Appendix III: Vertical and Horizontal Analysis DRAFT 2016 $ AUDITED 2015 $ AUDITED 2014 $ YoY Change 2016 2015 2016 % of Sales 2015 2014 Revenue Box office revenue Concession revenue Other income — arcade games Other income — party room rentals Total revenue 41,057 23,445 660 344 65,506 46,511 24,224 651 341 71,727 45,117 22,481 648 350 68,596 -11.7% -3.2% 1.4% 0.9% -8.7% 3.1% 7.8% 0.5% -2.6% 4.6% 62.7% 35.8% 1.0% 0.5% 100.0% 64.8% 33.8% 0.9% 0.5% 100.0% 65.8% 32.8% 0.9% 0.5% 100.0% Expenses Film costs Concession costs Advertising and promotion Amortization Employee wages and benefits Employee bonuses Rent Theatre operating costs General and administrative Total expenses 24,142 5,887 718 4,691 11,868 1,250 3,926 7,972 1,536 61,990 25,953 5,261 703 4,640 13,075 3,975 4,020 8,607 2,078 68,312 23,362 5,176 695 4,628 13,292 1,850 3,978 9,550 2,080 64,611 -7.0% 11.9% 2.1% 1.1% -9.2% -68.6% -2.3% -7.4% -26.1% -9.3% 11.1% 1.6% 1.2% 0.3% -1.6% 114.9% 1.1% -9.9% -0.1% 5.7% 36.9% 9.0% 1.1% 7.2% 18.1% 1.9% 6.0% 12.2% 2.3% 94.6% 36.2% 7.3% 1.0% 6.5% 18.2% 5.5% 5.6% 12.0% 2.9% 95.2% 34.1% 7.5% 1.0% 6.7% 19.4% 2.7% 5.8% 13.9% 3.0% 94.2% Operating income (loss) 3,516 3,415 3,985 3.0% -14.3% 5.4% 4.8% 5.8% Interest income Interest expense Foreign exchange gain (loss) Income before taxes Income taxes (25%) 22 (792) (93) 2,653 663 23 (851) (172) 2,415 604 15 (910) (55) 3,035 759 -4.3% -6.9% -45.9% 9.9% 9.8% 53.3% -6.5% 212.7% -20.4% -20.4% 0.0% -1.2% -0.1% 4.1% 1.0% 0.0% -1.2% -0.2% 3.4% 0.8% 0.0% -1.3% -0.1% 4.4% 1.1% Net earnings 1,990 1,811 2,276 9.9% -20.4% 3.0% 2.5% 3.3% Appendix IV: Financial Statement Ratios Comparable ratios Box office revenue per attendee Concession revenue per attendee Box office revenue per theatre (in $thousands) Liquidity ratios Current ratio Quick ratio Solvency ratios Long-term debt to equity Total debt to equity Total debt to assets Activity ratios Days in concession inventory (ending inventory only, and not average) Days in payable Days in film costs payable Profitability Film costs to box office revenue Concession costs to revenues Advertising as % of revenues Employee wages / benefits as % of revenues Theatre costs as % of total revenues G&A as % of total revenues Operating margin Net profit margin Return on assets ROA adj for after-tax bonuses Return on equity Debt Covenants Long term Debt to EBITDA Pro Forma Statements Benchmarks 2019 2018 2017 $9.10 $ 9.44 $ 9.10 $ 8.85 $5.25 $ 5.54 $ 5.27 $ 5.07 $ 4,453 $ 3,825 First View Theatres Inc. 2016 2015 2014 $ 8.67 $ 8.89 $ 8.75 $ 4.95 $ 4.63 $ 4.36 $ 3,732 $ 4,228 $ Cinéma LaRoche 2016 2015 $ 9.25 $ 9.11 $ 5.34 $ 5.27 $3,948 $ 4,635 4,102 0.67 0.64 1.66 1.60 1.32 1.27 0.95 0.90 0.30 0.22 0.29 0.23 0.25 0.18 0.50 0.36 0.52 0.36 0.47 1.2 0.54 0.49 0.59 0.30 0.74 0.86 0.37 0.97 1.11 0.42 1.24 1.69 0.63 1.56 2.24 0.69 1.95 2.55 0.72 4.61 7.16 5.57 3.20 5.59 4.50 21 32 35 23 39 28 22 40 31 26 41 32 23 44 33 27 39 34 26 36 36 25 44 40 28 42 40 52% 23% 2% 59% 25% 1% 59% 25% 1% 59% 25% 1% 59% 25% 1% 56% 22% 1% 52% 23% 1% 53% 25% 5% 53% 24% 6% 19% 15% 16% 18% 18% 18% 19% 18% 18% 12% 6% 9% 6% 4.7% 4.7% 10.4% 11% 2% 9.8% 7.5% 10.6% 10.6% 20.8% 11% 2% 4.6% 3.5% 5.1% 5.1% 11.8% 12% 2% 4.3% 3.3% 4.1% 4.1% 10.7% 12% 2% 5.4% 3.0% 4.0% 4.0% 10.8% 12% 3% 4.8% 2.5% 3.4% 3.4% 11.1% 14% 3% 5.8% 3.3% 4.4% 4.4% 15.6% 14% 91% 8.6% 6.6% 146.9% 14% 93% 6.9% 5.4% 114.6% 188.7% 142.4% 0.98 1.64 2.02 2.02 2.22 2.22 Appendix V: Income Based Valuation Valuation of Cinema LaRoche Capitalized Cash Flow (in thousands of $) Step 1 - Estimated maintainable operating cash flow (normalized EBITDA) Notes Income before interest and taxes Add/deduct: Building Rental Income Manager Salary and Benefit Savings in General and Admin Costs Lease Savings due to Favorable Rates Income from Marketable Securities Add: Amortization Per Income Statement $ (1) (2) Estimated maintainable operating cash flow (normalized EBITDA) $ 2016 4,587 $ 2016 4,587 (250) (425) 300 (117) (178) (250) (425) 300 (117) (178) 2,013 2,013 5,930 $ 5,930 Step 2 - Capitalized cash flow Estimated maintainable operating cash flow (EBITDA) Income taxes Annual maintainable cash flow from operations after tax $ Sustaining capital expenditures Maintainable discretionary cash flows Capitalization rate Capitalized discretionary cash flows Average Capitalized discretionary cash flows PV of CCA tax shield of equipment PV of CCA tax shield of Leasehold improvement Capitalized value of operations Add-back: Redundant marketable securities Enterprise value Interest bearing debt Estimated fair market value of equity (3) (3) 5,930 $ (1,483) 4,448 5,930 (1,483) 4,448 (2,300) 2,148 14% 15,339 12,768 (2,300) 2,148 16% 13,422 13,422 1,849 123 14,739 1,690 16,429 (8,623) 7,806 1,746 140 15,308 1690 16,998 (8,623) 8,375 Conclusion: The value of Cinema LaRoche shares as calculated using the capitalized cash flow approach is approximately Notes (1) Salary and benefits of the two managers replacing Marcel: $170,000 x 2 x 1.25 = 425,000 (2) Lease adj due to favourable market rates for Pierre, Laurent and Sharone theatres = 116,880 The favourable market rate is temporary and rate may change in the future, therefore the saving is not maintainable and should be subtract from operating income 14% 16% (3) PV of CCA tax shield for equipment 1,848,529 1,745,833 PV of CCA tax shield for leasehold improvement 122,500 140,000 Hidden below are case facts Appendix VI: Asset Based Valuation Cinéma LaRoche Balance sheet (As at November 30) (Under ASPE) (In thousands of C$) 2016 Assets Current assets Cash and cash equivalents Marketable securities Concession inventories Latent taxes and selling costs Total current assets Property, plant and equipment Forgone Tax Shield Latent taxes and selling costs Total assets Liabilities Current liabilities Trade payables and accrued liabilities Film costs payable Deferred subscriber fees Total current liabilities Shareholder's loan Total liabilities Total Value Book Value FMV Adjustment 20 1,690 315 Adjusted Net Asset Value (79) 20 1,690 315 (79) 1,946 (1,845) (637) (1,283) 19,450 (637) (1,283) 19,476 1,923 1,860 985 4,768 - 1,923 1,860 985 4,768 8,623 13,391 - 8,623 13,391 2,403 21,295 23,698 10,307 Low (-14%) High (+16%) 6,085 5,233 7,058 Notes: Note 1: Forgone tax shield Equipment - Class 8 (20%) FMV > Tax Value (17030*20%*25%)/(15%+20%)-(12570*20%*25%)/(15%+20%) Note 2: Original Cost Fair Market Value Selling Costs (3% of proceeds) Net Proceed for Tax Purposes Lower of Cost or Proceeds UCC / ACB Recapture (Terminal Loss) Taxabale Capital Gain - 50% Taxes @ 25% Latent Taxes and Selling Costs Hidden below are case facts 637 Equipment 16,940,000 17,030,000 (510,900) 16,519,100 16,519,100 12,570,000 3,949,100 Leasehold 4,355,000 2,420,000 (72,600) 2,347,400 2,347,400 3,500,000 (1,152,600) 987,275 1,498,175 (288,150) (215,550) Securities 1,409,000 1,690,000 (50,700) 1,639,300 1,409,000 115,150 28,788 79,488 Notes 2 1 2 Apendix VII: Connery's Bar and Grill NPV Analysis & Forecasted Income Statement Investment 2017 Revenue Cost of Food and Beverages Labour Annual Insurance Permits and Licences Menus and advertising Ongoing costs Opening event Fred's salary Operating costs Remove lease improvements Amortization Operating income Tax (at 25%) Net Income 2018 1,820,000 655,200 473,200 10,000 6,000 25,000 15,000 25,000 150,000 175,000 5 Year Projection 2019 2020 2021 2,300,000 2,800,000 2,856,000 805,000 980,000 999,600 598,000 728,000 742,560 11,000 12,000 12,240 6,200 6,200 6,324 12,000 13,000 13,260 15,000 15,000 15,300 2022 2,913,120 1,019,592 757,411 12,485 6,450 13,525 15,606 200,000 176,000 250,000 177,000 255,000 180,540 227,750 57,850 14,463 43,388 239,063 237,738 59,434 178,303 189,063 429,737 107,434 322,303 183,366 447,810 111,952 335,857 260,100 184,151 45,000 179,845 418,954 104,739 314,216 Add back amortization Operating Cash Flows FVTs Share of Cash Flows (40%) Current Concessions Cost New Concessions Cost Cost savings After Tax savings 227,750 271,138 108,455 700,000 550,000 150,000 112,500 239,063 417,366 166,946 700,000 550,000 150,000 112,500 189,063 511,366 204,546 700,000 550,000 150,000 112,500 183,366 519,224 207,689 700,000 550,000 150,000 112,500 179,845 494,061 197,624 700,000 550,000 150,000 112,500 Total Cash Flows PV Factor Net Cash Flows NPV 220,955 0.85 188,850 279,446 0.73 204,139 IRR 317,046 0.62 197,954 13% 320,189 0.53 170,869 310,124 0.46 141,451 % Ownership Required at 17% Rate of Return FVTs Share of Cash Flows (47.12%) 127,764 Total Cash Flows 240,264 Net Cash Flows (1,000,000) 205,354 NPV 0 47.12% 196,669 309,169 225,852 240,964 353,464 220,692 244,666 357,166 190,602 232,809 345,309 157,499 Recommended Ownership Share FVTs Share of Cash Flows (50%) Total Cash Flows Net Cash Flows (1,000,000) NPV 39,099 50.00% 208,683 321,183 234,628 255,683 368,183 229,883 259,612 372,112 198,577 247,030 359,530 163,986 CBG CCA Calculation Asset CCA Leasehold SL Chairs 20% Equipment 100% IT system 55% Total (1,000,000) 1.00 (1,000,000) (96,736) Cost 850,000 95,000 80,000 30,000 1,055,000 135,569 248,069 212,025 2018 170,000 9,500 40,000 8,250 227,750 2019 170,000 17,100 40,000 11,963 239,063 CCA Claim 2020 170,000 13,680 2021 170,000 10,944 2022 170,000 8,755 5,383 189,063 2,422 183,366 1,090 179,845 Appendix VIII: PPV NPV Analysis Premium Plus Viewing - $8.50 Premium Incremental box office CM Incremental concession CM Other incremental costs Net incremental cash flows before tax FVT's average corporate tax rate Net incremental cash flows after tax Capital cost of auditoriums Tax shield on capital additions Net cash flow Discount factor Discounted cash flows NPV of discounted cash flows Premium Plus Viewing - $10.00 Premium Incremental box office CM Incremental concession CM Other incremental costs Net incremental cash flows before tax FVT's average corporate tax rate Net incremental cash flows after tax Capital cost of auditoriums Tax shield on capital additions Net cash flow Discount factor Discounted cash flows NPV of discounted cash flows Note 3 Note 4 Note 5 25% Note 1 Note 2 15% Note 3 Note 4 Note 5 25% Note 1 Note 2 15% Year 0 (6,368,949) 850,512 (5,518,438) 1.0000 (5,518,438) (3,271) Year 0 (6,368,949) 850,512 (5,518,438) 1.0000 (5,518,438) 354,133 2017 (12,909) 37,218 (81,500) (57,191) 14,298 (42,893) (47,956) 1.0000 (47,956) 2017 (19,659) 37,218 (81,500) (63,941) 15,985 (47,956) 575,464 0.8696 500,403 2018 265,982 629,304 (128,000) 767,285 (191,821) 575,464 536,989 0.8696 466,947 2018 214,682 629,304 (128,000) 715,985 (178,996) 536,989 1,182,127 0.7561 893,858 2019 633,724 1,246,536 (304,090) 1,576,170 (394,042) 1,182,127 1,116,315 0.7561 844,094 2019 545,974 1,246,536 (304,090) 1,488,420 (372,105) 1,116,315 1,396,795 0.6575 918,415 2020 654,814 1,444,807 (237,228) 1,862,393 (465,598) 1,396,795 1,312,757 0.6575 863,159 2020 542,764 1,444,807 (237,228) 1,750,343 (437,586) 1,312,757 1,442,905 0.5718 824,986 2021 2022 - 2026 681,139 3,449,569 1,484,707 7,490,035 (241,973) (1,284,420) 1,923,873 9,655,184 (480,968) (2,413,796) 1,442,905 7,241,388 1,357,349 0.5718 776,068 2021 2022 - 2026 567,064 2,875,819 1,484,707 7,490,035 (241,973) (1,284,420) 1,809,798 9,081,434 (452,450) (2,270,358) 1,357,349 6,811,075 7,241,388 0.3836 2,777,801 6,811,075 0.3836 2,612,854 (42,893) 1.0000 (42,893) Note 1: Capital costs of auditoriums Cost of reclining and D-BOX seats Cost of screens and surround sound Total London #1 Leamington 3,534,000 2,834,949 25% 25% 20% 20% 15% 15% 471,932 378,580 Hidden cells are case facts 2017 Discounted London #1 Leamington (2,034,000) (1,631,660) (1,500,000) (1,203,289) (3,534,000) (2,834,949) Notes to Appendix VIII - PPV NPV Analysis Note 2: Tax shield on auditorium costs Capital investment Tax rate CCA rate (Class 8) Discount PV of tax shield benefits Total (3,665,660) (2,703,289) (6,368,949) 542,764 1,036,463 308,138 (801,836) 681,139 1,140,750 342,225 (801,836) 567,064 1,055,194 313,706 (801,836) 3,449,569 5,737,500 1,721,250 (4,009,181) 2,875,819 5,307,188 1,577,813 (4,009,181) 2022 - 2026 1,120,500 336,150 (801,836) 2021 2022 - 2026 2,247,700 11,305,000 (762,993) (3,814,965) 2021 654,814 7,490,035 2020 2020 2,207,800 (762,993) 1,484,707 2019 877,500 263,250 (468,024) (39,002) 633,724 1,444,807 2018 214,682 513,000 153,900 (400,918) 265,982 2019 1,729,000 (445,352) (37,113) 1,246,536 2021 241,973 2017 67,500 20,250 (67,106) (33,553) (12,909) 2018 1,010,800 (381,497) 629,304 2020 237,228 2022 - 2026 1,284,420 1,284,420 2019 284,090 20,000 304,090 241,973 474,525 141,075 (400,918) Note 3: Incremental box office contribution margin $8.50 Premium Box office CM per adult 75% Box office CM per senior 25% Lost box office CM per status quo Lost box office CM during renovation Incremental box office contribution margin $10.00 Premium Box office CM per adult 75% Box office CM per senior 25% Lost box office CM per status quo Lost box office CM during renovation Incremental box office contribution margin 2017 133,000 (63,855) (31,928) 37,218 2018 128,000 128,000 237,228 811,688 241,313 (468,024) (39,002) 545,974 Note 4: Incremental concession contribution margin Concession CM per attendee Lost concession CM per status quo Lost concession CM during renovation Incremental concession CM 2017 61,500 20,000 81,500 62,438 18,563 (67,106) (33,553) (19,659) Note 5: Other incremental costs for auditoriums Additional costs per case facts Additional bar inventory Total Appendix IX: PPV Contribution Margin Analysis Status Quo 2,168 1,192 975 45.00% $8.50 Premium 3,150 1,733 1,418 45.00% $10.00 Premium 3,413 1,877 1,536 45.00% Concession revenue Concession costs Concession contribution margin Concession CM % 1,238 309 928 75.00% 3,325 998 2,328 70.00% 3,325 998 2,328 70.00% Total revenue Total variable costs Total contribution margin Total CM % 3,405 1,502 1,904 55.90% 6,475 2,730 3,745 57.84% 6,738 2,874 3,863 57.34% Status Quo 13.62 6.01 7.61 55.90% $8.50 Premium 37.00 15.60 21.40 57.84% $10.00 Premium 38.50 16.43 22.08 57.34% Contribution Margin by Auditorium Box office revenue Film costs Box office contribution margin Box office CM % Contribution Margin by Attendee Total revenue Total variable costs Total contribution margin Total CM % Appendix X: TGP NPV Analysis Fiscal Year Year - # Revenue Food Beverages Amusement Special Events Total 1,250,000 525,000 2,590,000 250,000 4,615,000 1,696,000 768,000 3,856,000 630,000 6,950,000 1,805,000 975,000 4,150,000 850,000 7,780,000 1,950,000 1,160,000 4,505,000 880,000 8,495,000 1,989,000 1,183,200 4,595,100 897,600 8,664,900 2,028,780 1,206,864 4,687,002 915,552 8,838,198 2,069,356 1,231,001 4,780,742 933,863 9,014,962 2,110,743 1,255,621 4,876,357 952,540 9,195,261 Costs Food Beverages Amusement Wages Marketing, Other Opex and G&A Total 325,000 120,750 388,500 1,107,600 2,087,000 4,028,850 440,960 176,640 578,400 1,668,000 2,062,190 4,926,190 469,300 224,250 622,500 1,867,200 2,105,957 5,289,207 507,000 266,800 675,750 2,038,800 2,150,676 5,639,026 517,140 272,136 689,265 2,079,576 2,196,366 5,754,483 527,483 277,579 703,050 2,121,168 2,243,051 5,872,331 538,032 283,130 717,111 2,163,591 2,290,752 5,992,617 548,793 288,793 731,454 2,206,863 2,339,493 6,115,395 586,150 (146,538) 439,613 2,023,810 (505,953) 1,517,858 2,490,793 (622,698) 1,868,095 2,855,974 (713,994) 2,141,981 2,910,417 (727,604) 2,182,812 (860,000) 2,965,867 (741,467) 2,224,401 (860,000) 3,022,345 (755,586) 2,266,758 (860,000) 3,079,866 (769,967) 2,309,900 138,427 138,427 138,427 652,427 571,060 499,707 Net Income Tax - 25% AT Cash Flow Expenditures - Games Salvage - Furnture and Games PV of CCA Tax Shield Asset Retirement Obligation NPV (Year 1 - 8) Total Net Cash Flows Year 0 Expenditures PV of Salvage Tax Shield Loss PV of CCA Tax Shield Total NPV 2018 1 2019 2 2020 3 2021 4 2022 5 2023 6 2024 7 2025 8 1,070,000 374,138 6,312,827 (6,315,000) (44,292) 708,136 661,670 1,099,399 1,151,556 1,123,735 (325,000) 840,803 Appendix XI - TGP Forecast Balance Sheet At December 31 Asset Cash - Note 1 Leasehold Furniture Games Computer Hardware Inventory - Note 2 Asset Retirement Cost Total 2018 2019 2020 2021 2022 2023 2024 2025 439,613 1,786,950 1,604,550 2,214,000 37,500 220,000 12,270 6,314,883 1,957,470 1,598,850 1,435,650 1,722,000 32,500 220,000 11,624 6,978,094 3,825,565 1,410,750 1,266,750 1,230,000 27,500 220,000 10,979 7,991,543 5,967,545 1,222,650 1,097,850 738,000 22,500 220,000 10,333 9,278,878 7,290,358 1,034,550 928,950 1,020,000 17,500 220,000 9,687 10,521,045 8,654,758 846,450 760,050 1,376,000 12,500 220,000 9,041 11,878,800 10,061,517 658,350 591,150 1,806,000 7,500 220,000 8,395 13,352,912 12,371,416 470,250 422,250 1,290,000 2,500 220,000 7,750 14,784,166 Liability Deferred Revenue ARO - Note 3 Prize Liability SH & RE Total 111,370 15,176 77,700 6,110,636 6,314,883 165,808 17,832 115,680 6,678,774 6,978,094 178,450 20,953 124,500 7,667,640 7,991,543 193,715 24,619 135,150 8,925,394 9,278,878 197,589 28,928 137,853 10,156,675 10,521,045 201,541 33,990 140,610 11,502,658 11,878,800 205,572 39,938 143,422 12,963,980 13,352,912 209,683 46,928 146,291 14,381,264 14,784,166 Note 1 - Cash Upfront Costs in Year 0 - Assumption: Covered 100% by FTV Financing. No impact to B/S Cash Games Purchase (Year 5-7) - Decrease Cash $860,000 Net Earnings - Increase in Cash equal to After Tax Net Income (Assume Cash received) Note 2 - Inventory Inventory is assume to be constant at $220,000 required. Note 3 - ARO Calculation ARO 325000 Assumption - This is the FV of the Cost Cost of Capital 17.50% Calculated from WACC on Appendix XI Years 20 Lease term PV of ARO $12,916 Accretion expense 17.5% on the 12,916 cumulatively Accumulated Asset Retirement Cost Depreciation - Straight Line Appendix XII TGP Forecast Income Statement Fiscal Year Year - # Revenue Food Beverages Amusement Special Events Total 2018 1 2019 2 2020 3 2021 4 2022 5 2023 6 2024 7 2025 8 1,250,000 525,000 2,590,000 250,000 4,615,000 1,696,000 768,000 3,856,000 630,000 6,950,000 1,805,000 975,000 4,150,000 850,000 7,780,000 1,950,000 1,160,000 4,505,000 880,000 8,495,000 1,989,000 1,183,200 4,595,100 897,600 8,664,900 2,028,780 1,206,864 4,687,002 915,552 8,838,198 2,069,356 1,231,001 4,780,742 933,863 9,014,962 2,110,743 1,255,621 4,876,357 952,540 9,195,261 Cost of Sales Food Beverages Amusement Wages Total 325,000 120,750 388,500 1,107,600 1,941,850 440,960 176,640 578,400 1,668,000 2,864,000 469,300 224,250 622,500 1,867,200 3,183,250 507,000 266,800 675,750 2,038,800 3,488,350 517,140 272,136 689,265 2,079,576 3,558,117 527,483 277,579 703,050 2,121,168 3,629,279 538,032 283,130 717,111 2,163,591 3,701,865 548,793 288,793 731,454 2,206,863 3,775,902 Operating Expense Marketing, Other Opex and G&A Depreciation - PPE Depreciation - ARO Total 2,087,000 427,000 2,260 2,516,260 2,062,190 854,000 2,656 2,918,846 2,105,957 854,000 3,121 2,963,078 2,150,676 854,000 3,667 3,008,342 2,196,366 940,000 4,308 3,140,675 2,243,051 866,000 5,062 3,114,114 2,290,752 792,000 5,948 3,088,701 2,339,493 878,000 6,989 3,224,482 156,890 0 156,890 1,167,154 (291,789) 875,366 1,633,672 (408,418) 1,225,254 1,998,308 (499,577) 1,498,731 1,966,108 (491,527) 1,474,581 2,094,805 (523,701) 1,571,104 2,224,396 (556,099) 1,668,297 2,194,877 (548,719) 1,646,158 Net Income Tax - 25% Income After Tax Appendix XIII: Financing Options Option 1: Sale and Leaseback Proposal Original Cost 400,000 8,750,000 9,150,000 Land Building Total Price Offer Book Value Deferred Gain Deferred Gain/5 Years Year 0 1 2 3 4 5 Book Value 400,000 5,370,000 5,770,000 10,120,000 (5,770,000) 4,350,000 870,000 Deferred revenue recognized each year Payment 870,000 870,000 870,000 870,000 870,000 Interest 219,885 180,879 139,531 95,703 49,245 Principal 650,115 689,121 730,469 774,297 820,755 Balance 3,664,756 3,014,642 2,325,520 1,595,052 820,755 0 Option 2: Preferred Shares Redemption Retractable Shares authorized Issued & Outstanding 10,000 6,000 Scenario 1: Assuming redemption price increase has not been waived 10% increase Year 1 Year 2 Year 3 Year 4 Year 5 Mandatory Redemption 1,000 1,000 1,000 1,000 1,000 Redemption Price $ 1,500 $ 1,650 $ 1,815 $ 1,997 $ 2,196 1,500,000 1,650,000 1,815,000 1,996,500 2,196,150 Total Deferred Payment Scenario 2: Assuming redemption price increase has been waived Year 1 Year 2 Year 3 Mandatory Redemption 1,000 1,000 1,000 Redemption Price $ 1,500 $ 1,500 $ 1,500 1,500,000 1,500,000 1,500,000 Total Deferred Payment Scenario 1 Scenario 2 Total saved if redemption penalty increase is waived off PV of lease payments RATE: 6% NPER: 5 PMT: 72,500*12=870,000 FV: 0 TYPE: 0 $ Year 4 1,000 $ 1,500 1,500,000 $ $ 9,157,650 Year 5 1,000 1,500 1,500,000 7,500,000 9,157,650 7,500,000 1,657,650 Appendix XIV: Balanced Scorecard Objective Increase revenue Decrease concession costs Improve overall profitability Measure Target Financial Perspective BORPA $9.10 Concession costs as a % 23% of concession revenue Net earnings Growth of 5% Improve the concession experience Improve customer satisfaction ROA, Box office revenue 4.7%, $3,948 per per theatre theatre Customer Perspective # of unique food items 5 unique food items developed by 2018 90% customer % satisfaction satisfaction Improve customer's online experience % satisfaction of new website Improve use of assets 90% customers satisfied Improve movie experience # of theatres remodeled 2 theatres by 2017 Internal Perspective Increase manager % of annual goals 80% success rate engagement achieved Increase efficiency of Concession inventory Increase by 10% concession inventory turnover Increase local content shown % of locally produced 30% of films shown at theatres films are locally produced Improve relationship with film # of exclusive titles 4 per year distributors Increase customer loyalty Offer cross training for current employees to increase motivation Increase employee engagement by investing in a fun culture Introduce new viewing technology into theatres Retain talented employees # of repeat customers Increase by 10% Learning and Growth Perspective 70% of eligible % of eligible employees emlpoyees cross cross trained trained # of employee fun days Once per quarter # of new technologies implemented 2 per year Employee turnover 10% improvement from prior year Initiative PPV CBG Investment in PPV, Connery's Bar and Grill, Flix Rewards PPV, increase local content, targeted advertising CBG Customer surveys at each theatre Website redesign and survey customers who use the new website PPV Balanced Scorecard, new bonus structure Consult Fred to identify food trends and inventory levels Partner with local film schools for their content Offer a fund to help market the exclusive titles Tailored movie offerings per customer, Flix Rewards Training programs for employees, possibly partner with CBG Organize events for employees to attend PPV, conduct reasearch on upcoming technology Retirement plan, bonus scheme, organize events for employees to attend Appendix XV: Flix Rewards Loyal Customers Sign up Rate Expected Customers Extra Tickets sold Total Extra Tickets Canbalization Rate Net Tickets Sold Average Box Office Revenue Average Concession Revenue Total Additional Revenue Total Additional Concession Revenue Cost of Sales - Revenue Cost of Sales - Concession Upfront Cost 600,000 70% 420,000 2 840,000 35% 546,000 $8.77 Average from 2014-2016 $4.65 Average from 2014-2016 4,788,420 2,537,080 (2,815,647) 59% 2016 Income Statement (637,057) 25% 2016 Income Statement (3,500,000) Cost per Point Additional Revenue Total Cost per Point $0.02 50,715,000 -1,014,300 Marketing Allowance (Year 1) Marketing Expenses (Year 2-4) Points Earned Value Unredeemed Liability Net Total at Year 1 Net Total Year 2-4 Payback Period 150,000 Marketing covered by Allowance (150,000) Marketing paid out of own budget 50,715,000 $1 = 1 point 8,452,500 1,690,500 Recorded as a liability on the B/S -491,504 2,708,496 1.3 years Appendix XVI - Impairment of Goodwill 2015 2016 2017 2018 Location 1 Location 2 Location 1 Location 2 Location 1 Location 2 Location 1 Location 2 578,973 291,027 467,920 235,205 376000 189000 376000 189000 $ 8.50 $ 8.25 $ 8.50 $ 8.25 $ 8.50 $ 8.25 $ 8.50 $ 8.25 4,921,274 2,400,969 3,977,323 1,940,438 3,196,000 1,559,250 3,196,000 1,559,250 $ 4.50 $ 4.60 $ 4.50 $ 4.60 $ 4.50 $ 4.60 $ 4.50 $ 4.60 2,605,381 1,338,722 2,105,642 1,081,941 1,692,000 869,400 1,692,000 869,400 12,000 8,000 12,000 8,000 12,000 8,000 12,000 8,000 (2,706,701) (1,320,533) (2,187,528) (1,067,241) (1,757,800) (857,588) (1,757,800) (857,588) (651,345) (334,681) (526,410) (270,485) (423,000) (217,350) (423,000) (217,350) (30,000) (25,000) (30,000) (25,000) (30,000) (25,000) (30,000) (25,000) (233,000) (116,500) (233,000) (116,500) (233,000) (116,500) (233,000) (116,500) (1,056,000) (377,400) (1,056,000) (377,400) (1,056,000) (377,400) (1,056,000) (377,400) (424,000) (285,000) (424,000) (285,000) (424,000) (285,000) (424,000) (285,000) (875,000) (390,000) (875,000) (390,000) (875,000) (390,000) (875,000) (390,000) 1,562,609 898,578 763,027 498,753 101,200 167,813 101,200 167,813 1,795,609 1,015,078 996,027 615,253 334,200 284,313 334,200 284,313 618,513 3,092,563 Greater of Fair Value or Value in Use Attendence Box Office Revenue/Attendee Box Office Revenue Concession Revenue/Attendee Concesssion Revenue Other Revenue Films Costs Concession Costs Advertising Amortization Employee Wages Rent Theatre Operating Costs Net Income EBITDA EBITDA Market Value (Fair Value) 2,152,100 2,277,438 Carrying Value 39,000 1,290,000 2,210,000 2,423,000 (265,000) (327,000) 5,370,000 Value in Use - 8 more years Inventories Leasehold Improvements Equipment Goodwill Trades Payable Film Costs Total Value Possible Impairment Appendix XVII: Financing for Recommended Projects Available Financing Funds Total cash on hand Cash from Sales and Leaseback Total Available Financing Funds 1,859,000 10,120,000 11,979,000 Financing Required for Investments PPV Initial Renovation Cost Connery's Bar & Grill Mobile Strategy Flix Rewards Total Required for Investments 3,500,000 1,000,000 125,000 3,500,000 8,125,000 Total Remaining Available Financing 3,854,000 Appendix XVIII: Hedging Foreign Exchange Risk Expected Dec 2017 Rate Film Cost (25% of 2016 cost) Recommended Hedged Amount 0.77 4,245,500 4,246,000 Forward Contract USD ($30k minimum) 1% administration fee (max $650) Total Hedged Forward Rate Expected Dec 2017 Rate Foreign Exchange Gain/(Loss) 4,246,000 650 4,246,650 0.7704 0.77 1,699 CDN Future Contract Contract Required (4.3 million/100k) Total price for contracts Total amount to hedge Film Costs Total Amount to Hedge Film Costs 43 $430 $10 per contract 4,300,000 USD (rounded to nearest '000) 4,300,430 USD If settled in September 2017 Contract Rate Expected Dec 2017 Rate Foreign Exchange Gain/(Loss) 0.7731 0.77 13,331 CDN If settled in December 2017 Contract Rate Expected Dec 2017 Rate Foreign Exchange Gain/(Loss) 0.7766 0.77 28,383 CDN Difference 15,052 Appendix XIX: Pro Forma Income Statement Notes Inflation + Web redesign + Hedge + Lease 2017 2018 2019 2020 2021 4,982 2,640 5,082 2,692 Flix Rewards Contribution 2018 2019 2020 2021 4,884 2,588 2017 4,788 2,537 - 7,774 45,330 25,885 729 380 72,324 7,621 44,441 25,378 714 372 70,906 7,472 43,570 24,880 700 365 69,515 7,326 42,716 24,392 687 358 68,152 2,988 676 156 41,878 23,914 673 351 66,816 2,929 663 153 Revenue Box office revenue Concession revenue Other income — arcade games Other income — party room rentals Total revenue 2,872 650 150 26,655 6,500 1,411 4,010 13,103 1,380 5,276 8,802 1,696 2,816 637 26,132 6,372 1,236 4,168 12,846 1,353 5,173 8,629 1,663 1,076 25,620 6,247 1,065 4,333 12,594 1,327 5,071 8,460 1,630 1,055 1,076 25,117 6,125 897 4,506 12,347 1,301 4,972 8,294 1,598 1,035 1,055 24,625 6,005 732 4,595 12,105 1,275 4,875 8,131 1,567 125 1,035 67,572 1,014 3,500 4,514 66,347 - 65,157 68,833 64,035 6,697 Expenses Film costs Concession costs Advertising and promotion Amortization Employee wages and benefits Employee bonuses Rent (include sales leaseback) Theatre operating costs General and administrative Website Redesign Flixrewards Points Cost Flix Rewards Upfront Costs Total expenses 6,566 3,333 24 6,437 3,168 24 2,811 2,995 23 - 2,781 23 3,491 Operating income (loss) 22 870 (874) (72) 3,439 860 2,579 6,697 870 (857) (71) 3,299 825 2,474 6,566 870 (840) (69) 3,152 788 2,364 6,437 870 (824) (68) 2,997 749 2,248 2,811 870 (808) (66) 2,799 700 2,099 - Interest income Investment Income (50% CBG) Gain from sales leaseback Interest expense Foreign exchange gain (loss) Income before taxes Income taxes (25%) Net earnings 107 57 385 195 190 2017 442 815 433 2,926 1,482 1,444 598 1,394 741 5,005 2,535 2,470 817 1,780 946 6,391 3,237 3,154 PPV Contribution 2018 2019 2020 817 1,813 963 6,507 3,296 3,211 2021 (75) - (150) - (150) - (150) - CBG Contribution 2018 2019 2020 (150) - 2021 2017 74 242 - 237 - 304 - 128 - 163 82 - 165 163 - 125 165 - 55 125 - 11 55 - 11 - 6,507 6,507 6,391 6,391 5,005 5,005 2,926 2,926 385 385 Appendix XIX: Pro Forma Income Statement Notes Revenue Box office revenue Concession revenue Other income — arcade games Other income — party room rentals Total revenue Expenses Film costs Concession costs Advertising and promotion Amortization Employee wages and benefits Employee bonuses Rent (include sales leaseback) Theatre operating costs General and administrative Website Redesign Flixrewards Points Cost Flix Rewards Upfront Costs Total expenses Operating income (loss) Interest income Investment Income (50% CBG) Gain from sales leaseback Interest expense Foreign exchange gain (loss) Income before taxes Income taxes (25%) Net earnings Operating income (loss) Expenses Film costs Concession costs Advertising and promotion Amortization Employee wages and benefits Employee bonuses Rent (include sales leaseback) Theatre operating costs General and administrative Website Redesign Flixrewards Points Cost Flix Rewards Upfront Costs Total expenses Revenue Box office revenue Concession revenue Other income — arcade games Other income — party room rentals Total revenue 22 11 870 (808) (66) 2,951 738 2,213 2,922 24,732 5,987 732 4,669 12,105 1,275 4,875 8,213 1,567 125 64,279 42,073 24,104 673 351 67,201 2017 23 55 870 (824) (68) 3,668 917 2,751 3,612 28,748 7,045 897 4,947 12,347 1,301 4,972 8,422 1,598 1,014 3,500 74,792 48,986 28,373 687 358 78,404 2018 23 125 870 (840) (69) 8,161 2,040 6,121 8,052 29,886 7,488 1,215 4,931 12,594 1,327 5,071 8,764 1,630 1,035 73,941 50,989 29,938 700 365 81,993 2019 24 165 870 (857) (71) 9,046 2,261 6,785 8,915 30,842 7,831 1,389 4,984 12,846 1,353 5,173 8,866 1,663 1,055 76,003 52,660 31,171 714 372 84,918 2020 24 163 870 (874) (72) 9,301 2,325 6,976 9,190 31,455 7,989 1,567 4,827 13,103 1,380 5,276 9,044 1,696 1,076 77,414 53,707 31,789 729 380 86,604 2021 Appendix XIX: Pro Forma Income Statement First View Theatres Inc. Statement of earnings (For the years ending December 31) (Under ASPE) (In thousands of C$) Interest income Investment Income (50% CBG) Gain from sales leaseback Interest expense Foreign exchange gain (loss) Income before taxes Income taxes (25%) Net earnings Assumptions: Inflation set at 2% Not enough data to estimate impact from additional ticket/concession sales from CBG $10 premium from PPV Futures contract settled December each year at 2% inflation CGB has a June year end, so investment income is @ 50% Appendix XX: Pro Forma Balance Sheet First View Theatres Inc. Balance sheet (As at December 31) (Under ASPE) (In thousands of C$) Assets Current assets Cash and cash equivalents Concession inventories Prepaid expenses Total current assets Property, plant and equipment — net Intangible assets Goodwill Investment in Connery's Bar and Grill Total assets 2017 2018 2019 2020 2021 12,509 418 281 13,208 34,066 3,818 2,423 1,000 54,515 16,832 427 286 17,545 29,559 3,378 2,423 1,000 53,905 21,879 475 292 22,646 28,602 2,938 2,423 1,000 57,610 30,317 485 298 31,100 24,058 2,498 2,423 1,000 61,078 38,634 495 304 39,432 19,671 2,058 2,423 1,000 64,584 Liabilities Current liabilities Trade payables and accrued liabilities Film costs payable Income taxes payable Employee bonuses payable Current portion of long-term debt Current portion of redeemable preferred shares Deferred profit from sales leaseback Liability for rewards points Total current liabilities Long-term debt — term loan Redeemable preferred shares Total liabilities 1,726 2,203 738 1,275 1,275 1,500 3,480 1,691 13,888 14,036 6,000 33,924 1,760 2,247 917 1,301 1,275 1,500 2,610 1,691 13,301 12,761 4,500 30,562 1,796 2,292 2,040 1,327 1,275 1,500 1,740 1,691 13,660 11,486 3,000 28,146 1,831 2,338 2,261 1,353 1,275 1,500 870 1,691 13,119 10,211 1,500 24,830 1,868 2,385 2,325 1,380 1,275 1,500 1,691 12,424 8,936 21,360 Shareholders' equity Share capital Retained earnings Total shareholders' equity Total liabilities and shareholders' equity 4,000 16,592 20,592 54,515 4,000 19,343 23,343 53,905 4,000 25,464 29,464 57,610 4,000 32,248 36,248 61,078 4,000 39,224 43,224 64,584 Property, plant and equipment Opening balance Capital additions Dispositions Amortization Closing balance Amortization of intangible assets Total amortization 2017 40,406 3,659 (5,770) (4,229) 34,066 440 4,669 2018 34,066 2019 29,559 3,534 2020 28,602 2021 24,058 (4,507) 29,559 440 4,947 (4,491) 28,602 440 4,931 (4,544) 24,058 440 4,984 (4,387) 19,671 440 4,827 Assumptions: Cash used to balance total assets with liabilities and shareholders equity Cost method used to account for CBG, $40,000 added to inventory in 2017/2019 for PPV CPA Capstone 1 First View Theatres Inc. Analysis To: Board of Directors From: Renker and Curtis Co. Date: March 30, 2017 Re: Assessment of Current Situation Executive Summary First View Theatres (FVT) is a privately owned company currently operating theatres in southwest Ontario. The company differentiates themselves from large national players since they understand their local patrons and choose films that cater to the local community. Despite the decrease in revenue in 2016, the company is still profitable overall. Executive management have different opinions as to where they see FVT in the future. Therefore, as consultants at Renker and Curtis Co. (RCC), we must assess the situation, analyze the available strategic opportunities, and recommend what is the best direction FVT should take given the current constraints. The success of the industry is highly dependent on the films released in the year. In order to remain competitive, smaller competitors need to negotiate favorable rights to blockbuster films and continuously upgrade their facilities to improve the overall experience. FVT must decide whether to expand geographically, invest in premier experience upgrades, or diversify their services by investing in a game place and/or restaurant in order to assist with remaining competitive in the film industry. After an assessment of our current situation, we recommend the following options to be implemented: 1. Renovate FVT auditorium and update theatre technologies aiming to provide premium plus viewing experience to customers (2017) 2. Partnership with Connery’s Bar and Grill (CBG) and open CBG adjacent to FVT. (2017) 3. Implement customer reward programs - Flix Rewards (2018) 4. Update company current website and develop mobile application (2017) These options will help FVT achieve their objective of achieving an increase in box office revenues, improving margins for concession, and increase overall net earnings as well as staying aligned with their mission, vision, and core values. 1 Table of Contents Introduction ...................................................................................................................... 3
Assessment of FVT .......................................................................................................... 3
Vision Statement .......................................................................................................... 3
Mission Statement ........................................................................................................ 4
Key Success Factors .................................................................................................... 4
Goals and Stakeholder Preferences ............................................................................. 5
Current Competitive Strategy ....................................................................................... 6
Constraints to Decision Making .................................................................................... 6
Financial Analysis ......................................................................................................... 7
Analysis of Strategic Options ......................................................................................... 10
Option 1: Cinema LaRoche (CLR) .............................................................................. 10
Option 2: Connery’s Bar and Grill (CBG) .................................................................... 14
Option 3: Premium Plus Viewing (PPV) ..................................................................... 16
Option 4: The Games Place (TGP) ............................................................................ 18
Recommendation of Strategic Option ............................................................................ 20
Decision Criteria ......................................................................................................... 21
Comparison of Strategic Options ................................................................................ 21
Recommendation ....................................................................................................... 24
Analysis of Secondary Options ...................................................................................... 24
Flix Rewards ............................................................................................................... 24
The Mobile Strategy ................................................................................................... 26
Implementation Plan ...................................................................................................... 27
Financial Forecast and Financing ............................................................................... 28
Key Performance Indicators ....................................................................................... 28
Financing Recommendation ....................................................................................... 30
Analysis of Operational Issues ....................................................................................... 30
General Operational Issues ........................................................................................ 30
Governance Issues ..................................................................................................... 31
Performance Management Issues .............................................................................. 33
Audit Issues ................................................................................................................ 36
1 Tax Issues .................................................................................................................. 37
Finance Issues ........................................................................................................... 38
Conclusion ..................................................................................................................... 39
Appendices .................................................................................................................... 40
2 Introduction The purpose of this report is to analyze First View Theatre Incorporated’s (FVT) business strategy. The report will use external and internal analysis to provide insight into the company’s performance. Financial analysis over key ratios in comparison against industry benchmarks will be performed, and alignment between the company’s vision and mission statement versus its current and future competitive strategies will be considered. Assessment of FVT Vision Statement The vision statement paints a picture of what an organization wants to achieve over time, stating the organization's long term focus. It should discuss the following: ● Future for the company ● Clear and concise timeline for goals ● Vision that both customers and employees find valuable FVT’s Board of Directors approved the following vision statement: “Our vision is to ensure every guest enjoys a premier entertainment experience each and every time they visit our theatres.” FVT’s vision is in line with the shareholders’ aspirations for the business, and provides an excellent long term aspiration that the organization can continually strive towards. 3 Mission Statement The mission statement states the organization’s purpose, defining its service, customer value proposition and target market. FVT’s Mission is “to provide a premier entertainment experience tailored to the local community. We accomplish this by hiring and training employees to be respectful, attentive and friendly; selecting the best films to appeal to the local community; ensuring clean and safe venues for employees and attendees; and supporting entertainment and arts in the local community.” The mission statement clearly identifies the purpose of the company and defines the target market. It also identifies how the company will bring value to its customers and remain competitive in the industry. Key Success Factors Below are key factors that have led to FVT’s success: ● Remodeled auditoriums (digital capabilities) ● Diverse choice of concession goods ● Use of promotions to gain a competitive edge ● Located within local communities that need an entertainment sector ● Support to local communities - Workforce and Non-Profit events 4 Goals and Stakeholder Preferences FVT has the following goals for 2017: ● Increase box office revenue per attendee by 5% to $9.10 ● Improve concession margins by reducing costs as a percentage of concession revenues to 23% ● Increase net earnings by 5% The first two goals will bring FVT on par with industry benchmarks. In addition, the majority of the stakeholders would like to see growth for FVT, but have different preferences in achieving growth: Stephanie Lightfoot - Chief Executive Officer (CEO) ● Continue to build reputation and grow within industry ● Expand geographically Lanny Lightfoot - Chief Financial Officer (CFO) ● Achieve economies of scale ● Increase overall profits while maintaining controlled growth Viktor Pablo- Chief Technology Officer (CTO) ● Explore options to diversify company ● Expansion through Synergy 5 Kent Lightfoot - Chair Member ● Grow through mergers and acquisitions of new theatres in local communities ● Protect the FVT Brand Sheila Lightfoot - Chair Member ● Diversify film selections ● Protect the FVT Brand Current Competitive Strategy FVT intends to differentiate from other movie exhibitors by providing the local community with a premier entertainment experience. By presenting indie films that cater to local tastes and supporting local non-profit organizations in the entertainment and arts industry, FVT hopes to provide an experience to moviegoers that other exhibitors cannot replicate. However, FVT currently attracts customers by offering lower prices than its competitors. The company’s current strategy does not align with its vision and mission. The report has used two analyses (Appendix I, II) to gain an understanding over the internal and external factors that can influence the direction of the company. Constraints to Decision Making ● Stagnated growth in the supply of moviegoers, limiting revenue growth ● Debt covenant based on long term Debt-to-EBITDA 6 ● Limited cash on hand to support multiple strategic initiatives Financial Analysis Profitability Ratios Operating and Net Margins FVT’s operating and net profit margins are 5.4% and 3.0% respectively, both well below industry averages of 9% and 6%. This suggests that the company is not operating as efficiently as its peers, earning less on each dollar of sales. A few factors contribute to the low profit margins: ● Box office revenue per attendee (BORPA) - Currently at $8.67, $0.43 less than the industry benchmark of $9.10 and $0.22 less than the previous year. By charging less than competitors, FVT would need to lower costs in order to achieve profit margins that are at par with the industry. ● Concession revenue per attendee (CRPA) - This is at $4.95, which is $0.30 less than the industry benchmark but $0.32 higher than the previous year. In the past three years, CRPA has steadily grown. The fact that box office attendance has declined while CRPA has grown signals that patrons are willing to spend more on concession items. Return on Assets (ROA) FVT has a ROA of 4%, lower than the industry benchmark of 4.7%. The company is not utilizing its assets as efficiently to generate revenue compared to its peers. There could be opportunities to identify underutilized assets and use them to generate revenue more 7 effectively. Although higher than previous year’s return by 0.6% points, overall ROA has been trending downwards by 0.4% points since 2014. Return on Equity (ROE) FVT has a ROE of 10.8%, higher than the industry benchmark of 10.4%. However, it has declined 4.6% points over the past 3 years, signaling that FVT has struggled with declining profitability over that time frame. Liquidity Ratios Current Ratio FVT’s current ratio of 0.3 is below the industry average of 0.67, suggesting that the company may have difficulty in paying off its debts with its assets in the short-term. In order to compensate, FVT has been delaying payment on its payables. However, their current ratio has been trending upwards over the past 3 years, as FVT has been reducing their balance of short term liabilities. Quick Ratio FVT’s quick ratio is 0.22, a 27% decrease compared to the current ratio while the industry average is a 5% decrease compared to the current ratio. FVT could be taking on too much risk by not maintaining a reasonable buffer of cash and cash equivalents compared to the industry. Days in Payables 8 The average number of days it takes for FVT to pay off its payables is 44 days, which has increased by 5 days year over year. It is also 12 days above the industry average of 32 days. The company may not receive favourable credit terms from its suppliers, and costs may be higher due to avoidable interest on the outstanding payables. Days in Film Costs Payables FVT pays off its film costs payables in 33 days, which is 2 days earlier than the industry average of 35 days, and has decreased by 3 days since 2014. It is possible that FVT may not be taking advantage of the opportunity to hold onto a higher cash balance and stretching their payables to film suppliers. This is not optimal if there is no early payment discount with their suppliers. Solvency Ratios Debt-to-Equity (D/E) FVT’s D/E is 1.69, which is higher than the benchmark of 1.2. The company is more leveraged than its competitors, financing its growth with more debt than equity. Both solvency ratios have decreased since 2014, signaling that FVT has been reducing their overall debt obligation over time. However, high financial leverage plays a role in the poor profitability of the company, as a significant portion of its operating income (23%) goes towards interest payments. Furthermore, obtaining further financing through debt is more difficult and costly, given FVT’s debt position. 9 Long-Term Debt-to-EBITDA FVT has a debt covenant where its long-term debt (including current portion of longterm debt and excluding the retractable preferred shares) to EBITDA cannot exceed 2.5. It is currently at 2.02, suggesting the company has the ability to seek additional debt financing to pursue strategic initiatives. However, the company is already highly leveraged compared to its competitors, as mentioned above. Analysis of Strategic Options Option 1: Cinema LaRoche (CLR) An option for FVT is to acquire CLR, a theatre company currently operating in Quebec. Qualitative Analysis Advantages ● CLR has a loyal customer base and operates in Quebec ● Opportunity to expand geographically into another province. ● Theatre size is similar to FVT’s; management can utilize their current expertise. ● Marcel can stay for two years to assist the transition. ● Opportunity for FVT to access alternative film distributors. Disadvantages ● FVT has no experience/knowledge about Quebec market. ● Marcel more willing to sell shares of CLR to take advantage of CGE. 10 ● CLR is a flat organization with all decisions reporting to Marcel. ● Transition from Marcel to new management may propose challenges due to a heavy workload. ● Marcel’s replacement may lack of familiarity in CLR’s operation. Strategic Fit ● Vision - Aligned. CLR offers after-film parties with guest-speakers and 3D screen capabilities, which contributes to a premier experience. ● Mission - Aligned. CLR shares similar core values to FVT and selects films that appeal to the local communities. Valuation of CLR Income Based Valuation - Capitalized Cash Flow Approach (Appendix V) The value of CLR shares as calculated using the capitalized cash flow approach is approximately $7.8 million using 14% capitalization rate and $8.4 million using 16% capitalization rate. Asset Based Valuation - Net Asset Approach (Appendix VI) After fair value adjustments, the net asset value has decreased from $10.3 million to $6.1 million. By using a range of 14% to 16%, CLR is valued between $5.2 to 7 million. Conclusion 11 FVT should base their valuation on capitalized cash flow approach since it is typically used when the historical records of a company is reflective of anticipated future operating results. The recommended maximum purchase price is 8.4 million. Financing Needs The cost of purchasing CLR shares is $14 million. Marcel will consider a $6 million payable on closing and take back a note payable of $6 million and earn-out of $2 million payable in two-years, if revenue and operating margins are maintained. Ratio Analysis (Appendix IV) Solvency Ratios The solvency ratios suggest that CLR is highly leveraged compared to the industry and FVT. As a result, CLR is vulnerable to the risk of defaulting. It is risky since FVT has bank covenants to consider and acquiring CLR would increase their total debt. Profitability Ratios ROE (188.7%) is significantly higher than FVT (10.8%) in 2016 since CLR has no retained earnings, which artificially boost ROE. ROA (146.9%) is also significantly higher than FVT (4%) since Marcel owns the head office building. No value is recorded for PPE on the Balance Sheet, inflating ROA. Efficiency Ratios 12 CLR has 44 days in payables, which is the same as FVT. Days in film costs payable (40 days) is higher than FVT (33 days). This indicates that credit is not being utilized to take advantage of discounts and paying for avoidable interest costs. Financial Reporting Issues CLR would be considered subsidiary of FVT if shares were to be acquired and FVT has three option to account for the purchase of CLR: 1. Consolidation method: Consolidated financial statements would be prepared. All assets, revenues, expenses and revenues would be aggregated on a line-by-line basis; intercompany transactions and balances are eliminated and noncontrolling interest in subsidiary is recognized. 2. Equity method: The purchase is initially recorded at cost and the carrying value is adjusted thereafter to include FVT’s share of earning of CLR. Profit received from subsidiary reduces the carrying value of the investment. 3. Cost method: The investment is initially recorded at cost and earnings such as dividends are recognized only to the extent received or receivable. Tax Issues Acquiring CLR’s shares will allow Marcel to take advantage of the capital gains exemption. In addition, both FLL, FVT and CLR would share the $500K SBD limit. From FVT’s perspective, acquisition of control rules (AOC) will apply from the share purchase: ● AOC will trigger a deemed year-end for CLR. ● All accrued losses must be recognized at the deemed year-end. 13 ● Any net capital losses will expire on the AOC, which is a disadvantage to FVT. ● Non-capital losses may be carried forward to be used after AOC subject to certain conditions. FVT can continue to use current UCC pool for assets depreciation for tax purposes. Option 2: Connery’s Bar and Grill (CBG) The investment with Fred Connery will open CGB at a location adjacent to FVT’s London theatre. Under the partnership, FVT will own 40% of the business. Decisions will be made jointly and both parties will share in the net assets and net earnings of the business. Qualitative analysis Advantages ● There can be cross promotion with the restaurant and theatre ● Customized orders and new concession items. ● Good location ● Fred has 15 years of experience in the restaurant industry. ● Allows for diversification of non-theatre related revenue. Disadvantages ● FVT is not used to operating under joint decision making. ● Fred has not been successful in securing financing from 3 banks, which may signal issues with his forecasts ● Fred does not seem to have any experience in managing a restaurant. 14 ● The restaurant might not be a premier experience. ● The restaurant industry has intense competition Strategic Fit ● Vision – Aligned. The investment improves the entertainment experience at theatres through differentiated concession items. ● Mission – Aligned. The investment will allow FVT to tailor food items to the local community and improves the entertainment experience through differentiated concession items. Financial Analysis (Appendix VII) Cash flows are positive in all years of operation, totaling $447K for FVT’s share in earnings over 5 years. It will also create $112.5K in concession savings each year. However, based on a five-year lease, the investment has a NPV of -$97K with an IRR of 13%. Financial Reporting Issues FVT will have joint control and an equal share in the net assets and earnings. Thus, the venture is considered a jointly controlled enterprise under ASPE 3066. FVT can choose either the cost or equity method for financial reporting. Cost Method 15 The investment is recorded at cost, where any earnings received are recognized in income when received. Equity Method The investment is initially recorded at cost and is subsequently adjusted to reflect the investor's share of the net profit or loss. Any dividends will reduce the carrying amount of the investment. Financing Needs The investment will require $1 million immediately. Option 3: Premium Plus Viewing (PPV) FVT hopes to renovate two auditoriums in the London #1 theatre in 2017 and two more in the Leamington theatre in 2019 with recliner seating and wall-to-wall screens. If successful, FVT would implement this “Premium Plus Viewing” experience at other theatres. Qualitative Analysis Advantages ● Enhanced theatre experience will improve FVT’s brand in London, Ontario. ● New bar service and adult-only area would increase concession revenue and attract a new customer base. ● Improved technology would help FVT remain competitive moving forward. 16 ● FVT reduces business risks by pilot testing at select theatres. ● FVT can charge premium prices and raise admission revenues for the future. Disadvantages ● The PPV experience is only open to adults and not all age groups. ● PPV only improves the experience for customers at select theatres. ● Does not align with the Board o mandate to grow the company through expansion or diversification. ● FVT will need to keep up with the rapid changes to technology in order to continue charging premium prices. ● PPV will need to obtain liquor licenses and adhere to government regulations over serving alcohol. Strategic Fit ● Vision - Aligned. Improved auditorium technology and new bar service will contribute to FVT’s vision to provide a premier entertainment experience. ● Mission - Aligned. The investment tailors to local customers’ preference for an entertaining night out and a premier experience. Financial Analysis (Appendices VIII - X) The NPV of the investment is -$3K and $354K if a $8.50 premium or $10 premium is charged, respectively. Once all the renovations are complete, annual after-tax cash flows are estimated to be $1.3 - $1.4 million. 17 The contribution margin (CM) percentage is highest at 57.8% when an $8.50 premium is charged, compared to the current CM of 55.9%. The $CM is highest when a $10 premium is charged at $22 per attendee compared to $7.61 per attendee currently. However, the analysis assumes that CRPA would increase to $19 from $4.95, which may be optimistic. After the auditoriums are renovated and cash flows from PPV is stable, PPV is expected to improve net earnings by approximately 100%, assuming current earnings stay constant. Financing Needs An initial investment of $3.5 million in 2017 and $3.75 million in 2019 is required. Option 4: The Games Place (TGP) FVT will open an interactive amusement centre that will appeal to adults and children. TGP will have a restaurant and bar in addition to an assortment of interactive games. Qualitative analysis Advantages ● Aligned with Board’s mandate to diversify into other forms of entertainment. ● No similar establishment in London. ● Proposed location is near the head office. ● Credits will not expire, providing an incentive for customers to come back. 18 ● Targets a wide market. Disadvantages ● Arcades are not trendy; younger audiences prefer internet gaming ● 20-year lease with renewal every 5 years and penalties if terminated early ● Management lacks experience in this venture. ● Increased financial reporting complexity ● Arcades machines wear down quickly and need maintenance. Strategic Fit ● Vision – Not Aligned. FVT could alter the vision to be broader to cover the diversification of other entertainment sources, as TGP is not a theatre. ● Mission – Aligned. The investment offers a unique experience that will support the entertainment and arts in the local community. Financial Analysis (Appendices X-XII) The investment yielded an NPV of $662K.The forecasted balance sheet shows an increase in PPE balances and the recording of deferred revenue, prize point liability and ARO. Financing Needs TGP requires $6.1 million in upfront costs. The additional capital expenditures for games from 2022-2024 will can be financed through the incremental cash flows from TGP operations. 19 Financial Reporting Issues Revenue Recognition Per ASPE 3400, revenue can only be recognized once performance is achieved and collection is reasonably assured. The requirement for collection will be met since customers load credits to their play card. However, performance won’t be achieved until the credits are used. Prize Points Per IFRIC 13, the prize points should be interpreted as part of the sales transaction since it provides incentives to pay for a service. Therefore, the consideration of the points should be at fair value and be a separately identifiable component of the sale. Asset Retirement Obligation There will be an ARO at the end of the project to restore the location to its original state. Per ASPE 3110, the ARO will exist as a liability as it meets the definition of an obligation since restoring the site will not yield economic benefit to FVT. Recommendation of Strategic Option Based on our analysis of the strategic options above, we have assessed each option using the decision criteria below: Decision Criteria (1 Best to 4 - Worst) CLR CBG PPV TGP Meets Vision and Mission (Strategic Fit) 3 2 1 4 20 Provides Long-Term Sustainability 4 3 1 2 Meets Required Rate of Return 4 3 2 1 Upfront Investment Required 4 1 2 3 Financing Availability 3 1 2 4 Competitive Advantage - Differentiation 3 4 2 1 Total Score 21 14 10 15 Overall Ranking 4 2 1 3 Decision Criteria 1. Strategic fit: The strategic option must align with the FVT’s vision and mission. 2. Provides long-term sustainability: The option must improve FVT’s financial position and cash flows moving forward. 3. Required rate of return: The option must meet or exceed the Board of Director’s required rate of return. 4. Upfront investment required: Whether initial investment costs are required is a key decision factor, as it affects the company’s current cash flows and financing ability. 5. Financing availability: The company must be able to obtain sufficient funds for the strategic option. 6. Competitive advantage: The option must allow FVT to differentiate itself from other competitors for the future. Comparison of Strategic Options Cinema LaRoche (CLR) 21 Acquiring CLR is not recommended. Despite the opportunity to expand geographically into Quebec, there are too many risks associated with this option. The income-based and asset-based valuation suggests that the selling price of $14 million is overvalued. CLR is too highly leveraged by debt with negative cash flows. Additional costs relating to rent, capital expenditures, and new management salary and benefits will increase the overall risk. In addition, CLR does not offer assets that would help improve the entertainment experience at FVT’s current theatres. Also, CLR does not help improve FVT’s brand recognition. Finally, management is not experienced in the preferences and language of the Quebec market and transitioning Marcel out of his role will propose challenges due to his heavy workload. It would be best if FVT pursued another option at this time. Connery’s Bar and Grill (CBG) CBG fulfills the majority of the decision making criteria, bringing in steady cash flows with long term stability. There is alignment with both FVT’s vision and mission, as is improves the entertainment experience through unique concession items tailored to the local community. However, the investment has a return of 13%. FVT can negotiate to have 50% ownership, as there is joint decision making and an equal share of earnings and assets. Increased ownership has an NPV of $39K. If Fred agrees, the option is recommended. FVT can also meet their shareholder goal for BORPA by only offering discounts to restaurant patrons for premium admission tickets. The option should reduce concession costs and help increase earnings by $518k over the 5 year lease. 22 Premium Plus Viewing (PPV) Our financial analysis shows two separate outcomes based on the two price points: $3K NPV for an $8.50 premium and $354K for a $10 premium. Therefore, pursuing PPV is highly profitable and meets the Board’s required return of 15% if a $10 premium on admission fees is charged. PPV is aligned with FVT’s current mission and vision to provide a premier entertainment experience to customers. Based on our 10-year projection, PPV is a sustainable option, as it brings steady positive cash flows to FVT annually. As competitors have begun to implement similar high-end technologies, FVT will be able to maintain competitive with other theatres through PPV. After renovating the two auditoriums in London #1 theatre, FVT should assess the profitability of PPV compared to current projections. If PPV meets or exceeds current projected cash flows, FVT can consider implementing PPV in the Leamington location in 2019 and other locations in the future. FVT can reinvest the net cash flows from PPV to fund future renovations. The Games Place (TGP) Although TGP offers opportunities of long term sustainable profits, and differentiation in entertainment, it does not fit the vision of the company to improve the movie experience. The current management team does not have the expertise to be successful with a venture of this size within the gaming centre industry. Additionally, it is a risky 23 proposition since the company will need to invest a high amount of capital into assets over a long term in a building lease. FVT would inquire penalties if they wish to end the venture earlier, and deal with the aftermath of selling the assets and providing for the ARO. TGP does not synergize well enough with FVT’s current operations to justify the long term commitment. Therefore, it is not recommended at this time. Recommendation Our overall recommendation is for FVT to pursue and implement PPV and negotiate the ownership structure of CBG. Together with addressing operational issues identified below, FVT will achieve the growth goals set by the shareholders. Analysis of Secondary Options Flix Rewards One of the secondary proposals FVT should consider implementing is the Flix Rewards program. The points program will increase both box office and concession revenues and provide better value for FVT’s customers. Qualitative Analysis Advantages ● Synergy; Customers earn points at the theatre and restaurants (CBG). ● Analytics can be performed over customer data to identify trends. ● Access to new customers from different markets. ● Decreases buying power of consumers. 24 Disadvantages ● Risk of cannibalizing box office revenue. ● 4-year commitment required, with a penalty for ending the contract early. ● Increased complexity in accounting for the unredeemed points. ● Does not provide a sustained competitive advantage, as competitors have rewards programs. Strategic Fit ● Vision – Aligned. The loyalty program enhances the customer’s experience and synergizes with the company’s current operations. ● Mission – Aligned. The points will incentivize customers to return to the theatre for a premium experience, while tailoring rewards redemption to local community preferences. Financial Analysis (Appendices XV) From the analysis performed, FVT will be able to improve net sales by $2.7 million annually once implemented. However, the company will need to factor in the upfront cost of $3.5 million in the first year of implementation. Financial Reporting Issues FVT should expect 20% of the points to be unredeemed each year. As noted in the TGP’s analysis, reward points are considered a liability since the points offered 25 incentives for the customers to pay for the service. This means the company will need to record a liability on the balance sheet. Recommendation Based on the analysis above, FVT should implement the Flix Rewards program as it will open an opportunity to reward loyal customers, and encourage customers to return to their theatres and restaurants in the future. Given the shareholder’s goal of improving net earnings by 5% in 2017, the Flix Rewards should be implemented in 2018 to allow more flexibility in operations. The Mobile Strategy Another secondary option that FVT should consider implementing is the mobile strategy. This involves updating the company’s current website and developing a new mobile application that allows customers to book tickets online, view show times, write reviews and access other interactive functions. Qualitative Analysis Advantages ● Allows FVT to keep up with new technology and remain competitive ● Allows customers to interact with company website and enjoy service more conveniently, which aligns with FVT’s vision - providing premier entertainment experience ● Increase box office revenue by expanding methods to improve ticket sales. 26 ● FVT can leverage the mobile application to improve the experience by including linking trailers and reviews. Disadvantages ● Actual results and ROI are not easily measurable. ● There are on-going costs for FVT to maintain the website and mobile application. ● Research is required for the design of website and mobile application. The website will likely be completed within a year. Initial costs are $125K. Despite ongoing costs, there is low risk and FVT has sufficient cash flows to fund this option. The website is a strategic fit and improves the customer experience and should be implemented. Implementation Plan Task Time Frame Champion CBG Immediately with a July 1, 2017 launch date PPV Immediately Kent Lightfoot, as he is involved in managing FVT’s real estate and works with Zobair to find theatre Cost Zobair Terdel, $1 million as he has expertise in operations and execution of activities Initial costs of $3.5 million for auditoriums in London #1 theatre in 2017, and $3.75 million for the Leamington location in 2019. An estimated Other Requires a 50% ownership PPV auditoriums should be implemented in London #1 theatre first. As financial results are obtained from the first few years of PPV operations, FVT 27 locations. Flix Rewards Mobile Strategy 2018 $20,000 for initial concession inventory for each new location. Suisui Yang, $3.5 million and as she is in $0.02 per point charge of earned marketing and has been in contact with Flix Rewards Immediately Viktor Pablo, as he is experience with implementing IT $125,000 should evaluate expansion of PPV to other theatres. 4 year commitment; penalty if terminated early May require ongoing costs for maintenance Financial Forecast and Financing A pro forma income statement and balance sheet are provided in Appendix XIX & XX. Key Performance Indicators Based on the recommendations, net earnings will increase 11.2% (compared to the 5% growth goal) to $2.2 million in 2017, and grow from $2.75 to $7 million over the next 4 years. The forecasted BORPA will rise from $8.67 to $8.85 in 2017, meet the shareholder target in 2018, and hit $9.44 in 2019 when PPV has been fully implemented. As CBG has only been implemented at one location, the cost savings generated will not have a significant impact on overall concession costs, which will remain at 25% of concessions revenue. Further expansion will allow for more significant concession cost savings. CRPA will also surpass industry standards in 2018, at $5.27. The growth in earnings will increase the cash balance each year, allowing FVT to 28 accelerate expansion of PPV in other theatres, possibly pursue additional strategic investments, and pay down existing debt. Debt Covenant The growth in EBITDA and cash flows from earnings will help reduce overall long term debt, lowering the debt to EBITDA covenant to 2.02 in 2017 and 1.64 in 2018. Financing Financing Required PPV Flix Rewards CBG Mobile Strategy Total Cost Year 1 Year 2 Year 3 $3,500,000 $250,000 $3,750,000 $0 $3,500,000 $150,000 $1,000,000 0 0 $125,000 0 0 $4,625,000 $3,750,000 $3,900,000 Sale and Leaseback (Appendix XIII) The proceeds from the sale of the building is $10.12 million. The lease is considered an operating lease since there is no bargain purchase option or ownership being transferred at the end of term, the lease is not a major part of the economic life of the property, and the PV of $3.7 million is not substantially greater than the fair value of the leased asset. The profit of $4.4 million that resulted from the transaction is deferred and in proportion to the rental payments over the lease term, which is 5 years. Therefore, $870K of the deferred profit is recognized as revenue each year. 29 Redemption of Shares (Appendix XIII) The delayed redemption of shares will free up $1.5 million in cash flow each year. If the redemption price increase is not waived, FVT can defer $9.16 million in total over the five years. If FLL can waive the 10% penalty increase in redemption price, a total of $7.5 million in total can be deferred over the five years and $1.66 million will be saved from penalty fees. Financing Recommendation FVT has $1.86 million cash on hand available. It is recommended that FVT should accept the sale and leaseback offer to assist with the financing of PPV, CBG, Flix Rewards and the Mobile strategy. This will add an additional $10.12 million in available financing, increasing the total available financing funds to $11.98 million. Total initial financing required for all recommendations is $8.13 million (Appendix XVII). With the remaining cash of $3.85 million, FVT can consider retaining the cash in short-term investments in order to earn a return. This will allow FVT to have $3.75 million in cash available to be used for the PPV investment at Leamington theatre in 2019. Alternatively, FVT may also make repayments on their long-term debt to reduce financial leverage, or considering funding pension plans for employees. Analysis of Operational Issues General Operational Issues Vision and Mission Statement Update 30 The vision and mission statements have been updated to reflect the recommendations provided above: Vision “Our vision is to ensure every guest enjoys a premier entertainment experience each and every time they visit our theatres, with innovative technology, unique cuisine and excellent customer service.” Mission “To provide a premier entertainment experience tailored to the local community. We accomplish this by hiring and training employees to be respectful, attentive and friendly; selecting the best films and crafting unique cuisine to appeal to the local community; ensuring clean and safe venues for employees and attendees; and supporting premium entertainment and arts in the local community.” Governance Issues Board Composition Viktor (CTO), Lanny (CFO), and Stephanie (CEO) are currently part of the management team at FVT as well as holding a position in the Board of Directors, which causes a conflict of interest since they are potentially assessing their own performance and compensation. Therefore, opinions and decisions are subjected to bias due to their personal involvement with the company. FVT should consider additional board 31 members that have experience in the theatre industry, but also expertise in audit, finance and law to complement existing members. Board Structure Board members have a lot of responsibilities without defined roles. It is also not practical for the entire board to meet on every single matter. FVT currently has no formal board of committees to review hiring and audit functions, which increase risk if the company continues to grow. Common subcommittees recommended to be established are the following: ● Nominating Committee - responsible for evaluating board size and effectiveness. ● Audit Committee - responsible for overseeing the company’s quality and integrity of financial reporting functions. The Board only meets twice a year and since major shareholders have different opinions regarding the future of the company and strategy the company should moving forward, it is recommended to increase the frequency of meetings to four times per year to discuss quarterly financial results, and ensure actions that are implemented align with FVT’s strategy. Code of Conduct and Ethics FVT requires a code of conduct and code of ethics to prevent the risk of legal liability and loss of reputation with the company. Senior management is also prone to the risk 32 of personal liability if they fail to develop ethical standards to follow. The code of ethics should reflect the values of FVT as well as standards of society. The code of conduct will define what is considered acceptable and unacceptable employee behavior. The policy document will also indicate the implications resulting from violation of the code of conduct which can include suspension, penalties, and possible dismissal. Performance Management Issues The Balanced Scorecard The Balanced Scorecard (Appendix XIV) is a performance measurement tool starts at the organization’s mission and vision. Strategic objectives are then determined in alignment to the mission and vision, and finally how each objective will be measured. The BSC allows organizations to: ● Provide expectations to employees and measure their actual results. ● Allow employees to develop their own personal goals. ● Recognize how their actions impact the organization’s objectives, and align their goals with the shareholders goals. ● Recommend areas for improvement. ● Apply bonus compensation in a structured way. Bonus Structure The current bonus structure has a few drawbacks: 33 ● No fixed formula for the bonus pool ● No fixed guidelines for distribution ● No formal indicators are used for assessment As a result of these drawbacks, employees are unaware the bonus amount each year, and whether or not a bonus is justified, which some employees may feel is unfair. To mitigate this, FVT can tailor the BSC to each individual employee and measure their achievements of objectives. Based on the weights assigned in the BSC and the maximum bonus for each employee, FVT can calculate the bonus amount, while providing a feedback mechanism for their performance. Retirement Planning Alternatives A retirement plan can increase employee satisfaction, as they recognize the organization is making a long term investment in their future. FVT can look at 3 options for retirement planning: ● Defined contribution plan ● Defined benefit plan ● Deferred profit sharing plan Defined contribution plan Under a defined contribution plan, the organization pays a fixed contribution to the plan administrator. As the contribution is fixed, the employee bears the risk of how the fund performs, in case the fund does not hold sufficient assets to pay benefits. 34 Defined benefit plan Under a defined benefit plan, the future benefits paid out are defined in the plan terms. As the benefits are defined, the employer bears the actuarial and investment risks. Due to the additional risk, financial reporting is more complex. Deferred Profit Sharing Plan Under a deferred profit sharing plan (DPSP) the employer elects to share profits with employees. The employee bears the risk of the plan, as contributions are based on company performance, and benefits are not defined. Tax Implications The tax implications are similar across the three types of plans. Contributions made by FVT to the plan are deductible for tax purposes. For employees, any contributions they make to the RPP is deductible; they do not make contributions for a DPSP. Furthermore, employees do not pay personal taxes on the RPP or DPSP until the funds are withdrawn from the plan, deferring income taxes. However, a DPSP cannot be registered if the employer or related individual is a beneficiary (Kent, Sheila, Stephanie, Lanny and Viktor are shareholders). Taxes will not be deferred for those individuals. Setting up a RPP or DPSP to compensate employees would be more tax efficient than paying bonuses, as this would be taxable to employees. 35 Audit Issues Control Deficiencies Based on the current procedures, there are a deficiencies that could be improved at the Sarnia theatres. They affect both admission and concession sale procedures. See Appendix XXI for an explanation of risks and areas for improvement. Goodwill Impairment (Appendix XVI) Per ASPE 3064, goodwill should be tested for impairment when there are indicators that the carrying value of the asset is greater than the fair value. When the carrying value is indeed greater than the fair value, the asset will be impaired and written down to its fair value. In the case of Sarnia operations, the emergence of a national competitor and a decline in their projections are impairment indicators. Per the analysis performed (Appendix XVI), the fair value of the company was determined to be $3 million, while the carrying value of the company was $5.4 million. This means that goodwill is possibly impaired and a write-down equal to the excess calculated ($2.3 million) may be required. This will need to be investigated further by the auditors. In order to test the impairment, the auditors will need to inquire with management about indicators of impairment. Auditors will ask for support such as internal financial statements to calculate their own forecast and projection. Afterwards, they will need support for the carrying value of any material assets or liabilities (such as equipment and leasehold improvements) to calculate the anticipated carrying value for comparison against the fair value of the goodwill. They will likely vouch the assets to invoices and 36 recalculate the depreciation on the PPE to determine the carrying value. Lastly, the auditors will need to test the valuation of FVT’s anticipated fair value. FVT will need to provide their calculation working papers and documentation that will allow the auditors to perform their own calculations for reasonability. Tax Issues Employer-provided Vehicle FVT would like to determine whether providing cars to executives would be more tax efficient for the executives than providing an annual allowance of $24,000. The executives would receive taxable benefits known as standby charge and operating cost benefits if they were provided with a vehicle owned by FVT. The standby charge is based on the purchase or leased cost of the vehicle, and the benefit is reduced if the vehicle is primarily used for business purposes (>50%). Whether this is more tax efficient than a fully taxable allowance of $24,000 is dependent on the cost and usage of the vehicle. FVT may also consider providing a reasonable allowance based on kilometres instead, which is not taxable to the employee. This would be the most tax efficient option. Dividends or Salaries Kent and Sheila earn $350,000 in annual salaries, but would like to receive dividends instead moving forward. There are a few advantages and disadvantages in compensating shareholders with dividends compared to salaries: 37 Advantages ● Dividends are not subject to personal withholding taxes, such as EI and CPP, which need to be deducted each pay period and remitted to the CRA regularly. ● Dividends do not need to meet the reasonability test, as it is not deductible to the corporation. Salaries need to be reasonable for the amount and type of work performed by the employee. As Kent and Sheila are planning to cut back on work in FVT, the CRA may question the deductibility of a $325,000 salary. Disadvantages ● Dividends do not create contribution room for RRSP. Income used to make contributions to an RRSP is not taxable to the individual; instead, taxes are deferred until funds are withdrawn. ● Dividends are not deductible to the corporation, so FVT would have an increase in taxable income of $650,000 if salaries were not paid to Kent and Sheila. Typically, a mixture of dividends and salary as compensation for shareholders would be most tax efficient. However, more information on FVT’s current tax position and the shareholders’ personal income sources is required to provide an accurate estimate. Finance Issues Hedging Foreign Exchange Risk The US exchange rate has been fluctuating significantly since 2014 and it is recommended that FVT should look into hedging to decrease the risk of foreign 38 transactions. A forward and future contract are similar in nature, but the difference is that forward contracts are privately negotiated while future contracts exchange traded with less risk. Appendix XVIII provides a qualitative analysis associated with the contracts. It is recommended that FVT purchase the future contract and lock in at the December 2017 rate of 0.7766 since this will achieve the highest foreign exchange gain, while mitigating foreign exchange rate risk. Conclusion After evaluating FVT’s business model and assessing the internal and external situational analysis as well as analyzing the current strategic options available, we recommend to implement PPV and CBG. These investments will be financed with the help of sales leaseback, which will increase available funds by $10.12 million. With the residual funds, we recommend FVT to implement mobile strategy and Flix Rewards, which will complement the implemented strategic options. These options will help the board achieve their core objectives as well as support the company’s vision, mission, and values. 39 Appendices Appendix I: SWOT Analysis Strength (Internal) ● FVT has an established reputation in their community. ● Differentiates itself from market leaders by understanding the locals and what films appeal to their local community. ● Sheila has a strong relationship with film distributors. This gives FVT an advantage, since the company is usually able to obtain their desired licenses for films. ● Significantly lower employee turnover rates compared to the industry average. ● Kent and Sheila are involved in the community and in several charitable boards. ● FVT promotes from within, which increases motivation for employees to work hard in order to be promoted. ● All theatres have gone through upgrades, which is beneficial since comfortable seating and overall theatre quality are leading factors that moviegoers consider. ● A simple board structure compared to other companies, which may speed up the decision making process. ● FVT has added arcades in their theatre lobbies Weakness (Internal) ● FVT currently has weak controls in place to prevent theft, which could result in lower profit margins. ● Limited capital to pursue strategic options. ● The company website is also outdated, which results in FVT losing market share against their competitors who have a more interactive and up-to-date website. ● No pension plan for employees and no retirement/deferred profit sharing plan for senior management. ● Management has different opinions regarding the future of the company ● No fixed guidelines on how bonus is distributed, which concerns the CEO. ● There is no code of conduct and code of ethics, which increases the risk of legal and personal liability. ● No formal subcommittees to assist the board in decision making. (i.e. Compensation, Risk, etc.) 40 Opportunities (External) Threats (External) ● There is a large untapped market for special event exhibition for small-budget films with a message, but this may tarnish FVT’s brand. ● Many companies are broadening their concession items to include lunches, dinners, and bar services. This is an opportunity for FVT to attract consumers who are interested in a “night out”. ● There is a trend to implement a rewards program to increase customer loyalty. ● Heavy moviegoers in Canada primarily reside in Ontario (49%), while Quebec is the second largest (21%). (Source #1) ● There have been recent technological advancements in entertainment (virtual reality) that FVT could capitalize on to enhance the theatre experience. ● Partner with local vendors to provide concessions tailored to the local community. ● Enhanced digital platform for purchasing tickets where FVT can track moviegoer preferences and use targeted advertising. ● To expand or acquire companies within Ontario or at another province. ● Few key players dominating the market, which increases the risk of consolidation. ● There is also a rise of cheaper substitutes to view films. ● Competitive mature market with slow growth ● Profits are highly dependent on filmmakers and the quality of the films released in a given year. ● Shorter exhibition times for films, which causes revenues to decline. ● Film costs are affected by USD exchange rates, which increases the risk of foreign exchange loss if the Canadian conversion is unfavourable. ● 28% of moviegoers are attending less films, while only 10% are attending more. (Source#1) ● Larger competitors have the economies of scale to implement disruptive changes in the industry. ● Cineplex is the leader in revenue and operates in all of the busy and profitable metropolitan areas (i.e. Toronto, Montreal, and Vancouver) and earn three times as much as the industry average per location. (Source#2) 41 Appendix II: Porter’s 5 Forces Barriers to Entry (Level: High) ● Theatre exhibition industry is in a mature stage, which results in lower profit margins and slow growth. ● Industry requires heavy capital to enter and to remain competitive, smaller operators need to focus on upgrading their facilities to include the latest technology. ● There are only a few key players dominating the market. Industry leader holds 65% market share. Bargaining Power of Suppliers (Level: High) ● Companies compete for film licenses and exhibitors must negotiate film costs on a film-by-film and theatre-by-theatre basis. ● Suppliers hold high bargaining power, since film distributors represent major production companies who own the film, so FVT cannot easily switch suppliers. Competitive Rivalry (Level: High) ● Two of the largest companies in the industry own 73% of the market share, while the remaining 27% of the market is shared amongst 416 companies. ● Increased risk of consolidation occurring within the market. ● Industry is not considered attractive for newcomers due to its low profitability, slow growth, and competitive nature. Bargaining Power of Customers (Level: High) ● Variety of options to watch films at a lower cost and revenues are dependent on whether or not the consumers have the disposable income. ● Consumers will diverge to other substitutes if FVT’s prices are too high. Threat of Substitution ● There are numerous alternatives to visiting the theatres. (Level: High) Consumers have the choice of watching in-home videos, DVD’s, pay-per-view, digital downloads, and internet streaming. ● It requires little to no cost for consumers to switch to these other mediums. 42 Appendix XXI - Control Deficiencies Weakness Implication Response Admission Sales - Only 1 staff member validates and checks movie tickets prior to admission into theatre Staff members could be allowing their friends into the theatre without a ticket, or allowing their friends to provide fake tickets for admission. FVT should hire a second staff member that will check the tickets alongside the first staff member. This would prevent the staff members from allowing their friends into the theatre without a valid ticket. Admission Sales Assistant Manager manually inputs the number of people in the auditorium prior to the film starting This process is manual which can lead to human error when inputting the values. This could be causing the discrepancy when the daily reconciliation is performed FVT should have a second person perform a count prior to the start of the film to ensure the count is agreed upon by both counters. A recount will be performed if there are differences. Admission Sales Employee staff members are able to attend free films, however, no record is kept The discrepancy from the reconciliation could be related to the unrecorded staff members viewing free films FVT should record and track employees that are viewing free films. Their attendance should be included into the daily reconciliation. Concession Sales - A inventory count is performed on a weekly basis and compared to the perpetual inventory record Inventory counts are performed too infrequently and does not provide management enough time to deal with discrepancies FVT should implement daily inventory counts to determine to track discrepancies between the count and the perpetual system. Any variances can be followed up on with staff members that were on shift that day. 43 External Sources Telefilm and Movie Theatre Association of Canada (June 2015). Canadian Movie-going Statistics. Retrieved from https://telefilm.ca/en/studies/canadian-moviegoing statistics Gavin Smith (March 22, 2013). Movie Theatres in Canada Industry Market Research Report. Retrieved from http://www.prweb.com/releases/2013/3/prweb10557302.htm 44 Appendix III: Vertical and Horizontal Analysis DRAFT 2016 $ AUDITED 2015 $ AUDITED 2014 $ YoY Change 2016 2015 2016 % of Sales 2015 2014 Revenue Box office revenue Concession revenue Other income — arcade games Other income — party room rentals Total revenue 41,057 23,445 660 344 65,506 46,511 24,224 651 341 71,727 45,117 22,481 648 350 68,596 -11.7% -3.2% 1.4% 0.9% -8.7% 3.1% 7.8% 0.5% -2.6% 4.6% 62.7% 35.8% 1.0% 0.5% 100.0% 64.8% 33.8% 0.9% 0.5% 100.0% 65.8% 32.8% 0.9% 0.5% 100.0% Expenses Film costs Concession costs Advertising and promotion Amortization Employee wages and benefits Employee bonuses Rent Theatre operating costs General and administrative Total expenses 24,142 5,887 718 4,691 11,868 1,250 3,926 7,972 1,536 61,990 25,953 5,261 703 4,640 13,075 3,975 4,020 8,607 2,078 68,312 23,362 5,176 695 4,628 13,292 1,850 3,978 9,550 2,080 64,611 -7.0% 11.9% 2.1% 1.1% -9.2% -68.6% -2.3% -7.4% -26.1% -9.3% 11.1% 1.6% 1.2% 0.3% -1.6% 114.9% 1.1% -9.9% -0.1% 5.7% 36.9% 9.0% 1.1% 7.2% 18.1% 1.9% 6.0% 12.2% 2.3% 94.6% 36.2% 7.3% 1.0% 6.5% 18.2% 5.5% 5.6% 12.0% 2.9% 95.2% 34.1% 7.5% 1.0% 6.7% 19.4% 2.7% 5.8% 13.9% 3.0% 94.2% Operating income (loss) 3,516 3,415 3,985 3.0% -14.3% 5.4% 4.8% 5.8% Interest income Interest expense Foreign exchange gain (loss) Income before taxes Income taxes (25%) 22 (792) (93) 2,653 663 23 (851) (172) 2,415 604 15 (910) (55) 3,035 759 -4.3% -6.9% -45.9% 9.9% 9.8% 53.3% -6.5% 212.7% -20.4% -20.4% 0.0% -1.2% -0.1% 4.1% 1.0% 0.0% -1.2% -0.2% 3.4% 0.8% 0.0% -1.3% -0.1% 4.4% 1.1% Net earnings 1,990 1,811 2,276 9.9% -20.4% 3.0% 2.5% 3.3% Appendix IV: Financial Statement Ratios Comparable ratios Box office revenue per attendee Concession revenue per attendee Box office revenue per theatre (in $thousands) Liquidity ratios Current ratio Quick ratio Solvency ratios Long-term debt to equity Total debt to equity Total debt to assets Activity ratios Days in concession inventory (ending inventory only, and not average) Days in payable Days in film costs payable Profitability Film costs to box office revenue Concession costs to revenues Advertising as % of revenues Employee wages / benefits as % of revenues Theatre costs as % of total revenues G&A as % of total revenues Operating margin Net profit margin Return on assets ROA adj for after-tax bonuses Return on equity Debt Covenants Long term Debt to EBITDA Pro Forma Statements Benchmarks 2019 2018 2017 $9.10 $ 9.44 $ 9.10 $ 8.85 $5.25 $ 5.54 $ 5.27 $ 5.07 $ 4,453 $ 3,825 First View Theatres Inc. 2016 2015 2014 $ 8.67 $ 8.89 $ 8.75 $ 4.95 $ 4.63 $ 4.36 $ 3,732 $ 4,228 $ Cinéma LaRoche 2016 2015 $ 9.25 $ 9.11 $ 5.34 $ 5.27 $3,948 $ 4,635 4,102 0.67 0.64 1.66 1.60 1.32 1.27 0.95 0.90 0.30 0.22 0.29 0.23 0.25 0.18 0.50 0.36 0.52 0.36 0.47 1.2 0.54 0.49 0.59 0.30 0.74 0.86 0.37 0.97 1.11 0.42 1.24 1.69 0.63 1.56 2.24 0.69 1.95 2.55 0.72 4.61 7.16 5.57 3.20 5.59 4.50 21 32 35 23 39 28 22 40 31 26 41 32 23 44 33 27 39 34 26 36 36 25 44 40 28 42 40 52% 23% 2% 59% 25% 1% 59% 25% 1% 59% 25% 1% 59% 25% 1% 56% 22% 1% 52% 23% 1% 53% 25% 5% 53% 24% 6% 19% 15% 16% 18% 18% 18% 19% 18% 18% 12% 6% 9% 6% 4.7% 4.7% 10.4% 11% 2% 9.8% 7.5% 10.6% 10.6% 20.8% 11% 2% 4.6% 3.5% 5.1% 5.1% 11.8% 12% 2% 4.3% 3.3% 4.1% 4.1% 10.7% 12% 2% 5.4% 3.0% 4.0% 4.0% 10.8% 12% 3% 4.8% 2.5% 3.4% 3.4% 11.1% 14% 3% 5.8% 3.3% 4.4% 4.4% 15.6% 14% 91% 8.6% 6.6% 146.9% 14% 93% 6.9% 5.4% 114.6% 188.7% 142.4% 0.98 1.64 2.02 2.02 2.22 2.22 Appendix V: Income Based Valuation Valuation of Cinema LaRoche Capitalized Cash Flow (in thousands of $) Step 1 - Estimated maintainable operating cash flow (normalized EBITDA) Notes Income before interest and taxes Add/deduct: Building Rental Income Manager Salary and Benefit Savings in General and Admin Costs Lease Savings due to Favorable Rates Income from Marketable Securities Add: Amortization Per Income Statement $ (1) (2) Estimated maintainable operating cash flow (normalized EBITDA) $ 2016 4,587 $ 2016 4,587 (250) (425) 300 (117) (178) (250) (425) 300 (117) (178) 2,013 2,013 5,930 $ 5,930 Step 2 - Capitalized cash flow Estimated maintainable operating cash flow (EBITDA) Income taxes Annual maintainable cash flow from operations after tax $ Sustaining capital expenditures Maintainable discretionary cash flows Capitalization rate Capitalized discretionary cash flows Average Capitalized discretionary cash flows PV of CCA tax shield of equipment PV of CCA tax shield of Leasehold improvement Capitalized value of operations Add-back: Redundant marketable securities Enterprise value Interest bearing debt Estimated fair market value of equity (3) (3) 5,930 $ (1,483) 4,448 5,930 (1,483) 4,448 (2,300) 2,148 14% 15,339 12,768 (2,300) 2,148 16% 13,422 13,422 1,849 123 14,739 1,690 16,429 (8,623) 7,806 1,746 140 15,308 1690 16,998 (8,623) 8,375 Conclusion: The value of Cinema LaRoche shares as calculated using the capitalized cash flow approach is approximately Notes (1) Salary and benefits of the two managers replacing Marcel: $170,000 x 2 x 1.25 = 425,000 (2) Lease adj due to favourable market rates for Pierre, Laurent and Sharone theatres = 116,880 The favourable market rate is temporary and rate may change in the future, therefore the saving is not maintainable and should be subtract from operating income 14% 16% (3) PV of CCA tax shield for equipment 1,848,529 1,745,833 PV of CCA tax shield for leasehold improvement 122,500 140,000 Hidden below are case facts Appendix VI: Asset Based Valuation Cinéma LaRoche Balance sheet (As at November 30) (Under ASPE) (In thousands of C$) 2016 Assets Current assets Cash and cash equivalents Marketable securities Concession inventories Latent taxes and selling costs Total current assets Property, plant and equipment Forgone Tax Shield Latent taxes and selling costs Total assets Liabilities Current liabilities Trade payables and accrued liabilities Film costs payable Deferred subscriber fees Total current liabilities Shareholder's loan Total liabilities Total Value Book Value FMV Adjustment 20 1,690 315 Adjusted Net Asset Value (79) 20 1,690 315 (79) 1,946 (1,845) (637) (1,283) 19,450 (637) (1,283) 19,476 1,923 1,860 985 4,768 - 1,923 1,860 985 4,768 8,623 13,391 - 8,623 13,391 2,403 21,295 23,698 10,307 Low (-14%) High (+16%) 6,085 5,233 7,058 Notes: Note 1: Forgone tax shield Equipment - Class 8 (20%) FMV > Tax Value (17030*20%*25%)/(15%+20%)-(12570*20%*25%)/(15%+20%) Note 2: Original Cost Fair Market Value Selling Costs (3% of proceeds) Net Proceed for Tax Purposes Lower of Cost or Proceeds UCC / ACB Recapture (Terminal Loss) Taxabale Capital Gain - 50% Taxes @ 25% Latent Taxes and Selling Costs Hidden below are case facts 637 Equipment 16,940,000 17,030,000 (510,900) 16,519,100 16,519,100 12,570,000 3,949,100 Leasehold 4,355,000 2,420,000 (72,600) 2,347,400 2,347,400 3,500,000 (1,152,600) 987,275 1,498,175 (288,150) (215,550) Securities 1,4...
Purchase answer to see full attachment