DEVINE ENTERTAINMENT CORP - 10KSB - 20060331 - MANAGEMENTS_DISCUSSION
ITEM 6. MANAGEMENT DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
The following management's discussion and analysis has been prepared as of March
29, 2006 to provide a review of current activities and a comparison of the
performance and financial position of Devine Entertainment Corporation ("Devine"
or the "Company") for the year ended December 31, 2005 and 2004. Additional
information related to the Company is available on Sedar at www.sedar.com . The
financial data in this document have been prepared in accordance with accounting
principles generally accepted in Canada that conforms, in all material respects,
with U.S. GAAP. References to Canadian dollars, Cdn$ or $ are to the currency of
Canada and references to U.S. dollars or US$ are to the currency of the United
States.
OVERVIEW
Devine is an integrated developer and producer of high quality children's and
family films designed for the world-wide theatrical motion picture, television
broadcast and cable markets and the international home video and DVD markets.
The Company's primary focus is the production of quality children's and family
films, including broadly marketed commercial family films for the theatrical
release and broadcast internationally as well as specialty video and DVD markets
worldwide. Devine's library of films include 19 hours of award-winning broadcast
programs based on the lives of important international historical figures and
other classic family stories, which permit it access to sales in a wide variety
of outlets encompassing both the entertainment and educational markets. In 2004
the Company completed and delivered Bailey's Billion$, its first feature film
targeted at a family audience that was released in theatres in the US and Canada
in August of 2005 and is currently in distribution worldwide.
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The Company's business strategy is to: (i) focus on the production of its
high-quality children's and family films in order to continue building its
library of original programs; (ii) increase its production and distribution
through strategic alliances with major international distributors, broadcasters
and co-producers.
FORWARD-LOOKING STATEMENTS
Readers are cautioned that actual results may differ materially from the results
projected in any "forward-looking" statements included in this discussion and
analysis, which involve a number of risks and uncertainties. Forward-looking
statements are statements that are not historical facts, and include (but are
not limited to) statements regarding the Company's planned production slate and
development activities, anticipated future profitability, losses, revenues,
expected future expenditures, the Company's intention to raise new financing,
sufficiency of working capital for continued operations, and other statements
regarding anticipated future events and the Company's anticipated future
performance. Forward-looking statements generally can be identified by the words
"expected", "intends", "anticipates", "feels", "continues", "planned", "plans",
"potential", "with a view to", and similar expressions or variations thereon, or
that events or conditions "will", "may", "could" or "should" occur, or
comparable terminology referring to future events or results.
The Company's actual results could differ materially from those anticipated in
these forward-looking statements as a result of numerous factors, including
those listed under "Risks and Uncertainties", any of which could cause actual
results to vary materially from current results or the Company's anticipated
future results. The Company assumes no responsibility to update the information
contained herein.
FISCAL 2005 HIGHLIGHTS
The positive trends that started in 2004 continued in 2005.
o The Company's revenues increased by 6% to $4,019,745 in 2005 as
compared to $3,809,235 in 2004.
o The Company's proprietary film library of completed television
programs and recordings performed well in 2005, generating
$1,067,389 in revenues, reflecting an increase of 64% as compared
with $648,955 in 2004.
o DVD, video and ancillary publishing revenues generated by the
Company's library of completed television programs and recordings
increased by approximately 147% or $530,544 to $892,499 in 2005 as
compared to $361,955 in 2004.
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o The Company's feature film, Bailey's Billion$, which was delivered
in 2004 was released theatrically in the United States and Canada
continued to generate revenues around the world of $2,952,356, a
decrease of 7% as compared to $3,160,280 in 2004.
o EBITDA, defined as earnings before interest, taxes, depreciation,
amortization and gains on settlement of debt increased by 5% to
$3,150,327 in 2005, as compared to $3,007,389 in 2004.
Net loss in year ended December 31, 2005, was ($233,409) or (0.01) per share
reflecting the Company's accelerated amortization of its Inventors' Specials
television series which totaled $1,008,181 in 2005. While the Inventors'
Specials continues to be one of the Company's valued library assets and was
recently valued independently as having a fair market value of over $2,000,000,
under SOP-002 all of the costs related to a proprietary program or series must
be expensed within ten years of it original delivery and exploitation. 2006 will
be the tenth year that the Inventors' Specials have been in distribution and
accordingly, the Company is accelerating amortization of the series.
RESULTS OF OPERATIONS FOR THE YEAR ENDED DECEMBER 31, 2005
Revenues
In 2005, the Company's revenues increased by $210,510 or 6% to $4,019,745 in
2005 as compared to $3,809,235 in 2004.
The Company's proprietary film library of completed television programs and
recordings performed well in 2005, generating $1,067,389 in revenues, reflecting
an increase of 64% as compared with $648,955 in 2004. DVD, video and ancillary
publishing revenues generated by the Company's library of completed television
programs and recordings increased by approximately 147% or $530,544 to $892,499
in 2005 as compared to $361,955 in 2004. In addition, the library generated
$174,600 in revenues from the sale of broadcast licenses in 2005, a decrease of
$112,400 or approximately 39% as compared to $287,000 in 2004. Of the $174, 600
in Broadcast sales, $144,000 resulted from licenses to TVOntario and the British
Columbia based Knowledge Network, two Canadian broadcasters who have committed
to licensing the Company's new series based on landmark writers scheduled for
production in 2006. An additional broadcast sale was concluded in September of
2005 to the Al Jazeera Children's Channel for $30,600. Broadcast revenues in
2004 reflected a single $287,000 broadcast license in France to TPS Jeunesse.
The Company's feature film, Bailey's Billion$, which was delivered in 2004 was
released theatrically in the United States and Canada and continued to generate
revenues around the world of $2,952,356, a decrease of 7% as compared to
$3,160,280 in 2004. This
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reflected a sale of foreign distribution rights to a UK based distributor that
generated an initial payment of approximately $2,659,000 in the second quarter
of 2005.
The Company's revenues by geographic location, based on the location of
customers were as follows:
2005 2004
---- ----
Canada $ 446,000 $2,768,000
United States 591,000 326,000
France 99,000 287,000
United Kingdom 2,659,000 0
Europe - Other 0 305,000
Other foreign 225,000 123,000
Earnings (loss) per Common Share (EPS)
Net loss in year ended December 31, 2005, was ($233,409) or (0.01) per share
reflecting the Company's accelerated amortization of its Inventors' Specials
television series which totaled $1,008,181 in 2005. While the Inventors'
Specials continues to be one of the Company's valued library assets and was
recently valued independently as having a fair market value of over $2,000,000,
under SOP-002 all of the costs related to a proprietary program or series must
be expensed within ten years of it original delivery and exploitation. 2006 will
be the tenth year that the Inventors' Specials have been in distribution and
accordingly, the Company is accelerating amortization of the series.
EBITDA
EBITDA, defined as earning before interest, taxes, depreciation, amortization
and gains on settlement of debt increased by 5% to $3,150,327 in 2005, as
compared to $3,007,389 in 2004.
EBITDA is a non-GAAP financial measure. Management believes EBITDA to be a
meaningful indicator of the Company's performance that provides useful
information to investors regarding the Company's financial condition and results
of operations. EBITDA is a non-GAAP financial measure commonly used in the
entertainment industry and by financial analysts and others who follow the
industry to measure operating performance. While management considers EBITDA to
be an important measure of comparative operating performance, it should be
considered in addition to, but not as a substitute for, net income and other
measures of financial performance reported in accordance with GAAP. EBITDA does
not reflect cash available to fund cash requirements. Not all companies
calculate EBITDA in the same manner and the measure as presented may not be
comparable to similarly-titled measures presented by other companies.
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Shareholders' Equity
Shareholders' equity was $5,172,024 reflecting an increase of $213,735 from
$4,958,289 as at December 31, 2004.
The Company's operating expenses for the year ended December 31, 2005 increased
by $149,022 or approximately 21% to $851,018, as compared to $701,996 in 2004.
This increase reflects increased professional fees expended in relationship to
the Company's SEC registration application as well as the Company's limited
partnership financing activities.
Production and Development Activity
The Company continues to develop new projects in order to secure new production
activity. Projects which include initial participation and support of funds from
Telefilm Canada, Astral Communications and Corus Entertainment are feature films
and TV movies entitled Red, Miracle Journey, and October 7, 1944. The Company
has also acquired the rights and is actively developing additional films and
series projects targeted to the worldwide family audience including Revolving
Door, Quarterback, Fat Camp and
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Humchucker. The Company has also entered into an initial agreement to
co-develop, with the intent of co-producing in the future, a new series of
Writers' Specials with a co-producer in France.
Investment in Film and Television Programs and Recordings
The Company reviews and revises the estimated fair market value of its
investment in film, television programs and recordings as required on a regular
basis. Capitalized film costs are stated at the lower of unamortized cost or
estimated fair value on an individual film basis. For the proprietary films,
television programs and recordings produced by the company, a maximum period of
ten years after the delivery of the production is used in accordance with SOP
00-2 to estimate fair value. Development costs which are expected to benefit
future periods are also capitalized. If the property under development has not
been set for production within three years, the costs associated with such
property are written off to income.
Amortization expenses in 2005 for the Company's library of completed television
programs and recordings and motion picture totaled $3,325,049. As at December
31, 2005, the Company's investment in its proprietary film library of completed
television programs and recordings was estimated as $1,723,043 after accumulated
amortization. The Company's investment in its motion picture Bailey's Billion$
was estimated as $3,241,219 after accumulated amortization and the Company's
investment in projects in development was estimated as $1,883,846 as per the
following table:
Ultimate revenue estimates for the Company's completed motion picture are based
on in-depth discussions with and estimates provided by experienced third-party
distributors and sales agents, including the contracted foreign sales agent and
United States distributor. Each of these distributors has well over 20 years of
experience in its area of sales and distribution. The third party sales
estimates and the agreements have been reviewed and approved the motion
picture's co-producers, copyright purchasers and production lending bank and
them discounted by the Company in an effort to provide conservative and
realizable ultimate revenue estimates.
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In the United States, management has used the Company's twenty years of
experience with broadcasters in conjunction with the United States distributor's
estimates for three windows over ten years as a basis of its television sales
estimates. With regard to DVD/video sales estimates, the Company has reviewed
distributors' estimates and compared them to the Company's historical sales. P&L
models based on these sales estimates and incorporating the distribution fees
and expenses defined in the Company's distribution agreements assuming between
500,000 to 1,000,000 units sales over ten years with average net revenue of
$4.26 (U.S.) per unit were discounted and support what management believes are
conservative ultimate revenue estimates. The estimates were based on an initial
release at a retail pricing of $24.98 (U.S.) for rental and initial sell through
release and subsequent drops in pricing to $14.98 (U.S.) and $12.98 (U.S.) as
the DVD release migrates to distribution in mass market sell-through and
discount markets over the ten-year period. The Company compared and supported
this figure with industry standards and published unit sales for comparative
family feature films and then discounted them conservatively and modeled the
estimates to incorporate the distribution fees and expense limitations in its
various distribution agreements. The models provided net revenue estimates of
approximately $5 million (U.S.), which the Company then discounted to less than
fifty percent (50%), which in effect reflects 750,000 unit sales over ten years
at the lowest price and margin.
For estimates in the foreign territories, the Company has relied on its sales
agents estimates on an all rights basis per territory. The Company's ultimate
revenue estimates were based on bank approved estimates of initial advance
payments per territory which do not take into account any second window
television license values and longer term DVD/video royalty payments. These
estimates were then discounted to match the discounted United States ultimate
revenue estimates, conservatively assuming that all of the other territories
around the world would not exceed the revenues from the United States market.
The Company believes that ultimate revenue estimates for Bailey's Billion$ are
conservative and realizable, notwithstanding the fact that management reviews
the estimates on a regular basis and may adjust them down depending on changing
results and market conditions over the ten year period that started with the
delivery of the film in 2004.
In the nine-year period from 1997 to 2005, The Inventors' Specials revenue
totaled approximately $6,120,000 or $680,000 per annum. For the most recent five
years, Inventors' Specials revenue averaged $280,000 per annum. The Artists'
Specials generated approximately $5,543,000 in its first eight years after the
original release, which is an average of $693,000 per annum. For the last five
years, Artists' Specials revenue averaged $249,000. The Composers' Specials
continues to generate significant revenues with $632,333 in 2005, but given that
the ten year period since its delivery has expired, the value of Composers'
Specials is not reflected as an asset as part of the Company's investment in
film and television programs and recordings.
The Company believes that these lower results for the Inventors' and Artists'
Specials in the most recent years reflect the challenging conditions industry
wide in the international
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markets resulting from the collapse of investment markets that had fuelled high
valuations for content, the overestimated benefits for the models of media
convergence and the promise of media deregulation in Europe that proved
challenging in the context of 9/11, as well as the challenges associated with
the Company's debt, equity and capital position which were respectively settled
resulting in significant gains, improved significantly and successfully
reorganized in 2004.
The Company estimates average annual ultimate revenue for the Artists' Specials
at $438,333 per year for the next three years and estimates average annual
ultimate revenue for the Inventors' Specials at $380,000 per year for 2006. The
Company believes that its current ultimate revenue estimates for the Artists'
Specials and Inventors' Specials are reasonable and realizable given the
multi-year nature of television contracts and that annual revenue can fluctuate.
The Company's new agreements recently concluded with sales agents in Germany,
France, Italy, Spain, Japan and Korea, point both to the renewed opportunities
resulting from the Company's improved financial position and also to an industry
wide renewal of sales of broadcast licenses in international markets. As well,
the Company's experience supports the fact that when a new series of its branded
proprietary library of award-winning films is produced, sales for the previously
produced library of films are concluded concurrent with commitments for the new
production on a territory-per-territory basis. The Company expects to begin
production of a new series based on landmark authors entitled The Writers'
Specials in 2006 and has already begun to pre-sell the broadcast licenses for
the Writers Specials and, in conjunction, license the Company's completed
television programs as well.
While the specific revenues for each series vary from year to year, over the
long term, the Company's DVD and ancillary product sales have averaged between
$195,000 and $250,000 per series, per year.
DEVINE LIBRARY DVD/Video, publishing and Ancillary sales
(includes dvd and video sales, music publishing royalties, teachers guides,
stock footage rights, rentals of props etc.)
There have been significant increases in the Inventors (up 78% from 2004) and
Artists (up 29% from 2004) DVD sales in 2005, but the most dramatic increases
have come in Composers sales (up 272% from 2004) primarily as a result if a new
agreement in 2005
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with a major educational publisher through our existing client Hal Leonard for
the inclusion of our series in their Music Catalogue. The Company is pursuing
new DVD sales agreements with the same educational publisher for the Inventors,
for inclusion starting in their Social Sciences Catalogue and for the Artists in
their Arts Catalogue starting in 2006 and 2007. The Company estimates that this
distribution arrangement should result in the annual increase in sales of each
series of about $125,000, based on the results achieved by Composers. In
addition, the Company is negotiating with a Utah based telemarketer who has had
great success with the Company's titles in 2000 through 2002, and a new VOD
agreement in Italy as well as a DVD kiosk distributor in the Balkans that the
Company believes will be finalized in 2006.
The table below details Inventors DVD/ancillary sales currently being pursued
and the estimated values - in addition to existing DVD accounts in 2005 and
2006:
Year 2006
---- ----
Educational Science Catalogue 125,000
Utah telemarketer 45,000
Italy VOD 90,000
Balkan DVD Kiosks 90,000
New Foreign DVD sales 25,000
-------
Total additional expected 375,000
Expected base 200,000
Anticipated Annual DVD sales 575,000
The table below details Artists DVD/ancillary sales currently being pursued and
the estimated values - in addition to existing DVD accounts through 2008:
Year 2006 2007 2008
---- ---- ---- ----
Educational Art Catalogue 125,000 125,000 125,000
Utah Telemarketer 45,000 45,000 45,000
Italy VOD 90,000 0 0
Balkan DVD Kiosks 90,000 90,000 90,000
New Foreign DVD sales 25,000 25,000 25,000
------- ------- -------
Total additional expected 375,000 285,000 285,000
Expected base 150,000 150,000 150,000
------- ------- -------
Anticipated Annual DVD sales 525,000 435,000 435,000
In addition to the new DVD sales and agreements currently estimated above, the
Company is pursuing new broadcast licenses that it expects will be finalized in
2006.. They include a new sale in France being concluded by the co-production
company we are working with on our new series on Writers as well as a license
for all three series in the US, a license for French Canada, Holland, the U.K.
and licenses in the territories of Japan, Korea, Spain, Italy, and Germany noted
in our previous responses. Note the estimates and timing per series in the
following tables:
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Expected Inventors Broadcast sales and estimated values - in addition to
existing DVD accounts in 2005 and 2006:
Amount Year
------ ----
US Broadcast 90,000 2006
French Canada Broadcast 90,000 2006
France Broadcast 67,500 2006
German Broadcast 120,000 2006
UK Broadcast 150,000 2006
Spain, Japan, Korea, Holland Italy Broadcast 150,000 2006
Other ex-North America Broadcast 25,000 2006
-------
Anticipated total in 2006 692,500
Expected Artists Broadcast sales and estimated values - in addition to existing
DVD accounts in 2006 through 2008:
Years 2006-2007 2008
----- --------- ----
US Broadcast 90,000 60,000
English and French Canada Broadcast 90,000 60.000
France Broadcast 67,500 75,000
German Broadcast 120,000 0
UK Broadcast 150,000 75,000
Spain, Japan, Korea, Holland Broadcast 150,000 75,000
Other ex-North America Broadcast 175,000 75,000
------- -------
Anticipated total over 3 years 842,500 345,000
For Inventors, at the end of 2005, the Company used the following estimates to
arrive at Ultimate Revenue:
-------------------------------------------------------------------------------
Year Total Dvd sales Broadcast licenses
-------------------------------------------------------------------------------
2006 1,200,000 550,000 650,000
--------- ------- -------
-------------------------------------------------------------------------------
Due to the short period available to derive the revenue, the Company further
discounted Total Revenue to $380,000 .
For Artists, at the beginning of fiscal 2005, the Company used the following
estimates to arrive at our Ultimate Revenue:
-------------------------------------------------------------------------------
YEAR Total Dvd sales Broadcast licenses
-------------------------------------------------------------------------------
2006 1,150,000 500,000 525,000
-------------------------------------------------------------------------------
2007 800,000 400,000 300,000
-------------------------------------------------------------------------------
2008 800,000 400,000 325,000
--------- --------- ---------
-------------------------------------------------------------------------------
Total 2,450,000 1,300,000 1,150,000
-------------------------------------------------------------------------------
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As in prior periods, the Company used 75% to arrive at an Ultimate Revenue of
$1,500,000. The Company has further discounted Total Revenues and anticipates
using Ultimate Revenues Estimates of $1,315,000 for the Artists through the end
of 2008.
The Company believes that specific broadcast licenses and distribution
agreements currently in place and negotiations for the Company to commence a new
production of The Writers' Specials in 2006 will support the renewed sales of
the Company's film library in the near future. Nonetheless, if sales are not
concluded at the value and within the time period anticipated, the Company will
revise and disclose accordingly the ultimate revenue calculation and the
corresponding amortization of the applicable programs.
Annually, management reviews the estimate of total remaining ultimate revenue
and the fair value of the capitalized film costs. As a result of the review, the
Company reduced the carrying value of its completed film, television programs
and recordings by $1,373,356 (2004 - $1,393,826) and reduced the carrying value
of its completed motion picture by $1,979,997 (2004 - $1,744,151). The Company
expects to amortize approximately $770,000 for completed television programs and
recordings costs and $353,000 for completed motion picture costs during the next
fiscal year.
As at year end 2005 89% of competed television programs and recordings and 53%
of completed motion picture costs have been amortized.
The Company expects 100% of completed television programs and recordings and 70%
of completed motion picture costs will be amortized by December 31, 2008.
As at December 2011, over 80% of the completed motion picture costs will be
amortized. The remaining period of amortization for the completed projects
ranges from one to eight years at December 31, 2005.
Capital stock
At December 31, 2004 the Company had 32,251,008 common shares and 494,550 Series
1 Class A preferred shares outstanding.
The Company issued 3,102,500 common shares in the first six months of 2005 as
part of the following transactions:
(i) In January 2005, the Company issued 80,000 common shares for services
rendered, valued at $18,400.
(ii) In February 2005, the Company issued 125,000 common shares to employees who
exercised their stock options, for cash consideration of $12,500.
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(iii) On or before April 7, 2005, 2,547,500 warrants were exercised at a price
of $0.15 per unit for cash consideration of $382,125.
(iv) In May of 2005, the Company issued 350,000 common shares to settle accounts
payable for professional fees in the amount of $78,748.
At December 31, 2005 the Company had 35,353,508 common shares and 494,550 Series
1 Class A preferred shares outstanding.
Related Party Transactions
During the year ended December 31, 2005 $337,417 (2004 - $493,837) of fees were
paid or accrued to corporations controlled by two of the directors for writing,
directing and producing services. Additionally, $Nil (2004 - $30,000) were paid
(by issuance of 300,000 common shares) to the same corporations for bridge
financing provided in connection with Bailey's project. These transactions have
been measured at exchange amount, which is the amount of consideration
established and agreed to by the related parties and which the management
believes reflect prevailing market rates. Included in accounts payable and
accrued liabilities at December 31, 2005 was $32,477 (2004 - $Nil).
Limited Partnerships
During 2004 the Company entered into a services agreement with Devine
Entertainment Limited Partnership ("Partnership"). Under the terms of the
agreement, the Partnership will incur certain expenses, until December 31, 2004,
relating to the following services required in connection with the conduct of
business of the Company:
o Labour, employment and all other "direct" services;
o Marketing services, including production and placement of all
required advertising;
o The incurring of other operating expenses, excluding payments for
the purchase of real property,
o Administrative services
o Certain development services required in connection with new
projects of the business
In return, the Partnership is entitled to royalty payments equal to 0.8% of
gross revenue of the Company for calendar years from 2004 to 2014, payable 60
days after the completion of each calendar year in connection with the expenses
incurred during such year.
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Under the terms of the services agreement, the 2004 Partnership advanced
$846,350 to the Company for the 2004 services, which was originally accounted
for as royalty interest payable. Included in the $846,350 was $494,550 which was
initially loaned from the Company to an unrelated company which subsequently
loaned these funds to the limited partners.
The 2004 Partnership was also granted the right and option to exchange its
rights (including the 2004 royalties) under the services agreement, at anytime
until December 31, 2004, for 380,450 common shares and 494,550 preferred shares
of the Company.
On December 22, 2004 the Partnership exercised its right under the services
agreement and the royalty interest payable was reclassified to capital stock.
Included in the cash, as a reduction, is bank indebtedness of $Nil (2004 -
$94,665) and in accounts payable and accrued liabilities is $35,501 (2004 -
$108,151) of the Limited Partnership.
During the first quarter of 2005, the Company entered into a services agreement
with the QCF 2005 Limited Partnership ("QCF")., which to date has not been
finalized. Under the terms of the agreement, QCF incurred certain expenses,
until December 31, 2005, relating to the following services required in
connection with the conduct of business of the Company.
o Labour, employment and all other "direct" services;
o Marketing services, including production and placement of all
required advertising;
o The incurring of other operating expenses, excluding payments for
the purchase of real property,
o Administrative services
o Certain development services required in connection with new
projects of the business
In return, the Partnership would be entitled to a royalty equal to a percentage
of gross revenue of the Company in connection with the expenses incurred during
such year. The accounts of this variable interest entity have been included in
the consolidated financial statements of the Company.
In December 2005, The Devine Entertainment Film Library Limited Partnership, a
limited partnership formed and registered under the Limited Partnerships Act
(Ontario) on March 8, 2004, acquired Devine Entertainment Corporation's interest
in a defined part of the Company's proprietary film library for $6.8 million, as
valued by an outside valuator. The Company has provided financing for the
transaction, and has entered into a financing agreement and will enter into a
management agreement with the Limited Partnership in order to manage the
exploitation and expand the distribution of the properties. Under these
agreements the Company will receive management fees and interest revenue and the
Company will maintain a call right for between a minimum of 70% and a maximum
100% interest in the library assets. The accounts of this variable
38
interest entity have been included in the consolidated financial statements of
the Company.
Liquidity and Capital Resources
The Company's cash on hand as at December 31, 2005 was $239,990 as compared to
$104,727 as at December 31, 2004, an increase in cash position of $135,263.
The Company's bank film production loan for Bailey's Billion$ which was $919,664
as at December 31, 2004 was repaid in full on May 24, 2005 and the Company no
longer has any bank debt.
The Company expects to maintain renewed growth from operations and expects that
proceeds from sales of Bailey's Billion$ and its film library will generate
additional revenues and positive cash flow through 2006.
The Company's working capital deficiency, although reduced, remains significant
but is mitigated by the fact that the Company is working towards successfully
converting its $1,519,290 of outstanding convertible debentures into common
shares in 2006.
Nonetheless, the Company remains unable to service its convertible debt and the
Company will require additional working capital from its production activities
or corporate financing in 2006. The Company intends to actively seek additional
funding in calendar 2006.
Certain Foreign Business Considerations
At the end of 2001, the Company's then-existing Montreal-based sales agent,
Multi Media Group of Canada ("MMGC"), informed the Company that MMGC's
sub-agent, Daro Films Distribution GmbH ("Daro"), had bought, in the second or
third quarter of 2001, The Composers' Specials and The Inventors' Specials at
$570 per show for broadcast in Iran. The license resulting from this purchase
commenced in November 2001 and ended in the second or third quarter of 2005.
Daro is a Monaco-based distributor/agent specializing in African, Eastern
European, Australian, Asian and Middle Eastern territories. The purchase
occurred shortly prior to the Company's termination of its relationship with
MMGC. The Daro purchase was not pre-approved by the Company and thus constituted
a violation of the Company's agreement with MMGC.
The Daro purchase was a one-time event for the Company and was reflected in the
Company's 2001 financial statements at a gross value of less than $8,000 out of
$973,000, or less than 1% of the Company's 2001 revenues. As compared to overall
revenues from the Company's series of films which have totaled over $34,000,000
since the delivery of The Composers' Specials in 1995, this purchase reflects
less that 3/100 of 1% of the Company's revenues. The Company believes that the
Daro purchase had no material impact on the Company's costs and revenues in 2001
and no significant comparison can be made to any other period. In light of the
foregoing, the Company believes that the Daro purchase had no
39
material impact on the Company's costs and revenues in 2001 and no significant
comparison can be made to any other period. In light of the foregoing, the
Company believes that this purchase was not material to its business.
Since the date of Daro's purchase, Iran has been identified by the United States
Department as a terrorist-sponsoring state. As a result, Iran is subject to
restrictions imposed by the United States Treasury Office of Foreign Assets
Control ("OFAC"). Although the Company, by reason of being a Canadian
corporation, is not subject to the OFAC restrictions, the Company will take into
consideration that its reputation may suffer if it does business in Iran or any
other terrorist-sponsoring state in the future. Any such association could have
an adverse effect on the value of the Company's equity. The Company currently
has no continuing business or business interests in Iran or any other
terrorist-sponsoring state and does not foresee transacting business in any such
terrorist-sponsoring state in the future.
Further, certain states of the United States have recently enacted legislation
regarding investments by pension funds and other retirement systems in companies
that have business activities or contacts with countries that have been
identified as terrorist-sponsoring states and similar legislation may be pending
in other states. As a result, in the event that the Company has business
activities or contacts in or with a country identified by the United States
government as a state sponsor of terrorism, pension funds and other retirement
systems may be subject to reporting requirements with respect to investments in
Devine Entertainment or may be subject to limits or prohibitions with respect to
such investments that may adversely affect the value of the Company's equity. To
date, the Company is unaware of any pension fund and other retirement system
that has made a significant investment in the Company's equity.
OUTLOOK
As 2006 begins, the Company is optimistic about the successful commercial
exploitation of Bailey's Billion$, which was released theatrically in the United
States and Canada on August 5, 2005 and the growing sales of the Company's
proprietary film library of completed television programs and recordings, for
which revenues increased in 2005 by 64%.
The Company expects that the successful settlement and restructuring of the
majority of the Company's debt and the successful financings completed in 2004
and 2005 will bring new opportunities for additional corporate and limited
partnership financings in 2006 and the Company is actively pursuing financing to
produce new films, develop its marketing and distribution activities in North
America and abroad and for its general working capital requirements.
40
The Company continues to move forward with a significantly improved balance
sheet and the opportunity to attract new capital resources for its ongoing
business objectives. While many business risks remain and the success of these
strategies cannot be guaranteed, the Company expects that the successful
completion of all or some of these strategic objectives will assist with the
continued renewal of the Company's growth through 2006 and into the future.
CONTROLS AND PROCEDURES
The Company's Chief Executive Officer and Chief Financial Officer (collectively,
the "Certifying Officers") are responsible for establishing and maintaining
disclosure controls and procedures for the Company. Such officers have concluded
(based upon their evaluation of these controls and procedures as of a date
within 90 days of filing of this report) that the Company's disclosure controls
and procedures are effective to ensure that information required to be disclosed
by the Company in this report is accumulated and communicated to the Company's
management, including its Certifying Officers as appropriate, to allow timely
decisions regarding required disclosure. The Certifying Officers also have
indicated that there were no significant changes in the Company's internal
controls or other factors that could significantly affect such controls
subsequent to the date of their evaluation, and there were no corrective actions
with regard to significant deficiencies and material weaknesses.
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
These consolidated financial statements have been prepared in accordance with
accounting principles generally accepted in Canada that conforms, in all
material respects, with U.S. GAAP, except as described in the Note 20 to the
financial statements.
Basis of Consolidation
In October 2005 the Company amalgamated its operation with its wholly owned
subsidiaries.
The December 31, 2005 consolidated financial statements include the accounts of
Devine Entertainment Corporation with Variable Interest Entities ("VIE"). The
December 31, 2004 consolidated financial statements include Devine Entertainment
Corporation, all its wholly owned subsidiaries and Verifiable Interest Entity.
Inventory
Inventory consists of finished products and is stated at the lower of cost and
net realizable value
41
Revenue Recognition
Revenue is derived from broadcast licensing agreements, royalties, distribution
fees, the sale of distribution rights, sale of copyright interests and the sale
of home videos. All revenue is recognized upon meeting all recognition
requirements of SOP 00-2. Revenue from broadcast licensing agreements, together
with related costs, and revenue from the sale of copyright interests are
recognized once the licensing periods have commenced, the programs are delivered
and collection is reasonably assured. Revenue from royalties and distribution
fees is recognized when received. Revenue from the sale of distribution rights
is recognized when the film or television programs are substantially complete,
the investors have irrevocably committed to acquire distribution rights and
there is reasonable assurance of collectibility of proceeds. Revenue from the
sale of home videos and DVDs are recognized at the time of shipment. Amounts
received and not recognized as revenue are recorded as deferred revenue.
Investment in Film, Television Programs and Recordings
Investment in film, television programs and recordings represent projects in
progress and the unamortized costs of film, television programs and recordings,
net of anticipated federal and provincial film production tax credits, which
have been produced by the Company or for which the Company has acquired a
copyright interest or the rights to future revenue. Such costs include
development and production expenditures, capitalized overhead and financing
costs and other costs, which are expected to benefit future periods. Under SOP
00-2 exploitation costs, including advertising and marketing costs, are being
expensed as incurred. The Company also has an interest in programs, which have
been fully amortized in prior years and have no carrying value in these
financial statements.
Projects in progress include the costs of acquiring film rights to original
screenplays and costs to adapt such projects. Such costs are capitalized and,
upon commencement of production, are added to investment in film, television
programs, and recordings. Advances or contributions received from third parties
to assist in development are deducted from these costs. Projects in progress are
written off at the earlier of the date determined not to be recoverable or when
projects in progress are abandoned, and three years from the date of the initial
investment.
Amortization is determined based on the ratio that current gross film revenues
bear to management's estimate of total remaining ultimate gross film revenue as
of the beginning of the current fiscal year on a program by program basis (the
"individual film forecast method"). Revenue and film costs are continually
reviewed by management and revised when warranted by changing conditions. When
estimates of total revenues and costs indicate that a feature film or television
program will result in an ultimate loss, a reduction in the carrying value of
the investment is recognized to the extent that capitalized film costs exceed
estimated fair value. Such adjustments could have a material effect on the
results of operations in future periods. Production financing provided by third
parties that acquire substantive equity participation is recorded as a reduction
of costs of the production.
42
Capitalized film costs are stated at the lower of unamortized cost or estimated
fair value on an individual film basis. Fair market value is based on the
discounted projected net cash flows. The determination of the projected net cash
flows and discount rates are subjective in nature and involve uncertainties and
matters of significant judgement by management.
Property and Equipment
Property and equipment are recorded at cost less accumulated amortization.
Amortization is being provided for on the declining balance basis at the
following annual rates.
Computer and editing equipment - 30%
Furniture and fixtures - 20%
Foreign Currency Translation
Monetary assets and liabilities denominated in currencies other than Canadian
dollars are translated at year-end exchange rates. Revenue, expenses and film
production costs are translated at the rates prevailing at the times of the
transactions. The gains or losses resulting from these translations are
reflected in the statements of operations.
Government and Other Assistance
The Company has access to various government programs that are designed to
assist film, television programs and recordings production and distribution in
Canada. Effective January 1, 2004, amounts receivable in respect of production
assistance are recorded as a reduction of investment in film and television
programs. Government assistance towards current expenses is included in
earnings. Investment tax credits are recorded as a reduction to investment in
film, television programs and recordings, when the ultimate collection of the
credits are assured.
Stock-Based Compensation
The Company accounts for all stock-based payments using the fair value based
method. The Company grants stock options for a fixed number of shares to
employees and consultants with an exercise price equal to the fair value of the
shares at the date of grant. The Company recognizes compensation expense for the
stock-based compensation plan when stock or stock options are issued to
employees. Any consideration paid by employees on exercise of stock options or
purchase of stock is credited to share capital.
If stock or stock options are repurchased from employees or consultants, the
excess of the consideration paid over the carrying amount of the stock or stock
option cancelled is charged to retained earnings.
Future Income Taxes
The Company uses the asset and liability method to account for income taxes. The
asset and liability method requires that income taxes reflect the expected
future tax consequences of temporary differences between the carrying amounts of
assets or liabilities and their tax bases. Future income tax assets and
liabilities for each temporary
43
difference based on the tax rates which are expected to be in effect when the
underlying items of income and expenses are expected to be realized. The effect
of future income tax assets and liabilities of a change in the tax rates is
included in income in the period that the rate changes.
Earnings Per Share
Basic earnings per share is computed by dividing earnings available to common
shareholders by the weighted average number of common shares outstanding during
the year. The treasury stock method is used to calculate diluted earnings per
share. Diluted earnings per share is similar to basic earnings per share, except
that the denominator is increased to include the number of additional common
shares that would have been outstanding assuming that options and warrants with
an average market price for the year greater than their exercise price are
exercised and the proceeds used to repurchase common shares.
Measurements Uncertainty
The preparation of financial statements in conformity with Canadian generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts on assets and liabilities, revenues
and expenses and disclosures of contingent assets and liabilities. Significant
areas requiring the use of significant judgment include the measurement of
deferred revenue related to future sales, amortization of Long-Lived Assets,
valuation of stock compensation, recoverability of tax credits and estimation of
future income tax assets and valuation allowances. Actual results could differ
from these estimates.
These estimates are reviewed periodically and, as adjustments become necessary,
they are reported in earnings in the period in which they become known.
Impairment of Long-Lived Assets
Long-Lived Assets, Including property and equipment, Investments in Films,
Television programs and recording and deferred charges are reviewed for
impairment when significant events or circumstances indicate that the carrying
amount of an asset may not be recoverable. Impairment exist when the carrying
value of the assets is greater than the future undiscounted cash flows expected
to be provided by the asset. The amount of impairment loss, if any, which is in
excess of net carrying value over fair value, is charged to income for the
period. Fair value is generally measured equal to the estimated future
discounted net cash from the asset.
Deferred Revenue
Sales of rights and licences related to projects in progress are recorded as
deferred revenue until revenue recognition parameters have been met.
Deferred Charges
Deferred charges costs are being amortized using the straight-line method over a
five year period.
44
Recent Accounting Pronouncements
i) Effective January 1, 2006 the Company will adopt a recent accounting
pronouncement of the Financial Accounting Standards Board ("FASB"), issued
SFAS No. 123R, "Share- Based Payments" ("SFAS 123R"), which requires
companies to measure and recognize compensation expenses for all share
based payments at a fair value. The Company does not expect the adoption
of SFAS 123R to have a material impact on its financial consolidated
statements.
ii) In May 2005 the FASB issued SFAS No.154, "Accounting Changes and Error
Corrections" (SFAS 154"), which is providing guidance on the accounting
for, and reporting of, accounting changes and error of corrections. This
Statement replaces APB Opinion No. 20, Accounting Changes, and FASB
Statement No. 3, Reporting Accounting Changes in Interim Financial
Statements, and changes the requirements for the accounting for and
reporting of a change in accounting principle. This Statement applies to
all voluntary changes in accounting principle. It also applies to changes
required by an accounting pronouncement in the unusual instance that the
pronouncement does not include specific transition provisions. When a
pronouncement includes specific transition provisions, those provisions
should be followed. The provisions of SFAS 154 is effective for accounting
changes and corrections of error made in the period beginning after
December 31, 2005. We do not expect the adoption of SFAS 154 to have a
material impact on our financial position or result of operations.
iii) Effective December 1, 2004, the Company was required to adopt the Canadian
Institute of Chartered accountants' (CICA) Accounting Guideline
15(AcG-15), "Consolidation of Variable Interest Entities" ("VIP"). AcG-15
provides guidance that addresses when a company should consolidate in its
financial statements the assets, liabilities and operating results of
another entity. Under previous guidance, a company generally included
another entity in its consolidated financial statements only if controlled
the entity through a controlling voting interest. AcG-15 requires a VIE to
be consolidated by the company if that company is the primary beneficiary
of that entity. In January 2003, the FASB issued Interpretation No.
("FIN") 46, "Consolidation of Variable Interest Entities", which is
effective for financial statements of public companies that have special
purpose entities for periods ending after December 15, 2003 and for public
companies without special purpose entities for periods ending after March
15, 2004. Accordingly, the Company has included the results of operations
of the Devine Limited Partnership (Note 13) in its consolidated
operations.
iv) In January 2005, the CICA issued Handbook Section 3855, "Financial
Instruments - Recognition and Measurement". The section prescribes when a
financial instrument is to be recognized on the balance sheet and at what
amount. It also specifies how financial instrument gains and losses are to
be presented. This new standard will be effective for interim and annual
financial statements relating to fiscal years commencing on or after
October 1, 2006. The Company is assessing the impact of this new standard
on its consolidated financial statements.
45
v) In January 2005, the CICA issued Handbook Section 3865, "Hedges". The
Section provides alternative treatments to Section 3855 for entities which
choose to designate qualifying transactions as hedges for accounting
purposes. It replaces and expands on Accounting Guideline AcG-13 "Hedging
Relationships", and the hedging guidance in Section 1650 "Foreign Currency
Translation" by specifying how hedge accounting is applied and what
disclosures are necessary when it is applied. This new standard will be
effective for interim and annual financial statements relating to fiscal
years commencing on or after October 1, 2006. The Company is assessing the
impact of this new standard on its consolidated financial statements.
vi) In January 2005, the CICA issued Handbook Section 1530, "Comprehensive
Income". The section introduces a new requirement to temporarily present
certain gains and losses from changes in fair value outside net income,
but in a transparent manner. This new standard will be effective for
interim and annual financial statements relating to fiscal years
commencing on or after October 1, 2006. The Company is assessing the
impact of this new standard on its consolidated financial statements.
RECONCILIATION TO UNITED STATES GAAP
The consolidated financial statements of the Company have been prepared in
accordance with Canadian GAAP. The material differences between the accounting
policies used by the Company under Canadian GAAP and U.S. GAAP are disclosed
below in accordance with the provisions of the Securities and Exchange
Commission.
a) Under Canadian GAAP, the conversion feature on the convertible
debentures is valued at $181,510 and has been classified as
contributed surplus. Under U.S. GAAP the conversion feature is not
accounted separately and thus would not flow through contributed
surplus. This transaction occurred in 2000.
b) Under Canadian GAAP, the exchange of convertible debentures for new
convertible debentures and subsequent gain on settlement of the new
convertible debentures were valued at $284,803 and has been
classified as contributed surplus. Under U.S. GAAP, the conversion
and subsequent settlement is not accounted for through contributed
surplus and would be recorded through the statement of operations
thus reducing the deficit. This transaction occurred in 2000.
c) Under Canadian GAAP, the Company's preferred shares have been
included in shareholders' equity as the Company considers the
likelihood of redemption by the holders to be remote. Under U.S.
GAAP, the preferred shares would be classified as a liability. In
addition, cumulative dividends are part of the liability for the
shares.
46
d) Financial Accounting Standards Board Statement of Financial
Accounting Standards No. 130 "Reporting Comprehensive Income" (SFAS
130) requires the disclosure of comprehensive income, which includes
reported net earnings adjusted for other comprehensive income. Other
comprehensive income is defined as the change in equity of a
business enterprise during a period from transactions and other
events and circumstances from non-owner sources. During 2005 and
2004, there were no other comprehensive income.
December 31, 2005 CDN GAAP U.S. GAAP
----------------- -------- ---------
Convertible debentures 1,519,290 1,700,800
Contributed surplus 1,007,376 541,063
Deficit 8,075,447 7,790,644
Other liabilities 0 494,673
Capital stock 12,240,095 11,745,422
Interest Expense 50,832 95,836
December 31, 2004
-----------------
Convertible debentures 1,519,290 1,700,800
Contributed surplus 1,051,886 585,573
Deficit 7,797,034 7,512,354
Other liabilities 0 494,673
Capital stock 11,703,437 11,208,887
Interest Expense (recovered) (30,371) (30,248)
47
Impact of Newly Issued United States Accounting Standards
i) In December 2004, the Financial Accounting Standards Board ("FASB") issued
SFAS No. 123 (revised), "Share-Based Payment," which establishes standards
related to the accounting for transactions in which an entity exchanges
its equity instruments for goods or services. This revised standard also
addresses transactions in which an entity incurs liabilities in exchange
for goods or services that are based on the fair value of the entity's
equity instruments or that may be settled by the issuance of these equity
instruments. SFAS No. 123 (revised) focuses primarily on accounting for
transactions in which an entity obtains employee services in share-based
payment transactions. This standard requires a public entity measure the
cost of employee services received in exchange for an award of equity
instruments based on the grant-date fair value of the award and recognize
the cost over the period during which an employee is required to provide
service in exchange for the award. In April 2005, the SEC amended the
effective date to allow companies to implement this standard at the
beginning of their next fiscal year beginning after June 15, 2005. Devine
believes that this statement will not have a material impact on its
consolidated statement of operations.
ii) In May 2005, the FASB issued SFAS No. 154, "Accounting Changes and Error
Corrections - a replacement of APB Opinion No. 20 and FASB Statement No.
3." Under SFAS No. 154, changes in accounting principles will generally be
made by the retrospective application of the new accounting principle to
the financial statements of prior periods unless it is impractical to
determine the effect of the change on prior periods. The reporting of a
change in accounting principle as a cumulative adjustment to net income in
the period of the change, as was previously permitted under APB Opinion
No. 20, will no longer be permitted unless it is impractical to determine
the effect of the change on prior periods. Correction of an error in the
application of accounting principles will continue to be reported by
retroactively restating the affected financial statements. The provisions
of SFAS No. 154 will not apply to new accounting standards that contain
specific transition provisions. SFAS No. 154 is applicable to accounting
changes made in fiscal years beginning on or after December 15, 2005. The
Company does not expect SFAS No. 154 to have a material effect, if any, on
its consolidated financial statements.
RISK AND UNCERTAINTIES
In evaluating the Company and its business, shareholders should consider
carefully the following risk factors and uncertainties in addition to other
information contained herein:
Risks Related to the Nature of the Entertainment Industry
The entertainment industry historically has involved a substantial degree of
risk. Acceptance of entertainment programming represents a response not only to
the programming's artistic components, but also to the review of critics,
promotion by the distributor, the quality and acceptance of other competing
programs released into the
48
marketplace at or near the same time, the availability of alternative forms of
entertainment and leisure time activities, general economic conditions, public
tastes generally and other intangible factors, all of which could change rapidly
and cannot be predicted with certainty. There is a risk that some or all of the
Company's programming will not be successful, possibly resulting in a portion of
costs not being recouped or anticipated profits not being realized. While Devine
continually endeavors to develop new programming, there can be no assurance that
revenue from existing or future programming will replace a possible loss of
revenue associated with the cancellation of any particular production.
Fluctuating Results of Operations
Results of operations for any period are significantly dependent on the number
and timing of home video programs delivered or made available to various media.
Consequently, the Company's results of operations may fluctuate materially from
period to period and the results of any one period are not necessarily
indicative of results for future periods. Cash flows may also fluctuate and are
not necessarily closely correlated with revenue recognition. Results from
operations fluctuate materially from quarter to quarter and the results for any
one quarter are not necessarily indicative of results for future quarters.
Additional Financing
There is no assurance that additional financing will be available when required
or if available that it could be obtained on favorable terms. This lack of
additional financing will affect the Company's ability to continue with its
contemplated plan of operations.
Competition
Substantially all of the Company's revenues are derived from the production and
distribution of television and film programming. The business of producing and
distributing film and home video programs is highly competitive. The Company
faces intense competition from other producers and distributors, many of whom
are substantially larger and have greater creative, financial, technical and
marketing resources than the Company. The Company competes with other film and
home video production companies for ideas and storylines created by third
parties as well as for actors, directors and other personnel required for a
production.
Government Incentive Programs
The Company attempts to defray a significant portion of the production costs of
most of its programming by obtaining, prior to commencement of principal
photography, advances and guarantees from distributors and licensees in exchange
for distribution and broadcasting rights to the production and, in some cases,
investments from third parties. In addition to fees from broadcasters, financial
contributions by co-producers and presales of distribution rights, Canadian
industry incentive programs represent a financing source for the Company's
productions. There can be no assurance that individual incentive programs
available to the Company will not be reduced, amended or eliminated.
49
International Operations
The Company's international operations depend, in part, on local economic
conditions, currency fluctuations, changes in local regulatory requirements,
compliance with a variety of foreign laws and regulations and cultural barriers.
In addition, political instability in a foreign nation may adversely affect the
ability of the Company to distribute its product in that country. As a result of
the foregoing international risks, the Company's international operations may be
adversely affected.
Importance of Management Estimates in Reported Revenues and Earnings
The Company makes numerous estimates as to its revenues and matching production
and direct distribution expenses on a project-by-project basis. As a result of
this accounting policy, earnings can widely fluctuate if management has not
accurately forecast the revenue potential of a production.
Exchange Rates
The return to the Company from foreign commercial exploitations of its
properties is customarily paid in U.S. currency and as such may be affected by
fluctuations in the exchange rate of the U.S. dollar. Currency exchange rates
are determined by market factors beyond the control of the Company and may vary
substantially during the course of a production period. In addition, the ability
of the Company to repatriate to Canada funds arising in connection with foreign
exploitation of its properties may also be adversely affected by currency and
exchange control regulations imposed by the country in which the production is
exploited. At present, the Company is not aware of any existing currency or
exchange control regulations in any country in which the Company currently
contemplates exploiting its properties, which would have an adverse effect on
the Company's ability to repatriate such funds.
Canadian Content and Ownership
Canadian conventional, specialty, pay and pay-per-view television services are
required to devote a certain amount of their programming schedules, including
prime time, to Canadian productions. In addition to scheduling requirements,
such Canadian television services are typically required to invest in, or
acquire, Canadian programs based on the nature of the particular service and
financial performance. Under regulations and policies of the CRTC, a program
will qualify as a Canadian production if, among other things, (i) it is produced
by Canadians with the involvement of Canadians in principal functions, and (ii)
a substantial portion of the budget is spent on Canadian elements. The Company
believes it will continue to qualify as a Canadian producer for this purpose so
long as, among other things, more than 50% of the combined voting power of its
outstanding shares is beneficially owned by Canadian nationals. The Company
cannot be certain of the total percentage of the Company's stock currently held
in Canada because the Company has no way of determining the beneficial ownership
of its outstanding Common Shares.
50
Proprietary Rights
To the extent practicable, the Company attempts to retain and protect all
proprietary and intellectual property rights to its productions through
international copyright laws and licensing and distribution arrangements with
reputable international companies for specified territories and media for
limited durations. Despite these precautions, existing copyright laws afford
only limited practical protection in certain jurisdictions and, in fact, the
Company operates in other jurisdictions in which there is no copyright
protection. As a result, it may be possible for unauthorized third parties to
copy and distribute the Company's productions or certain portions or
applications of the Company's productions.
In addition, there can be no assurance that other companies will not
independently develop and produce programs that are similar to or imitate those
of the Company but legally circumvent the Company's intellectual property
rights.
OTHER INFORMATION
Additional information relating to Devine Entertainment Corporation is on SEDAR
at www.sedar.com
Disclosure of outstanding share data
As of March 24, 2006 the Company has the following voting or equity securities
or securities convertible or exercisable into voting or equity securities,
issued and outstanding:
Common shares issued & outstanding: 35,353,508
Series 1 preferred shares issued and outstanding: 494,550
Options: 3,180,000 outstanding options to purchase 3,180,000 common shares
Warrants: 4,877,450 outstanding to purchase 4,877,450 common shares
Debentures: 1,519,290 convertible into 3,301,600 common shares
51
ITEM 7. FINANCIAL STATEMENTS
DEVINE ENTERTAINMENT CORPORATION
CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2005
(expressed in Canadian dollars)
52
DEVINE ENTERTAINMENT CORPORATION
DECEMBER 31, 2005
CONTENTS
PAGE
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM I
CONSOLIDATED FINANCIAL STATEMENTS
Balance Sheet 55
Statement of Shareholders' Equity 56
Statement of Operations 57
Statement of Cash Flows 58
Notes to Financial Statements 59-86
53
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Shareholders of
DEVINE ENTERTAINMENT CORPORATION
We have audited the consolidated balance sheets of DEVINE ENTERTAINMENT
CORPORATION as at December 31, 2005 and 2004 and the consolidated statements of
shareholders' equity, operations and cash flows for years ended then. These
consolidated financial statements are the responsibility of the company's
management. Our responsibility is to express an opinion on these consolidated
financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States) and with generally accepted auditing
standards in Canada. 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. We believe that our audits provide a reasonable basis for our
opinion.
In our opinion, these consolidated financial statements present fairly, in all
material respects, the consolidated financial position of the company as at
December 31, 2005 and 2004 and the consolidated results of its operations,
changes in its shareholders' equity and its cash flows for years then ended in
conformity with accounting principles generally accepted in Canada.
COMMENTS BY AUDITORS ON U.S. - CANADA REPORTING DIFFERENCE
In Canada, reporting standards for auditors do not permit the addition of an
explanatory paragraph when the financial statements account for, disclose and
present in accordance with generally accepted accounting principles conditions
and events that cast substantial doubt on the company's ability to continue as a
going concern. Although our audit was conducted in accordance with both Public
Company Accounting Oversight Board (United States) and Canadian generally
accepted auditing standards, our report to the shareholders dated February 24,
2006 is expressed in accordance with Canadian reporting standards which do not
permit a reference to such uncertainties in the auditor's report when such
uncertainties are adequately disclosed in the financial statements.
/s/ Kraft, Berger, Grill, Schwartz, Cohen & March LLP
KRAFT, BERGER, GRILL, SCHWARTZ, COHEN & MARCH LLP
Chartered Accountants
Toronto, Ontario
February 24, 2006
DEVINE ENTERTAINMENT CORPORATION
CONSOLIDATED BALANCE SHEETS
DECEMBER 31, 2005
(expressed in Canadian dollars)
ASSETS
2005 2004
------------ ------------
Current
Cash $ 239,990 $ 104,727
Accounts receivable 229,581 841,888
Inventory 88,140 26,013
Film tax credits receivable (Note 3) -- 299,097
Prepaid and sundry assets 26,312 42,066
------------ ------------
584,023 1,313,791
Advances receivable (Note 4) 494,550 494,550
Investment in film, television programs
and recordings (Note 5) 6,848,108 9,221,170
Deferred financing charges -- 36,123
Property and equipment (Note 6) 23,872 31,727
------------ ------------
$ 7,950,553 $ 11,097,361
============ ============
LIABILITIES
Current
Accounts payable and accrued liabilities $ 1,259,239 $ 1,041,147
Bank film production loan (Note 7) -- 919,664
Current portion of Convertible
Debentures (Note 8) 1,519,290 1,519,290
Deferred revenue -- 2,658,971
------------ ------------
2,778,529 6,139,072
------------ ------------
SHAREHOLDERS' EQUITY
Capital stock (Note 14) 12,240,095 11,703,437
Contributed surplus (Note 16) 1,007,376 1,051,886
Deficit (8,075,447) (7,797,034)
------------ ------------
5,172,024 4,958,289
------------ ------------
$ 7,950,553 $ 11,097,361
============ ============
See accompanying notes to consolidated financial statements.
APPROVED ON BEHALF OF THE BOARD:
[signed] Director [signed] Director
-------------------------- --------------------------
David Devine Richard Mozer
55
DEVINE ENTERTAINMENT CORPORATION
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
FOR THE YEARS ENDED DECEMBER 31,
(expressed in Canadian dollars)
Stock Contributed
Common Shares Warrants Options Preferred Shares Surplus Deficit
------------------------ ---------- ---------- ----------------- ----------- -----------
# $ # # # $ $ $
(Note 16)
BALANCE,
December 31, 2003 14,261,838 9,393,316 550,000 -- -- -- 466,313 (12,095,951)
ISSUED
- on settlement
of bank loans 100,000 10,000 -- -- -- -- -- --
- on settlement
of long-term
debt 2,042,054 204,205 1,830,000 -- -- -- 18,300 --
- pursuant to
private placement 1,100,000 121,000 866,616 -- -- -- 99,000 --
- pursuant to
private placement 5,160,000 464,400 2,580,000 -- -- -- 51,600 --
- for cash consideration 100,000 10,000 -- -- -- -- -- --
- on settlement of
advances from
related parties 4,717,082 471,708 -- -- -- -- -- --
- on settlements of
accounts payable and
accruals 4,022,918 461,569 -- -- -- -- 371,823 --
- Less: share issuance
costs -- (28,111) -- -- -- -- -- --
- on conversion of
warrants 366,666 55,000 (366,666) -- -- -- (55,000) --
- issued to Devine
Limited Partnership 380,450 351,800 -- -- 494,550 494,550 -- --
- tax benefits utilized
by limited
partnership -- (306,000) -- -- -- -- -- --
- on issuance of stock
options -- -- -- 3,440,000 -- -- 99,850 --
NET INCOME -- -- -- -- -- -- -- 4,298,917
-----------------------------------------------------------------------------------------------------
BALANCE,
December 31, 2004 32,251,008 11,208,887 5,459,950 3,440,000 494,550 494,550 1,051,886 (7,797,034)
- on conversion of
warrants 2,547,500 433,450 (2,547,500) -- -- -- (50,950) --
- on issuance of step
up warrants -- (10,190) 2,547,500 -- -- -- 10,190 --
- on exercise
of stock options 125,000 16,250 -- (125,000) -- -- (3,750) --
- on settlement for
services rendered
and accounts payable 430,000 97,148 -- -- -- -- -- --
- expired
options/warrants -- -- (582,500) (135,000) -- -- -- --
- dividend distribution (45,004)
NET LOSS (233,409)
-----------------------------------------------------------------------------------------------------
BALANCE
December 31, 2005 35,353,508 11,745,545 4,877,450 3,180,000 494,550 494,550 1,007,376 (8,075,447)
=====================================================================================================
See accompanying notes to consolidated financial statements.
56
DEVINE ENTERTAINMENT CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE YEARS ENDED DECEMBER 31,
(expressed in Canadian dollars)
Operating 851,018 701,996
Amortization - film, television
programs and
recordings 3,325,049 2,076,357
- equipment 7,855 7,955
Stock-based compensation 18,400 99,850
Interest (recovered) (Note 9) 50,832 (30,371)
Write-down of investment in film,
television programs and
recordings (Note 5) -- 1,000,000
Gain on settlement of debt (Note 10) -- (4,039,825)
------------ ------------
4,253,154 (184,038)
------------ ------------
INCOME (LOSS) BEFORE INCOME TAXES (233,409) 3,993,273
INCOME TAXES (RECOVERED) (Note 11) -- (305,644)
------------ ------------
NET INCOME (LOSS) FOR THE YEAR $ (233,409) $ 4,298,917
============ ============
EARNINGS PER COMMON SHARE (Note 15)
Basic $ (0.01) $ 0.22
============ ============
Fully Diluted $ (0.01) $ 0.22
============ ============
THE WEIGHTED AVERAGE SHARES
-BASIC 34,649,419 19,223,507
-FULLY DILUTED 34,649,419 19,365,367
See accompanying notes to consolidated financial statements.
57
DEVINE ENTERTAINMENT CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED DECEMBER 31,
(expressed in Canadian dollars)
2005 2004
----------- -----------
OPERATING ACTIVITIES
Net income (loss) for the year $ (233,409) $ 4,298,917
Gain on settlement of debt -- (4,039,825)
Stock-based compensation 18,400 99,850
Amortization - film, television programs
and recordings 3,325,049 2,076,357
- property and equipment 7,855 7,955
- financing charges 36,123 31,960
Write-down of investment in film, television
programs and recordings -- 1,000,000
Change in non-cash components of working
capital (Note 18) (1,497,100) (3,045,288)
----------- -----------
1,656,918 429,926
----------- -----------
FINANCING ACTIVITIES
Decrease in bank loans (919,664) (1,359,721)
Decrease in long term debt -- (445,000)
Issuance of shares and warrants -- 746,000
Issuance of shares on conversion of warrants 382,500 --
Issuance of shares on exercise of options 12,500 --
Payment of share issuance costs -- (28,111)
Funds received from Limited Partnership -- 846,350
Preferred share dividends paid (45,004) --
----------- -----------
(569,668) (240,482)
----------- -----------
INVESTING ACTIVITIES
Investment in film, television programs
and recordings (951,987) (314,998)
Purchase of property and equipment -- (17,600)
Increase in advances receivable -- (494,550)
----------- -----------
(951,987) (827,148)
----------- -----------
CHANGE IN CASH 135,263 (637,704)
CASH, BEGINNING OF YEAR 104,727 742,431
----------- -----------
CASH, END OF YEAR $ 239,990 $ 104,727
=========== ===========
SUPPLEMENTAL CASH FLOW INFORMATION
Interest paid $ 21,171 $ 40,844
=========== ===========
Income taxes paid $ -- $ 356
=========== ===========
See accompanying notes to consolidated financial statements.
58
DEVINE ENTERTAINMENT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2005 AND 2004
(expressed in Canadian dollars)
1. NATURE OF BUSINESS AND GOING CONCERN
Devine Entertainment Corporation ("the Company") is an integrated
developer and producer of children's and family programs for worldwide
television and film broadcast and home video markets.
Television and film production and distribution is highly speculative and
inherently risky. There can be no assurance of the economic success of
such television and film programming since the revenues derived from the
production and distribution (which do not necessarily bear a direct
correlation to the production or distribution costs incurred) depend
primarily upon their acceptance by the public.
The success of the Company's television and film programming also may be
impacted by, among other factors, prevailing advertising rates, which are
subject to fluctuation. Therefore, there is a substantial risk that some
of all of the Company's television projects will not be commercially
successful, resulting in costs not being recouped or anticipated profits
not being realized.
These financial statements have been prepared on the basis of accounting
principles applicable to a going concern, which presumes the realization
of assets and settlement of liabilities in the normal course of operations
in the foreseeable future.
The Company has a significant working capital deficiency and its continued
existence is dependent upon its ability to restore and maintain profitable
operations and to successfully convert convertible debentures, which are
currently in default. Management is in constant communication with the
debenture holders and expects that the Company will be able to settle the
debentures in the normal course of operations.
If the going concern assumption were not appropriate for these financial
statements, then adjustments would be necessary in the carrying values of
assets and liabilities and the reported net income.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
These consolidated financial statements have been prepared in accordance
with accounting principles generally accepted in Canada that conforms, in
all material respects, with U.S. GAAP, except as described in Note 20 to
the financial statements.
(a) Basis of Consolidation
In October 2005 the Company amalgamated its operation with its
wholly owned subsidiaries.
The December 31, 2005 consolidated financial statements include the
accounts of Devine Entertainment Corporation with Variable Interest
Entities ("VIE"). The December 31, 2004 consolidated financial
statements includes Devine Entertainment Corporation and all of its
wholly-owned subsidiaries and Variable Interest Entity.
(b) Inventory
Inventory consists of finished goods and is stated at the lower of
cost and net realizable value.
59
DEVINE ENTERTAINMENT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2005 AND 2004
(expressed in Canadian dollars)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
(c) Revenue Recognition
Revenue is derived from broadcast licensing agreements, royalties,
distribution fees, the sale of distribution rights, sale of
copyright interests and the sale of home videos. All revenue is
recognized upon meeting all recognition requirements of SOP 00-2.
Revenue from broadcast licensing agreements, together with related
costs, and revenue from the sale of copyright interests are
recognized once the licensing periods have commenced, the programs
are delivered and collection is reasonably assured. Revenue from
royalties and distribution fees is recognized when received. Revenue
from the sale of distribution rights is recognized when the film or
television programs are substantially complete, the investors have
irrevocably committed to acquire distribution rights and there is
reasonable assurance of collectibility of proceeds. Revenue from the
sale of home videos and DVDs are recognized at the time of shipment.
Amounts received and not recognized as revenue are recorded as
deferred revenue.
(d) Investment in Film, Television Programs and Recordings
Investment in film, television programs and recordings represent
projects in progress and the unamortized costs of film, television
programs and recordings, net of anticipated federal and provincial
film production tax credits, which have been produced by the Company
or for which the Company has acquired a copyright interest or the
rights to future revenue. Such costs include development and
production expenditures, capitalized overhead and financing costs
and other costs, which are expected to benefit future periods. Under
SOP 00-2 exploitation costs, including advertising and marketing
costs, are being expensed as incurred. The Company also has an
interest in programs, which have been fully amortized in prior years
and have no carrying value in these financial statements.
Projects in progress include the costs of acquiring film rights to
original screenplays and costs to adapt such projects. Such costs
are capitalized and, upon commencement of production, are added to
investment in film, television programs, and recordings. Advances or
contributions received from third parties to assist in development
are deducted from these costs. Projects in progress are written off
at the earlier of the date determined not to be recoverable or when
projects in progress are abandoned, and three years from the date of
the initial investment.
Amortization is determined based on the ratio that current gross
film revenues bear to management's estimate of total remaining
ultimate gross film revenue as of the beginning of the current
fiscal year on a program by program basis (the "individual film
forecast method"). Revenue and film costs are continually reviewed
by management and revised when warranted by changing conditions.
When estimates of total revenues and costs indicate that a feature
film or television program will result in an ultimate loss, a
reduction in the carrying value of the investment is recognized to
the extent that capitalized film costs exceed estimated fair value.
Such adjustments could have a material effect on the results of
operations in future periods. Production financing provided by third
parties that acquire substantive equity participation is recorded as
a reduction of costs of the production.
Capitalized film costs are stated at the lower of unamortized cost
or estimated fair value on an individual film basis. Fair market
value is based on the discounted projected net cash flows. The
determination of the projected net cash flows and discount rates are
subjective in nature and involve uncertainties and matters of
significant judgement by management.
60
DEVINE ENTERTAINMENT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2005 AND 2004
(expressed in Canadian dollars)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
(e) Property and Equipment
Property and equipment are recorded at cost less accumulated
amortization. Amortization is being provided for on the declining
balance basis at the following annual rates.
Computer and editing equipment - 30%
Furniture and fixtures - 20%
(f) Foreign Currency Translation
Monetary assets and liabilities denominated in currencies other than
Canadian dollars are translated at year-end exchange rates. Revenue,
expenses and film production costs are translated at the rates
prevailing at the times of the transactions. The gains or losses
resulting from these translations are reflected in the statements of
operations.
(g) Government and Other Assistance
The Company has access to various government programs that are
designed to assist film, television programs and recordings
production and distribution in Canada. Effective January 1, 2004,
amounts receivable in respect of production assistance are recorded
as a reduction of investment in film and television programs.
Government assistance towards current expenses is included in
earnings. Investment tax credits are recorded as a reduction to
investment in film, television programs and recordings, when the
ultimate collection of the credits are assured.
(h) Stock-Based Compensation
The Company accounts for all stock-based payments using the fair
value based method. The Company grants stock options for a fixed
number of shares to employees and consultants with an exercise price
equal to the fair value of the shares at the date of grant. The
Company recognizes compensation expense for the stock-based
compensation plan when stock or stock options are issued to
employees. Any consideration paid by employees on exercise of stock
options or purchase of stock is credited to share capital.
If stock or stock options are repurchased from employees or
consultants, the excess of the consideration paid over the carrying
amount of the stock or stock option cancelled is charged to retained
earnings.
61
DEVINE ENTERTAINMENT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2005 AND 2004
(expressed in Canadian dollars)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
(i) Future Income Taxes
The Company uses the asset and liability method to account for
income taxes. The asset and liability method requires that income
taxes reflect the expected future tax consequences of temporary
differences between the carrying amounts of assets or liabilities
and their tax bases. Future income tax assets and liabilities for
each temporary difference based on the tax rates which are expected
to be in effect when the underlying items of income and expenses are
expected to be realized. The effect of future income tax assets and
liabilities of a change in the tax rates is included in income in
the period that the rate changes.
(j) Earnings Per Share
Basic earnings per share is computed by dividing earnings available
to common shareholders by the weighted average number of common
shares outstanding during the year. The treasury stock method is
used to calculate diluted earnings per share. Diluted earnings per
share is similar to basic earnings per share, except that the
denominator is increased to include the number of additional common
shares that would have been outstanding assuming that options and
warrants with an average market price for the year greater than
their exercise price are exercised and the proceeds used to
repurchase common shares.
(k) Measurements Uncertainty
The preparation of financial statements in conformity with Canadian
generally accepted accounting principles requires management to make
estimates and assumptions that affect the reported amounts on assets
and liabilities, revenues and expenses and disclosures of contingent
assets and liabilities. Significant areas requiring the use of
significant judgment include the measurement of ultimate revenue
related to future sales, amortization of Long-Lived Assets,
valuation of stock compensation, recoverability of tax credits and
estimation of future income tax assets and valuation allowances.
Actual results could differ from these estimates.
These estimates are reviewed periodically and, as adjustments become
necessary, they are reported in earnings in the period in which they
become known.
62
DEVINE ENTERTAINMENT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2005 AND 2004
(expressed in Canadian dollars)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
(l) Impairment of Long-Lived Assets
Long-Lived Assets, Including property and equipment, Investments in
Films, Television programs and recordings are reviewed for
impairment when significant events or circumstances indicate that
the carrying amount of an asset may not be recoverable. Impairment
exists when the carrying value of the assets is greater than the
future undiscounted cash flows expected to be provided by the asset.
The amount of impairment loss, if any, which is in excess of net
carrying value over fair value, is charged to income for the period.
Fair value is generally measured equal to the estimated future
discounted net cash from the asset.
(m) Deferred revenue
Sales of rights and licences related to projects in progress are
recorded as deferred revenue until revenue recognition parameters
have been met.
(n) Deferred charges
Deferred financing fees are being amortized using the straight-line
method over a five year period.
(o) Recent Accounting Pronouncements
(i) In May 2005, the FASB issued SFAS No. 154, "Accounting
Changes and Error Corrections" ("SFAS No. 154), which is
providing guidance on the accounting for, and reporting
of, accounting changes and error corrections. This
Statement replaces APB Opinion No. 20, Accounting
Changes, and FASB Statement No. 3, Reporting Accounting
Changes in Interim Financial Statements, and changes the
requirements for the accounting for and reporting of a
change in accounting principle. This Statement applies
to all voluntary changes in accounting principle. It
also applies to changes required by an accounting
pronouncement in the unusual instance that the
pronouncement does not include specific transition
provisions. When a pronouncement includes specific
transition provisions, those provisions should be
followed. The provisions of SFAS 154 is effective for
accounting changes and corrections of error made in the
period beginning after December 31, 2005. We do not
expect the adoption of SFAS 154 to have a material
impact on our financial position or results of
operations
63
DEVINE ENTERTAINMENT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2005 AND 2004
(expressed in Canadian dollars)
(o) Recent Accounting Pronouncements (Continued)
(ii) Effective December 1, 2004, the Company was required to
adopt the Canadian Institute of Chartered accountants'
(CICA) Accounting Guideline 15(AcG-15), "Consolidation
of Variable Interest Entities" ("VIE"). AcG-15 provides
guidance that addresses when a company should
consolidate in its financial statements the assets,
liabilities and operating results of another entity.
Under previous guidance, a company generally included
another entity in its consolidated financial statements
only if controlled the entity through a controlling
voting interest. AcG-15 requires a VIE to be
consolidated by the company if that company is the
primary beneficiary of that entity. In January 2003, the
FASB issued Interpretation No. ("FIN") 46,
"Consolidation of Variable Interest Entities", which is
effective for financial statements of public companies
that have special purpose entities for periods ending
after December 15, 2003 and for public companies without
special purpose entities for periods ending after March
15, 2004. Accordingly, the Company has included the
results of operations of the Devine Entertainment
Limited Partnership (Note 13) in its consolidated
operations.
(iv) In January 2005, the CICA issued Handbook Section 3855,
"Financial Instruments - Recognition and Measurement".
The section prescribes when a financial instrument is to
be recognized on the balance sheet and at what amount.
It also specifies how financial instrument gains and
losses are to be presented. This new standard will be
effective for interim and annual financial statements
relating to fiscal years commencing on or after October
1, 2006. The Company is assessing the impact of this new
standard on its consolidated financial statements.
(v) In January 2005, the CICA issued Handbook Section 3865,
"Hedges". The Section provides alternative treatments to
Section 3855 for entities which choose to designate
qualifying transactions as hedges for accounting
purposes. It replaces and expands on Accounting
Guideline AcG-13 "Hedging Relationships", and the
hedging guidance in Section 1650 "Foreign Currency
Translation" by specifying how hedge accounting is
applied and what disclosures are necessary when it is
applied. This new standard will be effective for interim
and annual financial statements relating to fiscal years
commencing on or after October 1, 2006. The Company is
assessing the impact of this new standard on its
consolidated financial statements.
64
DEVINE ENTERTAINMENT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2005 AND 2004
(expressed in Canadian dollars)
(o) Recent Accounting Pronouncements (Continued)
(vi) In January 2005, the CICA issued Handbook Section 1530,
"Comprehensive Income". The section introduces a new
requirement to temporarily present certain gains and
losses from changes in fair value outside net income,
but in a transparent manner. This new standard will be
effective for interim and annual financial statements
relating to fiscal years commencing on or after October
1, 2006. The Company is assessing the impact of this new
standard on its consolidated financial statements.
3. FILM TAX CREDITS RECEIVABLE
Tax credits receivable are federal and provincial refundable tax credits
related to specific film productions in Canada. Amounts recorded represent
management's best estimate of the amounts recoverable; however all amounts
are subject to final determination by the relevant tax authorities. As at
December 31, 2004, the Company had received a partial refund of $1,555,033
from the federal and provincial government. The provincial government has
fully completed their review of the tax credit and a balance amounting to
$323,097 was received during the year ended December 31, 2005.
4. ADVANCES RECEIVABLE
Advances to an unrelated company bears interest at 6.5% per annum and are
due December 16, 2014. Note 18 (a).
5. INVESTMENT IN FILM, TELEVISION PROGRAMS AND RECORDINGS
Annually, management reviews the estimate of total remaining ultimate
revenue and the fair value of the capitalized film costs. As a result of
the review, the Company reduced the carrying value of its completed film,
television programs and recordings by $NIL (2004 - $1,000,000).
65
DEVINE ENTERTAINMENT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2005 AND 2004
(expressed in Canadian dollars)
5. INVESTMENT IN FILM, TELEVISION PROGRAMS AND RECORDINGS (Continued)
The Company expects to amortize approximately $770,000 for completed
television programs and recordings costs and $353,000 for completed motion
picture costs during the next fiscal year.
The Company expects 100% of completed television programs and recordings
and 70% of completed motion picture costs will be amortized by December
31, 2008.
As at December 2011 over 80% of the completed motion picture costs will be
amortized.
The remaining period of amortization for the completed projects ranges
from one to eight years at December 31, 2005.
6. PROPERTY AND EQUIPMENT
2005 2004
---- ----
Accumulated
Cost Amortization Net Net
---- ------------ --- ---
Computer and editing equipment $177,922 $160,112 $17,810 $24,284
Furniture and fixtures 58,193 52,131 6,062 7,443
-------- -------- ------- -------
$236,115 $212,243 $23,872 $31,727
======== ======== ======= =======
66
DEVINE ENTERTAINMENT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2005 AND 2004
(expressed in Canadian dollars)
7. BANK FILM PRODUCTION LOAN
Term loan bearing interest at a fluctuating 2005 2004
per annum rate equal to 1.25% plus the Base ---- ----
Rate of the Comerica Bank, repayable on
November 30, 2004, secured by a general
security agreement against all the assets of
one of the 100% owned subsidiaries of Devine
Entertainment Corporation. On December 10,
2004 the loan was extended to April 4, 2005.
This loan was used for the financing of the $ -- $ 919,664
motion picture "Bailey's Billion$". The loan ========== ===========
was repaid on May 24, 2005.
Interest on the above term loan and other term loans in 2004 totalled
$18,423 (2004 - $63,313).
8. CONVERTIBLE DEBENTURES
Principal 2005 2004
--------- ---- ----
Issued
- February 1996 (i) $ 75,000 $ 75,000
- December 2000 (ii) 550,000 550,000
- December 2000 (iii) 835,800 835,800
- Capitalized interest (iv) 240,000 240,000
----------- ------------
1,700,800 1,700,800
Less - equity component (181,510) (181,510)
----------- ------------
$ 1,519,290 $ 1,519,290
=========== ============
(i) The Company issued a 7.5% $100,000 redeemable
convertible subordinated debenture in February 1996.
This debenture was to mature on December 31, 2000. The
debenture was convertible at the holder's option into
common shares at any time prior to maturity at a
conversion rate of $1.50 per share.
Management renegotiated repayment terms of this
debenture at an increased interest rate of 10%. The
principal was re-payable in four quarterly payments
during 2001 of $25,000 plus interest. The first
instalment was made in April 2001. The Company is still
in default on the second, third and fourth instalments.
As at December 31, 2005, there remains an outstanding
balance of $75,000 plus $37,500 (December 31, 2004 -
$30,000) in accrued interest on this debenture. As a
result of the default, the debenture is classified as a
current liability on the balance sheet. Management is in
constant communication with the debenture
67
DEVINE ENTERTAINMENT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2005 AND 2004
(expressed in Canadian dollars)
8. CONVERTIBLE DEBENTURES (Continued)
holders and expects that the Company will be able to
settle the debentures in the normal course of
operations.
(ii) The Company issued 550,000 units of debentures and
warrants in December 2000 for $550,000 less costs of
$85,000 for net proceeds to the Company of $465,000.
Each unit consists of a $1.00 debenture and 1
immediately separable warrant. The redeemable
convertible subordinated debentures matured on December
31, 2005, bear interest at 10.5% per annum, and are
payable semi-annually. The debentures are convertible at
the holders' option into common shares at any time prior
to maturity on the basis of one common share per $0.50
principal amount of debenture. The debentures are
subordinated to certain senior indebtedness of the
Company. As at December 31, 2005 the Company is in
default of an outstanding balance of $165,463 (December
31, 2004 - $107,713) in accrued interest on these
debentures. As a result of the default, the debenture is
classified as current liability on the balance sheet.
Management is in constant communication with the
debenture holders and expects that the Company will be
able to settle the debentures in the normal course of
operations.
(iii) On December 19, 2000, the Company obtained the approval
of the holders of the 7.5% debentures issued December,
1995 to: (i) extend the maturity date to December 31,
2002; (ii) reduce the conversion rate to $0.50 per
common share; (iii) increase the rate of interest
applicable to 10.5% per annum; (iv) issue to the holders
of the debentures one warrant for each $1.00 principal
amount held by such holder; and (v) to secure the 7.5%
debentures by way of a floating charge over all of the
Company's assets, such floating charge to be
subordinated to all existing and future "Senior
Indebtedness" and "Permitted Encumbrances" and to rank
pari passu with identical security to be granted to
holders of up to $1,000,000 principal amount of
convertible debentures issued by the Company on December
21, 2000. The Company is in default on the repayment of
the debentures. As at December 31, 2005, there remains
an outstanding balance of $249,328 (December 31, 2004 -
$161,569) in accrued interest on these debentures. As a
result of the default, the debenture is classified as a
current liability on the balance sheet. Management is in
constant communication with the debenture holders and
expects that the Company will be able to settle the
debentures in the normal course of operations.
(iv) As part of the settlement of the long-term debt the
Company has granted the same conversion privileges to
$240,000 portion of the interest accrued on the
debentures described in notes 8(ii) and 8(iii) and as on
the related debentures. As at December 31, 2005 there is
an outstanding amount of $37,800 (December 31, 2004 -
$12,600) in accrued interest. As a result of the
default, the debenture is classified as current
liability on the balance sheet. Management is in
constant communication with the debenture holders and
expects that the Company will be able to settle the
debentures in the normal course of operations.
68
DEVINE ENTERTAINMENT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2005 AND 2004
(expressed in Canadian dollars)
9. INTEREST EXPENSE (RECOVERED) 2005 2004
---------- ----------
Interest on convertible debentures $ 214,332 $ 215,547
Bank film production loan 18,629 63,313
---------- ----------
232,961 278,860
Interest income (39,208) (20,562)
Adjustment to prior period estimates -- (164,076)
---------- ----------
193,753 94,222
Less: amounts capitalized to projects (142,921) (124,593)
---------- ----------
$ 50,832 $ (30,371)
========== ===========
10. GAIN ON SETTLEMENT OF DEBT
During the year ended December 31, 2004, the Company settled certain bank
film production loans which resulted in an overall gain of $4,039,825.
(a) The following table sets forth reconciliation between prescribed tax
rates and the effective tax rate for the Company's total income
expense in each of the years presented in the consolidated financial
statements.
69
DEVINE ENTERTAINMENT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2005 AND 2004
(expressed in Canadian dollars)
11. INCOME TAXES (Continued)
2005 2004
---- ----
Income tax (recovery) based on combined
Statutory income tax rates $ (85,000) $ 1,442,000
Expenses renounced to Variable Interest Entities 491,000 305,500
Non-deductible items -- 17,356
Recognition of tax benefits as a result of
utilization of tax loss carryforward (406,000) (2,070,500)
--------- ----------
$ -- $ (305,644)
========= ===========
(b) Future tax assets
2005 2004
---- ----
Net operating loss carryforward $ 2,805,000 $ 3,300,000
Investment in film, television programs
and recordings 295,000 120,000
----------- -----------
3,100,000 3,420,000
----------- -----------
Valuation allowance (3,100,000) (3,420,000)
----------- -----------
Net Future Tax Assets $ -- $ --
=========== ===========
In assessing the realizability of future assets, management considers
whether it is more likely than not that some portion or all of the future
tax assets will not be realized. The ultimate realization of future tax
assets is dependent upon the generation of future taxable income during
the periods in which those temporary differences become deductible.
The valuation allowance was provided against the net future tax assets at
December 31, 2005 and 2004 due to uncertainties as to their ultimate
realization.
70
DEVINE ENTERTAINMENT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2005 AND 2004
(expressed in Canadian dollars)
Fair values approximate amounts at which financial instruments could be
exchanged between willing parties, based on current markets for
instruments of the same risk, principal and remaining maturities. Fair
values are based on estimates using valuation techniques, which are
significantly affected by the assumptions used concerning the amount and
timing of estimated future cash flows, which reflect varying degrees of
risk.
Therefore, due to the use of subjective judgement and uncertainties, the
aggregate fair value amount should not be interpreted as being realizable
in an immediate settlement of the instruments.
(i) Fair Value
The carrying values of cash, accounts receivable, film tax credits
receivable, bank loans, convertible debenture issued in February
1996 (Note 8(i) and accounts payable and accrued liabilities
approximate fair value due to their short-term maturity and normal
credit terms.
The carrying value of Advances Receivable approximates their fair
value because the interest rate is at market rate.
The fair value of the convertible debentures issued in December 2000
has been estimated by first calculating the present value of the
liability component using a discount factor and then assigning to
the equity component the difference between the proceeds of the
debenture and the fair value of the liability component. The
estimated discount factor used approximated the market interest
rates at December 31, 2005 and 2004. Accordingly, the carrying
amounts of the convertible debentures approximate fair value.
71
DEVINE ENTERTAINMENT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2005 AND 2004
(expressed in Canadian dollars)
12. FINANCIAL INSTRUMENTS (Continued)
(ii) Credit Risk
The Company's accounts receivable are subject to credit risk. The
Company continually monitors its positions with and credit quality
of the organizations, which are counterpart to its accounts
receivable and does not anticipate non-performance. The majority of
the accounts receivable are amounts due from sales of foreign
distribution rights and a limited number of licenses and
distributors of video cassettes and DVDs.
(iii) Currency Risk
The Company is subject to currency risk through its activities in
the United States and other countries. Unfavourable changes in the
exchange rate may affect the operating results of the Company.
The Company does not actively use derivative instruments to reduce
its exposure to foreign currency risk. However, dependent on the
nature, amount and timing of foreign currency receipts and payments,
the Company may enter into forward exchange contracts to mitigate
the associated risks. On the Comerica bank loan there was a hedged
rate of 1.3158 in which the Company's Canadian repayments were
exchanged at. There were no forward exchange contracts outstanding
at December 31, 2005 and 2004.
13. COMMITMENTS AND CONTINGENCIES
(a) In February 2004, the Company renewed the lease for its premises.
The agreement expires May 31, 2009. Minimum annual rent commitments
excluding occupancy costs are as follows:
(b) The Company has employment agreements with various principal
officers and employees. The agreements provide for minimum salary
levels.
(c) The Company has entered into contractual agreements for creative
talent related to future film production.
(d) The purchasers of the copyright interest are entitled to a priority
distribution of the future revenue earned from the motion picture
"Bailey's Billion$" up to the original amount of the purchase price
of $2,477,500 up to 42%. Subsequent to the priority distribution,
all the amounts would be distributed pari passu in accordance with
the percentage ownership acquired.
72
DEVINE ENTERTAINMENT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2005 AND 2004
(expressed in Canadian dollars)
13. COMMITMENTS AND CONTINGENCIES (Continued)
(e) The distributors of the film are entitled to a priority distribution
of the future revenue earned from the motion picture "Bailey's
Billion$" up to the original amount of the purchase price in the
amount of $2,908,971. Subsequent to the priority distribution, all
the amounts would be distributed in accordance with the contractual
agreements.
(f) In the normal course of operations the Company is involved in
negotiations, grievances and arbitrations with guilds and unions
related to the film production industry. Management estimates that
the grievances will not result in any future material financial
obligation. No amount has been recorded in the consolidated
financial statements with regard to this matter.
14. CAPITAL STOCK
(a) Authorized
An unlimited number of common shares and Class "A" shares
494,550 of Series 1 preferred shares.
(b) Issued - common shares Number $ Amount
---------- ---------
Balance, December 31, 2003 14,261,838 9,393,316
Common shares issued 17,989,170 1,815,571
---------- ---------
Balance, December 31, 2004 32,251,008 11,208,887
Common shares issued for services rendered 80,000 18,400
Common shares issued on conversion
of warrants 2,547,500 423,260
Common shares issued for settlement
of payables 350,000 78,748
Common shares issued on exercise
of stock options 125,000 16,250
---------- ---------
Balance, December 31, 2005 35,353,508 11,745,545
========== ==========
73
DEVINE ENTERTAINMENT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2005 AND 2004
(expressed in Canadian dollars)
14. CAPITAL STOCK (Continued)
(i) In January 2005, the Company issued 80,000 common shares for
services rendered, valued at $18,400.
(ii) In February 2005, the Company issued 125,000 common shares to
employees who exercised their stock options, for cash
consideration of $12,500.
(iii) On or before April 7, 2005, 2,547,500 warrants were exercised
at a price of $0.15 per unit for cash consideration of
$382,125.
(iv) In May of 2005, the Company issued 350,000 common shares to
settle accounts payable for professional fees in the amount of
$78,748
(v) On June 30, 2004, the Company issued 1,100,000 units, each
unit consisting of 1 common share, 0.4545 a series A warrant
and 1/3 of a series B warrant at $0.20 per unit.
(vi) Each whole series A warrant is exercisable at any time until
June 30, 2006 into one common share at an exercise price
ranging from $0.15 to $0.20 per common share, depending on
trading price of shares.
(vii) Each whole series B warrant shall be automatically exercised
on December 31, 2004 into one common share for no additional
consideration, but shall expire unexercised if the volume
weighted average trading price of the common share is equal to
or greater than $0.50 per share during a period of ten
consecutive trading days ending prior to December 31, 2004.
These series B warrants were converted into 366,666 common
shares on December 31, 2004, since the volume weighted average
trading price of the common share was less than $0.50 per
shares during the period of ten consecutive trading days
ending prior to December 31, 2004.
(viii) On April 7, 2004, the Company issued 5,160,000 units, each
consisting of one common share and one-half purchase warrant
at $0.10 per unit. Corporations controlled by certain officers
subscribed for 1,000,000 of the above units.
(ix) Each warrant is exercisable, at any time prior to April 7,
2005, to acquire one common share and one common share
purchase warrant (a "step-up warrant") at an exercise price of
$0.15 per unit. Each step-up warrant will be exercisable, at
any time on or prior to April 7, 2006, to acquire a common
share at an exercise price of $0.30.
74
DEVINE ENTERTAINMENT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2005 AND 2004
(expressed in Canadian dollars)
14. CAPITAL STOCK (Continued)
(x) On June 29, 2004, the Company issued 2,042,054 common shares,
valued at $204,206 on the settlement of long-term debt (Note
10(b)).
(xi) On April 5, 2004, the Company issued 100,000 common shares,
valued at $10,000 as part of settlement of bank loans (Note
9).
(xii) On May 26, 2004 the Company issued 100,000 common shares for
cash consideration of $10,000.
(xiii) On September 2004, the advances, of $471,708, from
corporations controlled by certain officers were settled by an
issuance of 4,717,082 common shares of the Company at $0.10
per share.
(xiv) During the year the Company settled accounts payable and
accrued liabilities for 4,022,918 common shares for prices
ranging from $0.10 per share to $0.22 per share.
(c) Issued - Series 1 preferred shares Number $ Amount
------- --------
Balance, December 31, 2004 and December 31, 2005 494,550 494,550
======= =======
The Series 1 preferred shares are non-voting, cumulative,
non-participating, $1 redeemable and retractable The shares pay dividends
at the rate of 9.1% per annum payable in annual instalments on the 15th
day of December in each year and shall accrue and be cumulative from the
date of issue. During the year the Company paid dividends totalling
$45,004. As of December 31, 2005 and 2004 dividends in arrears amounted to
$123.
(d) Stock Option Plan
Under the terms of a stock option plan approved by the shareholders, the
Company is authorized to grant directors, officers, employees and others
options to purchase common shares at prices based on the market price of
shares as determined on the date of grant.
75
DEVINE ENTERTAINMENT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2005 AND 2004
(expressed in Canadian dollars)
14. CAPITAL STOCK (Continued)
(c) Stock Option Plan (Continued)
The outstanding and exercisable stock options are as follows:
Weighted
Average
Number Allocated Exercise
Outstanding and Exercisable of Options Value Price
---------------------------------------------------------------------------------------------------------
Balance, December 31, 2003 1,927,000 -- 0.41
Issued 3,440,000 99,850 0.10
Expired (570,000) -- 0.50
Cancelled (1,357,000) -- 0.37
--------- ------ ----
Balance, December 31, 2004 3,440,000 99,850 0.10
Exercised (125,000) (3,750) 0.10
Expired (135,000) -- 0.15
--------- ------ ----
Balance, December 31, 2005 3,180,000 96,100 0.10
========= ====== ====
On June 25, 2004 the Company granted stock options as follows:
Number Exercise Outstanding and Weighted Average
Expiry Date Grant Date of Options Price Exercisable Remaining Life
---------------------------------------------------------------------------------------------------------
June 25, 2005 June 25, 2004 135,000 0.10 -- --
June 25, 2006 June 25, 2004 180,000 0.10 180,000 0.50
June 25, 2009 June 25, 2004 3,125,000 0.10 3,000,000 3.50
--------- --------- ----
3,440,000 3,180,000 3.34
========= ========= ====
The Company has recorded the fair value of options using the
Black-Scholes options pricing model with the following assumptions.
Issue date June 25, 2004 June 25, 2004 June 25, 2004
Number of options 3,125,000 180,000 135,000
Expected life 5 years 2 years 1 year
Price volatility 50% 50% 50%
Dividend yield -- -- --
Risk-free interest rate of return 5% 5% 5%
Amount recorded $93,750 $6,000 $100
The Company did not grant any options during the year ended December
31, 2005.
76
DEVINE ENTERTAINMENT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2005 AND 2004
(expressed in Canadian dollar)
14. CAPITAL STOCK (Continued)
(e) Warrants
Common shares have been reserved for warrants on the following
basis:
Outstanding and Exercisable of Warrants Value Price
----------------------------------------------------------------------------------------------------
Balance, December 31, 2003 550,000 -- 0.50
Issued on private placement 499,950 44,000 0.15 - 0.20
Issued on private placement 366,666 55,000 --
Issued pursuant to debt settlement 1,830,000 18,300 0.50
Issued on private placement 2,580,000 51,600 0.15
Converted to common shares (366,666) (55,000) --
--------- ------ ------------
Balance, December 31, 2004 5,459,950 113,900 0.37
Converted to common shares (2,547,500) (50,950) 0.15
Issuance of step up warrants 2,547,500 10,190 0.30
Expired (582,500) -- 0.48
--------- ------ ------------
Balance, December 31, 2005 4,877,450 73,140 $ 0.36
========= ====== ============
The Company has granted warrants as follows:
Number Exercise Outstanding Weighted Average
Expiry Date Grant Date of Warrants Price and Exercisable Remaining Life
--------------------------------------------------------------------------------------------------------------------------
April 7, 2005 April 7, 2004 2,580,000 0.15 -- --
December 31, 2005 December 31, 2000 550,000 0.50 -- --
September 26, 2006 June 30, 2004 499,950 0.15 - 0.20 499,950 0.72
February 26, 2007 June 30, 2004 1,830,000 0.50 1,830,000 0.27
April 7, 2006 April 7, 2005 2,547,500 0.30 2,547,500 1.17
--------- --------- ----
8,007,450 4,877,450 0.65
========= ========= ====
The Company has recorded the fair value of warrants using the
Black-Scholes options pricing model with the following assumptions.
Grant date April 7, 2004 June 30, 2004 June 30, 2004
Number of warrants 2,580,000 1,830,000 (i) 866,616
Expected life 1 year 2.67 years 2 years
Price volatility 40% 60% 50%
Dividend yield -- -- --
Risk-free interest rate of return 5% 5% 5%
Amount recorded $51,600 $18,300 $99,000
(i) Of the 866,616 warrants issued 366,666 have been converted and 499,950 are
outstanding and exercisable.
77
DEVINE ENTERTAINMENT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2005 AND 2004
(expressed in Canadian dollars)
14. CAPITAL STOCK (Continued)
(e) Warrants (Continued)
The Company granted 2,547,500 step up warrants on April 7, 2005 to
holders of previously issued warrants upon conversion to common
shares.
The Company has recorded the fair value of warrants using the
Black-Scholes options pricing model with the following assumptions.
Grant date April 7, 2005
Number of warrants 2,547,500
Expected life 1 year
Price volatility 30%
Dividend yield --
Risk-free interest rate of return 5%
Amount recorded $10,190
15. EARNINGS PER COMMON SHARE
(a) Basic: Earnings per share are calculated using the weighted average
number of shares outstanding during each of the years presented in
the consolidated financial statements. The following table sets
forth the weighted average number of common shares outstanding for
each of those years.
Year Outstanding
---- -----------
2004 32,251,008
2005 (Note 14) 35,353,508
2005 2004
Numerator: ------------ ------------
----------
Net income (loss) as reported for basic EPS $ (233,409) $ 4,298,917
Less: Preferred share dividends paid and in arrears (45,004) 123
------------ ------------
Net Income (Loss) $ (278,413) $ 4,298,794
------------ ------------
Denominator:
------------
Weighted average shares for basic EPS 34,649,419 19,223,507
============ ============
Basic diluted Income (loss) per share $ (0.01) $ 0.22
------------ ------------
78
DEVINE ENTERTAINMENT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2005 AND 2004
(expressed in Canadian dollars)
15. EARNINGS PER COMMON SHARE (Continued)
(b) Fully Diluted: The Company follows CICA Handbook Section 3500,
"Earnings per Share", effective January 31, 2003. The statement
requires the presentation of both basic and diluted earnings (loss)
per share ("EPS") in the statement of operations, using the
"treasury stock" method to compute the dilutive effect of stock
options and warrants and the "if converted" method for the dilutive
effect of convertible instruments. For the years ended December 31,
2005 and 2004 the assumed exercise of outstanding stock options and
warrants would have a dilutive effect on EPS. The following table
sets forth the weighted average number of common shares outstanding
for the computation of dilutive EPS for each of the years presented
in the consolidated financial statements.
2005 2004
------------- ------------
Numerator:
----------
Net income (loss) as reported for basic EPS $ (233,409) $ 4,298,917
Less: Preferred share dividends paid and in arrears (45,004) 123
------------ ------------
Net Income (loss) $ (278,413) $ 4,298,794
------------ ------------
Denominator:
------------
Weighted average shares for basic EPS 34,649,419 19,223,507
Effect of dilutive securities:
Stock options -- 141,860
Warrants -- --
------------ ------------
Adjusted weighted average shares and assumed
conversions for dilutive EPS 34,649,419 19,365,367
============ ============
Fully diluted income (loss) per share $ (0.01) $ 0.22
============ ============
(c) Anti-dilutive: Options to purchase 3,180,000 and nil common shares
and warrants of 4,877,450 and 5,459,950 for the years ended December
31, 2005 and 2004, respectively, were not included in the
computation of diluted earnings per share because of the loss
position in 2005 and the option and warrant exercise prices were
greater than the average market price of the common shares in 2004.
16. CONTRIBUTED SURPLUS
Balance, December 31, 2004 $ 1,051,886
Less: Stock Options exercised (3,750)
Less: Warrants converted into common shares (50,950)
Add: Step up warrants issued 10,190
-----------
$ 1,007,376
79
DEVINE ENTERTAINMENT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2005 AND 2004
(expressed in Canadian dollars)
16. CONTRIBUTED SURPLUS (Continued) 2005 2004
----------- -----------
Settlement of debt instruments $ 656,626 $ 656,626
Equity portion of long-term debt 181,510 181,510
Stock Options(Note 14(d)) 96,100 99,850
Warrants (Note 14(e)) 73,140 113,900
----------- -----------
$ 1,007,376 $ 1,051,886
=========== ===========
(a) On September 30, 2004, amounts due to corporations controlled by
certain officers, in the amount of $280,325, were settled for
282,918 common shares of the Company at $0.10 per share. The $0.10
per share cost was determined by using the trading value of the
shares as of the date of issuance. A gain of $252,033 was recorded
as contributed surplus.
(b) On September 30, 2004, amounts due to a corporation controlled by
certain officers, in the amount of $119,790, were forgiven for no
compensation. This forgiveness has been recorded as contributed
surplus
17. RELATED PARTY TRANSACTIONS
a. On September 30, 2004, the advances, of $471,708, from corporations
controlled by certain officers were settled by an issuance of
4,717,082 common shares of the Company at $0.10 per share. The $0.10
per share cost was determined by using the trading value of the
shares as of the date of issuance. These advances were non-interest
bearing and due on demand.
b. On September 30, 2004, amounts due to corporations controlled by
certain officers, in the amount of $280,325, were settled for
282,918 common shares of
80
DEVINE ENTERTAINMENT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2005 AND 2004
(expressed in Canadian dollars)
17. RELATED PARTY TRANSACTIONS (Continued)
c. the Company at $0.10 per share. The $0.10 per share cost was
determined by using the trading value of the shares as of the date
of issuance. A gain of $252,033 was recorded as contributed surplus
(Note 16).
d. During the year ended December 31, 2005 $337,417 (2004 - $493,837)
of fees were paid or accrued to corporations controlled by two of
the directors for writing, directing and producing services.
Additionally, $Nil (2004 - $30,000) were paid (by issuance of
300,000 common shares) to the same corporations for bridge financing
provided in connection with Bailey's project. These transactions
have been measured at exchange amount, which is the amount of
consideration established and agreed to by the related parties and
which the management believes reflect prevailing market rates.
Included in accounts payable and accrued liabilities at December 31,
2005 was $32,477 (2004 - $Nil).
e. On September 30, 2004, amounts due to a corporation controlled by
certain officers, in the amount of $119,790, were forgiven for no
compensation. This forgiveness has been recorded as contributed
surplus (Note 16).
f. During the year ended December 31, 2004, corporations controlled by
certain officers subscribed for 1,000,000 units of the Company (Note
14).
In total, during the year ended December 31, 2004, related parties were
issued 6,300,000 common shares of the Company.
18. VARIABLE INTEREST ENTITIES
a) During the year ended December 31, 2004, the Company entered into a
services agreement with Devine Entertainment Limited Partnership ("DELP").
Under the terms of the agreement, the DELP will incur certain expenses,
until December 31, 2004, relating to the following services required in
connection with the conduct of business of the Company:
o Labour, employment and all other "direct" services;
o Marketing services, including production and placement of all
required advertising;
o The incurring of other operating expenses, excluding payments
for the purchase of real property,
o Administrative services
o Certain development services required in connection with new
projects of the business
81
DEVINE ENTERTAINMENT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2005 AND 2004
(expressed in Canadian dollars)
18. VARIABLE INTEREST ENTITIES (Continued)
In return, DELP is entitled to royalty payments equal to 0.8% of gross
revenue of the Company for calendar years from 2004 to 2014, payable 60
days after the completion of each calendar year in connection with the
expenses incurred during such year.
Under the terms of the services agreement, the 2004 DELP advanced $846,350
to the Company for the 2004 services, which was originally accounted for
as royalty interest payable. Included in the $846,350 was $494,550 which
was initially loaned from the Company to an unrelated company (Note 5),
which subsequently loaned these funds to the limited partners.
DELP was also granted the right and option to exchange its rights
(including the 2004 royalties) under the services agreement, at anytime
until December 31, 2004, for 380,450 common shares and 494,550 preferred
shares of the Company.
On December 22, 2004, DELP exercised its right under the services
agreement and the royalty interest payable was reclassified to capital
stock.
b) During the first quarter of 2005, the Company entered into a services
agreement with the QCF 2005 Limited Partnership ("QCF")., which to date
has not been finalized. Under the terms of the agreement, the Partnership
incurred certain expenses, until December 31, 2005, relating to the
following services required in connection with the conduct of business of
the Company.
o Labour, employment and all other "direct services;
o Marketing services, including production and placement of all
required advertising;
o The incurring of other operating expenses, excluding payments
for the purchase of real property,
o Administrative services;
o Certain development services required in connection with new
projects of the business
In return, QCF would be entitled to a royalty equal to a percentage of
gross revenue of the Company in connection with the expenses incurred
during such year.
The accounts of these variable interest entities have been included in
these consolidated financial statements of the Company.
82
DEVINE ENTERTAINMENT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2005 AND 2004
(expressed in Canadian dollars)
18. VARIABLE INTEREST ENTITIES (Continued)
c) In December 2005, The Devine Entertainment Film Library Limited
Partnership ("DEFLLP"), a limited partnership formed and registered under
the Limited Partnerships Act (Ontario) on March 8, 2004, acquired Devine
Entertainment Corporation's interest in a defined part of the Company's
proprietary film library for $6.8 million, as valued by an outside
valuator. The Company has provided financing for the transaction, and has
entered into a financing agreement and will enter into a management
agreement with DEFLLP in order to manage the exploitation and expand the
distribution of the properties. Under these agreements the Company will
receive management fees and interest revenue and the Company will maintain
a call right for between a minimum of 70% and a maximum 100% interest in
the library assets. The accounts of this variable interest entity have
been included in the consolidated financial statements of the Company.
19. CHANGE IN NON-CASH WORKING CAPITAL AND SUPPLEMENTAL INFORMATION
2005 2004
------------ ------------
Accounts receivable $ 612,307 $ (642,017)
Film tax credits receivable 299,097 (299,097)
Inventory (62,127) (26,013)
Prepaid and sundry assets 15,754 125,629
Accounts payable and accrued liabilities 296,840 (164,040)
Deferred revenue (2,658,971) (2,039,750)
------------ ------------
$ (1,497,100) $ (3,045,288)
============= ============
The supplemental cash flow information are as follows: 2005 2004
---- ----
Non-cash transactions
Settlement of long-term debt by share issuance $ -- $204,206
Accrued interest converted to long-term debt principal -- 240,000
Settlement of accounts payable by share issuance 78,748 461,569
Settlement of loans from related parties by
share issuance -- 471,708
83
DEVINE ENTERTAINMENT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2005 AND 2004
(expressed in Canadian dollars)
20. SEGMENTED INFORMATION
The Company is considered to operate in one industry segment, and
generates revenue from film productions and film library. Revenue by
geographic location, based on the location of customers, is as follows:
2005 2004
--------- ---------
$ $
Revenue
Canada 446,000 2,768,000
United States 591,000 326,000
United Kingdom 2,659,000 --
France 99,000 287,000
Europe - Other -- 305,000
Other foreign 225,000 123,000
--------- ---------
4,020,000 3,809,000
========= =========
21. RECONCILIATION TO UNITED STATES GAAP
The consolidated financial statements of the Company have been prepared in
accordance with Canadian GAAP. The material differences between the
accounting policies used by the Company under Canadian GAAP and U.S. GAAP
are disclosed below in accordance with the provisions of the Securities
and Exchange Commission.
(a) Under Canadian GAAP, the conversion feature on the convertible
debentures (Note 8), is valued at $181,510 and had been classified
as contributed surplus. Under U.S. GAAP the conversion feature is
not accounted separately and thus would not flow through contributed
surplus. This transaction occurred in 2000.
(b) Under Canadian GAAP, the exchange of convertible debentures for new
convertible debentures and subsequent gain on settlement of a the
new convertible debentures were valued at $284,803 and had been
classified as contributed surplus. Under U.S. GAAP the conversion
and subsequent settlement is not accounted for through contributed
surplus and would be recorded through the statement of operations
thus reducing the deficit. This transaction occurred in 2000.
(c) Under Canadian GAAP, the Company's preferred shares have been
included in shareholders' equity as the Company considered the
likelihood of redemption by the holders to be remote. Under U.S.
GAAP, the preferred shares would be classified as a liability. In
addition, cumulative dividends are part of the liability for the
shares.
84
DEVINE ENTERTAINMENT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2005 AND 2004
(expressed in Canadian dollars)
21. RECONCILIATION TO UNITED STATES GAAP (Continued)
(d) Financial Accounting Standards Board Statement of Financial
Accounting Standards No. 130 "Reporting Comprehensive Income" (SFAS
130) requires the disclosure of comprehensive income, which includes
reported net earnings adjusted for other comprehensive income. Other
comprehensive income is defined as the change in equity of a
business enterprise during a period from transactions and other
events and circumstances from non-owner sources. During 2005 and
2004, there were no other comprehensive income.
December 31, 2005 CDN GAAP U.S. GAAP
----------------- -------- ---------
Convertible Debentures 1,519,290 1,700,800
Contributed Surplus 1,007,376 541,063
Deficit 8,075,447 7,790,644
Other liabilities 0 494,673
Capital stock 12,240,095 11,745,422
Interest expense 50,832 95,836
December 31, 2004
-----------------
Convertible Debentures 1,519,290 1,700,800
Contributed Surplus 1,051,886 585,573
Deficit 7,797,034 7,512,231
Other liabilities 0 494,673
Capital stock 11,703,437 11,208,764
Interest expense (30,371) (30,248)
Impact of Newly Issued United States Accounting Standards
(ii) Effective January 1, 2006, the Company will adopt a recent
accounting pronouncement of the Financial Accounting Standards
Board ("FASB"), SFAS No. 123R, "Share-Based Payments" ("SFAS
123R"), which requires companies to measure and recognize
compensation expenses for all share based payments at a fair
value. The Company does not expect the adoption of SFAS 123R
to have a material impact on its consolidated financial
statements.
85
DEVINE ENTERTAINMENT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2005 AND 2004
(expressed in Canadian dollars)
21. RECONCILIATION TO UNITED STATES GAAP (Continued)
(ii) In May 2005, the FASB issued SFAS No. 154, "Accounting Changes and
Error Corrections - a replacement of APB Opinion No. 20 and FASB
Statement No. 3." Under SFAS No. 154, changes in accounting
principles will generally be made by the retrospective application
of the new accounting principle to the financial statements of prior
periods unless it is impractical to determine the effect of the
change on prior periods. The reporting of a change in accounting
principle as a cumulative adjustment to net income in the period of
the change, as was previously permitted under APB Opinion No. 20,
will no longer be permitted unless it is impractical to determine
the effect of the change on prior periods. Correction of an error in
the application of accounting principles will continue to be
reported by retroactively restating the affected financial
statements. The provisions of SFAS No. 154 will not apply to new
accounting standards that contain specific transition provisions.
SFAS No. 154 is applicable to accounting changes made in fiscal
years beginning on or after December 15, 2005. The Company does not
expect SFAS No. 154 to have a material effect, if any, on its
consolidated financial statements.
22. COMPARATIVE FIGURES
Certain of the comparative figures have been reclassified to conform with
the current year's presentation.
ITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
ITEM 8A. CONTROLS AND PROCEDURES
The Company's Chief Executive Officer and Chief Financial Officer
(collectively, the "Certifying Officers") are responsible for establishing and
maintaining disclosure controls and procedures for the Company. Such officers
have concluded (based upon their evaluation of these controls and procedures as
of a date within 90 days of filing of this report) that the Company's disclosure
controls and procedures are effective to ensure that information required to be
disclosed by the Company in this report is accumulated and communicated to the
Company's management, including its Certifying Officers as appropriate, to allow
timely decisions regarding required disclosure. The Certifying Officers also
have indicated that there were no significant changes in the Company's internal
controls or other factors that could significantly affect such controls
subsequent
86
to the date of their evaluation, and there were no corrective actions with
regard to significant deficiencies and material weaknesses.
PART III
ITEM 9. DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS,
COMPLIANCE WITH SECTION 16(a) OF THE EXCHANGE ACT
The following table sets forth the names and ages of the members of the Board of
Directors and our executive officers, and sets forth the position with Devine
held by each:
Directors and Executive Officers
Name Age Positions
-----------------------------------------------------------
David Devine 53 Director, Chairman of the Board,
President and Chief Executive
Officer
Richard Mozer (1) 47 Director, Vice-Chairman of the
Board, Chief Financial Officer,
Treasurer and Secretary
Kenneth D. Taylor (2) 70 Director
Bryson Farrill (1) (2) 76 Director
Ron Feddersen (1) (2) 61 Director
(1) Member of the Audit Committee.
(2) Member of the Compensation Committee.
Set forth below are brief biographies of the Company's directors and
officers. Except for Mr. Feddersen, all of the directors and executive officers
of the Company have held their principal occupations indicated below for the
past five years.
87
David Devine, Chairman of the Board, President and Chief Executive Officer
of the Company, is a film and television producer/director with over twenty
years of experience and a co-founder of the Company. Mr. Devine graduated with
an Honours B.A. from Victoria College at the University of Toronto and received
his Masters of Fine Arts in film production from the University of California at
Los Angeles Film School. He has been a director of the Company since 1982.
Richard Mozer, Vice-Chairman of the Board, Chief Financial Officer and
Secretary of the Company, is a film and television producer with over 20 years
of experience and a co-founder of the Company. Mr. Mozer attended Cornell
University and received his Bachelors Masters of Fine Arts in film production
from the University of Southern California Film School. He has been a director
of the Company since 1982.
Kenneth D. Taylor is Chairman of Taylor and Ryan Inc., a public affairs
consulting company, and is currently Chancellor of Victoria University at the
University of Toronto. Mr. Taylor was appointed Chancellor in May 1998. Mr.
Taylor is and has been a director of several private corporations, foundations
and other organizations in Canada and the United States. Mr. Taylor serves as a
director of the following publicly-traded companies: Cenuco Inc., Sivault
Systems Inc., Desert Sun Mining Corp., Hydro One Inc., Rockwater Capital Corp.
and Taylor Gas Liquids Fund. Mr. Taylor was the Canadian Ambassador to Iran from
1977 to 1980. Mr. Taylor is the recipient of a United States Congressional Gold
Medal and is an Officer of the Order of Canada. He has been a director of the
Company since April 1994.
Since 1989, Bryson Farrill has been an independent financial consultant
and businessman, engaged in personal investing activities and advising
businesses with respect to various manufacturing, resource and commodities
ventures. Mr. Farrill has had a long career in the securities industry, and was
formerly Chairman of McLeod, Young, Weir International, an investment dealer in
Toronto, Ontario, Canada from 1974 to 1978. Mr. Farrill was also Chairman of
Scotia McLeod (USA) Inc. from 1978 to 1989. Since 1997, Mr. Farrill has also
served as a director of HomeLife, Inc., a publicly-traded company which provides
a broad range of real estate services. He has been a director of the Company
since April 1994.
Ron Feddersen has been Executive Principal of The Atticus Group Inc., an
interim management services company, since 2003. Prior thereto, Mr. Feddersen
was the President of Flehr Associates Limited, a business consulting company. He
has been a director of the Company since February 2004.
Board of Directors
The Company's Articles of Incorporation, as amended (the "Articles of
Incorporation"), require that the Company's board of directors consist of no
less than
88
three and no more than ten members. The board of directors of the Company
currently consists of five members. Directors serve for terms of one year and
until their successors are duly elected and have qualified. Subject to the
Business Corporations Act (Ontario) (the "OBCA"), the shareholders may, by
ordinary resolution passed at a meeting of shareholders called for such purpose,
remove any director from office before the expiration of his term of office and
the vacancy created by such removal may be filled at the same meeting, failing
which it may be filled by the remaining directors.
The Company's By-Laws, as amended (the "By-Laws"), require that at least
(i) a majority of the directors be Canadian residents and (ii) one-third of the
directors not serve as officers of, or be employed by, the Company.
Committees of the Board of Directors
As a public company, the Company has established an Audit Committee and a
Compensation Committee of the board of directors.
Audit Committee
The Audit Committee consists of Messrs. Mozer, Farrill and Feddersen, and
is responsible for reviewing the Company's financial statements and its internal
controls, reviewing the work of the Company's independent auditors and reporting
thereon to the board of directors. Neither Mr. Farrill nor Mr. Fedderson is or
has ever been an officer or employee of the Company or any of its subsidiaries.
Audit Committee Financial Expect
The board of directors does not currently have any member who is both an
audit committee financial expert as defined by Item 401(h) of Regulations S-K of
the Securities Exchange Act of 1934, as amended, and independent within the
meaning of Item 7(d)(3)(iv) of Schedule 14A of such Act.
Compensation Committee
The Compensation Committee consists of Messrs. Taylor, Farrill and
Feddersen, and is responsible for reviewing the level and form of compensation
payable to the executive officers of the Company, and making recommendations
with respect thereto to the board of directors. The Compensation Committee is
also responsible for making recommendations to the board of directors with
respect to the granting of stock options pursuant to the Option Plan (as such
term is defined in "Executive Compensation"). No member of the Compensation
Committee is or has ever been an officer or employee of the Company or any of
its subsidiaries.
89
Compliance with Section 16(a) of the Exchange Act
Compliance with Section 16(a) ("Section 16(a)") of the Exchange Act
requires our executive officers, directors, and persons who own more than 10% of
our Common Stock (collectively, "Reporting Persons") to file reports of
ownership on Form 3 and changes in ownership on Form 4 or Form 5 with the
Commission. Such Reporting Persons are also required by the Securities and
Exchange Commission rules to furnish us with copies of all Section 16(a) forms
that they file. We believe that during fiscal year 2005, all the Reporting
Persons complied with all applicable filing requirements.
ITEM 10. EXECUTIVE COMPENSATION
The compensation payable to the executive officers of the Company is
established by the Compensation Committee, no member of which is or has ever
been an officer or employee of the Company or any of its subsidiaries. The
Compensation Committee recognizes that the Company's business is largely
dependent on attracting and retaining motivated, skilled and
achievement-oriented personnel. By compensating the Company's executive officers
at levels which, on an annual basis, are commensurate with established industry
standards but expending their salaries to the Company over the entire duration
of a particular production as production, direction, writing and similar
services, the Company's executive compensation program is structured to align
each executive officer's financial interests with the Company's overall
objectives of maximizing and sustaining shareholder value. The Company is able
to achieve this alignment due to its receipt of Canadian federal and provincial
labor tax credits for salaries paid by the Company to its executive officers
when such officers act as a producer or director in connection with qualifying
film and television productions. See "Executive Services Agreement."
90
Summary Compensation Table
The following table sets forth all compensation earned during each of the
last three fiscal years ended December 31, 2005 by the Chief Executive Officer
and the Chief Financial Officer of the Company (collectively, the "Named
Executive Officers"), such individuals being the only executive officers of the
Company whose total annual salary, bonus and other annual compensation exceeded
$100,000 (U.S.).
-----------------------------------------------------------------------------------------------------------
Name and Year Annual Compensation Long Term
Principal Compensation
Position
-----------------------------------------------------------------------------------------------------------
Other Annual Securities Underlying
Salary Bonus Compensation Options (#)
($) ($) ($)(1)
-----------------------------------------------------------------------------------------------------------
David Devine, 2005 ___ ___ 195,150 $ --
Chairman, President 2004 ___ ___ 271,610 1,000,000
& Chief Executive 2003 ___ ___ 356,952 460,000
Officer
-----------------------------------------------------------------------------------------------------------
-----------------------------------------------------------------------------------------------------------
Name and Year Annual Compensation Long Term
Principal Compensation
Position
-----------------------------------------------------------------------------------------------------------
Other Annual Securities Underlying
Salary Bonus Compensation Options (#)
($) ($) ($)(1)
-----------------------------------------------------------------------------------------------------------
Richard Mozer, 2005 ___ ___ 166,170 $ --
Vice-Chairman, 2004 ___ ___ 222,226 1,000,000
Chief Financial 2003 ___ ___ 273,582 460,000
Officer, Treasurer
& Secretary
-----------------------------------------------------------------------------------------------------------
(1) In accordance with the executive services agreement described below under
"Executive Services Agreement," the Company pays fees to a corporation
controlled jointly by Messrs. Devine and Mozer as compensation for writing,
directing and producing services provided to the Company. Messrs.Devine and
Mozer were also issued Common Shares during 2004. See "Certain Relationships and
Material Transactions."
The Company does not have a long-term incentive plan or pension plan and
has never granted stock appreciation rights to any of its directors, officers or
employees.
91
Executive Services Agreement
Since April 1994, the Company has been a party to an executive services
agreement with Messrs. Devine and Mozer, and 1078459 Ontario Inc., a corporation
wholly-owned by Messrs. Devine and Mozer. Under the current executive services
agreement dated as of January 1, 2005, Messrs. Devine and Mozer are required to
provide senior management services to the Company through December 31, 2007.
From time to time, Messrs. Devine and Mozer may participate in production,
direction, writing and similar activities, depending on the needs of the
Company. Under this agreement, the base fee payable to 1078459 Ontario Inc. is
determined by the board of directors of the Company from time to time. 1078459
Ontario Inc. is also entitled to additional fees and/or equity-based incentives
in consideration of the services performed and provided by it, as determined to
be appropriate by the board of directors of the Company in view of any (i) bonus
paid by the Company to its executive officers or (ii) film or video development
and production project undertaken by the Company.
Under the executive services agreement, Messrs. Devine and Mozer are
entitled to participate in any incentive compensation or other employee benefit
plan or program generally maintained at the Company from time to time and
offered to the Company's employees generally or executive officers. The services
of these executives may be terminated by the Company at any time. If the
services of Messrs. Devine and Mozer are terminated without cause (as such term
is defined in the executive services agreement), the Company is required to
continue to pay to 1078459 Ontario Inc. its base fee entitlement until the
expiry of the greater of (i) the remaining term of the agreement or (ii)
eighteen months. The executive services agreement also includes confidentiality
and non-competition provisions.
Option Plan
The board of directors of the Company adopted a stock option plan (the
"Option Plan") on May 13, 2004, which was subsequently ratified by the
stockholders of the Company on June 25, 2004. In connection with the adoption
and ratification of the Option Plan, the Company terminated its then-existing
stock option plan and cancelled all outstanding options issued thereunder.
The Option Plan is for the benefit of employees, officers and directors
and certain consultants of the Company and its subsidiaries and is administered
by the board of directors of the Company. The board of directors may from time
to time designate individuals to whom options to purchase shares of the capital
stock of the Company may be granted and the number of shares to be optioned to
each. The exercise price of options issued under the Option Plan will be fixed
by the board of directors when such options are granted provided that such
exercise price shall not be less than the market price of the shares at the time
the options are granted. The period during which an option is exercisable may
not exceed five years from the date the option is granted and the options may
not be assigned, transferred or pledged, except in limited circumstances
92
as permitted under applicable securities legislation. Subject to any grace
period allowed under the policies of any stock exchange on which the shares are
then listed for trading, the options will expire 60 days following the
termination of the employment or office with the Company or any of its
subsidiaries or death of an individual.
Pursuant to the terms of the Plan: the (i) number of shares reserved for
issuance under options granted to related persons (as such term is defined under
applicable securities legislation) under the Option Plan and any similar plans
may not exceed 10% of the aggregate number of issued and outstanding shares of
the Company; (ii) issuance to related persons, within a 12 month period, of
shares under the 2004 Plan and any similar plans may not exceed 10% of the
aggregate number of issued and outstanding shares of the Company; (iii) number
of shares reserved for issuance under options to acquire shares granted to any
related person under the Option Plan and any similar plans may not exceed 5% of
the aggregate number of issued and outstanding shares of the Company; and (iv)
issuance to any one related person and the related person's associates, within a
12 month period, of shares under the 2004 Plan and any similar plans may not
exceed 5% of the aggregate number of issued and outstanding shares of the
Company.
A total of 4,500,000 Common Shares were reserved for issuance under the
Option Plan. As at March 24, 2006, the number of Common Shares which remain
available for issuance under the Option Plan is 4,250,000, of which 3,180,000
are subject to currently outstanding options.
Option Grants in Last Fiscal Year
The Company did not grant any options to purchase Common Shares to
Executive Officers during the fiscal year ended December 31, 2005.
The following table sets forth information regarding options to purchase
Common Shares granted during the fiscal year ended December 31, 2004 to each of
the Named Executive Officers.
--------------------------------------------------------------------------------------------
Number of % of Total Exercise
Name Securities Options Granted Price/Common Expiration Date
Underlying to Employees in Share)
Options Fiscal Year 2004
Granted (#)
--------------------------------------------------------------------------------------------
David Devine 1,000,000 29.1% $0.10 09.29.09
--------------------------------------------------------------------------------------------
Richard Mozer 1,000,000 29.1% $0.10 09.29.09
--------------------------------------------------------------------------------------------
93
Aggregated Option Exercises in Last Fiscal Year and Fiscal Year-End Option
Values
The Executive Officers of the Company did not exercise options to purchase
Common Shares during the fiscal year ended December 31, 2005.
The following table sets forth information concerning each exercise of
options to purchase Common Shares by the Named Executive Officers during the
fiscal year ended December 31, 2005.
--------------------------------------------------------------------------------------------------------
Name Securities Value Unexercised Value of Unexercised
Acquired on Realized Options at In-the-Money Options at
Exercise (#) December 31, 2005 December 31, 2005
(#)
Exercisable/ Exercisable/
Unexercisable Unexercisable
--------------------------------------------------------------------------------------------------------
David Devine -0- $0 1,000,000 $20,000
--------------------------------------------------------------------------------------------------------
Richard Mozer -0- $0 1,000,000 $20,000
--------------------------------------------------------------------------------------------------------
Compensation of Directors
As of January 1, 2006, Directors of the Company who are not employees, are
paid $1,500 per quarter, payable in common shares of the Company or cash. Prior
to January 1, 2006, Directors did not receive an annual retainer or any other
cash compensation for their services as members of the board of directors of the
Company. Directors of the Company, are entitled to reimbursement for any
expenses incurred for each meeting of the board of directors or of any committee
of the board of directors that they attend.
During 2004, Messrs. Taylor, Farrill and Feddersen were each granted
options under the Option Plan to purchase up to 150,000 Common Shares at a per
share exercise price of $0.10 on or before September 29, 2009.
In April 2005, Mr. Feddersen was granted an option under the Option Plan
to purchase up to 100,000 Common Shares at a per share exercise price of $0.10
on or before April 20, 2010.
The Atticus Group Inc., a company for which Mr. Feddersen serves as
Executive Principal, is party to an interim management and consultancy services
agreement with the Company. See "Certain Relationships and Material
Transactions."
94
Indemnification of Directors
The Company has agreed to indemnify each of its directors to the fullest
extent permitted by the OBCA for all costs, liabilities and expenses incurred by
each director, including legal fees, in respect of claims to which each director
is made a party by reason of being or having been a director of the Company or
any subsidiary thereof, provided such director acted honestly and in good faith
with a view to the best interests of the Company and, in the case of a criminal
or administrative proceeding enforced by monetary penalty, such director had
reasonable grounds for believing that his conduct was lawful.
Directors' and Officers' Liability Insurance
The Company maintains insurance for the benefit of its directors and
officers against liability in their respective capacities as directors and
officers. The annual premium payable by the Company in respect of such insurance
is $22,572 (inclusive of applicable taxes) and the total amount of insurance
purchased for the directors and officers as a group is $1,000,000. The directors
and officers are not required to pay any premium in respect of the insurance.
The Company is liable to the extent of $50,000 per claim under the deductibility
provisions of the policy.
ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The following table sets forth, as at February 1, 2006, certain
information as to (i) each person, who to the knowledge of the Company, is the
beneficial owner of more than five percent (5%) of any class of the Company's
voting securities and (ii) each class of equity securities of the Company or any
of its subsidiaries (other than directors qualifying shares) beneficially owned
by (A) each director of the Company and the Named Executive Officers (as such
term is defined in "Executive Compensation") and (B) all directors and executive
officers of the Company as a group.
Title of Class - Common Shares
Amount and
Name and Address of Nature of Beneficial
Beneficial Owner(1) Ownership Percent of Class
-------------------- -------------------- ----------------
Forvest Trust S.A. 3,570,000(2) 9.7%
6, Place Chevelu
1211 Geneva 1
Switzerland
David Devine 6,920,545(3) 19.1%
Richard Mozer 6,433,945(4) 17.7%
95
Kenneth D. Taylor 150,000(5) Less than 1%
Bryson Farrill 160,000(6) Less than 1%
Ron Feddersen 250,000(7) Less than 1%
All directors and executive 13,905,490 36.4%
officers (5 individuals)
The following table sets forth certain information with respect to the
directors and executive officers of Devine Entertainment.
(1) The address for each beneficial owner listed in the table, other than
Forvest Trust S.A., is c/o Devine Entertainment Corporation, Suite 504, 2
Berkeley Street, Toronto, Ontario, Canada M5A 2W3.
(2) Includes warrant to purchase 50,000 Common Shares and warrant to purchase
1,830,000 Common Shares. See "Description of Securities -- 10.5% Debentures and
10.5% Debenture Warrants" and "Recent Sales of Unregistered Securities."
(3) Includes option to purchase 1,000,000 Common Shares and warrant to purchase
250,000 Common Shares. See "Executive Compensation -- Option Grants in Last
Fiscal Year" and "Certain Relationships and Material Transactions."
(4) Includes option to purchase 1,000,000 Common Shares and warrant to purchase
250,000 Common Shares. See "Executive Compensation -- Option Grants in Last
Fiscal Year" and "Certain Relationships and Material Transactions."
(5) Includes option to purchase 150,000 Common Shares. See "Executive
Compensation -- Compensation of Directors."
(6) Includes option to purchase 150,000 Common Shares. See "Executive
Compensation -- Compensation of Directors."
(7) Includes option to purchase 250,000 Common Shares. See "Executive
Compensation -- Compensation of Directors."
96
ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The Company has entered into an executive services agreement dated as of
January 1, 2005 with Messrs. Devine and Mozer, and 1078459 Ontario Inc., a
corporation wholly-owned by Messrs. Devine and Mozer. Under this agreement,
Messrs. Devine and Mozer are required to provide services to the Company. See
"Executive Compensation -- Executive Services Agreement."
Effective April 7, 2004, the Company sold 5,160,000 units at a price of
$0.10 per unit for aggregate gross proceeds of $516,000. Each unit consisted of
(i) one Common Share and (ii) one-half Common Share purchase warrant. In order
to facilitate the sale of the aforesaid units, Messrs. Devine and Mozer, each of
whom is a director and an executive officer of the Company, sold an aggregate of
554,000 Common Shares at a price of $0.10 per and used the proceeds of such
sale, in part, to purchase 500,000 such units. See "Recent Sales of Unregistered
Securities."
During the third quarter of 2004, the Company completed settlements of
past debt, previously agreed to production financing fees and fees for services
from financial advisors, with the issuance of a total of 8,740,000 Common Shares
at $933,271. As a result, approximately $1.4 million of the Company's payables,
accrued liabilities and current expenses were settled. The settlements included
the issuance of 6,000,000 Common Shares to David Devine and Richard Mozer, each
a director and executive officer of the Company, to satisfy previous loans to
the Company and unpaid fees for services from 2001 through the end of the third
quarter of 2004.
During 2004, the Company issued 150,000 Common Shares to each of Messrs.
Devine and Mozer in consideration for the provision of bridge financing. See
"Recent Sales of Unregistered Securities."
Mr. Feddersen, a director of the Company, is the principal interim manager
under an interim management and consultancy services agreement between the
Company and The Atticus Group Inc. The Atticus Group Inc. is paid a fee of $560
per month for Mr. Feddersen's services under such agreement. Mr. Feddersen
serves as Executive Principal for the Atticus Group Inc.
97
ITEM 13. EXHIBITS AND REPORTS ON FORM 8-K
a.) Exhibits
--------------------------------------------------------------------------------
Sequential Page
Exhibit No. Description of Exhibit Number
--------------------------------------------------------------------------------
--------------------------------------------------------------------------------
3.1 Articles of Incorporation of the Company, **
as amended
--------------------------------------------------------------------------------
--------------------------------------------------------------------------------
3.2 By-Laws of the Company *
--------------------------------------------------------------------------------
--------------------------------------------------------------------------------
4.1 Specimen Form of Common Share Certificate **
--------------------------------------------------------------------------------
--------------------------------------------------------------------------------
10.1 Option Plan of the Company *
--------------------------------------------------------------------------------
--------------------------------------------------------------------------------
10.2 Executive Services Contract dated as of
January 1, 2005 among 1078459 Ontario Inc.,
the Company, David B. Devine and Richard Mozer **
--------------------------------------------------------------------------------
--------------------------------------------------------------------------------
21.1 Subsidiaries of the Company **
--------------------------------------------------------------------------------
--------------------------------------------------------------------------------
99.1 Form F-X of the Company *
--------------------------------------------------------------------------------
* Incorporated by reference to the exhibit of the same number filed with the
Registration Statement on Form 10-SB of the Company dated February 16,
2005.
** Incorporated by reference to the exhibit of the same number filed with
Amendment No. 1 to the Registration Statement on Form 10-SB of the Company
dated May 26, 2005.
98
b.) Reports on Form 8-K
No reports were filed on Form 8-K during the last quarter of the fiscal
year.
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES
Summary of Kraft, Berger, Grill, Schwartz, Cohen and March LLP, Chartered
Accountants for Professional Services Rendered
Years Ended December 31,
------------------------
2005 2004
--------- ------
Audit Fees (1) $129,300 63,500
Audit-Related Fees 2,940 16,500
Tax Fees -- 8,000
All Other Fees
132,240 88,000
======= ======
1) Services relating to audit of the annual consolidated financial
statements, review of quarterly financial statements, consents and
assistance with the review of documents filed with the SEC.
All engagements for audit services, audit related services and tax
services are approved in advance by the Audit Committee and the full Board of
Directors. The Audit Committee and the Board of Directors has considered whether
the provision of the services described above for the fiscal year ended December
31, 2005 and 2004, is compatible with maintaining the auditor's independence.
All audit and non-audit services that may be provided by our principal
accountant to us shall require pre-approval by the Audit Committee and Board of
Directors. Further, our auditor shall not provide those services to us
specifically prohibited by the SEC, including bookkeeping or other services
related to the accounting records or financial statements of the audit client;
financial information systems design and implementation; appraisal or valuation
services, fairness opinion, or contribution-in-kind reports; actuarial services;
internal audit outsourcing services; management functions; human resources;
broker-dealer, investment adviser, or investment banking services and expert
services unrelated to the audit; and any other service that Public Company
Oversight Board determines, by regulation, is impermissible.
99
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.
DEVINE ENTERTAINMENT CORPORATION
By _____________________________________
David Devine
Director, Chairman of the Board
President and Chief Executive Officer
Dated: March 24, 2006
Pursuant to the requirements of the Securities Exchange Act, this report
has been signed below by the following persons on behalf of the registrant and
in the capacities and on the dates indicated.
Signature Title Date
--------------------------------------------------------------------------------
/s/ David Devine Director, Chairman of the Board March 24, 2006
President and Chief Executive Officer
/s/ Richard Mozer Director, Vice-Chairman of the March 24, 2006
Board, Chief Financial Officer,
Treasurer and Secretary
/s/ Kenneth D. Taylor Director March 24, 2006
/s/ Bryson Farrill Director March 24, 2006
/s/ Ron Feddersen Director March 24, 2006
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