<PAGE>
SECURITIES AND EXCHANGE COMMISSION
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, 1999
Commission file number: _______________
PEACE ARCH ENTERTAINMENT GROUP INC.
(Exact name of registrant as specified in the charter)
BRITISH COLUMBIA, CANADA
(Jurisdiction of Incorporation or Organization)
#302, 1132 HAMILTON STREET, 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, 1999 was:
1,517,965 Class A Multiple Voting Shares, without par value
2,267,978 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
--- ---
1
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EXCHANGE RATES
Peace Arch Entertainment Group Inc. (hereinafter, together with its
subsidiaries, also referred to as "Peace Arch" or the "Company") publishes its
financial statements in Canadian dollars. In this Annual Report, references to
"dollars" or "$" are to Canadian dollars. For the convenience of the reader,
this Annual Report contains translations of certain Canadian dollar amounts into
United States dollars at specified rates. These translations should not be
construed as representations that the Canadian dollar amounts actually represent
such United States dollar amounts or could be converted into United States
dollars at the rate indicated. Unless otherwise stated, the translations of
Canadian dollars ("Cdn$") into United States dollars ("US$") have been made at
Cdn$1.4520 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, 1999. The Noon Buying
Rate on January 31, 2000 was Cdn$1.4512 per US$1.00.
The following table sets forth certain exchange rates based on the Noon Buying
Rate. Such rates are set forth as U.S. dollars per Cdn$1.00. On February 22,
1999, the inverse of the Noon Buying Rate was Cdn$1.00 per US$0.6855.
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PERIOD
- --------------------------
FROM TO AVERAGE HIGH LOW
- -------- ------- ------- ---- ---
<S> <C> <C> <C> <C>
8/31/94 8/31/95 0.7270 0.7471 0.6993
8/31/95 8/31/96 0.7336 0.7517 0.7219
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
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ITEM 1. DESCRIPTION OF BUSINESS
INTRODUCTION
Peace Arch Entertainment Group Inc. is a vertically integrated company that
develops, produces and distributes high-quality, proprietary television
programming for markets worldwide. The Company also provides production services
for third parties on a contract basis.
The head office of the Company is based in Vancouver, British Columbia, the
third largest film and television production center in North America. As a
British Columbia-based producer, the Company enjoys a number of competitive
advantages over producers outside of Canada, including tax and other
government incentives. The Company also enjoys a competitive advantage over
producers in other parts of Canada due to its proximity to Los Angeles, its
varied geography and its temperate climate.
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The Company was incorporated as Vidatron Enterprises Ltd. under the laws of
British Columbia on October 22, 1986 by registration of its Memorandum and
Articles. Effective February 13, 1992, the Company consolidated its share
capital on a one new for five old basis, increased its authorized share
capital to 25,000,000 common shares without par value and 25,000,000 serial
preference shares without par value, and changed its name to The Vidatron
Group Inc. Effective February 5, 1997, the Company consolidated its share
capital on a one new for four old share basis, increased its authorized share
capital to 25,000,000 common shares without par value and 25,000,000
preference shares without par value and changed its name to Vidatron
Entertainment Group Inc.
By resolution dated July 14, 1999 the Company's share capital was reorganized
by converting the Common Shares of the Company into Class A Multiple Voting
Shares and Class B Subordinate Voting Shares, 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, the Company's name was changed to
"Peace Arch Entertainment Group Inc.". All references in this document to
share data refer to post consolidated shares.
The following table shows the breakdown of the Company's total revenues
during our past three fiscal years by activity and by geographical market:
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Year Ended August 31,
------------------------------------
1997 1998 1999
---- ---- ----
(Canadian dollars in millions)
<S> <C> <C> <C>
REVENUES BY ACTIVITY
Proprietary programming.................................... $17.5 $28.0 $47.3
Production services........................................ 3.0 4.2 3.7
Other...................................................... 3.1 0.3 0.5
REVENUES BY GEOGRAPHIC MARKET
Canada..................................................... $ 6.1 $ 5.9 $ 7.3
U.S. ...................................................... 9.6 10.8 16.1
Europe and other markets................................... 7.9 15.8 28.1
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The Company has 5 material wholly-owned operating subsidiaries, each
incorporated in British Columbia, Canada, as follows:
PEACE ARCH ENTERTAINMENT GROUP INC.
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COMPANY NAME DATE OF INCORPORATION
- --------------------------------------------------------------------------------- ----------------------------------
<S> <C>
API Aviator Pictures Inc.* 12/31/86
- --------------------------------------------------------------------------------- ----------------------------------
The Eyes Multimedia Productions Inc. 5/19/93
- --------------------------------------------------------------------------------- ----------------------------------
Vidatron Television Inc.* 11/18/88
- --------------------------------------------------------------------------------- ----------------------------------
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4
- --------------------------------------------------------------------------------- ----------------------------------
Soho Enterprises Ltd. 1/3/91
- --------------------------------------------------------------------------------- ----------------------------------
Peace Arch Productions Inc. (Formerly Sugar Entertainment Ltd.) 3/15/96
- --------------------------------------------------------------------------------- ----------------------------------
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* These two subsidiaries are being wound up effective 31st August 1999.
The Company's 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. The Class B Subordinate Voting Shares trade on the
American Stock Exchange under the symbol "PAE".
The Company's consolidated financial statements are stated in Canadian Dollars
(CDN$) and are prepared in accordance with Canadian Generally Accepted
Accounting Principles (GAAP), the application of which, in the case of the
Company, conforms in all material respects for the periods presented with U.S.
GAAP except as explained in footnote 22 to the financial statements.
The Company's head office and production/distribution facility is located in the
Peace Arch Building, Third Floor, 1132 Hamilton Street, Vancouver, B.C. CANADA
V6B 2S2. The telephone number is (604) 681-9308 and the facsimile number is
(604) 681-3299. The contact person is Timothy R. Gamble, President and Director.
References in this document to "$" and "Cdn$ refer to Canadian dollars, unless
otherwise specified; references to "US$" refer to United States dollars.
The information in this Annual Report is stated as of January 31, 2000,
unless otherwise indicated.
DEVELOPMENT
The first stage in the process of creating television programming is concept
development. The Company selects programming concepts that the Company believes
will have domestic and international market appeal. The Company develops
programming for television, including episodic series, movies and documentaries.
It often arranges for the involvement of industry recognized creative talent,
such as writers, producers, directors and actors, which will make the
programming more saleable and may increase the value of the Company's library.
In some cases, one or more of these people may already be involved when the
Company becomes involved.
The Company's development department receives and evaluates written concepts,
scripts, books or other literary properties from agents, writers and prospective
production partners in the U.S., Canada and Europe. Once the Company has
selected and acquired the necessary rights to a source material, it may involve
broadcasters or third party investors to participate in the further development
of the concept. These activities may include the preparation of a series
"bible," script writing or the production of a promotional reel that can be used
as a sales tool. For concepts that have sufficient Canadian content, government
and related funding agencies, such as Telefilm Canada and BC Film, may provide
funding for the development process as described below under "Regulatory
Considerations".
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In some cases the Company gets involved at a later stage of development, when
creative materials may have already been prepared or when key creative people
are already attached. Involvement at this stage may shorten the Company's
development process, but involve less opportunity for it to influence the
financial structure of the programming.
Early involvement in the acquisition and development of projects generally
increases the Company's control over the exploitation of the finished program.
The Company believes that greater control enhances its ability to build targeted
brand identities for its programming that should increase revenues from
television distribution and potential long-term revenue from ancillary markets
such as clothing, toys, novelties, books, CDs, soundtracks and other audio
products, electronic and video games, Internet applications and other
merchandise. Increased ownership and control also will allow the Company to
capitalize on new ancillary markets that may arise in the future.
The Company has several new programs at an early stage of development with
various Canadian, U.S. and international producers, broadcasters and
distributors. It is negotiating with broadcasters interested in financing and
airing its proprietary one-hour drama called "Yaletown" and its half-hour
sit-com with the working title "The Agency". Also, the Company holds an option
for the rights to the screenplay "Jetlag", which is being developed with the CTV
Television Network, as a 22-episode one hour series for television. A number of
other television series projects, both drama and documentary, are at various
stages of development.
PRODUCTION
Most of the Company's business activity relates to proprietary programming. The
production of proprietary television programming involves the assembly of a team
of production personnel, including script writers, directors, cast and crew. In
the case of larger-budget productions such as "First Wave" and "Dead Man's Gun",
this team can include over 150 people who are hired either as employees or
independent contractors. Typically, the Company forms a wholly-owned production
company for each production which retains the necessary employees and
contractors.
One of these contractors hired by the production company is the producer that
the Company has designated to oversee the production process on its behalf. The
producer carries out a myriad of activities including development and approval
of scripts, casting, selecting directors and supervising the daily shooting
schedule. The producer is also responsible for supervising all post-production
activities, including editing, the insertion of music and special effects, and
ensuring that the finished product, usually in the form of a betacam tape, meets
the delivery specifications of the buyers.
The production of a 22-episode season of a one-hour dramatic series such as
"First Wave" can span 10 months. Each episode takes approximately 11 weeks to
complete, including one week of preparation, one week of shooting and up to 9
weeks of post-production. At any given time there may be one episode in
preparation, one episode shooting and three or four episodes in various stages
of post-production.
In addition to the Company's proprietary programming, the Company produces
creative works that are directed to training, education and the information
needs of third parties and it offers domestic and foreign language production
services for network television including entertainment segments, news segments
and electronic press kits, as well as sports, entertainment, documentary,
television commercial
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and music videos, all under various contract arrangements. As the demand for
interactive programming has increased, the Company has increased its involvement
in the production of CD-ROMs, on-line presentations and other digital
programming. While these production services represent only a small portion of
the Company's current revenues, it plans to continue to pursue production
service arrangements because they provide a training ground for the Company's
creative staff, foster its relationships with key industry participants, provide
an incubator for new skills and industry practices, and keep the Company's
facilities utilized during hiatus production periods of its television series
programming. These productions have won numerous awards, including most
recently, the Gold Camera Award in 1998 at the U.S. International Film and Video
Festival for the Company's video production entitled "Millennium". The Company's
music video entitled "'Apparitions" and featuring the Matthew Good Band also
received a Best Directed Music Video Award at the 1998 Canadian Music Video
Awards.
The Company's 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. Most of these activities are undertaken by the Company's crews using
facilities and equipment that the Company owns or rents. Some key activities,
such as computer-generated imaging, sound mixing and post-production finishing
are subcontracted to companies that specialize in these areas.
Since inception, the Company has produced feature length films, documentaries
and various specialty programs for television. The Company has also produced 82
one-hour episodes and 59 half-hour episodes of television series programming.
During fiscal 1999, the Company produced two documentaries and 60 hours of
programming. Production is currently underway on an additional 13 one-hour
episodes.
The Company's recent proprietary programming and other productions include:
FIRST WAVE. In April 1999, the Company commenced production of a second
22-episode season of its science fiction thriller television series "First
Wave". "First Wave" is produced in association with Pearson Television
International Ltd., Francis Ford Coppola and Chris Brancato. Based in the United
Kingdom, Pearson Television International Ltd. is a large international producer
and distributor of television programming. Mr. Coppola is an Academy Award
winner and producer and director of "The Godfather" and co-screenwriter of
"Apocalypse Now" and Mr. Brancato is an accomplished screenwriter ("Species 2"
and "Hoodlum"). Peace Arch controls North American rights to this series, and
has made an advance sale of 66 episodes (three seasons of production) to USA
Networks' Sci-Fi Channel. Pearson Television International Ltd. has agreed to
distribute the initial 66 episodes of "First Wave" outside of North America. To
date, CHUM Television has ordered 44 episodes for broadcast in Canada. In 1999
"First Wave" was nominated for a Leo Award for best dramatic series. The Leos
recognize excellence in British Columbia film and television production. In
December 1998, CHUM's Space: The Imagination Station announced that it has five
of the top ten dramatic series on specialty television and that "First Wave" was
their highest rated series, ahead of "The X-Files".
DEAD MAN'S GUN. In 1997, the Company commenced delivery of a 22-episode,
one-hour western-themed television series titled "Dead Man's Gun", produced
in association with Showtime Networks and Buena Vista Television, with Henry
Winkler as executive producer. This anthology series was nominated
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for three Cable Ace Awards in 1997, including best dramatic series, and won the
Western Heritage Award for Best Western Dramatic Script in 1997, 1998 and 1999.
"Dead Man's Gun" was renewed for a second 22-episode season by Showtime and MGM
Worldwide Television that commenced production in spring 1998 and was completed
in early 1999. It currently airs on TNN in the United States. The show has been
syndicated through most of Canada by CHUM Television, as well as airing on
Space: The Imagination Station. The Company is actively pursuing agreements to
sell additional seasons of "Dead Man's Gun".
CONTEMPORARY CLASSICS. Since 1996, the Company also produced two installments of
its ongoing "Contemporary Classics" youth movie series made in association with
Showtime and Hallmark Entertainment Network--"The Prisoner of Zenda, Inc." and
"Ronnie and Julie". Prior pictures in the series include "AnnieO", "The Halfback
of Notre Dame" and "Robin of Locksley". The Company jointly funded the
production of the Contemporary Classics in association with Showtime and
Hallmark and owns all Canadian rights to the movies.
THE ELECTRIC PLAYGROUND. In 1997, the Company began production on "The Electric
Playground", a series of 13 half-hour programming which review and promote
video-games and computer technology for the specialty cable market. The series
was renewed for the 1998-99 television season in Canada and is being shown on
CHUM's Space: The Imagination Station. "The Electric Playground" is also being
syndicated throughout Canada and in selected U.S. markets. A third season
commenced airing in the fall of 1999, however the Company now has a passive role
in the production. The Company has entered into an agreement with Boss Games of
Seattle, Washington ("Boss"), whereby Boss assumed active production and
ownership of the show. The Company received a cash payment and is entitled to an
ongoing revenue interest from the exploitation of the show.
DOCUMENTARIES. In 1998 and 1999, the Company 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. The Company
retains the rights to exploit these programs worldwide. These documentaries
combined the efforts of independent Canadian documentary filmmakers and the
Company's in-house production facilities and staff. Writers and producers for
the programs included Helen Slinger, a senior Canadian journalist and
documentary writer and David Massar, a writer, producer and director of many
programs for NBC, Lifetime Television, ESPN, The Learning Channel, History
Channel, Discovery Channel and A&E.
SO WEIRD. In 1998 the Company provided non-proprietary production services for
the initial 13 episodes of the children's television series "So Weird" for the
Disney Channel. Production has recently been completed on a second season of 26
episodes. Production of a third season of 26 episodes is scheduled to commence
in April 2000. Henry Winkler is the executive producer of "So Weird".
COMMERCIALS. The Company has produced commercials for an extensive list of
clients over the last ten years, including Disney, McDonald's, Molson Breweries,
Frisch's and the Canadian Banking Association. Commercials produced by the
Company has won the Canadian Television Commercial Award (the "Bessies") Gold
and Silver Awards category in 1997 and 1998.
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FEATURE FILMS. In addition to the Company's current activities, it has
participated in the production of numerous feature films and documentaries,
which are now included in its library. These include: "Cadence", a feature film
starring Martin Sheen and Charlie Sheen; "Island of Whales", a feature
documentary narrated by Gregory Peck and commissioned by the PBS Nova Series;
and "Outside Chance of Maximillian Glick", an award-winning Canadian feature
film.
LIBRARY
The Company retains varying ownership interests in its proprietary productions
and believes that this strategy will provide it with significant future asset
value. During fiscal 1999, the Company added 39 hours of dramatic programming
and two documentaries to its library. At August 31, 1999, the Company's library
contained approximately 120 hours of proprietary programming. Although currently
limited, the Company's library will continue to expand as it produces more
proprietary programming.
The Company's production group also has accumulated an extensive library of
stock footage on film and video that can be incorporated into future
programming. The Company may seek to add to its library through strategic
acquisitions.
MARKETING AND DISTRIBUTION
The Company markets and distributes its proprietary television programming under
arrangements with U.S., Canadian and international broadcasters and
distributors. The Company seeks to market and distribute titles in its library
to existing pay and free television, home video and other markets worldwide, as
well as through developing technologies. Historically, the Company has directly
distributed its programming in North America, where there are a limited number
of buyers and marketing costs are manageable. The Company currently contracts
with other parties, such as Pearson Television International Ltd., to distribute
its programs in markets outside North America. This provides the Company with
two principal benefits. It avoids the substantial costs and financial risks of
distributing its programs to markets throughout the world and, in certain
circumstances, allows the Company to secure distribution advances to provide
cash flow for the production.
The Company's marketing efforts are focused on creating branded identities for
its proprietary programs. The Company believes 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.
KEY RELATIONSHIPS
The Company expects that its relationships with domestic and international
broadcasters, distributors, financing sources and creative talent will be
important to the successful expansion of its proprietary television business.
U.S. AND INTERNATIONAL BROADCASTERS AND DISTRIBUTORS. The Company has produced
its programming in association with a variety of U.S. and international
broadcasters and distributors including Buena Vista Television, Pearson
Television International Ltd., Hallmark Entertainment Network, MGM and
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Showtime Networks. The sale of 66 episodes of its television series "First Wave"
to USA Networks' Sci-Fi Channel represents an important new relationship for the
Company.
CANADIAN DOMESTIC BROADCASTERS. The Company has long-standing relationships with
the Canadian broadcast community, including CHUM-City, CTV, CanWest Global,
Western International Communications, The Knowledge Network and The Family
Channel. During the past two years, the Company has sold its series "First
Wave", Dead Man's Gun", and "Electric Playground" to CHUM-City. The Company has
also licensed two documentaries, "Harm's Way" and "Citizen Shame", to CTV and
The Knowledge Network, and licensed its television movies, "The Prisoner of
Zenda, Inc." and "Ronnie and Julie", to The Family Channel. "So Weird", the 30
minute series we are currently producing for Disney, also airs on The Family
Channel.
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. The Company is currently working with Francis Ford
Coppola and screenwriter Chris Brancato ("Species 2" and "Hoodlum"), who is the
creator and lead writer on "First Wave". The Company's 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"). Henry Winkler is also the executive producer of "So Weird".
The Company has also hired Canadian talent at all levels in the production of
its programs, including writers, directors, production designers, editors and
actors. In late 1999, David Steinberg and Frank Van Keeken joined the creative
team developing our 1/2 hour sit-com which goes under the working title "The
Agency". Messrs. Steinberg and Van Keeken's combined writing and directing
credits with the U.S. Network sit-coms include "Mad About You", "Friends" and
"Seinfeld".
Five customers, Showtime Networks, Pearson Television International Ltd., USA
Network, MGM Worldwide Television and CHUM City, each accounted for 8% or
more of the Company's revenues in fiscal 1999. The loss of any of these
customers could have a material adverse impact on the Company's results of
operations and financial condition.
HISTORY
Since the Company's incorporation in 1986, it has 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, the Company derived the bulk of its revenues from
production service arrangements whereby the Company was retained to produce a
video program, film or television commercial for a fee. The Company expanded its
service production capability through the acquisition of The Eyes Multimedia
Productions Inc. The Company acquired The Eyes Multimedia Productions Inc. in
August 1995 for purchase consideration of common shares valued at $60,000 and
periodic cash payments totaling $215,000.
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In 1995, the Company expanded its operations into the areas of video and
software distribution through the acquisitions of Image Media Services Ltd. and
Pilot Software. The principal business of Image Media was the distribution of
video and software and multi-media titles to primary, secondary schools, and the
post-secondary educational institutions throughout British Columbia and most
regions of Canada. The Company acquired Image Media Ltd. in February 1995 for
purchase consideration of common shares valued at $250,000 and periodic cash
payments totaling $710,413. Pilot Software became a wholly-owned subsidiary of
Image Media and carried out the bulk of Image Media's distribution activities in
Ontario and Eastern Canada. The Company acquired Pilot Software in December 1995
for purchase consideration of common shares valued at $81,250 and periodic cash
payments totaling $133,725.
In 1996, the Company commenced a shift in its business toward the production of
proprietary television programming. The first steps in this process were the
production of the feature length family films "The Prisoner of Zenda, Inc." and
"Ronnie and Julie". The Company's shift into the business of proprietary
television production was accelerated through the acquisition of Sugar
Entertainment Ltd. effective September 1, 1996. The Company's principal
motivation for expanding this business was that it offered the Company greater
potential for growth than its prior businesses. The Company also believes that
the production of proprietary programming offers it the ability to create and
expand a library of produced programming which it believes will have a residual
asset value.
Effective September 1, 1996, the Company acquired Sugar Entertainment Ltd. for
purchase consideration of common shares valued at $260,000. On September 22,
1999 Sugar Entertainment Ltd.'s name was changed to "Peace Arch Productions
Inc.".
On August 31, 1997, the Company completed the sale of the assets and
operations of Image Media and Pilot Software and thereby exited the video and
software distribution business. The Company's decision to sell this business
was based on the fact that gross profit margins were declining as a result of
competitive pressures. The Company sold the assets and operations of Image
Media Services Ltd. and Pilot Software effective August 31, 1997 for total
proceeds of $575,000 comprised of $545,000 cash and the assumption by the
buyer of long-term debt of $30,000. The Company realized a loss on this sale
of $333,325.
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, 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.
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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 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 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, SuperChannel,
Channel D and Showcase in Canada.
INTERNATIONAL MARKETS
The worldwide television industry is experiencing growth as a result of the
development of new television broadcasting systems outside of North America.
These systems represent significant new sources of revenue for television
producers. Factors contributing to the growth of the worldwide television
industry include 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 seek 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. The Company is increasingly looking at structuring its productions as
international co-productions and thereby produce "international" programming
that qualifies as indigenous in more than one country.
CANADA'S ROLE IN THE TELEVISION AND FEATURE FILM INDUSTRY
The Canadian film and television industry in 1998 generated annual production
expenditures of nearly $3.0 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 have also 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 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, Kushner-Locke Company and New World Entertainment, Inc.,
among many others.
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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.
Of Canada's ten provinces, the provinces of British Columbia and Ontario are
most actively involved in the motion picture production industry, with 1998
production expenditures equaling approximately $808 million and $743 million,
respectively. These figures represent significant increases over the previous
year, when annual production expenditures in British Columbia and Ontario
totaled approximately $630 million and $635 million, respectively.
COMPETITION
Television production and distribution are highly competitive businesses. The
Company faces 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. The
Company competes 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 the Company has. The Company considers its
main competitors in Canada to be Alliance Atlantis Communications Corporation,
Salter Street Films, Ltd., Lions Gate Entertainment Corp., Telescene Film Group
Inc. and in the U.S. to be Spelling Entertainment Group Inc., Kushner-Locke Co.
and Carsey-Werner. The Company believes that it has a competitive advantage over
U.S. competitors through its eligibility for Canadian tax credits described
below under "--Regulatory Considerations--Industry Incentives". The Company also
enjoys a competitive advantage over producers in other parts of Canada due to
its proximity to Los Angeles, its varied geography and its temperate climate.
EMPLOYEES
As of January 31, 2000, the Company had 22 full-time permanent employees. The
Company also hires additional personnel on a project-by-project basis in
connection with the production of its television programming. The Company
believes that its employee and labor relations are good.
REGULATORY CONSIDERATIONS
The Company's status as a producer of "Canadian" programming, established and
operating in British Columbia, makes it currently eligible to receive Canadian
tax and business incentives.
The Company continues 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 64% of the voting power of the Company's
outstanding shares are held of record by Canadians. However, the Company has no
way of confirming actual beneficial ownership of its shares. If Canadians fail
to beneficially own or control a majority of the Company's voting rights, the
Company could lose its 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 Company's results of operations and financial
condition.
<PAGE>
13
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 the Company produces, 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.
The Company believes that it will continue to qualify as a "Canadian production
company" for this purpose, so long as Canadian citizens or permanent residents
beneficially own more than 50% of the combined voting power of the Company's
outstanding shares.
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
<PAGE>
14
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.
INDUSTRY INCENTIVES
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 lessor of qualified
labor expenditure and 48% of eligible costs of production of a given project.
Eligible cost of production are total production costs less any other government
assistance, including any provincial refundable tax credit. Since the Company's
labor expenditures for a production typically exceed this limitation, it is
generally eligible to receive a federal tax credit equal to 12% of the eligible
cost 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.
The Company currently qualifies for this tax credit, and the reclassification of
its common shares into Class A shares and Class B shares and other proposed
changes to its articles assisted the Company in continuing compliance while
allowing for non-Canadian investment. The Company believes that so long as,
among other things, it continues to be Canadian-controlled as determined for the
purposes of the Investment Canada Act, it will continue to so qualify and it
will use its best efforts to ascertain that all its production projects will
continue to be eligible for the tax credit. Federal tax credits refundable to
the Company pursuant to the Income Tax Act (Canada) for television programming
delivered in fiscal 1999 amounted to $5,920,000.
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 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. "So Weird", which the Company produces for the
Disney Channel, qualifies under this program.
<PAGE>
15
Through Telefilm Canada, the Canadian government provides financial assistance
to the Canadian film and television industry in the form of recoupable advances
in script development, equity investment in production, loan guarantees,
recoupable advances of the cost of dubbing into English or French and grants of
up to 75% of advertising and promotion costs. Telefilm Canada recently announced
that their development fund and the international component of their Marketing
Assistance Program would no longer be available to publicly traded companies.
Other than these programs, the Company is eligible for Telefilm Canada funding.
In fiscals 1997 and 1998, the Company did not use Telefilm funding from the
development fund or the international component of the Marketing Assistance
Program. In fiscal 1997, the Company did not use Telefilm funding for which it
is currently eligible. In fiscal 1998, the Company received less than $23,000 of
Telefilm funding for which it is currently eligible and in fiscal 1999, the
Company did not receive any funding from Telefilm. The Company may avail itself
of such funding in the future if management believes it is prudent to do so.
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:
- Basic incentives equal to 20% of qualified British Columbia labor
expenditures.
- A regional incentive equal to 12.5% of qualified British Columbia
labor expenditures for productions where principal photography occurs
outside of the Vancouver area in British Columbia.
- 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. The Company will continue to be
controlled by persons domiciled in British Columbia so long as more than 50% of
the members of its board of directors are persons domiciled in British Columbia
and more than 50% of the combined voting power of its 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. Since the British Columbia tax
credit system was not established until 1998, the Company received no tax
credits in fiscal 1998. The Company expects to receive tax credits under the
British Columbia program on account of television programming delivered in
fiscal 1999 in the amount of $4,910,000.
In addition to these governmental incentives, the Canadian Television Fund
("CTF") License Fee Program, a partnership composed of public and private
television industry participants, 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. The Company believes that it is a
production company eligible for funding under the CTF's License Fee Program that
could, for each project eligible under such
<PAGE>
16
program, represent contributions of up to 18% of the total production budget.
The maximum contribution varies with the categories of programs. The maximum
contribution provided under the program is for big-budget one hour drama series
and is limited to the lower of $3.48 million and 18% of production costs. During
fiscal 1999, the Company received $29,632 from the CTF's License Fee Program.
ITEM 2. DESCRIPTION OF PROPERTY
The Company's head office is located in the top two floors of a building it
leases in the Yaletown area of Vancouver, British Columbia. The lease expires in
August 2004, although the Company and its landlord each have the option to
terminate the lease after August 2001. The lease provides for annual rental
payments of $200,700. The Company also leases the first floor of this building
at an annual rate of $100,350. The Company may terminate its lease on the 1st
floor after April 2000. The Company originally acquired this building in 1994
and sold it in on August 31, 1999.
The Company's studio buildings, comprising approximately 78,000 square feet of
studio, production office and storage space, are located at 310 West 4th Avenue
and 150 West 1st Avenue, Vancouver, British Columbia, Canada. They accommodate
many of the Company's own productions and are available for rental by visiting
producers of feature films, television series and movies-of-the-week. The
studios house the Company's eight digital post-production suites which handle
off-line editing for all of its productions.
The Company's studios are well-positioned to capitalize on the growing trend
within the entertainment industry to complete production work in Vancouver. Both
are located within walking distance of Vancouver's premier film transfer and
post-production facilities and ten minutes from major downtown hotels and
restaurants. In addition to the direct impact on the Company's operating
results, the studios are a key asset which can be used to enhance the Company's
participation in a variety of film and television projects by ensuring access to
facilities, increasing the Company's flexibility and reducing its costs. The
West 4th studio is presently fully booked until December 2000 with the
production of the Company's television series "First Wave".
Approximately half of the West 1st Studio is currently being utilized by the
Company for its productions. The balance has been leased to third parties at
local market rates.
The following sets forth information concerning facilities that the Company
owns.
<TABLE>
<CAPTION>
ADDRESS AREA PURPOSE
- ----------------------------- -------------------------------------------------------------------------------------
<S> <C> <C>
310 West 4th Avenue 23,000 square feet Studio and production offices
Vancouver, B.C.
150 West 1st Avenue 55,000 square feet Production offices and post-production services
Vancouver, B.C.
</TABLE>
The Company believes that its facilities are adequate for its current needs but
that as the Company expands its productions, additional space must be leased or
otherwise acquired. The Company is also considering renting office space in Los
Angeles to facilitate marketing its programming in the U.S.
<PAGE>
17
ITEM 3. LEGAL PROCEEDINGS
The Company is not currently subject to any legal proceedings which, if
determined adversely to it, would have a material adverse effect on its business
or results of operations. The Company may, from time to time, become a party to
various legal proceedings arising in the ordinary course of business. The
Company maintains insurance coverage for such matters in amounts that it
believes to be adequate.
ITEM 4. CONTROL OF REGISTRANT
The Company is not directly or indirectly owned or controlled by another
corporation or by any foreign government.
The following table sets forth information regarding the beneficial ownership of
the Company's Class A and Class B shares as of January 31, 2000 for (a) each
person known to the Company to own beneficially more than 10% of either Class A
shares or Class B shares and (b) all executive officers and directors as a
group. The information in the table does not reflect ownership of options or
warrants.
<TABLE>
<CAPTION>
NUMBER OF NUMBER OF
CLASS A PERCENT CLASS B PERCENT
NAME SHARES OF CLASS SHARES OF CLASS
- ------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Working Opportunity Fund (EVCC) Ltd. 160,000* 10.6% 160,000* 7.1%
Officers and directors as a group (9 persons) 276,557* 18.3% 276,557* 12.2%
</TABLE>
* These numbers do not include any common shares which are issuable upon
the exercise of options or warrants.
ITEM 5. NATURE OF TRADING MARKET
The Company's Class A Multiple Voting Shares and Class B Subordinate Voting
Shares trade on The Toronto Stock Exchange ("TSE") symbols PAE.A and PAE.B in
Toronto, Canada. The Company's Class B Subordinate Voting Shares also trade on
The American Stock Exchange, symbol PAE. The Company's shares commenced trading
on the TSE in November 1997 under the symbol "VE". Effective July 19, 1999, the
Company's Class A shares and Class B shares began trading on the TSE, at which
time the Company's common shares were delisted. The Company's shares began
trading on AMEX on July 28, 1999.
The following table lists the volume of trading and high, low and closing sales
prices on the TSE for shares of the Company's Class A and Class B Shares for the
last nine fiscal quarters.
<PAGE>
18
<TABLE>
<CAPTION>
TORONTO STOCK EXCHANGE STOCK TRADING ACTIVITY
STOCK TRADING ACTIVITY
AVERAGE
DAILY
TRADING CDN$ CDN$ US$ US$
VOLUME HIGH LOW HIGH LOW
------ ---- --- ---- ---
<S> <C> <C> <C> <C> <C>
Vancouver Stock Exchange:
Fiscal year ended August 31, 1998:
First Quarter............................. 5,664 8.60 8.13 5.92 5.60
The Toronto Stock Exchange:
Fiscal year ended August 31, 1998:
Second Quarter............................ 3,466 8.05 7.83 5.54 5.39
Third Quarter............................. 7,330 10.38 9.95 7.15 6.85
Fourth Quarter............................ 3,982 9.40 8.93 6.48 6.15
Fiscal year ended August 31, 1999:
First Quarter............................. 3,695 5.93 5.63 4.08 3.88
Second Quarter............................ 4,780 8.10 7.68 5.58 5.29
Third Quarter............................. 13,264 4.10 2.75 2.12 1.89
Fourth Quarter (including up to
July 18, 1999)....................... 20,537 4.30 3.45 2.96 2.38
Fourth Quarter - Class A Shares
(commencing July 19, 1999)........... 859 12.00 6.40 8.27 4.41
Fourth Quarter - Class B Shares
(commencing July 19, 1999)........... 702 11.50 6.50 7.92 4.48
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
The American Stock Exchange:
Fiscal year ended August 31, 1999:
Fourth Quarter - Class B Shares
(commencing July 28, 1999)........... 3,635 7.55 6.71 5.19 4.62
Fiscal year ended August 31, 2000:
First Quarter - Class B Shares............ 3,045 8.16 3.99 5.62 2.75
</TABLE>
The Company's shares are issued in registered form and the following information
is from the Company's registrar and transfer agent, CIBC Mellon Trust Company,
located in Vancouver, British Columbia, Canada.
As at August 31, 1999, the shareholders' list for the Registrant's common stock
showed 217 Registered Class A shareholders and 218 registered Class B
shareholders and 1,517,965 Class A Shares and 2,267,978 Class B Shares
outstanding. Of these shareholders, 133 holders of Class A Shares and 134
holders of Class B shares were U.S. residents, owning 504,846 Class A Shares and
1,254,849 Class B Shares representing 33.25% of the Class A and 55.33% of the
Class B issued and outstanding shares.
The Company has researched the indirect holdings by depositories and other
financial institutions and believes it has in excess of 3,500 shareholders of
its common stock.
ITEM 6. EXCHANGE CONTROLS AND OTHER
LIMITATIONS AFFECTING SECURITY HOLDERS
<PAGE>
19
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 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. 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:
- Engages in production of uranium and owns an interest in producing
uranium property in Canada;
- Provides financial services;
- Provides transportation services;
- Is a cultural business.
Peace Arch is considered to be a cultural business pursuant to the Act.
<PAGE>
20
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:
- 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;
- the degree and significance of participation by Canadians in the
Canadian business and in any industry in Canada of which it forms a
part;
- the effect of the investment on productivity, industrial efficiency,
technological development, product innovation and product variety in
Canada;
- the effect of the investment on competition within any industry or
industries in Canada;
- the compatibility of the investment with national industrial, economic
and cultural objectives enunciated by the government or legislature of
any province likely to be significantly affected by the investment;
and
- the contribution of the investment to Canada's ability to compete in
world markets.
See "Business--Regulatory Considerations--Canadian Content Requirements" for a
description of other Canadian and British Columbia ownership requirements.
ITEM 7. 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
<PAGE>
21
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,
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 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 the Company, including the amount of any Canadian tax
withheld, as foreign source dividend income for U.S. federal income tax purposes
to the extent of the Company's 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
<PAGE>
22
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 the Company
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 the Company 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 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.
<PAGE>
23
For any taxable year of Peace Arch, if at least 75% of the Company's gross
income is "passive income", as defined in the Code, or if at least 50% of the
Company's 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, the Company will be a passive foreign investment
company ("PFIC"). If the Company is 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 the Company was 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.
The Company does not believe that it is 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 its control and
because the principles and methodology for determining the fair market values of
its assets are unclear, there can be no assurance that the Company will not be a
PFIC for such years. Special rules not described herein will also apply if the
Company becomes a "controlled foreign corporation" for U.S. federal income tax
purposes. The Company 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 the company. 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 the Company's
productions to constitute "Canadian-content" productions and for the Company to
claim Canadian tax benefits, it is not anticipated that it will become a
controlled foreign corporation for U.S. federal income tax purposes.
U.S. INFORMATION REPORTING AND BACKUP WITHHOLDING
Under current 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 31% U.S. backup withholding requirements. Unconnected U.S.
Shareholders generally can avoid the imposition of U.S. backup withholding 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. Any amounts withheld under the
backup 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.
<PAGE>
24
In general, dividends paid on the Class B shares, if any, by a foreign paying
agent will not be subject to U.S. backup withholding tax based on currently
effective regulations. Under treasury regulations that are generally effective
with respect to payments made after December 31, 2000 (the "New Withholding
Regulations"), 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 31% U.S. backup withholding tax unless
certification requirements are satisfied.
The New Withholding Regulations consolidate and modify the current 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 the Company deems 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 the Company's
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. The Company believes that the
value of its Class B shares is not currently principally derived, directly or
indirectly, from real property situated in Canada and does not expect this to
change in the foreseeable future.
Canada does not currently impose any estate taxes or succession duties.
ITEM 8. SELECTED FINANCIAL DATA
SELECTED CONSOLIDATED FINANCIAL AND OPERATING DATA
The consolidated statement of operations and deficit presented below for each of
the years in the three-year period ended August 31, 1999 and the consolidated
balance sheet data as of August 31, 1998 and 1999, 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
<PAGE>
25
August 31, 1996 and the consolidated balance sheet data as of each of August 31,
1997, 1996 and 1995, are derived from the Company's 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, 1999 has been translated into U.S. dollars using the average exchange
rate in effect during the period, and the Canadian dollar balance sheet data has
been translated using the rate in effect as of August 31, 1999. These
translations are not necessarily representative of the amounts that would have
been reported if the Company had historically reported its 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.
<PAGE>
26
SELECTED CONSOLIDATED FINANCIAL AND OPERATING DATA
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
YEAR ENDED AUGUST 31,
----------------------------------------------
CDN$ CDN$ CDN$ CDN$ CDN$ US$
---- ---- ---- ---- ---- ----
1995 1996 1997 1998 1999 1999
<S> <C> <C> <C> <C> <C> <C>
STATEMENT OF OPERATIONS DATA:
CANADIAN GAAP
Revenue............................ $ 4,012 $5,723 $ 23,584 $ 32,457 $ 51,547 $ 34,205
Expenses
Amortization of programming...... -- -- 14,796 23,659 40,296 26,739
Other costs of production and
sales.......................... 2,851 3,767 4,261 3,577 2,905 1,928
Selling, general and administra-
tion expense................... 1,401 2,404 2,453 2,201 3,049 2,023
Other............................ 376 579 640 965 1,672 1,109
------ ------ -------- ------- ------- -------
Total expenses..................... 4,628 6,750 22,150 30,402 47,922 31,799
------ ------ -------- ------- ------- -------
Net earnings (loss) from operations. (616) (1,027) 1,434 2,055 3,625 2,406
Gain (loss) on sale of capital assets
and other........................ -- (333) -- 360 239
Provision (against) limited partner-
ship revenue interests........... (297) (1,073) (2,313) -- -- --
Income taxes....................... -- -- -- (297) (2,132) (1,415)
------ ------ -------- ------- ------- -------
Net earnings (loss)................ $(913) $( 2,100) $ (1,212) $1,758 $1,853 $1,230
===== ======== ======== ====== ====== ======
Earnings (loss) per common share:(1)
Basic............................ $( 1.05) $(1.68) $ (0.65) $ 0.68 $0.60 $0.40
Diluted.......................... -- -- -- $ 0.63 $0.58 $0.39
Weighted average number of
common shares.................. 892 1,247 1,861 2,603 3,083 3,083
Diluted number of common
shares......................... -- -- -- 3,124 3,473 3,473
OTHER OPERATING DATA:
Cash flows provided by (used in):
Operating activities............. (1,189) (515) 13,442 21,473 39,771 26,391
Investing activities............. (95) (1,126) (16,939) (28,331) (44,130) (29,283)
Financing activities............. 1,309 1,695 5,118 6,990 6,938 4,604
EBITDA(2).......................... (223) (465) 2,074 3,020 5,297 3,515
<PAGE>
27
U.S. GAAP(3)
Earnings (loss) per common share:(1)
Basic............................ $ (1.05) $(1.68) $ (0.80) $ 0.23 $0.56 $0.37
Diluted.......................... $ (1.05) $(1.68) $ (0.80) $ 0.23 $0.56 $0.37
Weighted average number of
common shares.................. 892 1,247 1,511 2,304 2,935 2,935
Diluted number of common
shares......................... 892 1,247 1,511 2,304 2,954 2,954
</TABLE>
<TABLE>
<CAPTION>
AS OF AUGUST 31,
--------------------------------------
CDN$ CDN$ CDN$ CDN$ CDN$ US$
---- ---- ---- ---- ---- ----
1995 1996 1997 1998 1999 1999
----- ---- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C> <C>
BALANCE SHEET DATA:
Cash and marketable securities........ $ 70 $ 123 $ 1,744 $ 1,876 $4,455 $2,978
Accounts receivable................... 1,283 1,097 4,799 10,235 19,901 13,305
Production costs in progress.......... 112 64 3,862 11,906 3,446 2,304
Investments in television
programming, net.................... 77 462 2,057 5,632 10,227 6,837
Property and equipment, net........... 2,787 4,847 5,048 9,498 7,079 4,733
Goodwill.............................. 560 736 597 2,544 3,185 2,129
Total assets.......................... 5,370 7,710 18,510 42,187 48,863 32,667
Debt financing(4)..................... 2,730 4,706 4,152 10,367 11,172 7,469
Deferred revenue...................... 77 83 4,230 10,770 3,980 2,661
Total liabilities..................... 3,818 5,692 9,390 24,454 23,137 15,468
Shareholders' equity.................. 1,552 2,018 9,120 17,733 25,726 17,199
</TABLE>
(1) Basic earnings per share shown above are based on the weighted average
number of shares outstanding during the period. Diluted per share information is
not presented under Canadian GAAP if it would disclose a smaller loss per share
than the basic earnings per share.
(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. The Company has included EBITDA because it feels that some readers
will find it useful for evaluating the Company's business and this investment.
However, EBITDA should not be considered as an alternative to net earnings, as
determined in accordance with Canadian GAAP, as an indicator of the Company's
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 the Company's 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 the Company's officers and directors. Under
Canadian GAAP, the transfer is a capital transaction
<PAGE>
28
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.
Effective August 31, 1999 the Company sold real estate and reported a partial
gain under Canadian GAAP. Part of the consideration was a note receivable. Under
US GAAP this transaction would have been accounted for using the finance method
due to the existence of the note receivable and the partial gain of $187,000
would not have been realized.
(4) Debt financing shown above includes both bank indebtedness and long-term
debt.
The Company has not declared any dividends since incorporation and does not
anticipate that it will do so in the foreseeable future. The present policy of
the Company is to retain future earnings for use in its operations and the
expansion of its business.
ITEM 9. MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion should be read in conjunction with the consolidated
financial statements and related notes included elsewhere in this annual report.
Included in operations for fiscal years ended after 1996 are the accounts of
Peace Arch Productions (formerly Sugar Entertainment Ltd.), which was acquired
on September 1, 1996. Years subsequent to fiscal 1996 may not be comparable with
fiscal 1996 and prior years. Peace Arch Productions made up approximately 73% of
revenues in 1997, 86% in 1998 and 92% in 1999.
GENERAL
The Company develops, produces and distributes proprietary television
programming for worldwide markets. In 1996 the Company shifted its principal
business focus to proprietary television programming from production services
for third parties. The Company continues to provide production services on a
contract basis. Immediate prospects for future growth depend on the Company's
ability to identify, develop and acquire rights to ideas, storylines and other
creative concepts and to successfully market its proprietary programming.
BASIS OF PRESENTATION
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.
The Company operates through separate subsidiaries established for each
production or series. The costs of programming are financed through advances
obtained from customers, from borrowings under a bank credit facility and from
working capital. Typically, the Company retains the rights to its proprietary
programming for exploitation in future periods or in additional markets and
media.
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
<PAGE>
29
financing the project, and are recorded net of tax credits. 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 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, the Company amortizes a minimum of 90%
of the production costs over a three-year period. In the event that management
should determine that the capitalized costs of a production exceed its
recoverable value, capitalized costs would be written down in the current
period, resulting in a corresponding decrease in earnings. To date, the Company
has taken no material write-downs due to reevaluations of its future estimates
of revenues for film or television programs.
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 the
Company 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, the
Company has not entered into any material currency hedging instruments. In
addition, it has not maintained significant amounts of U.S. dollar balances in
order to reduce the risk of exchange rate fluctuations.
Due to the timing of US 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. Management anticipates that fiscal
2000 second quarter results will reflect a delay in production and third quarter
results will reflect additional program deliveries. Production services and
Other, which represented 8% of fiscal 1999, 14% of 1998 revenues and 26% of 1997
revenues, are not subject to significant seasonal variations.
As consideration for the acquisition of Sugar Entertainment Ltd. in 1996, the
Company 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 the Company is subject. The
performance shares are subject to release with the consent of the British
Columbia securities regulatory agencies, as specified financial performance
standards are met. At the time the shares are released from escrow, the Company
records increases to goodwill and share capital based on the fair value of the
shares at the date the performance can be determined. This additional goodwill
is amortized over 20 years. 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.
<PAGE>
30
In December 1997, beneficial ownership of an aggregate of 160,000 of the
performance shares was transferred to three of the Company's 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 91,428 of the transferred performance shares. See Note 22 to
consolidated financial statements for further discussion of this adjustment. A
further compensation expense is expected to be recorded in calendar 1999 when
the remaining 68,572 of those transferred performance shares still held in
escrow are released with the amount to be determined at that date.
OPERATING RESULTS
The Company's shift in business focus has resulted in a trend of increasingly
strong operating results that continued in 1999. Revenues reflected a 3-year
compound annual growth rate of 108%. Pretax earnings almost doubled from $2
million in 1998 to $4 million in 1999. Net income increased by 5%, which reflect
the Company becoming fully taxable during the year.
REVENUES. During the year ended August 31, 1999, revenues increased by 59% over
the comparable year, from $32.5 million to $51.5 million. Revenues for 1998
increased by 38% over 1997 revenues of $23.6 million. The Company realized
three-year compound annual revenue growth of 108%, due primarily to a
significant increase in proprietary programming.
During the year ended August 31, 1999 the Company derived 92% of revenues from
proprietary programming, compared with 86% for the prior year. Revenues from
this programming increased from $28 million in 1998 to $47.3 million in 1999
representing 69% growth. This growth is primarily due to an increase in program
deliveries for the television series "First Wave". The increase in revenues from
proprietary programming was partially offset by a $500,000 decrease in
production services revenues, from $4.2 million in 1998 to $3.7 million in 1999.
In 1997 the Company derived 74% of revenues from proprietary programming. Fiscal
1998 revenues from proprietary programming grew 60% over the comparable year,
due to the addition of the Company's second large-scale television series, First
Wave.
AMORTIZATION OF TELEVISION PROGRAMMING. Amortization of programming resulted in
a consistent 15% profit margin from proprietary programming over three years
ended August 31, 1997, 1998 and 1999. Amortization of programming grew by 70%
from $23.7 million in 1998 to $40.3 million in 1999. In 1998 amortization of
programming grew by 60% from 1997 amortization of $14.8 million. Amortization
increased due to an increase in the production of proprietary programming.
OTHER COSTS OF PRODUCTION AND SALES. Other costs of production and sales
declined by 19% in 1999 and 16% in 1998, primarily due to a decrease in the
production services business resulting from the Company's change of focus to
proprietary television programming.
<PAGE>
31
SELLING, GENERAL AND ADMINISTRATION EXPENSE. Selling, general and administration
expense increased by 39% in 1999 from $2.2 million in 1998 to $3.0 million in
1999 primarily due to increased administration expenses associated with the
Company's expansion in the area of proprietary programming.
In 1998, selling, general and administration expense decreased by 10%. The
decrease was the net result of a $0.9 million reduction in expense due to the
sale of the Company's educational video and software business, a $0.5 million
increase in administrative expense and a $0.1 million increase in selling
expense.
For fiscal 1999, selling, general and administration expense declined to 6% of
revenues from 7% in 1998 and 10% in 1997.
INTEREST EXPENSE. Interest expense for fiscal 1999 of $1.2 million is comprised
equally of interest on bank indebtedness and interest on long-term debt. Bank
indebtedness relates to the Company's credit facility. Long-term debt relates to
loans to acquire plant and equipment and other long-term debt. The increase in
interest for the year was due primarily to an increase in the Company's bank
indebtedness, which at times during the year exceeded $9 million. Although
long-term debt decreased by $3 million during the year, $2 million of the
decrease occurred on the last day of the year and therefore did not contribute a
decrease in expense.
In 1998 interest was comprised $0.13 million from bank indebtedness and $0.45
million from long-term debt. In 1997 substantially all of interest expense was
from long-term debt.
TAXES. At August 31, 1999 the Company had accumulated operating losses for tax
purposes of approximately $1.3 million, which are available for carry forward to
future years. The full benefit of these losses has been recognized as a
reduction of the Company's future income tax liability.
During the year ended August 31, 1999 the Company became fully taxable as it
recognized the benefit of the last of its losses. The effective tax rate for
fiscal 1999 of 53.5% is comprised of the corporate statutory income tax rate of
45.6%, less a 5.0% benefit from the recognition of the Company's remaining tax
losses, plus a 12.9% increase due to non-deductible expenses. In fiscal 1998,
the Company's effective tax rate was 14.4% comprised of the 45.6% statutory
corporate tax rate, less the benefit of its tax losses of 35.1%, plus an
increase of 3.9% due to non-deductible expenses. In fiscal 1997, the Company's
effective tax rate was nil, comprised of the 45.6% statutory corporate tax rate,
less the benefit of its tax losses of 48.6%, plus an increase of 3% due to
non-deductible expenses.
LIQUIDITY AND CAPITAL RESOURCES
The Company finances the capital costs of proprietary television programming and
other cash requirements principally through advances obtained from customers,
borrowings under its bank credit facility and from working capital. The Company
has also funded its capital requirements through the issuance of shares,
warrants and convertible debentures. The Company has used real estate mortgages
to finance the acquisition of its production facilities. Management believes it
can earn sufficient cash flow from operations to meet interest commitments on
debt.
During fiscal 1999 operating activities provided cash flow of $40 million
compared with $21 million in 1998 and $13 million in 1997. This increase was
primarily due to an increase in program revenues.
<PAGE>
32
Cash used for investing activities increased to $44 million in fiscal 1999
compared with $28 million in 1998 and $17 million in fiscal 1997 due to a steady
increase in production activities and an increase in the average per-episode
costs of production. The trend of increased cash used for investing activities
is expected to continue in fiscal 2000 as the Company employs the remaining
proceeds of its 1999 public offering. An increase in investments in television
programming is required in order to maintain sales growth.
Cash flows from financing activities were $6.9 million, compared with $7.0
million in 1998 and $5.1 million in 1997. During the year the Company raised
$4.2 million from the issuance of common shares and $1.2 million from the
issuance of debentures, of which $0.6 million was repaid during the year. An
additional $1.7 million of debt was retired during the year. In 1998 the Company
raised $4.9 million from the issuance of share capital and $2 million in debt as
compared with $5.8 million raised from the issuance of share capital in 1997.
The Company repaid debt in the amount of $1.7 million in fiscal 1998 as compared
to $1.1 million in fiscal 1997. At August 31, 1999 total liabilities decreased
to $23.1 million from $24.5 million in 1998.
The Company intends to renew its mortgages in the aggregate amount of $3.6
million as they come due over the next two fiscal years. The mortgages are held
by wholly owned subsidiaries and are secured by their assets. Debentures in the
amount of $0.6 million come due on October 21, 2000.
The Company's principal debt funding is through its $14 million bank credit
facility. This facility bears interest at a rate equal to the Canadian prime
rate plus 1% per annum, with monthly payments of interest only drawn from an
interest reserve held by the bank. The facility is secured by the refundable tax
credits, distribution rights to certain film properties and a general security
interest on the assets of the Company. During the year, the Company increased
borrowings under its credit facility by $4.3 million (1998 - $1.7 million, 1997
- - $0.5 million), which leaves an available balance of $9.7 million, subject to
certain provisions, at the end of the year.
Management believes that the Company has adequate resources to meet its current
cash requirements, and based on the current business activities will have
sufficient capital resources to meet its cash requirements for fiscal 2000. If
business activities increase substantially during the year, Management
anticipates it will have to raise additional capital to meet its cash
requirements. Management expects that as the Company grows it will be able to
extend its bank facility, however if it is not able to extend this facility it
will have to seek additional financing from other sources.
RISKS AND UNCERTAINTIES
There are trends and uncertainties that could impact revenues and earnings from
operations. In addition to uncertainty due to the year 2000 issue and the risks
referred to in the notes to the consolidated financial statements, there are
several other risks specific to the Company and its industry.
BUSINESS RISKS
The business of producing and distributing television programming is highly
competitive. The Company faces intense competition with other producers and
distributors, many of whom are substantially larger
<PAGE>
33
and have greater financial resources. The Company competes with other companies
for ideas and storylines created by third parties, as well as for actors,
directors and other personnel.
Results of operations for any period depend on the number of television programs
that are delivered. Consequently, results may vary materially from period to
period, and the results of any one period may not indicate results for future
periods. Cash flows may also fluctuate and may not directly correspond with
revenue recognition.
Actual production costs may exceed budget, perhaps significantly, due to factors
within or beyond the Company's control. These factors may delay or prevent
completion of a production. If there are significant cost overruns, the Company
may have to seek additional financing to complete the production. Financing on
terms acceptable to the Company may not be available. The Company may be unable
to recoup the additional costs, which could have a material adverse impact on
operating results and liquidity.
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 the proprietary television programs of the Company may not be
commercially successful, resulting in its failure to recoup its investment or
realize its anticipated profits.
Investments in television programming are amortized against revenues in the
ratio that current revenues bear to management's estimate of aggregate
anticipated gross revenues for the program. Generally the Company amortizes a
minimum of 90% of the costs over a three-year period. Management periodically
reviews its estimates and adjusts the amortization of its programs accordingly.
In the event that management should determine that capitalized costs for a
program exceed its recoverable value, capitalized costs would be written down in
the current period, resulting in a corresponding decrease in earnings. Although
to date the Company has taken no material write-down due to revaluation of its
revenue estimates for television programs, no assurance can be provided that a
material write-down will not occur.
Revenues have grown from $23.6 million in 1997 to $51.5 in 1999. This rapid
growth has placed increasing demands on the Company's financial resources, and
will continue to do so as the Company pursues its expansion strategy. There is
no assurance that the Company will have the liquidity and financial resources to
continue this rate of expansion.
GOVERNMENT INCENTIVES
The BC film industry has been experiencing a trend of rapid growth. This growth
could have a positive effect on the Company's revenues and income from
operations. Refundable tax credits are important to the Company's business. If
these tax credits were to be discontinued, revenues and earnings from operations
may not continue to increase or may decline causing a decrease in liquidity.
YEAR 2000
Many existing computer programs and other systems in use today were designed and
developed without considering the change in century, which could lead to the
failure of computer applications or create erroneous results by the Year 2000
and for some time following the Year 2000. The Year 2000 issue is a
<PAGE>
34
broad business issue, the impact of which extends beyond traditional computer
hardware and software to possible failure of other systems and instrumentation,
including equipment used by the Company and by third parties with which the
Company does business.
The Company has completed a remediation plan, including analysis, planning,
implementation, testing and contingency planning. Under this plan the Company
has replaced and modified as necessary some of its key systems with systems that
are expected to be Year 2000 compliant. The Company was unable to ascertain from
all its customers and suppliers that they have adequately addressed the Year
2000 issue. As such, there is uncertainty that the business of such third
parties will not be disrupted, which could have a material adverse impact on the
Company's business. There is no assurance that the Company's contingency plan
will be adequate to safeguard against unanticipated problems that arise due to
the Year 2000 issue.
In the worst-case scenario, the Company may miss delivery dates for its programs
due to an inability to procure supplies, such as film, and services, such as
special effects work and sound, and to deliver the final program due to
transportation problems. Postponing delivery could cause payments to be
postponed and may cause a postponement in realizing revenues and related costs.
In addition, once the Company's programs are delivered, its customers may be
unable to process payments. The Company has identified alternate suppliers and
will provide adequate liquidity to meet a possible delay in cash receipts.
To date, the Company has not experienced any material disruption of its business
due to the Year 2000 issue.
INFLATION
Historically, inflation has not had a material impact on the Company's results
of operations.
RECENT ACCOUNTING PRONOUNCEMENTS
Note 22 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 22, 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 the Company's reported results but
that it has not yet adopted because such standards are not effective for the
periods presented.
In June 1998, FAS 133, "Accounting for Derivative Instruments and Hedging
Activities", was issued. FAS 133 provides comprehensive standards for the
recognition and measurement of derivative and hedging activities. Generally, FAS
133 requires that all derivatives be recorded on the balance sheet at their fair
value and establishes new accounting requirements for different types of hedging
activities. FAS 133 is effective for fiscal years beginning after June 15, 2000.
Management does not believe that the adoption of FAS 133 will materially impact
the reported historical financial position or results of operations as set out
in the consolidated financial statements of the Company.
In October 1998, the FASB released an exposure draft of the proposed statement
on recission of FAS 53. If adopted, companies previously subject to the
requirements of FAS 53 would follow the guidance of a proposed Statement of
Position ("SOP"), "Accounting by Producers and Distributors of Films". This
<PAGE>
35
proposed SOP has not been finalized and its effective date is not certain.
Management has not concluded what, if any, impact these proposals will have on
the Company's reported historical financial position or results of operations
due to the preliminary stages of the proposed SOP.
SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS
The Company intends some statements in this report, including statements set
forth under the captions "Management's Discussion and Analysis of Financial
Condition and Results of Operations," "Business" and elsewhere in this report,
regarding, among other things, the Company's 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 the Company's 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
"Management's Discussion and Analysis of Financial Condition and Results of
Operations," "Business" and elsewhere in this report. Although Management
believes that the expectations reflected in the forward-looking statements are
reasonable, the Company cannot guarantee future results, levels of activity,
performance or achievements. The Company undertakes 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 9A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company is subject to two main market risks: Interest rate risk and foreign
currency exchange risk.
The interest rate risk arises through the Company's $14.0 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, 1999, the Company had borrowings of
$6.9 million outstanding under the credit facility, resulting in an annual
interest payment of $652,260. A 1% increase in the Canadian prime rate would
raise the Company's annual interest payment for fiscal 1999 to approximately
$707,000.
Revenues are typically received from US and international sources in US dollars
while costs are payable primarily in Canadian dollars. Accordingly, operating
results can be affected by fluctuations in the US
<PAGE>
36
dollar exchange rate. Currency exchange rates are determined by market factors
beyond the Company's 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, the Company's effective costs would rise in relation to its revenues.
The Company does not maintain US currency balances in excess of its estimated US
payables. To date the Company has not entered into agreements for any material
hedging instruments.
ITEM 10. DIRECTORS AND OFFICERS OF THE REGISTRANT
The following table lists as of January 31, 2000 the names of the Directors
and/or Executive Officers of the Company. The Directors have served in their
respective capacities since their election and will serve until the next Annual
General Meeting or until a successor is duly elected, unless the office is
vacated in accordance with the Articles of the Company. 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 Directors and Executive
Officers are residents and citizens of Canada.
<TABLE>
<CAPTION>
- ------------------------------- ---------------------- -------------------------------------------------- ----------
NAME DIRECTOR SINCE OFFICE HELD AGE
- ------------------------------- ---------------------- -------------------------------------------------- ----------
<S> <C> <C> <C>
STEPHEN CHEIKES January 20, 1998 Director and Compensation Committee Member 51
- ------------------------------- ---------------------- -------------------------------------------------- ----------
DARRELL ELLIOTT August 20, 1998 Director, Audit (Chairman) and Compensation 52
Committees Member
- ------------------------------- ---------------------- -------------------------------------------------- ----------
TIMOTHY GAMBLE October 22, 1986 Director and President of the Company 43
- ------------------------------- ---------------------- -------------------------------------------------- ----------
YAD GARCHA July 7, 1998 Director, Audit, Nominating and Compensation 41
(Chairman) Committees Member
- ------------------------------- ---------------------- -------------------------------------------------- ----------
JULIET JONES Not Applicable Chief Financial Officer of the Company since 34
November 1995
- ------------------------------- ---------------------- -------------------------------------------------- ----------
VINCENT LUM November 19, 1998 Director, Audit and Nominating (Chairman) 40
Committees Member
- ------------------------------- ---------------------- -------------------------------------------------- ----------
W.D. CAMERON WHITE February 12, 1993 Director and Chief Executive Officer of the 43
Company. Also Nominating Committee Member
- ------------------------------- ---------------------- -------------------------------------------------- ----------
LARRY SUGAR Not Applicable Past President of Peace Arch Productions Inc 54
(formerly Sugar Entertainment)
- ------------------------------- ---------------------- -------------------------------------------------- ----------
</TABLE>
TIMOTHY GAMBLE is our founder and has served as President and as director since
our inception in 1986. Mr. Gamble takes principal responsibility for business
development, marketing and corporate finance matters. He has been involved in
the production of numerous feature films, such as "Cadence," starring Martin
Sheen and Charlie Sheen.
<PAGE>
37
W.D. CAMERON WHITE is our Chief Executive Officer, having joined us on a
full-time basis in 1994. Prior to joining us, 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 1992-1994 and at Worrall Scott & Page, Barristers
and Solicitors, from 1981 to 1992. Mr. White is responsible for strategic
planning, acquisitions and corporate finance. Mr. White has been a director
since February 1993.
JULIET JONES has been our Chief Financial Officer since February 1996, and has
been with us since 1991. Ms. Jones is responsible for overseeing all accounting
and audit functions, operations management, financial planning and cash flow
analysis and controls. Ms. Jones is a member of the Certified General
Accountants Association of British Columbia and Canada.
LARRY SUGAR until January 2000, was the President of Peace Arch Productions Inc.
(formerly Sugar Entertainment Ltd.), our wholly owned subsidiary which we
acquired from him in 1996, and has served in that capacity since Sugar
Entertainment Ltd. was incorporated in March 1996. Sugar Entertainment Ltd.
produces most of our proprietary television programming. Mr. Sugar has over 25
years of experience in the feature film and television industry. Mr. Sugar has
held a number of senior industry positions, including President of International
Distribution for Republic Pictures from 1989 to 1991, President of Distribution
for CBS Television from 1985 to 1986, President of International Distribution
for Weintraub Entertainment Group from 1987 to 1989 and President of Lorimar
International from 1981 to 1985. In addition to heading up our creative team,
Mr. Sugar assists with the development and financing of television projects, as
well as the expansion of our international distribution presence.
STEPHEN CHEIKES has been a member of our board of directors since January 1998.
He is the co-founder, Chief Executive Officer and a director of Monarch
Entertainment Corporation, a British Columbia film finance company. Prior to
founding Monarch in 1993, Mr. Cheikes was a principal and senior executive of
the Beacon Group of Companies, from 1987 to 1992. He also practiced
entertainment law in Los Angeles from 1977 to 1987.
DARRELL ELLIOTT has been a member of our board of directors since August 1998.
He has been president of Isuma Strategies Inc., a private strategic advisory
company, since 1998. Mr. Elliott worked for approximately nine years until
August 1998 with Royal Bank Capital Corporation as Regional Vice President. Mr.
Elliott has 27 years of merchant banking, venture capital and analogous
operating experience in Africa, Europe and Canada and has served on numerous
boards of directors. Mr. Elliott is currently a director of Nortran
Pharmaceuticals Inc., a publicly traded company listed on the Vancouver Stock
Exchange and traded on the OTC Bulletin Board. He is also currently a director
of Develcon Electronics Ltd., a publicly traded company on The Toronto Stock
Exchange, and Vianet Technologies Inc., a publicly traded company on the OTC
Bulletin Board.
YAD GARCHA has been a member of our board of directors since 1998. He has been
Vice President of Growthworks Capital Ltd., a venture capital company, since
1998. Prior to joining Growthworks Capital Ltd., Mr. Garcha was Vice-President
of Investment of the Working Opportunity Fund (EVCC) ("WOF"), a venture capital
company, from 1994 to 1998. Mr. Garcha initially worked in commercial banking
with the Bank of Montreal from 1986 to 1988 before becoming an Investment
Manager with the Federal Business Development Bank from 1988 to 1994. Mr. Garcha
has an aggregate of more than 12 years
<PAGE>
38
experience in banking and finance and, in addition to serving on our board,
currently serves on the board of several bio-technology companies. Mr. Garcha
has been a director since July 1998. Mr. Garcha was nominated to our board
pursuant to the agreement between WOF and us that so long as WOF continues to
hold a specified number of our shares, WOF will have the right to have a
director-nominee nominated to the board. Mr. Garcha is a director of Angiotech
Pharmaceutical Inc., a publicly traded company on The Toronto Stock Exchange,
and is a director of Stressgen Biotechnologies Corp., a publicly traded company
on both The Toronto Stock Exchange and the Vancouver Stock Exchange.
VINCENT LUM has been a member of our board of directors since November 1998. He
has been an Investment Manager of Royal Bank Capital Corporation ("RBCC") since
1997. From 1993 until 1997, Mr. Lum was involved in early-stage investments in
technology companies for the B.C. Advanced Systems Institute. Mr. Lum was
nominated to our board pursuant to the agreement between RBCC and us which
provides that so long as RBCC or any of its affiliates holds our shares, RBCC
shall have the right to have a director-nominee nominated to the board.
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. RBCC and WOF each have a right to nominate one of the directors. 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.
The Board of Directors met six (6) times in fiscal 1999. Under the B.C. Company
Act, a majority of the Board of Directors must be resident Canadians and at
least one member of the Board of Directors must ordinarily be resident in the
Province of British Columbia. All of the Directors of the Company reside in the
Province of British Columbia and all are Canadians.
There are no arrangements or understandings between any two or more Directors or
Executive Officers, pursuant to which he/she was 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.
ITEM 11. COMPENSATION TO DIRECTORS AND OFFICERS
During the most recently completed fiscal year, the non-employee Directors of
the Company were paid a yearly retainer of $5,000. As well, these Directors are
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. Incentive stock options were granted pursuant to the Company's
Stock Option Plan to non-employee Directors of the Company during the last
completed financial year to purchase up to 20,000 Class A Shares at a price of
$9.50 per share and 20,000 Class B Shares at a price of $9.50 per share
exercisable on or before 16th February 2004, none of which were exercised. No
stock options were exercised by any non-employee Directors.
The aggregate cash compensation paid or payable to officers and directors, as a
group, of the Company and its subsidiaries for services rendered during the
fiscal year ended August 31, 1999 was $2,755,500.
<PAGE>
39
The following table sets forth all annual and long term compensation for
services to the Company for the three most recently completed financial years as
at 31st August 1999 in respect of the Named Executive Officers. At the end of
the most recently completed financial year, the Company had four Named Executive
Officers, Cameron White, the Company's CEO, Timothy Gamble, the Company's
President, Juliet Jones, the Company's CFO and Larry Sugar, President of the
Company's subsidiary, Peace Arch Productions Inc. (the "Named Executive
Officers"). There were no other executive officers of the Company, or other
individuals, whose total compensation exceeded $100,000 during the financial
year ended 31st August 1999.
Subsequent to the year end, Mr. Sugar resigned as the President of Peace Arch
Productions Inc. (formerly Sugar Entertainment Ltd.). Mr. Sugar is
negotiating a "first look" arrangement with Peace Arch Productions whereby
Peace Arch Productions will have the first opportunity to produce all future
programs under Mr. Sugar's control.
<TABLE>
<CAPTION>
- ----------------------- ---------------------------------------- ---------------------------------- -----------------
ANNUAL COMPENSATION LONG TERM COMPENSATION
---------------------------------------- ----------------------------------
AWARDS PAYOUTS
----------- ---------- ----------------- -------------------- -------------
OTHER ANNUAL ALL OTHER
NAME AND PRINCIPAL SALARY BONUS COMPENSATION SECURITIES UNDER LTIP PAYOUTS COMPENSATION
POSITION ($) ($) ($) OPTION GRANTED (#) ($) ($)
- ----------------------- ----------- ---------- ----------------- -------------------- ------------- -----------------
<S> <C> <C> <C> <C> <C> <C>
WD Cameron $165,000 Nil $35,000[1] Nil $100,000 Nil
White, CEO
- ----------------------- ----------- ---------- ----------------- -------------------- ------------- -----------------
Timothy Gamble, $165,000 Nil $35,000[2] Nil $100,000 Nil
President
- ----------------------- ----------- ---------- ----------------- -------------------- ------------- -----------------
Juliet Jones, Chief $120,000 Nil Nil Nil $60,000 Nil
Financial Officer
- ----------------------- ----------- ---------- ----------------- -------------------- ------------- -----------------
Larry Sugar Nil Nil Nil Nil Nil $1,956,000[3]
President, Peace Arch
Productions Inc.
- ----------------------- ----------- ---------- ----------------- -------------------- ------------- -----------------
</TABLE>
[1] A company controlled by Mr. White received fees of $35,000 in 1999.
[2] A company controlled by Mr. Gamble received fees of $35,000 in 1999.
[3] Paid as production fees.
LONG TERM INCENTIVE PLANS -
AWARDS IN MOST RECENTLY COMPLETED FINANCIAL YEAR
<TABLE>
<CAPTION>
- ---------------------------- ------------------ ---------------------- ---------------------------------------------
ESTIMATED FUTURE PAYOUTS UNDER
NON-SECURITIES-PRICE-BASED PLANS
SECURITIES UNITS PERFORMANCE OR OTHER --------------- --------------- -------------
OR OTHER RIGHTS PERIOD UNIT THRESHHOLD TARGET MAXIMUM
NAME (#) MATURATION OR PAYOUT ($ OR #) ($ OR #) ($ OR #)
- ---------------------------- ------------------ ---------------------- --------------- --------------- -------------
<S> <C> <C> <C> <C> <C>
W.D. Cameron White N/A August 31, 1999 N/A N/A N/A
- ---------------------------- ------------------ ---------------------- --------------- --------------- -------------
Timothy Gamble N/A August 31, 1999 N/A N/A N/A
- ---------------------------- ------------------ ---------------------- --------------- --------------- -------------
Juliet Jones N/A August 31, 1999 N/A N/A N/A
- ---------------------------- ------------------ ---------------------- --------------- --------------- -------------
</TABLE>
<PAGE>
40
The maximum Performance Bonus entitlement shall be equal to 50% of each of
Messrs. White, Gamble and Ms. Jones' (collectively, the "Employee") base salary
during the relevant fiscal year. For greater certainty, the Employees' base
salary during the fiscal year ended August 31, 1999 shall be deemed to be
$200,000 per annum in the case of Messrs. White and Gamble and $120,000 per
annum in the case of Ms. Jones.
The actual entitlement shall be based on the share price performance of the
Company's shares and shall be calculated as a percentage of the maximum
entitlement. The percentage increase or decrease of the Company's shares during
the year shall be compared to the share price performance of a peer group of
companies (the "Peer Group"). The composition of the Peer Group shall be
determined by the Compensation Committee of the Company and the Employee at the
beginning of each fiscal year.
If the price performance of the Company's shares ranks in the top quartile of
the Peer Group, the Employee will earn the maximum Performance Bonus. If the
price performance of the Company's shares ranks in the second quartile, the
Employee will earn 50% of the maximum Performance Bonus. If the price
performance of the Company's shares ranks in the lower half of the Peer Group,
the Employee will not be entitled to the Performance Bonus. Price performance
will be calculated based on a 10 day trading average taken during the last five
and the first five trading days of each fiscal year.
OPTION GRANTS DURING THE MOST RECENTLY COMPLETED FINANCIAL YEAR
During the most recently completed financial year, there were no options granted
to the Named Executive Officers.
Except for the Company's Stock Option Plan, there are no plans in effect
pursuant to which cash or non-cash compensation was paid or distributed to Named
Executive Officers during the most recently completed financial year or is
proposed to be paid or distributed in a subsequent year. The Company does not
have any pension plans or retirement benefit plans.
ITEM 12 OPTIONS TO PURCHASE SECURITIES FROM REGISTRANT OR SUBSIDIARIES
CLASS B STOCK OPTIONS OUTSTANDING AS AT JANUARY 31, 2000
<TABLE>
<CAPTION>
- ---------------------------- ------------------ ------------------------ ------------------ ------------------------
NAME TITLE EXPIRY DATE PRICE NO. OF B OPTIONS
- ---------------------------- ------------------ ------------------------ ------------------ ------------------------
<S> <C> <C> <C> <C>
Employee Jan 24/01 $11.20 375
- ---------------------------- ------------------ ------------------------ ------------------ ------------------------
T. Gamble President Mar 29/01 $14.00 12,250
- ---------------------------- ------------------ ------------------------ ------------------ ------------------------
Employees Mar 29/01 $14.00 11,250
- ---------------------------- ------------------ ------------------------ ------------------ ------------------------
Employee May 9/01 $19.40 500
- ---------------------------- ------------------ ------------------------ ------------------ ------------------------
WDC White CEO Oct 15/96 $13.50 12,025
- ---------------------------- ------------------ ------------------------ ------------------ ------------------------
Juliet Jones CFO Oct 15/96 $13.50 5,000
- ---------------------------- ------------------ ------------------------ ------------------ ------------------------
Employees Oct 15/01 $13.50 6,500
- ---------------------------- ------------------ ------------------------ ------------------ ------------------------
WDC White CEO June 2/02 $13.00 4,000
- ---------------------------- ------------------ ------------------------ ------------------ ------------------------
J. Jones CFO June 2/02 $13.00 3,800
- ---------------------------- ------------------ ------------------------ ------------------ ------------------------
T. Gamble President June 2/02 $13.00 4,000
- ---------------------------- ------------------ ------------------------ ------------------ ------------------------
Employees June 2/02 $13.00 5,700
- ---------------------------- ------------------ ------------------------ ------------------ ------------------------
T. Gamble President Mar 23/03 $9.50 7,000
- ---------------------------- ------------------ ------------------------ ------------------ ------------------------
<PAGE>
41
- ---------------------------- ------------------ ------------------------ ------------------ ------------------------
WDCWhite CEO Mar 23/03 $9.50 7,000
- ---------------------------- ------------------ ------------------------ ------------------ ------------------------
J. Jones CFO Mar 23/03 $9.50 5,000
- ---------------------------- ------------------ ------------------------ ------------------ ------------------------
S. Cheikes Director Mar 23/03 $9.50 10,000
- ---------------------------- ------------------ ------------------------ ------------------ ------------------------
Employees Mar 23/03 $9.50 31,500
- ---------------------------- ------------------ ------------------------ ------------------ ------------------------
Employees Nov 19/03 $7.50 5,700
- ---------------------------- ------------------ ------------------------ ------------------ ------------------------
Y. Garcha Director Feb 16/04 $9.50 5,000
- ---------------------------- ------------------ ------------------------ ------------------ ------------------------
V. Lum Director Feb 16/04 $9.50 5,000
- ---------------------------- ------------------ ------------------------ ------------------ ------------------------
D. Elliott Director Feb 16/04 $9.50 5,000
- ---------------------------- ------------------ ------------------------ ------------------ ------------------------
S. Cheikes Director Feb 16/04 $9.50 5,000
- ---------------------------- ------------------ ------------------------ ------------------ ------------------------
C. White CEO Jan 13/00 $5.50 25,000
- ---------------------------- ------------------ ------------------------ ------------------ ------------------------
T. Gamble President Jan 13/00 $5.50 25,000
- ---------------------------- ------------------ ------------------------ ------------------ ------------------------
J. Jones CFO Jan 13/00 $5.50 25,000
- ---------------------------- ------------------ ------------------------ ------------------ ------------------------
Employees Jan 13/00 $5.50 113,070
- ---------------------------- ------------------ ------------------------ ------------------ ------------------------
- ---------------------------- ------------------ ------------------------ ------------------ ------------------------
TOTAL 339,670
- ---------------------------- ------------------ ------------------------ ------------------ ------------------------
</TABLE>
CLASS B WARRANTS OUTSTANDING AS AT JANUARY 31, 2000
<TABLE>
<CAPTION>
- ------------------------- ---------------------- ----------------------------- ------------- ----------------------
DATE OF ISSUANCE OF THE NUMBER OF WARRANTS NUMBER OF WARRANTS EXERCISE EXPIRY DATE OF
WARRANTS ISSUED CURRENTLY OUTSTANDING PRICE WARRANTS
- ------------------------- ---------------------- ----------------------------- ------------- ----------------------
<S> <C> <C> <C> <C>
October 21, 1998 50,000 Class B 50,000 Class B $6.25 October 21, 2000
- ------------------------- ---------------------- ----------------------------- ------------- ----------------------
August 3, 1999 75,000 Class B 75,000 Class B $6.75 August 3, 2004
- ------------------------- ---------------------- ----------------------------- ------------- ----------------------
</TABLE>
The total amount of securities called for by all such options and warrants held
by directors and officers as a group is 165,075.
ITEM 13. INTEREST OF MANAGEMENT IN CERTAIN TRANSACTIONS
As at February 28, 1999, there was no indebtedness of any director, executive
officer, senior officer or associate of them to or guaranteed or supported by
the Company or any of its subsidiaries either pursuant to an employee purchase
program or otherwise.
The Company's only material transactions since the beginning of the last fiscal
year in which any of its 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 March 1996, the Company issued three-year 12% convertible debentures in the
aggregate principal amount of $500,000. The debentures were convertible into
13,158 Class A shares and 13,158 Class B shares. The debentures originally
matured on March 31, 1999. The maturity date was extended to July 31, 1999.
Messrs. Gamble and White, two of the Company's directors and officers, each
purchased $100,000 principal amount of the debentures. The debentures were
repaid August 5, 1999.
In October 1997, Mr. Cheikes, a director, loaned the Company $200,000 toward the
purchase of its property on West 1st Avenue in Vancouver. In February 1998,
Messrs. Gamble and White each loaned
<PAGE>
42
the Company $100,000 toward the purchase. The loans bore interest at 12% per
annum and were unsecured, with no specific terms of repayment. These loans were
repaid in full in February 1999.
In accordance with his employment agreement, Larry Sugar, the President of Peace
Arch Productions Inc., a wholly-owned subsidiary of the Company, received an
annual salary of $1.00 per year for 1998 and 1999 and the Company paid him
producer's, writer's and director's fees. The Company paid aggregate fees to Mr.
Sugar of $1,285,000 and $1,956,000 in 1998 and 1999.
The Company paid consulting fees to Plantation Capital Corp., a British Columbia
corporation owned and controlled by Mr. Gamble, of $35,000 in fiscal year 1999.
These fees were for consulting services rendered to the Company. The arrangement
was terminated effective March 31, 1999.
The Company paid consulting fees to W.D. Cameron White Law Corporation, a
British Columbia corporation owned and controlled by Mr. White, of $35,000 in
fiscal year 1999 for legal and other services provided to the Company. The
arrangement was terminated effective March 31, 1999.
In May 1998, Working Opportunity Fund (EVCC) Ltd. ("WOF"), the Company and
Messrs. Sugar, White and Gamble entered into a shareholders agreement which
allows WOF to nominate a director, provides WOF with pre-emptive rights in
future securities offerings, registration rights and includes rights of first
refusal and other buy-sell and protective provisions to each of the parties in
the event of proposed transfer by the others. The agreement, other than WOF's
right to designate a director, terminates in various circumstances, including in
the event the Company completes a financing that raises more than $7.0 million
from parties other than WOF. In July 1998, the Company entered into an agreement
with Royal Bank Capital Corp. ("RBCC") which grants RBCC substantially the same
rights.
By agreement dated September 1, 1996, the Company acquired all of the issued and
outstanding common shares of Peace Arch Productions Inc. In consideration for
the acquisition, the Company issued an aggregate of 22,500 Class A shares and
Class B shares, which are referred to as "trading shares", at a deemed price of
$10.00 per share and an aggregate of 350,000 Class A shares and Class B shares,
which are referred to as "performance shares", at a deemed price of $0.10 per
share. The trading shares and performance shares were subject to resale
restrictions whereby they could not be traded for a period of one year from the
date of issuance. The performance shares are held in escrow and may only be
released at a rate of one performance share for each $10.00 of cash flow
generated by Peace Arch Productions Inc. Additionally, the performance shares
may only be released if the Company meets its current financial obligations in
the ordinary course of business, remain in good standing under local securities
laws and receive the consent of the British Columbia Securities Commission. All
performance shares not released within five years of the escrow agreement must
be returned to the Company for cancellation. During the term of the escrow, Mr.
Sugar is not entitled to voting, dividend or any dissolution rights on any of
the performance shares not released. During the year ended August 31, 1999, all
of the 350,000 performance shares were released from escrow.
In December 1997, 160,000 of the 350,000 performance shares were transferred,
subject to the escrow, to Mr. Gamble and Mr. White, who each received 70,000
shares, and to Ms. Jones, who received 20,000 shares. 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. These amounts are also allocated equally
between Class A shares and Class B shares.
<PAGE>
43
A loan in the amount of $0.3 million was repaid in August 1999. The loan was
bearing interest at 12% per annum was due March 1, 1999, which was been extended
to July 31, 1999. The loan was personally guaranteed by Messrs. Gamble and
White.
<PAGE>
44
PART II
ITEM 14. DESCRIPTION OF SECURITIES TO BE REGISTERED
Not applicable.
<PAGE>
45
PART III
ITEM 15. DEFAULTS UPON SENIOR SECURITIES
Not Applicable.
ITEM 16. CHANGES IN SECURITIES AND CHANGES IN SECURITY FOR REGISTERED SECURITIES
Not Applicable.
<PAGE>
46
PART IV
ITEM 17. FINANCIAL STATEMENTS
The Company's financial statements are stated in Canadian Dollars (CDN$) and are
prepared in accordance with Generally Accepted Accounting Principles (GAAP) in
Canada, the application of which, in the case of the Company, conforms in all
material respects for the periods presented with United States GAAP, except as
described in Note 22 to the audited financial statements included herein.
ITEM 18. FINANCIAL STATEMENTS
The Registrant has elected to provide financial statements pursuant to Item #17.
<PAGE>
47
ITEM 19. FINANCIAL STATEMENTS AND EXHIBITS
(A) The Company's 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 the case of the
Company, 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 1998 and 1999 and the report of
Ellis Foster, Chartered Accountants for fiscal 1998, are included herein
immediately preceding the financial statements.
The following financial statements are filed as part of this Annual Report on
Form 20-F:
Audited Financial Statements for the years ended August 31, 1997, 1998 and
1999
<PAGE>
48
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/ W.D. CAMERON WHITE
-----------------------------------
W.D. Cameron White
Chief Executive Officer and
a Director
Date: February 29, 2000
<PAGE>
49
AUDITORS' REPORT
We have audited the consolidated balance sheets of Peace Arch Entertainment
Group Inc. (formerly known as Vidatron Entertainment Group Inc.) as at August
31, 1999 and 1998 and the consolidated statements of operations, deficit and
cash flows for the years then ended. These financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements based on our audits.
We conducted our audits in accordance with 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 disclosure 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, 1999
and 1998 and the results of its operations and its cash flows for the years then
ended in accordance with generally accepted accounting principles in Canada. As
required by the Company Act (British Columbia) we report that , in our opinion,
these principles have been applied on a consistent basis.
Significant differences between Canadian and United States accounting principles
are explained and qualified in note 22 to the financial statements.
The consolidated statements of operations, deficit and cash flows for the year
ended August 31, 1997 were audited by other auditors who expressed an opinion
without reservation on these statements in their report dated November 12, 1997.
/S/ KPMG LLP
Chartered Accountants
Vancouver, Canada
November 17, 1999
<PAGE>
50
AUDITORS' REPORT
We have audited the consolidated balance sheets of Peace Arch Entertainment
Group Inc. (formerly known as Vidatron Entertainment Group Inc.) as at August
31, 1997 the consolidated statements of operations, deficit and cash flows for
the year ended 1997 and 1996. These consolidated financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these consolidated financial statements based on our audits.
We conducted our audits 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 disclosure 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, 1997
and the results of its operations and its cash flows for the years ended August
31, 1997 and 1996 in accordance with generally accepted accounting principles in
Canada.
Significant differences between Canadian and United States accounting principles
are explained and qualified in note 22 to the financial statements.
/S/ ELLIS FOSTER
Chartered Accountants
Vancouver, Canada
November 12, 1997
<PAGE>
51
PEACE ARCH ENTERTAINMENT GROUP INC.
(FORMERLY VIDATRON ENTERTAINMENT GROUP INC.)
AMERICAN STOCK EXCHANGE - SYMBOL PAE
TORONTO STOCK EXCHANGE - SYMBOL PAE.A, PAE.B
ANNUAL REPORT
FOR THE YEARS ENDED
AUGUST 31, 1997, 1998 AND 1999
<PAGE>
PEACE ARCH ENTERTAINMENT GROUP INC.
(FORMERLY VIDATRON ENTERTAINMENT GROUP INC.)
CONSOLIDATED BALANCE SHEETS
AS AT AUGUST 31, 1998 AND 1999
<TABLE>
<CAPTION>
(Expressed in thousands of Canadian dollars)
=============================================================================================================================
1998 1999
- ------------------------------------------------------------------------------------------------------------- --------------
<S> <C> <C>
ASSETS
Cash and cash equivalents $ 1,876 $ 4,455
Accounts receivable (note 3) 10,235 19,901
Productions in progress 11,906 3,446
Prepaid expenses and deposits 367 292
Investment in television programming (note 4) 5,632 10,227
Property and equipment (note 5) 9,498 7,079
Deferred costs 129 278
Goodwill and trademarks (note 6) 2,544 3,185
- -----------------------------------------------------------------------------------------------------------------------------
$ 42,187 $ 48,863
=============================================================================================================================
LIABILITIES AND SHAREHOLDERS' EQUITY
Bank indebtedness (note 7) $ 2,649 $ 6,932
Accounts payable and accrued liabilities 3,317 6,674
Loans due to directors and shareholders (note 8) 400 -
Deferred revenue 10,770 3,980
Deferred gain (note 13(b)) - 514
Future income taxes (note 15) - 797
Debt (note 9) 7,318 4,240
- -----------------------------------------------------------------------------------------------------------------------------
24,454 23,137
- -----------------------------------------------------------------------------------------------------------------------------
Shareholders' equity:
Share capital (note 11) 26,178 32,182
Authorized:
100,000,000 Class A Multiple Voting Shares
Issued - 1,517,965 (August 31, 1998 - 1,512,965)
100,000,000 Class B Subordinate Voting Shares
Issued - 2,267,978 (August 31, 1998 - 1,512,978)
25,000,000 Preference Shares, issuable in series;
Issued - nil
Other paid-up capital - 136
Deficit (8,445) (6,592)
- -----------------------------------------------------------------------------------------------------------------------------
17,733 25,726
- -----------------------------------------------------------------------------------------------------------------------------
$ 42,187 $ 48,863
=============================================================================================================================
</TABLE>
Commitments and contingencies (notes 10 and 21)
The accompanying notes are an integral part of the consolidated financial
statements
-52-
<PAGE>
PEACE ARCH ENTERTAINMENT GROUP INC.
(FORMERLY VIDATRON ENTERTAINMENT GROUP INC.)
CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE YEARS ENDED AUGUST 31, 1997, 1998 AND 1999
<TABLE>
<CAPTION>
(Expressed in thousands of Canadian dollars except per share information)
============================================================================================================================
1997 1998 1999
- ----------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Revenue $ 23,584 $ 32,457 $ 51,547
Expenses:
Amortization of television programming 14,796 23,659 40,296
Other costs of production and sales 4,261 3,577 2,905
Depreciation and amortization 273 389 484
Selling, general and administrative 2,453 2,201 3,049
Interest (note 12) 367 576 1,188
- ----------------------------------------------------------------------------------------------------------------------------
22,150 30,402 47,922
- ----------------------------------------------------------------------------------------------------------------------------
Earnings from operations before undernoted 1,434 2,055 3,625
Gain (loss) on sale of assets (note 13) (333) - 360
Provision against Limited Partnership interests (note 14) (2,313) - -
- ----------------------------------------------------------------------------------------------------------------------------
(2,646) - 360
- ----------------------------------------------------------------------------------------------------------------------------
Earnings (loss) before income taxes (1,212) 2,055 3,985
Income taxes (note 15) - 297 2,132
- ----------------------------------------------------------------------------------------------------------------------------
Net earnings (loss) $ (1,212) $ 1,758 $ 1,853
============================================================================================================================
Basic net earnings (loss) per common share (note 16) $ (0.65) $ 0.68 $ 0.60
============================================================================================================================
Fully diluted earnings (loss) per common share (note 16) $ (0.65) $ 0.63 $ 0.58
============================================================================================================================
</TABLE>
The accompanying notes are an integral part of the consolidated financial
statements
-53-
<PAGE>
PEACE ARCH ENTERTAINMENT GROUP INC.
(FORMERLY VIDATRON ENTERTAINMENT GROUP INC.)
CONSOLIDATED STATEMENTS OF DEFICIT
For the Years Ended August 31, 1997, 1998 and 1999
<TABLE>
<CAPTION>
(Expressed in thousands of Canadian dollars)
============================================================================================================================
1997 1998 1999
- ----------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Balance, beginning of year $ (8,991) $ (10,203) $ (8,445)
Net earnings (loss) for the year (1,212) 1,758 1,853
- ----------------------------------------------------------------------------------------------------------------------------
Balance, end of year $ (10,203) $ (8,445) $ (6,592)
============================================================================================================================
</TABLE>
The accompanying notes are an integral part of the consolidated financial
statements
-54-
<PAGE>
PEACE ARCH ENTERTAINMENT GROUP INC.
(FORMERLY VIDATRON ENTERTAINMENT GROUP INC.)
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED AUGUST 31, 1997, 1998 AND 1999
<TABLE>
<CAPTION>
(Expressed in thousands of Canadian dollars)
=============================================================================================================================
1997 1998 1999
- -----------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Operating activities:
Net earnings (loss) $ (1,212) $ 1,758 $ 1,853
Items not involving cash:
Depreciation and amortization 15,245 24,513 40,119
Interest on debt discount - - 96
Future income taxes - - 1,816
Loss (Gain) on sale of assets 333 - (361)
Provision against Limited Partnership interest 2,313 - -
Other 20 19 7
Changes in non-cash working capital (note 17) (3,257) (4,817) (3,759)
- -----------------------------------------------------------------------------------------------------------------------------
13,442 21,473 39,771
- -----------------------------------------------------------------------------------------------------------------------------
Investing activities:
Investment in television programming (16,567) (27,698) (44,231)
Increase in deferred costs (208) - (243)
Increase in goodwill and trademarks - - (12)
Property and equipment acquired (709) (633) (270)
Proceeds on sale of assets, net (note 13) 545 - 626
- -----------------------------------------------------------------------------------------------------------------------------
(16,939) (28,331) (44,130)
- -----------------------------------------------------------------------------------------------------------------------------
Financing activities:
Issue of common shares, net 5,755 4,875 4,177
Increase (repayments) in loans due to directors and shareholders (221) 378 (386)
Increase in bank indebtedness 454 1,704 4,282
Increase in debt 17 1,737 1,200
Repayment of debt (887) (1,704) (2,335)
- -----------------------------------------------------------------------------------------------------------------------------
5,118 6,990 6,938
- -----------------------------------------------------------------------------------------------------------------------------
Increase (decrease) in cash and cash equivalents 1,621 132 2,579
Cash and cash equivalents, beginning of year 123 1,744 1,876
- -----------------------------------------------------------------------------------------------------------------------------
Cash and cash equivalents, end of year $ 1,744 $ 1,876 $ 4,455
=============================================================================================================================
Supplementary information:
Interest paid (net of amounts capitalized) $ 338 $ 543 $ 1,142
Income taxes paid - - 12
Non-cash transactions:
Property acquired through increase in long-term debt - 4,100 -
Property sold through decrease in long-term debt and increase
in accounts receivable (note 13(b)) - - 2,467
Value assigned to common shares issued:
On acquisition of product revenue interests 2,300 - -
For acquisition of Peace Arch Productions Inc. (note 6) 260 1,980 803
</TABLE>
The accompanying notes are an integral part of the consolidated financial
statements
-55-
<PAGE>
PEACE ARCH ENTERTAINMENT GROUP INC.
(FORMERLY VIDATRON 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. (formerly Vidatron Entertainment Group Inc.), together with
its subsidiaries, (collectively, the "Company") is a fully integrated
television production company that produces and distributes film,
television, video and interactive programming for world-wide markets.
2. 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 22, comply, in all material respects, with generally
accepted accounting principles in the United States. In
particular, the Company's accounting policies are in
accordance with industry guidance in the United States as set
out in Statement of Financial Accounting Standards No.53,
"Financial Reporting by Producers and Distributors of Motion
Picture Films" ("SFAS 53").
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. In accordance with the provisions of
SFAS 53, the Company has elected to present an unclassified
balance sheet.
(b) REVENUE RECOGNITION
(i) Revenues from television programming are recognized
when the license period has commenced, the program
has been delivered and other conditions as specified
in the 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 acquired.
(d) PRODUCTIONS IN PROGRESS
Productions in progress represent the costs of incomplete
programs and are carried at the lower of cost and estimated
net realizable value.
56
<PAGE>
(e) INVESTMENT IN TELEVISION PROGRAMMING
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.
The Company records amortization based on the ratio that
current revenues bear to expected total gross revenues for a
program. Investment in television programming is recorded at
the lower of unamortized cost and net realizable value,
determined on an individual program basis.
(f) PROPERTY AND EQUIPMENT
Property and equipment are stated at cost and depreciated on
the following basis:
<TABLE>
<S><C>
Buildings.........................................................5% declining balance
Computers, furniture and equipment................................20% declining balance
Production equipment..............................................20% declining balance
Other.............................................................2-5 year straight line
</TABLE>
(g) DEFERRED COSTS
Deferred costs represent financing costs, which are recognized
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.
(h) GOODWILL
Goodwill is recorded at cost and is amortized on a straight
line basis over 20 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.
(i) INCOME TAXES
Effective September 1, 1998 the Company adopted Section 3465
of the CICA Handbook, which requires a change from the
deferred method of accounting for income taxes to 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
or 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.
As there was no material cumulative effect of this change in
accounting for income taxes, no adjustment to previously
reported balances for the years ended August 31, 1997 and 1998
is required.
<PAGE>
(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 year presented, the Company has no
long-term monetary assets or liabilities denominated in a
foreign currency.
(k) 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. Investment in television
programming, productions in progress and goodwill are asset
accounts that require significant use of management estimates
to determine recoverability.
(l) COMPARATIVE FIGURES
Certain comparative figures have been restated to conform to
the basis of presentation adopted for the current year.
3. ACCOUNTS RECEIVABLE
<TABLE>
<CAPTION>
======================================================================================================================
1998 1999
----------------------------------------------------------------------------------------------------------------------
<S> <C> <C>
Trade receivables $ 2,505 $ 4,360
Tax credits receivable 7,730 14,724
Short-term note (note 13(b)) - 817
----------------------------------------------------------------------------------------------------------------------
$ 10,235 $ 19,901
======================================================================================================================
</TABLE>
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 2(e). During the year, tax credits aggregating
$10,830,223 were recorded (August 31, 1998 - $5,723,000).
4. INVESTMENT IN TELEVISION PROGRAMMING
<TABLE>
<CAPTION>
======================================================================================================================
1998 1999
----------------------------------------------------------------------------------------------------------------------
<S> <C> <C>
Cost $ 44,728 $ 88,716
Accumulated amortization (39,096) (78,489)
----------------------------------------------------------------------------------------------------------------------
Net book value $ 5,632 $ 10,227
======================================================================================================================
</TABLE>
5. PROPERTY AND EQUIPMENT
<TABLE>
<CAPTION>
----------------------------------------------------------------------------------------------------------------------
1998 1999
----------------------------------------------------------------------------------------------------------------------
ACCUMULATED ACCUMULATED
COST DEPRECIATION COST DEPRECIATION
----------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Land $ 6,594 $ - $ 5,203 $ -
Buildings 2,432 314 1,532 409
Computers, furniture and equipment 372 219 443 273
Production equipment 1,034 421 1,101 527
Other 77 57 23 14
<PAGE>
----------------------------------------------------------------------------------------------------------------------
10,509 1,011 8,302 1,223
----------------------------------------------------------------------------------------------------------------------
Net book value $ 9,498 $ 7,079
======================================================================================================================
</TABLE>
6. 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 50% of Class A shares and 50% of 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 records additional goodwill at the time the performance
shares are 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 shares were released from escrow.
As at August 31, 1999, accumulated amortization of goodwill amounted to
$224,020 (August 31, 1998 - $104,258).
7. BANK INDEBTEDNESS
Bank indebtedness is drawn under a credit facility of up to $14 million
for production financing and is comprised of demand loans bearing
interest at prime plus 1% per annum for 1999 (1.5% for 1998) with
monthly payments of interest only withdrawn from reserves held by the
bank. As at August 31, 1999, the prime rate was 6.25% (August 31, 1998
- 7.50%). The loans are secured by the refundable tax credits and
distribution rights of the film properties to which the loans relate
and a general security agreement.
8. LOANS DUE TO DIRECTORS AND SHAREHOLDERS
Loans due to directors and shareholders bearing interest at 12% per
annum, were unsecured and had no specific terms of repayment.
9. DEBT
<TABLE>
<CAPTION>
----------------------------------------------------------------------------------------------------------------------
1998 1999
----------------------------------------------------------------------------------------------------------------------
<S> <C> <C>
Mortgage due May 1, 2001 bearing interest at 7.2% per annum with aggregate
monthly payments of principal and interest of $9, secured by a first mortgage
on property $ 950 $ 927
Mortgage due February 1, 2000 bearing interest at 8% per annum with aggregate
monthly payments of principal and interest of $19, secured by a first mortgage
and a general security agreement on all assets located in or on the property
(note 13(b)) 1,970 -
Mortgage due March 1, 2001 bearing interest at 6.95% per annum with aggregate
monthly payments of principal and interest of $25, secured by a first mortgage
on property 2,755 2,641
Loans to purchase equipment, bearing interest at an average annual rate of the
bank rate plus 2.0% secured by the equipment acquired 275 90
Loans due $300 on March 1, 1999 and $500 on April 15, 1999 bearing interest at
12% per annum, with monthly payments of interest only, secured by a charge on
property 800 -
<PAGE>
Convertible debentures bearing interest at 12% per annum, payable quarterly and
secured by a charge on the assets of the Company and due March 25, 1999. The
principal amount is convertible into shares of the Company at a deemed price of
$19 per share on or before March 31, 1999 500 -
Debentures having a face value of $600 (recorded net of deemed debt discount of
$40) bearing interest at 10% per annum, payable quarterly, secured by a charge
on the assets of the Company, and due October 21, 2000 - 560
Other 68 22
----------------------------------------------------------------------------------------------------------------------
$ 7,318 $ 4,240
======================================================================================================================
</TABLE>
Included with the issuance of the debentures in the amount of
$1,200,000, $600,000 of which remain outstanding, were warrants to
purchase 50,000 Class A and 50,000 Class B shares at an exercise price
of $6.25 per share (note 11(d)). A value of $68,000 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 $40,000.
Principal due in each of the next five fiscal years ending August 31 is
approximately as follows:
<TABLE>
<S><C>
2000 $ 238
2001 1,609
2002 2,393
2003 nil
2004 nil
</TABLE>
10. COMMITMENTS AND CONTINGENCIES
Pursuant to the sale of real estate (note 13(b)), the purchaser assumed
debt in the amount of $1,897,705 that is secured by a charge on the
property by indemnifying the Company against all liability to make
future payments of principal and interest under the terms of the debt.
This debt becomes due on February 1, 2000. In the event that the
purchaser fails to retire the debt by the due date, the Company may be
required to refinance or retire the debt.
Also pursuant to the sale of real estate, the Company entered into a
lease agreement under which it is obligated, at minimum, to make annual
payments of $322,123 for 1999 and $241,593 for 2000.
11. SHARE CAPITAL
(a) ISSUED
Effective July 20, 1999, every five common shares were
consolidated and reclassified into one Class A Multiple Voting
share and one Class B Subordinate Voting share. 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 have been restated to reflect the share
consolidation and reclassification.
<TABLE>
<CAPTION>
----------------------------------------------------------------------------------------------------------------------
CLASS A CLASS B
NUMBER OF NUMBER OF TOTAL
SHARES AMOUNT SHARES AMOUNT AMOUNT
---------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Balance, August 31, 1996 687,972 $ 5,504 687,982 $ 5,505 $ 11,009
Change during the year:
Issued for cash 22,818 210 22,819 210 420
Issued for cash, pursuant to private
placement 267,000 3,003 267,000 3,004 6,007
<PAGE>
Issued on acquisition of Peace Arch
Productions Inc. (note 6) 186,250 130 186,250 130 260
Issued on acquisition of product revenue
interest (note 14) 87,608 1,150 87,609 1,150 2,300
Less share issue costs - (336) - (337) (673)
---------------------------------------------------------------------------------------------------------------------
Balance, August 31, 1997 1,251,648 9,661 1,251,660 9,662 19,323
Change during the year:
Issued for cash 268,817 2,513 268,818 2,514 5,027
Performance shares returned to treasury (7,500) - (7,500) - -
Performance shares released from escrow
(note 6) - 990 - 990 1,980
Less share issue costs - (76) - (76) (152)
---------------------------------------------------------------------------------------------------------------------
Balance, August 31, 1998 1,512,965 13,088 1,512,978 13,090 26,178
Change during the year:
Tax recovery, prior year share issue costs - 168 - 168 336
Performance shares released from escrow
(note 6) - 390 - 413 803
Issued for cash 5,000 37 5,000 37 74
Issued for cash, pursuant to public
offering - - 750,000 5,601 5,601
Less share issue costs, net of tax benefit - (1) - (809) (810)
---------------------------------------------------------------------------------------------------------------------
Balance, August 31, 1999 1,517,965 $ 13,682 2,267,978 $ 18,500 $ 32,182
=====================================================================================================================
</TABLE>
Shares issued for non-cash consideration have been valued at
their estimated fair value at the date of issuance.
(b) OPTIONS
For each of the periods presented, the following stock options
were outstanding. Of the number of shares shown in the
following table, 1/2 are Class A shares and 1/2 are Class B
shares.
<TABLE>
<CAPTION>
===============================================================================================================
1997 1998 1999
NUMBER OF NUMBER OF NUMBER OF EXERCISE
SHARES SHARES SHARES PRICE EXPIRY DATE
---------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
300 $ 15.50 March 30, 1998
4,400 5.20 June 12, 2000
800 6.20 July 10, 2000
6,275 1,350 750 11.20 January 24, 2001
47,500 47,000 47,000 14.00 March 29, 2001
3,500 1,000 1,000 19.40 May 9, 2001
63,500 49,500 47,950 13.50 October 15, 2001
52,400 39,600 35,000 13.00 June 2, 2002
6,000 6,000 - 10.25 August 26, 2002
- 158,200 130,000 9.50 March 23, 2003
- - 14,000 7.50 November 19, 2003
- - 1,000 11.25 February 1, 2004
- - 40,000 9.50 February 16, 2004
---------------------------------------------------------------------------------------------------------------
184,675 302,650 316,700
===============================================================================================================
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
===============================================================================================================
1997 1998 1999
---------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Balance, beginning of year 83,125 184,675 302,650
Granted 127,900 152,200 65,000
Exercised (26,350) (825) (11,000)
Expired or cancelled - (33,400) (39,950)
---------------------------------------------------------------------------------------------------------------
Balance, end of year 184,675 302,650 316,700
===============================================================================================================
</TABLE>
Stock options are granted having exercise prices based on
market prices at the date of grant and vest over a period that
does not exceed two and one-half years.
(c) UNDERWRITER'S OPTION AND WARRANTS
During the year, 750,000 Class B shares were issued by way of
public offering. In connection with this offering, the Company
granted the underwriter an option to purchase up to 112,500
Class B shares at $US 4.61 for the sole purpose of covering
over-allotments, exercisable for a period of 45 days after
July 28, 1999. Subsequent to August 31, 1999, this option
expired.
Also, in connection with the public offering in 1999, 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 for a period of four years
beginning one year after August 3, 1999, and may not be
transferred, assigned or hypothecated for a period of one
year, except to officers of the underwriter and any successors
to the underwriter.
(d) SHARE PURCHASE WARRANTS
For each of the periods presented, warrants were outstanding
to acquire common shares as indicated in the table. Of the
number of shares shown in the following table, 1/2 are Class A
shares and 1/2 are Class B shares:
<TABLE>
<CAPTION>
---------------------------------------------------------------------------------------------------------------
1997 1998 1999 EXERCISE PRICE
NUMBER OF SHARES PER SHARE EXPIRY DATE
----------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
267,000 267,000 - $ 6.25 March 31, 1999
- - 100,000 6.25 October 21, 2000
----------------------------------------------------------------------------------------------------------------
267,000 267,000 100,000
================================================================================================================
</TABLE>
(e) DIVIDENDS
Covenants attached to the debentures limit the Company's
ability to pay dividends without the approval of the lenders.
12. INTEREST EXPENSE
<TABLE>
<CAPTION>
================================================================================================================
YEARS ENDED AUGUST 31,
1997 1998 1999
----------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Interest expense:
Long-term debt $ 337 $ 447 $ 727
Other 30 129 461
Interest capitalized - 32 240
----------------------------------------------------------------------------------------------------------------------
</TABLE>
13. SALE OF ASSETS
(a) During the year ended August 31, 1997, the Company sold the
material assets of its educational video and software
distribution subsidiary, Image Media Ltd. and its wholly-owned
subsidiary 802117 Ontario Ltd. (D.B.A. Pilot Software Ltd.)
for proceeds of $575,000. For the year ended August 31, 1997
to the date of sale, the subsidiaries reported combined
revenue of $3,064,340, gross profit of $1,165,339 and a loss
from operations of $158,617.
<PAGE>
(b) Effective August 31, 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,
payable monthly with principal due on February 28, 2000. The
interest rate will increase to 18% in the event that the note
remains unpaid after the due date. In addition, the purchaser
assumed the Company's mortgage in the amount of $1,897,705,
which comes due on February 1, 2000. The Company continues to
occupy the property through a lease arrangement, with an
option to terminate after two years. The gain on the sale in
excess of the present value of the minimum lease payments,
being $284,528, has been realized in 1999. The remaining
amount of $513,493 is deferred and amortized over the lease
term (note 10).
14. LIMITED PARTNERSHIP PRODUCT REVENUE INTEREST
On March 6, 1996, the Company entered into a joint venture
marketing agreement with New Media Marketing II Limited Partnership
whereby the Partnership would provide marketing services in
exchange for an entitlement to future revenue of the Company above
a base level until December 31, 2006. The Company purchased the
Partnership's revenue interest by issuing 175,217 common shares of
the Company at the fair value of $13.13 per common share. In the
year ended August 31, 1997, the costs of the Limited Partnership
interest was written off resulting in a charge to earnings of
$2,312,722.
15. INCOME TAXES
The differences between the effective tax rate reflected in the
provision for income taxes and the Canadian statutory income tax
rate are as follows:
<TABLE>
<CAPTION>
----------------------------------------------------------------------------------------------------------------------
YEARS ENDED AUGUST 31,
1997 1998 1999
----------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Corporate statutory income tax rate 45.6% 45.6% 45.6%
Add (deduct) the effect of:
Utilization of previously unrecognized tax losses (48.6) (35.1) (5.0)
Expenses not deductible for income tax purposes 3.0 3.9 12.9
----------------------------------------------------------------------------------------------------------------------
Effective tax rate - 14.4% 53.5%
======================================================================================================================
</TABLE>
The temporary differences which give rise to future tax assets and
liabilities at August 31 consist of the following:
<TABLE>
<CAPTION>
======================================================================================================================
1998 1999
---------------------------------------------------------------------------------------------------------------------
<S> <C> <C>
FUTURE INCOME TAX ASSETS:
Property and equipment $ - $ 278
Share issue costs - 704
Investment in television programming 681 -
Other - 229
Losses available for future periods 1,039 580
---------------------------------------------------------------------------------------------------------------------
Gross deferred tax assets 1,720 1,791
Valuation allowance (184) -
---------------------------------------------------------------------------------------------------------------------
Net future income tax assets 1,536 1,791
FUTURE INCOME TAX LIABILITIES:
Property and equipment (82) -
Investment in television programming (1,454) (2,539)
Other - (49)
---------------------------------------------------------------------------------------------------------------------
$ - $ (797)
=====================================================================================================================
</TABLE>
<PAGE>
At August 31, 1999, the Company has operating losses for income tax
purposes of approximately $1,260,000, the benefit of which has been
recognized as a reduction of the Company's future income tax
liability. The losses expire as follows:
<TABLE>
<S> <C>
2000 $ 54
2001 106
2002 338
2003 190
2004 71
2005 364
2006 137
---------------------------------------------------------------------------------------------------
$ 1,260
===================================================================================================
</TABLE>
16. NET EARNINGS (LOSS) PER COMMON SHARE
Net earnings (loss) per common share has been calculated by dividing
into earnings (loss) the weighted average number of common shares
outstanding, including issued shares held in escrow, after giving
retroactive effect to the share consolidation in 1997 and share
consolidation and reclassification on July 20, 1999 (note 11(a)). For
the year ended August 31, 1997, fully diluted earnings per share were
equal to basic earnings (loss) per share as the effect of stock options
and warrants was anti-dilutive. The weighted average number of shares
outstanding for each of the periods presented is as follows:
<TABLE>
<CAPTION>
---------------------------------------------------------------------------------------------------------------------
YEARS ENDED AUGUST 31 BASIC FULLY DILUTED
---------------------------------------------------------------------------------------------------------------------
<S> <C> <C>
1997 1,860,616 1,860,616
1998 2,602,742 3,124,007
1999 3,083,121 3,473,357
---------------------------------------------------------------------------------------------------------------------
</TABLE>
17. CHANGES IN NON-CASH OPERATING WORKING CAPITAL
<TABLE>
<CAPTION>
----------------------------------------------------------------------------------------------------------------------
YEARS ENDED AUGUST 31,
1997 1998 1999
----------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Accounts receivable $ (3,525) $ (5,436) $ (8,848)
Productions in progress (667) (8,044) 8,460
Prepaid expenses and deposits (12) (186) 75
Accounts payable and accrued liabilities (120) 2,309 3,343
Deferred revenue 1,067 6,540 (6,789)
----------------------------------------------------------------------------------------------------------------------
$ (3,257) $ (4,817) $ (3,759)
======================================================================================================================
</TABLE>
18. FINANCIAL INSTRUMENTS
(a) FAIR VALUES
As at August 31, 1999 and 1998, the Company's financial instruments
included cash and cash equivalents, accounts receivable, bank
indebtedness, accounts payable and accrued liabilities and amounts due
to directors and shareholders. 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, 1999, the fair value of tax credits receivable is
estimated to be $14,080,764 (August 31, 1998 - $7,300,000).
Also included as a financial instrument is long-term debt consisting of
mortgages, demand loans and convertible 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.
<PAGE>
(b) CONCENTRATION OF CREDIT RISK
Although all of its revenue is generated from production in Canada, the
Company derived over 85% (1998 - 82%) of its revenues from export sales
to the U.S. and Europe. In the year ended August 31, 1999, one customer
represented 36%, two customers represented 14% each and a third
customer represented 14% of total revenues. In the year ended August
31, 1998, one of these customers represented 32%, two customers
represented approximately 20% each and a fourth customer represented
11% of total revenues. In the year ended August 31, 1997, one of these
customers represented 37%, a second represented 22% and a third
customer represented 13% of total revenues.
On August 31, 1999, approximately 74% (1998 - 76%) of accounts
receivable was comprised of refundable federal and provincial tax
credits. These credits are subject to audit by the appropriate
regulatory authorities.
(c) CURRENCY RISK
During the year ended August 31, 1999 the Company derived approximately
74% (1998 - 82%) of its revenues in U.S. funds. The Company estimates
its obligations payable in $US funds and converts all U.S. funds in
excess of these obligations into Canadian currency as they are
received. The Company did not use derivative instruments to reduce its
exposure to foreign currency risk.
(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 7
and 9.
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:
<TABLE>
<CAPTION>
-----------------------------------------------------------------------------------------------------------------------
PRODUCTION PROPRIETARY
1997 SERVICES PROGRAMMING OTHER TOTAL
-----------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Revenue $ 3,039 $ 17,412 $ 3,133 $ 23,584
Gross profits 591 2,541 1,395 4,527
Total assets 1,172 14,440 2,898 18,510
1998
-----------------------------------------------------------------------------------------------------------------------
Revenue $ 4,178 $ 27,945 $ 334 $ 32,457
Gross profits 1,075 3,727 419 5,221
Total assets 1,203 37,791 3,193 42,187
1999
-----------------------------------------------------------------------------------------------------------------------
Revenue $ 3,765 $ 47,298 $ 484 $ 51,547
Gross profits 1,220 6,972 154 8,346
Total assets 1,597 45,628 1,638 48,863
-----------------------------------------------------------------------------------------------------------------------
</TABLE>
Gross profits are comprised of revenue less amortization of television
programming and other costs of production and sales.
In 1998 and 1999 revenues from other business were mainly attributable
to the rental of production assets. In 1997 revenues from other
business also included rental of production assets, along with
educational software and video sales of approximately $3 million and
gross profit of $591,272.
<PAGE>
20. RELATED PARTY TRANSACTIONS
Related party transactions not disclosed elsewhere in these
consolidated financial statements are as follows:
<TABLE>
<CAPTION>
----------------------------------------------------------------------------------------------------------------------
YEARS ENDED AUGUST 31,
1997 1998 1999
----------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Production fees paid to an officer of the Company $ 725 $ 1,285 $ 1,956
Consulting fees paid to companies owned by officers and
Directors of the Company $ 58 $ 120 $ 70
----------------------------------------------------------------------------------------------------------------------
</TABLE>
At August 31, 1998 debt includes $200,000 in convertible debentures due
to directors of the Company.
21. UNCERTAINTY DUE TO THE YEAR 2000 ISSUE
The Year 2000 Issue arises because many computerized systems use two
digits rather than four to identify a year. Date-sensitive systems may
recognize the year 2000 as 1900 or some other date, resulting in errors
when information using year 2000 dates is processed. The effects of the
Year 2000 Issue may be experienced before, on, or after January 1,
2000, and, if not addressed, the impact on operations and financial
reporting may range from minor errors to significant systems failure
which could affect a company's ability to conduct normal business
operations. It is not possible to be certain that all aspects of the
Year 2000 Issue affecting the Company, including those related to the
efforts of customers, suppliers, or other third parties, will be fully
resolved.
22. 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) EARNINGS (LOSS) PER SHARE:
Under US GAAP, 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 (loss) per share
for all periods prior to the period in which the contingency is
resolved and the shares are released from escrow. They would be
included in diluted earnings (loss) per share prior to release under
certain limited circumstances. In addition, under US GAAP the
weighted average number of shares used in the calculation of diluted
earnings (loss) per share would be calculated by the treasury stock
method whereby it is assumed that proceeds received by the Company
from the exercise of dilutive securities are used to repurchase
outstanding shares in the market.
The effect of these items would be to reduce the weighted average
number of shares outstanding to as follows:
<TABLE>
<CAPTION>
---------------------------------------------------------------------------------------------------------------------
YEAR ENDED AUGUST 31, BASIC DILUTED
---------------------------------------------------------------------------------------------------------------------
<S> <C> <C>
1997 1,510,580 1,510,580
1998 2,303,988 2,303,988
1999 2,935,202 2,954,319
---------------------------------------------------------------------------------------------------------------------
</TABLE>
<PAGE>
(b) APPLICATION OF US GAAP:
(i) As discussed in note 6, effective September 1, 1996, the
Company issued 350,000 performance shares on the
acquisition of Peace Arch Productions Inc. In the year
ended August 31, 1998, and prior to the release of
200,000 shares from escrow, the holder of the performance
shares transferred, within escrow, 160,000 performance
shares to three officers of the Company. The 160,000
shares were transferred subject to the terms and
conditions of the escrow agreement for their initial
value of $0.10 per share. In the year ended August 31,
1999, the balance of the performance shares were recorded
as described in note 6.
On transfer, for US GAAP purposes, the excess of the
market value over the transfer price is charged against
income as compensation expense.
(ii) As described in note 13(b), for Canadian accounting
purposes, the Company has recognized a partial gain on
the sale of real estate. For US GAAP purposes, no gain is
recognized in the current year due to the existence of
the note receivable. Under US GAAP, this transaction
would be accounted for using the finance method.
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:
<TABLE>
<CAPTION>
=====================================================================================================================
YEARS ENDED AUGUST 31,
1997 1998 1999
---------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Net earnings (loss), Canadian GAAP $ (1,212) $ 1,758 $ 1,853
Compensatory value of transferred shares - (1,224) -
Gain on sale of asset, net of income tax - - (187)
---------------------------------------------------------------------------------------------------------------------
Net earnings (loss), US GAAP $ (1,212) $ 534 $ 1,666
=====================================================================================================================
Net earnings (loss) per share, US GAAP:
basic and diluted $ (0.80) $ 0.23 $ 0.56
=====================================================================================================================
</TABLE>
Under US GAAP, total assets would be $51,330,499 and shareholders'
equity would be $25,539,000. There would be no difference from total
assets or shareholder's equity calculated under Canadian GAAP in
1998 and 1997.
(c) STOCK-BASED COMPENSATIONS
As described in Note 12(b), the Company has granted stock options to
certain directors and employees. These options 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 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 the intrinsic value basis
set out in APB Opinion No. 25. As options are granted at exercise
prices based on the market value of the Company's share at the date
of grant, no adjustment for 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 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 calculations applied have assumed that the expected life of all
options granted equals 60% of the maximum term based on actual
experience, no dividends will be paid, and expected average
volatility and risk free interest rates as follows:
<PAGE>
<TABLE>
<CAPTION>
====================================================================================================================
YEARS ENDED AUGUST 31,
1997 1998 1999
--------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Volatility % 25 22 43
Risk free interest rate % 5.46 5.11 4.86
--------------------------------------------------------------------------------------------------------------------
</TABLE>
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:
<TABLE>
<CAPTION>
====================================================================================================================
YEARS ENDED AUGUST 31,
1997 1998 1999
--------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Earnings (loss), US GAAP $ (1,212) $ 534 $ 1,666
Stock compensation expense (331) (490) (403)
--------------------------------------------------------------------------------------------------------------------
Pro forma earnings (loss), US GAAP $ (1,543) $ 44 $ 1,263
===================================================================================================================
Pro forma basic earnings (loss) per share, US GAAP $ (1.02) $ 0.02 $ 0.43
====================================================================================================================
</TABLE>
(d) PROVISION AGAINST LIMITED PARTNERSHIP INTEREST
Under US GAAP, the provision against Limited Partnership interest
would be included in the earnings (loss) from operations.
(e) 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:
<TABLE>
<CAPTION>
====================================================================================================================
YEARS ENDED AUGUST 31,
1997 1998 1999
--------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Balance, beginning of period $ 31 $ 169 $ 316
Charges to expenses:
Expensed 138 147 37
Recovered/written-off - - (49)
--------------------------------------------------------------------------------------------------------------------
Balance, end of period $ 169 $ 316 $ 304
====================================================================================================================
</TABLE>
