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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 OCTOBER , 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.
FIRST QUARTER
[VHQ The Video Store With More. Logo.]
Fiscal 2003 First Quarter Interim Report (unaudited)
(for the period ended August 31, 2002)
<page>
PROFILE
VHQ Entertainment Inc. ("VHQ") is a dynamic and rapidly
growing video and home entertainment retailer. VHQ's mission
is to become the retail destination of choice for consumers
seeking home entertainment in rural and secondary markets.
With 49 company-owned retail locations operating as at August
31, 2002, VHQ plans to continue its strategic expansion - a
plan that, over the next five years, calls for VHQ to become
a leading national retailer in its field. VHQ strives to
offer its customers the best selection of quality home
entertainment including DVD, video, CD music, entertainment
and gaming related magazines and video games on all major
platforms.
Complementing its wide selection of entertainment software,
VHQ plans to add the latest entertainment hardware as well -
a step that will make VHQ a single stop destination for
"Everything Entertainment." VHQ's retail stores are located
widely throughout many rural communities and in some major
urban centers where VHQ's consistency and depth of product
offering ensures the best and latest selection of products
for all customers.
VHQ
The Video Store With More.
[PHOTOS OF STORE LOCATIONS]
<page>
LETTER TO SHAREHOLDERS
DEAR FELLOW SHAREHOLDERS,
On behalf of our Board of Directors, it is my pleasure to present you with VHQ
Entertainment's fiscal 2003 first quarter results for the period ended August
31, 2002.
Despite cautious consumer sentiment and mixed results from the retail sales
sector, the ongoing consumer embrace of the DVD format, next generation
interactive game platforms and growing consumer awareness of the VHQ brand have
helped us to achieve a strong financial quarter. VHQ's overall revenues grew by
12.1% for the period totaling $6.75 million, as compared to revenues recognized
for the same period in the prior year. A comparative measure of mature store
sales results achieved by outlets operating for more than one full year,
same-store sales grew by 7.22%, indicative of the growing market foothold
enjoyed by VHQ stores in their respective communities.
EBITDA income for the quarter increased 72.9% to $1.7 million, up from $985,866
in the first quarter of the previous year. This impressive increase is directly
attributable to our success in achieving industry leading same-store sales
increases, as well as our parallel initiative to lower operating costs. Our
continuing emphasis to decrease general and administrative expenses will be
further augmented by the elimination of one-time expenses incurred in connection
with financing and US registration initiatives.
At present, we are leading our industry in same-store sales growth, with our
stores well positioned to enjoy a profitable Christmas retailing season; a
holiday that will feature one of the most exciting movie lineups in home video
entertainment history. Several factors have contributed to our same-store sales
gains. The sale of previously viewed movies and games under the successful
launch of our "Hot Previously Viewed DVD and VHS Program" played a significant
role in boosting revenues for the period, and this will likely continue to be a
fundamental driver of enhanced revenues in the foreseeable future. Our ongoing
marketing initiatives have increased consumer awareness, netting new memberships
and increasing traffic in our stores. These factors aside, a strong release
schedule of hit movie titles over the first quarter, including Harry Potter,
Black Hawk Down, A Beautiful Mind and Lord of the Rings has aided revenues in
this period. Additionally, ongoing consumer acceptance of the DVD format, now
exceeding 31.3% of rental revenues for the quarter, provides us with further
proof that consumers continue to view home video as their number one choice for
accessing home entertainment.
Among the many initiatives taken to improve store performance, we have
recognized the importance of reaffirming our commitment to secondary market
expansion. Widely overlooked by our competitors, secondary markets of
5,000-50,000 people represent a key growth opportunity for us as we are
typically the only full-line home entertainment retailer available to these
markets.
At VHQ, our outlook is optimistic. We have successfully achieved a more
sustainable level of operating costs as a percentage of revenue, and our ongoing
operational improvements have had a significant impact on both revenue and net
income generated for the period. VHQ Management remains committed to secondary
market expansion, and we will continue or initiatives to enhance overall store
profitability. For these reasons we expect a strong second quarter for what
promises to be our best fiscal year yet. As we ready ourselves for another
profitable holiday season, we thank you for your continued support and
enthusiasm.
Sincerely,
VHQ Entertainment Inc.
/s/ Trevor M. Hillman
Trevor Hillman
Chief Executive Officer
03
<page>
MD&A
MANAGEMENT'S DISCUSSION
AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
This Management's Discussion and Analysis (MD&A) focuses on key statistics from
the consolidated financial statements of VHQ Entertainment Inc. ("VHQ" or the
"Corporation") for the three months ended August 31, 2002 and pertains to known
risks and uncertainties relating to its business. This MD&A should not be
considered all-inclusive, as it excludes changes that may occur in general
economic, political and environmental conditions. The MD&A of the financial
conditions and results of operations should be read in conjunction with the
attached consolidated financial statements and related notes for the three
months ended August 31, 2002, as well as the consolidated financial statements
for the year ended May 31, 2002 as set out in the Corporation's Annual Report.
BUSINESS OF THE CORPORATION
VHQ Entertainment Inc. is a rapidly growing video and home entertainment
retailer operating a chain of wholly owned retail stores that offer a large
selection of diverse home entertainment products. As the focus of its retailing
strategy, VHQ targets smaller neighborhood markets in large urban centers,
smaller urban centers and rural communities with a minimum trading population of
between 5,000 to 10,000 people. These smaller markets typically have lower
operating costs, less competition and the potential for greater market share
associated with smaller markets while still allowing for similar rental and
sales margins obtained in larger populated markets.
RESULTS OF OPERATIONS
The Corporation recorded another quarter of strong revenue growth. Total
revenues for the quarter ended August 31, 2002 increased 12.2% to $6.75 million
compared to $6.01 million for the quarter ended August 31, 2001.
The increase in revenues results from a number of factors, the most significant
of which includes: (i) an 8.9% increase in the number of new stores to 49 as at
August 31, 2002 compared to 45 stores at August 31, 2001; and, (ii) a 7.2%
increase in same-store sales for the quarter ended August 31, 2002 compared to
the similar quarter ended August 31, 2001.
The increase in the same-store sales results from: (i) the increase in sales of
previously viewed movies and games resulting from the successful launch and
execution of the Corporation's "Hot Previously Viewed DVD and VHS Program". To
further drive sales, this on-going sales program was combined with numerous
sidewalk sales to capitalize on the high summer traffic flow through the stores;
(ii) the continued growth and consumer acceptance of the DVD format resulting in
a significant increase in DVD related sell-through and rental revenues; (iii)
the continued focus and successful execution of VHQ's branded sales and
marketing campaigns that generate high consumer excitement, brand awareness and
traffic at its stores; (iv) a strong release schedule of movie titles that
included Harry Potter, Black Hawk Down, A Beautiful Mind, and Lord of the Rings;
and, (v) the continued growth of music sales and confectionery items.
Same-store sales includes all the stores that were operating during the entirety
of both periods being compared.
The relative mix of revenues between rental and product sales for the quarter
was 81.2% and 18.8% respectively, compared to 79.1% and 20.9% for the previous
quarter ended August 31, 2001.
Rental revenues include rentals of VHS tapes, DVDs, video games and sales of
previously viewed movie titles on VHS and DVD formats. The strategic importance
of DVDs as a product offering continues to grow,
04
<page>
by DVD rental revenues exceeding 31.3% of rental revenues for the quarter ended
August 31, 2002 compared to 15.4% of rental revenues for the quarter ended
August 31, 2001.
Product sales includes the sale of confectionery, CD and cassette based music,
sell-through filmed entertainment on VHS and DVD, gaming accessories, studio
merchandise, posters and ancillary goods. Product sales as a percentage of total
sales was 18.8% for the quarter ended August 31, 2002, relatively constant
compared to 20.9% of total sales for the quarter ended August 31, 2001.
COST OF SALES
COST OF SALES FOR RENTALS
Despite the significant revenue growth, the cost of sales for rentals only
increased 11.8% to $1.75 million for the quarter ended August 31, 2002, compared
to $1.57 million for the similar quarter in 2001.
The cost of sales for rentals is comprised of two key components. The first key
component is revenue sharing expenses incurred by the Corporation with certain
movie studios. The second key component is the amortization of rental assets
including VHS tapes, DVDs, video games, equipment for rent, and the unamortized
value of previously viewed rental inventory sold during the period.
The cost of revenue sharing agreement expenses as a percentage of total rental
revenue declined to 6.2% for the quarter ended August 31, 2002 compared to 14.5%
for the similar quarter in 2001. This decline results from the Corporation
buying an increasing percentage of its rental filmed entertainment product in
DVD format as compared to VHS format.
For the quarter ended August 31, 2002, amortization expense of rental inventory
increased to $1.4 million and was 80.4% of the cost of rentals up from $0.9
million or 56.1% for the previous quarter ended August 31, 2001. Compared to
total revenues, the amortization of rental product expense was 20.9% for the
quarter ended August 31, 2002 compared to 14.6% for the similar period in 2001.
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 games and equipment and other
goods inventoried for sale. The cost of product sales as a percentage of product
sales for the quarter ended August 31, 2002 increased to 93.7% compared to 80.6%
for the previous quarter due to lower margins earned on music. Management has
initiated a detailed program to review its selection and profitability of music
on a store by store basis to restore music margins.
GROSS MARGIN
Gross margin as a percentage of total revenues declined to 56.5% for the quarter
ended August 31, 2002 compared to 57.1% for the previous quarter ended August
31, 2001.
Store Operating Expenses
Store operating expenses include all store level expenses such as store rent,
telephone, utilities, signage, equipment rental, store personnel labour wages
and benefits, alarm monitoring, taxes and licenses, insurance, and repairs and
maintenance expenses.
Initiatives to control store operating expenses continue to be successful, with
total store expenses declining to 38.0% of total revenues compared to 43.5% of
total revenues for the quarter ended August 31, 2001. The key factor to the
decline in store operating costs as a percentage of total revenues is the
continuing careful management of store labor costs which declined to 16.9% of
total sales for the quarter ended August 31, 2002 compared to 20.5% for the
quarter ended August 31, 2001. Customer service levels continue to remain high
and uncompromised.
05
<page>
GENERAL AND ADMINISTRATIVE EXPENSES
General and administrative 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.
General and administrative expenses as a percent of total revenues increased to
14.0% for the quarter ended August 31, 2002 compared to 11.8% of total revenues
for the similar quarter in 2001.
The increase in general and administrative expenses results from increased
accounting, legal and consulting fees related to the Corporation's various
financing initiatives including the United States Securities and Exchange
Commission registration statement of Form 20F to make the Corporation's
securities tradable in the United States, as well as the costs associated with
the preparation of a prospectus for a fully marketed distribution of the
Corporation's shares in Canada which was subsequently withdrawn because of weak
equity market conditions. In total, these one time costs related to financing
initiative totaled approximately $163,000 for the quarter ended August 31, 2002.
When these one time financing expenses are excluded from G&A expenses, the
percentage of G&A expenses to total revenue favorably declined to 11.8%. The
Corporation has taken several initiatives to more closely control G&A expenses
over the coming quarters.
OPERATING INCOME
The operating income for the quarter was $174,604 compared to an operating loss
of $3,106 for the previous quarter ended August 31, 2001. The stronger operating
income results from the significant revenue growth combined with strong control
of store level expenses.
INTEREST EXPENSE
Interest expense for the quarter ended August 31, 2002 increased to $54,296 from
$45,991 for the similar period in 2001. The small increase results from the
interest costs related to the 8% convertible debentures that were issued in
December 2001.
NET INCOME
The Corporation recorded a net profit of $71,402 for the quarter ended August
31, 2002 compared to a net loss of $427,257 for the quarter ended August 31,
2001. As indicated in previous financial disclosures the stronger financial
performance for the current quarter and upcoming quarters result from the strong
revenue growth resulting from the continued maturation of the Corporation's base
of stores, containment of store level expenses and the December 1, 2001
elimination of the significant disbursements to the Video Limited Partnership.
LIQUIDITY AND CAPITAL RESOURCES
The Corporation generates cash from the rental and sale of entertainment
software including VHS tapes, DVDs, CD music and video games. The Corporation's
business is a cash business and thus the Corporation does not typically carry
receivables from customers. The Corporation's 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. The Corporation has funded its
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.
The Corporation's EBITDA favorably increased 72.9% to $1.7 million for the
quarter ended August 31, 2002 from $985,866 for the previous quarter ended
August 31, 2001.
06
<page>
This increase results from the Corporation's continued ability to expand
revenues via increases to same-store sales and increasing the number of store
locations combined with stronger control of costs.
EBITDA is a non-GAAP earnings measure and does not conform to Canadian or US
GAAP and may not be comparable to measures presented by other companies. EBITDA
is defined as earnings before interest, current and future taxes, amortization
of capital assets, intangibles and lease inducements, Video Limited Partnership
disbursements, write-down of investments and write-down of capital assets.
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 Generally Accepted
Accounting Principals.
CASH FROM OPERATING ACTIVITIES
Funds provided by operations for the quarter ended August 31, 2002 increased
136.9% to $1.9 million compared to $838,175 for the quarter ended August 31,
2001. The major factors contributing to the increase were higher revenues and
the increased amortization of capital assets and intangibles.
CASH FROM FINANCING ACTIVITIES
The Corporation used cash of $300,852 for financing activities for the quarter
ended August 31, 2002. The use of cash related mainly to the monthly repayments
on certain of its credit facilities. For the quarter ended August 31, 2001,
financing activities generated cash of $704,395.
CASH FROM INVESTING ACTIVITIES
Cash used for investing activities was $1.7 million for the quarter ended August
31, 2002 compared to $1.4 million for the previous year. The key investing
activity was the continual purchase of VHS tapes, DVDs and video games to ensure
the Corporation's product selection remains new and exciting to customers.
WORKING CAPITAL
At August 31, 2002, the Corporation had negative working capital of $5.0 million
compared to negative working capital of $4.8 million for the previous quarter
ended August 31, 2001. The negative working capital results from the accounting
treatment of our rental assets. Rental assets are treated as a non-current asset
under Generally Accepted Accounting Principals 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 these assets
generate a major portion of the Corporation's revenue, the classification of
this asset as non-current results in its exclusion from working capital. The
aggregate amount payable for these assets, however, is reported as a current
liability until paid and, accordingly, is included in working capital. As a
result, management does not believe that working capital is an appropriate
measure of our liquidity and anticipates that its business will continue to
operate with a working capital deficit.
OUTLOOK
The outlook for the Corporation is positive based, in part, on the impact from
recent operational improvements. Having addressed previous issues as rising
store labor costs, management is confident that a more sustainable level of
operating costs as a percentage of revenue has been achieved. Management
believes that operational efficiencies will continue to improve bottom line
results over the ensuing fiscal year as it continues efforts to reduce operating
expenses and increase overall revenues from store operations. The continued
emphasis on tight expense controls will be further augmented by the impact of
lower G&A expenses, as one time financing expenses, mostly in connection with
financing and US registration
07
<page>
initiatives work their way through. Attention will also be focused to improve
gross margins on video and music product sales.
Management expects an extremely strong calendar fourth quarter with the release
of several significant titles to our home entertainment channel. These titles
include, Blade II, Changing Lanes, Scorpion King, Monsters Inc., Scooby-Doo,
Spiderman, Star Wars - Attack of the clones, Men in Black II, Ice Age and Austin
Powers - Gold member, just to name a few. Many of the titles released during
this period are likely to provide not only significant rental revenue potential,
but sell-through product sale revenue as well. Additionally, revenue growth
resulting from higher than industry average same-store sales will continue to
result in improving store-level revenues, and this will become more apparent as
the Corporation enters what is typically regarded as the two strongest revenue
quarters of the year.
As an industry, we continue to witness a trend towards an increase in the number
of new release titles being produced for home video distribution. This
proliferation is a strong signal that the consumer remains committed to the home
entertainment channel and that expected gains from the adoption of DVD are now
becoming increasingly apparent. There are many aspects of the home entertainment
industry that continue to buoy management's expectations for the future. DVD has
emerged as the fastest adopted consumer technology in history and this DVD
"phenomena" has launched a renewed interest in the consumer to rent and buy
movies. As DVD technology continues to mature and add new and exciting
functionality for the consumer, management expects that the consumer will
continue to demonstrate that the rental of movies is the primary method for
Canadian households to access in-home entertainment.
In addition to movies, an exciting growth opportunity for the Corporation is the
evolution of new interactive video gaming platforms that have transformed the
face of gaming. No longer an entertainment choice of pre-teens and teens, new
gamers span an age demographic from pre-teens to retirees. Though hardware costs
have fallen dramatically making gaming affordable for most Canadian families,
the software remains quite expensive and out of the reach of many consumers. To
these disenfranchised consumers in particular, the Corporation offers a value
proposition of not only "try before you buy", but also the availability of
"previously played" new release games at significant discount to new retail
prices. VHQ management believes that video gaming software rentals and
"previously played sales are likely to deliver significant growth for the
Corporation and to this end will begin a heavier emphasis on gaming revenues
throughout the ensuing two quarters.
Management believes that overall gross revenues will improve as the Corporation
continues to benefit from the initiatives discussed in this outlook section, as
well as from the addition of storefronts likely over the balance of the fiscal
year, including the opening of a new store in Tuscany, Calgary on Dec 1, 2002
and the relocation of the Abbeydale store in Calgary store to a new Calgary
location with greater revenue potential.
Overall, the Corporation remains confident that it continues to benefit from
both operational improvements, as well as the overall strength of the home
entertainment industry. Management has signaled its intention to focus on
increasing net profitability of the chain and the results of these initiatives
will begin to bear fruit in Q2 and beyond.
08
<page>
CONSOLIDATED BALANCE SHEET
(UNAUDITED)
<table>
<caption>
August 31, 2002 May 31, 2002
$ $
----------------------------------
<s>
ASSETS
CURRENT
Cash 102,319 121,145
Accounts receivable 105,054 184,367
Inventory 1,673,430 1,860,242
Prepaid expenses and deposits 201,541 228,460
----------------------------------
2,082,344 2,394,214
PROPERTY, PLANT AND EQUIPMENT [note 3] 10,343,503 10,184,482
GOODWILL AND INTANGIBLES
Net of accumulated amortization 2,993,609 3,001,553
----------------------------------
15,419,456 15,580,249
----------------------------------
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT
Bank indebtedness [note 4] 1,133,954 1,150,358
Accounts payable and accrued liabilities 4,699,201 4,656,570
Current portion of long-term debt [note 5] 992,965 1,186,866
Current portion of equipment under lease 168,033 153,022
Current portion of deferred lease inducements 82,429 83,590
----------------------------------
7,076,582 7,230,406
----------------------------------
LONG-TERM DEBT [note 5] 607,037 713,845
EQUIPMENT UNDER LEASE 236,787 235,538
DEFERRED LEASE INDUCEMENTS 285,380 305,192
FUTURE INCOME TAXES 918,000 871,000
----------------------------------
9,123,786 9,355,981
----------------------------------
SHAREHOLDERS' EQUITY
Share capital [note 6] 9,108,803 9,108,803
Deficit (2,813,133) (2,884,535)
----------------------------------
6,295,670 6,224,268
----------------------------------
15,419,456 15,580,249
==================================
</table>
Approved on behalf of the Board:
/s/Trevor M. Hillman /s/ Gregg C. Johnson
- ------------------------------- -------------------------------
Trevor M. Hillman Gregg C. Johnson
Chief Executive Officer President
See accompanying notes to consolidated financial statements
09
<page>
CONSOLIDATED STATEMENT OF EARNINGS (LOSS) AND RETAINED EARNINGS (DEFICIT)
(UNAUDITED)
<table>
<caption>
For the three For the three
months ended months ended
August 31, 2002 August 31, 2001
($) ($)
--------------------------------------
<s>
REVENUE
Rentals 5,484,085 4,757,512
Product sales 1,267,376 1,258,144
--------------------------------------
6,751,461 6,015,656
--------------------------------------
COST OF SALES
Cost of revenue sharing agreements 342,483 687,590
Amortization of rental products 1,408,835 878,731
--------------------------------------
Rental 1,751,318 1,566,321
Product sales 1,188,030 1,013,415
--------------------------------------
2,939,348 2,579,736
--------------------------------------
GROSS MARGIN 3,812,113 3,435,920
--------------------------------------
OPERATING COSTS AND EXPENSES
Store operating expenses 2,568,438 2,615,947
Amortization of store property, plant and equipment 133,797 109,853
Amortization of deferred lease inducements (20,973) (6,306)
General and administrative 948,303 712,838
Amortization of intangibles 7,944 6,694
--------------------------------------
TOTAL OPERATING COSTS AND EXPENSES 3,637,509 3,439,026
--------------------------------------
OPERATING INCOME (LOSS) 174,604 (3,106)
Interest expense 54,298 45,991
Video Limited Partnership disbursements - 380,170
--------------------------------------
INCOME (LOSS) BEFORE THE FOLLOWING: 120,306 (429,267)
Gain (loss) on disposal of property, plant
and equipment (1,904) 2,010
--------------------------------------
INCOME (LOSS) BEFORE INCOME TAXES 118,402 (427,257)
Current income taxes (recovery) - (5,144)
Future income taxes (recovery) 47,000 -
--------------------------------------
NET INCOME (LOSS) 71,402 (422,113)
DEFICIT, BEGINNING OF THE PERIOD (2,884,535) (535,246)
--------------------------------------
DEFICIT, END OF THE PERIOD (2,813,133) (957,359)
======================================
EARNINGS (LOSS) PER SHARE [note 8] .01 (0.04)
-------------------
</table>
10
<page>
CONSOLIDATED STATEMENT OF CASH FLOWS
(UNAUDITED)
<table>
<caption>
For the three For the three
months ended months ended
August 31, 2002 August 31, 2001
$ $
--------------------------------------
<s>
CASH WAS PROVIDED BY (USED FOR):
OPERATING ACTIVITIES
Net income (loss) for the period 71,402 (422,113)
Add (deduct) items not affecting cash:
Amortization of property, plant and equipment and intangibles 1,550,576 995,277
Amortization of lease inducements (20,973) (6,306)
Loss (gain) on disposal of assets 1,904 (2,010)
Future income taxes 47,000 -
Net change in non-cash components of working capital 335,675 273,327
-----------------------------------
1,985,584 838,175
-----------------------------------
FINANCING ACTIVITIES
Proceeds from issue of share capital, net of issuance costs - 459,400
Increase (decrease) in short term debt (16,404) 96,977
Proceeds from long-term debt - 400,000
Repayment of long-term debt (300,709) (51,981)
Proceeds from equipment under lease 58,368 -
Repayment of equipment under lease (42,107) -
Advance from related company - (200,001)
-----------------------------------
(300,852) 704,395
-----------------------------------
INVESTING ACTIVITIES
Proceeds from disposal of property, plant and equipment 360 2,460
Purchase of property, plant and equipment (1,703,918) (1,381,976)
-----------------------------------
(1,703,558) (1,379,516)
-----------------------------------
INCREASE (DECREASE) IN CASH FOR THE PERIOD (18,826) 163,054
CASH, BEGINNING OF THE PERIOD 121,145 155,371
-----------------------------------
CASH, END OF THE PERIOD 102,319 318,425
===================================
SUPPLEMENTAL DISCLOSURE
Cash interest paid 48,291 45,991
===================================
</table>
See accompanying notes to the consolidated financial statements
11
<page>
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS YEAR ENDED MAY 31, 2002
(UNAUDITED)
1. SIGNIFICANT ACCOUNTING POLICIES
These interim consolidated financial statements should be read in conjunction
with the consolidated financial statements for the year-ended May 31, 2002.
These interim consolidated financial statements have been prepared in accordance
with Canadian Generally Accepted Accounting Principles, using the same
accounting policies as outlined in Note 1 of the consolidated financial
statements for the year-ended May 31, 2002, except as noted below in Note 2.
The preparation of the consolidated financial statements in conformity with
Generally Accepted Accounting Principles requires management to make estimates
and assumptions that affect the reported amounts of assets and liabilities at
the date of the consolidated financial statements and the reported amounts of
revenue and expenses during the reporting period. Actual results could differ
from these estimates.
2. CHANGE IN ACCOUNTING POLICY
Effective June 1, 2002, the Corporation adopted the recommendations of the
Canadian Institute of Chartered Accountants ("CICA") with respect to accounting
for stock-based compensation arrangements. The Corporation has elected to use
the intrinsic value-based method of accounting for its stock option plans,
whereby no compensation expense is recorded for stock options that have an
exercise price equal to the fair value of the stock at the date the options are
granted. The Corporation will disclose the pro-forma net earnings and the
pro-forma earnings per share resulting using the fair value method, under which
compensation expense is recorded based on the estimated fair value of the
options. (See Note 7). Proceeds arising from the exercise of share options are
credited to share capital. As a result of following the CICA's Emerging Issues
Committee Abstract 98 "Stock-Based Plans Disclosures", the Corporation provided
the majority of the disclosure required by Section 3870 in the 2002 Annual
Report. The additional disclosure required by Section 3870 as a result of the
Corporation not adopting the fair value method of accounting provisions for
employee stock-based compensation is provided in Note 7.
3. PROPERTY, PLANT AND EQUIPMENT
<table>
<caption>
August 31, 2002
--------------------------------------------------
Accumulated Net Book
Cost Amortization Value
$ $ $
--------------------------------------------------
<s>
Canopies and signs 609,459 294,392 315,067
Capital assets under lease 564,605 63,473 501,132
Equipment and fixtures 2,198,006 888,200 1,309,806
VCR's, TV's and Game players 492,871 322,650 170,221
Rental product 18,594,614 11,566,333 7,028,281
Computer hardware 572,240 425,410 146,830
Computer software 409,381 177,030 232,351
Leasehold improvements 893,906 285,382 608,524
Uniforms 41,015 9,724 31,291
--------------------------------------------------
24,376,097 14,032,594 10,343,503
==================================================
</table>
12
<page>
3. PROPERTY, PLANT AND EQUIPMENT (CONTINUED)
<table>
<caption>
May 31, 2002
--------------------------------------------------
Accumulated Net Book
Cost Amortization Value
$ $ $
--------------------------------------------------
<s>
Canopies and signs 607,046 263,919 343,127
Equipment under lease 506,237 50,624 455,613
Equipment and fixtures 2,133,535 855,531 1,278,004
VCR's, TV's and Game players 490,234 311,098 179,136
Rental product 19,765,826 12,869,035 6,896,791
Computer hardware 621,109 462,789 158,320
Computer software 439,775 195,194 244,581
Leasehold improvements 862,247 256,253 605,994
Uniforms 73,881 50,965 22,916
--------------------------------------------------
25,499,890 15,315,408 10,184,482
==================================================
</table>
Property, plant and equipment are recorded at cost. Amortization is provided
using the following rates and methods to amortize the costs, net of any residual
or salvage values, over their estimated useful lives:
Canopies and signs 20% straight line
Equipment under lease 10% declining balance
Equipment and fixtures 10% declining balance
VCR's, TV's and Game players 30% declining balance
VHS, DVD and videogames 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
The estimated salvage value of the Corporation's VHS, DVD and video games rental
items are $5, $10 and $15 respectively.
4. BANK INDEBTEDNESS
The Corporation has demand operating credit facilities with Canadian financial
institutions providing for overdrafts which have maximum limits in the amounts
of $1,000,000. The credit facilities bear interest at varying rates from prime
plus one percent (2002 - 5.50%) to prime plus one half of one percent (5.75%).
Certain of the operating facilities are secured by a general security agreement
covering all assets of the Corporation.
As at August 31, 2002, the outstanding balance under these credit facilities is
$787,695 (May 31, 2002 - $849,877) with the net of outstanding cheques less
funds held on deposit of $346,259 (May 31, 2002 - $300,481).
13
<page>
5. LONG-TERM DEBT
<table>
<caption>
August 31, 2002 May 31, 2002
$ $
-----------------------------------
<s>
Promissory note, due on September, 2002 bearing interest at 9%
per annum and the personal guarantee of a shareholder is
pledged as collateral. 77,299 77,299
Demand loan, due in monthly installments of $5,250 including
principal and interest, interest at prime plus 3% per annum.
The loan is secured by a general security agreement covering
all assets of the Corporation. 94,260 108,277
Promissory note from a director of the Corporation, due in
monthly installments of $8,772 plus interest at 10% per
annum. The note is secured by a general security agreement
covering assets of one store located in Saskatoon,
Saskatchewan. The final payment of the loan is due May 6,
2003. 75,986 100,000
Promissory note, due on demand plus interest at 1% per month.
The promissory note is unsecured. 70,000 200,000
Convertible debenture, due in blended monthly principal and
interest payments of $40,125. Interest is at 8% per annum.
The debenture is unsecured. 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. The final payment of
the debenture, if not fully exercised into shares, is December
1, 2004. 1,021,788 1,120,410
Demand loan, due in blended monthly principal and interest
payments of $12,398. Interest is at prime plus 1% per annum
and the loan is secured by a general security agreement on all
assets of the Corporation. 260,669 294,725
-----------------------------------
1,600,002 1,900,711
Less current portion 992,965 1,186,866
-----------------------------------
607,037 713,845
===================================
</table>
Estimated principal payments over the next three years are as follows:
$
---------
2003 992,965
2004 449,175
2005 157,862
---------
1,600,002
=========
14
<page>
6. SHARE CAPITAL
AUTHORIZED
Unlimited number of preferred shares
Unlimited number of common shares
COMMON SHARES ISSUED AND OUTSTANDING NUMBER OF SHARES $
----------------------------------
BALANCE, AUGUST 31, 2002 12,538,559 9,108,083
==================================
BALANCE, MAY 31, 2002 12,538,559 9,108,083
==================================
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 exercise price of each option equals the market price of the
Corporation's stock at the date of grant. 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:
Weighted Average
Shares Exercise Price ($)
-------------------------------------
Outstanding as at August 31, 2002 2,057,300 1.78
=====================================
Options exercisable as at August 31, 2002 1,781,651 1.74
=====================================
Weighted Average
Shares Exercise Price ($)
-------------------------------------
Outstanding as at May 31, 2002 2,057,300 1.78
=====================================
Options exercisable as at May 31, 2002 1,649,379 1.72
=====================================
15
<page>
OPTION AND WARRANTS (CONTINUED)
The following table summarizes information about stock options outstanding at
August 31, 2002:
<table>
<caption>
Options Outstanding Options Exercisable
Range of Number Weighted Weighted Number Weighted
Exercise Price Outstanding Average Average Exercise Exercisable Average
August 31, 2002 Remaining Price August 31, 2002 Exercise Price
Contract Life
- -------------------------------------------------------------------------------------------------------------------
<s>
$ 1 to 2 1,667,500 3.26 1.64 1,483,433 1.62
$ 2 to 3 389,800 3.67 2.38 298,218 2.34
------------------ -------------------
2,057,300 1,781,651
================== ===================
</table>
At August 31, 2002, 629,684 (May 31, 2002 - 980,751) warrants remained
outstanding.
7. STOCK-BASED COMPENSATION
The Corporation applies the intrinsic value based method of accounting for
share-based compensation awards granted to employees. Accordingly, no
compensation expense is recorded in the accounts for its share option plans.
The Corporation has not issued any options after June 1, 2002 and therefore no
disclosure on the impact on earnings and earnings per share has been presented
if the fair value based method of accounting for share-based compensation had
been adopted.
8. EARNINGS (LOSS) PER SHARE
The earnings (loss) per share has been calculated based on the weighted average
number of common shares outstanding for the period ended August 31, 2002 of
12,137,347 (May 31, 2002 - 11,903,465).
The Corporation has adopted the treasury stock method to compute dilutive
effects of stock options, warrants and convertible debentures on earnings (loss)
per share. Based on this method, the options, warrants and convertible
debentures do not have a dilutive effect on the earnings (loss) per share.
9. COMPARATIVE FIGURES
Certain comparative figures have been adjusted to conform to the current year's
financial statement presentation.
16
<page>
NOTES
NOTES:
17
<page>
NOTES
NOTES:
18
<page>
CORPORATE INFORMATION
DIRECTORS AND SENIOR OFFICERS
Trevor M. Hillman
Director, Chairman and Chief Executive Officer
Gregg C. Johnson
Director, Secretary, President and Chief Operating Officer
Derrek R. Wong, CFA
Senior Vice President, Finance and Chief Financial Officer
Michael D. McKelvie
Senior Vice President, Marketing and Communications
Ayaz Kara
Vice President, Business Development
Marc L. Gignac
Director and Vice President Operations, Saskatchewan
Peter A. Lacey
Director
Catherine J. McDonough
Director
PRINCIPAL BANKS
Community Savings
Red Deer, Alberta
CIBC
Red Deer, Alberta
AUDITORS
Collins Barrow, Chartered Accountants
Red Deer, Alberta
LEGAL COUNSEL
Shea, Nerland, Calnan
Barristers & Solicitors
Calgary, Alberta
TRANSFER AGENT
Computershare Trust Company of Canada
Calgary, Alberta and Toronto, Ontario
TRADING SYMBOL
"VHQ" Toronto Stock Exchange
VHQ ENTERTAINMENT INC. CORPORATE HEADQUARTERS
6201 - 46th Avenue
Red Deer, Alberta T4N 6Z1
Phone: (403) 346-8119 Fax: (403) 309-5511
Internet Address: www.vhq.ca
Email: mail@vhq.ca
19
<page>
VHQ
The Video Store With More.
FISCAL 2003 FIRST QUARTER INTERIM REPORT (UNAUDITED)
(FOR THE PERIOD ENDED AUGUST 31, 2002)
VHQ ENTERTAINMENT INC.
6201 - 46th Avenue
Red Deer, Alberta T4N 6Z1
Phone: (403) 346-8119
Fax: (403) 309-5511
Internet Address: www.vhq.ca
Email: mail@vhq.ca