MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Management’s Discussion and Analysis of the financial condition and results of operations is prepared at April 14, 2008 and comments on Peace Arch Entertainment Group Inc.’s (“Peace Arch” or the “Company”), operations, performance and financial conditions for the three and six months ended (Q2) February 29, 2008 and February 28, 2007. This should be read in conjunction with the Company’s unaudited consolidated financial statements for the second quarter of 2008. We incorporate by reference Peace Arch Entertainment Group Inc.’s Audited Consolidated Financial Statements for the year ended August 31, 2007 and Management’s Discussion and Analysis of Financial Condition and Results of Operations for the year ended August 31, 2007.
The financial information presented herein has been prepared on the basis of Canadian generally accepted accounting principles (“GAAP”).
All dollar amounts are in Canadian dollars unless otherwise indicated.
NOTE ON FORWARD-LOOKING STATEMENTS
Except for the statements of historical fact contained herein, some information presented in this annual report constitutes forward-looking statements. When used in this annual report, the words “estimate,” “project,” “believe,” “anticipate,” “intend,” “expect,” “predict,” “may,” “should,” the negative thereof or other variations thereon or comparable terminology are intended to identify forward-looking statements. Such forward-looking statements involve known and unknown risks, uncertainties and other factors which may cause the actual results, performance or achievements of the Company to be materially different from any future results, performance or achievements expressed or implied by such forward-looking statements. Such factors include, among others, those factors discussed in the section entitled “Risk Factors.” Alth ough the Company has attempted to identify important factors that could cause actual results to differ materially, there may be other factors that cause actual results not to be as anticipated, estimated or intended. There can be no assurance that such statements will prove to be accurate as actual results and future events could differ materially from those anticipated in such statements. Accordingly, prospective investors should not place undue reliance on forward-looking statements. The forward-looking statements in this annual report speak only as to the date hereof. The Company does not undertake any obligation to release publicly any revisions to these forward-looking statements to reflect events or circumstances after the date hereof or to reflect the occurrence of unanticipated events.
Although the Company believes that the expectations reflected in the forward-looking statements are reasonable, it cannot guarantee future results, levels of activity, performance or achievements. Except as required by applicable law, including the securities laws of the United States, the Company does not intend to update any of the forward-looking statements to reflect events or circumstances occurring after the date hereof.
RESTATEMENT
Fiscal 2006
The information contained in this Management Discussion and Analysis (“MD&A”) has been adjusted to reflect the restatement of our previously issued financial statements, as more fully described below and in note 3 of the audited consolidated financial statements for the year ended August 31, 2007.
During the year ended August 31, 2007, the Company identified errors in its financial statements related to our accounting treatment for interest incurred during the year ended August 31, 2006. It was determined that a portion of the interest incurred had been capitalized as a cost of the investment in film and television programming when no expenditures were being incurred on preproduction and production activities. The financing obtained by or arranged for consolidated sole purpose production companies was used by Peace Arch to fund corporate working capital. The adjustment results in an increase to interest expense and a corresponding decrease in the investment in film and television programming for the year ended August 31, 2006.
The reduction in the cost of the investment in film and television programming resulted in a reduction of amortization on investment in film and television programming for the year ended August 31, 2006, and a corresponding increase in investment in film and television programming.
04/16/2008
The Company identified an error in its financial statements related to its accounting treatment of penalties and uncertain tax positions. It was determined that an additional amount of penalties should have been accrued resulting in an increase to selling, general and administrative expenses for the year ended August 31, 2006.
In addition, as at August 31, 2006, the Company has reclassified loans totaling $7.2 million to corporate loans from production loans to be consistent with the use of proceeds from the loans.
There was no income tax impact resulting from the foregoing adjustments.
Impact of Adjustments
The following table presents the impact of the preceding adjustments to our previously reported quarterly results for 2006:
| | |
(thousands of Canadian dollars except per share amounts) | 2006 |
| Q3 | Q4 |
|
|
|
Net loss as reported | (441) | (2,239) |
|
|
|
Adjustments |
|
|
Amortization of investment in film and television programming | 17 | 160 |
Selling, general and administrative | - | (176) |
Interest expense | (132) | (189) |
| (115) | (205) |
|
|
|
Net loss as restated | (556) | (2,444) |
|
|
|
Basic and diluted loss per share |
|
|
Net loss as reported | (0.02) | (0.08) |
Net loss as restated | (0.03) | (0.08) |
Q1, Q2, Q3 Fiscal 2007
The information contained in this Management's Discussion and Analysis has been adjusted to reflect the restatement of our previously issued financial statements and other financial information, as more fully described below and in note 3 of the unaudited quarterly consolidated financial statements for November 30, 2006, February 28, 2007 and May 31, 2007.
During the year ended August 31, 2007, the Company identified errors in its financial statements related to its accounting treatment of interest during the periods ended November 30, 2006, February 28, 2007 and May 31, 2007. It was determined that a portion of the interest incurred had been capitalized as a cost of investment in films and television programs when no expenditures were being incurred on pre-production and production activities. The financing obtained by or arranged for consolidated sole purpose production companies was used by Peace Arch to fund corporate working capital. The adjustment results in an increase to interest expense and a corresponding decrease in the investment in film and television programming for the periods ended November 30, 2006, February 28, 2007 and May 31, 2007.
The reduction in the cost of the investment in film and television programming resulted in a reduction of amortization on investment in film and television programming for the periods ended November 30, 2006, February 28, 2007 and May 31, 2007, and a corresponding interest in the investment in film and television programming.
In addition, as at February 28, 2007, the Company has reclassified loans totalling $11.5 million to corporate loans from production loans to be consistent with the use of proceeds from the loans.
During the year ended August 31, 2007, the Company identified an error in its May 31, 2007 financial statements related to the accounting for a sale of film rights. It was determined that this arrangement should have been accounted for as a co-production, with each co-producer retaining its respective rights. Previously the Company had recorded amounts received from the other co-producer as revenues from the sale of the co-producers’ rights to the film. The adjustment resulted in a decrease to revenues, a decrease to amortization of investment in film and television programming and an increase in investment in film and television programming for the period ended May 31, 2007.
2
04/16/2008
During the year ended August 31, 2007, the Company identified an error in its February 28, 2007 financial statements related to the recognition of warrant costs and the revaluation of common share purchase warrants on the date they vested. The adjustment resulted in an increase to stock and warrant-based compensation costs and a corresponding increase to warrants in shareholders' equity for the period ended February 28, 2007.
During the year ended August 31, 2007, the Company identified an error in the classification of cash flows in the statement of cash flows related to interest incurred and paid on debt during the period ended February 28, 2007. The Company had included interest incurred during those periods in the carrying values of certain production loans with the change in such loans, and presented as financing activities in the statement of cash flows. The component of the increase in loan balances representing interest incurred should have been a non-cash transaction within operating activities. Interest paid throughout those periods had also been presented as financing activities in the statement of cash flows when repayments of certain production loans were made. The component of the repayment of loans representing interest should have been presented as cash used in operating activities in accordance with generally accepted accounting principles. As a re sult of this error, for the period ended February 28, 2007, additions to production loans and repayments of production loans in the statement of cash flows have been reduced by $348,000 and $261,000, respectively, with a corresponding net increase of $87,000 to cash used in operating activities. This adjustment had no impact on the Company’s financial position or results of operations for the period ended February 28, 2007.
During the year ended August 31, 2007, the Company identified an error in its November 30, 2006, February 28, 2007 and May 31, 2007 financial statements related to the recognition and measurement of the income tax provision after re-evaluating its potential risks associated with the rationale for certain tax positions. It was determined that a provision for income tax should be provided for. Previously, no income tax expense had been provided for. The adjustment resulted in an increase to income tax expense and a corresponding increase to accounts payable and accrued liabilities for the periods ended November 30, 2006, February 28, 2007 and May 31, 2007.
Impact of Adjustments
The following table presents the impact of the above adjustments on the Company’s previously reported quarterly results for the first, second and third quarters of fiscal 2007:
| | | |
(thousands of Canadian dollars, except per share amounts) | 2007 |
| Q1 | Q2 | Q3 |
|
|
|
|
Net earnings as reported | 86 | 2,239 | 1,913 |
|
|
|
|
Adjustments |
|
|
|
Amortization of investment in film and television programming | 48 | 136 | 85 |
Co-producer arrangement | - | - | (27) |
Stock and warrant-based compensation costs | - | (291) | - |
Interest expense | (245) | (272) | (266) |
Income tax expense | (262) | (576) | (567) |
| (459) | (1,003) | (775) |
|
|
|
|
Net (loss) earnings as restated | (373) | 1,236 | 1,138 |
|
| | |
Basic (loss) earnings per share |
| | |
Net (loss) earnings as reported | 0.00 | 0.07 | 0.05 |
Net (loss) earnings as restated | (0.02) | 0.04 | 0.03 |
| | | |
Diluted (loss) earnings per share | | | |
Net (loss) earnings as reported | 0.00 | 0.06 | 0.04 |
Net (loss) earnings as restated | (0.02) | 0.03 | 0.03 |
3
04/16/2008
ABOUT THE COMPANY’S BUSINESS
Peace Arch is an integrated media company that produces and acquires feature films, television and home entertainment content for distribution to worldwide markets. The Company owns one of the largest libraries of independent feature films in the world, featuring more than 1,000 classic and contemporary titles, and is a leading distributor of DVDs and related products in Canada and the United States. Peace Arch has five locations, two in Toronto, one in Los Angeles, one in Vancouver and one in New York.
The Company earns revenues primarily from two sources: the distribution of newly acquired product and productions, and the distribution of its library. Once a production is completed and delivered, the program is then included in the Company’s library of film and television programs along with acquired programming. Through its internal sales operations, the Company licenses that programming to theatrical distributors, television broadcasters, cable companies, satellite services and home entertainment distributors around the world.
Over the past few years, the Company has transformed itself into an integrated entertainment company, by acquiring first run and library content and compatible distribution vehicles, building its sales capacity and reducing the amount of capital and other resources devoted to production activities.
Peace Arch manages its business in three operating segments; Motion Picture, Television and Home Entertainment. These operating segments are supported by the Company’s Corporate segment.
Motion Picture
The Company produces or acquires feature films intended for DVD or television premieres as well as intended for worldwide theatrical release. The Motion Picture segment derives its revenues by licensing distribution rights to these productions to sub-distributors in various territories and media throughout the world. The Company also distributes a catalogue of approximately 1,000 titles on DVD and television.
Television
The Company’s Television segment derives revenues by licensing television films, series of episodes, documentaries and other programming produced or acquired by the Company to broadcasters, cable and satellite television providers and home entertainment distributors domestically and abroad. Over the past two years, the Company expanded its television division beyond its traditional lifestyle and documentary niche to include made-for-television movies and mini-series.
Home Entertainment
The Company’s Home Entertainment segment derives its revenues from the distribution of DVDs and ancillary merchandise to retailers in Canada and the United States. It distributes sell-through and rental films across a wide variety of genres, such as children’s and family, special interest and live action feature films.
Corporate
The Company’s corporate segment provides support to the operating segments including information technology, finance, human resources, legal, investor relations and other corporate services.
SIGNIFICANT EVENTS IN THE QUARTER
·
The television segment delivered 21 episodes of programming compared to 16 episodes last year, including the first 4 episodes of Season II of the ten-hour dramatic television series The Tudors.
·
Home Entertainment reported record revenues and strong earnings in the second quarter driven by quality product and the Christmas selling season.
·
Feature filmThe Deal had its world premier at the prestigious Sundance Film Festival in Park City, Utah.
·
Acquired exclusive Canadian distribution rights to 32 films from First Look Studios, 5 of which are (An American Crime, Smiley Face, Day of the Dead, Finding Rin Tin Tin andThe Amateurs), to be distributed through Theatrical DVD, Video-on-Demand and Television, with the remaining 27 on Television.
4
04/16/2008
·
The Tudorsearned two Golden Globe award nominations – “Best Dramatic Television Series”, and “Best Actor in a Dramatic Series” for Jonathan Rhys Myers.
·
Completed the acquisition of the remaining 59.99% of the shares of Dufferin Gate Productions Inc.
·
Received a bridge loan for $2.7 million from the interim Chief Executive Officer and the other Co-Chairman of the Board of Directors to be used by the Company for general corporate purposes.
·
Completed agreement with Canada’s largest independent music publisher, Ole, for worldwide music rights to several film and television properties.
·
Luna: Spirit of the Whale was nominated for Canadian Film and Television Production Associations’ prestigious “Indie Award.”
SIGNIFICANT EVENTS SUBSEQUENT TO THE QUARTER
·
The Last Hit Man received the Best Feature prize at the Canadian Film Fest, the only event of its kind dedicated to celebrating Canadian filmmakers.
KEY PERFORMANCE INDICATORS
The Company measures the success of its strategies using a number of key performance indicators. These have been outlined below, including a discussion as to their relevance, definitions, calculation methods and underlying assumptions.
Use of Non-GAAP Financial Measures
In addition to the results reported in accordance with Canadian GAAP, the Company uses various non-GAAP financial measures, which are not recognized under Canadian or U.S. GAAP as supplemental indicators of the Company’s operating performance and financial position. These non-GAAP financial measures are provided to enhance the user’s understanding of the Company’s historical and current financial performance and its prospects for the future. Management believes that these measures provide useful information in that they exclude amounts that are not indicative of the Company’s core operating results and ongoing operations and provide a more consistent basis for comparison between quarters.
While many in the financial community consider these non-GAAP financial measures to be important measures of operating performance, they should be considered in addition to, but not as a substitute for, net (loss) earnings for the quarter, cash flow and other measures of financial performance prepared in accordance with Canadian GAAP which are presented in the consolidated financial statements. In addition, these and related measures do not have any standardized meaning prescribed by Canadian GAAP and, therefore, are unlikely to be comparable with the calculation of similar measures used by other companies.
Revenue
Revenue is a measurement defined by Canadian and U.S. GAAP. Revenue is the inflow of cash, receivables or other consideration arising from the sale of product and services and is net of items such as trade or volume discounts and certain excise and sales taxes. Peace Arch’s revenue streams for the six months ended February 29, 2008 were derived primarily from its three business segments: Motion Picture 9%, Television 32% and Home Entertainment 59% (2007 – 34%, 27% and 39%, respectively).
Amortization of investment in film and television programming, other production and home entertainment direct costs
Amortization of investment in film and television programming, production and home entertainment direct costs represents the amortization of the capitalized costs associated with internally produced and acquired film and television programming, from which distribution and licensing revenues are derived. Other production costs include amounts due to third party participants with interests in the performance of the production. Home entertainment direct costs consist primarily of duplication, distribution and marketing expenses of video and DVD as well as royalty expenses.
5
04/16/2008
Selling, general and administrative expenses
Selling, general and administrative expenses include period costs that are not directly attributable to the film and television program or home entertainment product. These include such costs as employee remuneration, professional fees, regulatory license fees, occupancy and overhead costs.
Stock and warrant-based compensation costs
Stock and warrant-based compensation costs include the expenses associated with stock options granted to employees during the quarter, as well as the costs related to warrant issues.
Other Amortization
Other amortization includes amortization of property and equipment and intangible assets.
(Loss) earnings before the undernoted
(Loss) earnings before the undernoted is defined as revenue less expenses.
CONSOLIDATED RESULTS OF OPERATIONS
The following table presents summary financial information for Peace Arch’s operating business segments for Q2, 2008 and YTD 2008 compared with Q2, 2007 and YTD 2007, and a reconciliation of (loss) earnings before the undernoted to net (loss) earnings for the period noted.
| | | | | | |
| | | | | % Increase (decrease) |
(thousands of Canadian dollars except percentages and per share amounts) | Q2 2008 | Q2 2007 Restated(1) | % Change | YTD 2008 | YTD 2007 Restated(1) | 2008 over 2007 |
OPERATING REVENUES Motion Picture Television Home Entertainment |
1,196 8,207 11,375 |
6,245 7,476 6,555 |
(80.8) 9.8 73.5 |
3,346 12,235 22,368 |
10,705 8,662 12,239 |
(68.7) 41.2 82.8 |
| 20,778 | 20,276 | 2.5 | 37,949 | 31,606 | 20.1 |
|
|
|
|
|
| |
OPERATING EXPENSES Motion Picture Television Home Entertainment Corporate |
2,777 6,971 9,205 1,875 |
6,253 5,753 4,963 1,335 |
(55.6) 21.2 85.5 40.4 |
5,435 10,438 18,640 3,601 |
10,217 6,850 9,814 2,036 |
(46.8) 52.4 89.9 76.9 |
| 20,828 | 18,304 | 13.8 | 38,114 | 28,917 | 31.8 |
|
|
|
|
|
| |
(LOSS) EARNINGS BEFORE THE UNDERNOTED(2) Motion Picture Television Home Entertainment Corporate |
(1,581) 1,236 2,170 (1,875) |
(8) 1,723 1,592 (1,335) |
n.m. (28.3) 36.3 (40.4) |
(2,089) 1,797 3,728 (3,601) |
488 1,811 2,426 (2,036) |
(528.1) (0.8) 53.7 (76.9) |
| (50) | 1,972 | (102.5) | (165) | 2,689 | (106.1) |
|
|
|
|
|
| |
Interest income Interest expense Foreign exchange gain (loss) Legal settlement (Loss) on settlement of obligations | 296 (1,229) 202 - - | 407 (1,231) (348) 957 - | (27.3) 0.2 158.0 n.m. - | 738 (2,898) 558 - - | 667 (2,053) (665) 957 (13) | 10.6 (41.2) 183.9 - n.m. |
|
|
|
|
|
| |
(Loss) earnings before income taxes | (781) | 1,757 | (144.5) | (1,767) | 1,582 | (211.7) |
|
|
|
|
|
| |
Income tax expense | (155) | (521) | 70.2 | (294) | (719) | 59.1 |
|
|
|
|
|
| |
(LOSS) EARNINGS FOR THE PERIOD | (936) | 1,236 | (175.7) | (2,061) | 863 | (338.8) |
(1)
See discussion under “Restatement.”
(2)
As defined in “Key Performance Indicators – (Loss) earnings before the undernoted.”
n.m.: not meaningful.
6
04/16/2008
SECOND QUARTER FISCAL2008 COMPARED TO SECOND QUARTER FISCAL2007 RESULTS
Q2 2007 has been restated – see discussion under “Restatement.”
Revenues for the second quarter were $20.8 million, consistent with $20.3 million for the same period in the prior year. Revenues of $37.9 million for the six-month period represented 20% growth over revenues of $31.6 million in the prior year. The increase in revenues on a year to date basis was primarily due to a $10.0 million increase in revenues in the home entertainment segment which includes new revenues from the acquisition of Trinity in the U.S. of $4.8 million, and a $3.6 million increase in television revenues. This was partially offset by a $7.4 million decrease in motion picture revenues. The lower motion picture revenues was partly due to a delay in product delivery from the first two quarters to later in the year.
Operating expenses, defined as amortization of investment in film and television programming and other production costs, home entertainment direct costs, selling, general and administrative costs, stock and warrant-based compensation costs, and other amortization of $20.8 million for the second quarter up 14% from $18.3 million from the prior year, and $38.1 million for the six-month period up 32% from the prior year. The increase is primarily due to higher home entertainment direct costs from the higher revenues and increased corporate costs from the inclusion of the new businesses Castle Hill/Dream, Trinity and Dufferin Gate as well as additional overhead to support organic growth.
In the second quarter of fiscal 2008, the Company recorded a loss from operations before the undernoted of $(50,000) compared to earnings of $2.0 million last year, and $(165,000) for the six-month period compared to earnings of $2.7 million from the prior year. The loss in the quarter and six month period is driven by a loss in the motion picture segment due to lower revenue volumes available to cover fixed overhead costs.
Motion Picture
Motion Picture revenues for the three months ended were $1.2 million, down81% from $6.2 million last year, and for the six-month period revenues were $3.3 million, compared to $10.7 million last year. The four films delivered during the second quarter of fiscal 2008 wereTime Bomb, Just Business, Shred 2 andBitten,compared to five movies in the second quarter of last year. The Company is currently in production of 1 feature film compared to 1 last year.
Operating expenses for the three months were $2.8 million, down 56% from $6.3 million last year, and for the six-month period were $5.4 million, down 47% from last year. The decrease in operating expenses is consistent with the decrease in revenues.
Segment loss is defined as revenues less operating expenses. Segment loss was $(1.6) million for the three months ended, compared to a loss of $(8,000) reported in the prior year, and for the six-month period $(2.1) million compared to earnings of $488,000 in the prior year. The loss in the quarter is due to the lower revenue volumes available to cover fixed overhead costs. The lower revenue volumes are partly due to the delay in product delivery of certain titles from Q1 and Q2 to later in the year.
Television
Television revenues for the three months ended were $8.2 million compared to $7.5 million last year, and for the six-month period revenues were $12.2 million compared to $8.7 million last year. The increase in television revenues is from both organic growth, as well as new revenues from business acquisitions.
During the three months ended February 29, 2008, the Company delivered 21 episodes of television programming, compared to 16 episodes of programming last year. 3 television episodes ofMakeover Wish(Series II), 5 episodesof Last 10 Pounds(Series II),9 episodes ofBulging Brides, and 4 episodes ofThe Tudors Season II.
There were 5 television series in production in the second quarter of fiscal 2008 including;The Tudors(Series II),Makeover Wish(Series II),Last 10 Pounds(Series II),Air Dogs(Series II),andBulging Brides.
Operating expenses for the three months were $7.0 million compared to $5.8 million in the prior period consistent with the higher revenues, and for the six-month period $10.4 million compared to $6.9 million the prior year.
Segment earnings were $1.2 million for the period, compared to $1.7 million for the same period in the prior year, and for the six-month period $1.8 million consistent with $1.8 million in the prior year.
7
04/16/2008
Home Entertainment
Home entertainment revenues for the three months were $11.4 million up 74%, compared to $6.6 million for the same period in the prior year, and for the six-month period revenues were $22.4 million and $12.2 million in the prior year. Revenues in the quarter were strong driven by the Christmas selling period and the supply of higher quality content. Included in revenues for the six months is approximately $5.0 million recognized from the acquisition of Trinity in the U.S. The prior year comparative quarter revenue did not include this acquisition.
Operating expenses for the three months were $9.2 million up 86% from $5.0 million over the same period in the prior year, and for the six-month period $18.6 million and $9.8 million in the prior year. The increase represents the inclusion of Trinity in the U.S. as well as higher DVD duplication and other direct costs associated with the growth in revenues in the Canadian Home Entertainment division.
Segmented earnings were $2.2 million in the period, compared to $1.6 million in the same period last year, and the six-month period $3.7 million and $2.4 million in the prior year. The higher earnings reflect both the increased revenue volumes and higher margins from the sale of its supply of new content.
Corporate
Corporate expenses of $1.9 million for the three months ended increased from $1.3 million last year which represents the inclusion of additional corporate overhead related to the acquisitions of Castle Hill/Dream, Trinity and Dufferin Gate as well as a result of additional support required for organic growth. For the six months ended February 29, 2008, corporate expenses were $3.6 million compared to $2.0 million last year. This increase relates primarily to the increased cost of personnel associated with enhancing the management team focusing on sales and distribution activities.
Interest Income
Interest income for the three months was $296,000, compared to $407,000 in the prior year, and for the six-month period $738,000 and $667,000 in the prior year. Interest income relates to interest earned with respect to the Restricted Term Deposit and interest earned on restricted cash placed in short term deposits. The interest earned with respect to the Restricted Term Deposit is offset by interest expense of the same amount recorded in respect of the Film Financing Obligation.
Interest Expense
Interest expense for the three months was $1.2 million for the period, consistent with $1.2 million in the prior year, and for the six-month period $2.9 million and $2.1 million in the prior year. The change over the prior year for the six months reflects increased interest expense due to higher production loans, as well as the inclusion of loan arrangement fees paid for new loan facilities negotiated during the first quarter.
Foreign exchange gain (loss)
Foreign exchange gain for the three months was $202,000, compared to a loss of $(348,000) in the prior year, and for the six-month period $558,000, compared to a loss of $(665,000) the prior year which reflects the impact of the strengthening Canadian dollar on the Company’s U.S. operations.
Legal settlement
On October 2, 2001, the Company initiated an action in British Columbia Supreme Court against a co-financier in a television series for damages from the co-financier's failure to honour a contract for its share of the financing of the television series. On December 21, 2006, the parties met with an arbitrator and negotiated a settlement of the Company's claim against the co-financier. On January 16, 2007, the settlement amount, less legal costs, was received by the Company.
Income tax expense
Income tax expense for the three months was $155,000 compared to $521,000 in the prior year, and $294,000 on a year to date basis compared to $719,000. $294,000 for the six-month period consists of a $508,000 provision for income taxes net of a recovery for income taxes for $214,000 compared to $838,000 provision for income taxes which is net of a recovery for income taxes for $119,000 for the same period in the prior year. The recognition and measurement of the Company's income tax provision involves dealing with uncertainties in the application of complex tax regulations in a multitude of jurisdictions. Potential liabilities are recognized in various tax jurisdictions based on its estimate of whether, and the extent to which, additional taxes will be due. The Company has provided for these uncertainties in its provision for income taxes. A recovery for income taxes of $214,000 was recorded during the six months which relates to amortization of intangible asse ts resulting in a partial reversal of temporary timing differences and a future tax recovery relating to net operating losses in the United States, as well as current taxes recoverable in Dufferin Gate.
8
04/16/2008
Net (loss) earnings for the period
Net loss for the quarter was $(936,000) compared to earnings of $1.2 million in the prior year, and for the six-month period $(2.1) million compared to earnings of $863,000 in the prior year. (Loss) earnings per common share basic and diluted was $(0.02) in the quarter compared to basic $0.04 and diluted $0.03 in the prior year. Included in prior year’s second quarter results was a gain of $957,000 from the settlement of an outstanding dispute with a co-financier of a television series. The loss during the quarter can be explained by a loss in the motion picture segment. The loss year to date is due to both a loss in the motion picture segment and higher interest expense from increased production loans and loan arrangement fees paid for new loan facilities negotiated.
Comprehensive (loss) earnings for the period
Comprehensive loss for the quarter was $(1.2) million compared to earnings of $1.2 million in the prior year. The decrease is due to both a net loss for the quarter of $(936,000) compared to earnings of $1.2 million and unrealized foreign currency translation losses on net assets of self-sustaining foreign operations of $(304,000) compared to $nil in the prior year.
SUMMARY OF QUARTERLY RESULTS
The following tables set forth certain unaudited data from the consolidated statements of earnings (loss) for each of the eight most recent quarters ended February 29, 2008. The information has been derived from the Company’s unaudited consolidated financial statements that, in management’s opinion, have been prepared on a basis consistent with the audited financial statements for the year ended August 31, 2007.
| | | | |
(thousands of Canadian dollars except per share amounts) |
Revenues |
Net (loss) earnings | (Loss) earnings per share |
Basic |
Diluted |
2008 2nd Quarter 1st Quarter |
20,778 17,171 |
(936) (1,125) |
(0.02) (0.03) |
(0.02) (0.03) |
2007 4th Quarter 3rd Quarter (restated) 2nd Quarter (restated) 1st Quarter (restated) |
11,428 18,753 20,276 11,330 |
(7,685) 1,138 1,236 (373) |
(0.17) 0.03 0.04 (0.02) |
(0.17) 0.03 0.03 (0.02) |
2006 4th Quarter (restated) 3rd Quarter (restated) |
7,864 8,824 |
(2,444) (556) |
(0.08) (0.03) |
(0.08) (0.03) |
Restatement of Quarterly Results
See discussion under “Restatement.”
Seasonality
Results of operations for any period are dependent on the number, timing and commercial success of motion pictures and television programs delivered or made available to various media, none of which can be predicted with certainty. Home Entertainment results of operations are impacted by strong sales in the Christmas season and during the first and second quarters. Consequently, results of operations may fluctuate materially from period to period and the results of any one period are not necessarily indicative of results for future periods. Cash flows may also fluctuate and are not necessarily closely correlated with revenue recognition.
Significant items causing variations in quarterly results
During the second quarter ended February 28, 2007, the Company recognized a gain of $957,000 from the settlement of an outstanding dispute with a co-financier of a television series.
9
04/16/2008
During the third quarter ended May 31, 2007, the Company issued 277,406 common shares valued at $860,000 for settlement of a loan payable plus interest, in the amount of US$405,000 ($463,000). The Company recorded a loss on settlement of $396,000.
During the third and fourth quarters ended May 31, 2007 and August 31, 2007, the Company recorded a writedown of investment in film and television programming of $800,000 and $5.5 million to properly reflect the carrying value of certain film assets.
LIQUIDITY AND CAPITAL RESOURCES
While these consolidated financial statements have been prepared on the going concern basis, which assumes the realization of assets and the settlement of liabilities in the normal course of operations, there are conditions that cast substantial doubt on the validity of this assumption. The Company has undergone substantial growth in corporate and sales infrastructure and also through acquisitions. The Company will continue to require additional financing until it can generate substantial positive cash flows from operating activities. While the Company continues to maintain its day-to-day activities and produce and distribute films and television programming, its working capital situation is severely constrained.
The Company has the ability to generate cash internally from certain operating segments as well as to borrow funds against unsecured rights for films and other financing sources. The Company continues to pursue various financing initiatives. However, there is no assurance that the Company will be successful in its financing efforts. The application of the going concern basis is dependent upon the Company obtaining additional financing in the short-term to fund its continuing operations and meet its obligations as they come due. On January 2, 2008, the Company obtained short-term financing of $2.7 million in the form of related party loans due within one year.
These consolidated financial statements do not reflect adjustments that would be necessary if the going concern basis is not appropriate. If the going concern basis is not appropriate for the consolidated financial statements, then significant adjustments would be necessary in the carrying value of assets and liabilities and the reported revenues and expenses.
The Company operates in an industry that has long operating cycles which require cash injection into new projects significantly ahead of the delivery and exploitation of the final production. The Company has historically financed the capitalized costs of the proprietary film and television programming through financing presales from customers, borrowing from bank facilities high interest short-term bridge loan facilities, government tax incentives and contributions from co-producers, the repayment of which is limited to the future cash flows from the project. The Company also funds capital requirements through working capital deployed as interim financing and through the issuance of shares and warrants and is dependent on continued access to external sources of financing.
During fiscal 2007, the Company completed a private placement for proceeds of $33.0 million (net proceeds $29.8 million), which was used to finance certain business acquisitions, as well as to repay outstanding loans in the amount of $8.3 million. In addition, the Company secured new sources of financing with a Canadian limited partnership and received funds from the exercise of preferred and common share warrants. The acquisitions of PAHE in 2006 and Trinity in 2007 provide the Company with a diversified source of cash flows from operations.
During the last two years, the Company has used production loan facilities on an interim basis to fund corporate working capital. Wholly owned production subsidiaries of the Company borrow, from various parties, on an interim basis prior to finalizing the financing for a film or television series. The Company uses any portion of these facilities that are not immediately required to finance the costs of production in its operating activities. The Company also arranges interim bridge financing for third party owned production entities for which it also acts as distributor of film rights for the purpose of financing production costs. The Company repays the loans plus the interest owed to the original lender of the funds when these production entities require the funds to finance its costs of production. At February 29, 2008, the balance of such facilities was $3.6 million.
As at February 29, 2008, the Company had cash or cash equivalents available of $3.4 million compared to $5.5 million in 2007 and was fully drawn on its $3.0 million bank credit facility.
10
04/16/2008
Cash Flows
Q2 2007 has been restated – see discussion under “Restatement.”
Cash Flows from Operating Activities
During the three months ended February 29, 2008, cash flows from operating activities were $2.1 million, compared to $1.6 million used by operating activities in the same period last year. The improvement in cash flows from operations is primarily due to lower investment in film and television programming of $5.2 million compared to $10.9 million in the same period last year. During the six month period ended February 29, 2008, $17.4 million was used by operating activities, compared to $4.7 million used by operating activities in the same period last year. The increase in cash flows used from operations during the period was mainly attributable to a decrease in non-cash operating working capital. The decrease in non-cash operating working capital used is primarily due to higher accounts receivables and other amounts due of $20.2 million compared to $12.6 million and lower accounts payable and accrued liabilities of $8.2 million compared to $14.3 mi llion for the same period in the prior year. The increase in accounts receivables and other amounts due is due to higher revenues in the period.
Cash Flows from Investing Activities
During the three months ended February 29, 2008, cash flows from investing activities was $417,000 compared to $9.5 million used in the same period last year. The improvement in cash flows is due to no funds being used for acquisitions in 2008 compared to $9.2 million used for the acquisition of Castle Hill Productions Inc., and Dream LLC in the same period last year. During the six month period ended February 29, 2008, cash flows from investing activities were $637,000, compared to $10.1 million used in the same period of the prior year.The improvement in cash flows is primarily due to the acquisition of Castle Hill Productions Inc., and Dream LLC in the prior year described above. In addition, during the six-month period ended February 29, 2008 there was a decrease in restricted cash of $4.3 million related to the Dufferin Gate and Trinity acquisitions partially offset by the deferred payment of $ 3.6 million.
Cash Flows from Financing Activities
During the three months ended February 29, 2008, cash flows used for financing activities was $4.2 million compared to $13.0 million generated in the same period of the prior year. The decrease in cash flows from financing activities is primarily due to the issuance of corporate loans of $4.4 million compared to $10.6 million, and production loans taken out of $1.4 million compared to $15.3 million for the same period last year. During the six months ended February 29, 2008, cash flows from financing activities was $15.0 million compared to $19.1 million in the same period of the prior year. The decrease in cash from financing activities is primarily due to the issuance of corporate loans of $5.4 million in the period compared to $12.9 million, and $24.4 million of production loans taken out in the period compared to $27.5 million in the same period last year.
Capital Resources
Capital Structure
During the six months ended February 29, 2008 the following capital transactions occurred:
(i)
On September 19, 2007, 10,000 common share warrants were exercised at a price of US$0.54 per share for proceeds of US$5,000 (Cdn$5,500). A balance of $10,000 representing a portion of the value associated with warrants was transferred from warrants.
(ii)
On October 10, 2007, 10,000 common share warrants were exercised at a price of US$0.54 per share for proceeds of US$5,000 (Cdn$5,300). A balance of $9,000 representing a portion of the value associated with warrants was transferred from warrants.
(iii)
On October 11, 2007, 223,000 common share warrants were exercised at a price of $1.21 per share for proceeds of $270,000. A balance of $312,000 representing a portion of the value associated with warrants was transferred from warrants.
11
04/16/2008
(iv)
On January 7, 2008, the remaining shareholder exercised the put option requiring us to acquire the remaining 59.99% of the outstanding shares of Dufferin Gate. Pursuant to the exercise of the put option agreement, we purchased all of the issued and outstanding shares of the holding company that owns the remaining issued and outstanding shares of DGH for $2.8 million, consisting of cash consideration of $2.2 million and 393,781 common shares of Peace Arch valued at $600,000. The fair value of the common shares issued of $1.52 per share was based on Canadian exchange stock price quotation on the date the put option was exercised.
(v)
During the six months ended February 29, 2008, the Company issued 26,665 common shares for gross cash proceeds of $16,000 in connection with employee stock options that had been exercised. A balance of $10,000, representing a portion of the value associated with stock options was transferred from contributed surplus.
OFF BALANCE SHEET ARRANGEMENTS
Loan Guarantees
Certain film productions delivered during prior years were pursuant to co-production agreements with an independent producer (the “co-producer”) in another country. The production loans are arranged jointly by the co-producers to cover their individual funding of the respective film production. Each co-producer is responsible for the payment of its respective portion of the loans out of receipts from the respective co-producer’s exploitation of the production. In the event of default by the co-producer, the Company is liable for any unpaid balance of the co-producer’s share of the loan. At February 29, 2008, the total amount of such unpaid loans was approximately $95,000 (August 31, 2007 - $101,000). In the event of such a default, the Company has full recourse to all the copyright, exploitation and other rights attributed to the co-producer pursuant to the co-production agreement. No accrual has been made as the Company believes the likelihood of payme nt is remote.
Film Distribution Rights Commitment
At February 29, 2008, the Company had commitments of $8.1 million (August 31, 2007 - $11.5 million) with respect to the acquisition of film distribution rights to 7 films, which will be delivered to the Company during the year ended August 31, 2008. These payments are required to be made at the date of delivery of the respective films, which is expected to be no later than August 31, 2008. In addition, payment related to one television series with a film distribution rights commitment of $4.5 million is due during the year ended August 31, 2008.
RELATED PARTY TRANSACTIONS
The Company has entered into the following related party transactions. These transactions are measured at the exchange amount, which is the actual amount of consideration given as established and agreed between the related parties.
(i)
During the six months ended February 29, 2008, the Company paid $162,000 (2007 - $95,000) to a company controlled by a shareholder, former director and officer of the Company for executive services rendered. These expenditures are reflected in the Company’s selling, general and administrative expenses.
(ii)
As at February 28, 2007 the Company incurred interest of $nil (2007 – $245,000) in respect of a $2,740,000 loan from a company controlled by a director and a member of the company’s senior management. The loan beared interest at the rate of 18% per annum. The loan was repaid in December 2007. The interest is included in interest expense in the statement of earnings of the consolidated financial statements.
(iii)
As at February 29, 2008, included in production loans was $nil (August 31, 2007 - $4,935,000) due to a director of the Company in respect of a loan for the purpose of interim financing of a certain production. The loan was repaid in June 2007. Interest on the loan was $nil (2007 - $nil).
(iv)
On January 2, 2008, the Company’s Interim Chief Executive Officer and the other Co-Chairman of the Board of Directors provided a bridge loan for $2,650,000 to be used by the Company for general corporate purposes. The bridge loan bears interest at 12% per annum. The bridge loan is due January 2, 2009. The loan may be repaid in advance without penalty at the option of the Company. No fees are payable by the Company in respect of the bridge loan. The bridge loan is considered to be a loan from related parties. For the six months ended February 29, 2008, the Company incurred interest of $36,000 (2007 - $nil).
12
04/16/2008
Other related party transactions are disclosed in the unaudited consolidated financial statements for February 29, 2008.
OUTSTANDING SHARE DATA
The Company is authorized to issue an unlimited number of common shares without par value. At April 14, 2008, the Company had 48,785,864 common shares outstanding (excluding 222,689 shares in escrow). At August 31, 2007, the Company had 48,089,087 common shares outstanding (excluding 222,689 shares in escrow).
The Company is authorized to issue an unlimited number of preference shares, issuable in series without par value. At April 14, 2008, the Company had 4,347,825 Series I preference shares and 4,347,825 Series II preference shares issued and outstanding. There were 4,347,825 Series I preference shares and 4,347,825 Series II preference shares issued and outstanding at Fiscal 2007.
The Company has 9,461,947 common shares reserved for issuance pursuant to the current stock option plan, of which 1,164,993 were exercised prior to February 29, 2008.
ACCOUNTINGPOLICIES
The consolidated financial statements have been prepared according to Canadian GAAP. See note 2 to the annual consolidated financial statements for more information about the accounting principles used to prepare the financial statements.
There have not been any significant changes in accounting standards or our accounting policies or key estimates and assumptions that management has made under these principles, except as outlined below:
As described in note 2(b) to the consolidated financial statements for the six months ended February 29, 2008, effective September 1, 2007, the Company adopted the CICA Handbook Sections 1530, “Comprehensive Income”, 3251, “Equity”, 3855, “Financial Instruments – Recognition and Measurement”, 3861, “Financial Instruments – Disclosure and Presentation.” The Company adopted these standards prospectively; accordingly, comparative amounts for prior periods have not been restated, except to classify unrealized foreign currency translation gains and losses on net investments in self-sustaining foreign operations in accumulated other comprehensive income (loss).
RISK FACTORS
There have been no material changes in any risks or uncertainties facing the Company since the year ended August 31, 2007, as disclosed in the Company’s Management Discussion and Analysis for the year ended August 31, 2007 filed on SEDAR on March 17, 2008 which is incorporated by reference.
CHANGES IN INTERNAL CONTROL
There have not been significant changes in disclosure controls and procedures, and plans for remediation of material weaknesses from those described in the Company’s Management Discussion and Analysis for the year ended August 31, 2007 filed on SEDAR on March 17, 2008 which is incorporated by reference.
We have hired a SOX and Audit consultant to assist the Company in enhancing internal controls.
ADDITIONAL INFORMATION
Additional information relating to the Company can be found on its website atwww.peacearch.com and on SEDAR atwww.sedar.com.
13
