last decade the growth of broadcasting and cable television
markets outside North America through the privatization of broadcasting systems,
the proliferation of broadcast licenses and the introduction of new delivery
technologies, such as cable and satellite transmission systems, combined with
the decrease in United States revenues per program due to market fragmentation
has led to a higher proportion of revenues from international markets.
Generally, the right to broadcast a program is licensed by a production company
to a combination of the U.S., Canadian and international broadcasters, including
free television and cable networks or individual television stations in the
first-run syndication market. After the initial network, cable licensing or
first-run syndication period, the program is available for further commercial
exploitation on cable or in syndication.
As discussed above, the current fragmentation of the market, combined with
downward price pressure due to a weak worldwide market for television
programming, has resulted in a demand for more cost-effective programming, such
as lower cost reality and factual programs.
NORTH AMERICAN MARKETS
In North America, programming is delivered to the end user by way of free
television networks, cable channels and networks, individual television stations
and satellite delivery services. Free television networks include NBC, CBS, ABC,
Fox, UPN, WB and PBS in the U.S. and CBC, CTV and the Global Television Network
in Canada. Each of the major free television networks in the U.S. and Canada
currently schedules approximately 22 hours of programming in prime time during
the hours from 8 p.m. to 11 p.m. Monday through Saturday, and 7 p.m. to 11 p.m.
on Sunday of each week. Programming generally consists of a mix of
movies-of-the-week, mini-series, half-hour comedy and hour-length drama, factual
and reality based programming, or action/adventure series.
In recent years, alternatives to the free television networks in the U.S. have
expanded with the growth of other networks, cable channels and the development
of a first run syndication market leading to more
22
available slots for television programming. Cable channels include HBO,
Showtime, USA Networks, Lifetime, The Family Channel, TNT and TBS in the U.S.
and TMN, Super Ecran, Movie Central (formerly Super Channel), Channel D and
Showcase in Canada.
INTERNATIONAL MARKETS
Over the past ten years, the worldwide television industry experienced growth as
a result of the development of new television broadcasting systems outside of
North America. These systems represented significant new sources of revenue for
television producers. Factors contributing to the growth of the worldwide
television industry included the introduction of direct broadcast satellite
services and pay television, as well as increased cable penetration and the
growth of home video. Some foreign broadcasters sought out both indigenous
programming in order to satisfy the local content regulations of their broadcast
licenses, and international programming, largely from North America, to appeal
to a wide audience. We frequently look to structuring our productions as
international co-productions and thereby produce "international" programming
that qualifies as indigenous in more than one country. In the most recent year,
an overall economic downturn causing a decline in broadcast revenues has put
downward price pressure on programming.
CANADA'S ROLE IN THE TELEVISION AND FEATURE FILM INDUSTRY
The Canadian film and television industry in 2001 generated total production
activity of more than $4.4 billion. At the same time as the domestic industry
has matured, Canada has become a leading location for internationally originated
productions due to several factors. Canada's geographic proximity to the U.S.
and shared North American values and interests have led to the establishment of
close professional contacts between Canadian and U.S. studios, independent
producers, distributors and buyers. The current favorable exchange rate of the
Canadian dollar, government tax incentives and the availability of free location
assistance to television producers offered by many Canadian cities and several
provinces increased production activity in Canada. Canada has made an effort to
increase its pool of highly trained and professional crews, technicians and
production personnel. Finally, with its wide-ranging topography, stretching
3,400 miles from coast to coast, Canada is ideally suited for location shooting.
Urban centers such as Toronto, Vancouver and Montreal have been disguised as
London, Paris, New York, Los Angeles and Chicago. U.S. companies with a strong
presence in Canada include major U.S. studios such as Paramount, Disney,
Universal Pictures and Columbia Pictures/Tri-Star Pictures; U.S. television
networks such as ABC, NBC, CBS, Fox, UPN, WB and PBS; and film companies such as
The Hearst Corporation and New World Entertainment, Inc., among many others.
European and Asian film companies have also found Canada to be an attractive
location and have often been able to access Canada's numerous international film
and television co-production treaties.
Nonetheless, the weak worldwide market for television programming generally
caused an industry slowdown that is reflected in reduced production activities
in the Canadian market place.
COMPETITION
Television production and distribution are highly competitive businesses. We
face competition from companies within the entertainment business, as well as
alternative forms of leisure entertainment such as travel, sporting events,
outdoor recreation and other cultural activities, among many others. We compete
with numerous suppliers of television programming and related programming,
including national television networks and independent television production
companies, many of which are significantly larger and have substantially greater
resources than we have. Our main competitors in
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Canada include Alliance Atlantis Communications Corporation, Fireworks
Entertainment, owned by CanWest Global Communications Corp., and Lions Gate
Entertainment Corp. In the U.S. our competitors include Spelling Entertainment
Group Inc. and Carsey-Werner. We believe that we currently have a competitive
advantage over U.S. competitors through our eligibility for Canadian tax credits
described below under "--Regulatory Considerations--Industry Incentives". We
also enjoy a competitive advantage over producers in other parts of Canada due
to our proximity to Los Angeles, and British Columbia's varied geography and
temperate climate.
REGULATORY CONSIDERATIONS
Our status as a producer of "Canadian" programming, established and operating in
British Columbia, makes us eligible to receive Canadian tax and business
incentives.
We will continue to qualify for these tax and business incentives if, among
other things, Canadians beneficially own or control a majority of the voting
rights of Peace Arch. Approximately 55% of the voting power of our outstanding
shares is held by Canadians. However, we have no way of confirming actual
beneficial ownership of our shares. If Canadians fail to beneficially own or
control a majority of Peace Arch's voting rights, we could lose our eligibility
for these tax and business incentives. These tax and business incentive programs
also may be amended or eliminated in the future. The loss or elimination of
these tax or business incentives would have a material adverse effect on the
results of our operations and financial condition.
CANADIAN CONTENT REQUIREMENTS
Canadian conventional, specialty, pay and pay-per-view television services are
required to devote a certain amount of their programming schedules, including
prime time, to Canadian productions. Compliance with these requirements is
enforced by the Canadian Radio-Television and Telecommunications Commission
("CRTC") and failure to comply can result in fines or the loss of a license.
These requirements provide support to the market for Canadian programming, such
as those we produce, as long as they qualify as Canadian programming for CRTC
purposes.
In addition to scheduling requirements, Canadian conventional, specialty, pay
and pay-per-view television services are typically required to invest in, or
acquire, Canadian programming based on the nature of the particular service and
financial performance. The requirement for a broadcaster to spend a specific
amount on Canadian programming typically takes the form of policies or
conditions of license. The nature of such spending ranges from expenditures on
script and concept development to expenditures on specific categories of
Canadian production.
The CRTC determines the criteria for certification of a program as "Canadian".
According to CRTC regulations, a program will qualify if it is produced by an
individual Canadian producer with the involvement of individual Canadians in key
creative functions, and where a substantial portion of the remuneration paid to
individuals is for services provided by Canadians and processing and final
preparation costs are for services provided in Canada. A program may still
qualify as "Canadian" even though some of the producer functions are performed
by non-Canadian individuals, if the production company is a "Canadian production
company" and other requirements are met. A "Canadian production company"
includes a Canadian company which carries on business in Canada with a Canadian
business address, which is owned or controlled by Canadians and whose principal
business is the production of film, videotape or live programming for
distribution on television or in theatrical, industrial or educational markets.
We believe that we will continue to qualify as a "Canadian production company"
24
for this purpose, so long as Canadian citizens or permanent residents
beneficially own more than 50% of the combined voting power of our outstanding
shares or if we are controlled by Canadians.
The CRTC also requires Canadian conventional broadcasters to adhere to the
Canadian Association of Broadcasters' "Broadcast Code for Advertising to
Children".
INTERNATIONAL CO-PRODUCTION
Canada is a party to co-production treaties with more than 50 countries
throughout the world, excluding the U.S. Canada's co-production treaties allow
for the reduction of the risks of production by permitting the pooling of
creative, technical and financial resources of Canadian producers with
non-Canadian producers under prescribed conditions. Canadian co-production
treaty partners include China, France, United Kingdom, Germany, Italy, Hungary,
Israel, Mexico, New Zealand and Australia. A production that qualifies as a
co-production for treaty purposes is considered to be a national product in each
of the participating countries and, as such, is entitled to many local
advantages in each country. More specifically, the co-production usually
satisfies criteria for national certification in regard to content broadcasting
regulations, government subsidies and tax benefits. The copyright in the
production is shared by the co-producers, while the domestic distribution rights
are generally owned by the respective co-producers. Sharing of foreign revenues
is based on the respective contribution of each co-producer, subject to
negotiation between the co-producers and approval by the appropriate government
authorities. Two of our series, Big Sound and The Immortal, were produced under
The Canada/United Kingdom Co-production Treaty.
INDUSTRY INCENTIVES
(A) REFUNDABLE INCOME TAX CREDIT - FEDERAL
Since 1995, a refundable tax credit has been available under the Income Tax Act
(Canada) for eligible film and television productions undertaken by qualified
Canadian corporations. The tax credit is equal to 25% of the lesser of qualified
labor expenditure and 48% of eligible costs of production of a given project.
Eligible costs of production are total production costs less any other
government assistance, including any provincial refundable tax credit. Since our
labor expenditures for a production typically exceed this limitation, we are
generally eligible to receive a federal tax credit equal to 12% of the eligible
costs of production. The credit is calculated on the basis of each individual
production and is available only to taxable Canadian corporations which have
activities that are primarily those of a Canadian film or video production
business carried on through a permanent establishment in Canada and which are
Canadian-controlled as determined under the Investment Canada Act. A corporation
is controlled by Canadians for purposes of the Investment Canada Act where,
among other things, Canadians own and control a majority of the voting interest.
We currently qualify for this tax credit, and the reclassification of our Common
Shares into Class A Multiple Voting Shares and Class B Subordinate Voting Shares
and other changes to our Articles assists us in continuing compliance while
allowing for non-Canadian investment. We believe that so long as, among other
things, we continue to be Canadian-controlled as determined for the purposes of
the Investment Canada Act, we will continue to so qualify and we will use our
best efforts to ascertain that all our production projects will continue to be
eligible for the tax credit. Federal tax credits refundable to us pursuant to
the Income Tax Act (Canada) for television programming delivered in fiscal 2002
amounted to $420,000.
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(B) REFUNDABLE INCOME TAX CREDIT - PROVINCIAL
Under the terms of the current film and television provincial tax credit system
under the Income Tax Act (British Columbia), British Columbia offers refundable
tax credit incentives for British Columbia film productions. The incentives are
available at the following levels:
o Basic incentives equal to 20% of qualified British Columbia labor
expenditures.
o A regional incentive equal to 12.5% of qualified British Columbia labor
expenditures for productions where principal photography occurs outside of the
Greater Vancouver area in British Columbia.
o A training incentive equal to the lesser of 3% of British Columbia labor
expenditures or 30% of qualified labor expenditures attributable to payments to
eligible industry trainees.
Eligible labor expenditures are limited to 48% of the total production costs,
net of government assistance. The credit is calculated on the basis of each
individual production and is available only to a qualified corporation having a
permanent establishment in British Columbia and carrying on an eligible film or
television production business through a permanent establishment in Canada. In
order to access the basic credit, the corporation must also be controlled by
persons domiciled in British Columbia. Peace Arch will continue to be controlled
by persons domiciled in British Columbia so long as more than 50% of the members
of our board of directors are persons domiciled in British Columbia and more
than 50% of the combined voting power of our outstanding shares are beneficially
owned by persons domiciled in British Columbia. In addition, in order to access
the basic credit, the producer of the eligible production must be a British
Columbia resident for tax purposes. As the British Columbia tax credit system
was not established until 1998, we did not receive any tax credits in fiscal
1998. We have received tax credits under the British Columbia program on account
of television programming delivered in our 2002 fiscal year in the amount of
approximately $338,000.
In connection with the proposed Acquisition and Financing Transactions, subject
to shareholder and regulatory approval, we have entered into agreements to issue
shares to Ontario residents that would result in less than 50% of the combined
voting power of our common shares being held by residents of British Columbia.
We also anticipate that, if the Acquisition and Financing Transactions are
consummated, less than 50% of the members of our board of directors will be
persons domiciled in British Columbia. As a result, we anticipate that we will
not be able to directly access the basic credit and that for programs produced
in British Columbia, we will have to rely on partnerships with eligible
producers. However, as a result of the issuance of the aforementioned shares, we
anticipate that we will be able to access tax credits under the Ontario tax
credit program for programs produced in Ontario, which is comparable to the
British Columbia tax credit program.
(c) PRODUCTION SERVICES TAX CREDIT
In October 1997, the Canadian Minister of Finance announced the creation of a
new program to support film and video productions in Canada. Effective November
1, 1997, the film and video production services tax credit replaced the
privately promoted tax shelters that were affirmatively terminated on October
31, 1997, with a tax credit for films that do not satisfy all the requirements
of a Canadian-certified film or video production described above. This program
currently provides eligible production corporations engaged in an accredited
production with a tax credit equal to 11% of their qualified Canadian labor
expenditures for a production incurred after October 1997. An eligible
production corporation is a corporation that carries on a film or video
production business through a permanent
26
establishment in Canada, and that owns the copyright on an accredited production
throughout the period in which it is produced in Canada or that has contracted
directly with the owner of the copyright to provide production services in
Canada where the owner of the copyright is not an eligible production
corporation. An accredited production is a film or video production with a
production cost of not less than $1.0 million incurred during the two-year
period that begins with the principal filming or taping of the production. A
production that is part of a series of two or more episodes, or that is a pilot
program for such a series, also qualifies as an accredited production if the
production costs of each episode incurred during a two-year period that begins
with the principal filming or taping of the production exceeds $100,000 for an
episode with a running time of less than 30 minutes and $200,000 in any other
case. Accredited productions do not include, among other things, pornography,
advertising and various productions developed primarily for industrial,
corporate or institutional purposes. British Columbia has adopted a similar
program.
(D) CANADIAN TELEVISION FUND
The Canadian Television Fund ("CTF") is a private-public initiative with an
annual budget of about $250 million. It consists of two distinct but
complementary programs:
(i) License Fee Program
The License Fee Program was created in 1996 to form a television funding
initiative equal to approximately $80.0 million per year to promote high-quality
Canadian television programming. We could, for each project eligible under such
program, apply for contributions of up to 18% of the total production budget.
The maximum contribution varies with the categories of programs. During fiscal
2002 we recorded funding of $94,907 from the License Fee Program, and $273,894
in fiscal 2001.
(ii) Telefilm / Equity Investment Program
Administered for the CTF through Telefilm Canada, the Equity Investment Program
("EIP") provides financial assistance to the Canadian film and television
industry in the form of recoupable production advances. Telefilm Canada also
provides advances for script development, loan guarantees, recoupable advances
of the cost of dubbing into English or French and grants of up to 75% of
advertising and promotion costs on certain productions. Telefilm Canada's
development fund and the international component of their Marketing Assistance
Program are no longer available to publicly traded companies. In fiscal 1997 and
1998, we did not use Telefilm funding from the development fund or the
international component of the Marketing Assistance Program. In fiscal 1999 and
2000 we did not receive any funding from Telefilm Canada. In fiscal 2001 we
received an aggregate of $2,000,000 from the Equity Investment Program for
production funding in respect of Big Sound. In fiscal 2002 we did not receive
any funding from Telefilm Canada.
(E) OTHER GOVERNMENT INCENTIVES
We have also utilized production financing from other government sources
including, British Columbia Film, The Independent Production Fund and CanWest
Western Independent Producers Fund. We may use such funding in the future if we
believe it is prudent to do so.
Intellectual Property
27
We have the trademarks "Peace Arch Entertainment" registered in Canada, the
United States and the European Union. As well, we have the "Peace Arch" and
"StreamScapes" trademarks in Canada. We regard our trademarks as valuable
assets.
Copyright protection is a serious problem in the video cassette and DVD
distribution industry because of the ease with which cassettes and DVDs may be
duplicated. In the past, certain countries permitted video pirating to such an
extent that we did not consider these markets viable for distribution. Our
management believes the problem to be less critical at the present time. We will
explore initiating legal actions to enforce copyright protection when necessary.
C. ORGANIZATIONAL STRUCTURE
We have two wholly-owned significant operating subsidiaries, each incorporated
in British Columbia, Canada, as follows:
COMPANY NAME DATE OF INCORPORATION JURISDICTION OF INCORPORATION
------------ --------------------- ------------------------------
The Eyes Multimedia Productions Inc. 05/19/93 British Columbia, Canada
Peace Arch Productions Inc. 03/15/96 British Columbia, Canada
D. PROPERTY, PLANT AND EQUIPMENT
We lease 7,200 square feet of office space located in Vancouver, British
Columbia for our head office. The lease expires in June 2006. The basic rent for
the premises for the four fiscal years ending August 31, 2006 are $98,100,
$104,100, $104,700 and $89,700.
In October 2001, we sold our studio building located at 310 West 4th Avenue,
Vancouver, British Columbia for gross proceeds of $2.31 million. We realized net
cash proceeds of $1.46 million from the sale, which were used to pay down our
subordinated debt.
In January 2002, we sold our remaining production property, which is comprised
of approximately 55,000 square feet of studio, production office and storage
space, located at 150 West 1st Avenue, Vancouver, British Columbia. The property
was sold for gross proceeds of $4.72 million and, as consideration, we received
cash in the amount of $3.72 million and a note in the amount of $1 million. The
note receivable, which bears interest at 9% per annum, is due on January 1, 2004
and is secured by a second mortgage on the property. After repaying the existing
mortgage on the property, the remaining net cash proceeds of $1.03 million were
used to pay down our subordinated debt. We continue to occupy the West 1st
Avenue property through an operating lease arrangement to December 31, 2005 with
minimum monthly lease payments of $13,916. We are using approximately one-third
of the West 1st Studio for our production, Animal Miracles with Alan Thicke and
to house our ten digital post-production suites and two visual effects suites
which handle off-line editing for all of our productions. We sublease the
balance of the West 1st Avenue property to third parties at local market rates.
ITEM 5. OPERATING AND FINANCIAL REVIEW AND PROSPECTS
The following discussion should be read in conjunction with the consolidated
financial statements and related notes included elsewhere in this annual report.
28
GENERAL
We develop, produce and distribute proprietary television programming for
worldwide markets. These activities have comprised our core business since 1996,
when we commenced taking ownership in our programming. Peace Arch continues to
operate its other businesses, which include production activities on a fee for
service basis. Our growth is dependent on our ability to identify, develop and
acquire rights to ideas, storylines and other creative concepts and to
successfully finance, produce and market our proprietary programming.
Our business operates through several subsidiaries, which are established for
each production or series. The costs of production are financed by advances
obtained from customers, borrowings under a bank credit facility, contributions
from equity participants and working capital. Typically, we retain the rights to
our proprietary programming for exploitation in future periods and in additional
markets and media.
Revenues and expenses for television programming are realized when the license
period has commenced and the program or episode has been shipped. Deferred
revenues represent payments received in advance of a program or episode revenue
being realized.
Generally, the costs incurred in producing a film or television program are
capitalized. These costs include direct production costs, certain exploitation
costs, production overhead and interest relating to financing the project. Until
the date a program is completed, these costs are capitalized into "Productions
in progress" on the consolidated balance sheet. Costs related to completed
proprietary programming are included, net of tax credits and amortization, in
"Investment in television programming" on the consolidated balance sheet. Tax
credits are recorded when a program or episode is complete and reasonable
assurance exists of the amount realizable.
CRITICAL ACCOUNTING POLICIES
Our discussion and analysis of our financial condition and results of
operations, including the discussion on liquidity and capital resources, are
based on our consolidated financial statements that have been prepared in
accordance with Canadian generally accepted accounting principles. The
preparation of these financial statements requires management to make estimates
and judgments that affect reported amounts of assets, liabilities, revenues and
expenses, and the related disclosure of contingent assets and liabilities. On an
ongoing basis, management reevaluates its estimates and judgments, particularly
those related to the determination of the recoverability of investment in
television programming, productions in progress, goodwill, accounts receivable,
and investment tax credits receivable. Management bases its estimates and
judgments on historical experience, contractual arrangements and commitments and
on various other assumptions that it believes are reasonable in the
circumstances. Changes in these estimates and judgments will impact the amounts
recognized in the consolidated financial statements, and the impact may be
material.
Management believes the following critical accounting policies require more
significant estimates and judgments in the preparation of the consolidated
financial statements.
The consolidated financial statements have been prepared on the going concern
basis, which assumes the realization of assets and liquidation of liabilities in
the normal course of operations. If we were not to continue as a going concern
we would likely not be able to realize on our assets at values comparable to the
carrying value or the fair value estimates reflected in the balances set out in
the preparation of the consolidated financial statements. As described elsewhere
in this annual report, at August 31, 2002 there
29
are certain conditions that currently exist which raise doubt about the validity
of this assumption. While we have entered into agreements to raise additional
funds, restructure certain obligations and acquire a business and assets, these
proposed transactions are subject to regulatory and shareholder approval and
are, therefore, not assured. If we fail to complete these proposed transactions
or other financing we may be required to significantly reduce or cease
operations and liquidate assets, or seek potential buyers.
We have credit facilities with a Canadian chartered bank and loans from
subordinated lenders, all of which are secured by charges on our assets. The
credit facility balance and certain loans are due on demand pursuant to the
original terms of their agreements. We were not in compliance with debt
covenants with the debenture holders causing the obligation to be due on demand.
The debentures were fully repaid subsequent to year-end.
We record amortization of television programming based upon the ratio that
current revenues bear to estimated remaining unrecognized ultimate revenue as of
the beginning of the current fiscal year. Investment in television programming
is recorded at the lower of remaining unamortized film costs and fair value and
productions in progress are recorded at the lower of cost and estimated fair
value.
Estimates of future television programming revenue and fair value are impacted
by changes in general economic or industry conditions and market preferences.
These factors are primarily outside of our control. In addition, changes to our
distribution operations in the future due to restructuring or other business
decisions may impact management's estimates of future cash flows. Management
makes its estimates of future cash flows based on its best estimates of future
economic conditions as they impact Peace Arch. These estimates are reviewed
periodically in accordance with our policies. Significant decreases in future
estimates of revenue may result in accelerating amortization of television
programming costs or requiring unamortized costs and productions in progress
being written down to their fair value, based upon estimated future discounted
net cash flows from the related productions or series.
We assess the impairment of identifiable intangible assets, long-lived assets
(excluding the investment in television programming which is described above)
and related goodwill whenever events or changes in circumstances indicate that
the carrying value may not be recoverable. Factors we consider important, which
could trigger an impairment review, include significant underperformance
relative to historical or budgeted strategy, significant negative industry or
economic trends, or a significant decline in our stock price or market
capitalization for a sustained period of time. When we determine that the
carrying value of intangibles, long-lived assets and related goodwill may not be
recoverable due to the existence of indicators of impairment, we measure
impairment, if any, based upon projected net undiscounted cash flows expected to
be generated by those assets.
We maintain an allowance for doubtful accounts for estimated losses that may
arise if any of our customers or note holders are not able to make required
payments or if we no longer becomes eligible to receive tax credits claimable
under Canadian federal and provincial government assistance programs. Management
specifically analyses the age of outstanding customer balances, historical bad
debt experience, credit-worthiness and changes in payment terms, and our ability
to meet eligibility requirements for government assistance when making estimates
of the uncollectability of our accounts and other receivable balances. If we
determine that the financial condition of any of our debtors deteriorates,
increases in the allowance may be made.
30
BASIS OF PRESENTATION
Our business operates through separate subsidiaries established for each
production or series. The costs of production are financed through advances
obtained from customers, from borrowings under a bank credit facility, from
contributions from equity participants and from working capital. Typically, we
retain the rights to our proprietary programming for exploitation in future
periods and in additional markets and media.
Revenues and expenses for television programming are realized when the license
period has commenced and the program or episode has been shipped. Deferred
revenues represent payments received in advance of a program or episode being
shipped.
Generally, the costs incurred in producing a film or television program are
capitalized. These costs include direct production costs, certain exploitation
costs, production overhead and interest relating to financing the project. Until
the date a program is completed, these costs are capitalized into "Production
costs in progress" on the consolidated balance sheet. Costs related to completed
proprietary programming are included, net of tax credits and amortization, in
"Investments in television programming" on the consolidated balance sheet. Tax
credits are recorded when a program or episode is complete.
Investments in television programming are amortized against revenues in the
ratio that the current period's gross revenues from all sources for the program
bear to management's estimate of anticipated total gross revenues for such film
or program from all sources. Generally, we amortize a minimum of 80% of the
costs over a three-year period. Management periodically reviews its estimates
and adjusts the amortization of its programming accordingly. In the event that
management should determine that the capitalized costs for a program exceed its
fair value, capitalized costs would be written down in the current period,
resulting in a corresponding decrease in earnings.
In June 2000, the Accounting Standards Executive Committee of the American
Institute of Certified Public Accountants issued Statement of Position 00-2 (SOP
00-2). SOP 00-2 establishes new accounting standards for producers or
distributors of films including changes in revenue recognition and accounting
for exploitation costs, including advertising and marketing expenses.
Additionally, in June 2000, the Financial Accounting Standards Board rescinded
SFAS 53 "Financial Reporting by Producers and Distributors of Motion Picture
Films". Companies that were previously subject to SFAS 53 must now comply with
SOP 00-2. Peace Arch was compliant with SFAS 53 reporting. We elected to adopt
SOP 00-2 early, and applied the changes retroactively as required under Canadian
Generally Accepted Accounting Principles.
Results of operations for any period depend on the number of television programs
that are delivered. Consequently, results may fluctuate materially from
period-to-period, and the results of any one period may not necessarily indicate
results for future periods. Cash flows also may fluctuate and may not closely
correspond with revenue recognition.
Revenues from U.S. and international sources generally are payable to us in U.S.
dollars while costs are denominated primarily in Canadian dollars. Accordingly,
results can be affected by fluctuations in the U.S. dollar exchange rate. The
results of these fluctuations may be material. To date, we have not entered into
any material currency hedging instruments. In addition, we have not maintained
significant amounts of U.S. dollar balances in order to reduce the risk of
exchange rate fluctuations.
31
Due to the timing of U.S. television seasons and the lead-time required to
produce and deliver programs, revenues for the third fiscal quarter have
historically been lower than in other fiscal quarters. Production services and
other, which represented 57% of fiscal 2002 revenues, 17% of fiscal 2001
revenues, and 10% of fiscal 2000 revenues, are not subject to significant
seasonal variations.
As consideration for the acquisition of Peace Arch Productions Inc. (formerly
Sugar Entertainment Ltd.) in 1996, we issued an aggregate of 372,500 Class A
shares and Class B shares, giving retroactive effect to the share
reclassification and conversion, including 350,000 performance shares which were
issued and held in escrow as required by Canadian provincial securities policies
to which we are subject. The performance shares were subject to release with
consent of the British Columbia securities regulatory agencies, as specified
financial performance standards were met. At the time the shares were released
from escrow, we had recorded increases to goodwill and share capital based on
the fair value of the shares at the date the performance was determined. This
additional goodwill was amortized over 20 years until fiscal 1999, after which
we commenced amortizing the remaining balance over 10 years due to a change in
the estimate. During fiscal 1998, 200,000 of the performance shares were
released from escrow, resulting in increases in both goodwill and share capital
of $2.0 million. During fiscal 1999, the remaining 150,000 performance shares
were earned, resulting in additional goodwill and share capital increases of
approximately $0.8 million. The remaining shares were released from escrow
September 28, 1999.
In December 1997, beneficial ownership of an aggregate of 160,000 of the
performance shares was transferred to three of our officers and directors. The
transfer was subject to all of the escrow conditions at the same price per share
as was recorded when the performance shares were issued. Under Canadian GAAP,
the transfer is a capital transaction not involving Peace Arch and was not
accounted for as compensatory to any of the individuals who acquired the shares.
However, under U.S. GAAP, a compensation expense of Cdn$1.2 million was recorded
in the year ended August 31, 1998 in connection with the release from escrow of
the transferred performance shares.
During fiscal 2001, we wrote off the remaining unamortized cost of goodwill of
$2.7 million related to our 1996 acquisition of Peace Arch Productions Inc.
(formerly Sugar Entertainment Ltd.) in accordance with our policy.
A. OPERATING RESULTS
REVENUE. We reported an 88% reduction in revenue for fiscal 2002, from $54.9
million to $6.5 million, due to a reduction in the amount of dramatic television
programming produced and sold in 2002. Revenue for fiscal 2001 increased by 58%
to $54.9 million up from revenue of $34.7 million for the prior comparable year.
Due to the worldwide reduction in demand for programming, and reduced cash flow
available for development, we have experienced a sharp decline in our production
and distribution activities for dramatic television programming, which typically
makes up the majority of our revenues. During fiscal 2002 we increased
production of lifestyle and documentary programming, which reports less revenues
but adds value to our library of television programming.
During fiscal 2002, approximately 43% of revenue was derived from the production
and distribution of proprietary programming, compared with 84% in 2001 and 92%
in 2000. For fiscal 2002, revenue from proprietary programming decreased by 94%
in comparison to fiscal 2001. For fiscal 2001, revenue from proprietary
programming increased by 45% in comparison to 2000. During fiscal 2002, we
delivered 13 episodes of the second season of our prime-time series "Animal
Miracles", eight episodes of our new 13-episode series "Whistler Stories", and
our one hour documentary special "Rites of Passage".
32
Production services revenue represented 55% of total revenue compared with 16%
in fiscal 2001 and 8% in fiscal 2000. The increase in the relative amount of
service revenues for 2002 was primarily due to the significant decrease in
proprietary programming for the year. Production services revenue for fiscal
2002 included delivery of the remaining four episodes of the 13-episode series
"Sausage Factory" and for fiscal 2001 included 9 episodes.
Management anticipates that revenue for the first two quarters of fiscal 2003
will reflect a decrease when compared to the comparable quarters of fiscal 2002
due to a reduction in the amount of production services revenues. We anticipate
that we will deliver our third 13-episode season of "Animal Miracles", the
remaining eight episodes of our 13-episode series "Whistler Stories", and our
one-hour documentary specials "Raven in the Sun" and "Fantasy Lands".
AMORTIZATION OF TELEVISION PROGRAMMING. During fiscal 2002 we earned a gross
margin (loss) on our proprietary programming of (41%), compared with (11%) for
2001 and 2% for 2000. We periodically review our estimates for future revenue
from television programming and adjust amortization accordingly.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSE. Selling, general and administrative
expense was $3.1 million in fiscal 2002, as compared to $4.5 million in fiscal
2001, representing a decrease of 31% from fiscal 2001. The decrease was
primarily due to cost cutting measures, including staff reductions. We have
taken further steps to reduce certain selling, general and administrative
expenses for fiscal 2003.
BAD DEBT EXPENSE. During fiscal 2001, we guaranteed a loan to a maximum of
US$2.1 million on behalf of a co-production partner. At August 31, 2002, the
amount of the outstanding related debt was $1.7 million (US$1.1 million). During
fiscal 2002, we recognized the obligation as an increase in debt and an increase
in receivable from the co-producer. As the amount was not deemed recoverable,
the receivable balance was written off.
INTEREST EXPENSE. Interest expense was $2.4 million in fiscal 2002, as compared
to $2.3 million in fiscal 2001. Interest expense in fiscal 2002 includes
interest on long-term debt of $1.6 million, non-cash amortization of deferred
finance and debt discount costs of $0.7 million, and $14,000 of interest on bank
indebtedness and other balances. Interest on long-term debt in fiscal 2002
includes $0.1 million related to loans to acquire plant and equipment and $1.5
million related to other long-term debt.
Interest expense increased by 3% in fiscal 2002 over the prior year. The
reduction in interest expense for the year due to the substantial repayment of
debentures and the repayment of mortgages from the proceeds of the sale of our
remaining real estate properties, was offset by the increase in interest rate
for the debentures and the restructuring of a non-interest bearing liability of
$7.6 million into a 10% interest-bearing term debt.
Interest expense is expected to decrease in fiscal 2003 due to the substantial
repayment of debentures bearing interest at rates ranging from 18% to 36%.
In fiscal 2002, $671,000 of interest on bank indebtedness relating to production
of our television programs was capitalized. In fiscal 2001 and 2000, interest on
bank indebtedness capitalized in each year was $1,066,000 and $82,000,
respectively.
TAXES. At August 31, 2002, we had operating losses for tax purposes of $27.0
million which are available for carry forward to future years. The benefits of
the tax loss carry-forwards have not been reflected in the financial statements.
33
DURING FISCAL 2002, WE REPORTED AN EFFECTIVE TAX RATE OF (9.8%) WHICH IS
COMPRISED OF THE CORPORATE STATUTORY INCOME TAX RATE OF (40.3%), A (4.1%)
INCREASE FROM THE UTILIZATION OF PREVIOUSLY UNRECOGNIZED TAX LOSSES, LESS 5.6%
DUE TO NON-DEDUCTIBLE EXPENSES, AND LESS 29.0% FOR THE CHANGE IN VALUATION
ALLOWANCE OF FUTURE TAX ASSETS. OUR EFFECTIVE TAX RATE FOR FISCAL 2001 WAS 2.3%
(2000 - 8.8%) COMPRISED OF THE STATUTORY INCOME TAX RATE OF (45.0%), AN INCREASE
OF (0.4%) FROM THE UTILIZATION OF PREVIOUSLY UNRECOGNIZED TAX LOSSES, LESS 2.4%
FOR NON-DEDUCTIBLE EXPENSES, AND LESS 45.3% FOR THE CHANGE IN VALUATION
ALLOWANCE OF FUTURE TAX ASSETS.
B. LIQUIDITY AND CAPITAL RESOURCES
We are required to fund significant expenditures to produce television programs
in advance of receipt of revenues from these programs, which are received over
an extended period of time after their completion. We typically finance the
capitalized costs of our proprietary television programming through presales
from customers, borrowings under our bank credit facility, contributions from
equity participants and working capital. In the past, we have also funded our
capital requirements through the issuance of shares, warrants and debt. We use
leases to finance the acquisition of our production equipment.
As at August 31, 2002, we had available cash or cash equivalents of $1.97
million, as compared to $3.98 million as at August 31, 2001.
During fiscal 2002, $20 million was contributed by operating activities,
compared to $12.7 and $5.1 million being used for operating activities in 2001
and 2000, respectively. This increase in contribution by operating activities is
primarily attributable to $21.7 million inflow from changes in non-cash working
capital, primarily due to a $25.3 million reduction in accounts and other
receivables, net of other operating items. Included within the operating
activities is the 2002 investment in television programming of $1.6 million,
compared with $52.1 million in 2001 and $31.6 in 2000. In 2001 and 2000, we
reported a use of funds from changes in non-cash working capital of $1.1 million
and $2.4 million, respectively.
During fiscal 2002, investing activities contributed cash flow of $5.4 million,
compared with a use of cash from investing activities of $0.3 million in 2001
and $1.3 million in 2000. Investing activities for the year were comprised
mainly of the sale of our remaining real estate properties. We used $27.4
million in fiscal 2002 for financing activities, comprised of $16.6 million used
to repay our senior bank debt and $10.9 million used to repay long-term debt. In
fiscal 2001, $12.6 million was contributed from financing activities primarily
from the increase in senior bank debt and in 2000, $6.4 million was contributed
from financing activities primarily from the issuance of debentures.
We finance our production activities through our $15 million bank credit
facility, which bears interest at a rate equal to the Canadian prime rate plus
1% per annum, with monthly payments of interest only drawn under the credit
facility. The facility is secured by refundable tax credits and a general
security interest on our assets. During fiscal 2002, we reduced borrowings under
our credit facility by $16.6 million, compared with an increase in borrowings of
$12.7 million in the prior year. As at August 31, 2002 we had $1.86 million
outstanding under the credit facility and as at August 31, 2001, we had
borrowings of $18.4 million outstanding under the credit facility.
By November 30, 2001, we had repaid $2.2 million of our $7.9 million of our
convertible debentures. On November 30, 2001, we refinanced $5.7 million of the
debentures and entered into an amended loan agreement to extend the maturity of
the debentures to December 31, 2002, from February 16, 2002.
34
Under the amendment, with the exception of $251,963 of debentures due to our
Officers, the interest rate was increased to 36% per annum, compounded monthly,
and payable monthly. The amended agreement was structured with no prepayment
penalties and we repaid a further $5.2 million during the balance of 2002.
Subsequent to August 31, 2002, we repaid the remaining balance of $537,000,
including the amounts due to officers.
Our consolidated financial statements have been prepared on a going concern
basis, which assumes the realization of assets and settlement of liabilities in
the normal course of operations. There is substantial doubt about the
appropriateness of our use of the "going concern" assumption because of
significant losses from operations, material working capital and shareholders'
deficiencies as at August 31, 2002, contingency related to the listing of our
shares, non-compliance with certain debt covenants, and dependence upon the
continued financial support of our secured lenders. Our consolidated financial
statements do not reflect adjustments that would be necessary if the "going
concern" basis is not appropriate.
Subsequent to August 31, 2002, as part of the Acquisition and Financing
Transactions, in December 2002 we entered into the Asset Acquisition agreements
to issue Class B Subordinate Voting Shares for the Asset Acquisition for a price
of $2.5 million and the Private Placement agreements for cash proceeds of $1.5
million. We also entered into the Debt Restructuring agreements to restructure
our $7.6 million term debt, restricting our security to our assets immediately
prior to the above transactions, and to limit repayment of this debt to the net
income streams from these assets. In the event that there is a balance of the
debt remaining on December 31, 2004, the creditor at its option, for a period of
90 days, may convert the debt to our Class B Subordinate Voting Shares at a
price equal to the greater of $3.00 and the lesser of the average trading price
and $5.00 per share. Finally, as part of the Acquisition and Financing
Transactions, we also entered into the Release and Reconstitution of Loan
Guarantee agreements to reconstitute our loan guarantee to the Comerica Bank,
whereby the Comerica Bank would release us from the guarantee and would be
repaid the amount of our guarantee out of the net income streams of the above
assets after repayment of the term debt. In the event that there is any amount
outstanding under this guarantee on December 31, 2005, the Comerica Bank, at its
option, for a period of 90 days, may convert such balance to our Class B
Subordinate Voting Shares at a price of $5.00 per share. These Acquisition and
Financing Transactions are contingent on each other and are subject to
shareholder and regulatory approvals. See "Proposed Acquisition and Financing
Transactions" in Item 3D above.
In the event that we do not complete these Acquisition and Financing
Transactions, we believe that we will not have adequate resources to meet our
cash requirements into 2003. If the business climate does not improve so that we
may earn revenues from our library of television programming, and if we are
unable to raise capital from outside sources, we would be unable to make the
contracted payments or meet the financial covenant requirements of our debt,
causing our lenders to demand immediate repayment of our debt obligations. In
such event, if we are unable to renegotiate our debt with our creditors, it is
likely that we will be unable to continue operations.
RECENT ACCOUNTING PRONOUNCEMENTS
Note 20 to the Consolidated Financial Statements sets forth differences between
Canadian GAAP and U.S. GAAP. In addition to the U.S. GAAP issues taken into
account in the preparation of Note 20, there have been accounting standards
issued by the Financial Accounting Standards Board (the "FASB") or other bodies
in the U.S. that may become applicable to our reported results, but have not yet
been adopted because such standards are not effective for the periods presented.
35
C. RESEARCH AND DEVELOPMENT, PATENTS AND LICENCES, ETC.
Not applicable.
D. TREND INFORMATION
Major television networks around the world are faced with increasing competition
from various sources including basic and specialty cable channels, satellite,
digital stations and the Internet. This fragmentation of the market, combined
with downward price pressure due to a weak worldwide market for television
programming, has resulted in a demand for more cost-effective programming. In
order to meet market demands, we will increase the production of lower cost
reality and factual programs, will continue to take advantage of tax credits and
government incentives and will focus on programming with global market appeal.
The weak worldwide market for television programming caused an industry slowdown
that is reflected in reduced production activities in the Canadian market place.
Based on this market trend, as well as on our increased production of factual
programs that result in lower revenues than drama programs, we do not expect
proprietary revenues to change significantly from the prior year.
SPECIAL NOTE REGARDING FORWARD LOOKING STATEMENTS
We intend some statements in this report, including statements set forth under
the captions "Operating and Financial Review and Prospects," "Information on the
Company" and elsewhere in this report, regarding, among other things, our plans
to grow, future financial position, business strategies, budgets, projected
costs and plans and objectives of management for future operations, to be
"forward-looking statements." Forward-looking statements generally can be
identified by the use of forward-looking terminology, such as "may," "will,"
"expect," "intend," "estimate," "anticipate," or "believe," or the negative
thereof, or variations thereon or similar terminology. Prospective investors are
cautioned not to place undue reliance on these forward-looking statements, which
speak only as of the date hereof. Forward-looking statements involve unknown and
uncertain risks, uncertainties and other factors which may cause our actual
results, performance or achievements, or industry results, to be materially
different from any future results, performance or achievements expressed or
implied by such forward-looking statements. Important factors that could cause
actual results to differ materially from our expectations are disclosed under
"Operating and Financial Review and Prospects," "Information on the Company,"
"Risk Factors" and elsewhere in this report. Although Management believes that
the expectations reflected in the forward-looking statements are reasonable, we
cannot guarantee future results, levels of activity, performance or
achievements. We undertake no obligation to publicly release any revisions to
these forward-looking statements to reflect events or circumstances after the
date hereof, or to reflect the occurrence of unanticipated events.
ITEM 6. DIRECTORS, SENIOR MANAGEMENT AND EMPLOYEES
A. DIRECTORS AND SENIOR MANAGEMENT
Directors and Senior Management as of January 6, 2003
This table sets out, as of January 6, 2003, the names of our Directors and/or
Executive Officers. The Directors have served in their respective capacities
since their election or appointment on the date stated in the table and will
serve until the next Annual General Meeting or until a successor is elected or
appointed,
36
unless the office is vacated in accordance with our Articles. The Executive
Officers are appointed by the Directors and serve until the earlier of their
resignation or removal with or without cause by the Directors. All of our
Directors and Executive Officers are residents and citizens of Canada.
NAME DIRECTOR SINCE OFFICE HELD AGE
------------------------------- ------------------------ ------------------------------------------------ ----------
Alan Hibben April 9, 2001 Director and Executive/Corporate Governance 49
and Audit Committees Member
------------------------------- ------------------------ ------------------------------------------------ ----------
Juliet Jones February 22, 2001 Director and President 37
------------------------------- ------------------------ ------------------------------------------------ ----------
Vincent Lum November 19, 1998 Director, Audit and Compensation Committees 43
Member
------------------------------- ------------------------ ------------------------------------------------ ----------
W.D. Cameron White February 12, 1993 Director, Chairman, Executive/Corporate 46
Governance and Green Light Committees Member
------------------------------- ------------------------ ------------------------------------------------ ----------
Gary Howsam N/A Chief Executive Officer 51
------------------------------- ------------------------ ------------------------------------------------ ----------
Alan Hibben has been a member of our board since April 2001. Mr. Hibben is the
Chief Executive Officer of RBC Capital Partners (RBCP), having joined RBC
Capital Partners in 2000. RBCP is the private equity investment arm of the Royal
Bank of Canada. Previously, Mr. Hibben was Managing Director of Mergers and
Acquisitions with RBC Dominion Securities Inc. from 1996 to 2000.
Juliet Jones has been our President since December 2001. From March 2001 to
December 20, 2002 Ms. Jones was our Chief Executive Officer. From 1996 to March
2001 she was our Chief Financial Officer. She has been with us since 1991. Ms.
Jones is responsible for conducting our daily affairs, which includes operations
management and budgeting, corporate finance, recruitment and training and
management of employees.
Vincent Lum has been a member of our board of directors since November 1998. He
is currently Vice President of MDS Capital Corporation since March 2001. From
December 1997 to February 2001 he was a Director of Investment for Royal Bank
Capital Partners and previously an Investment Manager for Royal Bank Capital
Corporation ("RBCC"). From 1993 until 1997, Mr. Lum was involved in early-stage
investments in technology companies for the B.C. Advanced Systems Institute.
W.D. Cameron White is our Chairman, having joined us on a full-time basis in
1994. Mr. White is also Chairman of the Board and Secretary, and a Director of
Manele Bay Ventures Inc. (formerly T & E Theatre.com Inc.), a public company
whose shares trade on the TSX Venture Exchange. Formerly Mr. White was a
corporate and securities lawyer specializing in mergers and acquisitions and
public and private financings for emerging growth companies at White &
Associates, Barristers and Solicitors from 1992 to 1994 and at Worrall Scott &
Page, Barristers and Solicitors, from 1981 to 1992. Mr. White has been a
director since February 1993.
Gary Howsam was appointed our Chief Executive Officer effective December 20,
2002. His appointment is in anticipation of the proposed Asset Acquisition
scheduled to close in January 2003. See "Proposed Acquisition and Financing
Transactions" in Item 3D above. Mr. Howsam's responsibilities include our daily
affairs, which includes all strategic planning, operations management and
budgeting, corporate finance, recruitment, training and management of all
employees. Mr. Howsam has more than 20 years of executive level experience in
the Canadian motion picture industry. From 1997 to present Mr. Howsam is
President of Greenlight Film and Television Inc., which develops, finances,
produces and
37
distributes feature films. From 1994 to 1997 Mr. Howsam was Chief Executive
Officer of Greenlight Communications Inc., a publicly held Toronto company,
overseeing its entertainment division. From 1991 to 1997 he was President of
Healthlink Communications Inc., a company in the business of healthcare
communications. From 1980 to 1987 he was Chairman and Chief Executive Officer of
Greenlight Productions Ltd., a film and video production company.
Our directors are all elected annually at our shareholders meetings, for
one-year terms and serve until their successors are elected and qualified or
they sooner resign. As a British Columbia corporation, we are required by
British Columbia corporate laws to include on our board of directors at least
one person ordinarily resident in British Columbia and a majority of persons
ordinarily resident in Canada. This requirement may limit the persons eligible
to serve on our board in the future. All of our Directors and Officers are
Canadians and, with the exception of Alan Hibben who resides in Ontario, all
reside in the Province of British Columbia.
Our Board of Directors met nine (9) times in fiscal 2002.
There are no arrangements or understandings between any shareholders, customers,
suppliers, or others, pursuant to which any of our Directors or Executive
Officers are selected as a Director or Executive Officer.
There are no family relationships between any two or more Directors or Executive
Officers. There are no material arrangements or understandings between any two
or more Directors or Executive Officers.
Nominees for Directors and Senior Management as of January 20, 2003
In connection with our Annual General Meeting of Shareholders scheduled for
January 20, 2003, and in accordance with the terms of the Asset Acquisition,
described above under the heading "Operating and Financial Review and Prospects:
Proposed Share Issuance, our management has proposed that, at our Annual General
Meeting, currently scheduled for January 20, 2003, the number of our directors
be fixed at five (5) for the ensuing year, subject to such increases as may be
permitted by our Articles, and that Juliet Jones, Gary Howsam, Richard K.
Watson, Nelson Thall, and Jamie Brown be nominated for election to our Board of
Directors, conditional upon the Asset Acquisition receiving the approval of our
shareholders.
Richard Watson has practiced corporate commercial law in Toronto for over 25
years. During that time, he has been legal counsel for a wide variety of
Canadian public and private companies. Mr. Watson has over 20 years of business
and advisory experience in the Canadian film industry, working with writers,
directors and production companies and has had significant involvement with the
financing of Canadian feature films.
Nelson Thall has an extensive business career, including serving as a director
of Torstar Corp., McLuhan Institute and Nielsen-Ferns Limited. Mr. Thall also
has served in the North American entertainment industry as an independent
producer, a manager of talent and an advisor to such companies as Stan Lee Media
Inc. Mr. Thall is a well known media critic and social commentator in North
America. He studied media science under Marshall McLuhan at the Center for
Culture and Technology and St. Michaels College in Toronto.
Jamie Brown is a Canadian producer and writer who resides in London, England. He
has produced or executive produced approximately 29 feature films and in the UK
is one of the most active producers of U.K. \ Canada co-productions. As a
writer, Mr. Brown created several successfully-produced screenplays, supervised
story departments on major television series and has published five novels,
38
including a Canadian best-seller. Mr. Brown co-produced two major television
series in the Pound Sterling15 million budget region with Peace Arch. Through
his contacts in Canada, the U.K. France and Ireland, Jamie has become highly
experienced in developing and financing international co-productions.
Committees of the Board of Directors
During fiscal 2002 we had four committees as follows:
AUDIT COMMITTEE: The Audit Committee is comprised of Alan Hibben and Vincent
Lum. The Audit Committee's responsibilities include the review of our Annual and
quarterly financial statements. Also, the Audit Committee has direct
communication channels with the external auditors to discuss and review specific
issues as appropriate. They met four times in the last fiscal year.
COMPENSATION COMMITTEE: The Compensation Committee is comprised of Vincent Lum.
It is the responsibility of the Compensation Committee to administer the
compensation policies related to our executive management. They met three times
during the last fiscal year.
EXECUTIVE/CORPORATE GOVERNANCE COMMITTEE: The Executive/Corporate Governance
Committee is comprised of W.D. Cameron White and Alan Hibben who are responsible
for ensuring that we adhere to the corporate governance polices of the
securities regulatory authorities. They make recommendations with respect to the
composition of the board of directors. As well, the Committee, working
independent of management, reviews strategic proposals including potential
mergers, acquisitions and financing scenarios. They did not meet in the last
fiscal year.
GREEN-LIGHT COMMITTEE: The Green Light Committee is comprised of W.D. Cameron
White and Cecile Frot-Coutaz. Ms. Frot-Coutaz sits on our Board of Directors as
an observer of FremantleMedia, however she is not entitled to a vote at the
meetings. The Green-Light Committee is responsible for reviewing all projects,
ensuring that they are fully funded and ultimately giving authority for them to
proceed into production. They met once in the last fiscal year.
B. COMPENSATION
During fiscal 2001, our Directors were paid a yearly retainer of $5,000. As
well, Directors were paid $500 for each Directors' or Committee Meeting attended
in person and $300 for each Directors' or Committee Meeting attended by
conference call. Chairpersons of any Directors' or Committee Meeting were paid
twice that of a non-chair member. For the most recently completed fiscal year
ended August 31, 2002, each of our outside Directors and/or Committee Members
have agreed to waive all fees and compensation payable for meetings attended,
with the exception of Vincent Lum, who is due an amount of $16,500. During the
last completed fiscal year, stock options were granted pursuant to our Amended
Share Option Plan to Executive Officer Directors to purchase up to 30,000 of our
Class B Subordinate Voting Shares at a price of $0.30 per share on or before
three years from the date of grant. Such stock options were granted to Executive
Officer Directors subject to the approval of amendments to our Amended Share
Option Plan by our shareholders, unless an equivalent number of options become
available under our Amended Share Option Plan due to the expiry or cancellation
of outstanding options. Such equivalent number of options has since become
available. No stock options were exercised by any Executive Officer Directors.
The aggregate cash compensation paid or payable to our officers and directors,
as a group for services rendered during the fiscal year ended August 31, 2001
was $1,071,309.
39
Effective November 30, 2001, we entered into an Agreement with Timothy Gamble,
terminating his employment. Pursuant to the terms of the Agreement, Mr. Gamble
resigned as a director and officer of Peace Arch and all subsidiaries. Under the
Agreement, Mr. Gamble was paid, among other things, the amount of $50,000 for
services performed with respect to our television series "Animal Miracles". In
addition, we entered into a non-exclusive, Independent Contractor Agreement with
Mr. Gamble, which engages Mr. Gamble to provide services to us with respect to
certain television programs and provides that Mr. Gamble will earn fees from the
programs based on certain criteria.
Effective June 19, 2002, we entered into an agreement with Kent Wingerak. The
agreement provides that in the event of termination of employment without cause,
Mr. Wingerak would receive three (3) months salary in lieu of notice or that,
upon written notice, within ninety (90) days of a change of control of Peace
Arch, if Mr. Wingerak's position is significantly reduced in stature, he would
receive six (6) months salary in lieu of notice. Mr. Wingerak's employment was
terminated effective December 17, 2002.
Effective August 1, 2002 we entered into temporary Amendment Agreements with
Juliet Jones, Kent Wingerak and certain other employees in connection with their
respective Employment Agreements. Pursuant to the Amendment Agreements, a salary
reduction was in effect for a term of three (3) months, commencing August 1,
2002 until October 31, 2002. The salaries of Juliet Jones and Kent Wingerak were
reduced by 50% during the three-month period. In connection with such salary
reductions, a bonus entitlement of up to 50% of three (3) months base salary for
Ms. Jones and up to 100% of three (3) months base salary for Mr. Wingerak was
implemented upon certain performance criteria being fulfilled and employee stock
options were granted.
The following table sets forth all annual and long term compensation for
services for the three most recently completed fiscal years as at 31st August
2002 in respect of the Executive Officers named below. As at August 31, 2002 we
had three Executive Officers, Juliet Jones, Cam White, and Kent Wingerak. We had
no other executive officers, or other individuals, whose total compensation
exceeded $100,000 during the fiscal year ended 31st August 2002.
LONG TERM COMPENSATION
----------------------------------
Annual Compensation AWARDS PAYOUTS
---------------------------------------- ------------------- --------------
NAME AND OTHER ANNUAL SECURITIES UNDER LTIP PAYOUTS ALL OTHER
PRINCIPAL YEAR SALARY BONUS COMPENSATION ($) OPTIONS GRANTED ($) COMPENSATION
POSITION [1] ($) ($) (#) ($)
------------------ ------- ----------- ----------- ---------------- ------------------- -------------- -----------------
WD Cameron 2002 Nil Nil Nil 10,000[2[ Nil 200,000[8]
White,
Chairman[3]
------------------------------------------------------------------------------------------------------
2001 108,333 Nil Nil 25,000[2] Nil 91,667[8]
------------------------------------------------------------------------------------------------------
2000 200,000 100,000 Nil 25,000[2] Nil Nil
-------------------------------------------------------------------------------------------------------------------------
Timothy Gamble[4]
2002 50,000 Nil Nil Nil Nil 50,000[9]
------------------------------------------------------------------------------------------------------
2001 200,000 Nil Nil 50,000[2] Nil Nil
------------------------------------------------------------------------------------------------------
2000 200,000 100,000 Nil 25,000[2] Nil Nil
-------------------------------------------------------------------------------------------------------------------------
Juliet Jones, 2002 168,445 Nil Nil 100,000[2] Nil Nil
President and
Chief Executive
Officer[5]
-------------------------------------------------------------------------------------------------------------------------
40
LONG TERM COMPENSATION
----------------------------------
Annual Compensation AWARDS PAYOUTS
----------------------------------------- ------------------- --------------
NAME AND OTHER ANNUAL SECURITIES UNDER LTIP PAYOUTS ALL OTHER
PRINCIPAL YEAR SALARY BONUS COMPENSATION ($) OPTIONS GRANTED ($) COMPENSATION
POSITION [1] ($) ($) (#) ($)
------------------ ------- ----------- ----------- ----------------- ------------------- -------------- -----------------
2001 157,417 Nil Nil 50,000[2] Nil Nil
------------------------------------------------------------------------------------------------------
2000 120,000 60,000 Nil 25,000[2] Nil Nil
-------------------------------------------------------------------------------------------------------------------------
Garth Albright
Chief Financial 2002 112,626 Nil Nil Nil Nil 30,000[8]
Officer[10]
------------------------------------------------------------------------------------------------------
2001 49,520 Nil Nil 20,000[2] Nil Nil
------------------------------------------------------------------------------------------------------
2000 N/A N/A N/A N/A N/A N/A
-------------------------------------------------------------------------------------------------------------------------
Kent Wingerak.
Executive Vice 2002 86,250 22,500[7] Nil 35,000[2] Nil Nil
President, Peace
Arch Productions
Inc.
------------------------------------------------------------------------------------------------------
2001 82,500 Nil Nil Nil Nil Nil
------------------------------------------------------------------------------------------------------
2000 Nil Nil Nil 20,000[2] Nil Nil
-------------------------------------------------------------------------------------------------------------------------
John Nicolls
Director of 2002 97,867 Nil 2,200[11] Nil Nil 30,548[8]
Business
Affairs[12]
------------------------------------------------------------------------------------------------------
2001 97,500 Nil Nil Nil Nil Nil
------------------------------------------------------------------------------------------------------
2000 81,000 8,000 Nil 8,500[2] Nil Nil
------------------------------------------------------------------------------------------------------
[1] Ended 31st August.
[2] Class B Subordinate Voting Shares.
[3] CEO until 27th March 2001. Chairman from 27th March 2001 to present.
[4] President until 30th November 2001.
[5] Chief Financial Officer ("CFO") until 27th March 2001. CEO from 27th March
2001 and President/CEO from 1st December 2001 to present.
[6] Executive In Charge of Production until 5th October 2001.
[7] Bonus, awarded on successful completion of two films.
[8] Severance payments upon termination of employment, which have been paid in
full.
[9] Consulting fee paid to a company owned by Timothy Gamble.
[10] Chief Financial Officer from April 3, 2001 to August 20, 2002.
[11] Vacation pay upon termination.
[12] Director of Business Affairs from November 23, 1998 to July 31, 2002.
LONG TERM INCENTIVE PLANS --
AWARDS IN MOST RECENTLY COMPLETED FINANCIAL YEAR
There were no performance bonuses earned pursuant to long term incentive plans
during the most recently completed fiscal year.
Effective May 9, 2001, we eliminated the prior Compensation (Performance Bonus)
Plan and implemented a new Compensation (Performance Bonus) Plan available to
all employees including Juliet Jones and Timothy Gamble. The new Performance
Bonus is not limited in amount and is based on several key indicators including
working capital, earnings before interest, depreciation and taxes and free share
price cash flow calculation. The performance criteria is predetermined and
approved by the Board of Directors each year. The actual bonus calculation and
apportionment between employees is recommended by the CEO and is subject to the
approval of the Board of Directors.
Pursuant to the Amendment Agreements described above, a bonus entitlement of up
to 50% of three (3) months base salary for Ms. Jones and up to 100% of three (3)
months base salary for Mr. Wingerak was
41
implemented upon certain performance criteria being fulfilled in connection with
temporary salary reductions.
C. BOARD PRACTICES
See "Directors and Senior Management" above.
D. EMPLOYEES
As of January 6, 2003, we had 10 full-time permanent employees. We also hire
additional personnel on a project-by-project basis in connection with the
production of our television programming. We believe that our employee and labor
relations are good. None of our full-time employees are members of unions.
E. SHARE OWNERSHIP
This table describes the beneficial ownership of our Class A Multiple Voting
Shares and Class B Subordinate Voting Shares as of January 6, 2003 for all
executive officers and directors individually and as a group. This information
does not reflect ownership of options or warrants.
CLASS A PERCENT CLASS B PERCENT
NAME SHARES OF CLASS SHARES OF CLASS
---- -------- -------- ------- --------
Alan Hibben 0 0% 0 0%
Juliet Jones 9,981 0.9% 7,410 0.3%
Vincent Lum 0 0% 0 0
W.D. Cameron White 26,376 2.4% 30,776 1.1%
Gary Howsam (1) Nil N/A Nil N/A
Officers and directors as a group (6 persons) 36,357(2) 3.3% 38,186(2) 1.4%
(1) Does not give effect to proposed Acquisition and Financing Transactions.
(2) Does not include any shares which are issuable upon the exercise of
options or warrants.
The complete list of options outstanding to our directors and members of our
administration and management is set out below under "Class A Stock Options
Outstanding as at January 6, 2003" and "Class B Stock Options Outstanding as at
January 6, 2003".
OPTION GRANTS DURING THE MOST
RECENTLY COMPLETED FINANCIAL YEAR
During the most recently completed fiscal year, options to purchase an aggregate
of 145,000 Class B shares were granted to the Executive Officers, Directors, and
Employees as follows:
42
NAME OF EXECUTIVE OFFICER NO. OF CLASS B EXERCISE PRICE NO. OF CLASS B
OR DIRECTOR OPTIONS GRANTED EXPIRATION DATE ($/SHARE) OPTIONS EXERCISED
------------------------- --------------- --------------- -------------- -----------------
WD Cameron White 10,000 Aug. 21, 2005 $0.30 0
Juliet Jones 100,000 Aug. 21, 2005 $0.30 0
Kent Wingerak 35,000 Aug. 21, 2005 $0.30 0
Except for our Amended Share Option Plan and Compensation (Performance Bonus)
Plan, there are no plans in effect pursuant to which cash or non-cash
compensation was paid or distributed to Executive Officers during the most
recently completed fiscal year or is proposed to be paid or distributed in a
subsequent year. We do not have any pension plans or retirement benefit plans.
CLASS A STOCK OPTIONS OUTSTANDING AS AT JANUARY 6, 2003
NAME TITLE EXPIRY DATE PRICE NO. OF A OPTIONS
---- ----- ----------- ---- ----------------
J. Jones President March 23, 2003 $9.50 5,000
Employee March 23, 2003 $9.50 4,000
Employee March 23, 2003 $9.50 3,000
Employee March 23, 2003 9.50 2,000
Employee Nov 19/03 7.50 800
V. Lum Director Feb 16/04 $9.50 5,000
TOTAL 19,800
CLASS B STOCK OPTIONS OUTSTANDING AS AT JANUARY 6, 2003
NAME TITLE EXPIRY DATE PRICE NO. OF B OPTIONS
---- ----- ----------- ----- ----------------
J. Jones President Mar 23/03 $9.50 5,000
Employee Mar 23/03 $9.50 4,000
Employee Mar 23/03 $9.50 3,000
Employee Mar 23/03 $9.50 2,000
Employee Nov 19/03 $7.50 800
Employee Feb 16/04 $9.50 5,000
Employee Jan 13/03 $5.50 15,000
J. Jones President Jan 13/03 $5.50 25,000
Employee Jan 13/03 $5.50 4,200
Employee Jan 13/03 $5.50 7,000
V. Lum Director Feb 2/03 $5.00 7,500
Employee July 27/03 $5.00 20,000
Employee July 27/03 $5.00 3,000
Employee July 27/03 $5.00 4,000
Employee Dec 21/03 $3.00 15,000
Employee Dec 21/03 $3.00 1,000
J. Jones President April 12/04 $3.60 50,000
J. D. Douglas Director April 12/04 $3.60 7,500
V. Lum Director April 12/04 $3.60 7,500
43
NAME TITLE EXPIRY DATE PRICE NO. OF B OPTIONS
---- ----- ----------- ----- ----------------
A. Hibben Director April 12/04 $3.60 7,500
Employee July 24/04 $4.75 5,000
Employee July 24/04 $4.75 5,000
Employee Aug 15/05 $0.30 15,000
J. Jones President Aug 15/05 $0.30 50,000
Employee Aug 15/05 $0.30 15,000
Employee Aug 15/05 $0.30 20,000
Employee Aug 15/05 $0.30 10,000
Employee Aug 15/05 $0.30 20,000
J. Jones President Aug 15/05 $0.30 50,000
Employee Aug 15/05 $0.30 10,000
Employee Aug 15/05 $0.30 15,000
Employee Aug 15/05 $0.30 7,500
Employee Aug 15/05 $0.30 7,500
Employee Aug 15/05 $0.30 10,000
Employee Aug 15/05 $0.30 15,000
Employee Aug 15/05 $0.30 5,000
Employee Aug 15/05 $0.30 7,500
Employee Aug 15/05 $0.30 10,000
V. Lum Director Aug 15/05 $0.30 10,000
J. D. Douglas Director Aug 15/05 $0.30 10,000
A. Hibben Director Aug 15/05 $0.30 10,000
W. D. C. White Chairman Aug 15/05 $0.30 10,000
TOTAL 519,600
44
CLASS A WARRANTS OUTSTANDING AS AT JANUARY 6, 2003
DATE OF ISSUANCE OF THE NUMBER OF WARRANTS NUMBER OF WARRANTS EXERCISE EXPIRY DATE OF
WARRANTS ISSUED CURRENTLY OUTSTANDING PRICE WARRANTS
----------------------- ------------------ --------------------- -------- -----------------
August 16, 2000 225,750 225,118 $5.00 February 16, 2004
August 16, 2000 6,750 6,479 $1.20 February 16, 2004
CLASS B WARRANTS OUTSTANDING AS AT JANUARY 6, 2003
DATE OF ISSUANCE OF THE NUMBER OF WARRANTS NUMBER OF WARRANTS EXERCISE EXPIRY DATE OF
WARRANTS ISSUED CURRENTLY OUTSTANDING PRICE WARRANTS
-------------------------- --------------------- ----------------------------- -------------- ----------------------
August 3, 1999 75,000 75,000 $6.75(US) August 3, 2004
-------------------------- --------------------- ----------------------------- -------------- ----------------------
August 16, 2000 40,500 39,958 $5.00 February 16, 2004
-------------------------- --------------------- ----------------------------- -------------- ----------------------
April 16, 2001 100,000 100,000 $2.72(US) April 16, 2006
-------------------------- --------------------- ----------------------------- -------------- ----------------------
November 30, 2001 230,000 230,000 $1.20 June 30, 2003
-------------------------- --------------------- ----------------------------- -------------- ----------------------
The total amount of securities called for by all such options to purchase Class
A Multiple Voting Shares and Class B Subordinate Voting Shares and warrants to
purchase Class A Multiple Voting Shares and Class B Subordinate Voting Shares
held by directors and officers as a group is 10,000 Class A Multiple Voting
Shares and 250,000 Class B Subordinate Voting Shares.
ITEM 7. MAJOR SHAREHOLDERS AND RELATED PARTY TRANSACTIONS
A. MAJOR SHAREHOLDERS
This table describes the beneficial ownership of our Class A Multiple Voting
Shares and Class B Subordinate Voting Shares as of January 6, 2003 for each
person known to us to own beneficially more than 5% of either Class A Multiple
Voting Shares or Class B Subordinate Voting Shares in the aggregate. This
information does not reflect ownership of options or warrants.
CLASS A PERCENT CLASS B PERCENT
NAME SHARES OF CLASS SHARES OF CLASS
---- ------- -------- ------- --------
Working Opportunity Fund (EVCC) Ltd. 160,000 14.7% 160,000 5.7%
RBC Capital Partners 127,919 11.7% 139,170 5.0%
Timothy Gamble 75,599 6.9% 63,099 2.3%
All of the shareholders set out above are either persons resident in Canada, or
companies that are Canadian entities.
To the best of our knowledge, we are not, directly or indirectly, controlled by
another corporation, by any foreign government or by any other person. Pursuant
to the Share Issuance for the Asset Acquisition described under Acquisition and
Financing Transactions in 3D herein, which is subject to various conditions
including shareholder and regulatory approvals, a corporation will be issued
securities representing approximately 30.8% of the outstanding votes, and
approximately 52% of the outstanding shares, which will result in a change of
control. To the best of our knowledge there are no other arrangements that could
result in a change of control.
45
B. RELATED PARTY TRANSACTIONS
As at January 1, 2003, there was no indebtedness of any director, executive
officer, senior officer or associate of them to or guaranteed or supported by us
or any of our subsidiaries either pursuant to an employee purchase program or
otherwise.
The only material transactions we have entered into during the past three fiscal
years in which any of our directors or executive officers, or any principal
shareholder, or any associate or affiliate of them, has or had a material
interest, direct or indirect, were as follows.
In August 2000, we completed a $7.9 million subordinated debenture financing
(the "Debentures"). The Debentures were due in February 2002, bearing an
interest rate of 18% per annum, 4% of which was deferred until the Debentures
were repaid. The Debentures were subordinate to our senior indebtedness.
Purchasers of the Debentures received a 5% fee as well as warrants to purchase
Class "A" and/or Class "B" shares exercisable at $5.00 per share (the
"Warrants"). The directors, officers, insiders and associates who acquired
Debentures and Warrants are as follows:
AMOUNT OF WARRANTS
PURCHASER DEBENTURE
--------- --------- ---------------------------------------
CLASS A SHARES CLASS B SHARES
-------------- --------------
Timothy Gamble[4] $200,000 9,000
W.D. Cameron White[5] $150,000 6,750
Working Opportunity Fund (EVCC) Ltd. [1] $1,800,000[2] 40,500 40,500
BCMC Capital Limited Partnership[3] $2,586,000 77,580 38,790[6]
BCMC Capital II Limited Partnership[3] $1,414,000 42,420 21,210[6]
[1] Derek Douglas, a director until December 17, 2002, is an insider of Working
Opportunity Fund (EVCC) Ltd., which in turn was an insider of the Company.
The purchasers paid consideration equal to that paid by unrelated parties.
[2] $600,000 of this amount was used to retire a debenture previously held by
Working Opportunity Fund (EVCC) Ltd. which was due October 21 2000.
[3] Donald Steele, a director until August 27, 2001, is President of Mercantile
Bancorp Limited. Mercantile Bancorp Limited is the management company for
BCMC Capital Limited Partnership and BCMC Capital II Limited Partnership.
[4] Director and Senior Officer until November 30, 2001. The purchaser paid
consideration equal to that paid by unrelated parties.
[5] Director and Chairman. The purchaser paid consideration equal to that paid
by unrelated parties.
[6] These Warrants were cancelled on November 30, 2001, when we repaid the debt
in full.
During September and October of 2001, we repaid a portion of our subordinated
debt disclosed above. On November 30, 2001, we re-financed a portion of the
remaining $5,687,000 outstanding subordinated debt. The Working Opportunity Fund
(EVCC) Ltd. ("WOF") increased its subordinated debt by $3,959,000, of which the
proceeds repaid the outstanding indebtedness to BCMC Capital Limited
Partnership, BCMC Capital II Limited Partnership and Business Development Bank
of Canada. In consideration for advancing these funds and agreeing to extend the
loan past its February 2002 due date to December 2002, we agreed to pay WOF cash
interest at 36% per annum and to grant them warrants to purchase up to an
aggregate 160,000 Class B Subordinate Voting Shares at a price of $1.255 per
share on or before June 30 2003. Yad Garcha and John Derek Douglas, two former
Directors, are also insiders of WOF, which in turn was an insider of Peace Arch.
As consideration for not requiring the interest rate to be increased from 18% to
36% per annum, we agreed to grant Timothy Gamble, our former President and W.D.
Cameron White, our Chairman, warrants to purchase up to 70,000 Class B
Subordinate Voting Shares at a price of $1.255 per share on or before June 30,
2003.
46
As part of the Acquisition and Financing Transactions, in the Asset Acquisition,
we have agreed to acquire a portfolio of assets owned and controlled by a
company controlled by Gary Howsam, including the ongoing business activities of
Greenlight Film and Television Inc. See "Proposed Acquisition and Financing
Transactions" in Item 3D above. Gary Howsam, who became our CEO effective
December 20, 2002 pursuant to the Acquisition Agreement, is the President of
Greenlight Film and Television Inc. Upon closing the Asset Acquisition, as
purchase consideration, we would issue 8,333,333 Class B Subordinate Voting
Shares to CPC Communications Inc.
As part of the Release and Reconstitution of Loan Guarantee, we have agreed to a
reconstitution of a loan guarantee provided to Comerica Bank - California with
respect to the guarantee of a loan from Comerica to Big Sound Productions Inc.
of the United Kingdom, an unrelated company controlled by Jamie Brown, a nominee
for director of the Company.
C. INTERESTS OF EXPERTS AND COUNSEL
Not applicable.
ITEM 8. FINANCIAL INFORMATION
A. CONSOLIDATED STATEMENTS AND OTHER INFORMATION
Our financial statements are stated in Canadian Dollars (CDN$) and are prepared
in accordance with Canadian Generally Accepted Accounting Principles (GAAP) in
Canada, the application of which, in our case, conforms in all material respects
for the periods presented with United States GAAP.
The financial statements as required under Item 17 are attached hereto and found
immediately following the text of this Annual Report. The report of KPMG LLP,
Chartered Accountants for fiscal 2001 and 2002 is included herein immediately
preceding the financial statements.
Legal Proceedings
On October 2, 2001, wholly-owned subsidiaries of Peace Arch started an action
against Viacom International, Inc., MTV Networks, VH1 Music First, and others in
the British Columbia Supreme Court for damages in the amount of US$2,750,000 and
consequential damages arising from the Defendants' failure to honour a contract
for the co-financing of the television series Big Sound. Both sides are in the
process of amassing documents for production. We have prepared a substantial
number of Interrogatories which will be served shortly.
On December 2, 2001 an action was started in the BC Supreme Court against us by
Forgotten Kingdom Productions I. Inc., Danny Virtue and Lloyd Simandl, claiming
general and specific damages in connection with an alleged promise by us to
finance and co-produce a television series entitled Ariana's Quest. The
Plaintiffs are seeking damages, including lost fees (estimated at US$1.5
million), lost development costs (estimated at $100,000), breach of contract
(estimated at $25,000) and lost profits. It is our opinion that the claim is
without merit and counsel for the Plaintiffs has taken no steps since January
2002.
On October 4, 2001, we and our wholly-owned subsidiary, Immortal Productions
Inc. ("IPI"), were joined as third parties in an action by Rena Mero against
Western International Syndication ("WIS"). The Plaintiff is claiming damages
against WIS for use of her likeness and name, unfair competition,
47
commercial misappropriation and other related claims. These claims arise out of
an allegedly unauthorized press release and other communications by WIS at the
2001 NATPE convention. WIS has claimed indemnity from us and IPI as well as a
number of other third parties including the Plaintiffs' business manager, Arthur
Lieberman, who allegedly authorized the press release and cooperated in the
other communications. We support the allegations against Lieberman and believe
the claims against us and IPI are without merit.
On July 3, 2002, we commenced a suit in United States District Court, Central
District of California against WIS, seeking damages in the amount of
US$2,470,000 in connection with the syndication by WIS of the television series,
The Immortal (the "Series"). WIS has commenced third party proceedings against
Hill Top Entertainment, LLC, Victor & Grais and Victor and Grais Productions for
money damages and contribution and indemnity. WIS has counterclaimed against us
seeking money damages and costs relating to our efforts to syndicate Season I of
the Series, money damages due to the fact that Season II of the Series was not
produced and on the basis that our underlying rights to the Series are inferior
to those of WIS. It is our view that the counterclaim is without merit.
Other than as set out above, we are not currently subject to any legal
proceedings which, if determined adversely to us, would have a material adverse
effect on our business or results of operations. We may, from time to time,
become a party to various legal proceedings arising in the ordinary course of
business. We maintain insurance coverage for such matters in amounts that we
believe to be adequate.
Dividend Policy
We have not declared any dividends since incorporation and do not anticipate
that we will do so in the foreseeable future. Our present policy is to retain
future earnings for use in operations and the expansion of our business.
ITEM 9 THE OFFER AND LISTING
Not applicable except for Item 9A(4) and Item 9C.
Our Class A Multiple Voting Shares and Class B Subordinate Voting Shares trade
on The Toronto Stock Exchange ("TSX") symbols PAE.A and PAE.B respectively. Our
Class B Subordinate Voting Shares also trade on The American Stock Exchange,
symbol PAE. Our shares commenced trading on the TSX in November 1997 under the
symbol "VE". Effective July 19, 1999, our Class A Multiple Voting Shares and
Class B Subordinate Voting Shares began trading on the TSX, at which time our
Common Shares were delisted. Our Class B Subordinate Voting Shares began trading
on AMEX on July 28, 1999.
We have been advised by the TSX that we do not currently meet the minimum
requirements for the continued listing of our shares on the exchange. We have
been granted a 45 day extension from our original deadline of December 27, 2002
to meet the listing criteria, but the TSX may limit this extension if the
proposed Acquisition and Financing Transactions detailed elsewhere in this
report are not completed. We believe that we will meet the criteria subject to
the completion of these Acquisition and Financing Transactions.
The following table lists the volume of trading as well as the high and low
sales prices of our Class A and Class B Shares on the TSX for each of the last
nine fiscal quarters in the last two completed fiscal years.
48
TORONTO STOCK EXCHANGE STOCK TRADING ACTIVITY
STOCK TRADING ACTIVITY
AVERAGE
DAILY
TRADING CDN$ CDN$ US$ US$
VOLUME HIGH LOW HIGH LOW
-------- ---- ---- ---- ---
Fiscal year ended August 31, 2000
First Quarter - Class A Shares..................... 1,110 7.50 3.80 5.17 2.62
First Quarter - Class B Shares..................... 602 7.90 3.75 5.44 2.58
Second Quarter - Class A Shares.................... 3,530 9.00 4.00 6.11 2.72
Second Quarter - Class B Shares.................... 2,071 9.05 4.25 6.15 2.89
Third Quarter - Class A Shares..................... 1,969 8.00 4.05 5.43 2.75
Third Quarter - Class B Shares..................... 890 7.75 4.20 5.26 2.85
Fourth Quarter - Class A Shares.................... 729 5.00 3.90 3.40 2.65
Fourth Quarter - Class B Shares.................... 407 4.80 2.90 3.26 1.97
Fiscal year ending August 31, 2001
First Quarter - Class A Shares..................... 1,223 5.50 2.60 3.74 1.77
First Quarter - Class B Shares..................... 1,177 5.25 3.90 3.57 2.65
Second Quarter - Class A Shares.................... 1,306 3.25 3.19 2.10 2.06
Second Quarter - Class B Shares.................... 1,509 3.36 3.27 2.17 2.11
Third Quarter - Class A Shares..................... 2,225 3.95 3.89 2.55 2.51
Third Quarter - Class B Shares..................... 1,551 4.24 4.15 2.74 2.68
Fourth Quarter - Class A Shares.................... 747 3.93 3.87 2.54 2.50
Fourth Quarter - Class B Shares.................... 1,523 3.92 3.79 2.53 2.45
Fiscal year ending August 31, 2002
First Quarter - Class A Shares..................... 1,205 1.68 1.66 1.09 1.07
First Quarter - Class B Shares..................... 1,809 1.72 1.65 1.11 1.06
Second Quarter - Class A Shares.................... 1,037 1.30 1.00 0.83 0.64
Second Quarter - Class B Shares.................... 1,981 1.25 0.79 0.80 0.51
Third Quarter - Class A Shares..................... 927 1.10 0.85 0.71 0.54
Third Quarter - Class B Shares..................... 940 1.05 0.75 0.67 0.48
Fourth Quarter - Class A Shares.................... 316 0.95 0.25 0.61 0.16
Fourth Quarter - Class B Shares.................... 346 0.85 0.25 0.54 0.16
Fiscal Year ending August 31, 2003
First Quarter - Class A Shares 1,229 0.55 0.15 0.35 0.10
First Quarter - Class B Shares 437 0.35 0.11 0.22 0.07
THE AMERICAN STOCK EXCHANGE:
Fiscal year ended August 31, 2000:
First Quarter - Class B Shares..................... 3,045 8.16 3.99 5.62 2.75
Second Quarter - Class B Shares.................... 19,727 10.58 4.05 7.188 2.75
Third Quarter - Class B Shares..................... 7,881 8.65 4.23 5.875 2.875
Fourth Quarter - Class B Shares.................... 5,302 5.15 3.86 3.50 2.625
Fiscal Year ending August 31, 2001
First Quarter - Class B Shares..................... 3,115 5.43 2.76 3.688 1.875
Second Quarter - Class B Shares.................... 6,786 3.48 3.33 2.25 2.15
Third Quarter - Class B Shares..................... 5,100 4.18 4.09 2.70 2.64
49
AVERAGE
DAILY
TRADING CDN$ CDN$ US$ US$
VOLUME HIGH LOW HIGH LOW
-------- ---- ---- ---- ---
Fourth Quarter - Class B Shares................... 4,610 4.04 3.92 2.61 2.53
Fiscal Year ending August 31, 2002
First Quarter - Class B Shares.................... 5,367 1.72 1.64 1.11 1.06
Second Quarter - Class B Shares................... 5,385 1.12 0.48 0.73 0.31
Third Quarter - Class B Shares.................... 2,102 1.17 0.29 0.75 0.45
Fourth Quarter - Class B Shares 2,697 0.65 0.16 0.42 0.10
Fiscal Year ending August 31, 2003....................
First Quarter - Class B Shares.................... 3,812 0.44 0.17 0.28 0.11
Our shares are issued in registered form and the following information is from
our registrar and transfer agent, CIBC Mellon Trust Company, located in
Vancouver, British Columbia, Canada.
As at August 31, 2002, the shareholders' list for our shares showed 180
Registered Class A shareholders and 185 registered Class B shareholders and
1,091,874 Class A Multiple Voting Shares and 2,795,971 Class B Subordinate
Voting Share outstanding. Of these shareholders, 117 holders of Class A Shares
and 122 holders of Class B Shares were U.S. residents, owning 499,457 Class A
Shares and 1,261,289 Class B Shares representing 45.1% of the Class A and 45.7%
of the Class B issued and outstanding shares.
ITEM 10 ADDITIONAL INFORMATION
A. SHARE CAPITAL
Not applicable.
B. MEMORANDUM AND ARTICLES OF ASSOCIATION
Incorporated by reference to our registration statement on Form F-1 (Reg. No.
333-10354).
C. MATERIAL CONTRACTS
Except as otherwise disclosed in this annual report and our financial statements
and notes included elsewhere in this annual report, we have no other material
contracts.
D. EXCHANGE CONTROLS
There is no law or governmental decree or regulation in Canada that restricts
the export or import of capital, or affects the payment of dividends, interest
or other payments to non-resident holders of Class B Subordinate Voting Shares
("Class B shares"), other than withholding tax requirements. See "Taxation" for
a discussion of these withholding requirements.
There is no limitation imposed by Canadian law on the right of a non-resident to
hold or vote Class B shares, other than as provided by the Investment Canada Act
(the "Act") enacted on June 20, 1985, as amended, as further amended by the
North American Free Trade Agreement (NAFTA) Implementation Act (Canada) and the
World Trade Organization (WTO) Agreement Implementation Act, which requires the
prior notification and, in certain cases, advance review and approval by the
Government of Canada of the acquisition by a "non-Canadian" of "control" of a
"Canadian business", all as defined in the Act. For the purposes of the Act,
"control" can be acquired through the acquisition of all or substantially all of
the assets used in the Canadian business or the direct or indirect acquisition
of interests in an entity that carries on a Canadian business, or which controls
the entity which carries on the Canadian business.
50
Under the Act, control of a corporation is deemed to be acquired through the
acquisition of a majority of the voting shares of a corporation, and is presumed
to be acquired where one-third or more, but less than a majority, of the voting
shares of a corporation are acquired, unless it can be established that the
corporation is not controlled in fact through the ownership of voting shares.
Other rules apply with respect to the acquisition of non-corporate entities.
Investments requiring review and approval include direct acquisitions of
Canadian businesses with assets with a gross book value of $5.0 million or more;
indirect acquisitions of Canadian businesses with assets of $50.0 million or
more; and indirect acquisitions of Canadian businesses where the value of assets
of the entity or entities carrying on business in Canada, control of which is
indirectly being acquired, is greater than $5.0 million and represents greater
than 50% of the total value of the assets of all the entities, control of which
is being acquired. Generally speaking, the value of the business acquisition
threshold (the "Threshold") is increased from those levels outlined where the
acquisition is by a member of NAFTA or a WTO Investor or by a non-Canadian other
than a WTO Investor where the Canadian business that is the subject of the
investment is immediately before the investment controlled by a WTO Investor.
The Threshold is to be determined yearly in accordance with a formula set forth
in the Act.
Different provisions and considerations apply with respect to investment to
acquire control of a Canadian business that, as defined in the Act or
regulations:
o Engages in production of uranium and owns an interest in producing
uranium property in Canada;
o Provides financial services;
o Provides transportation services;
o Is a cultural business.
We are considered to be a cultural business pursuant to the Act.
If an investment is reviewable, an application for review in the form prescribed
by regulation is normally required to be filed with the Ministry of Industry,
Director of Investment prior to the investment taking place and the investment
may not be consummated until the review has been completed and ministerial
approval obtained. Applications for review concerning indirect acquisitions may
be filed up to 30 days after the investment is consummated. Applications
concerning reviewable investments in culturally sensitive and other specified
activities referred to in the preceding paragraph are required upon receipt of a
notice for review. There is, moreover, provision for the Minister (a person
designated as such under the Act) to permit an investment to be consummated
prior to completion of review if he is satisfied that delay would cause undue
hardship to the acquirer or jeopardize the operation of the Canadian business
that is being acquired.
Upon review of an application for review, the Minister will then determine
whether the investment is likely to be of "net benefit to Canada," taking into
account the information provided and having regard to certain factors of
assessment prescribed under the Act. Among the factors to be considered are:
o the effect of the investment on the level and nature of economic
activity in Canada, including the effect on employment, on resource
processing, on the utilization of parts, components and services
produced in Canada, and on exports from Canada;
51
o the degree and significance of participation by Canadians in the
Canadian business and in any industry in Canada of which it forms a
part;
o the effect of the investment on productivity, industrial efficiency,
technological development, product innovation and product variety in
Canada;
o the effect of the investment on competition within any industry or
industries in Canada;
o the compatibility of the investment with national industrial, economic
and cultural policies, taking into consideration industrial, economic
and cultural policy objectives enunciated by the government or
legislature of any province likely to be significantly affected by the
investment; and
o the contribution of the investment to Canada's ability to compete in
world markets.
See "Information on the Company--Regulatory Considerations--Canadian Content
Requirements" for a description of other Canadian and British Columbia ownership
requirements.
E. TAXATION
The discussions summarize the material tax considerations relevant to an
investment in Class B shares by individuals and corporations who, for income tax
purposes, are resident in the U.S. for purposes of the Convention (as
hereinafter defined) and are not resident in Canada, who hold Class B shares as
a capital asset, and who do not use or hold the Class B shares in carrying on a
business through a permanent establishment in Canada or in connection with a
fixed base in Canada (collectively, "Unconnected U.S. Shareholders" or
"Holders"). The tax consequences of an investment in the Class B shares by
investors who are not Unconnected U.S. Shareholders may differ substantially
from the tax consequences discussed herein. The discussion of U.S. tax
considerations is addressed only to Unconnected U.S. Shareholders whose
"functional currency" within the meaning of section 985 of the Internal Revenue
Code of 1986, as amended (the "Code"), is the U.S. dollar, and to U.S. citizens
who are not residents in the U.S. for purposes of the Convention, but who
otherwise meet the definition of Unconnected U.S. Shareholders. Furthermore, the
discussion of U.S. tax considerations does not address the tax treatment of
Unconnected U.S. Shareholders that own, or are deemed for U.S. federal income
tax purposes to own, 10% or more of the total combined voting power of all
classes of voting stock of Peace Arch. The discussion of Canadian tax
considerations does not address the tax treatment of a trust, company,
organization or other arrangement that is a resident of the U.S. and that is
generally exempt from U.S. tax.
This discussion does not address all of the income tax consequences that may be
applicable to any particular Holder subject to special treatment under the U.S.
federal income tax law or to any particular Holder in light of such Holder's
particular facts and circumstances. Some Holders, including tax-exempt entities,
banks, insurance companies and persons who hold the Class B shares as part of a
synthetic security, conversion transaction or "straddle" or hedging transactions
may be subject to special and/or different rules not discussed below. Statements
of legal conclusion of U.S. tax considerations as to the material U.S. federal
income tax consequences of the acquisition, ownership and disposition of the
Class B shares by Unconnected U.S. Shareholders do not purport to be a complete
analysis or listing of all possible tax considerations. The discussion of U.S.
tax considerations is based upon the provisions of the Code, and of published
administrative practices of the Internal Revenue Service and judicial decisions,
52
all of which are subject to change possibly with retroactive effect. Statements
of legal conclusions of Canadian tax considerations as to the material Canadian
federal income tax consequences of the acquisition, ownership and disposition of
the Class B shares by Unconnected U.S. Shareholders do not purport to be a
complete analysis or listing of all possible tax consequences. The discussion of
Canadian tax considerations is based upon the provisions of the Income Tax Act
(Canada) (the "Tax Act"), the Convention between Canada and the U.S. of America
with Respect to Taxes on Income and on Capital, as amended from time to time
(the "Convention"), and our understanding of published administrative practices
of Canada Customs and Revenue Agency (formerly, Revenue Canada) and judicial
decisions, all of which are subject to change. The discussion does not take into
account the tax laws of the various provinces or territories of Canada or the
tax laws of the various state and local jurisdictions in the U.S.
THIS DISCUSSION IS NOT INTENDED TO BE NOR SHOULD IT BE CONSTRUED AS LEGAL OR TAX
ADVICE TO ANY PARTICULAR INVESTOR. THEREFORE, PROSPECTIVE INVESTORS SHOULD
CONSULT THEIR OWN TAX ADVISORS WITH RESPECT TO THE TAX CONSEQUENCES OF AN
INVESTMENT IN THE CLASS B SHARES.
U.S. Federal Income Tax Considerations
Unconnected U.S. Shareholders generally will treat the gross amount of
distributions paid by us, including the amount of any Canadian tax withheld, as
foreign source dividend income for U.S. federal income tax purposes to the
extent of our current or accumulated earnings and profits, as computed for U.S.
federal income tax purposes. Distributions in excess of that amount will reduce
an Unconnected U.S. Shareholder's tax basis in the Class B shares, but not below
zero, and the remainder, if any, will be treated as taxable capital gain. In
general, in computing its U.S. federal income tax liability, an Unconnected U.S.
Shareholder may elect for each taxable year whether to claim a deduction or,
subject to the limitations described below, a credit for Canadian taxes withheld
from dividends paid on its Class B shares. If the Unconnected U.S. Shareholder
elects to claim a credit for such Canadian taxes, the election will be binding
for all foreign taxes paid or accrued by the Unconnected U.S. Shareholder for
such taxable year. The Code applies various limitations on the amount of the
foreign tax credit that may be available to a U.S. taxpayer based upon the
segregation of foreign source income into separate categories, or "baskets", of
income. For purposes of applying the foreign tax credit limitation, dividends
are generally included in the passive income basket or the financial services
income basket if received by a financial services entity. The amount of credit
that may be claimed with respect to the basket of income to which the dividend
is allocated, and to which the foreign taxes are attributable, generally may not
exceed the same proportion of the U.S. tax on worldwide taxable income, before
applying the foreign tax credit as the U.S. holder's foreign source taxable
income allocable to such basket bears to such U.S. holder's entire taxable
income. The foreign tax credit is disallowed for dividends on stock unless a
minimum holding period requirement is satisfied and additional limitations may
restrict the ability of some individuals to claim the foreign tax credit.
Accordingly, investors should consult their own tax advisors with respect to the
potential consequences to them of the foreign tax credit limitations. Dividends
paid by us generally will constitute "portfolio income" for purposes of the
limitation on the use of passive activity losses by investors and "investment
income" for purposes of the limitation on investors' investment interest
expense. Dividends paid by us will not be eligible for the "dividends received
deduction" generally allowed with respect to dividends paid by U.S. corporations
under Section 243 of the Code, but may be eligible for the dividends received
deduction which may be claimed by 10% corporate shareholders under Section 245
of the Code.
For U.S. federal income tax purposes, the amount of any distributions made on
Class B shares to an Unconnected U.S. Shareholder in Canadian dollars will equal
the U.S. dollar value of the Canadian dollars calculated by reference to the
appropriate exchange rate in effect on the date of receipt of the distribution,
regardless of whether the Canadian dollars are actually converted into U.S.
dollars upon
53
receipt. Unconnected U.S. Shareholders should consult their own tax advisors
regarding the treatment of foreign currency gain or loss, if any, on any
Canadian dollars which are converted into U.S. dollars subsequent to receipt by
the Unconnected U.S. Shareholder.
The sale of Class B shares generally will result in the recognition of gain or
loss to the Holder in an amount equal to the difference between the amount
realized and the Holder's adjusted basis in the Class B shares. Provided the
Holder is not considered a "dealer" in the Class B shares sold, gain or loss
upon the sale of Class B shares will generally be capital gain or loss.
Capital losses are deductible to the extent of capital gains. Individual
taxpayers may deduct excess capital losses up to $3,000 a year, $1,500 in the
case of a married individual filing separately, from ordinary income.
Non-corporate taxpayers may carry forward unused capital losses indefinitely.
Unused capital losses of a corporation may be carried back three years and
carried forward five years.
In the case of individuals, net capital gain from the disposition of property
held for investment is excluded from investment income for purposes of computing
the limitation on the deduction for investment interest applicable. An
individual may, however, elect to include such net capital gain in investment
income if such taxpayer reduces the amount of its net capital gain that is
otherwise eligible for preferential capital gains tax treatment by such amount.
In that event, such investment income would be taxable at ordinary income rates.
For any taxable year of Peace Arch, if at least 75% of our gross income is
"passive income", as defined in the Code, or if at least 50% of our assets, by
average fair market value, or, prior to fiscal year 1998, possibly by adjusted
tax basis, are assets that produce or are held for the production of passive
income, we will be a passive foreign investment company ("PFIC"). If we are a
PFIC for any taxable year during which an Unconnected U.S. Shareholder owns any
Class B shares, the Unconnected U.S. Shareholder will be subject to special U.S.
federal income tax rules, set forth in Sections 1291 to 1298 of the Code, with
respect to all of such Unconnected U.S. Shareholder's Class B shares. If we were
treated as a PFIC at any time during an Unconnected U.S. Shareholder's holding
period for Class B shares, such Unconnected U.S. Shareholder generally would be
subject to additional tax as well as interest charges with respect to the
deferral of tax for the period during which such Class B shares were held. Any
such additional tax and interest charges would apply upon the disposition of the
Class B shares or the receipt of dividends. Additionally, any gain realized on
the disposition of Class B shares would be treated as ordinary income or taxable
at ordinary income rates rather than as capital gain or taxable at capital gains
rates, and the tax basis of the Class B shares held by an Unconnected U.S.
Shareholder generally would not be stepped up to fair market value at death.
Under some circumstances, shareholders of a PFIC may elect to be taxed currently
on their pro rata shares of PFIC income and capital gain or, in accordance with
recently enacted legislation, report income currently on a mark to market basis
with respect to their shares of stock in the PFIC.
We do not believe that we are likely to be a PFIC in the current or future
taxable years; however, because the PFIC determination is made annually on the
basis of facts and circumstances that may be beyond our control and because the
principles and methodology for determining the fair market values of our assets
are unclear, there can be no assurance that we will not be a PFIC for such
years. Special rules not described herein will also apply if we become a
"controlled foreign corporation" for U.S. federal income tax purposes. We would
be treated as a controlled foreign corporation if "U.S. Shareholders" were to
own, actually or constructively, more than 50% of the total combined voting
power or total value of us. For this purpose, the term "U.S. Shareholder" means
a U.S. person who owns, actually or constructively, ten percent or more of the
total combined voting power of Peace Arch. In light of the ownership
requirements necessary for our productions to constitute "Canadian-content"
productions and for us to
54
claim Canadian tax benefits, it is not anticipated that we will become a
controlled foreign corporation for U.S. federal income tax purposes.
U.S. Information Reporting and Backup Withholding
Under U.S. treasury regulations that are generally effective with respect to
payments made after December 31, 2000 (the "new withholding Regulations"), the
proceeds of a sale of Class B shares through a U.S. or U.S. related broker will
be subject to U.S. information reporting and may be subject to the 30% (for tax
year 2002) U.S. backup withholding requirements. Unconnected U.S. Shareholders
generally can avoid the imposition of U.S. non-resident withholding tax by
reporting their taxpayer identification number on an Internal Revenue Service
Form W-9. Non-U.S. shareholders generally can avoid the imposition of U.S.
backup withholding tax by providing to their broker or paying agent a duly
completed Internal Revenue Service Form W-8 BEN. Any amounts withheld under the
backup/non-resident withholding rules will be allowed as a refund or a credit
against the shareholder's U.S. Federal income tax, provided the required
information is furnished to the Internal Revenue Service.
Dividends paid in the U.S. on the Class B shares to Unconnected U.S.
Shareholders or to non-U.S. shareholders through a U.S. or U.S. related person
may be subject to the 30% (for tax year 2002) U.S. backup/non-resident
withholding tax unless certification requirements are satisfied.
The New Withholding Regulations consolidate and modify the pre-2001
certification requirements and means by which a holder may claim exemption from
U.S. federal income tax withholding and provide presumptions regarding the
status of holders when payments to the holders cannot be reliably associated
with appropriate documentation provided to the payor. All holders should consult
their tax advisors regarding the application of the New Withholding Regulations.
Canadian Tax Considerations
Dividends paid or credited, or that we deem to pay or credit, on the Class B
shares to Unconnected U.S. Shareholders will be subject to Canadian withholding
tax. Under the Convention, the maximum rate of withholding tax on dividends paid
or credited on the Class B shares is 15% if the beneficial owner of such
dividends is an Unconnected U.S. Shareholder. However, that rate is reduced to
5% under the Convention if the beneficial owner of such dividends is an
Unconnected U.S. Shareholder that is a corporation that owns at least 10% of the
voting stock of Peace Arch.
An Unconnected U.S. Shareholder will not be subject to tax in Canada on any
capital gain realized upon a disposition or deemed disposition of the Class B
shares, provided that the Class B shares do not constitute "taxable Canadian
property" of the Unconnected U.S. Shareholder within the meaning of the Tax Act.
The Class B shares will not generally constitute taxable Canadian property of
the Unconnected U.S. Shareholder unless, at any time in the five-year period
that ends at the time of the disposition, the Unconnected U.S. Shareholder,
either alone or together with persons with whom the Unconnected U.S. Shareholder
did not deal at arm's length, owned, had an interest in or the right to acquire
25% or more of the issued Class B shares or any series or class of our capital
stock. Even if the Class B shares are taxable Canadian property, under the
Convention, gains derived by an Unconnected U.S. Shareholder would generally not
be taxable in Canada unless the value of the Class B shares is derived
principally from real property situated in Canada. We believe that the value of
our Class B shares is not currently principally derived, directly or indirectly,
from real property situated in Canada and do not expect this to change in the
foreseeable future.
Canada does not currently impose any estate taxes or succession duties.
55
F. DIVIDENDS AND PAYING AGENTS
Not applicable.
G. STATEMENTS BY EXPERTS
Not applicable.
H. DOCUMENTS ON DISPLAY
Any statement in this annual report about any of our contracts or other
documents is not necessarily complete. If the contract or document is filed as
an exhibit to the registration statement, the contract or document is deemed to
modify the description contained in this annual report. You must review the
exhibits themselves for a complete description of the contract or document.
You may review a copy of our filings with the SEC, including exhibits and
schedules filed with it, at the SEC's public reference facilities in Room 1024,
Judiciary Plaza, 450 Fifth Street, N.W., Washington, D.C. 20549 and at the
regional offices of the SEC located at 233 Broadway, New York, New York 10279
and at the Northwestern Atrium Center, 500 West Madison Street, Suite 1400,
Chicago, Illinois 60661. Please call the SEC at 1-800-SEC-0330 for further
information on the public reference rooms. In addition, the Commission maintains
an Internet site at http://www.sec.gov that contains reports and other
information regarding issuers that file electronically with the Commission.
You may read and copy any reports, statements or other information that we file
with the SEC at the addresses indicated above and you may also access them
electronically at the Web site set forth above. These SEC filings are also
available to the public from commercial document retrieval services.
WE ARE REQUIRED TO FILE REPORTS AND OTHER INFORMATION WITH THE SEC UNDER THE
SECURITIES EXCHANGE ACT OF 1934. REPORTS AND OTHER INFORMATION FILED BY US WITH
THE SEC MAY BE INSPECTED AND COPIED AT THE SEC'S PUBLIC REFERENCE FACILITIES
DESCRIBED ABOVE OR THROUGH THE INTERNET AT WWW.SEC.GOV. AS A FOREIGN PRIVATE
ISSUER, WE ARE EXEMPT FROM THE RULES UNDER THE EXCHANGE ACT PRESCRIBING THE
FURNISHING AND CONTENT OF PROXY STATEMENTS AND OUR OFFICERS, DIRECTORS AND
PRINCIPAL SHAREHOLDERS ARE EXEMPT FROM THE REPORTING AND SHORT-SWING PROFIT
RECOVERY PROVISIONS CONTAINED IN SECTION 16 OF THE EXCHANGE ACT. UNDER THE
EXCHANGE ACT, AS A FOREIGN PRIVATE ISSUER, WE ARE NOT REQUIRED TO PUBLISH
FINANCIAL STATEMENTS AS FREQUENTLY OR AS PROMPTLY AS UNITED STATES COMPANIES.
I. SUBSIDIARY INFORMATION
See Item 4C of this annual report.
ITEM 11. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We are subject to two main market risks: Interest rate risk and foreign currency
exchange risk.
56
The interest rate risk arises through our $15 million bank credit facility. This
facility bears interest at a rate equal to the Canadian prime rate plus 1% per
annum. As of August 31, 2002 we had $1.86 million outstanding under the credit
facility and for the year then ended we recorded interest expense of $14,000 and
capitalized interest of $671,000. As of August 31, 2001, we had borrowings of
$18.4 million outstanding under the credit facility and for the year then ended
we recorded interest expense of $9,000 and capitalized interest of $1.07
million. The average interest rate for fiscal 2002 was 5.8%. A change of 1% in
the average interest rate on this facility would have impacted our fiscal 2002
interest costs by approximately $110,000.
We receive a portion of our revenues from U.S. and international sources in U.S.
dollars while costs are payable primarily in Canadian dollars. Accordingly,
operating results can be affected by fluctuations in the U.S. dollar exchange
rate. Currency exchange rates are determined by market factors beyond our
control and may vary substantially during the course of a production. If the
Canadian dollar were to strengthen in relation to the U.S. dollar, our effective
costs would rise in relation to our revenues. We do not maintain U.S. currency
balances in excess of our estimated U.S. payables. From time to time we use
derivative instruments to reduce our exposure to foreign currency risk. At the
present time we have no derivative instruments outstanding. The average exchange
rate for fiscal 2002 was Cdn$1.5724 per US$1.00. A change of 1% in the average
exchange rate would have impacted our 2002 net loss by approximately $26,000.
ITEM 12. DESCRIPTION OF SECURITIES OTHER THAN EQUITY SECURITIES
Not applicable.
PART II
ITEM 13. DEFAULTS, DIVIDEND ARREARAGES AND DELINQUENCIES
In November 2001, we were in breach of covenants with the former debenture
holders and in November 2001 we renegotiated our remaining obligation of
$5,687,000, with certain debt holders having their position repaid and assumed
by another existing debt holder. In connection with the renegotiated $5,687,000
debt, we issued warrants to purchase 230,000 Class B shares at an exercise price
of $1.20 per share. A value of $212,650 was attributed to the warrants issued
and recorded as debt discount and other paid-in capital. This debt discount was
being amortized against income as interest expense over the term of the
debentures. The debentures bore interest at rates ranging from 18% to 36%
percent, and were paid by the due date of December 31, 2002. For accounting
purposes, the debt re-negotiation transaction was accounted for as a
modification of the original debentures, with any existing unamortized debt
discounts and deferred financing costs amortized over the remaining term of the
new debt instrument.
At August 31, 2002, we were not in compliance with debt covenants with the
debenture holders causing the obligation to be due on demand. The debentures
were fully repaid subsequent to year end.
At January 6, 2003 we are in default of payment of principal and interest under
our loan agreement with Fremantle Media Enterprises Ltd., causing the entire
obligation to be due on demand. As detailed in "Proposed Acquisition and
Financing Transactions" in Item 3D herein, we have agreed to a restructuring of
the debt due to Fremantle Media Enterprises Ltd. ("Fremantle"), subject to the
completion of the Acquisition and Financing Transactions. As at the date of this
report, we are indebted to Fremantle in the approximate aggregate principal
amount of $7.58 million, accruing interest at a rate of 10% per annum.
Also, as at January 6, 2003 the US$1.075 million balance of a third party loan
guaranteed by us was in default. Comerica Bank of California may demand payment
under this guarantee. As detailed in "Proposed Acquisition and Financing
Transactions" in Item 3D herein, we have agreed to a release and reconstitution
of the loan guarantee provided to Comerica, subject to the completion of the
Acquisition and Financing Transactions.
ITEM 14. MATERIAL MODIFICATIONS TO THE RIGHTS OF SECURITY HOLDERS AND
USE OF PROCEEDS.
Not Applicable.
ITEM 15. CONTROLS AND PROCEDURES
Under the supervision and with the participation of our management, including
our Chief Executive Officer and Principal Financial Officer, we have evaluated
the effectiveness of the design and operation of our disclosure controls and
procedures pursuant to Exchange Act Rule 13a-14(c) within 90 days of the filing
date of this annual report. Based on that evaluation, the Chief Executive
Officer and Principal Financial Officer have concluded that these disclosure
controls and procedures are effective. There were no significant changes in our
internal controls or in other factors that could significantly affect internal
controls subsequent to the date of their evaluation.
ITEM 16. [RESERVED]
58
PART III
ITEM 17. FINANCIAL STATEMENTS
Our financial statements are stated in Canadian Dollars (CDN$) and are prepared
in accordance with Generally Accepted Accounting Principles (GAAP) in Canada,
the application of which, in our case, conforms in all material respects for the
periods presented with United States GAAP, except as described in Note 20 to the
audited financial statements included herein.
59
ITEM 18. FINANCIAL STATEMENTS
We have elected to provide financial statements pursuant to Item #17.
AUDITORS' REPORT TO THE SHAREHOLDERS
We have audited the consolidated balance sheets of Peace Arch Entertainment
Group Inc. as at August 31, 2002 and 2001 and the consolidated statements of
operations, deficit and cash flows for each of the years in the three year
period ended August 31, 2002. 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.
With respect to the consolidated financial statements for the year ended August
31, 2002 and 2001, we conducted our audits in accordance with Canadian generally
accepted auditing standards and auditing standards generally accepted in the
United States of America. With respect to the consolidated financial statements
for the year ended August 31, 2000, we conducted our audit in accordance with
Canadian generally accepted auditing standards. Those standards require that we
plan and perform an audit to obtain reasonable assurance 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.
In our opinion, these consolidated financial statements present fairly, in all
material respects, the financial position of the Company as at August 31, 2002
and 2001 and the results of its operations and its cash flows for each of the
years in the three year period ended August 31, 2002 in accordance with Canadian
generally accepted accounting principles. As required by the Company Act
(British Columbia), we report that in our opinion these principles have been
applied, after giving retroactive effect to the change in accounting for net
loss per share as described in note 3(k), on a consistent basis.
/s/ KPMG LLP
Chartered Accountants
Vancouver, Canada
December 6, 2002, except for note 21 which is as of December 17, 2002
COMMENTS BY AUDITOR FOR U.S. READERS ON CANADA - U.S. REPORTING DIFFERENCE
In the United States, reporting standards for auditors require the addition of
an explanatory paragraph (following the opinion paragraph) when the financial
statements are affected by conditions and events that cast substantial doubt on
the Company's ability to continue as a going concern, such as those described in
note 2 to the financial statements. Our report to the shareholders dated
December 6, 2002, except for note 21 which is as of December 17, 2002, is
expressed in accordance with Canadian reporting standards which do not permit a
reference to such events and conditions in the auditor's report when these are
adequately disclosed in the financial statements.
/s/ KPMG LLP
Chartered Accountants
Vancouver, Canada
December 6, 2002, except for note 21 which is as of December 17, 2002
60
PEACE ARCH ENTERTAINMENT GROUP INC.
CONSOLIDATED BALANCE SHEETS
AS AT AUGUST 31, 2001 AND 2002
(Expressed in thousands of Canadian dollars)
2001 2002
---- ----
ASSETS
Cash and cash equivalents $ 3,977 $ 1,968
Accounts and other receivables (note 4) 28,203 3,871
Productions in progress 3,039 1,356
Prepaid expenses and deposits 459 206
Investment in television programming (note 5) 3,667 2,332
Property and equipment (note 6) 7,277 842
Deferred costs 410 188
Goodwill and trademarks (note 7) 238 -
--------- ---------
$ 47,270 $ 10,763
========= =========
LIABILITIES AND SHAREHOLDERS' EQUITY (DEFICIENCY)
Bank indebtedness (note 8) $ 18,447 $ 1,855
Accounts payable and accrued liabilities 12,876 2,650
Deferred revenue (note 17(a)) 3,191 1,197
Deferred gain (note 9) - 436
Debt (note 12) 11,215 9,892
--------- ---------
45,729 16,030
--------- ---------
Shareholders' equity (deficiency):
Share capital (note 13) 31,870 31,870
Authorized:
100,000,000 Class A Multiple Voting Shares without par value Issued -
1,091,875 (August 31, 2001 - 1,105,875)
100,000,000 Class B Subordinate Voting Shares without par value Issued -
2,795,969 (August 31, 2001 - 2,781,969)
25,000,000 Preference Shares, issuable in series without par value
Issued - nil
Other paid-in capital (note 12) 467 680
Deficit (30,796) (37,817)
--------- ---------
1,541 (5,267)
--------- ---------
$ 47,270 $ 10,763
========= =========
Future operations (note 2)
Commitments and contingencies (notes 17)
Subsequent events (note 21)
/s/ Cameron White /s/ Juliet Jones
Cameron White Juliet Jones
Director Director
The accompanying notes are an integral part of the
consolidated financial statements
PEACE ARCH ENTERTAINMENT GROUP INC. ANNUAL REPORT FOR THE YEARS ENDED
AUGUST 31, 2000, 2001 AND 2002
- 2 -
PEACE ARCH ENTERTAINMENT GROUP INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE YEARS ENDED AUGUST 31, 2000, 2001 AND 2002
(Expressed in thousands of Canadian dollars except per share information)
2000 2001 2002
---- ---- ----
Revenue $ 34,663 $ 54,900 $ 6,494
Expenses:
Amortization of television programming and Production
costs (note 3(d)) 31,144 57,612 6,639
Other costs of production and sales 2,157 1,755 615
Other amortization 781 748 476
Selling, general and administrative 3,668 4,521 3,101
Bad debt (note 17(b)) - - 1,675
---------- ---------- ----------
37,750 64,636 12,506
---------- ---------- ----------
Loss from operations before undernoted (3,087) (9,736) (6,012)
Interest income 775 499 597
Interest expense (note 14) (963) (2,295) (2,364)
Loss on write-down of assets (note 7) - (2,665) (166)
Gain on sale of assets (note 9) 272 233 176
---------- ---------- ----------
84 (4,228) (1,757)
---------- ---------- ----------
Loss before income taxes (3,003) (13,964) (7,769)
Income tax expense (recovery) (note 11) 265 316 (748)
---------- ---------- ----------
Net loss $ (3,268) $ (14,280) $ (7,021)
========== ========== ==========
Basic net loss per common share (note 15) $ (0.86) $ (3.71) $ (1.81)
========== ========== ==========
Diluted loss per common share (note 15) $ (0.86) $ (3.71) $ (1.81)
========== ========== ==========
The accompanying notes are an integral part of the
consolidated financial statements
PEACE ARCH ENTERTAINMENT GROUP INC. ANNUAL REPORT FOR THE YEARS ENDED
AUGUST 31, 2000, 2001 AND 2002
- 3 -
PEACE ARCH ENTERTAINMENT GROUP INC.
CONSOLIDATED STATEMENTS OF DEFICIT
FOR THE YEARS ENDED AUGUST 31, 2000, 2001 AND 2002
(Expressed in thousands of Canadian dollars)
2000 2001 2002
---- ---- ----
Balance, beginning of year $ (13,248) $ (16,516) $ (30,796)
Net loss for the year (3,268) (14,280) (7,021)
----------- ----------- -----------
Balance, end of year $ (16,516) $ (30,796) $ (37,817)
=========== =========== ===========
The accompanying notes are an integral part of the
consolidated financial statements
PEACE ARCH ENTERTAINMENT GROUP INC. ANNUAL REPORT FOR THE YEARS ENDED
AUGUST 31, 2000, 2001 AND 2002
- 4 -
PEACE ARCH ENTERTAINMENT GROUP INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED AUGUST 31, 2000, 2001 AND 2002
(Expressed in thousands of Canadian dollars)
2000 2001 2002
---- ---- ----
Operating activities:
Net loss ............................................ $ (3,268) $(14,280) $ (7,021)
Items not involving cash:
Amortization of television programming (note 3(d)) 31,144 50,970 4,070
Amortization of deferred finance costs ........... 28 358 470
Other amortization ............................... 781 748 476
Interest on debt discount ........................ 48 221 250
Future income taxes .............................. (124) -- --
Loss (gain) on sale of assets .................... 290 (233) (176)
Loss on write-down of assets (note 7) ............ -- 2,665 166
Bad debt (note 17(b)) ............................ -- -- 1,675
Investment in television programming ................ (31,599) (52,077) (1,577)
Changes in non-cash operating working capital
(note 16) ........................................... (2,361) (1,105) 21,674
-------- -------- --------
(5,061) (12,733) 20,007
-------- -------- --------
Investing activities:
Increase in deferred costs .......................... (998) (142) (430)
Increase in goodwill and trademarks ................. (39) (17) (1)
Property and equipment acquired ..................... (589) (178) (44)
Reduction of note receivable ........................ 817 -- --
Proceeds on sale of assets, net (note 9) ............ -- -- 5,870
Acquisition of assets (note 10) ..................... (477) -- --
-------- -------- --------
(1,286) (337) 5,395
-------- -------- --------
Financing activities:
Issue of common shares, net ......................... 191 196 --
Increase in loans due to directors
and shareholders ................................ 350 -- --
Increase (decrease) in bank indebtedness ............ (1,135) 12,650 (16,592)
Increase in debt .................................... 7,817 -- --
Repayment of debt ................................... (872) (258) (10,819)
-------- -------- --------
6,351 12,588 (27,411)
-------- -------- --------
Increase (decrease) in cash and cash equivalents ........ 4 (482) (2,009)
Cash and cash equivalents, beginning of year ............ 4,455 4,459 3,977
-------- -------- --------
Cash and cash equivalents, end of year .................. $ 4,459 $ 3,977 $ 1,968
======== ======== ========
Supplementary information:
Interest paid (net of amounts capitalized) ......... $ 787 $ 1,217 $ 1,978
Income taxes paid .................................. 505 12 18
Income taxes received .............................. 242 8 349
Non-cash transactions:
Conversion of an accounts payable to debt ...... -- -- 6,626
Increase in investment in television
programming and debt ......................... -- -- 1,158
Increase in note receivable on sale of
property (note 9) ............................ -- -- 1,000
Increase in liabilities and receivable from
co-producer (note 17(b)) ..................... -- -- 1,675
Discounts on debt .............................. -- 332 213
The accompanying notes are an integral part of the
consolidated financial statements
PEACE ARCH ENTERTAINMENT GROUP INC. ANNUAL REPORT FOR THE YEARS ENDED
AUGUST 31, 2000, 2001 AND 2002
- 5 -
PEACE ARCH ENTERTAINMENT GROUP INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollar amounts in tables expressed in thousands of Canadian dollars,
except per share amounts)
1. OPERATIONS
Based in Vancouver, British Columbia, Canada, Peace Arch Entertainment
Group Inc., together with its subsidiaries, (collectively, the "Company")
is a fully integrated company that creates, develops, produces and
distributes film, television and video programming for world-wide markets.
2. FUTURE OPERATIONS
These consolidated financial statements have been prepared on the "going
concern" basis, which assumes the realization of assets and the settlement
of liabilities in the normal course of operations. The application of the
"going concern" basis is dependent upon the Company achieving profitable
operations to generate sufficient cash flows to fund continuing operations
or, in the absence of adequate cash flows from operations, obtaining
additional financing to meet its obligations as they come due. There is
substantial doubt about the appropriateness of the Company's use of the
"going concern" assumption because of the significant losses from
operations, material working capital and shareholder deficiencies as at
August 31, 2002, contingency related to the listing of its shares (17(e)),
non-compliance with certain debt covenants and dependence upon the
continued financial support of its secured lenders. The Company only has
sufficient cash resources to maintain its current level of operations until
December 2002. As a result of these factors, realization of assets and
discharge of liabilities are subject to significant uncertainty.
Significant restructuring initiatives, including staff reductions, were
carried out during the year ended August 31, 2002 in an effort to reduce
operating costs. Management continues to review operations in order to
identify additional strategies, including further cost reductions and
obtaining future sales contracts, to increase cash flow, improve the
Company's financial position and enable timely discharge of the Company's
obligations. The Company has entered into a term sheet for a potential
financing and restructuring transaction (note 21). There is no assurance
the Company will be successful in its restructuring initiatives, its
financing efforts and in achieving profitable operations. If the Company is
unsuccessful, the Company may be required to significantly reduce or cease
operations and liquidate assets or seek potential buyers of the Company.
The Company has credit facilities with a Canadian chartered bank and loans
from subordinated lenders, all of which are secured by charges on the
assets of the Company. As discussed in notes 8 and 12, the credit facility
balance and certain loans are due on demand pursuant to the original terms
of their agreements. The Company was not in compliance with certain loan
covenants at August 31, 2002. There is also no assurance that the Company
will remain in compliance with its other debt covenants and repayment
requirements, which if violated could result in such obligations being
immediately due and payable.
These consolidated financial statements do not reflect adjustments that
would be necessary if the "going concern" basis is not appropriate. If the
"going concern" basis is not appropriate for the consolidated financial
statements, then significant adjustments would be necessary in the carrying
value of assets and liabilities, the reported revenues and expenses, and
the balance sheet classifications used. Additionally, the amounts reported
could materially change because of any plan of reorganization in the
future, since the reported amounts in the consolidated financial statements
do not give effect to adjustments to the carrying value of the underlying
assets or amounts of liabilities that may ultimately result.
PEACE ARCH ENTERTAINMENT GROUP INC. ANNUAL REPORT FOR THE YEARS ENDED
AUGUST 31, 2000, 2001 AND 2002
- 6 -
3. SIGNIFICANT ACCOUNTING POLICIES
(a) Basis of Presentation
The consolidated financial statements of the Company are prepared in
accordance with generally accepted accounting principles in Canada
and, except as explained and quantified in note 20, comply, in all
material respects, with generally accepted accounting principles in
the United States of America.
These consolidated financial statements include the accounts of the
Company and its subsidiaries, all of which are wholly owned. All
material intercompany balances and transactions have been eliminated.
(b) Revenue Recognition
(i) Revenues from television programming are recognized only when
persuasive evidence of a sale or licensing arrangement with a
customer exists, the film is complete and has been delivered or
is available for immediate and unconditional delivery, the
license period has commenced, the arrangement fee is fixed or
determinable, collection of the arrangement fee is reasonably
assured, and other conditions as specified in the respective
agreements have been met.
(ii) Revenues from production services for third parties are
recognized when the production is completed and delivered. All
associated production costs are deferred and charged against
earnings when the film is delivered and the revenue recognized.
(iii) Cash received in advance of meeting the revenue recognition
criteria described above is recorded as deferred revenue.
(c) Cash Equivalents
Cash equivalents include highly liquid investments with terms to
maturity of 90 days or less when purchased.
(d) Investment in Television Programming and Productions in Progress
Investment in television programming represents the unamortized cost
of completed proprietary television programs (net of related tax
credits received or receivable) which have been produced by the
Company or to which the Company has acquired distribution rights.
Productions in progress represent the costs of incomplete programs and
are carried at the lower of cost and estimated fair value.
For episodic television series, capitalized costs are limited to the
amount of revenue contracted for each episode until estimates of
secondary market revenue can be established. Costs in excess of this
limitation are expensed as incurred.
Participation and exploitation costs are capitalized when they are
likely to be incurred and can be reasonably determined.
The Company records amortization based on the ratio that current
revenues bear to estimated remaining unrecognized ultimate revenue as
of the beginning of the current fiscal year. Investment in television
programming is recorded at the lower of remaining unamortized film
costs and estimated fair value, determined on an individual program
basis.
Estimates of ultimate revenue to be received in respect of a
particular film includes revenue from a market or territory only when
persuasive evidence exists that such revenue will occur, or the
Company has a history of earning such revenue in the market or
territory.
(e) Property and Equipment
Property and equipment are stated at cost and amortized on the
following basis:
Buildings..............................................................5% declining balance
Computers, furniture and equipment.....................................20% declining balance
Production equipment...................................................20% declining balance
Other..................................................................2-5 year straight line
Equipment under capital lease is amortized using the above rates.
The Company monitors the recoverability of long-lived assets based
upon factors such as current market value, future asset utilization,
business climate and future undiscounted cash flows expected to result
from the use of the related assets. The Company's policy is to record
an impairment loss in the period when it is determined that the
carrying amount of the asset may not be recoverable. The impairment
loss is calculated as the amount by which the carrying amount of the
asset exceeds the undiscounted estimate of future cash flows from the
asset.
(f) Deferred Costs
Deferred costs represent financing costs, which are amortized to
interest expense over the term of the related financing, and
development costs incurred on projects prior to production. Upon
commencement of production, the development costs are reclassified to
productions in progress. Development costs are written off when it is
determined that they will not be recovered, normally within three
years of the first capitalized transaction for each project not yet
set for production.
(g) Goodwill
Goodwill is amortized on a straight-line basis over 10 years.
Management performs annual assessments to determine whether the
amortization of the goodwill balance over its remaining life can be
recovered through undiscounted future operating cash flows of the
acquired operation. When the future cash flows are less than the
carrying value, the excess is charged against income.
Effective July 1, 2001, the Company adopted the provisions of the
Canadian Institute of Chartered Accountants recommendations under
Handbook 1581 "Business Combinations", and certain provisions of
Handbook 3062 "Goodwill and Other Intangible Assets", as required for
goodwill and intangible assets resulting from business combinations
consummated after June 30, 2001. Handbook 1581 requires the purchase
method of accounting be used for all business combinations initiated
after June 30, 2001. Use of the pooling-of-interests method is
prohibited. Handbook 3062 changes the accounting for goodwill from an
amortization method to an annual impairment test and is required for
goodwill arising on business combinations made after June 30, 2001
and, otherwise to the Company will be applied prospectively effective
September 1, 2002. Under Handbook 3062, the Company is required to
perform an initial benchmark test of impairment within six months of
adoption and subsequent annual tests of goodwill will be at the
reporting unit level. If the carrying value of goodwill of a reporting
unit exceeds the fair value of the reporting unit's goodwill, the
carrying value must be written down to fair value.
(h) Government Assistance
The Company has access to several government programs that are
designed to assist film and television production in Canada. Amounts
received in respect of government programs are recorded as revenue in
accordance with the Company's revenue recognition policy for completed
film and television programs. Refundable tax credits are recorded as a
reduction of the cost of related films as described in note 3(d).
(i) Income Taxes
Future income taxes are recorded for using the asset and liability
method. Under the asset and liability method, future tax assets and
liabilities are recognized for the future tax consequences
attributable to differences between the financial statement carrying
amounts of existing assets and liabilities and their respective tax
bases. Future tax assets and liabilities are measured using enacted or
substantively enacted tax rates expected to apply when the asset is
realized or the liability settled. The effect on future tax assets and
liabilities of a change in tax rates is recognized in income in the
period that substantive enactment occurs. To the extent that the
Company does not consider it to be more likely than not that a future
tax asset will be recovered, it provides a valuation allowance against
the excess.
(j) Foreign Currency Translation
The Company's functional currency is the Canadian dollar. Foreign
currency denominated monetary assets and liabilities are translated
into Canadian dollars at exchange rates in effect at the end of the
period. Revenues and expenses are translated at exchange rates in
effect at the time of the transaction. Translation gains and losses
are included in income except for unrealized gains and losses arising
from the translation of long-term monetary assets and liabilities,
which are deferred and amortized over the life of the asset or
liability. For each of the fiscal years presented, the Company has no
long-term monetary assets or liabilities denominated in a foreign
currency.
(k) Net Earnings (Loss) per Common Share
Effective September 1, 2001, the Company adopted the new Canadian
Institute of Chartered Accountants recommendations relating to the
calculation and disclosure of net earnings (loss) per share. The new
recommendations have been applied retroactively and did not require a
change to previously reported amounts. Under the revised policy, the
calculation of basic net earnings (loss) per share has not been
impacted. Basic net earnings (loss) per share is computed using the
weighted average number of common shares outstanding during the
periods. Under the new recommendations, the treasury stock method is
used for the calculation of diluted net earnings (loss) per share
instead of the imputed income approach used previously. Under the
treasury stock method, the weighted average number of common shares
outstanding for the calculation of diluted net earnings (loss) per
share assumes that the proceeds to be received on the exercise of
dilutive stock options and warrants are applied to repurchase common
shares at the average market price for the period. Stock options and
warrants are dilutive when the average market price of the common
shares during the period exceeds the exercise price of the options and
warrants.
Shares that are contingently returnable to treasury are excluded from
the weighted average number of shares outstanding for purposes of the
calculation of basic earnings per share for all periods prior to the
period in which the contingency is resolved and the shares are
releasable from escrow. Contingent returnable shares are included in
diluted earnings per share prior to release if conditions for their
release have been achieved or would be if the contingency was not
determined as at a later date.
(l) Stock-Based Compensation
The Company accounts for stock-based compensation granted to certain
directors, employees and other service providers in exchange for
services rendered using the intrinsic value method set out in APB
Opinion No. 25 and related interpretations. Under this method,
compensation expense is recorded on the date of grant only if the then
current market price of the underlying stock exceeds the exercise
price. As the Company's policy is to grant options and warrants with
the exercise prices equal to the market price of the underlying stock
on the date of grant, no expense is typically recognized for these
type of awards.
(m) Comparative Figures
Certain comparative figures have been restated to conform to the basis
of presentation adopted for the current year. For fiscal 2002,
interest revenue earned on refundable tax credits have been
reclassified from revenues to interest income.
(n) Use of Estimates
The presentation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates
and assumptions that affect the reported amounts of assets and
liabilities and the disclosure of contingent assets and liabilities at
the date of the financial statements and the reported amounts of
revenues and expenses during the reporting period. Actual results may
ultimately differ from those estimates.
Investments in television programming are carried at the lesser of
unamortized capitalized cost and estimated fair value determined on a
film-by-film basis. Future changes in general economic conditions,
market preferences and other factors may result in the carrying value
of a particular film becoming impaired as management revises its
estimates of the ultimate revenue to be received in respect of each
film.
Productions in progress, goodwill, and accounts and tax credits
receivable are asset accounts that also require significant use of
management estimates to determine recoverability.
4. ACCOUNTS AND OTHER RECEIVABLES
2001 2002
---- ----
Trade receivables $ 4,448 $ 559
Note receivable (note 9) -- 1,000
Tax credits receivable 23,729 2,312
Income taxes recoverable 26 --
------- -------
$28,203 $ 3,871
======= =======
Tax credits receivable are federal and provincial refundable tax credits
related to specific film productions in Canada. The credits are recorded as
a reduction to the related investment in television programming in the
period in which the related production is completed and then amortized in
accordance with note 3(d). All amounts are subject to final determination
by the relevant tax authorities. During the year, tax credits aggregating
$1,752,020 were recorded (2001 - $13,538,134).
5. INVESTMENT IN TELEVISION PROGRAMMING
2001 2002
------------------------------- -------------------------------
ACCUMULATED ACCUMULATED
COST AMORTIZATION COST MORTIZATION
-------- ------------ -------- -----------
Television movies $ 7,910 $ 6,376 $ 8,274 $ 7,213
Television series 164,926 162,793 167,297 166,026
172,836 169,169 175,571 173,239
Net book value $ 3,667 $ 2,332
Investment in television programming is expected to be amortized not less
than 80% within the next three years. The Company expects amortization of
August 31, 2002 completed films will be approximately $2,000,000 in the
next fiscal year ending August 31, 2003.
As at August 31, 2002, the Company has no accrued participation costs that
it expects to pay in the next year.
6. PROPERTY AND EQUIPMENT
2001 2002
------------------------ --------------------------
ACCUMULATED ACCUMULATED
COST AMORTIZATION COST AMORTIZATION
--------- ------------ --------- ------------
Land $ 5,203 $ - $ - $ -
Buildings 1,229 231 - -
Computers, furniture and equipment 488 322 483 341
Production equipment 1,352 799 1,366 911
Equipment under capital lease 325 108 267 113
Other 192 52 161 70
--------- --------- ------ -------
8,789 1,512 2,277 1,435
--------- --------- ------ -------
Net book value $ 7,277 $ 842
========= =======
During the year ended August 31, 2002, the Company sold its remaining two
buildings (note 9).
7. GOODWILL AND TRADEMARKS
Effective September 1, 1996, the Company acquired 100% of the shares of
Peace Arch Productions Inc. (formerly Sugar Entertainment Ltd.), for
consideration of 22,500 common shares at a deemed price of $10.00 per
common share and contingent consideration of 350,000 cancelable performance
shares at a deemed price of $0.10 per common share. The shares were
comprised of 50% Class A shares and 50% Class B shares. The performance
shares were releasable from escrow at a rate of one share for every $10.00
of cash flow generated by Peace Arch Productions Inc. Goodwill recorded at
the time of acquisition was $318,232.
The Company recorded additional goodwill at the time the performance shares
were releasable from escrow. During the year ended August 31, 1998, 200,000
of the performance shares were released from escrow, resulting in an
increase in purchase goodwill and share capital of $1,980,000. During the
year ended August 31, 1999, the remaining 150,000 performance shares were
earned and additional purchase goodwill and share capital in the amount of
$802,500 was recorded. On September 28, 1999, the remaining 150,000 shares
were released from escrow.
During the year ended August 31, 2001, the Company wrote off the remaining
unamortized cost of goodwill of $2,665,000 related to its 1996 acquisition
of Peace Arch Productions Inc. (formerly Sugar Entertainment Ltd.) in
accordance with Company policy as described in note 3(g).
During the year ended August 31, 2002, the Company wrote off the remaining
unamortized cost of goodwill of $166,000 related to its 1995 acquisition of
The Eyes Multimedia Productions Inc. in accordance with Company policy as
described in note 3(g).
8. BANK INDEBTEDNESS
Bank indebtedness is drawn under a credit facility of up to $15 million
(August 31, 2001 - $29.5 million) for production financing and is comprised
of demand loans bearing interest at prime plus 1% per annum with monthly
payments of interest drawn under the credit facility. As at August 31,
2002, the prime rate was 4.50% (August 31, 2001 - 5.75%). The loans are
secured by the refundable tax credits of $2,311,902, accounts receivable of
$274,370, and distribution rights of the film properties with a carrying
value of $2,218,845 as of August 31, 2002 to which the loans relate and a
first priority general security agreement covering the assets of the
Company.
9. DEFERRED GAIN
In August 1999, the Company sold one of its three properties for gross
proceeds of $3,265,000. As consideration, the Company received cash in the
amount of $550,000 and a note in the amount of $817,295 bearing interest at
12% per annum. The principal was due and repaid in the year ended August
31, 2000. The gain on the sale in excess of the present value of the
minimum lease payments, being $284,528, was realized in 1999. The remaining
amount of the gain on sale of $513,493 was deferred and amortized over the
two-year minimum lease term. As at August 31, 2001, the deferred gain had
been fully amortized.
During the year ended August 31, 2002, the Company sold its remaining two
properties. In October 2001, the first property was sold for gross proceeds
of $2,313,000 and realized a gain on the sale of $88,322. In January 2002,
the second property was sold for gross proceeds of $4,722,200. As
consideration, the Company received cash in the amount of $3,722,200 and a
note in the amount of $1,000,000 bearing interest at 9% per annum
commencing January 10, 2002. The note receivable secured by a second
mortgage on the real property. The principal is due and payable January 1,
2004. At August 31, 2002, the Company continues to occupy the second
property through an operating lease arrangement. As the present value of
the minimum lease payments is greater than the gain on the sale of
$523,483, the gain was deferred and is being amortized over the four-year
minimum lease term. As at August 31, 2002, the unamortized balance of the
deferred gain was $436,236.
10. ACQUISITION OF MVP MOVIE VISTA PRODUCTIONS INC.
Effective August 31, 2000, the Company acquired 100% of the issued and
outstanding shares of MVP Movie Vista Productions Inc. for cash
consideration of $476,975. Assets acquired included film rights and tax
loss carry-forwards valued at $1,566,762. The benefit of the tax loss
carry-forwards has not been recognized in the financial statements.
11. FUTURE INCOME TAXES
Temporary differences give rise to the following future income tax assets
and liabilities at August 31:
2001 2002
------- --------
FUTURE INCOME TAX ASSETS:
Property and equipment $ 119 $ 115
Share issue costs 298 193
Investment in television programming 278 1,330
Deferred gain 2 1
Other 112 109
Losses available for future periods 9,110 10,313
------- -------
Gross future tax assets 9,919 12,061
Valuation allowance (9,851) (11,996)
------- -------
Net future income tax assets 68 65
FUTURE INCOME TAX LIABILITIES:
Property and equipment (68) (65)
Investment in television programming - -
Other - -
------- -------
$ - $ -
======= =======
At August 31, 2002 the Company has approximately $26,952,000 in non-capital
losses available for deduction against taxable income in future years.
These losses expire as follows:
2003 $ 265
2004 393
2005 919
2006 1,358
2007 1,337
2008 16,779
2009 5,901
---------
$ 26,952
=========
The differences between the effective tax rate reflected in the provision
for income taxes and the Canadian statutory income tax rate are as follows:
YEARS ENDED AUGUST 31,
-----------------------------------------
2000 2001 2002
---- ---- ----
Corporate statutory income tax rate (45.6)% (45.0)% (40.3)%
Add (deduct) the effect of:
Utilization of previously unrecognized tax losses (7.4) (0.4) (4.1)
Expenses not deductible for income tax purposes 13.5 2.4 5.6
Change in valuation allowance on future tax assets 48.3 45.3 29.0
----- ----- -----
Effective tax rate 8.8% 2.3% (9.8)%
===== ===== =====
12. DEBT
2001 2002
---- ----
(i) Mortgage due Nov 1, 2001 bearing interest at 7.55% per annum with
aggregate monthly payments of principal and interest of $9, secured by
a first mortgage on property. $ 863 $ -
(ii) Mortgage due March 1, 2002 bearing interest at 7.95% per annum
with aggregate monthly payments of principal and interest of $25,
secured by a first mortgage on property. 2,392 -
(iii)Debentures having a face value of $7,900 (recorded net of deemed
debt discount) bearing interest at 14% per annum, payable quarterly,
and 4% interest compounded quarterly, payable at maturity. The debt is
secured by a charge on the assets of the Company, and is due Feb 16,
2002 (notes 13(c)(ii) and 13(c)(iii)). 7,799 -
(iv) Debentures having an original face value of $5,687 (recorded net
of deemed debt discount) bearing interest from 18% to 36% per annum,
payable monthly. The debt is secured by a charge on the assets of the
Company, subordinated to bank indebtedness (note 8) and due Dec 31, 2002. - 537
(v) Term loan, bearing interest at 10% per annum, 8.5% payable monthly,
and accruing 1.5% monthly and payable at such time as the debentures
(iv) have been paid in full. The term loan, secured by a charge on the
personal property of the Company, subordinated to debentures (iv) and
bank indebtedness (note 8), and a secured interest in certain copyrights to - 7,606
productions, due Jun 30, 2004.
(vi) Bank guarantee with Comerica Bank to a maximum of US$2,074 on behalf
of a co-production partner, bearing interest at U.S. prime plus 1.5%
per annum, payable monthly, secured by a charge on the assets of the
co-production partner (note 5). - 1,675
(vii) Capital leases to purchase equipment, bearing interest from 7.2 to
10.2% per annum, secured by the equipment acquired. 161 74
-------- -------
$ 11,215 $ 9,892
======== =======
Of the $7,900,000 debentures issued (note 12(iii)), $350,000 was to related
parties. Included with the issuance were warrants to purchase 210,000 Class
A and 27,000 Class B shares at an exercise price of $5.00 per share (note
13(c)(ii)). A value of $322,000 was attributed to the warrants issued and
recorded as debt discount and other paid-in capital. This debt discount was
amortized against income as interest expense over the term of the
debentures. As at August 31, 2002, the debt discount has been fully
amortized. Also in connection with the debt issue, the Company granted as
contingent compensation warrants to purchase 105,000 Class A and 13,500
Class B shares at an exercise price of $5.00 per share (note 13(c)(ii)).
The warrants were only exercisable if the lenders agreed to an extension of
the original maturity date of the debentures on February 16, 2002.
Subsequent to August 31, 2001, the Company entered into a new loan
agreement and cancelled 83,403 Class A and 542 Class B warrants granted as
contingent consideration. Of the remaining 21,597 Class A warrants and
12,958 Class B warrants, 6,479 Class A warrants were re-priced to $1.20 and
expire February 16, 2004.
As a result of breach of covenants with the former debenture holders (note
12(iii)), in November 2001 the Company renegotiated its remaining
obligation of $5,687,000, with certain debt holders having their position
repaid and assumed by another existing debt holder. Included with the
renegotiated $5,687,000 debt (note 12(iv)) were warrants to purchase
230,000 Class B shares at an exercise price of $1.20 per share (note
13(c)(v)). A value of $212,650 has been attributed to the warrants issued
and recorded as debt discount and other paid-in capital. This debt discount
is being amortized against income as interest expense over the term of the
debentures, and has a current unamortized value of approximately $65,513.
The debentures bear interest at rates ranging from 18% to 36% percent, are
due December 31, 2002 and require earlier payments of principal upon cash
flow collections from certain current and future refundable tax credits
claims, proceeds from certain asset sales received and other transactions
by the Company. For accounting purposes, the debt re-negotiation
transaction was accounted for as a modification of the original debentures,
with any existing unamortized debt discounts and deferred financing costs
amortized over the remaining term of the new debt instrument.
At August 31, 2002, the Company was not in compliance with debt covenants
with the debenture holders causing the obligation to be due on demand. The
debentures were fully repaid subsequent to year end (note 21(b)).
Included in debt outstanding at August 31, 2002 (notes 12(iii) and 12(iv))
are amounts owing to related party shareholders of $581,963 (2001 -
$2,150,000)
During the year-ended August 31, 2002, the Company entered into an
agreement with an existing trade creditor whereby the creditor agreed to
exchange its trade payable balance of $7,783,470 for a long-term promissory
note obligation (note 12(v) having a security interest in copyrights to
certain productions. The promissory note bears interest at 10% per annum
and matures June 30, 2004. Subsequent to August 31, 2002 and pursuant to
the promissory note obligation, the Company failed to make payments of
principal of $500,000 and also interest owing. The Company has entered into
a proposed debt restructuring transaction with this creditor subsequent to
August 31, 2002 (note 21(a)(iii)).
The Company is also required to make other future principal repayments as
follows:
December 31, 2002 1,000,000
June 30, 2003 1,000,000
December 31, 2003 1,000,000
March 31, 2004 1,500,000
June 30, 2004 2,606,000
=========
The creditor is entitled to accelerated repayments under certain
situations, including the right to 100% of amounts collected by the Company
on the $1,000,000 note receivable (note 4).
Principal due in each of the next five fiscal years ending August 31 on
debt is approximately as follows:
2003 $ 4,786
2004 5,106
2005 -
2006 -
2007 -
---------
$ 9,892
=========
13. SHARE CAPITAL
(a) Issued
Class A shares are entitled to ten votes per share and Class B shares
are entitled to one vote per share. Each Class A share is convertible
at any time into one Class B share at the option of the holder. The
information in these consolidated financial statements has been
restated to reflect the share consolidation and reclassification.
CLASS A CLASS B
------------------------- -------------------------
NUMBER OF NUMBER OF TOTAL
SHARES AMOUNT SHARES AMOUNT AMOUNT
----------- ------ ---------- ------ -------
Balance, August 31, 1999 1,517,965 13,682 2,267,978 17,796 31,478
Change during the year:
Issued for cash on exercise of stock options - - 36,800 202 202
Converted (130,174) (1,173) 130,175 1,173 -
Less share issue costs, net of tax benefit - 29 - (35) (6)
--------- -------- --------- -------- --------
Balance, August 31, 2000 1,387,791 12,538 2,434,953 19,136 31,674
Change during the year:
Issued for cash on exercise of stock options - - 65,100 196 196
Converted (281,916) (2,611) 281,916 2,611 -
Less share issue costs, net of tax benefit - 63 - (63) -
--------- -------- --------- -------- --------
Balance, August 31, 2001 1,105,875 9,990 2,781,969 21,880 31,870
Change during the year:
Converted (14,000) (129) 14,000 129 -
Less share issue costs, net of tax benefit - 3 - (3) -
--------- -------- --------- -------- --------
Balance, August 31, 2002 1,091,875 $ 9,864 2,795,969 $ 22,006 $ 31,870
========= ======== ========= ======== ========
(b) Options
In 1997, the Company adopted a stock option plan (the "Plan") pursuant
to which the Company's Board of Directors may grant stock options to
officers and key employees. The Plan authorizes grants of options to
purchase up to 115,950 Class A and 650,000 Class B shares authorized
but unissued common stock. Stock options are granted with an exercise
price in Canadian dollars equal to the stock's fair market value at
the date of grant. All stock options have terms between three and five
years and vest and become fully exercisable immediately or after up to
21 months.
As at August 31, 2002, the following stock options were outstanding.
-------------------------------------------------------------------------------------------------------------------
EXERCISE OPTIONS OUTSTANDING OPTIONS EXERCISABLE
PRICE ------------------------ -------------------------
Expiry Date PER SHARE CLASS A CLASS B CLASS A CLASS B
----------- --------- -------- ------- ------- --------
January 13, 2003 5.50 - 106,700 - 106,700
February 2, 2003 US 5.00 - 10,500 - 10,500
March 23, 2003 9.50 28,000 28,000 28,000 28,000
July 27, 2003 5.00 - 27,000 - 27,000
November 19, 2003 7.50 2,800 2,800 2,800 2,800
December 21, 2003 3.00 - 14,100 - 14,100
February 16, 2004 9.50 5,000 5,000 5,000 5,000
March 29, 2004 3.35 - 25,000 - 25,000
April 9, 2004 3.60 - 20,000 - 20,000
April 12, 2004 3.60 - 122,500 - 122,500
July 24, 2004 4.75 - 14,000 - 14,000
August 21, 2005 0.30 - 274,400 - -
---- ------ ------- -------
35,800 650,000 35,800 375,600
------ ------- -------
Weighted average remaining contractual life 0.70 years 2.00 years 0.70 years 0.60 years
========== ========== ========== ==========
CLASS A CLASS B
------------------------------------ ------------------------------------
WEIGHTED-AVERAGE WEIGHTED-AVERAGE
NUMBER OF EXERCISE NUMBER OF EXERCISE
SHARES PRICE SHARES PRICE
--------- ---------------- --------- ----------------
Balance, August 31, 1999 158,350 11.11 158,350 11.11
Granted -- -- 346,570 6.08
Exercised -- -- (36,800) (5.50)
Expired or cancelled (31,900) (10.90) (61,850) (8.54)
------- ------ -------- -----
Balance, August 31, 2000 126,450 11.17 406,270 7.72
Granted -- -- 302,600 3.49
Exercised -- -- (65,100) (3.00)
Expired or cancelled (51,825) (12.57) (112,345) (9.70)
------- ------ -------- -----
Balance, August 31, 2001 74,625 10.20 531,425 5.47
Granted -- -- 284,400 0.30
Exercised -- -- -- --
Expired or cancelled (38,825) (10.98) (165,825) (6.86)
------- ------ -------- -----
Balance, August 31, 2002 35,800 9.34 650,000 2.77
======= ====== ======== =====
Excluded from the above option tables are 38,100 Class B options
expiring August 21, 2005, which were issued subject to the approval of
the shareholders of the Company, unless an equivalent amount of
options become available due to the expiry or cancellation of
outstanding options.
At August 31, 2002, a total of 411,400 options were exercisable
(August 31, 2001 - 599,383; August 31, 2000 - 467,071) at a weighted
average exercise price of $4.78 (August 31, 2001 - $6.08; August 31,
2000 - $8.79).
(c) Warrants
(i) In 1999, 750,000 Class B shares were issued by way of public
offering. In connection with the public offering, the Company
granted as compensation a warrant to purchase up to 75,000 Class
B shares at an exercise price of $US 6.75 per share. The warrant
is exercisable to August 3, 2004.
(ii) In connection with the debentures issued in 2000 (note 12(iii)),
the Company issued share purchase warrants to purchase an
aggregate 210,000 Class A shares and 27,000 Class B shares, all
at an exercise price of $5.00 per share, exercisable for a period
of 42 months from August 16, 2000.
(iii) In 2001, in connection with the debentures issued in 2000 (note
12(iii)), the Company granted as consideration to the
debentureholders for a release of certain security interests
warrants to purchase up to 100,000 Class B shares at an exercise
price of $5.30 per share. The warrants are exercisable for a
period of six months following the due date of the debenture on
February 16, 2002. As the warrants were granted at an exercise
price equal to the market value of Company's shares on the date
of grant, no expense has been recorded.
(iv) Also during 2001, the Company granted as partial compensation to
retain an investment banker as its financial advisor a warrant to
purchase up to 100,000 Class B shares at an exercise price of $US
2.72 per share, exercisable to April 16, 2006. As the warrants
were granted at an exercise price equal to the market value of
Company's shares on the date of grant, no compensation expense
has been recorded.
(v) During the year, in connection with the debentures issued (note
12(iv)), the Company issued share purchase warrants to purchase
up to 230,000 Class B shares at an exercise price of $1.20 per
share, exercisable to Jun 30, 2003.
For each of the periods presented, warrants were outstanding to
acquire common shares as indicated in the table.
--------------------------------------------------------------------------------------------------------------------------
EXERCISE 2002
PRICE -------------------------
Expiry Date PER SHARE 2000 2001 CLASS A CLASS B
----------- --------- ------- ------- -------- --------
October 21, 2000 $ 6.25 100,000 - - -
August 16, 2002 5.30 - 100,000 - -
June 30, 2003 1.20 - - - 230,000
February 16, 2004 (note 12) 1.20 - - 6,479 -
February 16, 2004 5.00 342,000 342,000 225,118 39,958
August 3, 2004 US 6.75 75,000 75,000 - 75,000
April 16, 2006 US 2.72 - 100,000 - 100,000
--------- ------- ------- ------- -------
517,000 617,000 231,597 444,958
========= ======= ======= ======= =======
(d) Dividends
Covenants attached to the debentures limit the Company's ability to
pay dividends without the approval of the lenders.
14. INTEREST EXPENSE
YEARS ENDED AUGUST 31,
-----------------------------------------
2000 2001 2002
------- -------- --------
Interest expense:
Long-term debt $ 369 $ 1,707 $ 1,630
Amortization of deferred finance costs and debt discounts 76 579 720
Other 518 9 14
Interest capitalized 82 1,066 671
15. NET LOSS PER COMMON SHARE
Basic loss per common share has been calculated by dividing into net loss
the weighted average number of common shares outstanding. As the Company
has a net loss in each of the periods presented, basic and diluted net loss
per share are the same as the exercise of all warrants or options would be
anti-dilutive. The weighted average number of shares outstanding for each
of the years presented is as follows:
YEARS ENDED AUGUST 31,
--------------------------------------------
2000 2001 2002
--------- --------- ---------
Basic 3,794,714 3,843,929 3,887,844
Diluted 3,794,714 3,843,929 3,887,844
16. CHANGES IN NON-CASH OPERATING WORKING CAPITAL
YEARS ENDED AUGUST 31,
-------------------------------------------------------
2000 2001 2002
-------- -------- --------
Accounts and other receivables. ........ $ 2,641 $(11,760) $ 25,332
Productions in progress ................ (12,191) 12,598 1,683
Prepaid expenses and deposits .......... (590) 423 253
Accounts payable and accrued liabilities 3,421 2,781 (3,600)
Deferred revenue ....................... 4,358 (5,147) (1,994)
-------- -------- --------
$ (2,361) $ (1,105) $ 21,674
======== ======== ========
17 COMMITMENTS AND CONTINGENCIES
(a) Government Assistance
During the year ended August 31, 2002, the Company received $94,907 (2001 -
$1,369,470; 2000 - $1,369,471) in production assistance and nil (2001 -
$2,350,000; 2000 - $100,000) in equity participation from government
sources. The production assistance is not repayable and the equity
participation is repayable from distribution revenues in respect of which
the financing was made.
Deferred revenue as at August 31, 2002 includes $151,852 (2001 - nil; 2000
- $1,369,471) related to production assistance and nil (2001 - nil; 2000 -
$100,000) in equity participation obtained from government sources during
the year.
(b) Loan Guarantee
The Company guaranteed a loan to a maximum of US$2,074,750 on behalf of a
co-production partner during the year ended August 31, 2001. During the
fiscal year ended August 31, 2002, the co-production partner defaulted on
its loan
payments. As a result, the Company agreed to make interest payments on
behalf of the co-producer partner to keep the loan current. As at August
31, 2002, the amount of the outstanding related debt was $1,675,000
(US$1,074,791) (note 12(vi)) and the Company has recognized its obligation
as an increase in debt and an increase in receivable from co-producer. The
receivable balance was written off at August 31, 2002, as the amount was
not deemed recoverable. The amount owing of $1,675,000 (US$1,074,791) is
currently due and payable under the original terms of the agreement with
the co-producer.
(c) Legal claims
Western International Syndication
The Company has filed a claim against Western International Syndication
("WIS") asserting chain of title to The Immortal ("Series"), a television
series that was produced and distributed by the Company in the United
States. The Company also asserts that WIS is liable for damages as a result
of the manner in which it syndicated the first season of the Series. WIS
has responded to the Company's claims by asserting counterclaims against
the Company for breach of contract, fraud and is seeking a declaration that
it controls the rights to any future distribution of the Series in the
United States. The Company believes the claim is without merit. A trial
date of April 15, 2003 has been established for the declaratory relief
claim only.
The Company has determined that it is not possible at this time to predict
the final outcome of these legal proceedings, including the outcome of
WIS's claim of title to the Series. It is not possible to establish a
reasonable estimate of the possible damages, if any, or reasonably estimate
the range of damages that may be awarded. Accordingly no provision with
respect to this lawsuit has been made in the Company's consolidated
financial statements.
Forgotten Kingdom Productions I. Inc. et al.
On December 2, 2001 Forgotten Kingdom Productions I. Inc. and Danny Virtue
and Lloyd Simandl instituted an action against the Company in the British
Columbia Supreme Court for failing to finance and co-produce a television
series entitled Ariana's Quest. The Plaintiffs seek damages of
approximately US$1,500,000 in lost fees, lost development costs of
$100,000, breach of contract of $25,000 and lost profits. The Company
believes the claim is without merit.
The Company has determined that it is not possible at this time to predict
the final outcome of these legal proceedings. It is not possible to
establish a reasonable estimate of the possible damages, if any, or
reasonably estimate the range of damages that may be awarded. Accordingly
no provision with respect to this lawsuit has been made in the Company's
consolidated financial statements.
Viacom, Inc.
On October 2, 2001 the Company initiated an action against Viacom Inc., MTV
Networks, VH1 Music First, et al in British Columbia Supreme Court for
damages in the amount of US$2,750,000 and consequential damages arising
from the Defendants' failure to honour a contract for the co-financing of
the television series Big Sound. A recovery or award to the Company, if
any, will be recognized in the statement of operations when it is realized.
Other
The Company is a party to other legal proceedings in the ordinary course of
its business but does not expect that the outcome of any other proceedings,
individually or in aggregate, to have a material adverse effect on the
Company's financial position, results of operations or liquidity.
(d) Operating lease commitments
The Company is committed to operating lease payments for premises in the
following approximate amounts:
2003 $ 265
2004 271
2005 272
2006 145
2007 -
-------
$ 953
=======
(e) Listing requirements
The Company has been advised by the Toronto Stock Exchange ("TSX") that
the Company currently does not meet the eligibility requirements for
the continued listing of its Class A and Class B shares on the TSX. The
Company has been granted a 45 day extension from December 27, 2002 to
meet the eligibility requirements, but the TSX may limit this extension
if the proposed transaction under 21(a) is not completed. If the
Company cannot meet TSX requirements before the expiration of the 45
day extension, the TSX has indicated that the Company's securities will
be suspended from trading. The Company will have an opportunity to make
a submission to TSX before any final suspension decision is made.
18. FINANCIAL INSTRUMENTS
(a) Fair Values
As at August 31, 2002, 2001 and 2000, the Company's financial
instruments included cash and cash equivalents, accounts and other
receivables, bank indebtedness, and accounts payable and accrued
liabilities. As at these dates, the carrying value of these financial
instruments approximated their fair value due to their ability for
prompt liquidation or short term to maturity, with the exception of
tax credits and short-term notes included in accounts receivable,
which are receivable over a period of up to two years. As at August
31, 2002, the fair value of tax credits receivable is estimated to be
$2,301,000 (August 31, 2001 - $22,643,000) based on discounted cash
flows to the expected timing of receipt of the tax credits.
Also included as a financial instrument is long-term debt consisting
of mortgages, demand loans and debentures. The fair value of long-term
debt has been estimated to approximate carrying value based upon
discounting future cash flows at the rate currently offered for debt
that is estimated by management to be of similar maturity and credit
quality.
(b) Concentration of Credit Risk
Although all of its revenue is generated from production in Canada,
the Company derived over 64% (2001 - 77%, 2000 - 84%) of its revenues
from export sales to the U.S. and Europe.
In the year ended August 31, 2002, one customer represented 45%, two
customers represented 14% each, and a fourth represented 8% of total
revenues.
In the year ended August 31, 2001, two customers represented 19% each,
a third represented 16%, a fourth represented 11%, a fifth represented
9%, a sixth represented 7%, and two represented 5% of total revenues.
In the year ended August 31, 2000, one customer represented 48%, a
second represented 21%, a third represented 13%, and a fourth
represented 7% of total revenues.
At August 31, 2002, approximately 59% (August 31, 2001 - 84%) of
accounts and other receivable was comprised of refundable federal and
provincial tax credits. These credits are subject to audit by the
appropriate regulatory authorities.
Substantially all capital assets and goodwill of the Company is
located in Canada.
(c) Currency Risk
During the year ended August 31, 2002, the Company derived
approximately 64% (2001 - 59%; 2000 - 41%) of its revenues in U.S.
funds. The Company estimates its obligations payable in U.S. funds and
converts all U.S. funds in excess of these obligations into Canadian
currency as they are received. The Company earns revenue in foreign
currencies and employs from time to time derivative instruments to
reduce its exposure to foreign currency risk. The Company had no
derivative instruments outstanding at August 31, 2002, 2001 and 2000.
(d) Interest Rate Risk
The Company's exposure to interest rate risk is limited to the cash
flow risk associated with variable rate debt as disclosed in notes 8
and 12.
19. SEGMENTED INFORMATION
The Company manages its operations in two business segments: production
services for projects in which the Company does not hold a financial
interest in a film or video program, and proprietary programming which is
programming the Company owns or in which it holds a financial interest. The
Company operates only in Canada, although its programs are distributed
throughout the world (note 18(b)). Selected information for the Company's
operating segments, net of inter-company amounts, is as follows:
PRODUCTION PROPRIETARY
2000 SERVICES PROGRAMMING OTHER TOTAL
---- ---------- ----------- ----- -----
Revenue $ 2,853 $ 31,723 $ 87 $ 34,663
Gross profits 696 579 87 1,362
Total assets 1,553 49,678 109 51,340
--------- --------- ------- ---------
2001
----
Revenue $ 9,017 $ 45,860 $ 23 $ 54,900
Gross profits 620 (5,110) 23 (4,467)
Total assets 10,349 35,354 1,567 47,270
--------- --------- ------- ---------
2002
----
Revenue $ 3,582 $ 2,781 $ 131 $ 6,494
Gross profits 398 (1,139) 131 (610)
Total assets 658 8,539 1,566 10,763
--------- --------- ------- ---------
Gross profits are comprised of revenue less amortization of television
programming, production costs, and other costs of production and sales.
Revenues from other business include interest earned on short-term
investments.
20. UNITED STATES GENERALLY ACCEPTED ACCOUNTING PRINCIPLES
These consolidated financial statements have been prepared in accordance
with generally accepted accounting principles in Canada ("Canadian GAAP")
which differ in certain respects with accounting principles generally
accepted in the United States ("US GAAP"). Material differences to these
consolidated financial statements are as follows:
(a) Application of US GAAP:
(i) As described in note 9, for Canadian accounting purposes, during
the years ended August 31, 1999 and 2002, the Company recognized
a partial gain on the sale of real estate. For US GAAP purposes,
no gain is recognized due to the existence of the note
receivable. Under US GAAP, this transaction would be accounted
for using the deposit method. Under the deposit method, the
transaction would not be recognized as a sale. As a result, the
Company would continue to record the property and related
depreciation in the consolidated financial statements and
recognize the cash collected as a deposit until sales recognition
and sales-lease back accounting is appropriate.
(ii) During the year ended August 31, 2001, the Company early adopted
Statement of Position 00-2 ("SOP 00-2"), "Accounting by Producers
or Distributors of Films" which established new accounting
standards on revenue recognition, capitalization and amortization
of film costs, accounting for exploitation costs, including
advertising and marketing expenses, and presentation and
disclosure of related information in financial statements. For
Canadian accounting purposes, changes in accounting policy are
applied retroactively with the prior years' financial statements
restated accordingly. For US GAAP purposes, changes in accounting
policy are applied prospectively with a cumulative adjustment to
the current year's financial statements.
(iii) As described in note 13(c)(iv), the Company granted warrants for
release of certain security interests or to retain an investment
banker as its financial advisor. As discussed in note 3(l), for
Canadian accounting purposes, the Company accounted for these
warrants using the intrinsic value method and did not record an
adjustment for compensation expense. For US GAAP purposes,
compensation expense would be recorded based on the fair value of
the warrants at the date of grant.
During fiscal year 2002, 21,597 Class A warrants and 12,958 Class
B warrants were earned by creditors upon granting an extension on
debt, of which 6,497 Class A warrants were re-priced to $1.20 per
share (note 12). Furthermore, in fiscal year 2001, 100,000 Class
B warrants were granted to debtholders to release certain
security rights (note 13(c)(iii)). For U.S. GAAP purposes, the
fair value of these warrants would be recognized as an additional
debt discount and additions to other paid-up capital. The debt
discount is amortized against income as interest expense over the
term of the debt. For Canadian GAAP purposes, the Company's
policy is described in note 3(l).
The effect of these differences on net earnings (loss) and earnings (loss) per
share (calculated by reference to the weighted average number of shares
outstanding) under US GAAP would be as follows:
YEARS ENDED AUGUST 31,
--------------------------------------------
2000 2001 2002
---------- ---------- ----------
Net earnings (loss), Canadian GAAP $ (3,268) $ (14,280) $ (7,021)
Gain on sale of asset, net of income tax (note 20(a)(i)) 187 - (53)
Adjustment to eliminate retroactive change in accounting for film
costs, net of income tax (note 20(a)(ii)) 4,080 - -
Stock compensation expense to service providers (note 20(a(iii)) - (24) (44)
Additional debt discount - warrants (note 20(a)(iii) (60) (133)
--------------------------------------------------------------------------------------------------------------------------
Net earnings (loss) before cumulative adjustment to reflect change in
accounting for films costs, US GAAP 999 (14,364) (7,251)
Cumulative adjustment to reflect change in accounting for film costs
(note 20(a)(ii)) - (10,736) -
--------------------------------------------------------------------------------------------------------------------------
Net earnings (loss), US GAAP $ 999 $ (25,100) $ (7,251)
==========================================================================================================================
Basic net earnings (loss) per share, US GAAP:
YEARS ENDED AUGUST 31,
--------------------------------------------
2000 2001 2002
--------- ---------- ---------
Net earnings (loss) before cumulative adjustment to reflect change in
accounting for films costs, US GAAP $ 0.26 $ (3.74) $ (1.87)
Cumulative adjustment to reflect change in accounting for film costs - (2.79) -
--------------------------------------------------------------------------------------------------------------------------
Net earnings (loss), US GAAP $ 0.26 $ (6.53) $ (1.87)
==========================================================================================================================
Diluted net earnings (loss) per share, US GAAP:
YEARS ENDED AUGUST 31,
--------------------------------------------
2000 2001 2002
--------- ---------- ---------
Net earnings (loss) before cumulative adjustment to reflect change in
accounting for films costs, US GAAP $ 0.26 $ (3.74) $ (1.87)
Cumulative adjustment to reflect change in accounting for film costs - (2.79) -
--------------------------------------------------------------------------------------------------------------------------
Net earnings (loss), US GAAP $ 0.26 $ (6.53) $ (1.87)
==========================================================================================================================
NET LOSS PER COMMON SHARE, US GAAP
The weighted average number of shares outstanding for each of the years
presented is as follows:
YEARS ENDED AUGUST 31,
--------------------------------------------
2000 2001 2002
--------- ---------- ---------
Basic 3,794,714 3,843,929 3,887,844
Diluted 3,808,430 3,843,929 3,887,844
--------------------------------------------------------------------------------------------------------------------------
Under US GAAP, total assets and shareholders' equity would be:
AUGUST 31,
---------------------------
2001 2002
--------- ---------
Total assets $ 47,270 $ 14,774
Liabilities 45,603 20,070
Shareholders' equity (deficiency) 1,667 (5,296)
--------- ----------
(b) Stock-Based Compensation
As described in notes 12 and 13, the Company has granted stock options
and warrants to certain directors, employees, and service providers.
These options and warrants are granted for services provided to the
Company. For US GAAP purposes, Statement of Financial Accounting
Standards No. 123, "Accounting for Stock-Based Compensation" ("SFAS
123"), requires that an enterprise recognize or, at its option,
disclose the impact of the fair value of employee stock options and
other forms of stock-based compensation in the determination of
income. The Company has elected under SFAS 123 to continue to measure
compensation cost on awards to employees by the intrinsic value basis
set out in APB Opinion No. 25 and related interpretations. As options
and warrants are granted at exercise prices based on the market value
of the Company's shares at the date of grant, no adjustment for
employee compensation expense is required.
Under SFAS 123, where a company chooses to continue to apply APB
Opinion No. 25 in its basic financial statements, supplementary pro
forma information as if the fair value method was applied to employee
awards must be disclosed. This pro forma information is set out below.
The pro forma stock compensation expense has been determined by
reference to an option-pricing model that takes into account the stock
price of the grant date, the exercise price, the expected life of the
option, the estimated volatility of the underlying stock, expected
dividends and the risk free interest rate over the term of the option.
The Company's calculations applied are based on the expected life of
all options granted equaling 60% of the maximum term. Based on actual
experience, no dividends will be paid, and expected average volatility
and risk free interest rates are:
YEARS ENDED AUGUST 31,
----------------------------------------
2000 2001 2002
----- ----- -----
Volatility % 57 104 189
Risk free interest rate % 6.38 4.40 3.38
----- ----- -----
Unaudited pro forma information with respect to impact of the fair
value of stock options at the date of grant on reported loss for the
periods presented is as follows:
YEARS ENDED AUGUST 31,
---------------------------------------------------------
2000 2001 2002
-------- -------- ---------
Earnings (loss), US GAAP $ 999 $(25,100) $ (7,251)
Stock compensation expense (753) (589) (22)
-------- -------- --------
Pro forma earnings (loss), US GAAP $ 246 $(25,689) (7,273)
======== ======== ======
Pro forma basic earnings (loss) per share, US GAAP $ 0.06 $ (6.68) (1.87)
======== ======== ======
The per share weighted average fair value of stock options granted during
2002 was $0.30 (2001 - $3.58; 2000 - $5.78) on the date of grant using the
Black Scholes option-pricing model with the assumptions reported above.
(c) Supplementary Information - Allowance for Doubtful Accounts:
Accounts receivable is disclosed net of allowance for doubtful
accounts. Changes in the allowance for each of the periods presented
are as follows:
YEARS ENDED AUGUST 31,
--------------------------------------------
2000 2001 2002
--------- -------- --------
Balance, beginning of period $ 304 $ 66 $ 50
Charges to expenses:
Expensed 25 911 1,823
Recovered/written-off (263) (927) (1,676)
-------- -------- --------
Balance, end of period $ 66 $ 50 $ 197
======== ======== ========
(d) Recent Accounting Pronouncements
In June 2001, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Standards No. 142, "Goodwill and Other
Intangible Assets" (SFAS No. 142). SFAS No. 142 requires companies to
test goodwill for impairment annually in lieu of amortization at a
reporting unit level. Goodwill is impaired if the reporting unit's
fair value is less than its carrying amount, and if impaired, the
Company would recognize an impairment loss by writing down the
goodwill to its implied fair value. SFAS No. 142 is effective in
fiscal years beginning after December 15, 2001. The SFAS No. 142 is
substantively consistent with the CICA Handbook in Canada (note 3(g)).
SFAS No. 143, "Accounting for Asset Retirement Obligations" (SFAS No.
143) establishes accounting standards for recognition and measurement
of a liability for asset retirement cost. SFAS No. 143 is effective
for fiscal years commencing after June 15, 2002. SFAS No. 144,
"Accounting for Impairment or Disposal of Long-Lived Assets" (SFAS No.
144), addresses financial accounting and reporting for the impairment
of long-lived assets to be disposed of. SFAS No. 144 is effective for
fiscal years commencing after December 15, 2001.
In July 2002, the FASB released SFAS No. 146, "Accounting for Costs
Associated with Exit or Disposal Activities" (SFAS 146), which
addresses the financial accounting and reporting for costs associated
with exit or disposal activities. SFAS No. 146 relates to the
recognition of a liability for a cost associated with an exit or
disposal activity and requires that a liability be recognized for
those costs only when the liability is incurred, that is, when it
meets the definition of a liability under the FASB's conceptual
framework. SFAS No. 146 also established fair value as the objective
for initial measurement of liabilities related to exit or disposal
activities. As a result, SFAS 146 significantly reduces an entity's
ability to recognize a liability for future expenses related to a
restructuring. SFAS No. 146 is effective for exit and disposal
activities initiated after December 31, 2002.
The Company does no believe that the adoption of SFAS No. 142, SFAS
No. 143, SFAS No. 144, or SFAS No. 146 will have a material affect on
the Company's financial results.
In November 2001, the Accounting Standards Board ("AcSB") in Canada
issued final amendments to Handbook Section 1650, Foreign Currency
Translation, that eliminate the deferral and amortization of foreign
currency translation gains and losses on long-lived monetary items.
This change is required to be applied to all financial statements for
fiscal years beginning on or after January 1, 2002, with retroactive
restatement of prior periods. The amendments also add a requirement to
disclose exchange gains and losses. The Company does not believe that
the amendments to the Handbook Section will have a material impact on
the Company's financial results.
In December 2001, the AcSB issued new Handbook Section 3870,
Stock-Based Compensation and Other Stock-Based Payments. This new
Section establishes new standards for the recognition, measurement and
disclosure of stock-based compensation and other stock-based payments
made to employees and non-employees in exchange for goods and
services. The new section requires a fair value based method of
accounting for all awards granted to other than employees
("non-employees"), and for certain, but not all, awards granted to
employees. For all other types of awards ("exempt awards"), the
enterprise may elect not to apply the fair value based method as a
matter of policy. HB 3870 is effective for fiscal years beginning on
or after January 1, 2002, and applies to awards granted on or after
the date of adoption. Certain types of awards granted prior to, but
remain outstanding at, the date of adoption, however, will be captured
within the scope of the new standard. The Company does not have any of
these certain types of awards outstanding at August 31, 2002.
21. SUBSEQUENT EVENT
(a) Subsequent to August 31, 2002, the Company has entered into agreements
with regard to a series of transactions, which are all subject to
shareholder and regulatory approval. Pursuant to such agreements, the
Company has agreed to affect a private placement financing, an asset
acquisition, a debt restructuring and the release and reconstitution
of a loan guarantee (collectively the "Proposed Transactions"), as
described below. The Proposed Transactions are each contingent upon
certain of the other transactions and will close concurrently.
(i) Proposed Private Placement Financing
The Company has agreed to issue 5,000,000 Class B Subordinate
Voting Shares at an agreed price of $0.30 per share, for total
cash proceeds of $1,500,000.
(ii) Asset Acquisition
The Company has agreed to acquire a portfolio of assets owned and
controlled by CPC Communications Inc. ("CPC") and/or its
subsidiaries, unrelated third parties, in exchange for
consideration of 8,333,333 Class B Subordinate Voting Shares of
the Company at a deemed price of $0.30 per share. The assets
include five films that are in production, certain loans, tax
credits and accounts receivable and the future business
activities of Greenlight Film and Television Inc., a wholly owned
subsidiary of CPC. The assets, described herein, are represented
by CPC to have a value of not less than $2,500,000.
(iii) Debt Restructuring
Subsequent to August 31, 2002, the Company entered into an
agreement to restructure its $7.6 million of term debt due to
FremantleMedia Enterprises Ltd. ("Fremantle"). Fremantle has
agreed that the scope of its debt and collateral charged will be
restricted to the business, assets, and undertakings of the
Company as they exist immediately prior to the closing of the
acquisition and financing transactions and any proceeds derived
from the pre-existing business of the Company after closing the
transactions described in note 21(a)(i) and (a)(ii). The Company
has agreed that if there is any amount of the Fremantle Debt
which remains outstanding as of December 31, 2004, Fremantle will
for a period of ninety (90) days have the right to convert such
unpaid amount to Class B Subordinate Voting Shares in the capital
of the Company at the lesser of either (a) $5.00 per share or (b)
the average trading close price of the shares for the thirty (30)
days prior to December 31, 2004, provided that in no event shall
the conversion price be less than $3.00 per share.
(iv) Release and Reconstitution of a Loan Guarantee
The Company has entered into a release and reconstitution
agreement with Comerica Bank - California ("Comerica") which will
reconstitute the Company's guarantee of a third party loan in the
amount of a US$1,075,000 million liability. Repayment of the
liability will be restricted to the specific exploitation rights
secured under the original loan agreement and, subject to
priority interests including repayment to Fremantle, to income
streams from the business, assets, and undertakings of the
Company as they exist immediately prior to the closing of the
transactions described in note 21(a)(i) and (a)(ii). If there is
any amount of the Comerica liability which remains outstanding as
of December 31, 2005, Comerica will for a period of ninety (90)
days have the right to convert such unpaid amount to Class B
Subordinate Voting Shares in the capital of the Company at a
price of $5.00 per share.
(b) Subsequent to August 31, 2002, the Company fully repaid its
outstanding debentures at August 31, 2002 of $537,000 and accrued
interest.
ITEM 19. EXHIBITS
Exhibit
Number Description
------- -----------
1.1 Special Resolution of Vidatron Enterprises Ltd., filed May 1, 1990,
cancelling previous Articles of Vidatron Enterprises Ltd. and substituting
new Articles of Vidatron Enterprises Ltd. (1)
1.2 Certificate and Special Resolution Vidatron Enterprises Ltd., filed
February 13, 1992 (1)
1.3 Certificate of Change of Name and Special Resolution of The Vidatron Group
Inc., filed February 5, 1997. (1)
1.4 Special Resolution Amending the Memorandum and Articles of the Company
adopted February 16, 1999 (1)
1.5 Special Resolutions Amending the Memorandum and Articles of Vidatron
Entertainment Group Inc. adopted July 14, 1999. (1)
2.1 Consent and Waiver Agreement dated July 2, 2002 with Working Opportunity
Fund (EVCC) Ltd.
2.2 Amendment Agreement dated August 1, 2002 with Juliet Jones;
2.3 Amendment Agreement dated August 1, 2002 with Kent Wingerak;
2.4 CPC Management Services Agreement dated December 20, 2002 with CPC
Communications Inc.;
2.5 Term Sheet dated November 19, 2002 with FremantleMedia Enterprises Ltd. and
Greenlight Film & Television Inc.;
2.6 Release and Reconstitution Agreement dated November 22, 2002 with Comerica
Bank - California;
2.7 Term Sheet dated December 18, 2002 with CPC Communications Inc. and Richard
Watson;
------------------------------
(1) Incorporated by reference to our registration statement on Form F-1 (Reg.
No. 333-10354).
Pursuant to the requirements of Section 12 of the Securities Exchange Act of
1934, the Registrant certifies that it meets all of the requirements for filing
on Form 20-F and has duly caused this annual report to be signed on its behalf
by the undersigned, thereunto duly authorized.
PEACE ARCH ENTERTAINMENT GROUP INC.
By: /S/ JULIET JONES
--------------------------------------------
Juliet Jones
Principal Financial Officer
Date: January 20, 2003
CERTIFICATION
I, Gary Howsam, certify that:
1. I have reviewed this annual report on Form 20-F of Peace Arch Entertainment
Group Inc.;
2. Based on my knowledge, this annual report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this annual report;
3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all material
respects the financial condition, results of operations and cash flows of
the registrant as of, and for, the periods presented in this annual report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined
in Exchange Act Rules 13a-14 and 15d-14) for the registrant and have:
a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this annual report
is being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date of
this annual report (the "Evaluation Date"); and
c) presented in this annual report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on
our most recent evaluation, to the registrant's auditors and the audit
committee of the registrant's board of directors (or persons performing the
equivalent functions):
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have
identified for the registrant's auditors any material weaknesses in
internal controls; and
b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
controls; and
6. The registrant's other certifying officers and I have indicated in this
annual report whether there were significant changes in internal controls
or in other factors that could significantly affect internal controls
subsequent to the date of our most recent evaluation, including any
correction actions with regard to significant deficiencies and material
weaknesses.
Date: January 20, 2003
/s/ Gary Howsam
---------------------------------------------
Gary Howsam
Chief Executive Officer
4
CERTIFICATION
I, Juliet Jones, certify that:
1. I have reviewed this annual report on Form 20-F of Peace Arch Entertainment
Group Inc.;
2. Based on my knowledge, this annual report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this annual report;
3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all material
respects the financial condition, results of operations and cash flows of
the registrant as of, and for, the periods presented in this annual report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined
in Exchange Act Rules 13a-14 and 15d-14) for the registrant and have:
a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this annual report
is being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date of
this annual report (the "Evaluation Date"); and
c) presented in this annual report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on
our most recent evaluation, to the registrant's auditors and the audit
committee of the registrant's board of directors (or persons performing the
equivalent functions):
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have
identified for the registrant's auditors any material weaknesses in
internal controls; and
b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
controls; and
6. The registrant's other certifying officers and I have indicated in this
annual report whether there were significant changes in internal controls
or in other factors that could significantly affect internal controls
subsequent to the date of our most recent evaluation, including any
correction actions with regard to significant deficiencies and material
weaknesses.
Date: ______________, 2003
/s/ Juliet Jones
------------------------------------------------
Juliet Jones
Principal Financial Officer
5