-------------------------------
OMB Approval
-------------------------------
OMB Number: 3235-0116
-------------------------------
Expires: March 31, 2003
-------------------------------
Estimated average burden
hours per response . . .2.0
-------------------------------
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
FORM 6-K
REPORT OF FOREIGN PRIVATE ISSUER
PURSUANT TO RULE 13a-16 OR 15d-16 UNDER
THE SECURITIES EXCHANGE ACT OF 1934
For the month of JUNE , 2002.
----------------
VHQ ENTERTAINMENT INC.
- --------------------------------------------------------------------------------
(Translation of registrant's name into English)
6201 - 46th Avenue, Red Deer, Alberta Canada T4N 6Z1
- --------------------------------------------------------------------------------
(Address of principal executive offices)
Indicate by check mark whether the registrant files or will file annual
reports under cover of Form 20-F or Form 40-F:
Form 20-F X Form 40-F
------- --------
Indicate by check mark if the registrant is submitting the Form 6-K in
paper as permitted by Regulation S-T Rule 101(b)(1): _______
Note: Regulation S-T Rule 101(b)(1) only permits the submission in
paper of a Form 6-K if submitted solely to provide an attached annual report to
security holders.
Indicate by check mark if the registrant is submitting the Form 6-K in
paper as permitted by Regulation S-T Rule 101(b)(7): _______
Note: Regulation S-T Rule 101(b)(7) only permits the submission in
paper of a Form 6-K if submitted to furnish a report or other document that the
registrant foreign private issuer must furnish and make public under the laws of
the jurisdiction in which the registrant is incorporated, domiciled or legally
organized (the registrant's "home country"), or under the rules of the home
country exchange on which the registrant's securities are traded, as long as the
report or other document is not a press release, is not required to be and has
not been distributed to the registrant's security holders, and, if discussing a
material event, has already been the subject of a Form 6-K submission or other
Commission filing on EDGAR.
<page>
Indicate by check mark whether by furnishing the information contained
in this Form, the registrant is also thereby furnishing the information to the
Commission pursuant to Rule 12g3-2(b) under the Securities Exchange Act of 1934.
Yes No X
------ ------
If "Yes" is marked, indicate below the file number assigned to the
registrant in connection with Rule 12g3-2(b): 82-_____________
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934,
the registrant has duly caused this report to be signed on its behalf of the
undersigned, thereunto duly authorized.
VHQ ENTERTAINMENT INC.
------------------------------------
(Registrant)
Date December 2, 2002 By /s/ TREVOR M. HILLMAN
------------------- ---------------------------------
(Signature)1
Trevor M. Hillman
Chief Executive Officer
- --------
1 Print the name and title of the signing officer under his signature.
[VHQ WHERE ENTERTAINMENT BEGINS!(TM) logo]
A COPY OF THIS PRELIMINARY PROSPECTUS HAS BEEN FILED WITH THE SECURITIES
REGULATORY AUTHORITIES IN EACH OF BRITISH COLUMBIA, ALBERTA, SASKATCHEWAN,
MANITOBA, ONTARIO AND QUEBEC, BUT HAS NOT YET BECOME FINAL FOR THE PURPOSE OF
THE SALE OF SECURITIES. INFORMATION CONTAINED IN THIS PRELIMINARY PROSPECTUS MAY
NOT BE COMPLETE AND MAY HAVE TO BE AMENDED. THE SECURITIES MAY NOT BE SOLD UNTIL
A RECEIPT FOR THE PROSPECTUS IS OBTAINED FROM THE SECURITIES REGULATORY
AUTHORITIES.
NO SECURITIES REGULATORY AUTHORITY HAS EXPRESSED AN OPINION ABOUT THESE
SECURITIES AND IT IS AN OFFENCE TO CLAIM OTHERWISE. THIS PROSPECTUS CONSTITUTES
A PUBLIC OFFERING OF THESE SECURITIES ONLY IN THOSE JURISDICTIONS WHERE THEY MAY
BE LAWFULLY OFFERED FOR SALE, AND THEREIN ONLY BY PERSONS PERMITTED TO SELL SUCH
SECURITIES. THE SECURITIES OFFERED HEREBY HAVE NOT BEEN AND WILL NOT BE
REGISTERED UNDER THE UNITED STATES SECURITIES ACT OF 1933, AS AMENDED.
ACCORDINGLY THE SECURITIES OFFERED HEREBY MAY NOT BE OFFERED OR SOLD IN THE
UNITED STATES OF AMERICA AND THIS PROSPECTUS DOES NOT CONSTITUTE AN OFFER TO
SELL OR A SOLICITATION OF AN OFFER TO BUY ANY OF THE SECURITIES OFFERED HEREBY
WITHIN THE UNITED STATES OF AMERICA. SEE "PLAN OF DISTRIBUTION".
PRELIMINARY PROSPECTUS DATED JUNE 6, 2002
NEW ISSUE
[GRAPHIC OMITTED][GRAPHIC OMITTED]
VHQ ENTERTAINMENT INC.
PRICE: $__ PER UNIT
MAXIMUM OFFERING: $ 10,000,000 (__ UNITS)
MINIMUM OFFERING: $ 4,000,000 (__ UNITS)
EACH UNIT CONSISTS OF 1 COMMON SHARE AND 1/2 COMMON SHARE PURCHASE
WARRANT WHICH ARE NOT SEPARABLE UNTIL AFTER A DATE TO BE DETERMINED
BY THE CORPORATION AND THE AGENTS (THE "RECORD AND DISTRIBUTION DATE")
WHICH WILL NOT BE LATER THAN __, 2002.
We, VHQ Entertainment Inc, are offering through our agents, Desjardins
Securities Inc. and First Associates Investments Inc. (each an "Agent" and
collectively referred to as the "Agents"), a maximum of __ units (the "Units")
and a minimum of __ Units of VHQ. Each Unit consists of 1 common share (a
"Common Share") in our capital and 1/2 Common Share purchase warrant (each whole
Common Share purchase warrant referred to as a "Warrant"). Each whole Warrant
will entitle the holder of that Warrant to purchase 1 Common Share (a "Warrant
Share") at any time from the date it is issued until 5:00 p.m. (Toronto time) on
__ at an exercise price of $__ per Warrant Share. The Units are being offered at
a purchase price of $__ per Unit (the "Offering Price"). We determined the
Offering Price through negotiations with the Agents.
NET PROCEEDS TO
PRICE TO PUBLIC AGENTS' FEE(1)<F1> CORPORATION(2)<F2>
Per Unit $__ $__ $__
Total Minimum Offering(3)<F3> $__ $__ $__
Total Maximum Offering(3)<F3> $__ $__ $__
<FN>
(1)<F1> The Agents will also be granted, upon completion of the offering, non-
transferable options to purchase that number of Units equal to 10% of
the Units sold pursuant to the offering at the Offering Price which
options will expire 24 months from the closing of the offering (the
"Agents' Options"). The Agents' Options (one-half only in Ontario) are
qualified for distribution pursuant to this prospectus. See "Plan of
Distribution".
(2)<F2> Before deducting expenses of the offering, estimated to be $180,000
which, together with the Agents' fee, will be paid from the proceeds of
the offering.
(3)<F3> We have granted the Agents an option (the "Over-Allotment Option"),
exercisable for a period of 90 days from the date of closing of the
offering, to purchase up to 15% of the total number of Units sold
pursuant to the offering, on the same terms set forth above, to cover
over-allotments, if any. If the Agents exercise the Over-Allotment
Option in full, the total price to the public, the Agents' fee and the
net proceeds to us before expenses of the offering will be $o, $o and
$o, respectively, assuming completion of the maximum offering and $o,
$o and $o, respectively, assuming completion of the minimum offering.
This prospectus also qualifies the granting of the Over-Allotment
Option and the distribution of the Units issued upon the exercise of
the Over-Allotment Option. See "Plan of Distribution".
</FN>
</table>
We are a video and home entertainment retailer. We operate, through our
wholly-owned subsidiaries, a chain of 49 video and home entertainment stores in
Alberta, Saskatchewan and the Northwest Territories.
OUR COMMON SHARES ARE TRADED ON THE TORONTO STOCK EXCHANGE ("TSX") UNDER THE
SYMBOL "VHQ". THE CLOSING SALE PRICE OF OUR COMMON SHARES ON THE TSX ON JUNE 5,
2002 WAS $0.85. THERE IS CURRENTLY NO MARKET THROUGH WHICH, AFTER THE RECORD AND
DISTRIBUTION DATE, THE WARRANTS MAY BE SOLD AND PURCHASERS MAY NOT BE ABLE TO
SELL THE WARRANTS.
AN INVESTMENT IN THE UNITS IS SUBJECT TO A NUMBER OF RISK FACTORS THAT SHOULD BE
CONSIDERED BY PROSPECTIVE PURCHASERS. THESE RISK FACTORS INCLUDE, WITHOUT
LIMITATION, RISKS ASSOCIATED WITH OUR HISTORY OF RECENT LOSSES, OUR LIMITED
OPERATING HISTORY, OUR ABILITY TO INCREASE REVENUE GROWTH AT EXISTING STORES,
OUR ABILITY TO SUSTAIN OUR GROWTH OR TO MANAGE THE GROWTH OF OUR OPERATIONS, OUR
ABILITY TO OBTAIN ADDITIONAL FINANCING TO EXPAND OUR BUSINESS, PIRACY OF THE
PRODUCTS WE OFFER, OUR ABILITY TO COMPETE WITH OTHER VIDEO CHAINS FOR
ACQUISITION TARGETS, OUR RELIANCE ON REPRESENTATIONS MADE BY SELLERS OF
ACQUISITION TARGETS, OUR ABILITY TO MAKE INFORMED DECISIONS ON PRIVATE COMPANY
ACQUISITION TARGETS, OUR ABILITY TO INTEGRATE THE OPERATIONS OF VIDEO RETAIL
STORES THAT WE ACQUIRE WITH OUR EXISTING STORES AND SYSTEMS, COMPETITION IN THE
VIDEO RETAIL INDUSTRY, COMPETITORS WITH GREATER RESOURCES, TECHNICAL
OBSOLESCENCE OF THE ENTERTAINMENT PRODUCTS THAT WE OFFER, ADDITIONAL CAPITAL
EXPENDITURES REQUIRED TO INCREASE OUR DVD SELECTION, MOVIE STUDIOS ADVERSELY
CHANGING THEIR DISTRIBUTION PRACTICES, OUR DEPENDENCE ON SUPPLIERS AND
WHOLESALERS FOR INVENTORY, SEASONAL AND OPERATING FLUCTUATIONS OF OUR
OPERATIONS, NEWLY RELEASED MOVIES BEING INITIALLY PRICED AS A SELL-THROUGH
PRODUCT, CHANGES IN OUR COST STRUCTURE, CHANGES IN THE LOCAL ECONOMIES WHERE WE
OPERATE, OUR RELIANCE ON THE EXPERTISE OF KEY PERSONNEL, THE IMMEDIATE AND
SUBSTANTIAL DILUTION THAT PURCHASERS OF UNITS WILL SUFFER, THE LACK OF A MARKET
FOR THE WARRANTS, AND THE IMPROBABILITY THAT ANY DIVIDENDS WILL BE PAID IN THE
FORESEEABLE FUTURE. SEE "RISK FACTORS".
The offering is not underwritten and is subject to receipt by us, through our
Agents, of a minimum subscription of $4,000,000 which must be raised within 90
days of the issuance of a receipt from the securities commissions in British
Columbia, Alberta, Saskatchewan, Manitoba, Ontario and Quebec (the "Qualifying
Jurisdictions") for the (final) prospectus, or such other time as may be
authorized by the securities commissions in the Qualifying Jurisdictions and
agreed to by the Agents. During the 90 day period, subscription funds will be
held by Computershare Trust Company of Canada, as depository. If the minimum
subscription is not raised, subscription monies will be returned to subscribers
without interest or deduction. Subscriptions will be received subject to
rejection or allotment in whole or in part, and the right is reserved by the
Agents to close the subscription book at any time without notice. See "Plan of
Distribution".
The Agents, as agents on our behalf, conditionally offer the Units on a
reasonable efforts basis. The Units are offered subject to prior sale, if, as
and when issued, sold and delivered by us and accepted by the Agents in
accordance with the conditions contained in the Agency Agreement referred to
under "Plan of Distribution" and subject to the approval of certain legal
matters on our behalf by Shea Nerland Calnan and on behalf of the Agents by
Gowling Lafleur Henderson LLP. It is expected that definitive certificates
evidencing the Units will be available for delivery at closing which is expected
to occur on or about o, 2002, or such later date as we and the Agents may agree,
but in any event no later than o, 2002. See "Plan of Distribution".
TABLE OF CONTENTS
ELIGIBILITY FOR INVESTMENT..........................2 COMPENSATION OF EXECUTIVE OFFICERS.................30
FORWARD LOOKING STATEMENTS..........................2 EMPLOYMENT CONTRACTS............................31
PROSPECTUS SUMMARY..................................3 USE OF PROCEEDS....................................32
THE CORPORATION.....................................5 CONSOLIDATED CAPITALIZATION........................32
OUR BUSINESS........................................5 DESCRIPTION OF SHARE CAPITAL.......................33
OUR RETAIL BUSINESS GROWTH STRATEGY..............5 COMMON SHARES...................................33
OUR RETAIL STORES................................6 PREFERRED SHARES................................33
OUR EXISTING RETAIL LOCATIONS....................6 DIVIDENDS AND DIVIDEND POLICY...................33
MARKET SEGMENTS AND REVENUE MIX..................7 TRADING IN OUR COMMON SHARES.......................33
SEASONALITY OF THE RETAIL VIDEO INDUSTRY.........7 DETAILS OF THE OFFERING............................34
LICENSES / SUPPLY AGREEMENTS.....................7 PLAN OF DISTRIBUTION...............................35
MARKETING AND ADVERTISING........................8 RIGHTS TO ACQUIRE COMMON SHARES....................36
INVENTORY........................................9 STOCK OPTION PLAN...............................36
INFORMATION SYSTEMS..............................9 OTHER RIGHTS TO PURCHASE COMMON SHARES..........37
COMPETITION AND TECHNOLOGICAL OBSOLESCENCE.......9 PRINCIPAL SHAREHOLDERS.............................37
TRADEMARKS......................................10 RELATED PARTY TRANSACTIONS.........................38
OUR EMPLOYEES...................................10 DILUTION...........................................39
CORPORATE STRUCTURE.............................10 CONFLICTS OF INTEREST..............................39
OUR ACQUISITIONS................................10 RISK FACTORS.......................................39
OUR CAPITAL EXPENDITURES........................12 CORPORATION SPECIFIC RISKS......................39
E-TREND NETWORKS, INC...........................13 ACQUISITION RISKS...............................41
OUR PROPERTIES AND EQUIPMENT....................13 OPERATING RISKS.................................42
SELECTED CONSOLIDATED FINANCIAL INFORMATION........14 CORPORATION AND SECURITIES RELATED RISKS........45
OPERATING AND FINANCIAL REVIEW.....................15 PRIOR SALES........................................46
NINE MONTHS ENDED FEBRUARY 28, 2002 MATERIAL CONTRACTS.................................46
COMPARED TO NINE MONTHS ENDED FEBRUARY 28, 2001.15 LEGAL MATTERS......................................46
FISCAL 2001 COMPARED TO FISCAL 2000.............19 LEGAL PROCEEDINGS..................................46
FISCAL 2000 COMPARED TO FISCAL 1999.............23 AUDITORS, TRANSFER AGENT AND
BUSINESS RISKS AND MANAGEMENT...................26 REGISTRAR..........................................47
DIRECTORS AND SENIOR MANAGEMENT....................26 PURCHASER'S STATUTORY RIGHTS.......................47
COMPENSATION OF DIRECTORS AND EXECUTIVE OFFICERS...29 AUDITORS' REPORT...................................48
COMPENSATION OF DIRECTORS.......................29 CERTIFICATE OF THE CORPORATION.....................64
CERTIFICATE OF THE AGENTS..........................65
1
ELIGIBILITY FOR INVESTMENT
In the opinion of Shea Nerland Calnan and Gowling Lafleur Henderson LLP in
accordance with legislation in effect at the date hereof and subject to
compliance with the prudent investment standards and general investment
provisions and restrictions of the statutes referred to below (and, where
applicable, the regulations thereunder) and, where applicable, subject to the
satisfaction of additional requirements relating to investment or lending
policies, procedures or goals, and, where applicable without resort to the
so-called "basket provisions", the Units (and the Common Shares and the Warrants
contained therein) will not, at the closing of the offering, be precluded as
investments under the following statutes:
INSURANCE COMPANIES ACT (Canada) LOAN AND TRUST CORPORATIONS ACT (Ontario)
TRUST AND LOAN COMPANIES ACT (Canada) AN ACT RESPECTING INSURANCE (Quebec) for an
PENSION BENEFITS STANDARDS ACT, 1985 (Canada) insurer as defined therein, constituted under the
LOAN AND TRUST CORPORATIONS ACT (Alberta) laws of Quebec, other than a guarantee fund
INSURANCE ACT (Alberta) AN ACT RESPECTING TRUST COMPANIES AND SAVINGS
EMPLOYMENT PENSION PLANS Act (Alberta) COMPANIES (Quebec) for savings companies
PENSION BENEFITS STANDARDS ACT investing their own funds and by trust companies
(British Columbia) investing their own funds and funds received
FINANCIAL INSTITUTIONS ACT (British Columbia) as deposits
THE INSURANCE ACT (Manitoba) SUPPLEMENTAL PENSION PLANS ACT (Quebec), for a
THE TRUSTEE ACT (Manitoba) plan governed thereby
THE PENSION BENEFITS ACT (Manitoba) THE PENSION BENEFITS ACT, 1992 (Saskatchewan)
PENSION BENEFITS ACT (Ontario)
In the opinion of Shea Nerland Calnan and Gowling Lafleur Henderson LLP, at the
date hereof, the Units (and the Common Shares and the Warrants contained
therein) are qualified investments under the INCOME TAX ACT (Canada) (the "Tax
Act") and the regulations thereunder for a trust governed by a registered
retirement savings plan, a registered retirement income fund, a deferred profit
sharing plan and a registered education savings plan. Also in the opinion of
such counsel, based upon the information provided by the Corporation, at the
date hereof, the Units (and the Common Shares and the Warrants) do not
constitute "foreign property" for the purposes of Part XI of the Tax Act.
FORWARD LOOKING STATEMENTS
Except for statements of historical fact, certain information contained herein
constitutes "forward-looking statements," including, without limitation,
statements containing the words "believes," "anticipates," "intends," "expects"
and words of similar import. Such forward-looking statements involve known and
unknown risks, uncertainties and other factors which may cause our actual
results or achievements to be materially different from any future results or
achievements expressed or implied by such forward-looking statements. These
factors include, without limitation, risks associated with our history of recent
losses, our limited operating history, our ability to increase revenue growth at
existing stores, our ability to sustain our growth or to manage the growth of
our operations, our ability to obtain additional financing to expand our
business, piracy of the products we offer, our ability to compete with other
video chains for acquisition targets, our reliance on representations made by
sellers of acquisition targets, our ability to make informed decisions on
private company acquisition targets, our ability to integrate the operations of
video retail stores that we acquire with our existing stores and systems,
competition in the video retail industry, competitors with greater resources,
technical obsolescence of the entertainment products that we offer, additional
capital expenditures required to increase our DVD selection, movie studios
adversely changing their distribution practices, our dependence on suppliers and
wholesalers for inventory, seasonal and operating fluctuations of our
operations, newly released movies being initially priced as a sell-through
product, changes in our cost structure, changes in the local economies where we
operate, and our reliance on the expertise of key personnel. See "Risk Factors".
Although the forward looking statements contained in this prospectus are based
upon assumptions believed solely by our management to be reasonable, we cannot
assure investors that actual results will be consistent with these forward
looking statements. These forward looking statements are made as at the date of
this prospectus, and we assume no obligation to update or revise them to reflect
new events or circumstances.
2
PROSPECTUS SUMMARY
THE FOLLOWING IS A SUMMARY OF THE PRINCIPAL FEATURES OF THE OFFERING AND SHOULD
BE READ TOGETHER WITH THE MORE DETAILED INFORMATION AND FINANCIAL DATA AND
STATEMENTS CONTAINED ELSEWHERE IN THIS PROSPECTUS.
VHQ ENTERTAINMENT INC.
We, VHQ Entertainment Inc., are a Canada corporation, incorporated on September
5, 1997. In this prospectus "VHQ Entertainment", "VHQ", "we", "us", "our" or the
"Corporation" refers to VHQ Entertainment Inc. and its subsidiaries as the
context requires. We operate, directly and through our wholly-owned
subsidiaries, a chain of 49 video and home entertainment stores in Alberta,
Saskatchewan and the Northwest Territories. Our business strategy is to focus on
serving rural and secondary markets and smaller urban centers, which typically
have less competition, lower fixed costs and lower staffing costs. We intend to
grow by opening new stores using our video and home entertainment store format
that we have developed and by acquiring existing video and home entertainment
stores in the markets that we target to serve.
Our principal business office is located at 6201 - 46th Avenue, Red Deer,
Alberta T4N 6Z1, and our registered office is located at 1900, 715 - 5th Avenue,
S.W., Calgary, Alberta T2P 2X6. Our web site is WWW.VHQ.CA.
THE OFFERING
OFFERING: The offering is a maximum of __ Units for gross proceeds
of $10,000,000 and a minimum of __ Units for gross proceeds
of $4,000,000, in either case before the exercise, if any,
of the Over-Allotment Option. Each Unit consists of 1
Common Share and 1/2 Warrant which are not separable until
after the Record and Distribution Date which will not be
later than __, 2002. Each whole Warrant entitles the holder
of that Warrant to purchase 1 Warrant Share at any time
from the date it is issued until 5:00 p.m. (Toronto time)
on __ at an exercise price of $__ per Warrant Share. See
"Plan of Distribution".
OFFERING PRICE: The Offering Price is $__ per Unit.
PROCEEDS: Assuming that the Agents do not exercise the Over-Allotment
Option in whole or in part, the total price to the public,
the Agents' fee and the net proceeds to us after deducting
estimated expenses of the offering will be $__, $__ and
$__, respectively, assuming completion of the maximum
offering, and $__, $__ and $__, respectively, assuming
completion of the minimum offering.
If the Agents exercise the Over-Allotment Option in full,
the total price to the public, the Agents' fee and the net
proceeds to us after deducting estimated expenses of the
offering will be $__, $__ and $__, respectively, assuming
completion of the maximum offering, and $__, $__ and $__,
respectively, assuming completion of the minimum offering.
See "Plan of Distribution".
USE OF PROCEEDS: The net proceeds of the offering will be used by us to
open new stores or acquire additional stores, purchase
additional inventory for resale, reduce outstanding short
term debt and complete a new point of sale software system.
See "Use of Proceeds".
3
RISK FACTORS
Investment in the Units is subject to a number of risk factors that investors
should consider carefully. These risk factors include, without limitation, risks
associated with our history of recent losses, our limited operating history, our
ability to increase revenue growth at existing stores, our ability to sustain
our growth or to manage the growth of our operations, our ability to obtain
additional financing to expand our business, piracy of the products we offer,
our ability to compete with other video chains for acquisition targets, our
reliance on representations made by sellers of acquisition targets, our ability
to make informed decisions on private company acquisition targets, our ability
to integrate the operations of video retail stores that we acquire with our
existing stores and systems, competition in the video retail industry,
competitors with greater resources, technical obsolescence of the entertainment
products that we offer, additional capital expenditures required to increase our
DVD selection, movie studios adversely changing their distribution practices,
our dependence on suppliers and wholesalers for inventory, seasonal and
operating fluctuations of our operations, newly released movies being initially
priced as a sell-through product, changes in our cost structure, changes in the
local economies where we operate, our reliance on the expertise of key
personnel, the immediate and substantial dilution that purchasers of Units will
suffer, the lack of a market for the Warrants, and the improbability that any
dividends will be paid in the foreseeable future. See "Risk Factors".
SELECTED FINANCIAL DATA
The following table sets out selected financial data regarding our consolidated
operating results and financial position. The data has been derived from our
consolidated financial statements, which have been prepared in accordance with
accounting principles generally accepted in Canada ("Canadian GAAP"). The
following selected financial data is qualified in its entirety by, and should be
read in conjunction with, the consolidated financial statements and notes
thereto included elsewhere in this prospectus.
Nine Months Ended
February 28 Twelve Months Ended May 31
--------------------------------------------------------------------------------
2002 2001 2001 2000 1999
------------- ------------ ------------ -------------- -------------
(unaudited) (unaudited) (audited) (audited) (audited)
Revenues 19,695,750 15,797,843 21,330,467 12,884,852 4,919,535
Operating income (loss) 769,612 1,933,159 1,241,411 891,794 398,754
Income (loss) before certain (70,624) 703,324 (387,803) 7,307 390,383
items(1)<F1>
EBITDA(2)<F2> 4,416,023 4,429,418 4,570,824 2,959,479 1,312,669
Amortization of rental product 3,269,065 1,975,341 2,599,104 1,450,933 643,896
Net income (loss) (1,299,933) 122,513 (2,813,521) 2,102,867 217,383
Net income (loss) per share(3)<F3> (0.11) 0.01 (0.24) 0.21 0.03
Total assets 15,587,644 16,420,314 13,737,968 14,553,094 3,955,310
Total long term debt(4)<F4> 1,075,420 201,571 110,794 233,996 222,422
<FN>
(1)<F1> Certain items includes: write down of capital assets, write down
of investments, minority interest, equity loss on investment, gain on
dilution of investment, gain on disposal of assets and future income
taxes.
(2)<F2> EBITDA is not a recognized measure under Canadian GAAP. As used in
this prospectus, EBITDA means net income before future income taxes
(recovery), gain on disposal of assets, gain on dilution of investment,
equity loss of investment, minority interest, write-down of capital
assets, write-down of investment, Video Limited Partnership
disbursements, income tax recovery, interest on convertible debenture,
interest expense (net), amortization of intangibles, amortization of
rental product, and amortization of other store related capital assets
in the amount of $357,264, $245,810, $368,375, $370,464, and $266,200
for the 9 months ended February 28, 2002, 9 months ended February 28,
2001, and the 12 months ended May 31, 2001, 2000, and 1999,
respectively, which is included in store operating expenses.
(3)<F3> Net income (loss) per share was calculated using the weighted average
number of Common Shares outstanding. An assumed conversion of the
options and warrants to purchase Common Shares and the resultant
imputed interest savings does not have a dilutive effect on earnings
(loss) per share.
(4)<F4> Excluding current portion.
</FN>
4
THE CORPORATION
We, VHQ Entertainment Inc., were incorporated as 753541 Alberta Ltd., an Alberta
corporation under the BUSINESS CORPORATIONS ACT (Alberta) on September 5, 1997.
Our authorized capital consisted of an unlimited number of Common Shares. On
December 22, 1997, our Articles of Incorporation were amended to change our name
to Video Headquarters Inc. and to create a new class of an unlimited number of
preferred shares issuable in series. On September 18, 1998, our Articles of
Incorporation were amended to consolidate our Common Shares on the basis of 2
old shares for 1 new share. All references to numbers of Common Shares in this
prospectus are after giving effect to the share consolidation. On November 25,
1999, our articles were amended to allow for the election or appointment of
directors for terms expiring not later than the close of the third annual
meeting of shareholders following their election or appointment. Pursuant to
Articles of Continuance dated December 1, 2000, we were continued under the
CANADA BUSINESS CORPORATIONS ACT ("CBCA") and our name was changed to "VHQ
Entertainment Inc."
Our principal business office is located at 6201 - 46th Avenue, Red Deer,
Alberta T4N 6Z1, and our registered office is located at 1900, 715 - 5th Avenue,
S.W., Calgary, Alberta T2P 2X6. Our phone number is (403) 346-8119 and our
e-mail address is www.mail@vhq.ca.
Our web site is located at WWW.VHQ.CA. Information contained on our web site is
not part of this prospectus.
OUR BUSINESS
We operate, directly and through our wholly owned subsidiaries, a chain of 49
retail video and home entertainment stores in Alberta, Saskatchewan and the
Northwest Territories. Our business strategy is to focus on serving rural and
secondary markets and smaller urban centers, which typically have less
competition, lower fixed costs and lower staffing costs. We intend to grow by
opening new stores using our video and home entertainment store format that we
have developed and by acquiring existing video and home entertainment stores in
the markets that we target to serve.
OUR RETAIL BUSINESS GROWTH STRATEGY
Our business strategy is to compete in rural markets with a trading area
population averaging approximately 10,000, small urban centers and, to a lesser
degree, within neighborhood markets in large urban centers. We believe that the
advantages of targeting these markets are:
o less competition.
o less indirect competition from other entertainment venues such as
organized sport, theatres, pools and other forms of entertainment or
recreation.
o the ability to develop market share at lower per customer expense.
o lower fixed costs, such as for leased space.
o lower staffing costs including, generally, less staff turnover.
o lower existing market penetration by competitors.
We generally charge rental rates that are competitive with rates charged by our
competitors in larger urban centers.
We intend to grow by establishing new, or acquiring established, video and home
entertainment stores.
We intend to apply specific selection criteria when evaluating new locations,
including:
o population base within 30 kilometres exceeding 10,000 persons.
o competition, or lack thereof, in a target market.
o availability of convenient retail space with available drive-up
parking.
o traffic, frontage and exposure at retail site.
o demographic characteristics of the area (household size, age and
income).
5
OUR RETAIL STORES
Our video and home entertainment stores are typically located in retail strip
shopping centres and well-located stand-alone retail stores and range in size
from 3,500 to 8,000 square feet. Our stores are open seven days a week,
generally from 10 a.m. to 12 midnight.
Our stores display new release movies alphabetically and catalogue titles are
displayed alphabetically by category, such as "Action," "Comedy," "Drama" and
"Children." Our typical store's inventory consists of video cassettes ("VHS"),
digital versatile discs ("DVD"s), video games and music compact discs ("CD"s).
The actual inventory of each store varies depending on its location. We
continually review each store to ensure that inventory is meeting local demand.
Also, each store has a few special interest titles, covering such subjects as
hunting, golf and education, selected by management to appeal to the customer
base in the store's local market area. We make buying decisions centrally and
base these decisions on box office results, actual rental history of comparable
titles within each store and industry research.
Based on our experience, we believe that our typical store's revenues are
affected by internal factors such as our new release title selection and the
number of copies of each new release available for rental as compared to our
competitors. We are committed to offering as many copies of new releases as
necessary to be competitive within a market, while at the same time keeping our
costs as low as possible. New VHS tapes, DVDs and music CDs offered by us for
sale are primarily "hit" titles promoted by the studios for sell-through, as
well as special interest titles, children's titles and seasonal titles related
to particular holidays.
We design each store using uniform store fixtures, equipment and layout to
create brand identity. Our stores play movie previews and promotions of coming
attractions on in-store video and sound preview systems for the enjoyment of our
customers. Each of our stores is decorated in bright and attractive colours and
features posters and stand-up displays promoting specific movie, music and video
game titles. We arrange movies, music and video games in attractive display
boxes organized into categories by topic, except for new releases, which are
assembled alphabetically in their own section for ease of selection by
customers.
Our stores were originally operated under the brand "Video Headquarters". During
the past 18 months, we have adopted a new format under the "VHQ" brand. This new
format is designed to generate higher traffic volumes and repeat business as
part of our re-branding effort. Our new store layout uses inviting colours,
state-of-the-art entertainment systems, and a broader selection of
entertainment-related products, including music CDs, video game accessories,
video games for sale, studio merchandise related to filmed entertainment and
music, sell-through filmed entertainment and an expanded selection of DVD titles
for rent. As part of our re-branding strategy, we are in the process of painting
and installing new fixtures in existing stores and in making physical layout
changes to enhance check-out processes. The final stage of our re-branding
strategy will be to update store exteriors and signage. We believe that the
increased product selection provides opportunities for cross-product promotion
in order to increase the average size of a purchase. We have opened 13 locations
using the new format and have begun the introduction of the new format in an
additional 17 locations. At the date of this prospectus, the remaining stores
continue to operate under the "Video Headquarters" brand.
Generally, we spend approximately $225,000-$275,000 to open each new store.
These costs are net of tenant inducements and include tenant finish, fixtures,
computers, point-of-sale equipment, security devices, interior and exterior
signage, inventory for rent, deposits, staff recruitment and training, and
inventory for sale.
Our policy is to constantly evaluate our existing store base to determine where
improvements may benefit our competitive position in the areas we serve. In
negotiating leases, we attempt to negotiate flexible lease terms to allow us to
react to changing demographics and other market conditions.
In the future, we may actively pursue relocation opportunities to adapt to
market shifts. Similarly, we may elect to expand and/or remodel certain of our
stores in order to improve facilities, meet customer demand and maintain the
visual appeal of each store.
OUR EXISTING RETAIL LOCATIONS
On September 18, 1998, we acquired Integrated Retail Corp., which operated 7
video retail outlets in Alberta. Since that date, we have opened 26 new video
retail outlets (24 in Alberta, 1 in Saskatchewan and 1 in the
6
Northwest Territories) and acquired 16 video retail outlets (eight in each of
Alberta and Saskatchewan). These openings and acquisitions bring the total
number of our video and home entertainment outlets to 49.
The following table sets forth the locations of our video and home entertainment
outlets:
Alberta Airdrie; Blackfalds; Brooks; Calgary (13); Camrose;
Drayton Valley; Drumheller; Edmonton (2); Ft.
Saskatchewan; Lacombe; Leduc (2); Lethbridge (3);
Lloydminster; Okotoks; Ponoka; Red Deer (2); Rocky
Mountain House; Spruce Grove; Stony Plain; Sylvan
Lake; Wetaskiwin; and Whitecourt.
Saskatchewan Saskatoon (8); and Weyburn.
Northwest Territories Yellowknife.
MARKET SEGMENTS AND REVENUE MIX
Our revenues are derived principally from VHS and DVD rental, video game rental,
sell-through video/gaming software sales, music sales, confectionery sales and
previously viewed video/gaming software sales. The sale and distribution of each
category of product is conducted principally through our retail storefronts and
via the Internet through our web site. The following table sets forth the
breakdown of sales in each category as a percentage of total revenues for the
periods indicated:
Nine Months Ended
February 28 Twelve Months Ended May 31
------------------ --------------------------------------------------
2002 2001 2000 1999
------------------ -------------- --------------- --------------
VHS and DVD rental 66.4% 68.2% 74.3% 67.6%
Video game rental 8.8% 9.9% 5.2% 9.9%
Sell-through video/gaming software sales 8.7% 8.3% 11.0% 8.9%
Music sales 7.3% 6.1% 2.8% 6.1%
Confectionery sales 6.2% 6.5% 5.1% 6.5%
Previously viewed video/gaming software 2.6% 1.0% 1.6% 1.0%
sales
SEASONALITY OF THE RETAIL VIDEO INDUSTRY
The home entertainment industry is characterized by a degree of fluctuating
sales related to weather and other factors such as statutory and school
holidays. We generally experience our greatest sales during periods of inclement
weather during the winter when outdoor or other competing activities may not be
available. Also, our sales generally increase during statutory and school
holidays when families and school children are at home.
LICENSES / SUPPLY AGREEMENTS
We obtain our product from a number of suppliers. Approximately 50% of our VHS
and DVD inventory is supplied through Video One Canada Ltd. ("Video One") and
Rentrak Corporation ("Rentrak"). We have a non-exclusive Product Fulfillment
Agreement with Video One which provides for the supply of film entertainment
rental and retail products, entertainment merchandise and video game rental
products. This agreement will expire on January 31, 2003.
We also have a ten year non-exclusive Revenue Share Agreement with Rentrak which
provides for the supply of rental products on a revenue share basis.
The other 50% of our VHS and DVD rental and retail product is obtained through
direct revenue sharing agreements we have with a number of the movie film
studios and other product purchase arrangements we have
7
with individual suppliers and wholesalers. The film studios that we have direct
revenue sharing agreements with are Columbia TriStar Home Video Canada, Inc.,
Warner Home Video (Canada) Ltd., and Paramount Pictures (Canada) Inc.
We obtain our video game product almost entirely from Video One and our music
from Langara Distribution Inc., a music distribution company owned by E-Trend
Networks, Inc. See "E-Trend Networks, Inc.". We continually review arrangements
with third-party suppliers and may, in the normal course of business, change
such suppliers if more advantageous terms of supply can be negotiated.
MARKETING AND ADVERTISING
We have developed a comprehensive advertising and promotion strategy that is
implemented in the various markets depending on the market demographics. The
various marketing approaches include:
1. Local Store Marketing/Sales Promotions
Sales promotions include price discounts, contests, and daily or weekly
features. Also, each retail store is encouraged to participate in local
community events, including sports, charities and other public
functions.
2. Bulk Mail
The mailing of unaddressed fliers with coupons is believed by
management to be one of the most effective ways to build store traffic
and maintain customer loyalty.
3. Radio Advertising
Radio advertising is a core strategy used in major markets. It is also
a key element in building our brand recognition.
4. Print
Newspaper advertising is used on a local level to promote in-store
activities and major product announcements.
5. Outdoor Signage
In highly competitive markets, outdoor advertising (including billboard
and transit signage) is used in the perimeter marketing area of the
competition. This is a defensive strategy to keep the VHQ brand
prominent in locations where consumers have a choice as to where they
buy home entertainment.
6. Third Party Partnership/Strategic Partners
On an ongoing basis we participate in cross-promotions with strategic
partners and co-op advertising in conjunction with film studios and
music labels. Also, each store is encouraged to continually exploit
cross-marketing opportunities (such as cross-couponing) with other
retailers, such as pizza stores, in its local market.
7. Customer Data Base
Customers who fail to return to a store in a specified period of time
are contacted directly by telephone and/or direct mail. More recently,
we have adopted new marketing strategies including "late fee" waivers
and $5.00 credit vouchers to bring customers back.
8. Television
The use of television advertising will be used commencing during the
latter half of calendar 2002.
8
Our current marketing budget is approximately 1% of sales. We also receive
funding for advertising through various vendor co-operative advertising funds
and market development funds established with product suppliers and movie
studios. We also benefit from advertising marketing done by studios and theatres
in connection with the promotion of the theatrical release of films. We expect
we will increase our marketing budget, particularly as we add television
advertising and as we expand our stores into new provinces.
Our retail stores are actively involved in their respective communities, and are
focused on meeting the needs of their loyal customers.
INVENTORY
The VHS, DVD, music CD, and video game inventory in each store consists of our
catalogue titles (those in release for more than one year) and new release
titles. New releases of VHS tapes and video games purchased from suppliers for
existing stores are drop-shipped to the stores. Our stores generally offer from
5,000 to 10,000 VHS tapes, from 1,000 to 5,000 DVDs, from 500 to 1,500 video
games and from 500 to 3,000 music CDs for rental and sale, depending upon
location. We generally have a one-day rental term for new release movies less
than 90 days old which tends to keep new releases more readily available. Rental
terms for new releases greater than 90 days old but less than one year old are
generally two days and rental terms on children's and catalogue titles are
generally seven days. Video games generally have a two-day rental term for the
most recent new releases and five days for older, catalogue titles. Music CDs
are currently sold on a retail basis.
VHS tapes, DVD, music CDs and video games used as initial inventory in our new
stores consist of excess copies of catalogue titles and new release titles from
existing stores, supplemented as necessary by purchases directly from suppliers.
Each rental VHS tape, DVD and video game is removed from its original packaging,
and an optical bar code label used in our computerized inventory system and a
security label is applied to the media directly. The cassette is placed in the
rental case, and the original product packaging is then used for display
purposes. The repackaged VHS tapes, DVDs, video games and display cartons are
then shipped to the store ready for use.
INFORMATION SYSTEMS
Each of our stores is equipped with a point-of-sale ("POS") system. Our POS
system provides detailed information with respect to a store's operations
(including the rental history of titles and daily operations for each store).
Our POS system tracks all rental and sale information using scanned bar code
information. Each night our POS system transmits store data to the management
information system ("MIS") at our corporate office. All data is processed,
generating reports which allow our management to effectively monitor store
operations and inventory, as well as to review rental history by title and
location to assist in making purchasing decisions with respect to new releases.
Our POS system also enables us to perform a monthly physical inventory using bar
code recognition. Management is currently reviewing our current system and
intends to replace it with a customized POS system that provides greater
functionality and ability to data mine for marketing purposes. Management
intends to develop and implement a new POS system during calendar 2003.
COMPETITION AND TECHNOLOGICAL OBSOLESCENCE
We believe the principal competitive factors in the home entertainment industry
are:
o store location, visibility, and layout and design.
o title selection.
o the number of copies of each new release available.
o customer service.
o pricing.
The home entertainment industry is highly competitive, and we compete with other
video and home entertainment stores, including stores operated by other regional
and national chains such as Blockbuster Video, Rogers Video and Video Update. We
also compete with other businesses offering VHS tapes, DVDs and video games such
as supermarkets, pharmacies, convenience stores, bookstores, mass merchants,
mail order operations and other retailers.
9
In addition, we compete with all forms of entertainment, such as movie theatres,
network and cable television, direct broadcast satellite television,
Internet-related activities, live theatre, sporting events and family
entertainment centres. Some of our competitors have significantly greater
financial and marketing resources and name recognition than us. Emerging new
technologies such as "Near Video On Demand", "Video On Demand" and digital cable
also provide competition. See "Risk Factors".
We cannot assure you that we will successfully compete in the markets that we
serve or that we will generate sufficient revenues to remain profitable.
TRADEMARKS
We have or are in the process of applying for various Canadian trademarks
including, but not limited to, "VHQ", the VHQ logo, "WHERE ENTERTAINMENT
BEGINS", and "MOVIES MUSIC GAMES ... AND MORE". We expect to receive final
Canadian trademark approval for those marks in due course but there can be no
assurance that we will be successful.
Our brand names are important to us and we believe that their importance will
increase as we continue to expand our operations. We have sought registration,
where possible, to afford some measure of protection for our intellectual and
intangible property.
We cannot assure you that our efforts to protect our intellectual and intangible
property will be successful.
OUR EMPLOYEES
As of April 30, 2002, we had approximately 445 employees, including 60 employees
in management and administration and approximately 385 employees who service
customers in our video and home entertainment stores. A majority of our
employees are either permanent part-time or part-time employees. Of the total
number of employees at such date, 343 were located in Alberta, 90 in
Saskatchewan and 12 in the Northwest Territories.
CORPORATE STRUCTURE
We operate our retail video and home entertainment business directly and through
four wholly-owned subsidiaries: Integrated Retail Corp. ("Integrated Retail"),
an Alberta corporation, Safiqa Holdings Ltd. ("Safiqa"), an Alberta corporation,
Star Vision Enterprises Inc. ("Star Vision"), a Saskatchewan corporation, and
705556 Alberta Ltd. ("705556"), an Alberta corporation.
OUR ACQUISITIONS
In implementing our business strategy, we identified and acquired established
video stores in markets that we targeted. We have completed the following
acquisitions:
OUR ACQUISITION OF INTEGRATED RETAIL
On September 18, 1998, we acquired Integrated Retail, a retailer operating seven
video stores, from its security holders pursuant to a share purchase agreement
dated July 20, 1998 (the "Integrated Retail Agreement"). The transaction was
non-arms length since a majority of the shares of Integrated Retail were owned
by Trevor Hillman (our Chairman and Chief Executive Officer), his family, and
Gregg Johnson (our President and Chief Operating Officer). Under the terms of
the Integrated Retail Agreement, we purchased all of the issued shares and
certain outstanding options and broker warrants of Integrated Retail in
consideration for a total purchase price of $2,600,000. The purchase price was
paid by issuing:
(i) 5,000,000 Common Shares to the shareholders of Integrated
Retail, including 1,400,000 to Trevor Hillman;
(ii) 200,000 Common Shares to Gregg C. Johnson in exchange for
the cancellation of his option to acquire 250,000 shares of
Integrated Retail;
10
(iii) warrants exercisable to purchase 500,000 Common Shares at
$0.75 per share until March 31, 1999, 479,000 of which were
exercised; and
(iv) warrants exercisable to purchase 210,000 Common Shares at
$0.50 per share until March 31, 1999, 104,000 of which were
exercised.
As VHQ Entertainment and Integrated Retail were under common control at the time
of the acquisition, our financial statements have been presented using the
continuity of interest method of accounting. Under this method of accounting,
the financial position and results of operations for the current and prior
periods are presented as if the new corporate structure had existed since the
inception of Integrated Retail.
OUR ACQUISITION OF SAFIQA
On September 29, 1999, we acquired Safiqa, an independent video retailer
operating four video stores in the Calgary, Alberta market under the brand name
"Rainbow Video", pursuant to a share purchase agreement dated June 1, 1999 (the
"Safiqa Agreement") with Ayaz Kara, Nayaz Kara, and Moez Hirji. Under the Safiqa
Agreement, we acquired all of the issued shares of Safiqa in consideration for a
total purchase price of $2,125,000. The purchase price was paid:
(i) as to $1,125,000, by issuing 900,000 Common Shares at a deemed
value of $1.25 per share;
(ii) as to $100,000, in cash; and
(iii) as to the balance, by issuing promissory notes in the
aggregate principal amount of $900,000 payable on or before
March 31, 2000, with interest calculated at the rate of 12%
to December 31, 1999 and 18% from January 1, 2000 to March 31,
2000, all of which have been fully paid and cancelled.
Our acquisition of Safiqa was accounted for by the purchase method of
accounting.
OUR ACQUISITION OF STAR VISION
On December 1, 1999, we acquired Star Vision, an independent video retailer
operating six video stores in the Saskatoon market under the brand name "Family
Video", pursuant to a share purchase agreement dated December 1, 1999 (the "Star
Vision Agreement") with Marc Gignac and Gisele Gignac. Pursuant to the Star
Vision Agreement, we acquired all of the issued shares of Star Vision in
consideration for a total purchase price of $2,914,000. The purchase price was
paid:
(i) as to $1,000,000, by issuing a promissory note in that
principal amount, $500,000 payable on January 31, 2000, and
$500,000 payable on February 29, 2000, with interest
calculated at the rate of 10% per annum, which note was fully
paid and cancelled;
(ii) as to $1,414,000, by issuing 1,010,000 Common Shares at a
deemed value of $1.40 issued per share; and
(iii) as to $500,000, in cash.
Subsequent to closing, a cash payment adjustment to the purchase price of
$297,188 was paid based on the working capital position of Star Vision on
November 30, 1999.
In addition, we granted Marc Gignac an option exercisable to acquire 25,000
common shares of E-Trend Networks, Inc. for $1.00 per share until November 31,
2002. This option was subsequently cancelled on the disposition of our interest
in E-Trend. See "E-Trend Networks, Inc.".
Our acquisition of Star Vision was accounted for by the purchase method of
accounting.
11
OUR ACQUISITION OF 705556
Effective March 21, 2000, we acquired 705556, an independent video retailer
operating two video and home entertainment stores under the trade name "Movies
Plus", pursuant to a share purchase agreement dated March 21, 2000 (the "705556
Agreement") with Altaf Hirji and Shelina Hirji. Under the 705556 Agreement, we
acquired all of the issued shares of 705556 in consideration for a total
purchase price of $625,000. The purchase price was paid:
(i) as to $150,000, in cash;
(ii) as to $50,000, by issuing promissory notes in that aggregate
principal amount payable on or before April 30, 2000, which
notes have been fully paid and cancelled;
(iii) as to $50,000, by issuing promissory notes in that aggregate
principal amount payable on or before May 30, 2000, which notes
have been fully paid and cancelled; and
(iv) as to $375,000, by issuing 86,207 Common Shares at a deemed
value of $4.35 per share.
OUR ASSET ACQUISITIONS
On June 15, 2000, Star Vision acquired from Raeco Holdings Incorporated
("Raeco") all the assets of Silver Screen Video, a video and home entertainment
store operating in Saskatoon, Saskatchewan, in consideration for a total
purchase price of $200,000. The purchase price was paid as to $100,000 by
issuing 25,000 Common Shares at a deemed price of $4.00 per share and as to the
balance by three cash payments aggregating $100,000.
On July 11, 2000, we acquired the assets of M&K Video Spot Inc. ("M&K"), an
independent video retailer operating a video store in Stony Plain, Alberta and a
store in Spruce Grove, Alberta under the brand name "Five Star Movies", pursuant
to an asset purchase agreement dated July 11, 2000 (the "M&K Agreement"). Under
the M&K Agreement, we acquired all of the assets of M&K in consideration for a
total purchase price of $425,000. The purchase price was paid as to $175,000 by
issuing 43,750 Common Shares at a deemed value of $4.00 per share, as to 125,000
in cash and as to the balance by issuing a secured promissory note in the
principal amount of $125,000, payable in twelve monthly installments beginning
September 1, 2000, with interest at the rate of 9% per year, which note has been
fully paid and cancelled.
Effective March 15, 2001 we acquired all of the assets and business operations
of Hollywood North Video Limited, an independent video retailer operating a
video rental and retail store in La Ronge, Saskatchewan, for three cash payments
aggregating $70,000.
OUR CAPITAL EXPENDITURES
Our capital expenditures, which result from the purchase of rental assets and
the consideration paid for acquisitions net of asset sales, have been as
follows:
Nine Months Ended Twelve Months Ended May 31
February 28, ------------------------------------------------------
2002 2001 2000 1999
---- ---- ---- ----
Purchase of Capital Assets $4,361,860 $9,972,272 $4,989,913 $2,766,957
Consideration paid for acquisitions $2,097,519 $625,000 $1,664,000 -
(net of asset sales)
---------------------- --------------- --------------- ---------------
Total $6,459,379 $7,597,272 $6,653,913 $2,766,957
====================== =============== =============== ===============
We have made capital asset purchases of approximately $553,000 during the months
of March and April 2002.
Information concerning our principal capital expenditures and divestitures,
since inception and currently planned, are further described under "Our
Acquisitions" and "Operating and Financial Review".
12
E-TREND NETWORKS, INC.
In furthering our desire to mitigate the potential risk from the Internet
evolving as a means of the sale and distribution of competing entertainment
content and products, in April 1999 we participated in the formation of E-Trend
Networks, Inc. ("E-Trend"), a Nevada corporation headquartered in Calgary,
Alberta. Through its web site located at WWW.ENTERTAINME.COM, E-Trend created an
online entertainment portal for filmed entertainment in both VHS and DVD format
and access to industry related information and news. At the time of E-Trend's
incorporation, we owned 66.67% of its outstanding common shares. However, our
ownership position was gradually reduced as E-Trend issued shares from treasury
to finance its activities.
On February 22, 2001, E-Trend was acquired by Cool Entertainment Inc. ("Cool"),
a Delaware corporation, in a share exchange transaction with the E-Trend
shareholders including us. As a result of the acquisition, the shareholders of
E-Trend became the controlling shareholders of Cool, which changed its name to
E-Trend Networks, Inc., and the Delaware corporation became the parent of
E-Trend. At the date of E-Trend's acquisition by Cool, we owned 40.10% of the
issued shares of E-Trend.
On December 21, 2001, we entered into an agreement to sell our entire holdings
in Cool, being 2,000,000 common shares, to The Game Holdings, Ltd. (the "Game
Holdings"), a British Virgin Islands corporation, for US$800,000. The purchase
price was paid by way of a secured promissory note of Game Holdings payable as
follows:
(a) US$10,000 per month from January 2002 until March 2002;
(b) US$30,000 per month from April 2002 until May 31 2003; and
(c) the remainder of the purchase price on June 30, 2003.
The promissory note bears interest at a rate of 6% per annum and is secured by
way of a second charge against a yacht owned by Game Holdings which had an
estimated current resale value of approximately US$1,800,000 as determined by an
appraisal delivered by the purchaser. To date, we have not received any payments
from Game Holdings as required by the terms of the promissory note. We are
currently in negotiations with Game Holdings over amending the payment schedule
and the interest rate under the promissory note and the security to be provided
under such an amended note.
Management intends to continue the retail sale of its core products through the
Internet. Rather than pursue the Internet through E-Trend, we will conduct such
operations as a division of VHQ. We expect to initiate such sales during the
latter half of fiscal 2003.
OUR PROPERTIES AND EQUIPMENT
Our head office is located in Red Deer, Alberta where we operate an
administrative and central distribution facility from a 7,000 square foot
facility leased from a related party. See "Related Party Transactions". Our head
office consists of administrative and executive offices and our central
receiving, warehousing and distribution facility for all our retail locations.
We are also the head tenant on a lease for a 5,000 square foot facility in
Calgary, Alberta which is currently sublet to and occupied by E-Trend.
We currently operate 49 retail video and home entertainment stores, all of which
are leased from third parties, including 39 stores located in Alberta, with the
greatest concentration in central and southern Alberta, 9 stores in
Saskatchewan, and 1 in Yellowknife, Northwest Territories. We lease all of our
video and home entertainment stores at market rates for each geographic
location. The average term of our video and home entertainment store leases is 5
years.
13
SELECTED CONSOLIDATED FINANCIAL INFORMATION
The following table sets forth selected consolidated annual financial
information of VHQ.
Nine Months Ended
February 28 Twelve Months Ended May 31
-------------------------- ----------------------------------------------------
2002 2001 2001 2000 1999
------------ ------------ ------------- ------------- ---------------
(unaudited) (unaudited) (audited) (audited) (audited)
Revenues 19,695,750 15,797,843 21,330,467 12,884,852 4,919,535
Operating income (loss) 769,612 1,933,159 1,241,411 891,794 398,754
Income (loss) before certain items(1)<F1> (70,624) 703,324 (387,803) 7,307 390,383
EBITDA(2)<F2> 4,416,023 4,429,418 4,570,824 2,959,479 1,312,669
Amortization of rental product 3,269,065 1,975,341 2,599,104 1,450,933 643,896
Net income (loss) (1,299,933) 122,513 (2,813,521) 2,102,867 217,383
Net income (loss) per share(3)<F3> (0.11) 0.01 (0.24) 0.21 0.03
Total assets 15,587,644 16,420,314 13,737,968 14,553,094 3,955,310
Total long term debt(4)<F4> 1,075,420 201,571 110,794 233,996 222,422
<FN>
(1)<F1> Certain items includes: write down of capital assets, write down
of investments, minority interest, equity loss on investment, gain on
dilution of investment, gain on disposal of assets and future income
taxes.
(2)<F2> EBITDA is not a recognized measure under Canadian GAAP. As used in this
prospectus, EBITDA means net income before future income taxes
(recovery), gain on disposal of assets, gain on dilution of investment,
equity loss of investment, minority interest, write-down of capital
assets, write-down of investment, Video Limited Partnership
disbursements, income tax recovery, interest on convertible debenture,
interest expense (net), amortization of intangibles, amortization of
rental product, and amortization of other store related capital assets
in the amount of $357,264, $245,810, $368,375, $370,464, and $266,200
for the 9 months ended February 28, 2002, 9 months ended February 28,
2001, and the 12 months ended May 31, 2001, 2000, and 1999,
respectively, which is included in store operating expenses.
(3)<F3> Net income (loss) per share was calculated using the weighted average
number of Common Shares outstanding. An assumed conversion of the
options and warrants to purchase Common Shares and the resultant
imputed interest savings does not have a dilutive effect on earnings
(loss) per share.
(4)<F4> Excluding current portion.
</FN>
</table>
The following table sets forth selected quarterly consolidated financial
information of VHQ.
<table>
<caption>
Quarter ended
February Nov. 30, August 31, May 31, February Nov. 30, August 31, May 31,
28, 2002 2001 2001 2001 28, 2001 2000 2000 2000
----------- ----------- ----------- ----------- ----------- ----------- ----------- -----------
(unaudited) (unaudited) (unaudited) (unaudited) (unaudited) (unaudited) (unaudited) (unaudited)
<s>
Revenue ($) 7,156,277 6,523,817 6,015,656 5,532,624 5,975,219 5,218,034 4,604,590 4,176,316
Operating income 705,032 67,686 (3,106) (691,748) 930,372 661,307 341,482 410,131
(loss)
Income (loss) before 694,828 (341,329) (424,123) (1,091,127 498,885 245,466 (41,027) (320,141)
certain items(1)<F1>
EBITDA ($)(2)<F2> 2,155,530 1,268,320 992,262 141,406 1,774,759 1,527,646 1,127,015 1,179,318
Amortization of 1,323,505 1,066,829 878,791 623,763 707,788 695,377 572,176 476,656
rental product
Net income (loss) ($) (879,491) 1,671 (422,113) (2,936,034) 291,302 (20,439) (148,350) (308,198)
Net income (loss) per (0.07) 0.00 (0.04) (.26) 0.02 0.00 (0.01) (0.03)
share(3)<F3> ($)
<FN>
(1)<F1> Certain items includes: write down of capital assets, write down of
investments, minority interest, equity loss on investment, gain on
dilution of investment, gain on disposal of assets and future income
taxes.
(2)<F2> EBITDA is not a recognized measure under Canadian GAAP. As used in this
prospectus, EBITDA means net income before future income taxes
(recovery), gain on disposal of assets, gain on dilution of investment,
equity loss of investment, minority interest, write-down of capital
assets, write-down of investment, Video Limited Partnership
disbursements, income tax recovery, interest on convertible debenture,
interest expense (net), amortization of intangibles, amortization of
rental product, and amortization of other store related capital assets
in the amount of $120.299, $127,111, $109,853, $70,789, $94,188,
$(1,229), $204,627, and $55,060 for the quarters ended February 28,
2002, November 30, 2001, August 31, 2001, May 31, 2001, February 28,
2001, November 20, 2000, August 31, 2000 and May 31, 2000,
respectively, which is included in store operating expenses.
(3)<F3> Net income (loss) per share was calculated using the weighted average
number of Common Shares outstanding.
</FN>
</table>
14
<page>
OPERATING AND FINANCIAL REVIEW
This management's discussion and analysis of our financial condition and results
of operations focuses on key statistics from our consolidated financial
statements for the interim nine month period ended February 28, 2002, and the
fiscal years ended May 31, 2001, 2000, and 1999 and pertains to known risks and
uncertainties relating to our businesses. This management's discussion and
analysis should be read in conjunction with the consolidated financial
statements and related notes contained elsewhere in this prospectus.
NINE MONTHS ENDED FEBRUARY 28, 2002 COMPARED TO NINE MONTHS ENDED FEBRUARY 28,
2001
OPERATING RESULTS
REVENUES
We experienced an increase in revenues for the nine months ended February 28,
2002 compared to the same nine month period ended February 28, 2001. Revenues
increased 24.7% to $19.7 million compared to $15.8 million for the similar
period in 2001. The third quarter of fiscal 2002 is of particular significance
as we experienced our strongest quarter in terms of total revenues. The
substantial increase in revenues resulted from: (i) an increase in the number of
stores to 48 as at February 28, 2002 compared to 42 stores as at February 28,
2001, and (ii) a 6.3% increase in same-store sales for the nine months ended
February 28, 2002 compared to the similar nine month period in 2001. The
increase in same-store sales primarily resulted from:
(i) continued consumer acceptance and growth of the DVD format;
(ii) strong product availability for customers from the direct
revenue sharing and copy depth programs for filmed
entertainment products;
(iii) the continuing success of the chain-wide implementation of our
re-branding campaign and internal marketing program designed
to generate higher customer awareness, store traffic and
purchase of items including music and sell-through filmed
entertainment;
(iv) the continued growth of music sales into a greater number of
stores; and
(v) increases in ancillary sales that include confectionery items.
The relative mix of revenues between rental revenues and product sales for the
nine months ended February 28, 2002 was 75.2% and 24.8%, respectively, compared
to 77.8% and 22.2% for the similar nine month period in 2001. The increase in
the lower margin product sales resulted from our successful implementation of
the previously viewed VHS tape sales program and a higher number of movie titles
released as direct sell-through product by certain movie studios, and our
continued focus on increasing product availability for music and confectionery.
Rental revenues include rentals of VHS tapes, DVDs, video games, and sales of
previously viewed new release titles on VHS and DVD formats. The strategic
importance of DVDs as a product offering continues to grow, evidenced by DVD
rental revenues exceeding 20.1% of total rental revenues for the nine months
ended February 28, 2002 as compared to 9.1% for the similar nine month period in
February 28, 2001.
Revenues from product sales include sales of all items, excluding previously
viewed new release titles on VHS and DVD. This category includes the sale of
other previously viewed items, confectionery, CD and cassette based music,
sell-through filmed entertainment on VHS and DVD, gaming accessories, studio
merchandise, posters and ancillary goods.
COST OF SALES FOR RENTALS
For the nine month period ended February 28, 2002, the cost of sales for rentals
increased 61.2% to $4.76 million compared to $2.95 million for the similar
period in 2001.
15
<page>
The cost of sales for rental is comprised of two components. The first component
is revenue sharing expenses incurred with certain movie studios under the direct
revenue sharing programs, and the second component is the amortization of rental
inventory including VHS tapes, DVDs, video games and equipment for rent.
The first component, the revenue sharing expenses, totaled $1.49 million for the
nine months ended February 28, 2002 compared to $979,475 in the nine months
ended February 28, 2001. The 52.2% increase reflects our increased usage of
these revenue sharing programs designed to increase the copy depth of certain
movie titles.
The second component, the amortization of rental inventory, was $3.27 million
for the nine months ended February 28, 2002, representing 68.7 % of the total
cost of sales for rentals, compared to $1.98 million, or 66.9% of the total cost
of sales for rentals for the similar period in 2001. As a percentage of total
rental revenues, the amortization expense was 22.1% for the nine months in 2002
compared to 16.1% for the same nine month period in 2001.
The significant increase in the amortization expense of rental inventory results
from our change to a 12 month amortization policy from a 24 month amortization
policy effective May 31, 2001. As well, as at May 31, 2001, we changed the
salvage value estimate on our rental assets to $5 per VHS tape, $10 per DVD, and
$15 per video game from $7 per item. This change has been applied to the May 31,
2001 annual statements, as well as all periods after that date, including the
nine month period ended February 28, 2002. As a result of this change, a higher
than normal amount of amortization of rental product is being expensed over the
fiscal year ending May 31, 2002, after which the amortization of rental product
expense is expected to decline to more normalized levels.
COST OF PRODUCT SALES
The cost of product sales includes the cost of new VHS tapes and DVDs for
sell-through, confectionery items, music, video gaming equipment and other goods
inventoried for sale. The cost of product sales as a percentage of product sales
for the nine months ended February 28, 2002 was 75.4% compared to 77.4% for the
nine month period ended February 28, 2001.
GROSS MARGIN
Gross margin as a percentage of total revenues for the nine month period ended
February 28, 2002 declined to 57.1% compared to 64.1% for the similar nine month
period in 2001.
The decline in the gross margin resulted from: (i) a higher amount of
amortization expense for rental inventory as a percentage of total rental
revenues; (ii) the higher cost of sales for rentals attributable to our revenue
sharing programs for filmed entertainment that, on average, have lower margins
than do traditional buying arrangements; and (iii) the higher proportion of
lower margin product sales revenues to total revenues. Product sales were 24.8%
of total sales for the nine months ended February 28, 2002 compared to 22.2% for
the similar period in fiscal 2001.
The decline in gross margin resulting from the revenue sharing agreements was
mitigated by the reduced capital outlay for the rental inventory coupled with
the substantial increase in the number of movie title copies that we have
available for rent. This competitive advantage results in the near elimination
of stock outs, thus increasing customer satisfaction and repeat business.
STORE OPERATING EXPENSES
Store operating expenses include all store level expenses such as store rent,
telephone, utilities, signage, equipment rental, store personnel labor wages and
benefits, alarm monitoring, amortization of capital assets other than rental and
intangible assets, taxes and licenses, insurance, and repairs and maintenance
expenses.
For the nine months ended February 28, 2002, our store operating expenses
remained essentially flat as a percentage of total revenues at 41.3% compared to
40.6% during the first nine months of fiscal 2001. Included in store operating
expenses is amortization of assets (excluding rental assets and intangibles),
which was $357,263 for the nine months ended February 28, 2002 and $297,586 for
the nine months ended February 28, 2001. This increase resulted from the higher
level of capital assets due to the increase in stores to 48 as at February 28,
2002 from 42 as at February 28, 2001.
16
<page>
GENERAL AND ADMINISTRATIVE EXPENSES
General and administrative ("G&A") expenses include administrative and warehouse
wages and benefits, advertising and promotion, bank charges, business taxes and
licenses, consulting and professional fees, equipment rental, head office
expenses and rent, travel and entertainment, public company fees, head office
telephone and utilities, shop supplies and insurance for the head office
premises.
For the nine months ended February 28, 2002, G&A expenses as a percentage of
total revenues increased to 11.8% compared to 9.5% for the similar nine month
period in fiscal 2001 reflecting the addition of key personnel in finance and
marketing.
AMORTIZATION OF INTANGIBLES
Amortization expense of intangibles for the nine months ended February 28, 2002
declined to $20,082 compared to $275,108 for the similar nine month period in
fiscal 2001. In accordance with the new accounting treatment in the CICA
Handbook, section 3062, the goodwill arising from our acquisitions is not
subject to amortization. This new accounting policy became effective June 1,
2001.
OPERATING INCOME
Operating income for the nine months ended February 28, 2002 was $769,612
compared to $1,933,159 for the nine months ended February 28, 2001.
One of the factors contributing to the lower operating income for February 28,
2002, was the change in the amortization policy of our rental inventory from 24
months to 12 months which significantly increased non-cash amortization
expenses, combined with higher than normal purchases of rental products to
provide greater copy depth and on-hand inventory for new store locations.
NET INTEREST EXPENSE
Net interest expense on bank debt was $118,445 for the nine months ended
February 28, 2002, compared to $94,450 for the similar nine month period in
fiscal 2001.
Interest expense of $20,792 was paid on the convertible debenture discussed in
the following section.
VIDEO LIMITED PARTNERSHIP DISBURSEMENTS
In December 1999, we sold certain assets comprised of filmed entertainment and
video games of our wholly-owned subsidiary, Integrated Retail to Video Limited
Partnership ("Video LP") for net proceeds of $4.0 million, resulting in a gain
of $1.3 million. Video LP, in turn, engaged us to manage the distribution and
rental of such rental assets, with the parties sharing the revenues generated
from these capital assets. We had the option to repurchase these rental assets
any time after June 30, 2001.
Pursuant to agreements with the Video LP limited partners effective December 1,
2001, we purchased all of the partnerships units of Video LP for a total
consideration of $2.1 million payable as to $820,000 by way of the issuance of
546,336 units (each unit comprised of one Common Share and one-half of one
warrant) and as to the balance by the issuance of a $1.28 million principal
amount three year composite subordinated convertible debenture (the "Convertible
Debenture"). The Convertible Debenture bears interest at 8% per annum with
blended monthly principal and interest payments of $40,215. The principal amount
of the Convertible Debenture can be converted at any time into Common Shares at
the option of the holder at $2.50 per share to December 1, 2003 and at $3.00 per
share to December 1, 2004. Each whole warrant issued as part of the units is
exercisable to purchase one Common Share until December 1, 2003 at $2.00 per
share.
As a result of this purchase, we effectively eliminated all future disbursements
to Video LP. For the nine months ended February 28, 2002, the disbursements were
$710,170 compared to $1.14 million for the similar nine month period in fiscal
2001.
17
<page>
The write-down of capital assets relates to our acquisition of the partnership
units of Video LP. In this transaction, we effectively purchased all the VHS
tapes owned by Video LP for $2.1 million. The amount by which the purchase price
exceeded the residual value of the VHS tapes from the purchase was expensed
against earnings. The capital asset write-down of $1.32 million is a non-cash
expense.
NET INCOME
We recorded a net loss for the nine months ended February 28, 2002 of $1.3
million compared to a net profit of $122,513 in the first nine months of fiscal
2001. Our net loss per share (basic) was $0.11 for the nine months ended
February 28, 2002, compared to net earnings per share (basic) of $0.01 for the
nine months ended February 28, 2001.
LIQUIDITY AND CAPITAL RESOURCES
We generate cash from operations, being the rental and sale of entertainment
software including VHS tapes, DVDs, CD music and video games. Our business is a
cash business and we do not typically carry receivables from customers. Our
primary capital requirements are for opening and acquiring new stores and for
the purchase of rental and sell-through inventory. Other capital requirements
include the refurbishment, remodeling and relocation of existing stores. We have
funded our capital requirements primarily from cash flow from operations, the
proceeds of various private placement equity offerings, senior debt credit
facilities, vendor financing and the securitization of certain assets.
We have demand operating credit facilities with Canadian financial institutions
providing for overdrafts of $800,000 and $200,000. The $800,000 overdraft
facility is secured by a general security agreement on all of our assets. The
$200,000 overdraft facility is unsecured. The credit facilities bear interest at
prime plus 1% (4.75% at February 28, 2002) and prime plus 0.5% (4.25% at
February 28, 2002), respectively. We believe it will be necessary to obtain
greater revolving short term facilities to facilitate the operations of an
expanding retail network of stores.
We also have a $1.5 million long-term expansion credit facility that bears
interest at the rate of 4.5% per annum and which is secured by a $1.5 million
short term deposit. On June 15, 2001, $400,000 of this credit facility was
released to us with monthly payments of $12,398 including principal and interest
commencing August 1, 2001, bearing interest at a rate of 1% per annum above the
bank's prime rate. In order to make draws under the facility certain covenants
with respect to substantial completion of new-build stores, as well as other
operating and capital criteria had to be met. There are no financial covenants
on any of our credit facilities.
We recorded an EBITDA income of $4.4 million in both of the nine month periods
ended February 28, 2002 and February 28, 2001. EBITDA is a non-GAAP earnings
measure and does not conform to Canadian GAAP and may not be comparable to
measures presented by other companies. As used in this prospectus, EBITDA means
net income before future income taxes (recovery), gain on disposal of assets,
gain on dilution of investment, equity loss of investment, minority interest,
write-down of capital assets, write-down of investment, Video Limited
Partnership disbursements, income tax recovery, interest on convertible
debenture, interest expense (net), amortization of intangibles, amortization of
rental product, and amortization of other store related capital assets in the
amount of $357,264, $245,810, $368,375, $370,464, and $266,200 for the 9 months
ended February 28, 2002, 9 months ended February 28, 2001, and the 12 months
ended May 31, 2001, 2000, and 1999, respectively, which is included in store
operating expenses. EBITDA should be considered in addition to, but not as a
substitute for, or superior to, operating income, net income, cash flow and
other measures of financial performance prepared in accordance with Canadian
GAAP.
CASH FROM OPERATING ACTIVITIES
Funds provided by operations increased to $3.6 million for the nine months ended
February 28, 2002, compared to $2.8 million for the nine months ended February
28, 2001. The major contributing factor to the increase was the growth in the
number of operating stores and continued maturation of the revenue streams from
such stores. The net change in non-cash components of working capital amounted
to an increase of $253,702 for the nine months ended February 28, 2001. The
difference is primarily due to an increase in the accounts payable, due to
higher purchases and slightly higher levels of bank debt.
18
<page>
CASH FROM FINANCING ACTIVITIES
Financing activities provided net cash of $2.7 million for the nine months ended
February 28, 2002, compared to $1.5 million for the same nine month period in
fiscal 2001. During the nine month period ended February 28, 2002, we raised
$459,400 from a private equity placement, $400,000 from our bank facility, and
issued the Convertible Debentures and $819,504 in Common Shares in consideration
for the purchase of Video LP. A note payable of $493,578 was repaid in full to
our subsidiary, E-Trend. We believe it necessary to continue to source
additional debt and equity financing to fund our continued growth in store
locations.
CASH FROM INVESTING ACTIVITIES
Cash used for investing activities for the nine months ended February 28, 2002,
was $6.27 million and related to the purchase of capital assets (consisting
mainly of VHS tapes, DVDs and video games for rent) and the purchase of the
partnership units of Video LP.
WORKING CAPITAL DEFICIT
At February 28, 2002, we had negative working capital of $3.99 million compared
to $2.86 million as at May 31, 2001. The negative working capital results from
the accounting treatments of our rental inventory. Rental inventory is treated
as a capital rather than a current asset under Canadian GAAP because it is a
depreciable asset and is not an asset that is reasonably expected to be
completely realized in cash or sold in the normal business cycle. Although the
rental of this inventory generates a major portion of our revenue, the
classification of this asset as non-current results in its exclusion from
working capital. The aggregate amount payable for this inventory, however, is
reported as a current liability until paid and, accordingly, is included in
working capital. As a result, we do not believe that working capital is an
appropriate measure of our liquidity and anticipate that we will continue to
operate with a working capital deficit.
We believe our projected cash flow from operations, borrowing capacity with our
credit facility, cash on hand and trade credit will provide the necessary
capital to fund our current plan of operations for fiscal 2002, including our
anticipated new store openings. However, to fund a major acquisition program, or
to provide funds in the event our need for funds is greater than expected, or if
certain of the financing sources identified above are not available to the
extent anticipated or if we increase our growth plan, we will need to seek
additional or alternative sources of financing. This financing may not be
available on terms satisfactory to us. Failure to obtain financing to fund our
expansion plans or for other purposes could have a material adverse effect on
us.
FISCAL 2001 COMPARED TO FISCAL 2000
OPERATING RESULTS
REVENUES
Total revenues increased 65.1% to $21.3 million for fiscal 2001 from $12.9
million for fiscal 2000. This increase was due to a number of factors, the most
significant of which included (i) an increase in same-store revenues of 47%, and
(ii) a 36% increase in the number of stores operating during fiscal 2001 versus
fiscal 2000 as we added 12 stores to our network during fiscal 2001. The
increase in same-store revenues was primarily the result of:
(i) increased product availability for customers as a result of
direct revenue sharing and copy depth programs for filmed
entertainment products;
(ii) a strong slate of new title releases versus the prior year;
(iii) the continued consumer acceptance and growth of the DVD
format;
(iv) the successful chain-wide re-branding campaign and internal
marketing program designed to generate more consumer
excitement and purchase of items, including music and
sell-through filmed entertainment;
19
<page>
(v) the addition of CD music sales into a greater number of
stores; and
(vi) increases in ancillary sales, including predominantly
confectionery items.
It has been our experience that new-built stores typically reach mature revenue
streams in 12 to 18 months from opening. Generally, revenue streams mature
earlier in our rural markets and later in urban markets where our stores face
greater competition. As such, for so long as we continue our aggressive
new-build strategy, management anticipates strong revenue and same-store sales
growth results from operations.
The relative mix of revenues between rental and product sales revenues for
fiscal 2001 were 77.7% and 22.3%, respectively. This ratio remained consistent
with fiscal 2000 revenues that were 79.2% and 20.8%, respectively. Many of the
gains experienced in the addition of sales related to music were offset by
similar gains in rental revenues resulting from greater copy depth and the
addition and growth of the DVD rental market. As expected by our management,
such rental and product revenue ratios have remained stable over fiscal 2002
with some slight gains experienced in the product sales category as a result of
anticipated DVD sales during the Christmas 2001 season. Our decision to increase
our inventory of DVDs resulted in DVD rental revenues increasing to 15% of
rental revenues for fiscal 2001 compared to less than 5% of rental revenues for
fiscal 2000.
COST OF SALES FOR RENTALS
Rental revenue costs for fiscal 2001 were 26.4% of rental revenues, a 6.1%
increase from 20.3% in fiscal 2000 due primarily to the significant
concentration of product purchases in the fourth quarter of calendar 2000.
The amortization expense associated with rental products was $2.6 million,
representing 59.5% of the cost of rental revenues for fiscal 2001. In
comparison, such amortization expenses for fiscal 2000 were $1.5 million,
representing 69.9% of the cost of rental revenues. The decrease in amortization
expense as a percentage of revenue was attributable to our shifting purchases of
new rental product towards revenue sharing programs in which the initial capital
outlay is lower.
We commenced revenue sharing programs in November 2000 and the initial financial
effects of these and subsequent programs were reflected in this period.
COST OF PRODUCT SALES
The cost of product sales as a percentage of the revenue generated was 77.2% for
fiscal 2001, a 4.6% decrease from the prior fiscal year results that posted
81.6%. The decrease was primarily attributable to greater supplier discounts,
particularly with respect to purchases of CD based music in the third and fourth
quarters of fiscal 2001.
GROSS MARGINS
Our gross margin for fiscal 2001 amounted to $13.3 million, an increase of 54.7%
over the $8.6 million posted for fiscal 2000. The increase in gross margin
resulted directly from a significant increase in revenues during the period,
together with a successful program to control expansion costs. Gross margins
declined to 62.3% of total revenues for fiscal 2001 from 66.9% for fiscal 2000.
The decline resulted from our participation in revenue sharing and copy depth
programs for filmed entertainment that, on average, have lower gross margins
than do traditional buying arrangements. Additionally, increasing product sales
and, in particular, CD music sales have negatively affected overall margins for
the period as product sales typically generate lower margins than do rental
sales. As anticipated by our management, gross margins have remained relatively
stable as gains made from higher margin DVD rentals have been offset by
increased low-margin product sales.
STORE OPERATING EXPENSES
Store operating expenses increased slightly to 43.9% of total revenue for fiscal
2001, up from 42.9% for fiscal 2000. The increase in store operating expenses
was primarily due to an increase in the number of stores operating in urban
centers that generally require higher lease payments per square foot, higher
store updating/rebranding costs and higher wages paid to store level staff.
20
<page>
GENERAL AND ADMINISTRATIVE
G&A expenses increased to $2.3 million for fiscal 2001 from $2 million in the
prior fiscal year. The increase resulted from higher administration salaries
required in connection with the 36% growth in the number of stores, as well as
legal and professional fees associated with our listing on the TSX, and audit
fees incurred in connection with back audits of subsidiaries as required by
Regulation S-X of the United States Securities and Exchange Commission.
Although G&A expenses increased over those recorded in the prior year, they
declined favorably to 10.9% of revenues for fiscal 2001 as compared to 15.2% for
fiscal 2000. During the period, we began to realize the benefits of economies of
scale as G&A expenses were amortized over a greater number of operating stores.
Our management expects such favorable declines to continue as we currently
retain a full complement of management necessary to operate a substantially
greater number of stores. Total G&A has increased as additional regional
managers have been added to the staff complement, but the trend towards a
reduction of G&A expenses as a percentage of revenue is expected to continue.
AMORTIZATION OF INTANGIBLES
Amortization of intangibles decreased slightly to 1.7% of total revenues in
fiscal 2001 versus 1.9% in fiscal 2000. This decrease was primarily due to the
increase in same-store revenue in fiscal 2001. We continued to account for
additional goodwill in connection with our acquisitions made during the year.
OPERATING INCOME
Operating income increased by 39.0% to $1.24 million in fiscal 2001, up from
$891,794 in fiscal 2000. Increases in operating income resulted from increased
same store sales and revenue gains.
VIDEO LIMITED PARTNERSHIP DISBURSEMENTS
In December 1999, we entered into an agreement whereby we sold certain capital
assets for net proceeds of $4.0 million resulting in a gain of $1.3 million. The
funds were raised through the disposition of rental movies and games by
Integrated Retail to Video LP. Video LP in turn engaged us to manage the
distribution and rental of such rental inventory, and the parties agreed to
split the revenues generated from these capital assets. We had an option
exercisable on demand at any time after June 30, 2001 to reacquire these capital
assets.
Payments to Video LP amounted to $1.5 million in fiscal 2001 as compared to
$732,990 during fiscal 2000. The increase is attributable to the fact that
payments made during fiscal 2000 commenced in December 1999 and were not made
for a full one-year period. Payments to Video LP amounted to approximately
$125,000 per month. Of such amount, a graduated portion is applied to pay down
the principal portion of the initial $4.0 million purchase of capital assets.
Effective December 1, 2001 we purchased all of the partnership units of Video LP
for $2.1 million payable as to $820,000 by issuing 546,336 units with each unit
comprised of one Common Share and one-half of a warrant (each whole warrant
exercisable to purchase one Common Share at an exercise price of $2.00 per share
for a period of two years), and as to the balance by issuing the Convertible
Debenture which is convertible into Common Shares at $2.50 per share for the
first two years and $3.00 in the third year.
NET INTEREST EXPENSE
Net interest expense decreased to 0.6% of total revenues in fiscal 2001 versus
1.2% in fiscal 2000. This decrease was primarily due to reductions in average
debt outstanding during fiscal 2001.
INCOME (LOSS) BEFORE INCOME TAXES AND EXTRAORDINARY ITEMS
In fiscal 2001, we posted a loss before income taxes and extraordinary items of
$387,803 compared to income of $7,307 reported in fiscal 2000. The relative
results are comparable given that we did not remit payments to Video LP for the
whole of fiscal 2000. Management recognized the need to deal with disbursements
made to Video LP and, effective December 1, 2001, we purchased all of the
partnership units of Video LP as described above.
21
<page>
RECOVERY OF INCOME TAXES
The income tax recovery in the amount of $1,717,000 for fiscal 2001 is largely
attributable to the change in the estimate of the useful life of rental product
and to the write-down of the investment in E-Trend. As a result of these two
changes, the differences between the tax cost and the accounting cost of certain
assets and liabilities on the balance sheet has been reduced, resulting in a
future tax recovery.
INVESTMENT WRITE-DOWN
As at May 31, 2001 we held a 38.37% equity interest in E-Trend. E-Trend is
engaged primarily in the on-line sale and distribution of movies on VHS and DVD,
music on CD and video games on various platforms. E-Trend is also engaged in the
research and development of technologies and strategies to mitigate the
evolution of the Internet as a means of competitive distribution to us. Due to
market conditions at the time and, in particular, to conditions respecting
high-tech and "dot-com" companies, our management decided to take a one-time,
non-cash charge and effect a write down of $1.9 million in the value of our
ownership in E-Trend. We sold our interest in E-Trend on December 26, 2001 to
Game Holdings. See "E-Trend Networks, Inc.".
WRITE-DOWN OF CAPITAL ASSETS
Effective May 31, 2001, we changed our estimation of the useful life and salvage
value of our rental products. As a result of this change, we have revised our
estimates of the useful life of rental products to a 12 month amortization
period from 24 months and have reduced our estimate of the salvage value per
item. This change has been applied prospectively as a change in accounting
policy and resulted in a one-time write-down of capital assets in the amount of
$2.26 million.
NET LOSS
We recorded a net loss of $2.8 million for fiscal 2001 for the reasons stated
above, compared to a net profit of $2.1 million for fiscal 2000. Our net loss
per share (basic) was $0.24 for the 12 months ended May 31, 2001 compared to net
earnings of $0.21 per share (basic) for the twelve months ended May 31, 2000.
During fiscal 2001, we generated $4.57 million in EBITDA compared to $2.96
million in fiscal 2000. The increase in EBITDA was driven primarily by operating
earnings resulting from a 65.1% increase in total revenues.
LIQUIDITY AND CAPITAL RESOURCES
CASH FROM OPERATING ACTIVITIES
Net cash provided by operating activities was $3.55 million for fiscal 2001
compared to $3.24 million for fiscal 2000. The major components of the cash from
operating activities was amortization of capital assets and intangibles of $3.33
million of which $2.60 million or 78.1% was amortization of rental assets, $2.26
million from the write down of capital assets, $1.89 million from the write down
of the value of our investment in E-Trend, and $721,186 from the net change in
non-cash components of working capital.
The net change in non-cash components of working capital decreased to $721,186
for the twelve months ended May 31, 2001 from $1.19 million for the twelve
months ended May 31, 2000. During fiscal 2001, we received payment in full on
the $884,009 note receivable from Video LP. Inventory, which consists mainly of
music based software such as CDs and cassettes, increased to $1.6 million from
$789,971 as we stocked a greater number of our stores with music product for
sale.
CASH FROM FINANCING ACTIVITIES
In June 2000, we entered into a short-term credit facility for a secured,
revolving line of credit in the amount of $800,000. This facility augmented an
existing short-term revolving facility in the amount of $200,000 for an
aggregate short-term revolving credit line of $1.0 million.
22
<page>
Net cash provided by financing activities was $2.7 million for fiscal 2001 in
comparison to $987,081 in the prior fiscal year. The major contributors to cash
from financing activities for fiscal 2001 were 366,754 Common Shares that we
sold for approximately $1.38 million as well as an increase of $731,325 in the
utilization of our short-term credit facilities. Proceeds from long-term debt
also increased during 2001, although the net effect of such proceeds was offset
by even greater repayments of long-term debt made during the fiscal year.
On March 21, 2001 we entered into a long-term expansion credit facility in the
amount of $1.5 million. The facility was available to us for expansion purposes
only and not to fund general working capital needs. The facility was secured by
a $1.5 million deposit by us. In order to make draws under the facility certain
covenants with respect to substantial completion of new-build stores, as well as
other operating and capital criteria had to be met. There are no financial
covenants on any of our credit facilities.
CASH FROM INVESTING ACTIVITIES
Net cash used in investing activities was $6.3 million for fiscal 2001 compared
to $4.2 million for fiscal 2000. This increase in funds used for investing
activities was primarily the result of increases in capital expenditures of
$6.97 million, primarily related to rental inventory and property, furnishings
and equipment purchased to support the growth in our store base, our increased
new store development plan, and a strategic move to stock greater copy-depth of
product. As well, we used $225,000 as part consideration towards the purchase of
the assets of each of Silver Screen Video (one store) and M&K (two stores). See
"Our Acquisitions".
WORKING CAPITAL DEFICIT
At May 31, 2001, we had a working capital deficit of $2.86 million, due to the
accounting treatment of our rental inventory. See "Nine Months Ended February
28, 2002 Compared to Nine Months Ended February 28, 2001 - Working Capital
Deficit".
FISCAL 2000 COMPARED TO FISCAL 1999
OPERATING RESULTS
REVENUES
Total revenues increased 162% to $12.88 million for the twelve months ended May
31, 2000 compared to $4.92 million for the twelve months ended May 31, 1999. The
substantial increase in revenues resulted from a 136% increase in the number of
stores from 14 as at May 31, 1999 compared to 33 as at May 31, 2000, and a 14.9%
increase in same-store sales for the twelve months ended May 31, 2000 compared
to the twelve months ended May 31, 1999.
During fiscal 2000 we added 19 stores. Eleven of these stores were added during
the third and fourth quarters of fiscal 2000, including six stores in Saskatoon
that we acquired from Star Vision, two stores in Calgary that we acquired from
M&K and three new build store locations. Accordingly, much of the new stores'
revenues was not present for the entire fiscal period and the reported revenues
were not indicative of expected annualized revenues. See "Our Acquisitions".
The relative mix of revenues between rental revenues and product sales for the
twelve months ended May 31, 2000 and the twelve months ended May 31, 1999 was
approximately 79% and 21%, respectively. Revenues generated from DVDs in fiscal
2000 were less than 5% of total rental revenues. There were marginal revenues
generated from DVDs in fiscal 1999.
We introduced DVD based entertainment in our stores commencing July 1998 and
introduced CD and cassette based music for sell-through in our stores commencing
July 1999.
COST OF SALES FOR RENTALS
The cost of sales for rentals increased 100% to $2.08 million for the twelve
months ended May 31, 2000 compared to $1.04 million for the twelve months ended
May 31, 1999. The increase in the cost of sales for
23
<page>
rentals resulted from our revenue sharing programs with certain studios which
commenced in November 2000 and increased use of copy depth programs.
For the twelve months ended May 31, 2000, amortization expense on rental
inventory was $1.45 million representing 69.8% of the total cost of rentals,
compared to $643,896 or 62.2% of the costs of rentals for the twelve months
ended May 31, 1999. Our rental products, which include VHS tapes, DVDs, and
video games, were amortized for fiscal 1999 and fiscal 2000. The salvage value
for each unit of rental product is $7.00 per unit.
COST OF PRODUCT SALES
The cost of product sales as a percentage of product sales for the twelve months
ended May 31, 2000 was 81.6%% compared to 67.7% for the twelve months ended May
31, 1999.
GROSS MARGIN
Gross margin for the twelve months ended May 31, 2000 increased to 66.9% of
total revenues compared to 64.8% of total revenues for the twelve months ended
May 31, 1999.
The increase gross margin resulted primarily from improved gross margins from
rental revenues which increased from 73.4% of total rental revenues for the
twelve months ended May 31, 1999 to 79.7% of total rental revenues for the
twelve months ended May 31, 2000. The increased gross margins from rental
revenues more than offset the decline in gross margins from product sales, the
gross margins of which declined to 18.4% of product sales for the twelve months
ended May 31, 2000 compared to 32.3% for the twelve months ended May 31, 1999.
The increase in gross margins from rental revenues resulted from lower revenue
sharing costs as a percentage of total rental revenues for the period as we
purchased fewer movie titles as a percentage of total rental revenues under
revenue sharing arrangements in fiscal 2000 than in fiscal 1999.
STORE OPERATING EXPENSES
Store operating expenses decreased as a percentage of total revenues to 42.9%
for the twelve months ended May 31, 2000 compared to 46.1% for the twelve months
ended May 31, 1999. Lower year over year rent, amortization of non-rental
assets, equipment rental, and shop supplies as a percentage of total revenues
were the main factors for the improvement in store operating costs as a
percentage of total revenues.
Included in store operating expenses was amortization of assets (excluding
rental and intangible assets), which was $370,464 for the twelve months ended
May 31, 2000 and $266,200 for the twelve months ended May 31, 1999. This
increase resulted from the higher level of capital assets resulting from
acquisitions and the build out of new stores during the twelve months ended May
31, 2000.
GENERAL AND ADMINISTRATIVE EXPENSES
G&A expenses as a percentage of total revenues increased to 15.2% of total
revenues for the twelve months ended May 31, 2000 compared to 10.5% of total
revenues for the twelve months ended May 31, 1999. This increase, as a
percentage of total revenues, primarily resulted from the one-time development
expenses of approximately $243,000 related to the development of E-Trend.
AMORTIZATION OF INTANGIBLES
Amortization of intangibles increased to $246,288 or 1.9% of total revenues for
the twelve months ended May 31, 2000 compared to $3,819 for the twelve months
ended May 31, 1999. The increase in amortization of intangibles was the result
of our acquisition of Safiqa, Star Vision, and 705556 which were purchased on
September 29, 1999, December 1, 1999, and March 21, 2000, respectively. See "Our
Acquisitions".
24
<page>
NET INTEREST EXPENSE
Interest expense on long term debt increased to $151,497 for the twelve months
ended May 31, 2000 from $8,371 for the twelve months ended May 31, 1999. The
increase in interest costs resulted from additional short term notes and long
term debt incurred to finance our new store openings and acquisitions. During
fiscal 2000 we repaid, in full, the promissory notes that were associated with
the acquisition of Safiqa and Star Vision. See "Our Acquisitions".
OTHER ITEMS
In December 1999, we sold certain rental assets of Integrated Retail to Video LP
for net proceeds of $4.0 million which resulted in a $1.3 million non-cash gain.
During the period June 1, 1999 to March 1, 2000 we fully consolidated the
operations of E-Trend on our consolidated balance sheet, statement of earnings
and statement of cash flow. During this time, we held a majority interest in
E-Trend's voting shares but did not have control of E-Trend's board. Subsequent
to March 1, 2000, as a result of two equity offerings by E-Trend, our interest
declined to 38.37% which then resulted in changing the treatment of our
ownership of E-Trend to the equity method of accounting. This change resulted in
a non-cash gain of $2.45 million.
The non-cash minority shareholder's interest of $114,572 resulted from the
consolidation treatment of E-Trend to March 1, 2000. The non-cash equity loss on
investment of $268,249 is our proportion of losses that E-Trend incurred from
the period March 1, 2000 to May 31, 2000 based on the equity method of
accounting.
FUTURE INCOME TAX EXPENSE
Future income taxes increased to $1.5 million for the twelve months ended May
31, 2000 compared to $173,000 for the twelve month period ended May 31, 1999.
The increase in future income taxes resulted from an increase in the difference
between the tax cost and the accounting cost of certain assets on the balance
sheet.
NET INCOME
Net income for the twelve months ended May 31, 2000 increased to $2.1 million
compared to $217,383 for the twelve months ended May 31, 1999. Our earnings per
share (basic) were $0.21 in fiscal 2000 compared to $0.03 per share (basic) in
fiscal 1999. The increase in net income resulted from the increased number of
stores, gain on disposal of assets to Video LP and a gain on dilution of our
equity interest in E-Trend.
LIQUIDITY AND CAPITAL RESOURCES
CASH FROM OPERATING ACTIVITIES
Funds provided by operations increased to $3.24 million for the twelve months
ended May 31, 2000 compared to $1.30 million for the twelve months ended May 31,
1999. The major contributing factor to the increase was the growth in the number
of operating stores and continued maturation of the revenue streams from such
stores. The net change in non-cash components of working capital increased to
$1.19 million for the twelve months ended May 31, 2000 from $9,734 for the
twelve months ended May 31, 1999. Accounts receivable increased to $354,747 for
the twelve months ended May 31, 2000 due to increased tenant allowances
receivable from various landlords as we opened six new stores during fiscal
2000. Consistent with the increase in the number of stores, inventory levels
also increased to $789,971 as at May 31, 2000 compared to $214,138 as at May 31,
1999.
CASH FROM FINANCING ACTIVITIES
Financing activities provided cash of $987,081 for the twelve months ended May
31, 2000 compared to $1.4 million for the twelve months ended May 31, 1999.
During fiscal 2000, a combination of 575,947 options and warrants were exercised
for net proceeds of $480,248 and 1,996,207 Common Shares were issued for $2.91
million in lieu of cash related to our acquisitions. In addition, we were
advanced $361,331 from a related company for operational financing. During
fiscal 1999, 2,624,276 Common Shares were issued for net cash proceeds of
$643,059, an additional 673,000 Common Shares upon the exercise of options and
warrants for $429,250, and long term debt, net of repayment, of $225,029.
25
<page>
CASH FROM INVESTING ACTIVITIES
For the twelve months ended May 31, 2000, we expended $5.0 million on the
purchase of capital assets and $5.7 million on the acquisition of Safiqa, Star
Vision, and 705556. We paid for these acquisitions with $2.8 million of cash and
issued 1,996,207 Common Shares for a deemed value of $2.9 million. See "Our
Acquisitions".
For the twelve months ended May 31, 1999 we expended $2.8 million that was used
for the build out of seven new stores and to purchase rental product for the new
and existing stores.
A note receivable of $884,009 as at May 31, 2000 was due from Video LP which
bore interest at the rate of 15% per annum, was unsecured, and was payable upon
demand. This note was repaid in cash on January 19, 2001.
WORKING CAPITAL
At May 31, 2000, we had negative working capital of $549,127 compared to
$182,719 as at May 31, 1999. See "Nine Months Ended February 28, 2002 compared
to Nine Months Ended February 28, 2001 - Working Capital Deficit".
BUSINESS RISKS AND MANAGEMENT
We believe the principal competitive factors in the home entertainment industry
are store location, visibility, and layout and design; title selection; the
number of copies of each new release available; customer service; and pricing.
The home entertainment industry is highly competitive, and we compete with other
video and home entertainment stores, including stores operated by other regional
and national chains such as Blockbuster Video, Rogers Video and Video Update. We
also compete with other businesses offering VHS tapes, DVDs and video games such
as supermarkets, pharmacies, convenience stores, bookstores, mass merchants,
mail order operations and other retailers. In addition, we compete with all
forms of entertainment, such as movie theatres, network and cable television,
direct broadcast satellite television, Internet-related activities, live
theatre, sporting events and family entertainment centres. Some of our
competitors have significantly greater financial and marketing resources and
name recognition than us. Emerging new technologies such as "Near Video On
Demand", "Video On Demand" and digital cable also provide competition. There can
be no assurance that we will be successful in addressing competitive threats or
adequately assessing future industry trends.
We have developed a business strategy targeting the secondary retail markets
located in communities of approximately 10,000 people. The strength of the local
economy in these types of communities typically depends upon the strength of a
small number of key industries. If the major sustaining industry in one of these
communities is negatively affected, the strength of the entire local economy
will be negatively affected and the amount of disposable income of the residents
in that particular community will decrease. Consequently, a store operated by us
in that location may be negatively affected.
We intend to further increase the number of stores that we operate. The start-up
costs associated with establishing a new store are significant. We have
calculated that it will cost approximately $225,000 to establish each new store
location (and up to $275,000 for each full product mix VHQ Entertainment store).
Such costs may increase as we introduce new concept retail stores in an effort
to match competitor offerings. There is no assurance that we will be able to
obtain adequate financing or adequate cash flows from operations to cover the
projected start-up costs of establishing a new store location.
In order to gain efficiencies generated by economies of scale, we must open a
larger number of stores across a geographically dispersed area. We must rely
initially upon outside sources of capital to finance start-up costs associated
with the opening of new stores as current cash flows alone are not sufficient to
fund new store openings in the numbers we anticipate. In the event we are not
successful in raising additional capital to open new stores, we will not be able
to achieve anticipated efficiencies or pricing structures, all of which could
have a material adverse impact on operations and profitability.
DIRECTORS AND SENIOR MANAGEMENT
The following table sets forth our directors and our senior management team,
each an executive officer, all positions they hold with us, and their current
principal occupations.
26
<page>
<table>
<caption>
Name and
Municipality of Residence Position(s) Held Current Principal Occupation
- ---------------------------------- ------------------------------------ -------------------------------------
<s>
Trevor M. Hillman Chairman of the Board, Chief Officer of the Corporation
Red Deer, Alberta Executive Officer and Director
Gregg C. Johnson President, Chief Operating Officer Officer of the Corporation
Red Deer County, Alberta and Director
Derrek R. Wong Senior Vice President, Finance and Officer of the Corporation
Olds, Alberta Chief Financial Officer
Michael D. McKelvie Senior Vice President, Marketing & Officer of the Corporation
Calgary, Alberta Communications
Ayaz Kara Vice President, Business Development Officer of the Corporation
Calgary, Alberta
Marc L. Gignac Director of Operations, Saskatchewan Officer of the Corporation
Saskatoon, Saskatchewan and Director
Timothy J. Sebastian Secretary Lawyer with the law firm of Bryan &
Edmonton, Alberta Company
Peter Lacey(1)<F1> Director President and Chief Executive Office
Red Deer, Alberta of Cervus Corporation
Catherine J. McDonough(1)<F1> Director Retired Businesswoman
Red Deer County, Alberta
<FN>
(1)<F1> Member of the audit committee, corporate governance and nominating
committee, and compensation committee.
</FN>
</table>
The following is brief biographical information on each of the executive
officers and directors listed above:
Trevor M. Hillman is our Chairman of the Board, Chief Executive Officer and a
Director.
Mr. Hillman has been our Chief Executive Officer and a Director since December
1997. He was our President from December 1997 to November 2001, when he was
appointed Chairman of the Board. Also, since July 1997, Mr. Hillman has been the
President of Integrated Retail which we acquired in September 1998. Mr. Hillman
was a Director of E-Trend from inception until December 2001. Mr. Hillman has
been a Director of IROC Systems Corp., a public company listed on the TSX
Venture Exchange ("TSX Venture"), involved in the oil and gas safety industry,
since March 2000. Mr. Hillman also has been a Director of Chinook Energy
Services Inc., a public company listed on the TSX Venture, involved in
non-destructive testing in the oil and gas industry, since September 2000. From
1994 to 1997, Mr. Hillman provided consulting services to entertainment based
retail clients through TMH Holdings Ltd. Prior to 1994, Mr. Hillman was
Operations Manager of Video View Ltd.
27
<page>
Gregg C. Johnson is our President, Chief Operating Officer and a Director.
Mr. Johnson served as our Executive Vice President from December 1997 to
November 2001 when he was appointed as our President and Chief Operating
Officer. He has also been a Director since December 1997. A graduate of Osgoode
Hall Law School of York University in Toronto, Canada, in 1988, Mr. Johnson
articled and was in private practice with the law firm of Burnet Duckworth &
Palmer in Calgary, Alberta until he moved to Japan and joined the Japanese law
firm, Aoki, Christensen & Nomoto in 1989. In 1991, Mr. Johnson joined the law
office of Dr. Mujahid Al-Sawwaf in Jeddah, Saudi Arabia. In 1993, Mr. Johnson
joined The Tracker Corporation of Toronto, Ontario, a public company trading on
the NASD OTCBB market, where he was primarily responsible for legal, financing
and public reporting matters. Since August 1995, Mr. Johnson has provided
investment banking services with Summit Capital Corporation. Mr. Johnson was the
Executive Vice President and Secretary of Merch Performance Inc., a public
company listed on the TSX Venture engaged in the manufacture and distribution of
motorcycle engines and parts, from April 1997 to June 1998. Mr. Johnson was a
Director of Cervus Corporation, a public company listed on the TSX Venture
engaged in the acquisition and management of John Deere dealerships, from
inception until December 2001, and a Director of IROC Systems Corp., a public
company listed on the TSX Venture involved in the oil and gas safety business,
from inception until April 2001. Mr. Johnson was the President of E-Trend from
inception to February 2001, and a Director of E-Trend from inception to December
2001. Mr. Johnson was also a Director of Chinook Energy Services Inc., a public
company listed on the TSX Venture involved in the non-destructive testing
business, from September 2001 to January 2002. Mr. Johnson was elected to a
second three-year term in October 2001 as a councilor with Red Deer County,
Alberta and is currently the Reeve (Mayor of the municipality).
Derrek R. Wong is our Senior Vice President, Finance and Chief Financial
Officer.
Mr. Wong has been our Senior Vice President, Finance and Chief Financial Officer
since September 2001. From 1997 to 2001 Mr. Wong was President of Cirrus Capital
Corporation, a financial consulting company. Through Cirrus Capital Corporation,
Mr. Wong provided financial consulting services, including services relating to
mergers and acquisitions, investor relations and corporate finance to Atlas Cold
Storage Limited, a wholly owned subsidiary of Atlas Cold Storage Income Trust,
from 1997 to 2000. From 1991 to 1997 Mr. Wong was Vice President, Corporate
Finance of Bank of America. From 1985 to 1991, Mr. Wong held various positions
with the Royal Bank of Canada. Mr. Wong received a Bachelor of Commerce degree
from the University of Calgary in 1982, a Masters of Business Administration
from the Richard Ivey School of Business in 1985, and is a Chartered Financial
Analyst.
Michael D. McKelvie is our Senior Vice President, Marketing & Communications.
Mr. McKelvie has been our Senior Vice President, Marketing & Communications
since May 2000. Mr. McKelvie has held senior level marketing, sales and
communications positions in the home entertainment industry since 1977. He
served as Director, Sales & Marketing for Universal Studios Home Entertainment
Canada from March 1987 to November 1990. From November 1990 to November 1997 he
was the founding partner of EMG Media Inc., where he created and launched
HOLLYWOOD@home(TM), a Canadian video trade magazine. Most recently, he was
Senior Marketing and Communications Manager for Blockbuster Canada Co. from
November 1997 to April 2000. Mr. McKelvie has served as our Senior Vice
President, Marketing for E-Trend from May 2000 to March 2002.
Ayaz Kara is our Vice-President, Business Development.
Mr. Kara has been our Vice President, Business Development since September 1999
and served as a Director of the Corporation from November 1999 until June 5,
2002. Mr. Kara was the President and a Director of Safiqa from February 1993
until we acquired it in September 1999. Mr. Kara also served as a Director of
IROC Systems Corp., a public company listed on the TSX Venture, from March 2000
to December 2000. Mr. Kara was the interim President of E-Trend from October
2001 to January 2002 and has been a Director of E-Trend since December 2001.
28
<page>
Marc L. Gignac is our Director of Operations, Saskatchewan and a Director.
Mr. Gignac has been our Director of Operations, Saskatchewan since December
1999. Mr. Gignac has also served as a Director since March 2000. Mr. Gignac was
the President and a Director of Star Vision from December 1986 until we acquired
it in November 1999.
Timothy J. Sebastian is our Secretary
Mr. Sebastian was our General Counsel and Secretary from October 2000 until
April 2002. As of May 1, 2002, Mr. Sebastian resigned as our General Counsel to
return to private practice with the law firm of Bryan & Company in Edmonton,
Alberta but remains our Secretary. Mr. Sebastian graduated from the University
of Alberta Law School in 1990. He was an associate and then a partner with the
law firm of Bryan & Company in Edmonton and Calgary, Alberta, from 1990 until
October 2000. During his law career, Mr. Sebastian practiced in the areas of
general corporate law, corporate finance, securities and intellectual property.
Mr. Sebastian is also the Secretary for IROC Systems Corp. and Chinook Energy
Services Inc., each of which is a public company listed on the TSX Venture. Mr.
Sebastian also served as General Counsel and Corporate Secretary for E-Trend
from October 2001 to January 2002.
Peter A. Lacey is a Director of the Corporation.
Mr. Lacey has been a Director of VHQ since November 1999. Mr. Lacey has been
President, Chief Executive Officer and a Director of Cervus Corporation, a
public company listed on the TSX Venture, since November 1998. Mr. Lacey has
been the President of Deermart Equipment Sales Ltd., a John Deere farm implement
and garden equipment dealer located in Red Deer, Alberta, since April 1982. Mr.
Lacey has been a Director of River Valley Energy Services Corp., an oil and gas
company listed on the TSX Venture, since September 1994. Mr. Lacey has been a
member of Red Deer College Board of Governors since October 1997 and Chairman
since May 2000.
Catherine J. McDonough is a Director of the Corporation.
Mrs. McDonough has been a Director of VHQ since November 1999. Mrs. McDonough
has been and continues to be a successful investor with over twenty years of
investment experience. She owned and operated a jewelry design business in
Honolulu, Hawaii. She has been active in charitable organizations and has served
on the Boards of several of them including the U.S. Navy Submarine Officer's
Wives Club and various charitable causes related to the Pearl Harbor Naval
Station.
None of our directors and/or executive officers has been the subject of any
order, judgment, or decree of any governmental agency or administrator or of any
court of competent jurisdiction, revoking or suspending for cause any license,
permit or other authority of such person or of any corporation of which he or
she is a director and/or executive officer, to engage in the securities business
or in the sale of a particular security or temporarily or permanently
restraining or enjoining any such person or any corporation of which he or she
is an officer or director from engaging in or continuing any conduct, practice,
or employment in connection with the purchase or sale of securities, or
convicting such person of any felony or misdemeanor involving a security or any
aspect of the securities business or of theft or of any felony.
COMPENSATION OF DIRECTORS AND EXECUTIVE OFFICERS
COMPENSATION OF DIRECTORS
We have five directors. Directors who are not also executive officers receive
$500 per meeting to a maximum of six meetings per year.
Our directors (including directors who are also executive officers) hold
outstanding options to purchase a total of 1,185,000 of our Common Shares. See
"Stock Option Plan".
29
<page>
COMPENSATION OF EXECUTIVE OFFICERS
The aggregate compensation paid to all our executive officers in the fiscal year
ended May 31, 2002 was $815,565. The following table sets forth compensation
information for Mr. Trevor M. Hillman, our Chairman and Chief Executive Officer,
Mr. Gregg C. Johnson, our President and Chief Operating Officer, Ayaz Kara, our
Vice President, Business Development, and Timothy J. Sebastian, our Secretary
and former General Counsel, for the periods indicated. We are not required to
disclose and do not publicly disclose the compensation of any executive officer
unless such officer received a combined base salary and bonus of more than
$100,000 during the fiscal year ended May 31, 2002.
<table>
<caption>
- --------------------------------------------------------------------------------------------------------------------------
Long Term
Compensation
- --------------------------------------------------------------------------------------------------------------------------
Annual Compensation Awards
- --------------------------------------------------------------------------------------------------------------------------
Other Annual All Other
Name and Principal Fiscal Salary Bonus Compensation Securities Under Compensation
Position Year ($) ($) ($)(1)<F1> Options($)(2)<F2> ($)(3)<F3>
- --------------------------------------------------------------------------------------------------------------------------
<s>
Trevor M. Hillman 2002 139,705 Nil 16,884 200,000 Nil
Chairmain and Chief 2001 102,935 Nil 10,900 Nil Nil
Executive Officer 2000 73,799 17,500 7,908 237,500 Nil
- --------------------------------------------------------------------------------------------------------------------------
Gregg C. Johnson 2002 139,705 Nil 6,000 200,000 Nil
President and Chief 2001 58,541 Nil Nil Nil Nil
Operating Officer 2000 26,110 Nil Nil 187,500 Nil
- --------------------------------------------------------------------------------------------------------------------------
Ayaz Kara 2002 50,753 57,954 Nil Nil Nil
Vice President, 2001 50,753 42,586 Nil 75,000 Nil
Business Development 2000 50,753 28,021 Nil Nil Nil
- --------------------------------------------------------------------------------------------------------------------------
Timothy J. Sebstian 2002 104,376 Nil Nil 75,000 Nil
Secretary 2001 86,251 Nil Nil Nil Nil
2000 Nil Nil Nil Nil Nil
- --------------------------------------------------------------------------------------------------------------------------
<FN>
(1)<F1> Relates to vehicle allowances.
(2)<F2> See the two tables below.
(3)<F3> Perquisites and other personal benefits do not exceed the lesser of
$50,000 and 10% of the annual salary.
</FN>
</table>
The following table details information with respect to the grant of stock
options to Trevor M. Hillman, Gregg C. Johnson, Ayaz Kara and Timothy J.
Sebastian during the fiscal year ended May 31, 2002.
<table>
<caption>
- ------------------------------------------------------------------------------------------------------------------------
% of Total Market Value of
Securities Options Granted Exercise or Securities Underlying
Under Option to Employees in Base Price Options on the Date
Name Granted (#) Financial Year ($/Security) of Grant ($/Security) Expiration Date
- ------------------------------------------------------------------------------------------------------------------------
<s>
Trevor M. Hillman 200,000 26.05 $1.80 $1.80 November 30, 2006
- ------------------------------------------------------------------------------------------------------------------------
Gregg C. Johnson 200,000 26.05 $1.80 $1.80 November 30, 2006
- ------------------------------------------------------------------------------------------------------------------------
Ayaz Kara Nil N/A N/A N/A N/A
- ------------------------------------------------------------------------------------------------------------------------
Timothy J. Sebastian 75,000 9.77% $1.80 $1.80 November 30, 2006
- ------------------------------------------------------------------------------------------------------------------------
</table>
The following table sets forth information with respect to all options exercised
by Trevor M. Hillman, Gregg C. Johnson, Ayaz Kara and Timothy J. Sebastian
during our most recently completed fiscal year and all options held and
outstanding by them on May 31, 2002.
30
<page>
<table>
<caption>
- --------------------------------------------------------------------------------------------------------------------------
Securities
Acquired on Aggragate Value Unexercised Options at Value of Unexercised in
Exercise Realized Financial Year End the Money Options at
Name (#) ($) (#) Financial Year End (1)<F1>
- --------------------------------------------------------------------------------------------------------------------------
<s>
Trevor M. Hillman Nil Nil 437,500 exercisable, Nil exercisable,
Nil unexercisable Nil unexercisable
- --------------------------------------------------------------------------------------------------------------------------
Gregg C. Johnson Nil Nil 387,500 exercisable, Nil exercisable,
Nil unexercisable Nil unexercisable
- --------------------------------------------------------------------------------------------------------------------------
Ayaz Kara Nil Nil 75,000 exercisable, Nil exercisable,
Nil unexercisable Nil unexercisable
- --------------------------------------------------------------------------------------------------------------------------
Timothy J. Sebastian Nil Nil 28,124 exercisable, Nil exercisable,
46,876 unexercisable Nil unexercisable
- --------------------------------------------------------------------------------------------------------------------------
<FN>
(1)<F1> This amount was determined by multiplying the number of Common Shares
issuable under such options by the closing price of the Common Shares
on the TSX on May 31, 2002 ($0.85) and subtracting therefrom the
product of the number of such Common Shares and the exercise price
thereof.
</FN>
</table>
EMPLOYMENT CONTRACTS
TREVOR HILLMAN, CHIEF EXECUTIVE OFFICER, CHAIRMAN OF THE BOARD AND A
DIRECTOR
We have a services agreement with TMH Holdings Ltd. ("TMH") for the services of
Trevor M. Hillman as our Chairman and Chief Executive Officer. Pursuant to the
agreement, we agreed to pay annually to TMH the greater of $60,000 and an amount
equal to 0.5% of the gross sales actually achieved by us during each fiscal year
provided that our earnings before interest, taxes, depreciation and amortization
exceeds 11% on an annualized basis.
The contract commenced on April 1, 2001 and ends on December 31, 2004 unless
terminated earlier in accordance with the agreement. We may terminate the
agreement at any time for cause without payment of any compensation either by
way of anticipated earnings or damages. The agreement may not otherwise be
terminated earlier by us without the consent of TMH. In the event of a change of
control of VHQ Entertainment, as defined in the agreement, TMH has the right to
terminate the agreement and be paid an amount equal to three times the highest
annual amount we paid to TMH during the three years prior to the change of
control.
GREGG C. JOHNSON, PRESIDENT, CHIEF OPERATING OFFICER AND A DIRECTOR
We have a services agreement with Summit Capital Corporation ("Summit") for the
services of Gregg C. Johnson as our President and Chief Operating Officer.
Pursuant to the agreement, we agreed to pay annually to Summit the greater of
$60,000 and an amount equal to 0.5% of the gross sales actually achieved by us
during each fiscal year provided that our earnings before interest, taxes,
depreciation and amortization exceeds 11% on an annualized basis.
The contract commenced on April 1, 2001 and ends on December 31, 2004 unless
terminated earlier in accordance with the agreement. We may terminate the
agreement at any time for cause without payment of any compensation either by
way of anticipated earnings or damages. The agreement may not otherwise be
terminated earlier by us without the consent of Summit. In the event of a change
of control of VHQ Entertainment, as defined in the agreement, Summit has the
right to terminate the agreement and be paid an amount equal to three times the
highest annual amount we paid to Summit during the three years prior to the
change of control.
MARC GIGNAC, DIRECTOR OF OPERATIONS, SASKATCHEWAN
We have an employment contract with Marc Gignac for his services as our Director
of Operations, Saskatchewan. Pursuant to the agreement, we agreed to pay
annually to Marc Gignac $50,000 plus a quarterly bonus of 1% of gross sales
generated by Star Vision.
The agreement commenced on December 1, 1999 and is for a term of three years
unless terminated earlier in accordance with the agreement. The agreement may be
terminated by us at any time for cause without payment
31
<page>
of any compensation either by way of anticipated earnings or damages. If the
agreement is terminated earlier by us without cause, Marc Gignac is entitled to
12 months notice or 12 months salary in lieu of notice. There are no change of
control provisions in the agreement.
USE OF PROCEEDS
The gross proceeds to be raised under this offering are a maximum of $10,000,000
and a minimum of $4,000,000. The net proceeds of this offering, after deducting
the Agents' fee and expenses of this issue estimated to be $180,000, will be
$9,020,000 assuming completion of the maximum offering and $3,500,000 assuming
completion of the minimum offering. We intend to use the net proceeds from the
issue and sale of the Units as set forth in the table below:
<table>
<caption>
MAXIMUM OFFERING MINIMUM OFFERING
<s>
Open new stores/ acquire additional stores(1)<F1> $6,550,000 $2,130,000
Purchase additional inventory for resale(2)<F2> $1,250,000 $650,000
Reduce short term debt(3)<F3> $970,000 $470,000
Complete new point of sale software system(3)<F3> $250,000 $250,000
Total $9,020,000 $3,500,000
<FN>
(1)<F1> We continually review potential opportunities for opening new stores
or acquiring existing stores. As of the date of this prospectus, we
have not determined the timing or location of opening new stores or
acquiring existing stores. Generally, we spend $225,000 - $275,000 to
open each new store. The purchase price for acquiring existing stores
varies in each individual circumstance. We expect that any new store
openings or acquisitions of existing stores will be completed in
accordance with our retail business growth strategy. See "Our Retail
Business Growth Strategy".
(2)<F2> See "Inventory".
(3)<F3> Short term debt incurred to date was used to fund the build out of new
stores, the purchase of rental assets and music inventory, and general
working capital requirements. See "Operating Results and Financial
Review".
(4)<F4> See "Information Systems".
</FN>
</table>
There may be circumstances where, for sound business reasons, a reallocation of
funds may be necessary. It is difficult at this time to definitively project the
total funds necessary to affect our planned activities. For these reasons, we
consider it to be in our best interest to afford management a reasonable degree
of flexibility as to how our funds are employed among the uses identified above
or for other purposes as the need arises.
We may require additional financing. Our ability to arrange such financing in
the future will depend in part upon the prevailing capital market conditions as
well as our business performance. There can be no assurance that we will be
successful in our efforts to arrange additional financing on terms satisfactory
to us. If additional financing is raised by the issuance of shares, shareholders
may suffer additional dilution. If adequate funds are not available, or are not
available on acceptable terms, we may not be able to take advantage of
opportunities, develop new products or otherwise respond to competitive
pressures and remain in business. See "Risk Factors".
CONSOLIDATED CAPITALIZATION
The following table sets forth the consolidated capitalization of the
Corporation as at May 31, 2001, as at February 28, 2002 before giving effect to
this offering, and as at February 28, 2002, after giving effect to both the
minimum and maximum offering:
<table>
<caption>
Outstanding as at Outstanding as at Outstanding as at
February 28, 2002 February 28, 2002 February 28, 2002
Outstanding as at May before giving effect assuming completion of assuming completion of
31, 2001 to the offering the minimum offering(1) the maximum offering(1)
--------------------- -------------------- ----------------------- -----------------------
(audited) (unaudited) (unaudited) (unaudited)
<s>
Bank Indebtedness (2) $800,556 $1,244,141 $771,141 $274,141
Long Term Debt(3) $269,544 $1,744,554 $1,744,554 $1,744,554
Common Shares(4)(5) $7,626,499 $8,905,403 $__(6) $__(6)
(authorized - unlimited (11,530,767 shs) (12,306,803 shs) (__ shs) (__ shs)
Preferred Shares Nil Nil Nil Nil
(authorized - unlimited)
</table>
32
<page>
(1) We have granted the Agents the Over-Allotment Option, exercisable for
a period of 90 days from the date of closing of the offering, to
purchase up to 15% of the total number of Units sold pursuant to the
offering. See "Plan of Distribution".
(2) Bank Indebtedness is described in note 7 of the Notes to the
Consolidated Financial Statements.
(3) Long term debt includes current portion and is described in note 8 of
the Notes to the Consolidated Financial Statements.
(4) An additional 3,650,241 Common Shares are reserved for issuance: (i)
1,957,300 Common Shares upon the exercise of options granted under our
stock option plan; (ii) an aggregate of 1,180,751 Common Shares upon
the exercise of other outstanding warrants and options; and (iii) a
maximum of 512,190 Common Shares upon conversion of the Convertible
Debenture. See "Rights To Acquire Common Shares".
(5) The Agents will be granted, upon completion of this offering, the
Agents' Options to purchase that number of Common Shares equal to 10%
of the Units sold pursuant to this offering. See "Plan of
Distribution".
(6) After deducting the Agents' fee and estimated expenses of this
offering.
(7) Our deficit, as of February 28, 2002, was $1,835,179.
DESCRIPTION OF SHARE CAPITAL
Our authorized capital consists of an unlimited number of Common Shares and an
unlimited number of preferred shares, issuable in series. As of May 31, 2002,
there were 12,538,529 Common Shares issued and outstanding.
COMMON SHARES
Holders of Common Shares are entitled to receive dividends in cash, property or
shares when and if dividends are declared by the board of directors out of funds
legally available. There are no limitations on the payment of dividends. Holders
of Common Shares are entitled to one vote per share. Upon any liquidation,
dissolution or winding up of our business, if any, after payment or provision
for payment of all our debts, obligations or liabilities, our remaining assets
as are distributable shall be distributed to the holders of Common Shares. There
are no pre-emptive rights, subscription rights, conversion rights and redemption
provisions relating to the Common Shares and the Common Shares have no liability
for further calls.
PREFERRED SHARES
The preferred shares are issuable in series, with each series consisting of such
number of shares and having such rights, privileges, restrictions and conditions
as may be determined by our Board of Directors prior to the issuance thereof.
With respect to the payment of dividends and the distribution of assets in the
event of liquidation, dissolution or winding-up of the Corporation, whether
voluntary or involuntary, the preferred shares are entitled to preferences over
the Common Shares and any other shares ranking junior to the preferred shares
and may also be given such other preferences over the Common Shares and any
other shares ranking junior to the preferred shares as may be determined at the
time of creation of each series.
DIVIDENDS AND DIVIDEND POLICY
No dividends have been paid on any of our shares since the date of our
incorporation and it is not contemplated that any dividends will be paid in the
immediate or foreseeable future.
TRADING IN OUR COMMON SHARES
Our Common Shares have traded on the TSX under the symbol "VHQ" since July 24,
2001. Our shares traded on the TSX Venture from September 18, 1998 until July
30, 2001 when we voluntarily de-listed from the TSX Venture as a result of our
TSX listing. Set forth below are the trading prices for our Common Shares during
the periods indicated:
33
<page>
2000 HIGH LOW VOLUME
---- ---- --- ------
1st Quarter $2.50 $1.30 475,950
2nd Quarter $2.50 $1.65 134,946
3rd Quarter $5.25 $1.85 839,657
4th Quarter $3.60 $2.65 229,056
2001
----
1st Quarter $3.04 $2.00 449,766
2nd Quarter $2.40 $1.90 418,830
July(1) $3.00 $2.00 639,026
August $2.95 $2.25 42,320
September $2.30 $1.80 40,810
October $2.45 $1.70 121,465
November $2.20 $1.65 201,678
December $2.30 $1.73 145,750
2002
----
January $1.95 $1.66 94,725
February $1.75 $1.50 121,480
March $1.55 $1.40 405,598
April $1.53 $0.90 943,555
May $1.15 $0.75 896,100
June (through June 5) $0.85 $0.75 18,500
(1) On July 30, 2001, the Common Shares were listed on the TSX and delisted
from the TSX Venture.
The closing sales price of our Common Shares on the TSX was $0.85 on June 5,
2002.
DETAILS OF THE OFFERING
The offering consists of a maximum of o Units and a minimum of o Units. Each
Unit consists of 1 Common Share and 1/2 Warrant which are not separable until
after the Record and Distribution Date which will not be later than o, 2002. On
or prior to the Record and Distribution Date, Units will be evidenced by
legended share certificates which represent Common Shares and Warrants. After
the Record and Distribution Date, the share certificates will represent only
Common Shares and, as soon as practicable after the Record and Distribution
Date, the holders of record of the Units as of the close of business on the
Record and Distribution Date will receive a separate certificate representing
the Warrants. No certificate representing a fractional Warrant will be issued
and holders of Units on the Record and Distribution Date will not be entitled to
any cash payment or other compensation in respect of a fractional Warrant that
would otherwise have been issued.
The Warrants will be issued under and subject to a warrant indenture (the
"Warrant Indenture") to be entered into at the closing of the offering between
us and Computershare Trust Company of Canada ("Computershare"). Subject to
adjustment as provided in the Warrant Indenture, each whole warrant will entitle
the holder to purchase 1 Warrant Share at any time from the date it is issued
until 5:00 p.m. (Toronto time) on o at an exercise price of $o per Warrant
Share. The Warrant Indenture will provide that, on subdivision or consolidation
of the Common Shares, the number of Warrants Shares issuable on the exercise of
the Warrants and the exercise price thereof will be adjusted proportionately,
and that, in the event of any reclassification or change of the Common Shares or
consolidation, amalgamation or merger of the Corporation or any transfer of our
undertakings or assets as an entirety or substantially as an entirety, the
holder will be entitled to receive the type and amount of Warrant Shares or
other securities or property which he or she would have been entitled to receive
as a result of such event if, on the effective date thereof, he or she had been
a registered owner of the number of Warrant Shares to which he or she was
theretofore entitled upon exercise. The Warrant Indenture will also provide for
an adjustment of the exercise price in certain instances where there is a stock
dividend or rights offering of Common Shares or other participating shares or
other specified distribution to the holders of Common Shares.
34
<page>
PLAN OF DISTRIBUTION
Pursuant to an agreement dated o, 2002 (the "Agency Agreement") among the
Agents, Computershare, and us, we have appointed the Agents as our agent to
offer for sale to the public a maximum of o Units for gross proceeds of
$10,000,000, and a minimum of o Units for gross proceeds of $4,000,000, at $o
per Unit (the "Offering Price"), on a reasonable efforts basis, subject to the
terms and conditions contained in the Agency Agreement. The Offering Price of
the Units was determined through negotiations between us and the Agents. We will
allocate $o of the Offering Price to the Common Shares and nil to the 1/2
Warrant.
A commission of 8% of the gross proceeds raised pursuant to the offering will be
paid to the Agents. We will also grant to the Agents irrevocable and
non-transferable options to purchase that number of Units equal to 10% of the
Units sold pursuant to the offering at the Offering Price for a period of 24
months from the closing of the offering. The Agents' Options (one-half only in
Ontario) are qualified for distribution pursuant to this prospectus.
While the Agents have agreed to use their reasonable efforts to sell the Units
under the offering, the Agents are not obliged to purchase any Units. The Agents
may form a selling group with other registered dealers for the purpose of
selling the offering at no additional cost to us. Further, the obligations of
the Agents under the Agency Agreement may be terminated at their discretion on
the basis of their assessment of the state of the financial markets and upon the
occurrence of certain stated events.
We have granted the Agents an Over-Allotment Option, exercisable for a period of
90 days from the date of closing of the offering, to purchase up to 15% of the
total number of Units sold pursuant to the offering, on the same terms set forth
above, to cover over-allotments, if any. If the Agents exercise the
Over-Allotment Option in full, the total price to the public, the Agents' fee
and the net proceeds to us before expenses of the offering will be $o, $o and $o
respectively, assuming completion of the maximum offering, and $o, $o and $o,
respectively, assuming completion of the minimum offering. This prospectus also
qualifies the granting of the Over-Allotment Option and the distribution of the
Units issued upon the exercise of the Over-Allotment Option.
The offering is not underwritten and is subject to receipt by us, through our
Agents, of a minimum subscription of $4,000,000 which must be raised within 90
days of the issuance of a receipt from the securities commissions in the
Qualifying Jurisdictions for the filing of the (final) prospectus, or such other
time as may be authorized by the securities commissions in the Qualifying
Jurisdictions and agreed to by the Agents. During the 90 day period,
subscription funds will be held by Computershare Trust Company of Canada, as
depository. If the minimum subscription is not raised, subscription monies will
be returned to subscribers without interest or deduction. Subscriptions will be
received subject to rejection or allotment in whole or in part, and the right is
reserved by the Agents to close the subscription book at any time without
notice.
The Agents, as agents on our behalf, conditionally offer the Units on a
reasonable effort basis. The Units are offered subject to prior sale, if, as and
when issued, sold and delivered by us and accepted by the Agents in accordance
with the conditions contained in the Agency Agreement and subject to the
approval of certain legal matters on our behalf by Shea Nerland Calnan and on
behalf of the Agents by Gowling Lafleur Henderson LLP. It is expected that
definitive certificates evidencing the Units will be available for delivery at
closing which is expected to occur on or about o, 2002, or such later date as we
and the Agents may agree, but in any event no later than o, 2002.
Pursuant to policy statements of the Ontario Securities Commission and the
Commission des valeurs mobilieres du Quebec, the Agents may not, throughout the
period of distribution, bid for or purchase Common Shares. The foregoing
restriction is subject to exceptions, on the condition that the bid or purchase
is not engaged in for the purpose of creating actual or apparent active trading
in, or raising the price of, Common Shares. These exceptions include a bid or
purchase permitted under the by-laws and rules of the TSX relating to market
stabilization and passive market-making activities and a bid or purchase made
for and on behalf of a customer where the order was not solicited during the
period of distribution. Under the first-mentioned exception, in connection with
the offering, the Agents may over-allot or effect transactions which stabilize
or maintain the market price of the Common Shares at levels other than those
which might otherwise prevail in the open market. Those transactions, if
commenced, may be discontinued at any time.
The Units have not been and will not be registered under the United States
Securities Act of 1933, as amended (the "1933 Act") and accordingly may not be
offered or sold within the United States except in certain
35
<page>
transactions exempt from the registration requirements of the 1933 Act. The
Agents have agreed that, except as permitted by the Agency Agreement, they will
not offer or sell Units within the United States. In addition, until 40 days
after the commencement of the offering, an offer or sale of Units within the
United States by any dealer, whether or not participating in the offering, may
violate the registration requirements of the 1933 Act if such offer or sale is
made otherwise than in accordance with Rule 144A of the 1933 Act or another
exemption from registration under the 1933 Act.
RIGHTS TO ACQUIRE COMMON SHARES
STOCK OPTION PLAN
A maximum of 2,352,000 Common Shares may be issued on the exercise of stock
options granted pursuant to our stock option plan (the "Option Plan"). There are
two primary purposes for the Option Plan. The first is to develop the interest
of our directors, officers, employees and other persons who provide on-going
services to us and our subsidiaries in our growth and development by providing
such persons with the opportunity to acquire an increased proprietary interest
in us. The second is to better enable us and our subsidiaries to attract and
retain persons of desired experience and ability.
The Option Plan provides that the directors, subject to the price restrictions
and other requirements of the TSX and the Option Plan, shall fix the terms of
the options granted under the Option Plan. When we listed on the TSX, we amended
the Option Plan to state than the exercise price of an option may not be less
than the closing market price of the Common Shares on the TSX on the day
immediately preceding the date on which the option is granted. When we were
listed on the TSX Venture, the Option Plan allowed the exercise price of an
option to be at a discount to the market price provided that the discount was
not more than that allowed by the rules of TSX Venture. The Option Plan does not
restrict the number of Common Shares that may be issued to our directors or
officers as a group. However, the Option Plan does restrict the number of Common
Shares that may be granted to any one person pursuant to the Option Plan, and in
combination with any other share compensation arrangement, at not more than 5%
of our issued Common Shares. Options granted under the Option Plan may not be
for a period longer than 10 years.
There are currently outstanding options to purchase a total of 1,957,300 Common
Shares under the Option Plan. The following table sets forth certain information
concerning options granted pursuant to the Option Plan:
<table>
<caption>
Number of
Shares Market Price on
Group Date of Grant Under Option Date of Grant Exercise Price Expiration Date
- ---------------------- ------------------- ------------ ---------------- --------------- --------------------
<s>
Executive Officers (7) January 19, 2000 550,000 $1.85 $1.51 January 19, 2005
September 20, 2000 50,000 $3.15 $2.68 September 20, 2005
November 30, 2001 635,000 $1.80 $1.80 November 30, 2006
Directors who are not January 19, 2000 200,000 $1.85 $1.51 January 19, 2005
Executive Officers (2) November 30, 2001 20,000 $1.80 $1.80 November 30, 2006
Employees January 19, 2000 150,000 $1.85 $1.51 January 19, 2005
September 20, 2000 39,800 $3.15 $2.68 September 20, 2005
November 30, 2001 62,500 $1.80 $1.80 November 30, 2006
Consultants May 10, 2002 200,000 $1.08 $1.10 May 10, 2006
Total 1,907,300
</table>
(1) The above table does not include an option to purchase 50,000 Common
Shares until July 5, 2002 at $1.80 per share granted to a former
director.
EMPLOYEE SHARE OWNERSHIP PLAN
A maximum of 600,000 Common Shares may be issued pursuant to our employee share
ownership plan (the "Purchase Plan"). Under the Purchase Plan, officers,
directors, consultants and certain employees may purchase Common Shares at
market prices. The purpose of the Purchase Plan is to facilitate the purchase of
our Common Shares by employees, continue our efforts to share our success with
our employees, improve our ability to retain a skilled work force, and encourage
teamwork and cooperation among our employees.
36
<page>
Eligible participants may make cash contributions to the Purchase Plan at any
time during a fiscal quarter. The maximum contribution is limited to 10% of each
participant's gross annual salary. We will match those contributions. We will
issue Common Shares at the market price within 30 business days of the end of
each fiscal quarter in which an eligible participant has subscribed for Common
Shares under the Purchase Plan. For the purposes of the Purchase Plan, market
price means the closing price for the Common Shares on the TSX on the last
business day of the applicable fiscal quarter for which purchases are made under
this plan.
The number of Common Shares that may be issued to an eligible participant
pursuant to the Purchase Plan, in combination with any other share compensation
arrangement, may not exceed 5% of our issued Common Shares.
As at the date of this prospectus, 5,726 Common Shares have been purchased by
our employees under the Purchase Plan.
OTHER RIGHTS TO PURCHASE COMMON SHARES
As of May 31, 2002, the following additional options, warrants and convertible
securities were issued and outstanding:
1. Warrants to purchase up to 240,205 Common Shares until June 28, 2002 at
an exercise price of $6.00 per share.
2. Warrants to purchase up to 114,850 Common Shares until August 7, 2002
at an exercise price of $2.50 per share.
3. Warrants to purchase up to 110,862 Common Shares until August 31, 2002
at an exercise price of $6.00 per share.
4. Warrants to purchase up to 15,666 Common Shares until October 18, 2002
at an exercise price of $6.00 per share.
5. Warrants to purchase up to 226,000 Common Shares until May 31, 2003 at
an exercise price of $2.00 per share and from June 1, 2003 until May
31, 2004 at an exercise price of $2.25 per share.
6. Warrants to purchase up to 273,168 Common Shares until December 1, 2003
at an exercise price of $2.00 per share.
7. The Convertible Debenture which is convertible into Common Shares until
December 1, 2003 at a conversion price of $2.50 and until December 1,
2004 at a conversion price of $3.00.
8. An option to purchase 200,000 Common Shares until July 30, 2002 at
$2.20 per share granted to Noble House Investments Inc., which has
provided us with investor relations services.
PRINCIPAL SHAREHOLDERS
To the best of our knowledge, as of May 31, 2002, no person or corporation or
other entity beneficially owns, directly or indirectly, more than 10% of our
Common Shares, the only class of securities with voting rights, except Trevor M.
Hillman. Mr. Hillman is our Chairman of the Board, Chief Executive Officer and a
director. Mr. Hillman beneficially owns 2,674,730 Common Shares. This represents
21.3% of the currently outstanding Common Shares, o% of the outstanding Common
Shares assuming completion of the minimum offering, and o % of the outstanding
Common Shares assuming completion of the maximum offering.
Our officers and directors as a group beneficially own, directly or indirectly,
6,470,624 Common Shares. This represents 51.6% of the currently outstanding
Common Shares, o% of the outstanding Common Shares assuming completion of the
minimum offering, and o% of the outstanding Common Shares assuming completion of
the maximum offering. As a result, they can influence the control of our
Corporation.
37
<page>
RELATED PARTY TRANSACTIONS
None of our insiders or their associates and affiliates, has had any material
interest in any material transaction with us since June 1, 1998, which has not
been previously disclosed in this prospectus except as follows:
1. We lease our principal office and warehouse facility in Red Deer,
Alberta from G&J Holdings Inc., a company controlled by Gordon Hillman,
the father of Trevor H. Hillman. At the time the lease was entered
into, Trevor M. Hillman was our President, Chief Executive Officer and
a Director. The lease is for a five year term commencing March 27,
1998. The rent payable was $3,723.96 per month in the first year and
increases by increments to $4,869.79 per month in the fifth year. We
are also responsible for operational costs under the lease. The lease
is renewable for two further five year terms under the same terms and
conditions and at a rental rate based on a current rental market in Red
Deer, Alberta. See "Our Properties and Equipment".
2. We lease one of our retail locations in Saskatoon, Saskatchewan from a
company in which Marc Gignac and his spouse have a combined 50%
beneficial interest. At the time the lease was entered into, Marc
Gignac was our Director of Operations, Saskatchewan and a Director. The
lease is for a five year term commencing January 1, 2002. The rent
payable is $5,082 per month in the first two years and $5,505 per month
in the last three years. We are also responsible for operational costs
under the lease. The lease is renewable for one further five year term
under the same terms and conditions and at a rental rate based on a
current rental market in Saskatoon, Saskatchewan. See "Our Properties
and Equipment".
3. In September 1998, we acquired Integrated Retail from, among others,
Trevor H. Hillman, at the time our President, Chief Executive Officer
and a Director and Gregg C. Johnson, at the time our Executive
Vice-President and a Director. See "Our Acquisitions".
4. In April 1999, we participated in the formation of E-Trend to engage
in the e-commerce sale and distribution of filmed entertainment, music
and video games. On E-Trend's incorporation, E-Trend issued shares for
nominal consideration to us (66.67%). E-Trend also issued shares for
nominal consideration to Trevor H. Hillman (8.33%), at the time our
President, Chief Executive Officer and a Director, Gregg C. Johnson
(8.33%), at the time our Executive Vice-President and a Director, and
Ayaz Kara (less than 1%), at the time our Vice President - Business
Development and a member of our board of directors. See "E-Trend
Networks, Inc.".
5. In January 2000, we completed a revenue sharing agreement whereby we
sold certain capital assets of Integrated Retail to Video LP. Holders
of the Video LP units included the following insiders of VHQ
Entertainment: Peter Lacey, at the time a Director of VHQ Entertainment
who beneficially owned 18.75% of the partnership units; Ayaz Kara, at
the time our Vice President, Business Development and a Director, who
beneficially owned 2.5% of the partnership units; Catherine McDonough,
a Director, who beneficially owned 2.5% of the partnership units;
Trevor Hillman, at the time our President, Chief Executive Officer and
a Director, who beneficially owned 1.25% of the partnership units;
Gregg C. Johnson, at the time our Executive Vice-President and a
Director, who beneficially owned 1.25% of the partnership units; and
Marc Gignac, at the time our Director of Operations, Saskatchewan, who
beneficially owned 1.25% of the partnership units.
Effective December 1, 2001, we acquired all of the outstanding
partnership units from the Video LP limited partners. The Video LP
limited partners had the option to receive units comprised of one
Common Share and one-half of a warrant exercisable until December 1,
2003 at $2.00 per share; or a portion of the Convertible Debenture. The
Convertible Debenture is convertible into Common Shares at $2.50 per
share for two years and $3.00 per share for the final year. As a result
of the acquisition of the Video LP units, we issued 546,336 units (each
unit comprised of 1 Common Share and 1/2 warrant) and $1,280,475
principal amount of the Convertible Debenture. Trevor Hillman received
22,764 Common Shares and 11,382 warrants; Gregg Johnson received 22,764
Common Shares and 11,382 warrants; Marc Gignac (through his holding
company) received 11,382 Common Shares and 5,691 warrants, and $17,073
principal amount of the Convertible Debenture; Peter Lacey received
45,528 Common Shares, 22,764 warrants, and $341,460 principal amount of
the Convertible Debenture; Ayaz Kara received 45,528 Common Shares and
22,764 warrants; and Catherine McDonough received 22,764 Common Shares
and 11,382 warrants.
38
<page>
6. On April 1, 2002, we received a loan of $200,000 from Hillman Holdings
Inc. a company controlled by Gordon Hillman, the father of Trevor H.
Hillman, our Chairman of the Board, Chief Executive Officer and a
Director. In return, we issued a promissory note in that principal
amount plus interest at rate of 1% for each month or portion thereof
that the principal amount remains outstanding. This promissory note is
payable on the date that is 30 days after we receive a written demand
for payment from the lender.
7. On May 6, 2002, we received a loan of $100,000 from Marc Gignac, our
Director of Operations, Saskatchewan and then a Director. In return, we
issued a promissory note in that principal amount plus interest at the
rate of 10% per annum. The promissory note is payable in 12 equal
monthly installments of $8,771.55 commencing June 6, 2002 and ending
May 6, 2003.
DILUTION
The financial risk of our activities will be borne to a significant degree by
purchasers of Units under this offering who, based on the gross proceeds of this
offering, will suffer an immediate and substantial dilution of o% ($o per Common
Share) based upon completion of the maximum offering and o% ($o per Common
Share) based upon completion of the minimum offering, in each case assuming no
exercise of the Over-Allotment Option. The following table sets forth the
dilution with respect to the price per Common Share based upon the unaudited net
tangible book value per Common Share as at February 28, 2002, including,
subsequent share issuances to date:
<table>
<caption>
Maximum Offering Minimum Offering
---------------------------- ------------------------
<s>
Offering Price $__ $__
Tangible book value per Common Share before the
offering $__ $__
Increase of tangible book value attributable to the __ __
offering
-------------- ------------
Tangible book value per share after offering $__ $__ $__ $__
------------- ----------
Dilution $__ $__
============= ==========
Percentage dilution __% __%
============= ==========
</table>
CONFLICTS OF INTEREST
There are potential conflicts of interest to which our directors and officers
are subject in connection with our operations. Some of our directors and
officers have been and will continue to be engaged in the identification and
evaluation of businesses and corporations on their own behalf and on behalf of
other corporations, and situations may arise where they will be in direct
competition with us. Conflicts, if any, will be resolved pursuant to the
procedures and remedies under the CANADA BUSINESS CORPORATIONS ACT.
RISK FACTORS
Our securities are highly speculative. It is important to consider that we are
in the growth stage of our operations in the video and home entertainment
business. Described below are specific risks that are associated with our
business.
CORPORATION SPECIFIC RISKS
WE HAVE A HISTORY OF RECENT LOSSES AND WE MAY INCUR LOSSES IN FUTURE
PERIODS.
As of February 28, 2002, our retained deficit was $1,835,179. We reported net
losses of $1,299,933 during the nine month period ended February 28, 2002, and
$2,813,521 for the fiscal year ended May 31, 2001. Our operating expenses and
marketing expenses have increased continuously since inception and we expect
them to continue to increase significantly in the next several years as we
implement our growth strategy and expand our business. As a result, we
anticipate that we will need to increase our revenues significantly to remain
profitable. In order to increase our revenues, our stores must remain
competitive and we must maintain continued growth in same store sales and
generate expected sales from new stores. If our revenues do not increase as much
as we expect or if our expenses increase at a greater pace than revenues, we may
not be able to sustain or increase profitability during any fiscal period.
39
<page>
WE HAVE A LIMITED OPERATING HISTORY, WHICH MAKES IT DIFFICULT TO
PREDICT THE FUTURE SUCCESS OF OUR OPERATIONS AND OUR INDIVIDUAL VIDEO AND HOME
ENTERTAINMENT STORES.
We have only a limited operating history upon which an investor can evaluate our
business and prospects. We entered into the retail video rental industry by
acquiring Integrated Retail in September 1998. See "Our Acquisitions".
Approximately 40% of our video and home entertainment stores are less than two
years old, which makes it difficult to predict the future success of each store.
Our prospects should be considered in light of the risks, expenses and
difficulties we may encounter as an early stage company in a stage of rapid
growth through acquisition. These risks include:
o our ability to effectively integrate new stores into our organization.
o the adverse effect that acquisition costs may have on the results of
our historical operations.
o competition, including increased competition, in the markets we
service.
o the adverse effect that our new stores or acquisitions may have on the
sales of our existing stores serving the same markets.
o our ability to attract and maintain quality personnel.
o general regional and national economic conditions.
o consumer trends related to video entertainment and home entertainment.
o acceptance of our entertainment and product mix.
o timing of promotional events and product introductions.
o our ability to execute our business strategy effectively.
Comparable store sales may not increase at historical rates and operating costs
may increase in the future. Changes in our comparable store sales results could
cause the price of the Common Shares to fluctuate substantially.
TO DATE, MUCH OF OUR REVENUE GROWTH IS ATTRIBUTABLE TO THE OPENING OR
ACQUISITION OF NEW STORES. IF WE ARE NOT ABLE TO INCREASE REVENUE GROWTH AT
EXISTING STORES, WE MAY NOT BE ABLE TO INCREASE OR SUSTAIN REVENUE GROWTH ONCE
WE REACH A LOWER GROWTH STAGE.
The majority of our revenue growth since inception can be attributed to the
acquisition of new retail locations. Since inception, we have paid $3.19 million
in cash and issued an aggregate of 7,974,957 Common Shares, warrants and options
in making such acquisitions. In order to sustain revenue growth as our
acquisitions decrease, we must increase the revenue of existing retail
locations. If we fail to increase existing store revenue, our results will
suffer.
WE MAY BE UNABLE TO SUSTAIN OUR GROWTH OR TO MANAGE THE GROWTH OF OUR
OPERATIONS, WHICH MAY AFFECT OUR PROFITABILITY.
Our growth strategy includes the acquisition of existing video and home
entertainment stores and the opening of new stores. During the fiscal year ended
May 31, 2001, we acquired five stores and opened eleven new stores. We now
operate a total of 49 stores, compared to 33 stores as at May 31, 2000, and 14
stores at May 31, 1999. Execution of our growth strategy requires our existing
management personnel to, among other things:
o identify acquisition candidates who are willing to sell their
businesses at reasonable prices.
o identify new sites where we can successfully compete and negotiate
acceptable leases to implement cost-efficient development plans for new
stores.
o obtain financing for acquisitions and new store development.
o hire, train and assimilate store managers and other store personnel.
o hire and train additional product fulfillment personnel to handle
additional product distribution.
o integrate each store's management information system and marketing
programs into our system.
Our growth could strain the ability of existing management to accomplish these
tasks and lessen the effectiveness of management with respect to existing
operations. There is no assurance that we will successfully open new stores or
identify, negotiate, finance, consummate or assimilate the acquisition of
additional video and home entertainment stores in the future. Continued
substantial growth could have a
40
<page>
material adverse effect on our results of operations, while the failure to
maintain our growth rate could have a material adverse effect on the price of
our Common Shares.
In addition to the management challenges, our future growth will require
significant capital. In the past, acquisitions and store openings have been
financed primarily with proceeds from our previous private and public offerings
of Common Shares, debt and internally generated cash flow. We may seek to raise
additional capital through future public or private sales of debt or equity
securities. However, there is no assurance that we can obtain sufficient capital
on reasonable terms, if at all, to implement our growth strategy.
OUR BUSINESS STRATEGY REQUIRES THE OPENING OF, OR ACQUISITION OF, NEW
RETAIL LOCATIONS, BOTH OF WHICH ARE RESOURCE INTENSIVE, AND MAY REQUIRE US TO
OBTAIN ADDITIONAL FINANCING. IF WE FAIL TO OBTAIN SUCH FINANCING, WE MAY BE
UNABLE TO IMPLEMENT OUR BUSINESS STRATEGY AND OUR RESULTS MAY SUFFER.
Financing for the opening and acquisition of new stores may be in the form of
debt or equity or both and may not be available on terms acceptable to us, if at
all. We estimate that the average cash investment for tenant improvements,
inventory (net of payables), marketing and training required to open a new store
is approximately $225,000 for our traditional store format. We estimate the cost
of opening a rebranded VHQ Entertainment store to be up to approximately
$275,000. The actual cost of opening a store may be significantly greater than
such current estimates. We will need to seek additional debt and/or equity
financing in order to fund our continued expansion. In addition, our ability to
incur indebtedness or issue equity or debt securities could be limited by risks
described throughout this section, including general economic risks and risks
affecting our business and results of operations; some of which are beyond our
control. Further, our issuance of equity securities to raise capital to acquire
or open additional stores may have the effect of diluting the interests of our
existing stockholders.
PIRACY OF THE PRODUCTS WE OFFER MAY ADVERSELY AFFECT OUR OPERATIONS.
With the advent of the Internet, the risk with respect to the access to pirated
motion picture products has increased. Traditionally, pirated VHS tapes could be
obtained on the black market. However, these tapes were of poor quality and the
distributors of the tapes could be shut down quickly since they could be located
as soon as they attempted to sell the pirated tapes. With the development of the
Internet, and its non-jurisdictional nature, there is now the potential for wide
distribution of pirated movies at a low cost. This poses a threat not only to
the producers and creators of motion pictures but to entertainment providers
like us.
Currently movie studios generate approximately 60% of their overall revenues
from non-theatrical resources (including retail and rental). Accordingly,
maintaining rights and control over their product distribution over the Internet
is fundamental to the ongoing profitability of the studios. We expect that the
movie industry will follow the music industry, which in the United States
recently challenged the sale of non-licensed music over the Internet. The
creators and owners of music were successful in stopping a significant web based
distributor of unlicensed music from continuing to sell its product. Like the
music industry, we believe the studios will take an aggressive position against
piracy over the Internet, since it is fundamental to profitability of the
studios to ensure that only licensed providers distribute their products. There
can be no guarantees, however, that the studios will take steps to enforce their
rights against Internet piracy or that they will be successful in preventing the
distribution of pirated movies.
IF WE DON'T RECEIVE ADDITIONAL FINANCING, WE WILL NOT BE ABLE TO
EXECUTE OUR BUSINESS PLAN.
We will require additional financing to execute our business plan. Our ability
to arrange such financing in the future will depend in part upon the prevailing
capital market conditions as well as our business performance. There can be no
assurance that we will be successful in our efforts to arrange additional
financing on satisfactory terms. If additional financing is raised by the
issuance of Common Shares, shareholders may suffer additional dilution. If
adequate funds are not available, or are not available on acceptable terms, we
may not be able to take advantage of opportunities, develop new products or
otherwise respond to competitive pressures and remain in business.
ACQUISITION RISKS
Our growth strategy involves the continued acquisition of existing video and
home entertainment stores. This strategy includes the following risks:
41
<page>
WE MAY BE UNABLE TO COMPETE WITH OTHER VIDEO CHAINS FOR ATTRACTIVE
ACQUISITION TARGETS, WHICH MAY LIMIT OUR GROWTH.
Some of our competitors may seek to acquire some of the same video and home
entertainment stores that we seek to acquire. This competition for acquisitions
would likely increase acquisition prices and related costs and result in fewer
acquisition opportunities, which could have a material adverse effect on our
growth or our ability to acquire acquisition targets on acceptable terms.
SELLERS OF ACQUISITION TARGETS MAY MAKE MISREPRESENTATIONS TO US OR
BREACH THE TERMS OF AN ACQUISITION AGREEMENT, WHICH COULD ADVERSELY AFFECT THE
VALUE OF AN ACQUISITION.
Our acquisitions of Safiqa, Star Vision and 705556 were share transactions and
subject to all of their liabilities, stated or otherwise. In completing each
acquisition, we relied upon the representations, warranties and indemnities made
by the sellers, as well as our own due diligence investigations.
In the future, we may acquire additional video and home entertainment stores or
chains in either asset acquisitions or share acquisitions. In each case, we will
rely upon the representations, warranties and indemnities made by the sellers
and our due diligence. There is no assurance that the sellers' representations
and warranties will be true and correct or that our due diligence investigations
will uncover all materially adverse facts relating to the operations and
financial condition of the acquired businesses. In the event that we are
required to pay for obligations not expressly assumed, or which the sellers have
not disclosed or in the event there are material misrepresentations, we may not
be able to recoup the costs of paying such obligations, or recover our damages,
from the sellers.
WE ANTICIPATE THAT MOST POTENTIAL ACQUISITION TARGETS WILL BE PRIVATE
COMPANIES AND THAT WE WILL HAVE LIMITED KNOWLEDGE OF THEIR OPERATING HISTORIES,
WHICH MAY ADVERSELY AFFECT OUR ABILITY TO MAKE AN INFORMED ACQUISITION DECISION.
Notwithstanding our due diligence investigations, our management will have
limited knowledge about the specific operating histories, trends and customer
buying patterns of the video and home entertainment stores that we seek to
acquire. Further, we anticipate that potential acquisition targets may have
limited operating histories, which could make predicting their future success
uncertain. Consequently, there is no assurance that we will make acquisitions,
if any, at favorable prices, that acquired stores will perform as well as they
have performed historically or that we will have sufficient information to
accurately analyze the markets in which we elect to make acquisitions. Our
failure to pay reasonable prices for acquisitions or to acquire profitable video
and home entertainment stores could have a material adverse effect on our
results of operations.
OUR FAILURE TO INTEGRATE THE OPERATIONS OF VIDEO AND HOME ENTERTAINMENT
STORES THAT WE ACQUIRE WITH EXISTING STORES AND SYSTEMS MAY CREATE OPERATING
INEFFICIENCIES, WHICH COULD ADVERSELY AFFECT OUR RESULTS OF OPERATIONS.
The success of the video and home entertainment stores we acquire depends in
large part on our ability to integrate these stores into our purchasing,
marketing and management information systems. If we fail to integrate acquired
stores successfully and on a timely basis, we may not achieve operating
efficiencies and our results of operations may suffer. We currently operate
stores that we have acquired under different brand names and we may acquire and
operate other video and home entertainment stores under other brand names.
Operating stores under different brand names creates a challenge for our
management and may diminish our operating efficiencies. We anticipate that we
will maintain the personnel and the general business operations of the video and
home entertainment stores we acquire. The success of these acquisitions will be
dependent, in part, upon the manner in which we are able to integrate the
personnel into our operations and the manner in which the acquired stores were
operated. There is no assurance that we will be able to integrate these existing
video and home entertainment stores in a manner consistent with our standards.
OPERATING RISKS
Our business is subject to operating risks associated with the video and home
entertainment industry and our operations. Set out below are material risks
associated with the operation of our business.
42
<page>
THE VIDEO AND HOME ENTERTAINMENT INDUSTRY IS HIGHLY COMPETITIVE AND
SOME OF OUR COMPETITORS HAVE SUBSTANTIALLY GREATER RESOURCES THAN US, WHICH THEY
MAY USE TO IMPLEMENT STRATEGIES THAT COULD ADVERSELY AFFECT OUR MARKET SHARE AND
RESULTS OF OPERATIONS.
The video and home entertainment industry is highly competitive and there are
few barriers to entry. We compete with many other video and home entertainment
stores, including stores operated by regional and national chains, as well as
other businesses offering VHS tapes, DVDs and video games such as supermarkets,
pharmacies, convenience stores, bookstores, mass merchants, mail order
operations and other retailers. Some of our competitors may open locations in
close proximity to our video and home entertainment stores and may offer broader
product selections, lower prices and better rental terms than us, which may
cause our customers to patronize our competitors. Some of our competitors have
greater financial and marketing resources, market share and name recognition
than us, which may allow them to quickly develop market presence in the markets
we serve or allow them to expand into new markets that we intend to serve. There
is no assurance that we will be able to effectively compete with these
competitors.
In addition, we compete with all leisure-time activities, such as movie
theatres, network and cable television, direct broadcast satellite television,
live theatre, sporting events and family entertainment centres. In the event the
demand for our products declines, our business and results of operations will be
adversely affected.
THE VIDEO ENTERTAINMENT PRODUCTS THAT WE OFFER ARE SUBJECT TO TECHNICAL
OBSOLESCENCE, WHICH COULD REDUCE THE DEMAND FOR THE PRODUCTS WE OFFER.
We compete with, among others, pay-per-view cable television systems
("Pay-Per-View"), in which subscribers pay a fee to see a movie that they
select. Pay-Per-View presently offers only a limited number of channels and
movies in certain cable television markets. However, recently developed
technologies, referred to as "Near Video-on-Demand" ("NVOD"), permit certain
cable companies, direct broadcast satellite companies (such as DirecTV),
telephone companies and other telecommunications companies to transmit a much
greater number of movies to homes throughout the United States at frequent
intervals (often as frequently as every five minutes) throughout the day. NVOD
does not offer full interactivity or VCR functionality such as allowing the
consumer to control the playing of the movie, starting, stopping and rewinding.
Ultimately, further improvements in these technologies could lead to the
availability of a broad selection of movies to consumers on demand, referred to
as "Video-on-Demand" ("VOD"), at a price which may be competitive with the price
of VHS tape rentals and with VCR functionality. Some cable and other
telecommunications companies have tested and are continuing to test limited
versions of NVOD and VOD in various markets throughout Canada, the United States
and Europe. Changes in the manner in which movies are marketed, primarily
related to an earlier release of movie titles to NVOD and VOD distribution
channels, could substantially decrease the demand for VHS tape rentals, which
would have a material adverse effect on our business. Currently, movie titles
are released to the video and home entertainment specialty store market from 30
to 120 days before release to the Pay-Per-View (including NVOD and VOD)
distribution channels.
THE DVD FORMAT IS EXPECTED TO GAIN POPULARITY WHICH WILL REQUIRE US TO
MAKE ADDITIONAL CAPITAL EXPENDITURES TO INCREASE OUR DVD SELECTION.
We anticipate that the popularity of movies recorded on DVDs will increase as
the price of DVDs become comparable with VHS tapes. We currently offer a
selection of DVDs in all of our stores and anticipate that the selection will
grow as a percentage of the titles we offer. In the future, we may be required
to offer a broader selection of catalogue titles on DVD to remain competitive
and to meet the demands of the markets we serve. We anticipate that this may
require a substantial investment in DVD inventory, which may not be offset by
increased unit rentals. In addition, the advent of video CD's may result in
consumers purchasing more films than in the past, which could have a materially
adverse effect on our rental volume and, as a result, on our profit margins.
THE VIDEO RENTAL INDUSTRY WOULD LOSE A SIGNIFICANT COMPETITIVE
ADVANTAGE IF THE MOVIE STUDIOS ADVERSELY CHANGE THEIR CURRENT DISTRIBUTION
PRACTICES.
A significant competitive advantage that the video rental industry currently
enjoys over most other movie distribution channels, except theatrical release,
is the early timing of the video store distribution "window." This window is
exclusive against most other forms of non-theatrical movie distribution, such as
Pay-Per-View, premium television, basic cable and network and syndicated
television. The length of the window for movie rental
43
<page>
varies, typically ranging from 30 to 90 days for domestic video stores and from
120 to 180 days for international video stores. Thereafter, movies are made
sequentially available to television distribution channels.
We could be materially adversely affected if:
o the video store windows were no longer the first following the
theatrical release;
o the length of the video store windows were shortened;
o the video store windows were no longer as exclusive as they are now; or
o an increasing number of titles were released to "sell-through" instead
of rental;
because newly released movies would be made available earlier on other forms of
non-theatrical movie distribution. As a result, consumers would no longer need
to wait until after the video store distribution window to view a newly released
movie on other distribution channels and our business results might suffer.
OUR PRIMARY DEPENDENCE ON CERTAIN SUPPLIERS AND WHOLESALERS TO SUPPLY
US WITH INVENTORY MAY AFFECT OUR ABILITY TO OPERATE IN THE EVENT ANY SUCH
SUPPLIER IS UNABLE TO FULFILL OUR INVENTORY NEEDS ON REASONABLE TERMS.
Our continuing profitability depends in part on our ability to acquire
sufficient quantities of the latest and most popular titles (VHS, DVDs, video
games and music CDs) on a timely basis and at favorable prices. As of April 30,
2002, we acquired approximately 50% of our supply of rental VHS and DVDs, and
substantially all of our video game products, from Video One. We have a
non-exclusive Product Fulfillment Agreement with Video One which expires on
January 30, 2003.
While we believe that we can obtain comparable quantities of titles from other
suppliers, the number of alternative suppliers has diminished in recent years
due to the consolidation of the industry. Accordingly, the termination of our
present relationship with Video One could adversely affect our results of
operation until a suitable replacement is found. Also, we cannot guarantee that
any such replacement would provide service or payment terms as favorable as
those provided by Video One.
OUR OPERATIONS ARE SUBJECT TO SEASONAL AND OPERATING FLUCTUATIONS,
WHICH MAY AFFECT THE RESULTS OF OUR OPERATIONS.
Our VHS, DVD and video game rental business is somewhat seasonal, with revenues
in April and May generally being lower due in part to the change to Daylight
Savings Time and improved weather, and revenues in September and October
generally being lower due in part to the start of school, the football season
and the new television season. The seasonality of our business could adversely
affect our financial results.
In addition, future operating results may be affected by many factors, including
variations in the number and timing of store openings, the timing of, and public
acceptance of new release titles available for rental and sale, the timing of
our acquisition of existing video and home entertainment stores, the extent of
competition, marketing programs, weather, special or unusual events, such as the
Olympics or a televised event of significant public interest, and other factors
that may affect retailers in general. Any concentration of new store openings
and the related new store pre-opening costs near the end of a fiscal quarter
could have an adverse effect on the financial results for that quarter.
BECAUSE MARGINS ON SELL-THROUGH PRODUCTS ARE LOWER THAN RENTAL MARGINS,
OUR MARGINS COULD BE MATERIALLY ADVERSELY AFFECTED IF A GREATER PROPORTION OF
NEWLY RELEASED MOVIES WERE INITIALLY PRICED AS A SELL-THROUGH PRODUCT AND
CONSUMERS DESIRED TO OWN THESE MOVIES RATHER THAN RENT THEM.
In general, studios initially price their movies at prices that are too high to
generate significant consumer demand for purchase. Recently, however, the
studios have released a limited number of movies at prices intended to generate
consumer demand to purchase these movies rather than rent them. This is referred
to as sell-through pricing. If studios release more movies at sell-through
prices, demand for video rentals may decrease and our results may be adversely
affected.
Sell-through retail margins are generally lower than rental margins. Some of our
competitors, such as mass merchandisers, warehouse clubs and Internet sites, can
distribute and sell these sell-through movies on VHS or DVD at lower costs
and/or may operate at lower margins than us. As a result, our sell-through
business has
44
<page>
comprised only a small percentage of our total revenue. We believe our
profitability would be adversely affected if we did not derive most of our
revenues from the higher margin rental business. We could be materially
adversely affected if:
- a greater proportion of either release format were initially priced as
sell-through merchandise; and
- consumers desired to own, and not rent, these movies.
A CHANGE IN OUR COST STRUCTURE COULD ADVERSELY AFFECT OUR BUSINESS
Fixed costs, including costs associated with our premises and salaries, account
for a significant portion of our costs and expenses. As a result, downtime or
lost productivity resulting from lower demand, equipment failures or other
factors could result in operating losses for our business.
OUR BUSINESS MAY BE AFFECTED BY CHANGES IN LOCAL ECONOMIES
We have developed a business strategy targeting the secondary retail markets
located in communities of approximately 10,000 people. The strength of the local
economy in these types of communities typically depends upon the strength of a
smaller number of key industries. If the major sustaining industry in one of
these communities is negatively affected, the strength of the entire local
economy will be negatively affected and the amount of disposable income of the
residents in that particular community will decrease. Consequently, a store
operated by us in that location may be negatively affected. A significant
improvement in a local economy may also adversely affect our stores in that
community because the residents may be attracted to other forms of
entertainment.
CORPORATION AND SECURITIES RELATED RISKS
WE DEPEND ON THE EXPERTISE OF KEY PERSONNEL. IF ANY OF THESE
INDIVIDUALS WERE TO LEAVE, OUR BUSINESS MAY SUFFER.
Our future success depends on the continued services of certain key management
personnel, including Trevor M. Hillman, our Chairman and Chief Executive
Officer, Gregg C. Johnson, our President and Chief Operating Officer, Derrek R.
Wong, our Senior Vice President, Finance and Chief Financial Officer and Michael
D. McKelvie, our Senior Vice President, Marketing & Communications. The loss of
any one of these individuals could have a material adverse effect on our results
of operations. We maintain key-man life insurance for Trevor M. Hillman. We have
entered into consulting agreements with Mr. Hillman and Mr. Johnson. To date we
have not entered into written employment agreements with Mr. Wong or Mr.
McKelvie. Our continued growth and profitability also depend on our ability to
attract and retain other management personnel, including qualified store
managers.
PURCHASERS OF UNITS WILL SUFFER IMMEDIATE AND SUBSTANTIAL DILUTION
The financial risk of our activities will be borne to a significant degree by
purchasers of Units under this offering who, based on the gross proceeds of this
offering, will suffer an immediate and substantial dilution of o% ($o per Common
Share) based upon completion of the maximum offering and o% ($o per Common
Share) based upon completion of the minimum offering, in either case assuming no
exercise of the Over-Allotment Option.
PURCHASERS MAY NOT BE ABLE TO SELL WARRANTS PURCHASED PURSUANT TO THIS
PROSPECTUS
Our Common Shares are traded on the TSX under the symbol "VHQ". The closing sale
price of our Common Shares on the TSX on June 5, 2002 was $0.85. However, there
is currently no market through which, after the Record and Distribution Date,
the Warrants may be sold and purchasers may not be able to sell Warrants
purchased pursuant to this prospectus.
IT IS NOT CONTEMPLATED THAT ANY DIVIDENDS WILL BE PAID IN THE IMMEDIATE
OR FORESEEABLE FUTURE
No dividends have been paid on any of our shares since the date of our
incorporation and it is not contemplated that any dividends will be paid in the
immediate or foreseeable future.
45
<page>
PRIOR SALES
Since May 1, 2001, we have issued the following Common Shares:
<table>
<caption>
Number of Common Issue Price Per Nature of Consideration
Date Shares Common Share Gross Proceeds Received
- -------------------- ----------------- --------------- -------------- ------------------------
<s>
July 31, 2001 229,700 $2.00 $ 459,400 Cash
December 1, 2001 546,336 $1.50 $ 819,504 Assets(1)<F1>
April 29, 2002 5,726 $1.40 $ 8,016 Cash(2)<F2>
May 31, 2002 226,000(3)<F3> $1.00 $ 226,000 Cash
<FN>
(1)<F1> Issued as partial consideration for the assets of Video LP. See
"Operating and Financial Review".
(2)<F2> Issued pursuant to the Purchase Plan. See "Employee Share Ownership
Plan".
(3)<F3> Plus an equal number of warrants, each warrant exercisable to purchase
one Common Share at $2.00 until May 31, 2003 and at $2.25 until May 31,
2004.
</FN>
</table>
MATERIAL CONTRACTS
The following are the material contracts, other than in the ordinary course of
our business, which we have entered into in the last two years:
1. Services Agreement with TMH dated effective April 1, 2001. See
"Employment Contracts".
2. Services Agreement with Summit dated effective April 1, 2001. See
"Employment Contracts".
3. Definitive Share Purchase Agreement dated December 21, 2001 with Game
Holdings. See "E-Trend Networks, Inc.".
4. Promissory Note granted by Game Holdings dated December 22, 2001. See
"E-Trend Networks, Inc.".
5. Agency Agreement dated __, 2002 with the Agents and Computershare. See
"Plan of Distribution".
6. Warrant Indenture to be entered into with Computershare. See "Details
of the Offering".
Copies of the material contracts will be available for inspection at our head
office at 6201 - 46th Avenue, Red Deer, Alberta T4N 6Z1, during business hours
for a period of 30 days after a receipt has been issued for this prospectus in
each of the Qualifying Jurisdictions.
LEGAL MATTERS
Certain legal matters in connection with the Units will be passed upon on our
behalf by Shea Nerland Calnan of Calgary, Alberta, and on behalf of the Agents
by Gowling Lafleur Henderson LLP of Toronto, Ontario. The partners and
associates of Shea Nerland Calnan, as a group, and Gowling Lafleur Henderson
LLP, as a group, each beneficially own, directly and indirectly, less than 1% of
our outstanding Common Shares.
LEGAL PROCEEDINGS
On January 18, 2001, Beamscope Canada, Inc. ("Beamscope"), which had previously
supplied us with video game rental products, filed a statement of claim in the
Ontario Superior Court of Justice. The claim alleges that Beamscope is owed
$159,074.56 for video games and related merchandise provided to us from August
2000 to November 2000. We filed a counterclaim against Beamscope seeking
$1,500,000 in damages for lost business as a result of Beamscope's failure to
deliver products in a timely manner. As of April 30, 2002 the parties have
agreed to settle the claim by the payment from us to Beamscope in the amount of
$50,000 for a full release by both sides.
46
<page>
On January 2, 2002, Brian Meyer filed a statement of claim against us and
E-Trend in the Court of Queen's Bench, Alberta, Judicial District of Red Deer.
Mr. Meyer claims that he was improperly terminated and is seeking a judgment in
the amount of $30,750 and general/punitive damages in the amount of $25,000,
plus interests and costs. On January 29, 2002, we filed a statement of defense
as well as a counterclaim in the amount of $5,000 for a loan we made to Mr.
Meyer which has not been repaid. We intend to defend against Mr. Meyer's claim.
AUDITORS, TRANSFER AGENT AND REGISTRAR
Since April 27, 2001 our auditors have been Collins Barrow, Chartered
Accountants and Consultants, Suite 400, 5010 - 43rd Street, Red Deer, Alberta
T4N 6H2. Prior to April 27, 2001, our auditors were Ernst & Young, LLP,
Chartered Accountants, Suite 1000, 400 - 2nd Ave SW, Calgary, Alberta T2P 5E9.
The transfer agent and registrar for the Units and the Warrants will be, and the
transfer agent and registrar for the Common Shares is, Computershare Trust
Company of Canada at its principal offices in Calgary, Alberta and Toronto,
Ontario.
PURCHASER'S STATUTORY RIGHTS
Securities legislation in certain of the provinces of Canada provides purchasers
with the right to withdraw from an agreement to purchase securities. This right
may be exercised within two business days after receipt or deemed receipt of a
prospectus and any amendment. In several of the provinces, the securities
legislation further provides a purchaser with remedies for rescission or, in
some jurisdictions, damages if the prospectus and any amendment contains a
misrepresentation or is not delivered to the purchaser, provided that the
remedies for rescission or damages are exercised by the purchaser within the
time limit prescribed by the securities legislation of the purchaser's province
or territory. The purchaser should refer to any applicable provisions of the
securities legislation of the purchaser's province or territory for the
particulars of these rights or consult with a legal advisor.
47
AUDITORS' REPORT
To the Directors of
VHQ Entertainment Inc.
We have audited the consolidated balance sheets of VHQ Entertainment Inc. as at
May 31, 2001 and 2000 and the consolidated statements of earnings and retained
earnings (deficit) and cash flows for the twelve months ended May 31, 2001, 2000
and 1999. These financial statements are the responsibility of the Corporation's
management. Our responsibility is to express an opinion on these financial
statements based on our audit.
We conducted our audit in accordance with Canadian generally accepted auditing
standards. Those standards require that we plan and perform an audit to obtain
reasonable assurance whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
In our opinion, these consolidated financial statements present fairly, in all
material respects, the financial position of the Corporation as at May 31, 2001
and 2000 and the results of its operations and cash flows for the twelve-month
periods ended May 31, 2001, 2000 and 1999 in accordance with Canadian generally
accepted accounting principles.
Red Deer, Alberta
May 23, 2001, Chartered Accountants
except as to Note 16
which is as of __, 2002
48
VHQ ENTERTAINMENT INC.
CONSOLIDATED BALANCE SHEET
(ALL FIGURES $ CDN)
<table>
<caption>
February 28, May 31,
---------------- --------------------------------
2002 2001 2000
---------------- --------------- --------------
(unaudited)
<s>
ASSETS
CURRENT
Cash 210,569 155,371 238,635
Accounts receivable 331,515 237,583 354,747
Inventory 1,750,150 1,561,352 789,971
Note receivable [NOTE 3] - - 884,009
Prepaid expenses and deposits 208,374 189,286 201,553
---------------- --------------- --------------
2,500,608 2,143,592 2,468,915
INVESTMENT IN SUBSIDIARY [NOTE 4] - - 1,886,851
CAPITAL ASSETS [NOTE 5] 10,077,151 8,575,627 6,827,334
GOODWILL [NOTE 6] 3,009,885 3,018,749 3,369,994
---------------- --------------- --------------
15,587,644 13,737,968 14,553,094
================ =============== ==============
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT
Bank indebtedness [NOTE 7] 1,244,141 800,556 69,231
Accounts payable and accrued liabilities 4,533,137 3,977,617 2,860,675
Current portion of lease inducements 46,827 65,744 25,212
[NOTE 12]
Current portion of long-term debt [NOTE 8] 669,134 158,750 62,924
---------------- --------------- --------------
6,493,239 5,002,667 3,018,042
DEFERRED LEASE INDUCEMENTS [NOTE 12] 291,676 291,676 108,684
LONG-TERM DEBT [NOTE 7,8] 1,075,420 110,794 233,996
DUE TO RELATED COMPANY [NOTE 11] 85 493,578 361,331
FUTURE INCOME TAXES [NOTE 10] 657,000 748,000 2,465,000
---------------- --------------- --------------
SHAREHOLDERS' EQUITY
Share capital [NOTE 9] 8,905,403 7,626,499 6,087,766
Retained earnings (deficit) (1,835,179) (535,246) 2,278,275
---------------- --------------- --------------
7,070,224 7,091,253 8,366,041
---------------- --------------- --------------
15,587,644 13,737,968 14,553,094
================ =============== ==============
</table>
On behalf of the Board of Directors
By: (Signed) GREGG C. JOHNSON By: (Signed) CATHERINE J. MCDONOUGH
Director Director
SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
49
VHQ ENTERTAINMENT INC.
CONSOLIDATED STATEMENT OF EARNINGS AND RETAINED EARNINGS
(ALL FIGURES $ CDN)
<table>
<caption>
Nine Months Ended
February 28, Year Ended May 31,
---------------------------- ------------------------------------------
2002 2001 2001 2000 1999
------------- ------------- ------------ ------------- -------------
(unaudited)
<s>
REVENUES
Rentals 14,801,857 12,296,186 16,579,831 10,205,031 3,893,290
Product Sales 4,893,893 3,501,657 4,750,636 2,679,821 1,026,245
------------- ------------- ------------ ------------- -------------
TOTAL REVENUES 19,695,750 15,797,843 21,330,467 12,884,852 4,919,535
COST OF SALES
Revenue sharing 1,490,309 979,475 1,772,261 625,743 391,243
Amortization of rental product 3,269,065 1,975,341 2,599,104 1,450,933 643,896
------------- ------------- ------------ ------------- -------------
Rental 4,759,374 2,954,816 4,371,365 2,076,676 1,035,139
Product sales 3,689,096 2,711,778 3,665,497 2,187,754 694,454
------------- ------------- ------------ ------------- -------------
TOTAL COST OF SALES 8,448,470 5,666,594 8,036,862 4,264,430 1,729,593
GROSS MARGIN 11,247,280 10,131,249 13,293,605 8,620,422 3,189,942
OPERATING COSTS AND EXPENSES
Store operating expenses 8,127,370 6,415,827 9,371,740 5,525,630 2,268,725
General and administrative 2,330,216 1,507,155 2,318,520 1,956,710 518,644
Amortization of intangibles 20,082 275,108 361,934 246,288 3,819
------------- ------------- ------------ ------------- -------------
TOTAL OPERATING COSTS AND 10,477,668 8,198,090 12,052,194 7,728,628 2,791,188
EXPENSES
OPERATING INCOME (LOSS) 769,612 1,933,159 1,241,411 891,794 398,754
Interest expense (net) 118,445 94,450 119,649 151,497 8,371
Interest - convertible debenture 20,792 - - - -
Income tax recovery (9,171) - - - -
Video Limited Partnership 710,170 1,135,385 1,509,565 732,990 -
disbursements ------------- ------------- ------------ ------------- -------------
[NOTE 11]
INCOME (LOSS) BEFORE THE FOLLOWING: (70,624) 703,324 (387,803) 7,307 390,383
Write-down of investment [NOTE 4] - (481,811) (1,886,851) - -
Write-down of capital assets (1,320,309) - (2,255,867) - -
[NOTE 2,13]
Minority interest [NOTE 4] - - - 114,572 -
Equity loss of investment [NOTE 1, 4] - - - (268,249) -
Gain on dilution of investment - - - 2,452,188 -
[NOTE 1,4]
Gain on disposal of assets [NOTE 14] - - - 1,297,049 -
------------- ------------- ------------ ------------- -------------
INCOME (LOSS) (1,390,933) 221,513 (4,530,521) 3,602,867 390,383
------------- ------------- ------------ ------------- -------------
Future income taxes (recovery) (91,000) 99,000 (1,717,000) 1,500,000 173,000
------------- ------------- ------------ ------------- -------------
NET INCOME (LOSS) (1,299,933) 122,513 (2,813,521) 2,102,867 217,383
------------- ------------- ------------ ------------- -------------
RETAINED EARNINGS (DEFICIT), BEGINNING (535,246) 2,278,275 2,278,275 175,408 (41,975)
OF THE PERIOD
RETAINED EARNINGS (DEFICIT), END OF THE (1,835,179) 2,400,788 (535,246) 2,278,275 175,408
PERIOD ============= ============= ============ ============= =============
EARNINGS (LOSS) PER SHARE [NOTE 15] (0.11) (0.01) (0.24) 0.21 0.03
============= ============= ============ ============= =============
</table>
SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
50
VHQ ENTERTAINMENT INC.
CONSOLIDATED STATEMENT OF CASH FLOWS
(ALL FIGURES $ CDN)
<table>
<caption>
Nine Months Ended
February 28, Year Ended May 31,
-------------------------- ------------------------------------------
2002 2001 2001 2000 1999
------------ ----------- ------------- ------------ ------------
(unaudited)
<s>
CASH WAS PROVIDED BY (USED FOR):
OPERATING ACTIVITIES
Net income (loss) for the period (1,299,933) (122,513) (2,813,521) 2,102,867 217,383
Add (deduct) items not affecting cash:
Amortization of capital assets and 3,646,410 2,496,259 3,329,413 2,067,683 913,915
intangibles
Amortization of lease inducements (18,917) (25,223) (109,876) (21,042) (12,080)
Write-down of capital assets [NOTE 2,13] 1,130,580 - 2,255,867 - -
Write-down of investment [NOTE 4] - - 1,886,851 - -
Minority interest - - - (114,572) -
Gain on dilution of investment - - - (2,452,188) -
Equity loss of investment - 481,811 - 268,249 -
Gain on disposal of assets - - - (1,297,049) -
Future income taxes (recovery) (91,000) 99,000 (1,717,000) 1,500,000 173,000
Net change in non-cash components of
working capital
Accounts receivable (93,932) 167,002 117,164 (345,003) 39,626
Inventory (188,798) (527,794) (771,381) (575,833) (127,047)
Prepaid expenses (19,088) (41,021) 12,267 (109,755) (77,347)
Accounts payable 555,520 54,640 1,116,942 2,239,878 174,502
Working capital from acquisitions - - 246,194 (23,608) -
------------ ----------- ------------- ------------ ------------
3,620,842 2,827,187 3,552,920 3,239,627 1,301,952
------------ ----------- ------------- ------------ ------------
FINANCING ACTIVITIES
Proceeds from issue of share capital, net 1,278,904 1,271,807 1,538,733 509,596 1,092,170
of issuance costs
Proceeds from long-term debt 1,680,475 - 125,000 74,065 270,000
Repayment of long-term debt (205,465) (48,295) (183,626) (89,369) (44,971)
Increase (decrease) in short-term debt 443,585 173,007 731,325 69,231 -
Lease inducements received - - 333,400 62,227 104,791
Repayment of note payable - (61,989) - - -
Advance from (payment to) related company (493,493) 123,998 132,247 361,331 -
------------ ----------- ------------- ------------ ------------
2,704,006 1,458,528 2,677,079 987,081 1,421,990
------------ ----------- ------------- ------------ ------------
INVESTING ACTIVITIES
Acquisitions [NOTE 2] (1,910,250) (225,000) (225,000) (2,750,000) -
Dilution of subsidiary - - - 406,345 -
Issuance of note receivable - - - (925,000) -
Repayment of note receivable - 884,009 884,009 40,991 -
Proceeds from disposal of capital assets 2,460 - - 4,000,000 -
Purchase of capital assets (4,361,860) (4,784,119) (6,972,272) (4,989,913) (2,766,957)
------------ ----------- ------------- ------------ ------------
(6,269,650) (4,125,110) (6,313,263) (4,217,577) (2,766,957)
------------ ----------- ------------- ------------ ------------
INCREASE (DECREASE) IN CASH FOR THE PERIOD 55,198 160,605 (83,264) 9,131 (43,015)
CASH, BEGINNING OF THE PERIOD 155,371 238,635 238,635 229,504 272,519
------------ ----------- ------------- ------------ ------------
CASH, END OF THE PERIOD 210,569 399,240 155,371 238,635 229,504
============ =========== ============= ============ ============
CASH INTEREST PAID 139,237 94,450 116,415 145,892 8,371
CASH TAXES PAID - - - - -
</table>
SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
51
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
1. SIGNIFICANT ACCOUNTING POLICIES
The consolidated financial statements of the Corporation have been prepared in
accordance with accounting principles generally accepted in Canada and include
the accounts of the Corporation and its subsidiaries. As a precise determination
of many assets and liabilities is dependent upon future events, the preparation
of financial statements for a period necessarily involves the use of estimates
and approximations, which have been made using careful judgment. The
consolidated financial statements have, in management's opinion, been properly
prepared within reasonable limits of materiality and within the framework of the
accounting policies summarized below.
DESCRIPTION OF BUSINESS
The Corporation has been continued under the Canada Business Corporations Act
and through its subsidiaries operates video and home entertainment stores in
Canada. The Corporation was incorporated on September 5, 1997 and commenced
operations on September 5, 1997. Integrated Retail Corp. was incorporated on May
1, 1997 and commenced operations on May 1, 1997.
BASIS OF CONSOLIDATION
These consolidated financial statements include the accounts of the Corporation
and its wholly owned subsidiaries: Integrated Retail Corp., Safiqa Holdings
Ltd., Star Vision Enterprises Inc., and 705556 Alberta Ltd.
The excess of the acquisition costs of investment in subsidiaries over the
Corporation's proportionate share of the underlying value of the net assets at
the date of acquisition represents goodwill, and is amortized over periods not
exceeding 10 years. The value of goodwill, and any impairment of that value, is
assessed by reference to cash flows, operating income and estimation of fair
value.
During the period June 1, 1999 to March 1, 2000 the Corporation included the
accounts of E-Trend Networks, Inc. (E-Trend), which was under common control, in
the accounts of the Corporation excluding minority interest.
Subsequent to March 1, 2000, the Corporation's investment in E-Trend was diluted
to 38.37%. Due to the loss in control of E-Trend, the Corporation adopted the
equity method of accounting for this investment.
INVENTORY
Inventory, consisting primarily of filmed entertainment on VHS and DVD formats,
video games and CD music for resale, studio merchandise, video-gaming
accessories and confectionery items, is valued at the lower of cost and net
realizable value.
REVENUE RECOGNITION
Due to the short term nature of the rental of VHS, DVDs and video games, revenue
is recognized at the time of the rental. Where the Corporation has entered into
revenue sharing agreements, the revenues are recorded on a gross basis with an
offset to cost of sales. Where the Corporation sells VHS, DVDs and games that
have been previously used to earn rental revenue, the Corporation records the
sale in rental revenue and reduces the carrying value of its rental assets using
the salvage value.
Revenue from the sale of product is recognized at the point of sale.
PRE-OPENING COSTS
Pre-opening costs are expensed as they are incurred.
52
<page>
ADVERTISING EXPENSES
Advertising costs are expensed as incurred. Advertising credits are recognized
when the credits are received and are recorded as an offset to advertising
expenses, which are included in store operating costs.
CAPITAL ASSETS
Capital assets are recorded at cost. Amortization is provided using the
following rates and methods to amortize the costs, net of any salvage values,
over their estimated useful lives:
Canopies and signs 20% straight line
Equipment and fixtures 10% declining balance
VCRs, TVs and game players 30% declining balance
VHS, DVDs and video games 12 month straight line
Computer hardware 30% declining balance
Computer software 20% declining balance
Leasehold improvements Over term of the lease plus one renewal period
Logo and jingle 3 years straight line
Uniforms 2 years straight line
During the fiscal year ended May 31, 2001, the Corporation changed its method of
amortization of its rental product (VHS, DVDs, and video games). This method
accelerates the rate of amortization and was adopted as a result of an industry
trend towards significant increases in copy depth availability from movie
studios and revenue sharing agreements, that have resulted in earlier
satisfaction of consumer demand, thereby accelerating the rate of revenue
recognition. As a result of the change, the Corporation has revised its estimate
of the useful life of its rental product to a 12 month period of amortization
from a 24 month period, and has revised the salvage value of its VHS and DVD
movies and video games from $7 per unit to $5, $10, and $15, respectively.
FUTURE INCOME TAXES
Under the liability method, future tax assets and liabilities are determined
based on differences between the financial reporting and tax bases of assets and
liabilities, and measured using the substantially enacted tax rates and laws
that will be in effect when the differences are expected to reverse.
FINANCIAL INSTRUMENTS
Financial instruments of the Corporation consist mainly of cash and cash
equivalents, accounts receivable, accounts payable and accrued liabilities, due
to related corporations, and long-term debt. There are no significant
differences between the carrying values of these amounts and their estimated
market values.
STOCK OPTION PLAN
The Corporation's stock option plan is described in note 9. Consideration paid
by employees, consultants and directors on the exercise of stock options is
credited to share capital. The Corporation does not record any amounts to
compensation expense related to the granting or exercise of stock options.
SEGMENTED INFORMATION
The Corporation does not disclose segmented information as the Corporation
engages in and monitors only one operating segment. The Corporation's geographic
segment is within the Canadian market.
53
<page>
2. ACQUISITIONS
Effective December 1, 2001, the Corporation acquired all the assets of Video
Limited Partnership for total consideration of $2.1 million. The assets acquired
were as follows:
$
------------
Assets Acquired
Working capital 248,062
Capital assets 1,910,250
Long-term debt (58,333)
Net assets 2,099,979
Consideration
Convertible debenture 1,280,475
Common stock 819,504
2,099,979
The consideration given under the acquisition agreement was 546,336 units, each
comprised of one common share of the Corporation and one half of one common
share purchase warrant and a $1.28 million principal amount three year,
composite, subordinated, convertible debenture. Each whole warrant issued as
part of the units is exercisable to purchase one common share until December 2,
2003 at $2.00 per share. The rate of interest on the debenture is 8% per annum
with blended monthly principal and interest payments. The principal amount of
the debenture can be converted at any time into common shares of the Corporation
at the option of the holder at $2.50 per share until December 1, 2003 and at
$3.00 per share until December 1, 2004.
Subsequent to this acquisition, the value of the capital assets acquired under
the agreement was reduced to its residual value as the rental assets acquired
were older stock and, therefore, the rental revenue value has been diminished
resulting in a one time charge to net income of $1,320,309.
On July 11, 2000, the Corporation acquired the assets of M & K Video Spot Inc.,
an independent video retailer operating one video store in Stony Plain, Alberta
and one video store in Spruce Grove, Alberta under the name "Five Star Movies".
On June 15, 2000, the Corporation's wholly owned subsidiary Star Vision acquired
from Raeco Holdings Incorporated all of the assets of a video and home
entertainment store operating under the name "Silver Screen Video" in Saskatoon,
Saskatchewan.
Five Star Silver Screen
Movies Video
-------------- -----------------
Assets Acquired
Capital Assets $425,000 $200,000
----------------------------------
$425,000 $200,000
----------------------------------
Consideration
Cash $125,000 $100,000
Note Payable 125,000 - -
Share Capital 175,000 100,000
----------------------------------
$425,000 $200,000
==================================
54
<page>
During the period ended May 31, 2000, the Corporation acquired all of the issued
and outstanding shares of 705556 Alberta Ltd., Star Vision Enterprises Inc., and
Safiqa Holdings Ltd. Each Corporation is engaged in the operations of video
rental and retail stores in Canada. The acquisitions have been accounted for
using the purchase method of accounting as follows:
<table>
<caption>
705556 Star Vision Safiqa
Alberta Enterprises Holdings
Ltd. Inc. Ltd. Total
$ $ $ $
--------------- ----------------- ---------------- --------------
<s>
Assets Acquired
Working capital (7,768) (23,609) -- (31,377)
Capital assets 414,490 1,572,043 1,058,248 3,044,781
Goodwill 343,278 1,809,566 1,372,752 3,525,596
Deferred taxes (125,000) (444,000) (306,000) (875,000)
-----------------------------------------------------------------------
625,000 2,914,000 2,125,000 5,664,000
=======================================================================
Consideration
Cash 250,000 1,500,000 1,000,000 2,750,000
Common shares 375,000 1,414,000 1,125,000 2,914,000
-----------------------------------------------------------------------
625,000 2,914,000 2,125,000 5,664,000
=======================================================================
</table>
On August 1, 1998, the Corporation acquired all of the issued and outstanding
shares of Integrated Retail Corp. for consideration of 5,200,000 common shares
and warrants of the Corporation. Both of these companies have been controlled by
the same individuals since inception and there was, therefore, no substantive
change in ownership of the shares. As the companies were under common control,
these financial statements have been presented using the continuity of interest
method of accounting under which the financial position and results of
operations for the current and prior periods are presented as if the new
corporate structure had existed since inception. Accordingly, as at May 31, 2000
and 1999, the consolidated balance sheets include the assets and liabilities of
the Corporation and Integrated at their carrying values and the consolidated
statements of earnings and retained earnings (deficit) and cash flows include
the results of their operations for all periods presented.
3. NOTE RECEIVABLE
The Note was due on demand from Video Limited Partnership, bore interest at 15%
per annum and was unsecured. The Note was paid in full on January 19, 2001.
4. INVESTMENT IN SUBSIDIARY
The Corporation consolidated the financial statements of its subsidiary, E-Trend
Networks, Inc., up to February 29, 2000.
Between the period from September, 1999 to February 29, 2000, the Corporation's
ownership was diluted to 45.03% through the issuance by E-Trend of common shares
from treasury. As a result of the dilution of the Corporation's ownership of
E-Trend, the Corporation's interest in E-Trend was subsequently accounted for by
the equity method of accounting and a dilution gain of $2,452,188 was recorded.
E-Trend reported a net loss during the period of March 1, 2000 to May 31, 2000.
The Corporation's share of this loss was $268,249.
On May 31, 2001, the Corporation wrote down its investment in E-Trend resulting
in a one-time charge of $1,886,851 to net income.
55
<page>
On December 21, 2001, the Corporation entered into an agreement to sell its
entire holdings of 2,000,000 common shares of E-Trend, Inc. to The Game
Holdings, Ltd., a British Virgin Islands corporation, for US$0.40 per share, for
a total price of US$800,000. The purchase price was paid by way of a secured
promissory note of Game Holdings payable as follows: (a) US$10,000 per month
from January 2002 until March 2002; (b) US$30,000 per month from April 2002
until May 31 2003; and (c) the remainder of the purchase price on June 30, 2003.
The promissory note bears interest at a rate of 6% per annum and is secured by
way of a second charge against a yacht owned by Game Holdings which had an
estimated current resale value of approximately US$1,800,000 as determined by an
appraisal delivered by the purchaser. To date, the Corporation has not received
any payments from Game Holdings as required by the terms of the promissory note.
As the payments are received, a gain on the sale will be recognized.
5. CAPITAL ASSETS
<table>
<caption>
February 28, 2002
------------------------------------------------
Accumulated Net Book
Cost Amortization Value
$ $ $
------------- ------------- -----------
<s>
Canopies and signs 566,439 261,197 305,242
Equipment and fixtures 2,118,089 823,035 1,295,054
VCRs, TVs, DVD and game players 486,765 291,124 195,641
Rental product 18,305,010 10,848,984 7,456,026
Computer hardware 619,246 445,407 173,839
Computer software 414,426 176,106 238,320
Leasehold improvements 701,340 304,621 396,719
Uniforms 64,420 48,110 16,310
------------------------------------------------
23,275,735 13,198,584 10,077,151
================================================
</table>
<table>
<caption>
May 31, 2001
------------------------------------------------
Accumulated Net Book
Cost Amortization Value
$ $ $
------------- ------------- -----------
<s>
Canopies and signs 492,738 178,137 314,601
Equipment and fixtures 2,074,197 720,041 1,354,156
VCRs, TVs, DVD and game players 420,883 234,325 186,558
Rental product 13,468,906 7,636,718 5,832,188
Computer hardware 591,739 394,937 196,802
Computer software 374,973 134,049 240,924
Leasehold improvements 684,921 247,250 437,671
Logo and jingle 3,250 3,250 - -
Uniforms 44,867 32,140 12,727
------------------------------------------------
18,156,474 9,580,847 8,575,627
================================================
</table>
<table>
<caption>
May 31, 2000
------------------------------------------------
Accumulated Net Book
Cost Amortization Value
$ $ $
------------- ------------- -----------
<s>
Canopies and signs 295,323 89,129 206,194
Equipment and fixtures 1,876,713 660,255 1,216,458
VCRs, TVs, DVD and game players 188,559 81,788 106,771
Rental product 8,267,602 3,697,698 4,569,904
Computer hardware 481,195 323,913 157,282
</table>
56
<page>
<table>
<caption>
<s>
Computer software 281,010 80,173 200,837
Leasehold improvements 526,441 160,103 366,338
Logo and jingle 3,250 2,617 633
Uniforms 27,220 24,303 2,917
------------------------------------------------
11,947,313 5,119,979 6,827,334
================================================
</table>
<table>
<caption>
May 31, 1999
------------------------------------------------
Accumulated Net Book
Cost Amortization Value
$ $ $
------------- ------------- -----------
<s>
Canopies and signs 178,421 33,119 145,302
Equipment and fixtures 705,746 94,266 611,480
VCRs, TVs and game players 115,608 33,190 82,418
Rental product 3,172,825 911,941 2,260,884
Computer hardware 93,921 27,601 66,320
Computer software 91,585 17,678 73,907
Leasehold improvements 161,786 18,991 142,795
Uniforms 10,693 10,693 --
------------------------------------------------
4,530,585 1,147,479 3,383,106
================================================
</table>
Amortization of rental assets, in the amount of $3,269,065; $2,599,104;
$1,450,933 and $643,896, is included in the cost of rental revenues for the
fiscal periods ended February 28, 2002, May 31, 2001, May 31, 2000 and May 31,
1999.
Amortization of other related store capital assets is included in store
operating expenses.
6. GOODWILL
The Canadian Institute of Chartered Accountants issued Handbook Section 3062,
Goodwill and Other Intangibles, dealing with the measurement and disclosure of
goodwill and other intangibles. The measurement standards require that goodwill
not be amortized but rather that the value of goodwill be reviewed annually to
determine if the carrying value exceeds the fair value. Where the carrying value
exceeds the fair value, a charge against net income is recorded in the period
the impairment has occurred.
In accordance with the recommendations of Section 3062, no provision has been
made in these financial statements for amortization of goodwill. As prescribed
by the transitional provisions of the new recommendations, this change has been
applied prospectively.
Amortization of intangibles in the amount of $20,082; $361,934; $246,288; and
$3,819 has been recognized as a separate category in operating costs and
expenses, for the fiscal periods ending February 28, 2002, May 31, 2001, May 31,
2000 and May 31, 1999.
7. BANK INDEBTEDNESS
The Corporation has two demand operating credit facilities with Canadian
financial institutions providing for overdrafts which have maximum limits in the
amounts of $800,000 and $200,000. The credit facilities bear interest at prime
plus 1% (2001 - 7.25%) and prime plus 0.5% (6.75%), respectively.
On March 23, 2001, the Corporation obtained a $1.5 million credit facility to be
used in connection with the Corporation's new-build strategy. The credit
facility bears interest at the rate of 4.5% per annum and $1.5 million of short
term deposits have been pledged as security. On June 12, 2001, $400,000 of the
credit
57
<page>
facility was released to the Corporation with monthly payments of $12,398,
including interest commencing August 1, 2001, bearing interest at a rate of 1%
per annum above the prime rate.
8. LONG-TERM DEBT
<table>
<caption>
February 28 May 31
------------ --------------------------------------
2002 2001 2000 1999
$ $ $ $
------------ ---------- ---------- ----------
<s>
Demand loan, due in blended monthly principal and 327,931 - - -
interest payments of $12,398. Interest at prime plus 1%
per annum (4.75% at February 28, 2002) secured by a
general security agreement on all assets of the
Corporation.
Promissory note, due on July 29, 2002 bearing interest 77,299 77,299 74,065 -
at 9% per annum secured by a personal guarantee of a
shareholder.
Small business loan, due in blended monthly principal 122,237 160,995 205,483 246,880
and interest payments of $5,305. Interest at prime plus
3% per annum, (6.75% at February 28, 2002) secured a by
a general security agreement on all assets of the
Corporation.
Convertible debenture, due in blended monthly principal 1,217,087
and interest payments of $40,125 maturing December 1,
2004; interest calculated at 8% per annum. The
principal amount of the debenture can be converted into
common shares of the Corporation at $2.50 per share
until December 1, 2003 and at $3.00 per share until
December 1, 2004.
Promissory note, due in monthly installments of $10,417 - 31,250 - -
plus interest at 9% per annum secured by a general
security agreement covering assets located in Spruce
Grove and Stony Plain.
Other - - 17,372 65,344
-----------------------------------------------------------
1,744,554 269,544 896,922 312,224
Less current portion 669,134 158,750 62,924 89,802
-----------------------------------------------------------
1,075,420 110,794 233,996 222,422
===========================================================
</table>
Estimated principal payments over the next three years are as follows:
$
-------------
2002 669,134
2003 635,502
2004 439,918
-------------
1,744,554
=============
58
<page>
9. SHARE CAPITAL
AUTHORIZED
Unlimited number of preferred shares
Unlimited number of common shares
Common Shares Issued Number of Shares $
----------------------------------- ---------------- -------------
Balance, May 31, 1998 5,200,000 1,572,000
-----------------------------------
Exercise of options 90,000 18,000
Exercise of warrants 104,000 52,000
Exercise of warrants 479,000 359,250
Shares issued to settle debt 30,555 19,861
Issued for cash 2,593,721 745,291
Share issue costs - (102,232)
-----------------------------------
Balance, May 31, 1999 8,497,276 2,664,170
-----------------------------------
Exercise of options 200,000 40,000
Exercise of warrants 316,575 395,719
Exercise of broker options 59,372 44,529
Issued for acquisitions [NOTE 2] 1,996,207 2,914,000
Issued for cash 25,833 33,750
Share issue costs - - (4,402)
-----------------------------------
Balance, May 31, 2000 11,095,263 6,087,766
-----------------------------------
Issued for acquisitions [NOTE 2] 68,750 275,000
Issued for cash 366,754 1,375,289
Share issue costs - - (111,556)
-----------------------------------
Balance, May 31, 2001 11,530,767 7,626,499
-----------------------------------
Issued for cash 229,700 459,400
Issued for acquisitions 546,336 819,504
-----------------------------------
Share issue costs - -
-----------------------------------
Balance, February 28, 2002 12,306,803 8,905,403
===================================
OPTIONS AND WARRANTS
The Corporation has a stock option plan available to officers, directors and
employees with grants under the plan approved from time to time by the Board of
Directors. The plan provides for vesting at the discretion of the Board and the
options expire after five years from the date of grant.
The Corporation has issued the following stock options:
59
<page>
Weighted
average
exercise price
Shares ($)
-------------- --------------
Granted during the year 200,000 0.20
--------------------------------
Outstanding as at May 31, 1999 200,000 0.20
--------------------------------
Granted during the year 1,000,000 1.51
Exercised during the year (200,000) 0.20
--------------------------------
Outstanding as at May 31, 2000 1,000,000 1.51
--------------------------------
Granted during year 142,200 2.68
Exercised during year - - - -
--------------------------------
Outstanding as at May 31, 2001 1,142,200 1.66
--------------------------------
Granted during the period 1,017,500 1.90
Exercised during the period (102,400) 1.53
--------------------------------
Outstanding as at February 28, 2002 2,057,300 1.78
--------------------------------
Options exercisable as at February 28, 2002 1,573,562 1.69
================================
As of February 28, 2002, the Corporation has the following warrants to purchase
common shares outstanding:
<table>
<caption>
Warrants Date of Expiration
Outstanding Date Issued Exercise Price
------------- --------------- ------------------ ------------------------------
<s>
240,205 June 28, 2000 June 28, 2002 Exercisable at $5.00 per
share until June 28, 2001;
$6.00 per share until June
28, 2002
110,862 Aug 31, 2000 Aug 31, 2002 Exercisable at $5.00 per
share until Aug 31, 2001;
$6.00 per share until Aug 31,
2002
15,666 Oct 18, 2000 Oct 18, 2002 Exercisable at $5.00 per
share until Oct 18, 2001;
$6.00 per share until Oct
18, 2002
114,850 Aug 7, 2001 Aug 7, 2002 Exercisable at $2.50 per
share until Aug 7, 2002
273,168 Dec 1, 2001 Dec 1, 2003 Exercisable at $2.00 per
share until Dec 1, 2003
</table>
10. INCOME TAXES
The provision for income taxes varies from the amount computed by applying the
combined federal and provincial tax rates as follows:
60
<page>
<table>
<caption>
Nine Months Ended Feb 28, Year Ended May 31
--------------------------- --------------------------------------------
2002 2001 2001 2000 1999
$ $ $ $ $
----------- ------------ ------------- ------------ ------------
<s>
Computed income taxes (recovery) (535,230) 99,635 (1,743,344) 1,620,570 172,597
at 38.48% (2000 - 44.98%)
Non-deductible expenses 28,860 33,735 38,480 - -
Amortization of goodwill 3,410 117,181 129,330 106,153
Dilution of investment (151,551) - - (196,723)
Gain on disposal of assets and 411,960 241,676 (30,000)
asset write-downs
Investment write-down (26,928) - -
Effect of change in expected tax (356,214) - -
rates in computing future taxes
Other 25,403
----------------------------------------------------------------------------
(91,000) 99,000 (1,717,000) 1,500,000 198,000
============================================================================
</table>
Significant components of the future tax liability are:
<table>
<caption>
Nine Months
Ended Feb 28, Year Ended May 31,
----------------------------------------------------------------
2002 2001 2000 1999
$ $ $ $
------------ ---------- ----------- ----------
<s>
Net book value in excess of tax pools 693,000 797,000 1,938,000 205,000
Book value of investment in excess of
adjusted cost base - - 565,000 (83,000)
Share issue costs (36,000) (49,000) (38,000) (32,000)
---------------------------------------------------------------
657,000 748,000 2,465,000 90,000
===============================================================
</table>
11. DUE TO RELATED CORPORATION
As at May 31, 2001 the amount due to a related corporation was due to E-Trend,
had no fixed terms of repayment, bore interest at bank prime plus 1% per annum,
(8% at May 31, 2001), and was unsecured. This amount was repaid in full as at
November 30, 2001.
Included in accounts payable as at May 31, 2001 are amounts due to Langara
Distribution Inc., a wholly owned subsidiary of E-Trend: $246,776 (February 28,
2002), $470,315 (May 31, 2001) and $94,251 (May 30, 2000).
The Corporation entered into a revenue sharing agreement with Video Limited
Partnership whereby the two parties agreed to share revenues generated by
certain rental assets in certain of the Corporation's stores. The general
partner of Video Limited Partnership is also a director and shareholder of the
Corporation. Disbursements paid to Video Limited Partnership relate to the terms
under this revenue sharing agreement. Included in accounts payable are amounts
owing to Video Limited Partnership: $710,170 as at February 28, 2002, $203,100
as at May 31, 2001 and $261,045 as at May 31, 2000. Effective December 1, 2001,
the Corporation acquired all the partnership of Video Limited Partnership for
total consideration of $2.1 million, as detailed in Note 2.
61
<page>
12. COMMITMENTS
The Corporation is committed to the following rental payments under leases for
various premises:
$
--------------
2002 732,490
2003 2,779,723
2004 2,403,308
2005 2,081,652
2006 1,931,149
Thereafter 4,934,947
--------------
14,863,269
==============
With respect to the above leases, the Corporation received certain lease
inducements, which are being amortized and offset against rent expense over the
terms of the leases. Rent expense is included in store operating expenses. The
lease inducements to be amortized over the next five years are as follows:
2002 2003 2004 2005 2006 Thereafter
-------- -------- -------- -------- -------- ----------
$ 49,827 71,292 54,574 44,870 39,237 81,703
o The Corporation has employment agreements with four officers that
entitle them to a percentage of gross revenues of the Corporation. Two
of these agreements require payments of 0.5% each of the Corporation's
gross revenues. One agreement requires payments of 1% of the gross
revenues realized by the operations of certain retail stores operated
within the City of Calgary. The other agreement requires payments of 1%
of the gross revenues realized by the operation of certain retail
stores operated within the Province of Saskatchewan. Total payments
under these agreements were $120,894 and $48,529 for the years ended
May 31, 2001 and 2000.
13. WRITE-DOWN OF CAPITAL ASSETS
Effective May 31, 2001, the Corporation changed its estimation of the useful
life and salvage values of its rental product. As a result of this change, the
Corporation has revised its estimates of the useful life of rental product to a
12 amortization period from a 24 month amortization period and has reduced its
estimate of the salvage value from $7 per item to $5 per VHS, $10 per DVD and
$15 per video game. This change has been applied prospectively as a change in
accounting estimate and resulted in a one-time write-down of capital assets in
the amount of $2,255,867.
14. GAIN ON DISPOSAL OF ASSETS
Effective September 30, 1999, the Corporation sold existing video-tapes, video
games and DVD's used for rental revenue to Video Limited Partnership for cash of
$4,000,000 resulting in a gain of $1,297,049. Video Limited Partnership
contracted the Corporation to manage these assets for which the Corporation
earned a revenue sharing fee. As of May 31, 2000, the Corporation earned
$2,226,813 under the contract with Video Limited Partnership. The Corporation
has subsequently acquired Video Limited Partnership, as detailed in note 2.
62
<page>
15. EARNINGS (LOSS) PER SHARE
The earnings (loss) per share has been calculated based on the weighted average
number of common shares outstanding for the fiscal periods ended February 28,
2002 of 11,884,205, May 31, 2001 of 11,490,281, May 31, 2000 of 10,086,383 and
May 31, 1999 of 7,301,172. An assumed conversion of the options and warrants to
purchase common shares and the resultant imputed interest savings does not have
a dilutive effect on earnings (loss) per share.
16. SUBSEQUENT EVENTS
On __, 2002, the Corporation entered into an Agency Agreement whereby the
Corporation agreed to file a prospectus for the issuance of a maximum of __
units for gross proceeds of $10,000,000 and a minimum of __ units for gross
proceeds of $4,000,000 at $__ per unit. In connection with the offering, the
Corporation has granted the agents options to purchase up to 10% of the units
sold pursuant to the offering at $__ per unit for 24 months from the date of
closing of the offering. The Corporation has also granted the agents an option,
exercisable for a period of 90 days from the date of closing of the offering, to
purchase up to 15% of the total number of units sold pursuant to the offering on
the same terms set forth above, to cover over-allotments, if any.
63
CERTIFICATE OF THE CORPORATION
Dated: June 6, 2002
The foregoing constitutes full, true and plain disclosure of all material facts
relating to the securities offered by this prospectus as required by Part 9 of
the SECURITIES ACT (British Columbia), by Part 9 of the SECURITIES ACT
(Alberta), by Part XI of the SECURITIES ACT, 1988 (Saskatchewan), by Part VII of
THE SECURITIES ACT (Manitoba), and by Part XV of the SECURITIES ACT (Ontario),
and the respective regulations thereunder. This preliminary prospectus does not
contain any misrepresentation within the meaning of the SECURITIES ACT (Quebec)
and the regulations thereunder likely to affect the value or the market price of
the securities to be distributed.
By: (Signed) TREVOR M. HILLMAN By: (Signed) DERREK R. WONG
Chief Executive Officer Chief Financial Officer
On behalf of the Board of Directors
By: (Signed) GREGG C. JOHNSON By: (Signed) CATHERINE J. MCDONOUGH
Director Director
64
CERTIFICATE OF THE AGENTS
Dated: June 6, 2002
To the best of our knowledge, information and belief, the foregoing constitutes
full, true and plain disclosure of all material facts relating to the securities
offered by this prospectus as required by Part 9 of the SECURITIES ACT (British
Columbia), by Part 9 of the SECURITIES ACT (Alberta), by Part XI of the
SECURITIES ACT, 1988 (Saskatchewan), by Part VII of THE SECURITIES ACT
(Manitoba), and by Part XV of the SECURITIES ACT (Ontario), and the respective
regulations. To our knowledge, this preliminary prospectus does not contain any
misrepresentation within the meaning of the SECURITIES ACT (Quebec) and the
regulations thereunder likely to affect the value or the market price of the
securities to be distributed.
DESJARDINS SECURITIES INC. FIRST ASSOCIATES INVESTMENTS INC.
By: (Signed) JACQUES LEMAY By: (Signed) RICHARD STUCHBERRY
65
<page>
[VHQ WHERE ENTERTAINMENT BEGINS!(TM) logo]