MOVING FORWARD ANNUAL REPORT 2010 ABOUT CINRAM
Cinram International Inc. is an indirect, wholly owned subsidiary of Cinram International Income Fund. We are one of the world’s largest providers of pre‑recorded multimedia products and related logistics services. Our facilities in North America and Europe have the capacity to manufacture approximately 2.1 billion DVDs, 57 million Blu-ray discs and 459 million CDs each year. An integral part of our offering is distribution and supply-chain management services, which we provide to customers such as motion- picture studios, music labels, video game publishers, computer software companies, telecommunications companies and retailers around the world. At the end of 2010, Cinram had approximately 8,800 employees worldwide. Our units are listed on the Toronto Stock Exchange under the symbol CRW.UN. www.cinram.com
2 Taking the reins 4 Building the bridge 6 Raising the bar 8 Chairman’s message 9 Letter to unitholders 13 Management’s Discussion and Analysis 59 Consolidated Financial Statements 64 Notes to the Consolidated Financial Statements 104 Financial Highlights 106 Comparative Balance Sheets OVER THE PAST YEAR WE CONTINUED TO ADD VALUE, PROVIDE SOLUTIONS AND DELIVER EXCITEMENT. DESPITE SOME SIGNIFICANT BUSINESS CHALLENGES, WE STAYED FOCUSED ON MAKING FUNDAMENTAL IMPROVEMENTS AND PUTTING IN PLACE THE FOUNDATIONAL CHANGES THAT WILL ALLOW US TO CAPITALIZE ON FUTURE OPPORTUNITIES. NOW WE’RE MOVING FORWARD ON OUR STRATEGIC PLAN, ENHANCING BOTH OUR PHYSICAL AND DIGITAL OFFERINGS, AND ENSURING THAT A WORLD-CLASS ORGANIZATION WILL ONLY GET BETTER.
Cinram 2010 Annual Report 1 TAKING THE REINS
SOMETIMES THE TOUGHEST CIRCUMSTANCES BRING OUT THE BEST IN PEOPLE. WE’VE TURNED ADVERSITY INTO FOCUS AND CHALLENGE INTO OPPORTUNITY. AND NOW WE’RE READY TO ACCELERATE THE PACE.
2 Cinram 2010 Annual Report FORWARD MOMENTUM A firm purpose, a shared focus, and the ability to adapt as we go. These are the things that set Cinram apart.
resilience, what we find on the other side is resoundingly optimistic. We have always moved forward with purpose while adapting dynamically to the evolving needs of customers. The Warner termination presented a significant obstacle, forcing us to make a number of complex decisions. They were the right decisions, and, thanks to the strength and spirit of our people, we continued to deliver solid financial results, maintain uninterrupted customer support and outperform the market. Now, with client satisfaction as high as ever, it’s full steam ahead. In 2009, we began executing the long-term strategic plan laid out by CEO Steven Brown. This momentum has already been highlighted The unexpected termination of one of our by some exciting wins, including the acquisition main customers, Warner, in 2010 required us of 1K Studios, a leading digital media studio to take corrective action, but it did not divert whose innovative flair and technical brilliance our overall focus or alter our ongoing will enhance our digital content delivery commitment to excellence. platforms and allow customers to have truly special experiences today and in the future. Out of challenge comes focus, and we lived We also launched a new version of our popular that dictum all year, putting us in a strong vendor-managed inventory software, Vision 2.0, position for 2011 and beyond. We made tough to strong market response. These are just a few decisions and focused on our most important of the bright spots, with many more on the strategic priorities. As a result of this collective horizon as we drive forward.
Cinram 2010 Annual Report 3 BUILDING THE BRIDGE
Our company mission involves making a KEEPING OUR FINGER number of small connections in order to ensure ON THE PULSE successful connections on a larger scale. In a world where technology We connect ideas and information. We offerings expand constantly, Cinram is committed to connect different parts of the supply chain. staying in lock-step with Most important, we bring exciting products consumer preferences. into the hands of customers around the world.
At Cinram, we like to think of this as building bridges. Among the most important bridges we build are those within our own company. Only from cross-pollination can you unearth the best ideas from the greatest number of As a result, our customers have shown us people. Across individual sites and broader great support, and in turn we’ve delivered the geographies we stress information exchange outstanding service they’ve come to expect. and idea-sharing constantly, making us a better, stronger organization that uses its resources Finally, we are building a bridge between the in optimal ways. We continue to discover how physical media formats that remain crucial bright, creative and committed our people are, to our business and the digital platforms that and those qualities are enhanced many times continue to evolve almost daily. As our logo over by the collaboration we promote. symbolizes, support of our core physical market remains as important as ever, while at the same Of course, bridge-building doesn’t just happen time we are putting in place measures that will on the inside. We take great pride in the ensure we are on the leading edge of enhanced interaction we maintain with our customers. digital offerings. Whether the customer wants Knowing what your customer needs means their content packaged traditionally or in newer listening, understanding and responding. It formats, we will enable that delivery. We like to is a testament to our people that, despite the think of ourselves as analogous to the candle challenges we encountered over the past year, maker. He isn’t in the business of candles. our relationships remained as solid as ever. He’s in the business of light.
4 Cinram 2010 Annual Report CONNECTING WITH OUR CUSTOMERS. COLLABORATING WITH EACH OTHER. LINKING THE TRADITIONAL WITH THE INNOVATIVE. AT CINRAM, DELIVERING EXCITEMENT MEANS BUILDING BRIDGES.
Cinram 2010 Annual Report 5 RAISING THE BAR
THE ONLY WAY WE’RE HAPPY IS IF OUR CUSTOMERS ARE HAPPY. WE DON’T AIM TO BE GOOD. WE AIM TO BE THE BEST.
6 Cinram 2010 Annual Report ENTERTAINMENT VALUE The desire to be entertained has always existed; it’s the form that changes over time. Cinram will enable entertainment in whatever form it may take — today, tomorrow and into the future.
Delivering excitement happens on two fronts. Our revitalized brand identity marks the start We deliver exciting results and experiences of what we know will be a successful journey. to our customers, and also for our customers. Whatever type of entertainment a consumer Delivering excitement to our customers seeks, be it movies, music, games or their new means providing them cutting-edge products, phone or tablet, and in whatever manner of outstanding business results and flawless delivery, whether box, truck or by digital means, customer service. Delivering excitement for we will make it happen. our customers means helping them get their own exciting products into consumers’ hands. To execute this goal, we must continue our pursuit of maximum efficiency throughout the In both cases, we strive for nothing less than organization. We have already implemented making the customer experience perfect steps to maintain our volume levels while leaving at every touchpoint. We recognize this is a a smaller footprint, and we continue to identify lofty expectation, and we aim to meet it. ways to drive out waste at every opportunity. Our internal expectations in this regard are likewise high. We aren’t looking at what we’ve done; we’re looking at what we’ve yet to do. If we’re shipping boxes that are three-quarters full, there’s still one quarter of opportunity to be seized. This mindset exists top to bottom and is reflected in the efforts of groups like our Cinram Retail Services division, a brain trust that is showing the marketplace inventive ways to minimize cost and maximize space.
Finally, while our balance sheet has seen significant deleveraging, we have full lender support to reduce the company’s indebtedness to our lowest level in history, and this support is in place for another three years. We are on firm footing – and committed to delivering excitement every step of the way.
Cinram 2010 Annual Report 7 FROM THE CHAIRMAN
WILLIAM J. ANDERSON Chairman Cinram International Income Fund
This past year brought with it a number of challenges, A key part of 2010’s challenge was the need to make most significant among them the loss of a major customer, some difficult decisions resulting from the Warner loss. Warner Home Entertainment, and protracted refinancing Your management team, along with the Board of Trustees, and restructuring events. But out of adversity often comes undertook this task with a view toward ensuring a profitable renewed strength and focus. In the wake of the challenges future for the company. Staying focused and performing that arose we have seen a number of strong positives, well are not always easy when tough decisions are being resulting in a revitalized Cinram bolstered by a long-term made around you, but everyone at Cinram redoubled their renewal from our largest customer, a well-positioned productivity and dedication in 2010 even in the face of balance sheet, and several new initiatives for rebuilding downsizing and restructuring. We, the Board of Trustees, our DVD volumes, expanding our Blu-ray investment, are extremely proud of this show of spirit and solidarity and creating best-in-class digital delivery and media that has not only carried us through rough waters but has enhancement. In addition, the acquisition of 1K Studios, also landed us on the other side poised to make great the hiring of key management leaders, and our continued strides in the years to come. commitment to meet the present and future needs of our customers will ensure that Cinram maintains a strategic I also want to extend my deepest thanks to our customers and effective path in its ongoing evolution. for their continued support and partnership. The year ahead brings with it plenty of promise and anticipation, and we look forward to making good on our enhanced, enriched value proposition of delivering excitement at every point in the customer experience.
WILLIAM J. ANDERSON Chairman Cinram International Income Fund
8 Cinram 2010 Annual Report TO OUR UNITHOLDERS
STEVEN G. BROWN President and Chief Executive Officer
The foundational changes we laid out in 2009 became ingrained in 2010 as Cinram took up its own transformation with passion and proficiency. Over the past year we became a more streamlined, efficient operation, enabling us to re-energize a strategic plan that had been delayed by unexpected business events early in the year. Now, on the strength of a simplified structure, a commitment to excellence and vigorous cross-collaboration, we are moving forward at a renewed pace and starting to reap the benefits.
Cinram 2010 Annual Report 9 LETTER TO “ WE ARE ALL PULLING ON ONE UNITHOLDERS SIDE OF THE ROPE, COMMITTED TO DELIVERING EXCITEMENT IN THE BEST, MOST EFFICIENT WAY POSSIBLE.”
FINANCIAL HIGHLIGHTS PARALLEL PROGRESS For the year ended December 31, 2010, revenue decreased 24% to Much has been made of the tug-of-war between physical and digital $1,108.8 million from $1,453.0 million in 2009. DVD replication and media in the industry. We don’t see it as a one-or-the-other situation. distribution revenue was down 25% primarily as a result of the loss of We are focused on maximizing both formats, and to that end we are the Warner Home Entertainment contract in July 2010, resulting in ensuring methods to enhance our delivery in whatever form is preferred. significantly lower DVD unit sales. Despite the loss of our largest A large part of that effort is our acquisition of 1K Studios, which boasts customer, the Fund was able to partially offset the decline in revenue some of the most creative and energetic people in the business. with an intensive review of operations globally with the company-wide Their technical prowess will help us augment our digital delivery so that mandate of reducing labour and overhead costs through facility it amounts to much more than just data transference. It will be a truly rationalization, headcount reduction and improving efficiencies. enhanced experience. We believe our customers manufacture, As a result, EBITA excluding other charges of $133.4 million represented produce and direct some of the world’s most interesting video and 12.0% of revenue in 2010, compared to 12.6% in 2009, despite the audio content, and we want to make sure consumers receive that decline in revenue. Net earnings from continuing operations were content in a way that does it justice. $18.4 million in 2010, compared to a net loss from continuing operations of $6.0 million in 2009. The 2009 results included an impairment charge And though our digital platform has shown dramatic growth, it is of $82.2 million and a gain on repurchase of debt of $38.4 million. important to remember that this growth started from a comparatively small percentage. We are not questioning the digital ascent, but it We ended 2010 with a cash balance of $164.4 million, up from $122.1 must be said that the demise of physical media is slower than many million in 2009. We generated cash flow from continuing operations imagine it to be. We have actually seen some studios increase their of $90.0 million during 2010, compared to $302.8 million in 2009, as the physical media output over the past year. We have increased our focus prior year figure reflected a significant improvement in working capital on the ability to manufacture physical media in a far more efficient performance related to a reduction in accounts receivable days sales manner, with a smaller global footprint than ever before, while still outstanding. During 2010, we invested $14.7 million in capital asset maintaining the same level of volume and demonstrating the same additions, compared to $42.2 million in the prior year. quality of output. The future Cinram will offer customers the ability As of December 31, 2010, our net debt position (long-term debt to transcend their current choices. Our improved offerings will make excluding unamortized transactions costs, less cash and cash us a true partner rather than just a provider. equivalents) was $202.3 million, compared with $273.3 million at December 31, 2009.
On January 25, 2011, the Fund announced the Refinancing and Recapitalization with its current lenders. In addition, Cinram had agreed to the material terms for further agreements with a major customer for a term of three years, subject to completion of the Refinancing and Recapitalization. We closed the refinancing and recapitalization transaction and executed the new long term agreements with our major customer on April 11, 2011.
A full discussion of the Fund’s financial and operating performance can be found in the Management Discussion and Analysis, which begins on page 13 of this report.
10 Cinram 2010 Annual Report “ THE BENCHMARK WE ACHIEVED YESTERDAY IS ONLY THE NEWEST MILESTONE IN AN ONGOING JOURNEY.”
A CULTURE OF COLLABORATION THE ROAD AHEAD One undeniable trend is the emergence of Blu-ray as a market In 2010, though we encountered many challenges, we maintained favourite, which has driven our significant investment in the format. uninterrupted customer support, world-class delivery and above- As it has cemented its foothold on both sides of the Atlantic, we are market performance. This is a testament to our executive team increasing our market share, which will in turn drive further investment. and our employees around the world, all of whom have a solid And because of the cross-pollination we promote on both sides of the understanding of our strategic focus and a firm commitment to Atlantic, we have been able to perfect our manufacturing techniques making it happen. We are all pulling on one side of the rope, in Europe with remarkable speed, giving us an important head start committed to delivering excitement in the best, most efficient way in that region. By the same token we have been able to very efficiently possible. As a result we have already seen some big wins, such as execute shorter runs due to language diversification and implement the launch of our new software Vision 2.0, the acquisition of Morrison more agile manufacturing techniques as the DVD business compresses. Supermarket, the UK’s fourth-largest retailer, and the continued A good idea in France or Germany can move at light speed throughout growth of our business intelligence division. our global operation, giving us a constant leg up. The global environment During my first 18 months as CEO I emphasized direction more than has driven consumers’ inability to wait. Many studies have shown that speed. It was important that we made sure the company was headed people do not want to illegally download movies or music; they do so down the right path. We are now on that path, and speed is the only when the product they want is not available. Our goal is to make watchword in 2011 as we forge ahead. We did an admirable job in 2010 sure the consumer gets it when they want it, in the way they want it. under often trying circumstances, and I applaud everyone at the company for their efforts. This year we are ready to grow the top line, IMPORTANT LESSONS push forward to add new customers and continue making the new Coming from a career in the automotive industry, I’ve dealt first- Cinram the best it can be. hand with the global pressures that require a company to solidify an efficient cost structure. No industry can afford waste, because ultimately the consumer pays for it. When I look at what we at Cinram accomplish every day, I’m extremely proud, but I’m not satisfied. The benchmark we achieved yesterday is only the newest milestone in an ongoing journey. One thing I learned in the auto industry is that you never receive a good suggestion from a robot. I firmly believe that human nature will drive efficiencies, and I am a great believer STEVEN G. BROWN in our employees helping us get better. We are truly showing the rest President and Chief Executive Officer of the marketplace fresh ways to eliminate waste from the system. As physical media reaches a point of maturation, the only way to increase margins is with data. Our Retail Services Group is analyzing factors such as demographics, store sales and pricing to uncover new modes of efficiency. For instance, we will reduce our costs per unit by better leveraging unutilized space in delivery trucks. This is an example of a seemingly small step that can have tremendously positive ramifications.
Cinram 2010 Annual Report 11 FINANCIAL TABLE OF CONTENTS
13 MANAGEMENT’S DISCUSSION AND ANALYSIS 46 NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS 13 Forward-looking statements 46 1. Description of the Fund 13 Non-GAAP financial measures 46 2. Significant accounting policies 14 1. About Our Business 07 3. Inventories 18 2. 2010 Performance 07 4. Property, plant and equipment 20 3. Segmented Results 27 5. Goodwill and intangible assets 24 4. Gross Profit 47 6. Asset retirement obligations 25 5. Impairment of Goodwill and Long-Lived Assets 57 7. Long-term debt 25 6. Amortization of Intangible Assets 77 8. Lease commitments 25 7. Selling, General and Administrative Expenses 87 9. Unitholders’ deficiency 25 8. Other Charges (Income), Net 97 10. Basic and diluted earnings (loss) per unit/ 26 9. Interest Expense limited partnership unit 26 10. Investment Income 08 11. Accumulated other comprehensive earnings 26 11. Foreign Exchange Gain 08 12. Other charges, net 27 12. Income Taxes 18 13. Other interest and financing charges, net 27 13. Earnings/Loss 28 14. Income taxes 27 14. Liquidity and Capital Resources 38 15. Contingent liabilities and guarantees 31 15. Risks and Uncertainties 48 16. Related party transactions 43 16. 2010 Fourth Quarter Performance 48 17. Pension and non-pension employment benefit plans 46 17. Critical Accounting Policies and Estimates 09 18. Change in non-cash operating working capital 50 18. Disclosure Controls and Procedures Over 09 19. Segmented information Financial Reporting 19 20. Financial risk management and financial instruments 50 19. Management’s Report On Operating Effectiveness 89 21. Capital risk management of Internal Controls Over Financial Reporting 99 22. Discontinued operations and assets held for sale 50 20. International Financial Reporting Standards (IFRS) 1 0 1 23. Subsequent events 57 21. Additional Information 1 0 3 24. Comparative figures
58 MANAGEMENT’S RESPONSIBILITY 104 FINANCIAL HIGHLIGHTS FOR FINANCIAL STATEMENTS 106 COMPARATIVE BALANCE SHEETS 58 INDEPENDENT AUDITORS’ REPORT 107 TRADING OF UNITS: CRW.UN 59 CONSOLIDATED BALANCE SHEETS 108 TRUSTEES OF CINRAM INTERNATIONAL INCOME FUND 60 CONSOLIDATED STATEMENTS OF EARNINGS 108 SENIOR MANAGEMENT TEAM 61 CONSOLIDATED STATEMENTS OF COMPREHENSIVE 108 CORPORATE INFORMATION EARNINGS (LOSS) 109 WORLDWIDE LOCATIONS 62 CONSOLIDATED STATEMENTS OF UNITHOLDERS’ DEFICIENCY 63 CONSOLIDATED STATEMENTS OF CASH FLOWS
12 Cinram 2010 Annual Report MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (IN U.S. DOLLARS) MARCH 16, 2011
This management’s discussion and analysis (MD&A) for the year ended December 31, 2010 should be read in conjunction with Cinram International Income Fund’s audited consolidated financial statements as at and for the years ended December 31, 2010 and 2009, and with the notes contained therein. The consolidated financial statements are prepared in accordance with Canadian generally accepted accounting principles (GAAP). Where reference is made to “we,” “us,” “Cinram” or the “Fund,” it refers to Cinram International Income Fund and its subsidiaries. External economic factors remain substantially unchanged, unless otherwise stated.
FORWARD-LOOKING STATEMENTS
Certain statements included in this management’s discussion and analysis (MD&A) and elsewhere in this annual report, contain words such as “could,” “expects,” “expectations,” “may,” “anticipates,” “believes,” “intends,” “estimates” and “plans” (and similar expressions) and constitute “forward-looking statements” within the meaning of applicable securities laws. These statements are based on Cinram’s current expectations, estimates, forecasts and projections about the operating environment, economies and markets in which it operates. Such forward-looking statements, and other forward-looking statements specifically identified, involve known and unknown risks, uncertainties and other factors which are difficult to predict and may cause the actual results, performance or achievements of the Fund to be materially different from any future results, performance or achievements expressed or implied by such forward-looking statements. Such factors include, among others, the following: general economic and business conditions that will, among other things, impact the demand for the Fund’s products and services (including risks related to international operations and foreign exchange risks); the Fund’s ability to retain major customers; multimedia replication industry conditions and capacity (including, among other things, competitive and pricing pressures, increases in raw material costs, increasingly compressed production cycle and seasonality of the business, the need for capital expenditures for maintenance of Blu-ray and standard DVD capacity, and variability in quarterly earnings); risks relating to the Fund’s proposed refinancing and recapitalization plan, including the risk of non-completion; risks associated with the Fund’s leverage generally, and its potential impact on the business; risks of dilution to unitholders from issuances of equity interests; the ability of the Fund to implement its business strategy; a shortage of product due to labour disruptions; the Fund’s ability to invest successfully in new technologies; the current estimated financial impacts of converting to International Financial Reporting Standard (IFRS) accounting standards and other factors. All of the foregoing factors are described in detail in the Fund’s filings with Canadian securities commissions (reference is made in particular, but without limitation, to the section entitled “Risks and Uncertainties” in this 2010 annual report and to prior quarterly financial reports). For a complete list of risks and uncertainties, please consult Cinram’s annual information form filed with Canadian securities commissions, available on www.sedar.com.
The Fund disclaims any intention or obligation to update or revise any forward-looking statements whether as a result of new information, future events or otherwise. You should read this MD&A and annual report with the understanding that the Fund’s actual future results may be materially different from what we expect. These cautionary statements expressly qualify all forward-looking statements attributable to the Fund.
NON-GAAP FINANCIAL MEASURES
EBITA is defined in this report as earnings (loss) from continuing operations before impairment charges, interest expense and financing charges, gain on repurchase of debt, foreign exchange gain, investment income, income taxes, and amortization and is a standard measure that is commonly reported and widely used in the Fund’s industry to assist in understanding and comparing operating results. EBITA is not a defined term under GAAP. Accordingly, this measure should not be considered as a substitute or alternative for net earnings or cash flow, in each case as determined in accordance with GAAP. See reconciliation of EBITA to net earnings under GAAP as found in the table below.
EBIT is defined in this report as earnings (loss) from continuing operations before interest expense and financing charges, gain on repurchase of debt, foreign exchange gain, investment income and income taxes, and is a standard measure that is commonly reported and widely used in the Fund’s industry to assist in understanding and comparing operating results. EBIT is not a defined term under GAAP. Accordingly, this measure should not be considered as a substitute or alternative for net earnings or cash flow, in each case as determined in accordance with GAAP. See reconciliation of EBIT to net earnings under GAAP as found in the table below.
We use EBIT and EBITA, as defined above, as benchmarks for measuring operating performance and for our lending arrangements.
Note that certain comparative figures have been reclassified throughout the MD&A to conform with the financial statement presentation adopted in the current year.
Cinram 2010 Annual Report 13 MANAGEMENT’S DISCUSSION AND ANALYSIS
RECONCILIATION OF EBITA AND EBIT TO NET EARNINGS (LOSS) FROM CONTINUING OPERATIONS
Years ended December 31 (unaudited, in thousands of U.S. dollars) ’10 ’09
EBITA excluding other charges $ 133,402 $ 183,788
Other charges, net 17,544 2,483
EBITA $ 115,858 $ 181,305
Impairment of long-lived assets and goodwill — 82,234 Amortization of property, plant and equipment 54,733 86,641 Amortization of intangible assets 15,146 41,465
EBIT $ 45,979 $ (29,035)
Interest expense and financing charges 32,618 37,584 Other interest and financing charges, net (306) 6,101 Gain on repurchase of debt — (38,440) Foreign exchange gain (956) (15,179) Investment income (317) (429) Income taxes (recovery) (3,500) (12,677)
Net earnings (loss) from continuing operations $ 18,440 $ (5,995)
1. ABOUT OUR BUSINESS
CORPORATE OVERVIEW AND RECENT DEVELOPMENTS
Cinram International Inc. (CII), an indirect wholly-owned subsidiary of Cinram International Income Fund, is one of the world’s largest providers of pre-recorded multimedia products and related logistics services. With facilities in North America and Europe, we manufacture DVDs, Blu-ray discs and CDs, and we provide distribution services for motion picture studios, music labels, video game publishers, computer software companies, telecommunication companies and retailers around the world.
Cinram operates facilities globally that span approximately 10.7 million square feet. As of December 31, 2010, we employed approximately 8,800 people worldwide including contract and agency workers. We currently have the capacity to manufacture approximately 2.1 billion DVDs, 57 million Blu-ray discs and about 459 million CDs per year to service seasonal peaks in demand, which typically occur around the U.S. Thanksgiving and Christmas holiday shopping seasons. We primarily manufacture on firm orders from our customers, generally pursuant to multi-year contracts. We do not bear the risk of unsold products as customers cannot return any previously purchased inventory, with the exception of defective product (which occurs rarely). We do not have title to the products we distribute. Our major contracts are, to a large extent, exclusive for particular territories, and many of our manufacturing agreements contain periodic market price tests and most- favoured-nations clauses that may require us to lower our selling prices. The products we manufacture generally experience price declines on an annual basis with declines historically being steeper in the early stages of the products’ life cycles.
On January 31, 2011, Cinram International Income Fund acquired Los Angeles-based digital media company One K Studios (1K). The move is part of a broad initiative to advance Cinram, a provider of media delivery services around the world, further into digital platforms. 1K specializes in building enhanced consumer experiences for movies, TV shows, music, books and games. 1K has been a key service provider to many of the world’s top media and technology companies, including Apple, Paramount Home Entertainment, HBO, and Warner Bros Home Entertainment. 1K provides creative and technical services to these companies to help them release their content in different venues, including digital downloads, mobile and tablet apps, advanced Blu-ray discs, stereoscopic 3D and social media. These services will be integrated with Cinram’s existing media production and logistics business, creating an end-to-end supply chain for our customers. The new expertise will play an important role in Cinram’s effort to identify and evaluate additional opportunities to add to our client offerings.
14 Cinram 2010 Annual Report MANAGEMENT’S DISCUSSION AND ANALYSIS
On January 25, 2011, Cinram International Income Fund announced a proposed refinancing and recapitalization transaction (the “Refinancing and Recapitalization”) with its lenders. In addition, Cinram agreed to the material terms that will form the basis for further agreements with a major customer for a term of three years, subject to completion of the Refinancing and Recapitalization.
A majority of the Fund’s unitholders consented in writing to the Refinancing and Recapitalization and related transactions, including the issuance of new equity units and warrants. The following are the key elements of the changes to Cinram’s capital structure that will result from the proposed transactions:
• Amendment and extension of Cinram’s senior secured credit facility (the “Credit Facility”) to December 31, 2013.
• Reduction in the amount of term debt outstanding and revolving commitments available under the amended Credit Facility: • Existing term debt of approximately $367 million to be reduced by $120 million through: cash pay-down at closing in the principal amount of $30 million; and exchange of outstanding first-lien term debt in the amount of $90 million for $90 million second-lien secured debt that is mandatorily exchangeable into equity of the Fund on December 31, 2011 if not earlier repaid from equity proceeds.
• Reduction of commitments under revolving facility from $100 million to $35 million. • An option for Cinram to raise new equity proceeds to repay the mandatorily exchangeable secured debt through the end of 2011. • The issuance of up to 9.85 million Cinram units and a cash fee of $11.2 million to lenders that consented to the Refinancing and Recapitalization. • The issuance of warrants to acquire 13 million Cinram units.
Cinram undertook a solicitation process with the lenders with respect to the Refinancing and Recapitalization and, as announced on February 17, 2011, the Fund has received 100% lender support for the Refinancing and Recapitalization and the arrangements with Cinram’s major customer. Each lender, in consideration for having executed and delivered a consent to the Refinancing and Recapitalization, will receive a consent fee equal to their pro rata share (based on the full amount outstanding under the Credit Facility) of: (a) approximately $11.2 million in cash; (b) approximately 6.2 million units in the Fund; and (c) if any portion of the mandatorily exchangeable secured debt has not been repaid by June 30, 2011, approximately 3.65 million additional units in the Fund. The Refinancing and Recapitalization is scheduled to close in March 2011, and Cinram is pursuing opportunities to raise capital to repay the mandatorily exchangeable secured debt.
On November 17, 2010, the Fund entered into new agreements with Warner Music Group (WMG) under which Cinram will continue to serve as WMG’s primary supplier for manufacturing and distribution services for WMG’s recorded music products in the U.S., Canada and parts of Europe. The service contracts extend to January 2014 and include some ability for WMG to offload volume to other replicators as part of a business risk strategy.
On June 30, 2010, the Fund sold its 50% share of the Mexican joint venture, Cinram Latinoamericana, S.A. de C.V., to the joint venture partner for initial proceeds of $0.3 million. The agreement for sale of stock included contingent consideration of up to another $0.2 million should certain conditions be met before the end of 2010. However, none of these conditions were met. The Fund’s proportionate share of the results of operations of the joint venture were segregated and presented separately as discontinued operations in the consolidated financial statements for the years ended December 31, 2010 and 2009. The loss on sale of this business unit was $0.6 million.
On February 1, 2010, the Fund announced that it received written notice from Warner Home Video Inc. (WHV) that WHV was exercising its option to terminate its service agreements on July 31, 2010. The notice covers all Cinram entities globally and will directly impact operations in North America, UK, France, Germany and Spain. WHV revenues for 2009 represented approximately 32% of the total consolidated revenues of the Fund. Although the service agreements terminated on July 31, 2010, the Fund continued performing offload services during the third and fourth quarters of 2010.
On January 14, 2010, Steven Brown, the Company’s Chief Executive Officer, was appointed to the Board of Trustees. The Board also announced that it accepted the resignation of Mr. George Armoyan, who stepped down from the Board of Trustees.
Cinram 2010 Annual Report 15 MANAGEMENT’S DISCUSSION AND ANALYSIS
During September 2009, the Fund extended its exclusive replication agreement with Lions Gate Entertainment in the United States for an additional three years. The extension includes additional options for Lions Gate to extend the agreement into 2017. The agreement contains certain market test rights and certain competitive price guarantee provisions in favour of Lions Gate.
On April 9, 2009, the Fund sold substantially all of Ivy Hill Corporation’s assets, net of its operating liabilities. Accordingly, Ivy Hill’s results, which comprised the North American printing business, were excluded from Cinram’s continuing operations for the years ended December 31, 2010 and 2009. With the classification of the U.S. printing business as discontinued operations effective in the first quarter of 2009, the Fund is no longer reporting a separate Printing segment. Consequently, the Fund has combined the results of the European printing activities with the pre-recorded multimedia products segment.
On March 30, 2009, the Fund announced that its lenders approved an amendment to its subsidiaries’ senior secured credit facility to, among other things, permit Cinram to use up to $150.0 million to repurchase term advances outstanding under the senior secured credit facility at prices below par through one or more “modified Dutch” auctions during a one-year period commencing on March 31, 2009. The amendment also restricted debt repurchases to 25% of total credit commitments. The amendment did not obligate Cinram to make any such repurchases. In addition, Cinram agreed (i) to make a $35.0 million prepayment at par of term advances on the effective date of the amendment; (ii) to make quarterly prepayments at par of $10.0 million commencing with the second quarter of 2009; (iii) to reduce the revolving credit commitment under the senior credit facility by $50.0 million on the date of the amendment; and (iv) not to pay any unitholder distributions for the balance of the term of the facility, subject to certain limited exceptions. During 2009, the Fund repurchased $169.7 million of term advances for cash consideration of $131.2 million, resulting in a net gain of $38.4 million. No repurchases were made in the year ended December 31, 2010.
On February 13, 2009, the Fund announced the resignation of David Rubenstein, its Chief Executive Officer, effective March 31, 2009. On June 9, 2009, the Board of Trustees announced that Steve Brown had been appointed President and Chief Executive Officer of the Fund effective June 15, 2009.
In December 2008, Motorola Europe announced its intention to cease local distribution for its mobile device business in the European market. Accordingly, Cinram and Motorola Europe entered into a settlement agreement setting forth the terms under which Cinram’s distribution services for mobile devices were phased out during the first six months of 2009. The transition was finalized on July 6, 2009.
Due to several factors, including the termination of the WHV service contract effective July 31, 2010, the Fund revisited its business and operations in the fourth quarter of 2010. As a result, the Fund reorganized internally to consolidate its sales, manufacturing and distribution functions. As part of the internal reorganization, reporting for the Home Video and CD business lines were combined, on the basis that the sales, manufacturing and distribution requirements for both of these segments possess similar management, operational and cost structures. Accordingly, the Fund concluded it was appropriate to combine its previously disclosed Home Video and CD segments into the pre-recorded multimedia products segment.
The Fund operates three business segments: pre-recorded multimedia products, video game and other. The pre-recorded multimedia segment consists of the replication, packaging and distribution of DVDs, Blu-ray discs and CDs, including new releases and catalog titles, for the entertainment divisions of motion picture studios and music labels. The Video Game segment includes revenues from the assembly, packaging and distribution of video games. The Other segment includes revenue from logistics services for our telecommunications customer (Motorola) as well as revenue from the retail services division (Vision Information Services) and other non-core activities. Revenue from Ivy Hill, our U.S. printing business, was classified as discontinued operations during the first quarter of 2009. Accordingly, prior periods have been reclassified on this basis.
1.1 RECENT ACQUISITIONS AND DISPOSITIONS
Acquisition of 1K On January 31, 2011, the Fund acquired Los Angeles-based digital media company 1K. The acquisition is part of a broad initiative to advance Cinram, a provider of media delivery services around the world, further into digital platforms. 1K specializes in building enhanced consumer experiences for movies, TV shows, music, books and games. 1K has been a key service provider to many of the world’s top media and technology companies including Apple, Paramount Home Entertainment, HBO, and Warner Bros Home Entertainment.
16 Cinram 2010 Annual Report MANAGEMENT’S DISCUSSION AND ANALYSIS
Disposition of 50% interest in Cinram Latinoamericana S.A. de C.V. On June 30, 2010, the Fund sold its 50% share of the Mexican joint venture, Cinram Latinoamericana, S.A. de C.V., to the joint venture partner for initial proceeds of $0.3 million. The agreement for sale of stock included contingent consideration of up to another $0.2 million, but the conditions for this additional consideration were not met. Accordingly, the Funds’ proportionate share of the results of operations of the joint venture were segregated and presented separately as discontinued operations in the consolidated financial statements for the year ended December 31, 2010.
Disposition of Simi Valley facility In January 2010, the Fund completed the sale of its owned distribution centre in Simi Valley, California for proceeds of $14.0 million less transaction costs, resulting in a gain of $7.5 million. This gain was recorded during the first quarter of 2010.
Disposition of the assets and business of Ivy Hill On April 9, 2009, the Fund sold substantially all of the assets, net of its operating liabilities, of Ivy Hill to Multi Packaging Solutions, Inc. (MPS) for net cash proceeds of $14.0 million, subject to working capital adjustments. During the 2009 third quarter, the Fund recorded a working capital adjustment of $2.8 million, which resulted in a reduction in net cash proceeds from the sale to $11.2 million. Ivy Hill’s results, which comprised all of the North American printing business, have been excluded from Cinram’s continuing operations for the year ended December 31, 2009 and December 31, 2010.
At the time of the sale in April 2009, the Fund recorded a net loss on the sale of $4.7 million, which included a continuing obligation to fund a net withdrawal liability relating to the multi-employer pension plans estimated to be approximately $2.7 million as at the date of the sale. This net withdrawal liability obligation is partially offset by preferred shares of MPS that have been placed in escrow to fund the withdrawal liability. During 2010, accretion charges and a mark-to-market gain of $1.2 million were recognized. The net present value of the withdrawal liability obligation, net of the preferred shares is estimated to be approximately $0.9 million as of December 31, 2010. This obligation will be settled no later than the second quarter of 2013.
Jack of All Games acquisition In September 2008, Cinram acquired substantially all of the assets of the warehouse management, distribution, processing, and value- added service operations of Jack of All Games, Inc. (JOAG), for cash consideration of $3.4 million. JOAG distributes products of Take-Two Interactive Software, Inc. and other third party software, hardware and accessories to retail outlets in North America.
In December 2009, Cinram was notified by Take-Two Interactive, a distribution customer, that it had sold its JOAG subsidiary to a third party, effective the first quarter of 2010. Given the loss of this business, this transaction had a negative impact on 2010 video game revenues, partially offset by steps taken during the year to reduce direct and indirect costs associated with this business.
1.2 CAPITAL STRUCTURE
In May 2006, CII converted from a corporate structure to an income trust structure through a plan of arrangement that was approved by shareholders on April 28, 2006. As a result of the recapitalization, shareholders exchanged their shares of CII for units of Cinram International Income Fund (or in the case of electing shareholders, into units of the Cinram International Limited Partnership) on a one-for- one basis. The Fund’s units are listed on the Toronto Stock Exchange under the symbol CRW.UN.
1.3 OUR STRATEGY
In 2009 and throughout 2010, the management team set a new strategy for the Fund, which was presented to and approved by the Board of Trustees. The following is a summary of that strategy:
• maintain a culture of operation excellence within the business – promoting world-class practices and an attitude of continuous improvement. • grow our client base amongst the major and mid-sized entertainment studios by providing global, cost effective services. • expand our service offerings to our clients and thereby maximize value in the supply chain to our mutual benefit. • provide innovative products and solutions to our clients, responding to the changes in how entertainment is delivered to the ultimate consumer.
The Fund continues to aggressively pursue this strategy across all business segments.
Cinram 2010 Annual Report 17 MANAGEMENT’S DISCUSSION AND ANALYSIS
1.4 OPERATING AND FINANCIAL PERFORMANCE
Over the past few years, the Fund has taken the following steps to strengthen its operational and financial position.
• Debt reduction – During 2009 and 2010, the Fund retired $280 million of debt, reducing the outstanding term debt balance to $367 million at December 31, 2010, through combined debt repurchases below par, mandatory debt repayments and voluntary debt repayments at par. As part of the refinancing proposal announced on January 25, 2011, the Fund intends to reduce debt by an additional $120 million and will continue to focus on debt reduction over the foreseeable future. • Cost reduction – In 2010, we continued to focus on reducing our cost structure as witnessed by the direct cost and fixed overhead efficiencies achieved during the year. This is an ongoing area of focus that will continue throughout 2011. • Reduced capital expenditures – In 2010, capital expenditures decreased to $15 million from $42 million in 2009. In 2011, capital expenditures will be allocated primarily towards expanding the Blu-ray capacity in both North America and Europe. • Focus on core operations – We continue to focus on producing standard DVDs and Blu-ray discs, and on providing related distribution services, with the intention of disposing of non-core assets, including facility rationalization where appropriate.
Three-year revenue by product
Years ended December 31 (In thousands of U.S. dollars) ’10 ’09 ’08
Pre-recorded multimedia products $ 995,539 90% $ 1,289,137 89% $ 1,478,624 86% Video Game 59,049 5% 91,608 6% 126,561 7% Wireless 41,123 4% 61,918 4% 95,420 6% Other 13,079 1% 10,368 1% 13,749 1%
$ 1,108,790 100% $ 1,453,031 100% $1,714,354 100%
2. 2010 PERFORMANCE
Despite the loss of its largest customer during 2010, the Fund was able to partially offset the 24% decline in revenue with an intensive review of operations globally with the company-wide mandate of reducing labour and overhead costs through facility rationalization, headcount reduction and improving efficiencies. As a result, EBITA excluding other charges of $133.4 million represented 12.0% of revenue in 2010, compared to 12.6% in 2009, despite the decline in revenue. Net earnings from continuing operations were $18.4 million in 2010, compared to a net loss from continuing operations of $6.0 million in 2009. The 2009 results included an impairment charge of $82.2 million and a gain on repurchase of debt of $38.4 million.
With respect to revenue, sales of DVDs, which are included in our pre-recorded multimedia segment, continued to be the dominant source and the main driver of operating profit for Cinram in 2010. DVD revenue (including related distribution services) accounted for 75% of consolidated revenue in 2010, compared with 76% in 2009 and 73% in 2008. We replicated 933 million DVDs in 2010, a decrease of 20% from 1,161 million in 2009, and, as a result, DVD revenue decreased to $828.7 million from $1,105.2 million in 2009 and $1,248.1 million in 2008. This was primarily the result of the loss of the WHV contract, which terminated on July 31, 2010, although the Fund continued to replicate and distribute DVDs for WHV by way of offload agreements during the third and fourth quarters of 2010.
Blu-ray replication revenue increased to $36.1 million in 2010, compared to $22.5 million in 2009 and $16.7 million in 2008 as consumers continue to migrate towards Blu-ray discs.
CD revenue decreased to $130.7 million in 2010, compared to $161.4 million and $213.8 million in 2009 and 2008, respectively. The declining revenues are consistent with industry declines for pre-recorded physical music. CD revenue as a percent of consolidated revenue remained fairly consistent around 12% during this three year period.
18 Cinram 2010 Annual Report MANAGEMENT’S DISCUSSION AND ANALYSIS
Selected annual financial information
Years ended December 31 (In thousands of U.S. dollars, except per unit/share amounts) ’10 ’09 ’08
Revenue $ 1,108,790 $ 1,453,031 $ 1,714,354 EBITA excluding other charges* 133,402 183,788 256,768 Other Charges, net* 17,544 2,483 2,148 EBITA* 115,858 181,305 258,916 Impairment charges — 82,234 21,638 EBIT 45,979 (29,035) 94,246 Net earnings (loss) from continuing operations 18,440 (5,995) 23,649 Basic earnings (loss) from continuing operations per unit $ 0.34 $ (0.11) $ 0.42 Diluted earnings (loss) from continuing operations per unit $ 0.33 $ (0.11) $ 0.42 Cash flow from continuing operations 89,982 302,770 146,224 Cash and cash equivalents 164,399 122,072 73,349 Total assets 638,816 784,700 1,191,236 Long-term liabilities 273,638 441,233 715,644 Working capital 10,082 92,507 172,703
* see reconciliation of EBITA to net earnings
For the year ended December 31, 2010, revenue decreased 24% to $1,108.8 million from $1,453.0 million in 2009. DVD replication and distribution revenue was down 25% primarily as a result of the loss of the WHV contract resulting in lower DVD unit sales as well as lower DVD selling prices. Revenue was also adversely impacted by a 19% drop in CD segment revenues in 2010, primarily as a result of declining orders for physical CDs combined with the closure of a CD facility in the United States during 2009. Our video game business also experienced revenue declines in 2010, primarily as a result of decreased consumer spending.
EBITA excluding other charges was $133.4 million in 2010, compared to $183.8 million in 2009. While the decline in revenue led to the decline in EBITA, margins as a percentage of revenue were fairly consistent with the prior year. This was the result of cost saving initiatives implemented by management during the year, including headcount reductions and facility consolidation.
Summary of quarterly results Cinram’s annual and quarterly operating results vary from period to period as a result of the timing and value of customer orders, fluctuations in materials and other costs, and the relative mix of value-added products and services. Our business is seasonal, as a large portion of our revenue and earnings are recorded in the fourth quarter, since most large-scale home video release dates are clustered around the U.S. Thanksgiving and Christmas holiday shopping seasons. The timing of the release schedules as well as the success of a few titles can play an important role in December re-order volumes and, in turn, influence our full-year results. For these reasons, we generate a significant amount of our revenue and EBITA in the fourth quarter.
Revenue from continuing operations
Quarter ’10 ’09 ’08
First $ 298,744 $ 300,971 $ 370,380 Second 255,922 298,386 382,240 Third 254,056 348,761 408,163 Fourth 300,068 504,913 553,571
Year $ 1,108,790 $ 1,453,031 $ 1,714,354
Cinram 2010 Annual Report 19 MANAGEMENT’S DISCUSSION AND ANALYSIS
Net earnings (loss) Net earnings (loss) from continuing operations from discontinued operations Net Earnings (loss)
Quarter ’10 ’09 ’08 ’10 ’09 ’08 ’10 ’09 ’08
First $ 7,918 $ (17,828) $ 7,885 $ (57) $ (4,597) $ (11,272) $ 7,861 $ (22,425) $ (3,387) Second (8,876) 7,210 (3,840) (5,077) (7,822) (3,240) (13,953) (612) (7,080) Third 11,988 13,937 1,729 — (4,456) 293 11,988 9,481 2,022 Fourth 7,410 (9,314) 17,875 — 842 (40,959) 7,410 (8,472) (23,084)
Year $ 18,440 $ (5,995) $ 23,649 $ (5,134) $ (16,033) $ (55,178) $ 13,306 $ (22,028) $ (31,529)
Basic/Diluted EPS Basic/Diluted EPS from continuing operations from discontinued operations Basic/Diluted EPS
Quarter ’10 ’09 ’08 ’10 ’09 ’08 ’10 ’09 ’08
First $ 0.15 $ (0.32) $ 0.14 $ — $ (0.08) $ (0.20) $ 0.15 $ (0.40) $ (0.06) Second (0.16) 0.13 (0.07) (0.10) (0.14) (0.05) (0.26) (0.01) (0.12) Third 0.22 0.26 0.03 — (0.08) 0.01 0.22 0.17 0.04 Fourth 0.13 (0.17) 0.32 — 0.02 (0.74) 0.13 (0.16) (0.42)
Year $ 0.34 $ (0.11) $ 0.42 $ (0.10) $ (0.29) $ (0.98) $ 0.24 $ (0.40) $ (0.56)
Over the past several years, the release schedule has become more compressed as the peaks in demand have risen while the seasonal troughs have widened. As a result of the loss of the WHV contract during 2010 and the resulting available capacity, the Company was able to meet all demand requirements for its customers within its own facilities. As a result, the likelihood of outsourcing production to a third party to meet existing customer deliverables is significantly reduced. Our results are also hit-driven, based on the demand for our customers’ content. With our high customer concentration, we are dependent on our customers’ ability to capture and maintain their market share of consumer spending, especially in pre-recorded multimedia products. In 2010, our three largest customers accounted for approximately 28%, 21% and 14% of consolidated revenue, respectively. In 2009 our three largest customers accounted for 32%, 23% and 11%, respectively, of consolidated revenue.
3. SEGMENTED RESULTS
3.1 INDUSTRY SEGMENT REVENUE
Due to several factors, including the termination of the WHV service contract effective July 31, 2010, the Fund revisited its business and operations in the fourth quarter of 2010. As a result, the Fund reorganized internally to consolidate its sales, manufacturing and distribution functions. As part of the internal reorganization, reporting for the Home Video and CD business lines were combined, on the basis that the sales, manufacturing and distribution requirements for both of these segments possess similar management, operational and cost structures. Accordingly, the Fund has concluded it is appropriate to disclose its Home Video and CD operations as Pre-Recorded Multimedia Products. The Fund has restated its presentation of its operating segments for each of the years ended December 31, 2010 and December 31, 2009.
The pre-recorded multimedia products segment manufactures and distributes DVDs, Blu-ray discs and CDs. The Video Game segment includes results from Ditan, and the Other segment primarily includes logistics (handset distribution) and Cinram Retail Services, primarily business intelligence software (Vision Information Services).
20 Cinram 2010 Annual Report MANAGEMENT’S DISCUSSION AND ANALYSIS
Years ended December 31 (In thousands of U.S. dollars) ’10 ’09
Pre-recorded multimedia products $ 995,539 90% $ 1,289,137 89% Video game 59,049 5% 91,608 6% Other 54,202 5% 72,286 5%
Total $ 1,108,790 100% $ 1,453,031 100%
3.1.1 PRE-RECORDED MULTIMEDIA PRODUCTS Revenue from our pre-recorded multimedia segments (including DVD, Blu-ray discs, CDs and related distribution services), experienced declines in 2010. DVD replication and distribution revenue was $828.7 million in 2010, down from $1,105.2 million in 2009, reflecting the impact of the loss of the WHV business resulting in lower unit sales combined with lower DVD selling prices.
The most significant contributor to the pre-recorded multimedia product segment is the home video industry, which today is led by DVD, and provides a medium for the delivery of their content. Since the demand for these products is concentrated within a few large movie studios, each content owner represents a sizeable business opportunity for replicators with the required scale and distribution capabilities. DVD replication revenue represented 67% of home video sales in 2010, down from 69% in 2009.
Major motion picture studios adopted a sell-through philosophy with DVDs, maintaining attractive price points to encourage sales of DVDs rather than rentals, generally making the DVD release of a film the largest component of a film’s profitability for the studios. This sell- through philosophy was widely accepted by big-box retailers, such as Wal-Mart, which use DVDs to attract customers into their stores and encourage additional purchases.
According to industry trade association Digital Entertainment, U.S. consumer home entertainment rental and sell-through spending decreased by 3% to $18.8 billion in 2010 compared to $20.0 billion in 2009. While DVD spending decreased to $14.0 billion from $15.8 billion, Blu-ray spending increased to $2.3 billion from $1.5 billion. Furthermore, an industry research and consulting firm reported a 15% decrease in North American DVD-video production to 1.7 billion units in 2010 from 2.0 billion units in 2009.
The average replication prices for DVDs (as measured in the industry by the price of replicating raw DVD-9 discs) are expected to continue to decline in coming years as a result of defined contractual commitments, continued pressure from customers and competition. In many instances, renegotiation of the terms of our agreements with our customers typically results in lower pricing. We expect that future price declines will be less than recent price declines due to the maturation and cost structure of the format. Price negotiations with customers routinely occur on an annual basis as a result of market tests or contract renewals.
Our strategy has been to secure exclusive, multi-year manufacturing and distribution agreements with industry leaders in North America and Europe. Given the contract termination notice received from WHV, we will continue to assess the impact on sizing of existing facilities and infrastructure. We will also continue to focus on our core business and seek opportunities to replace lost volume from WHV with volume from other studios.
Although management expects the existing DVD format to remain the home video standard for several years to come, we believe that the replication of Blu-ray discs continues to represent an opportunity to participate in this industry. As our pre-recorded multimedia product customers continue the transition to Blu-ray, we hope to leverage our customer relationships in North America and Western Europe, as well as our established manufacturing and distribution infrastructure to service this market.
Our largest pre-recorded multimedia product customers during 2010 included Twentieth Century Fox Home Entertainment (Fox), Warner Home Video (WHV), Lions Gate Films, Alliance Atlantis and Universal Pictures International in Europe.
We currently face competition in the pre-recorded multimedia product business from other major replicators that can offer substantially the same products and services, including Technicolor, Berterlsmann AG (Arvato) and Sony (Sony DADC). Sony has a competitive advantage in the production of Blu-ray discs because of its leading role in the development of these discs. Cinram continues to expand its capacity to manufacture Blu-ray discs and to secure long-term customer agreements for the format. Blu-ray disc replication revenue was $36.1 million in 2010, compared to $22.5 million in 2009.
Cinram 2010 Annual Report 21 MANAGEMENT’S DISCUSSION AND ANALYSIS
While we believe that electronic delivery of pre-recorded multimedia content and the unauthorized copying and distribution of video files continues to be a threat to our DVD business, we still believe the physical manufacturing and distribution of DVDs (both standard and Blu-ray) will exist for many years. Based on the sell-through pricing of DVDs, combined with the time required and quality issues associated with the unauthorized transfer and downloading of video files, management believes that consumers will continue to purchase and rent DVDs for a number of years to come. In addition, high-definition content requires greater bit buckets and new manufacturing technology that we believe makes unauthorized distribution and piracy increasingly cumbersome and more difficult than it is today compared with standard-definition DVDs.
With respect to the music industry, there has been a major shift in recent years in the distribution of recorded music, from specialty shops to mass-market and online retailers. Sales of recorded music fell again during 2010, as consumers continued to migrate away from the CD format. Reduced floor space for music by large retailers and the recession dampened consumer spending during the critical year-end holiday shopping period.
Total album sales in the United States, including CDs and full-album downloads, were 351.1 million, a 12% drop from 2009, according to data from Nielsen SoundScan. While CD album sales are on a downward trend, the trend is opposite for digital music, with over a billion songs downloaded, and a 13% increase in digital album sales from 2009.
Historically, our CD strategy has been to secure exclusive, multi-year manufacturing and distribution agreements with industry leaders in North America and Europe. As CD replication continues to be affected by declining order volumes, price competition, industry overcapacity and lower order run sizes, rationalization and consolidation continues within the CD manufacturing industry.
Our largest CD customers include Warner Music Group (WMG), an independent entity from Warner Home Video, and Universal Music in Canada. Our principal competitors in the CD replication industry include content owner Sony BMG (Arvato and Sony DADC). We also compete with other smaller independent replicators that can offer substantially the same products.
During the fourth quarter of 2010, the Fund announced that it has entered into a series of new agreements with WMG under which Cinram will continue to serve as WMG’s primary supplier for manufacturing and distribution services for WMG’s recorded music products in the U.S., Canada and parts of Europe.
Revenue from CDs (including audio CDs, CD-ROMs and related distribution) was down 19% to $130.7 million from $161.4 million in 2009, resulting from lower unit sales combined with the closure of our CD facility in Richmond, Indiana during the summer of 2009 and the concurrent termination of our services agreement with EMI Music Group in the United States. CD replication sales represented 80% of the CD sales in 2010, down slightly from 83% in 2009. Related distribution services accounted for 20% of CD sales in 2010, up from 17% in 2009. Overall, CD sales continued to show weakness in 2010 on lower unit shipments combined with lower related distribution revenue across all territories.
Distribution and fulfillment services continue to be a major factor in our ability to attract customers. Our studio and music customers continue to look to Cinram to provide complete manufacturing to retail distribution solutions that allow them to focus their efforts on their own core competencies in creating content. Our capital investments in distribution services over the past few years allow us to provide our customers with increased frequency of shipments, more customized order sizes and the ability to handle more stock-keeping units. However, given the loss of the WHV business during 2010, distribution services revenue associated with DVDs was $252.4 million in 2010, compared to $327.3 million in 2009.
The pre-recorded multimedia products segment accounted for 90% of consolidated revenue in 2010, up from 89% in 2009.
3.1.2 VIDEO GAME Revenue from the Video Game segment was $59.0 million in 2010 compared to $91.6 million in 2009 as a result of reduced consumer spending, combined with the loss of several video game customers. According to NPD Group, a respected industry analyst, overall U.S. video game industry sales, including hardware, software and accessories declined 6% to $18.6 billion during 2010.
22 Cinram 2010 Annual Report MANAGEMENT’S DISCUSSION AND ANALYSIS
Video game consoles have historically had a life cycle of four to six years, which creates cyclical software sales, emphasizing higher unit volumes in the early years of a console’s life. Console price reductions, in response to competitive pressures and the emerging market for online gaming, imposed pressure on our margins during 2010. The current cycle of consoles, including XBOX, Wii and PS3 which had initial releases several years ago, all experienced price reductions in 2010. According to industry figures, console sales in 2010 fell to $6.3 billion, a 12.5% decline from 2009 while software sales were $9.4 billion, a 5.6% decline from 2009.
Ditan Distribution (also known as Cinram Games, which comprises the entire Video Games segment) specializes in distributing packaged software for console games and computers, and related peripherals in the gaming marketplace. In addition, Cinram Games manages on behalf of its clients’ third party logistics, virtual warehousing services, direct channel sales, merchandising, transportation management and retail product lifecycle management services. The peak processing period is from mid-August through early January, with November as the focal point of activity. The customer base is comprised of video game publishers, content providers, studios, major retail chains and distributors and includes many of the industry’s leaders, including: Best Buy, Gamestop, Sega of America, LucasArts Entertainment, Namco, Atari, Square Enix, Ubisoft and SEGA.
We estimate that the video game distribution market is led by a limited number of major distributors, including Cinram. We consider our main competitors to be Technicolor and JVC. The majority of software publishers utilize third party distribution to control costs and limit expenses in non-core areas, and Cinram Games has been a preferred partner to those publishers and content providers. Other publishers self-distribute, led by Electronic Arts, a major publisher, who is the world’s largest interactive entertainment software company. With Cinram’s strong retailer relationships and virtual warehouse services, we estimate that we provide servicing to approximately 50% of all new video games distributed within the U.S. Most of our competitors offer substantially similar base services, with the exception of cross- docking and shipment consolidation.
Cinram Games strategically differentiates itself from competitors by emphasizing expedited order-to-delivery cycles; accurate, on-time shipments; increased visibility, accessibility and management of the supply chain; and superior, real-time customer service. Our online portal, “DitanAccess”, provides customers with real-time access to in-depth order and movement information and key reporting and analytical tools. Cinram’s strategies for the video game segment are to cross-sell our replication, assembly/kitting, and distribution services to these customers, and create stronger and wider bonds in those customer relationships.
3.1.3 OTHER Revenue from other activities, which includes revenue from Motorola and vendor managed inventory revenues associated with Cinram Retail Services (Vision), decreased to $54.2 million from $72.3 million in 2009. The prior year figure includes $15.0 million of revenue from the Motorola Europe contract that was terminated in July 2009. The decline in organic revenue for 2010 reflects a revised U.S. pricing structure with Motorola following the move into a new facility during the summer of 2009.
Other revenue also includes activities such as authoring and other pre-production services, and the sale of components and stampers.
Revenue from the Other segment represented 5% of consolidated revenue in 2010, consistent with 2009.
3.2 GEOGRAPHIC SEGMENTS
Years ended December 31 (In thousands of U.S. dollars) ’10 ’09
North America $ 645,699 58% $ 825,715 57% Europe 463,091 42% 627,316 43%
Total $ 1,108,790 100% $ 1,453,031 100%
Cinram 2010 Annual Report 23 MANAGEMENT’S DISCUSSION AND ANALYSIS
3.2.1 NORTH AMERICA North American revenue decreased 22% to $645.7 million from $825.7 million in 2009, primarily from lower revenues associated with the loss of the WHV contract effective July 31, 2010, combined with lower DVD selling prices. Pre-recorded multimedia product replication revenue associated with Blu-ray, standard DVD and CD decreased 21% to $403.2 million from $510.2 million in 2009, and related distribution revenue decreased 20% to $138.7 million from $173.2 million in 2009.
Included in pre-recorded multimedia product revenue is Blu-ray replication sales, which increased to $28.0 million from $15.1 million in 2009 due to higher unit volumes from our studio customers and CD replication revenue which declined to $56.0 million from $74.2 million in 2009 as a result of lower CD unit sales industry wide.
Video Game segment revenue during 2010 was $59.0 million compared to $91.6 million in the prior year as a result of reduced consumer spending and continued softness in this industry.
North America accounted for 58% of consolidated revenue in 2010, up from 57% in 2009.
3.2.2 EUROPE European revenue decreased 26% to $463.1 million from $627.3 million in 2009 as a result of lower revenue associated with the loss of the WHV contract effective July 31, 2010 combined with the termination of the Motorola Europe contract in July 2009. Pre-recorded multimedia product replication revenue associated with Blu-ray, standard DVD and CD decreased 26% to $313.9 million from $424.9 million in 2009, and related distribution revenue decreased 23% to $139.7 million in 2010 from $180.9 million in 2009.
Included in pre-recorded multimedia product revenue is Blu-ray replication sales, which increased to $8.1 million from $7.4 million in 2009 and CD replication revenue, which declined to $48.7 million from $60.4 million in 2009, resulting from lower unit sales for this format, consistent with industry trends.
European Other revenue from non-core activities decreased to $9.5 million from $21.6 million in 2009 as a result of the termination of distribution services provided to Motorola Europe effective July 2009.
As a percentage of consolidated sales, European revenue decreased to 42% from 43% in 2009.
4. GROSS PROFIT
Gross profit was $216.4 million for the year ended December 31, 2010, compared with $262.1 million in the prior year period. As a percentage of consolidated revenue, gross profit margins improved to 20% for 2010, compared with 18% for 2009. The improvement in gross profit margins was the result of direct material, direct labour and overhead efficiencies combined with reduced amortization of property, plant and equipment.
Amortization expense from property, plant and equipment, which is included in cost of goods sold, decreased to $54.7 million from $86.6 million in 2009. The decrease resulted from lower DVD depreciation expense combined with a lower net book value of capital assets resulting from the impairment charge at the end of 2009.
One of the components included in cost of goods sold is royalty expense. We record royalty charges for using third party replication technologies. These royalty charges are recorded as a cost of goods sold at the time of shipment on a per unit basis according to contractual terms and conditions or our best estimates. In situations where formal license agreements are not in place, we use our best estimates, which are subject to periodic review. As adjustments become necessary, they are made in the period when they become known.
Foreign exchange related to operations, which is included in cost of goods sold, was a loss of $1.3 million in 2010, compared to a gain of $1.1 million in 2009. The loss in 2010 was primarily from U.S.-denominated accounts payable in our non-U.S.-based subsidiaries as the U.S. dollar strengthened during 2010 against most foreign currencies.
24 Cinram 2010 Annual Report MANAGEMENT’S DISCUSSION AND ANALYSIS
5. IMPAIRMENT OF GOODWILL AND LONG-LIVED ASSETS
We review tangible and intangible assets (long-lived assets) for impairment annually, or more frequently if events or changes in circumstances indicate that the carrying amount may not be recoverable. Absent any triggering factors during the year, we conduct our long-lived asset assessment in the fourth quarter to correspond with our planning cycle. Our budgeting process is subject to the risks and factors in the risk factors section, and there is no assurance that it is predictive of future performance.
We assess recoverability by comparing the carrying amount to the projected undiscounted future net cash flows that the long-lived assets are expected to generate. If the sum of undiscounted future cash flows expected to result from the use and disposition of a group of assets is less than its carrying amount, it is considered impaired. An impairment loss is measured as the amount by which the carrying amount of a group of assets exceeds its fair value.
Based on future cash flow projections in our 2011 budget and multi-year projections for 2012 through 2014, we determined that the estimated undiscounted future cash flows were in excess of the associated carrying value of plant and equipment and customer supply agreements. Accordingly, no write-down of the long-lived assets was required in 2010. In 2009, an impairment charge of $59.8 million was recorded as the carrying value of certain plant and equipment and customer supply agreements was in excess of the associated estimated undiscounted future cash flows.
During the fourth quarter of 2010, we completed our annual goodwill impairment test for our identified reporting units. We estimated the fair values for the reporting units using discounted cash flows. Future cash flow projections were based on the 2011 budget and multi-year projections for 2012 through 2014. These projections include the latest information and estimates on unit growth trends, contractual pricing commitments, non-contractual price expectations and anticipated cost fluctuations based on market costs and efficiencies. The impairment test determined that the fair value of the goodwill was above its carrying value, and, as a result, no impairment charge was recorded in 2010. In 2009, an impairment charge of $22.4 million was recorded.
6. AMORTIZATION OF INTANGIBLE ASSETS
We recorded intangible asset amortization of $15.1 million, compared to $41.5 million in 2009. The 2010 amortization related primarily to the Warner Home Video supply contract in Germany up to and including the contract termination date of July 31, 2010, in addition to amortization of customer relationships for both Ditan and Vision. The prior year figure includes a full year of amortization relating to the WHV supply contracts in both North America and Europe.
7. SELLING, GENERAL AND ADMINISTRATIVE EXPENSES
Selling, general and administrative expenses, which include sales and marketing expenses, consulting expenses, office expenses and non- manufacturing related salaries and professional fees, decreased 17% to $137.7 million from $165.0 million in 2009. The prior year total includes $17.4 million of combined severance charges associated with certain executive employees and consulting fees. As a percentage of consolidated revenues, selling, general and administrative expenses were 12% in 2010, compared with 11% in 2009.
8. OTHER CHARGES (INCOME), NET
(In thousands of U.S. dollars) ’10 ’09
Facility restructuring (a) $ 25,004 $ 4,229 Gain on sale of property, plant and equipment (b) (7,460) (1,746)
$ 17,544 $ 2,483
Cinram 2010 Annual Report 25 MANAGEMENT’S DISCUSSION AND ANALYSIS
(a) Facility restructuring During 2010, the Fund continued the rationalization of several of its plants, primarily as a result of the WHV termination notice effective July 31, 2010. During the year, net costs of $25.0 million related to severance and other restructuring costs were recorded as other charges. Included in this was $14.7 million for North American operations, which was comprised of $8.3 million, $6.0 million and $0.4 million for severance, facility exit and other costs, respectively. In Europe, a charge of $10.3 million was recorded, which was comprised of $9.0 million and $1.3 million for severance and other costs, respectively. As at December 31, 2010, a total of $15.4 million remains in accrued liabilities.
In March 2009, the Fund (i) closed its CD replication facility in Richmond, Indiana and relocated part of the operations to the Olyphant, Pennsylvania facility, (ii) closed its Simi Valley, California, distribution facility and relocated operations to Nashville, Tennessee and Aurora, Illinois and (iii) closed the Swindon, UK, distribution facility that was acquired as part of the acquisition of the assets of ODS Business Services in 2008. During 2009, costs of $4.2 million related to severance, facility decommissioning and lease termination were recorded as other charges.
(b) Gain on sale of property, plant and equipment In January 2010, the Fund sold its distribution centre in Simi Valley, California for proceeds of $14.0 million less transaction costs, resulting in a gain of $7.5 million. This gain was recorded to other income during the first quarter of 2010.
In January 2009, the Fund completed a sale-leaseback transaction of its facility in Aurora, Illinois, for net cash proceeds of $23.0 million. An immediate gain of $1.7 million was recorded to other charges on the transaction. A further gain of $9.5 million was deferred and is being amortized over the minimum lease term of five years. During 2010 and 2009, $1.9 million and $1.8 million, respectively, of the deferred gain was amortized with the credit recorded to cost of goods sold.
9. INTEREST EXPENSE
Interest expense decreased to $32.6 million in 2010 from $37.6 million in 2009, due to lower debt balances. Interest expense for 2010 included straight line amortization of transaction costs and loan fees of $2.4 million, consistent with 2009. The weighted average interest rate on our long-term debt in 2010 was 7.7% compared with 6.1% in 2009. While our debt balance has decreased significantly over the past year, the effective interest rate on our debt is impacted by the $400 million fixed rate hedge that is fixed at a rate of 7.55% until August 2011. Therefore, for as long as the interest rate swap is in place, the average interest rate on the long-term debt is expected to increase regardless of variable interest rate fluctuations.
As of December 31, 2010, there were no borrowings outstanding under our revolving credit facility, except for letters of credit issued to various agencies, primarily in the United States, for $14.1 million.
GAIN ON REPURCHASE OF DEBT
During 2010, the Fund did not repurchase any debt below par pursuant to the 2009 credit facility amendment, as the Fund reached its limit during the 2009 calendar year. During 2009, the Fund repurchased $169.7 million of debt for total cash proceeds of $131.2 million, including transaction costs of $1.5 million, resulting in a net gain of $38.4 million.
10. INVESTMENT INCOME
We earned interest income of $0.3 million in 2010 compared with $0.4 million in 2009 due to lower rates of return.
11. FOREIGN EXCHANGE GAIN
During the year ended December 31, 2010, we recorded an unrealized foreign exchange gain of $1.0 million, compared to a gain of $15.2 million in 2009. The gain recorded in the prior year was primarily the result of the strengthening of the Euro relative to the U.S. dollar over the corresponding time period.
26 Cinram 2010 Annual Report MANAGEMENT’S DISCUSSION AND ANALYSIS
12. INCOME TAXES
The Fund records income tax expenses based on taxable income in various jurisdictions and taking into account tax deductions available under the existing corporate structure. We recorded an income tax recovery of $3.5 million for the year ended December 31, 2010, compared to a tax recovery of $12.7 million for the prior year on continuing operations. Our effective tax rate for the year was a negative 23% and reflects utilization of tax benefits previously not recognized, primarily in the United States as well as adjustments to certain tax provisions due to changes in facts and circumstances.
Legislation enacted by the Canadian federal government on June 22, 2007 (Bill C-52) to implement proposed income tax changes to publicly traded income trusts such as the Fund is not expected to have any impact on the Fund’s current or future year earnings. For a more complete description of Bill C-52 and its impact on the Fund, see section 15.3 – Tax related risks.
The Fund believes it has adequately provided for income taxes based on all of the information that is currently available. The calculation of income taxes in many cases, however, requires significant judgment in interpreting tax rules and regulations. The Fund’s tax filings are subject to audits which could materially change the amount of current and future income tax assets and liabilities, and could, in certain circumstances, result in the assessment of interest and penalties.
At December 31, 2010, the Fund has non-capital loss carryforwards in Europe, U.S. and Canada totaling $250.5 million. In addition, the Fund has net capital loss carryforwards of $84.6 million in Canada. The Fund recorded a valuation allowance for both non-capital and net capital losses, as there is no assurance that it will be able to use these losses in the future.
13. EARNINGS/LOSS
The Fund generated net earnings from continuing operations of $18.4 million or $0.34 per basic unit in 2010 compared to net loss from continuing operations of $6.0 million or $0.11 per basic unit in 2009. The prior year loss was primarily as a result of an $82.2 million impairment charge for long-lived assets and goodwill.
14. LIQUIDITY AND CAPITAL RESOURCES
Cinram’s principal sources of funds include existing cash balances on hand, cash flow from operating activities and the sale of non-core assets. During 2010, our primary uses of funds included the scheduled debt repayments at par and maintenance and growth capital spending.
Sources and uses of cash
(In thousands of U.S. dollars) ’10 ’09
Cash flow provided by continuing operating activities $ 89,982 $ 302,770 Cash flow used in continuing financing activities (36,590) (220,116) Cash flow used in continuing investing activities, net of proceeds from asset sales (5,909) (32,273)
We ended 2010 with a cash balance of $164.4 million, up from $122.1 million in 2009. We generated cash flow from continuing operations of $90.0 million during 2010, compared to $302.8 million in 2009, as the prior year figure reflected a significant improvement in working capital performance related to a reduction in accounts receivable days sales outstanding.
Cash used in continuing financing activities was $36.6 million in 2010, compared with $220.1 million in 2009, as the prior year total reflects $131.2 million of cash used for the repurchase of long-term debt at a discount combined with $82.1 million of debt repayments at par.
Cash used in continuing investing activities represented a net outflow of $5.9 million in 2010, compared to an outflow of $32.3 million in the prior year, primarily reflecting reduced spending on property, plant and equipment. During 2010, we invested $14.7 million for capital asset additions, compared to $42.2 million in the prior year.
Cinram 2010 Annual Report 27 MANAGEMENT’S DISCUSSION AND ANALYSIS
As of December 31, 2010, our net debt position (long-term debt excluding unamortized transaction costs, less cash and cash equivalents) was $202.3 million, compared with $273.3 million at December 31, 2009.
At December 31, 2010, we had total assets of $638.8 million, compared with $784.7 million at December 31, 2009. The reduction in total assets was primarily attributable to lower accounts receivable and long-lived asset balances.
14.1 CAPITAL SPENDING
We paid $14.7 million for property, plant and equipment in 2010, principally for additional Blu-ray capacity and maintenance capital spending, compared with $42.2 million in 2009. Our capital spending in 2011 will primarily consist of Blu-ray capacity expansion.
We anticipate that capital spending for the foreseeable future will be primarily financed with cash generated from operations. The form of any other capital expansion financing will vary depending on prevailing market and other conditions. However, there can be no assurance that funds will be available on terms acceptable to Cinram.
14.2 LONG-TERM DEBT
In May 2006, in connection with the income trust conversion, we entered into a credit facility and repaid all balances outstanding under our previous facilities. Our credit facility is a five-year senior secured credit facility for $825 million that matures in May 2011, and was comprised of a $675 million term loan and a $150 million revolving credit facility that initially bore interest at LIBOR plus 175 basis points, subject to financial ratio tests.
On March 30, 2009, the Fund amended certain provisions under the credit facility, primarily to permit the Fund to use up to $150 million to repurchase term advances outstanding under the senior secured credit facility at prices below par through one or more “modified Dutch” auctions during a one-year period ending March 29, 2010. Concurrently, the Fund agreed to the following conditions:
(i) a loan repayment of $35 million on March 30, 2009 upon amendment effectiveness; (ii) increase in the quarterly principal repayments to $10 million commencing with the June 30, 2009 payment; (iii) suspension of all unit distributions and unit buybacks until the May 2011 scheduled maturity of the credit facility; and, (iv) reduction in the revolving credit commitment by $50 million to $100 million. The reduction was allocated ratably to both the U.S. and Canadian revolving credit facilities.
There were no amendments to the financial covenants nor changes to the interest rate spread on borrowings.
As of December 31, 2010, the revolving credit facility of $100 million remained undrawn except for issued letters of credit totaling $14.1 million. During 2010, pursuant to the credit facility amendment, we made total debt repayments of $28.6 million and, accordingly, the outstanding term loan balance as at December 31, 2010 was $366.7 million.
On January 25, 2011 the Fund announced the Refinancing and Recapitalization with its current lenders. In addition, Cinram has agreed to the material terms that will form the basis for further agreements with a major customer for a term of three years, subject to completion of the Refinancing and Recapitalization.
A majority of the Fund’s unitholders have consented in writing to the Refinancing and Recapitalization, including the issuance of new equity units and warrants. The following are the key elements of the changes to Cinram’s capital structure that will result from the proposed transactions:
• Amendment and extension of the Credit Facility to December 31, 2013. • Reduction in the amount of term debt outstanding and revolving commitments available under the amended Credit Facility:
28 Cinram 2010 Annual Report MANAGEMENT’S DISCUSSION AND ANALYSIS
• Existing term debt of approximately $367 million to be reduced by $120 million through: cash pay-down at closing in the principal amount of $30 million; and exchange of outstanding first-lien term debt in the amount of $90 million for $90 million second-lien secured debt that is mandatorily exchangeable into equity of the Fund on December 31, 2011 if not earlier repaid from equity proceeds. • Reduction of commitments under revolving facility from $100 million to $35 million. • An option for Cinram to raise new equity proceeds to repay the mandatorily exchangeable secured debt through the end of 2011. • The issuance of up to 9.85 million Cinram units and a cash fee of $11.2 million to lenders that consented to the Refinancing and Recapitalization. • The issuance of warrants to acquire 13 million Cinram units.
On January 28, 2011, Cinram commenced an amendment process with the lenders with respect to the Refinancing and Recapitalization and, as announced on February 17, 2011, the Fund has received 100% lender support for the transaction. The lenders have agreed to consent to and support the Refinancing and Recapitalization and the arrangements with Cinram’s major customer. The lenders will receive a consent fee equal to their pro rata share (based on the full amount outstanding under the Credit Facility) of: (a) approximately $11.2 million in cash; (b) approximately 6.2 million units in the Fund; and (c) if any portion of the mandatorily exchangeable secured debt has not been repaid by June 30, 2011, approximately 3.65 million additional units in the Fund. The Refinancing and Recapitalization is scheduled to close in March 2011 and Cinram is pursuing opportunities to raise capital to repay the mandatorily exchangeable secured debt.
In December 2010, Moody’s Investor Service downgraded Cinram’s long-term corporate family rating to Caa2 from Caa1. The rating has a negative outlook. In January 2011, Standard and Poor’s downgraded the rating on the Cinram debt to CC from CCC+ with a negative outlook.
Credit ratings are intended to provide investors with an independent measure of credit quality of an issue of securities. Ratings for debt instruments range from AAA, in the case of S&P or Aaa in the case of Moody’s, which represent the highest quality of securities rated, to D, in the case of S&P and C in the case of Moody’s which represent the lowest quality of securities rated. The credit ratings accorded by the rating agencies are not recommendations to purchase, hold or sell the rated securities inasmuch as ratings do not comment as to market price or suitability for a particular investor. There is no assurance that any rating will remain in effect for any period of time or that any rating will not be revised or withdrawn entirely by a rating agency in the future if in its judgment circumstances so warrant.
14.3 DEBT COVENANTS
As of December 31, 2010, our credit agreement has the following significant covenants:
• Leverage not to exceed 3.00x EBITA; • Minimum interest coverage ratio of 4.00:1.00; • Annual capital expenditures not to exceed $150 million; • Suspension of distributions and unit buyback until maturity of credit agreement; • Minimum liquidity consisting of cash on hand and revolver availability of $37.5 million at all times, and cash on hand and revolver availability of $100 million prior to offering to repurchase debt at an amount below par; • Restricted payment covenants.
At December 31, 2010 and 2009, we were in compliance with all of the terms and covenants of our credit agreements. Based on our current internal forecasts, which are subject to the risks described in the risks and uncertainties section, we anticipate remaining compliant with our debt covenants for the foreseeable future. There is no assurance that the current forecasts will be accurate. Under the terms of our existing credit agreement, we are obliged to make a mandatory offer to prepay the credit facilities from the following:
• 75% of net cash proceeds of non-ordinary course asset sales subject to certain reinvestment rights; • 50% of proceeds of debt issuance; • 75% of certain insurance proceeds (in excess of $5 million) subject to exceptions including replacement and repair of affected assets; and • 50% of net proceeds of equity issuance.
Cinram 2010 Annual Report 29 MANAGEMENT’S DISCUSSION AND ANALYSIS
The existing credit agreement is guaranteed by each of Cinram International Inc’s (CII) existing and future material subsidiaries, and is secured by all of the assets of each guarantor, including but not limited to (a) a first-priority pledge of all the capital stock of each of the subsidiaries of CII and (b) perfected first-priority security interests in, and mortgages on, substantially all tangible and intangible assets of each guarantor (including but not limited to all material multi-year revenue-generating contracts, accounts receivable, inventory, equipment, leaseholds, investment property, intellectual property, real property, cash and proceeds of the foregoing).
Under the proposed Refinancing and Recapitalization outlined previously, the amended credit facility will include revised covenant levels and debt repayment schedules.
14.4 LONG-TERM OBLIGATIONS
Based on the anticipated refinancing and recapitalization which is scheduled to close during the first quarter of 2011, we had contractual obligations that require future payments as follows:
(In millions of U.S. dollars) Long-term debt Capital leases Operating leases Total
2011 $ 132.3 $ 1.2 $ 40.1 $ 173.6 2012 18.5 0.6 29.3 48.4 2013 215.9 0.5 16.2 232.6 2014 — — 10.4 10.4 2015 and after — — 27.4 27.4
Total $ 366.7 $ 2.3 $ 123.4 $ 492.4
All of Cinram’s debt and future lease commitments are disclosed in Notes 7 and 8 to the consolidated financial statements for the year ended December 31, 2010.
14.5 PENSION OBLIGATIONS
At December 31, 2010, we had a $0.1 million defined benefit pension obligation in the United States representing the expected contributions to our defined benefit pension plan. Contributions for the year ending December 31, 2012 and beyond cannot be reasonably estimated as they will depend on future economic conditions and may be impacted by future government legislation.
In Germany, the Fund’s defined benefit pension plan covers certain existing and former employees who have signed specific agreements related to pension benefits, including members of senior and middle management. The pension contributions are based on German tax law and requirements, and, therefore, the plan remains unfunded. See Note 17 to our financial statements for a comprehensive explanation of our pension and non-pension employment benefit plans.
14.6 DERIVATIVE FINANCIAL INSTRUMENTS
In August 2006, the Fund entered into a five-year, $400-million swap agreement fixing the interest rate on the hedged portion of the term loan at 5.55%, plus 200 basis points, resulting in a rate of 7.55% maturing in August 2011. As at December 31, 2010 the credit-adjusted mark-to-market liability is $11.1 million, compared with $25.2 million at December 31, 2009.
14.7 UNITHOLDERS’ EQUITY, DIVIDENDS AND DISTRIBUTIONS
At December 31, 2010, there were 55.245 million units issued and outstanding in addition to 0.029 million exchangeable Cinram International Limited Partnership units issued and outstanding (which units are exchangeable for Fund units on a one-for-one basis). The Fund also has 0.67 million deferred units outstanding at December 31, 2010.
30 Cinram 2010 Annual Report MANAGEMENT’S DISCUSSION AND ANALYSIS
During the year ended 2009, the Fund entered into two separate agreements to advance up to Cdn. $3.3 million to named officers for the purpose of buying units of the Fund on the open market. At December 31, 2010, Cdn. $2.4 million has been advanced for the purchase of 1,268,400 units. The balances outstanding are secured by the units purchased or any proceeds realized upon sale of the units. At December 31, 2010, the market value of the units held as collateral was Cdn. $1.7 million. The loans were originally repayable in four equal annual installments commencing in the second quarter of 2011, or earlier under certain specified conditions. However during the fourth quarter of 2010, the repayment of the loans was extended by one year. Also, during the 2010 fourth quarter, the Fund placed Cdn. $1.9 million into escrow to offset any potential personal tax liabilities of the named officers related to these loans. The funds in escrow are included in other long-term assets.
In November 2007, the Fund announced its intention to suspend all distribution payments following the distribution for the month of December 2007. There were no per unit cash distributions declared in 2008, 2009 or 2010 by Cinram’s Trustees.
14.8 RELATED PARTY TRANSACTIONS
The Fund entered into the following related party transactions:
In 2010, a total of $0.6 million (2009 — $1.1 million) was paid to a law firm in which the Senior Vice President and General Counsel of the Fund was a former partner. The Senior Vice President and General Counsel of the Fund remained a partner in this law firm until January 31, 2008 and is currently of counsel to the firm. The Fund has been advised that the Senior Vice President and General Counsel received no credit or compensation with respect to the amounts paid by the Fund to the firm since the Senior Vice President and General Counsel’s commencement date.
In 2010, as a result of the relocation of the CEO pursuant to his employment agreement, the Fund agreed to purchase his principal residence for $1.3 million in April 2010, representing the estimated fair market value at the time of purchase. This transaction was reviewed and approved by the Board of Trustees, without the participation of the CEO.
These transactions were recorded at the exchange amount, being the amount agreed to by the related parties.
15. RISKS AND UNCERTAINTIES
15.1 RISKS RELATING TO THE BUSINESS
Development or proliferation of digital distribution alternatives, including copying and distribution of music and video files Our core business depends on the continued viability of physical distribution of music, video and games through authorized pre-recorded media. Alternative distribution channels and methods, both authorized and unauthorized, for delivering music and video have eroded our volume of sales and the pricing of our products and services. The growth of these alternatives is driven by advances in technology that allow for the transfer and downloading of music and video files from the Internet and other channels. The proliferation of this copying, use and distribution of such files is supported by the increasing availability and decreasing price of new technologies, such as analog recorders, personal video recorders, CD and DVD burners and portable MP3 music and video players (including smart phones, tablets and similar devices), widespread access to the Internet (including televisions and Blu-ray disc players with built-in Internet access), Internet radio services and the increasing number of peer-to-peer digital distribution services that facilitate file transfers and downloading also impact the volume of physical media products. Over the past few years, music files have accounted for most of the transfer and downloading, a substantial amount of which was conducted without authorization from the content owners. Most major music industry labels, studios and other content owners have entered into arrangements with Internet providers that broaden the opportunities for legitimate downloading of music and video files, with the Apple iTunes Store catalog currently offering more than 12 million songs, 55,000 TV episodes and 8,500 movies. Apple has reported that over 10 billion songs have been downloaded from the iTunes Store, with many other sites also now offering authorized music and video content. We expect that file sharing and downloading, both legitimate and illegal, will continue to exert significant downward pressure on the demand for DVDs and CDs. In addition, as current technologies improve, and as more devices are able to deliver Internet access to televisions and portable devices, the digital transfer and downloading of video and game files will become more widespread. Certain of our customers have begun to develop or partner with new service providers for the authorized digital distribution of their movies, television programs and games, and many of these are now easily downloadable to home entertainment systems and portable devices. As the speed and quality with which video files can be transferred and downloaded improves, file sharing and downloading is expected to exert significant downward pressure on the demand for DVDs in the future. Demand for our physical products has also been,
Cinram 2010 Annual Report 31 MANAGEMENT’S DISCUSSION AND ANALYSIS
and is expected to continue to be, adversely affected by CD and DVD piracy, which is the unauthorized production of music, movies and games for commercial sale. In addition, our business faces pressure from emerging distribution alternatives, like video-on-demand (VOD) and personal digital video recorders. These services may offer more attractive pricing or more convenient delivery and, as a result, could materially reduce demand for pre-recorded CDs and DVDs. As a significant portion of our revenue is derived from the sale of DVDs, the continued growth of alternative distribution channels and methods, along with the growth in file sharing, downloading (both legal and illegal) and piracy, could materially adversely affect the Fund’s business, financial condition and results of operations. The company recognizes this threat to its core business and is developing a digital strategy to enable the company to participate in the eventual growth of the legitimate digital delivery of entertainment products. The recent acquisition of 1K is an important foundational investment in the development of this strategy.
Economic trends and consumer preferences Our financial performance depends on consumer demand for our customers’ products. A significant portion of the purchases of prerecorded media products sold by our customers are discretionary. Accordingly, weak economic conditions or outlook or weak consumer confidence could reduce consumption in any of our customers’ major markets, thereby causing declines in our revenue and net earnings. In addition, due to the discretionary nature of their products, our customers must continually compete for the public’s leisure time and disposable income with other forms of entertainment, including sporting events, concerts, live theatre and restaurants. They also compete for retail shelf space with other consumer goods. Consumers are also increasingly looking to listen to music and to view movies and television programs on devices other than traditional home entertainment systems, including on tablet computers and other portable devices. These devices typically do not utilize CDs or DVDs, and instead rely on downloading or streaming to provide the product. As a result of this competition, demand for our customers’ products could be reduced and, accordingly, sales volumes, financial condition and results of operations of the Fund could be adversely affected.
Significant competitive and pricing pressures We are engaged in an industry that is highly price competitive. Some of our competitors are companies, or divisions or operating units of companies that have greater financial and other resources than the Fund. In addition, competitive pressure is exerted by lower-cost, offshore replicators. We may not be able to compete successfully in our industry, and this could have a material adverse effect on the Fund’s business, results of operations and financial condition. Furthermore, as previously disclosed in our prior year public filings, our financial results were adversely impacted and may from time to time be impacted by significant pricing pressure pursuant to our multi-year contracts with our customers that contain a periodic market price test and most-favoured-nations clauses. These contracts, depending on prevailing industry prices, require that we lower the prices we charge our customers to match market prices tested periodically or to meet competitors’ terms. There is no assurance that customers will renew or continue their contractual agreements.
On February 1, 2010, the Fund announced that it received written notice from WHV that WHV was exercising its option to terminate its service agreements on July 31, 2010. The notice covers all Cinram entities globally and will directly impact operations in North America, UK, France, Germany and Spain. WHV revenues for 2009 represented approximately 32% of the total consolidated revenues of the Fund.
Many of our customers have recently undergone, or may undergo, consolidation. As our customers grow larger and their industries grow more concentrated, the few remaining large entities may develop greater bargaining power and may be able to exert significant pricing pressure on our products, which would adversely affect the Fund’s margins. If any one of our customers is acquired by or consolidates with another participant in the industry that has either an existing relationship with one of our competitors or the internal capacity to supply the same products and services that we provide, we may lose that customer and the Fund’s results of operations may be materially adversely affected.
Dependence on a limited number of large customers with substantial bargaining power and renewal of contracts We operate in an industry in which there is a high degree of customer concentration. Our three largest customers in 2010 were Fox, WHV and Universal Pictures. Collectively, these three customers accounted for approximately 63% of our consolidated 2010 revenue. Fox, our largest customer, accounted for 28% of our 2010 consolidated revenue. If any one of our significant customers, individually or collectively, discontinues their relationship with us for any reason (including as a result of our failure to perform under our contracts), the Fund’s business would be adversely affected. In addition, our customers face a variety of risks and competitive pressures in the industries in which they operate, and if market and other factors cause them to cancel, reduce or postpone current or expected purchase commitments, the Fund’s operating results and financial condition may be materially adversely affected. Similarly, if our significant customers do not own the licensing and distribution rights to the content they produce, there is no assurance that we will be provided with the contract for these products and services regardless of the exclusive nature of our contracts. The Fund’s operating results could also be impacted if one of our larger customers fails or is unable to pay amounts owed to us in a timely manner, or at all, whether due to strategic redirections or adverse changes in their businesses or for other reasons.
32 Cinram 2010 Annual Report MANAGEMENT’S DISCUSSION AND ANALYSIS
Although our customer relationships comprise contractual arrangements of varying terms, in any given year, certain contracts come up for renewal. If we were unable to renew contracts with significant customers, either individually or as a group, under favourable terms, or if our relationship with any of these customers terminated, the Fund’s results of operations may be materially adversely affected.
Dependence on key personnel Our operations and prospects depend, in large part, on the performance and continued service of our senior and middle management teams. The loss of key employees or the inability to attract and retain skilled employees could adversely affect our ability to effectively pursue our business strategy. Currently, only certain of our key officers and employees are bound by written employment contracts.
Increased costs or shortages of raw materials or energy Each year we purchase significant quantities of plastics, the key raw materials used in the production of DVDs, Blu-ray discs, and CDs. The availability and prices of these materials may be influenced by a number of different factors, many of which are beyond our control, including weather, transportation, supply capacity constraints, delays and the price of oil. Significant shortages and price increases for the plastics we use have occurred in the past. We generally do not hedge against price increases in raw materials, although many of our customer contracts include some ability to adjust pricing based on changes in commodity prices. If we experience raw material price increases and are either unable to pass these increases through to our customers, or if we are contractually restricted as to the timing of any increases in the amount we charge our customers, the Fund’s gross margins would be adversely affected. Also, the processes we use in our manufacturing, distribution and printing facilities are energy intensive. Therefore, increases in energy costs would adversely affect the Fund’s gross margins and, consequently, our results of operations.
Demand and pricing for mature products Demand for our products and the prices at which we are able to sell our products generally decline as the products mature. Over the course of its product life cycle, the CD format has experienced a substantial decline in demand and pricing. As a result, to the extent we are unable to increase our sales volumes or reduce our manufacturing costs, the Fund’s profit margin for this format will and can be expected to further decline. We have experienced similar pricing declines in respect of the DVD format and expect to experience similar volume declines given the maturation of the DVD format. We also expect to experience similar pricing and volume declines in any future formats that we manufacture, including Blu-ray discs. Therefore, to a certain extent, our success depends on our ability to invest in new technologies and secure contracts with our customers for new formats as they make the transition from mature formats. In particular, we will need to invest in Blu-ray replication capacity as may be required by our customers, and there can be no assurance that we will be able to obtain this additional capacity in the time frames needed or secure contracts with our customers for Blu-ray. In addition, as a result of declines in demand for the CD format, our revenue continues to be dependent on sales of the DVD format.
Management of the production, supply or security of products We are required to deliver substantial volumes of products to meet the stringent requirements of our customers. Our failure to successfully manage the production or supply of our products, including the failure to meet scheduled production and delivery deadlines, or the failure to meet the quality requirements of customers, could materially adversely affect the Fund’s business, operating results and financial condition. In particular, many of our larger customer contracts include penalties for failure to meet production and delivery requirements under the agreements, and these penalties could be significant if there was a material failure to perform. In addition, if a person was to make and distribute an unauthorized copy of one of our customers’ audio or video files prior to the scheduled release, we could be subject to liability arising from this breach of security, and the Fund’s business operations, as well as our reputation, could be adversely affected.
We are exposed to warranty and product liability claims in cases of product performance issues. There can be no assurance that we will not experience material product liability losses arising from such claims in the future and that these will not have a negative impact on our reputation and sales. We generally maintain insurance against many product liability risks, but there can be no assurance that this coverage will be adequate for any liabilities ultimately incurred. In addition, there is no assurance that insurance will continue to be available on terms acceptable to the Fund. A successful claim that exceeds our available insurance coverage or a product recall could have a material adverse impact on the Fund’s financial condition and results of operations, as well as our reputation.
Cinram 2010 Annual Report 33 MANAGEMENT’S DISCUSSION AND ANALYSIS
Intellectual property infringement The industry in which we compete has many participants that own, or that claim to own, intellectual property for certain manufacturing processes we employ, the products we produce or the content that is produced by our customers. In situations where formal license agreements are not in place, management’s best estimate of the royalty obligation is used. These estimates are reviewed periodically. While management currently believes that its accruals are adequate, there can be no assurance that, if we are required to obtain licensing in respect of these rights, we could obtain licensing on the terms assumed in these accruals. Furthermore, we cannot determine with certainty whether these or any other existing third party patents or the issuance of any new third party patents would require us to alter, or obtain licenses for, their processes or products. There is no assurance that we will be able to obtain any such licenses on terms favourable to us, if at all, and obtaining and paying royalties on new licenses might materially increase our costs. Additionally, the fees we pay for existing licenses could increase in the future when these licenses are renewed. New multimedia formats will also likely require that we obtain additional licenses.
From time to time we are audited by patent rights holders to determine our compliance with the relevant patent license agreements, and these audits can indicate errors in our calculation and underpayment of patent royalties. To the extent any such errors or underpayments exist, we may be required to pay royalty rates substantially higher than the rates under the license agreements, as well as penalties and interest. Accordingly, any material errors or underpayments could have a material adverse impact on the Fund’s financial condition and results of operations.
There can be no assurance that the content on the multimedia products we manufacture on behalf of our customers does not infringe upon the rights of third parties. Any claims brought against us by third parties with respect to intellectual property rights, with or without merit, could be time consuming, result in costly litigation or cause delays in our operations. Since there can be no assurance of the outcome of such claims, we may be subject to fines or penalties that could be significant. We are involved in various intellectual property-related legal actions that are in the ordinary course of its business. We cannot be certain that these actions, or any future actions, will not have a material adverse effect on the Fund’s business, operating results or financial condition.
Conduct of business internationally A significant portion of our sales are made to customers located outside of North America, primarily in Western Europe. We expect our international operations to continue to account for a significant portion of our revenue in the future, and we may expand into new international markets in the future. The economies of foreign countries that are important to our operations could suffer slower or negative economic growth or instability in the future. In addition, our operations and sales in foreign markets could be negatively affected by a variety of risks, including new restrictions and controls on access to markets, unusual or burdensome foreign laws or regulatory requirements or unexpected changes to such laws or requirements, fluctuations in the value of foreign currencies against the Canadian and U.S. dollars, dependence on foreign distributors and their sales channels and the failure to recognize intellectual property rights. We may not be able to insure or hedge against these risks, and we may not be able to ensure compliance with all applicable regulations without incurring significant additional costs.
Exchange rate fluctuations Our operations in foreign markets expose us to the risk of foreign currency fluctuations. To the extent we incur expenses or invoice customers in currencies other than the entity’s functional currency, exchange rate fluctuations could cause our expenses to increase or our revenues to decrease, thereby negatively affecting profitability and cash flows. In addition, we are exposed to currency exchange rate risk on debt denominated in U.S. dollars, as a portion of our consolidated earnings are generated in different currencies.
Changes in interest rates The Fund’s current credit facility bears interest at variable rates with a fixed interest rate spread. The weighted average interest rate on the debt outstanding under the senior credit facility for the year ended December 31, 2010 was 7.7%. Cinram has an interest rate hedge on $400 million in place which expires in August 2011. This hedge exceeds the amount of outstanding debt.
Blu-ray format Our exclusive contractual arrangements with our major customers generally do not include the replication of Blu-ray discs and, accordingly, we cannot be assured that any of our existing customers will continue to employ our services with respect to this format (or any future generations of multimedia products). In order for us to manufacture Blu-ray discs, provided that we are able to secure long-term customer agreements for the format, we may be required to extensively upgrade or alter our manufacturing processes and production facilities. If we are unable to materially participate in the Blu-ray format, because we are unable to secure long-term customer commitments, unable to obtain the resources necessary to fund product expansion or unable to secure future financing from lenders to purchase production equipment for any other reason, we may not be able to successfully implement our business strategies and our customer relationships, market share, gross profit margins, and our results of operations could be adversely affected.
34 Cinram 2010 Annual Report MANAGEMENT’S DISCUSSION AND ANALYSIS
Increased compression and seasonality Our production levels and, in turn, our revenue and cash flows, are largely affected by the schedule according to which our major customers release their products. This in turn is dependent on a variety of factors, such as consumer demand and the availability of marketable content. The Fund’s results of operations and cash flows in any period are materially affected by the timing of product releases by its customers, which may result in significant fluctuations from period to period. In addition, in the music and video industries, consumer purchases typically are made in the last three months of the calendar year. Accordingly, an increasing percentage of our annual revenue and earnings is being realized during the fourth quarter, making the fourth quarter results material to the Fund’s full-year performance. These fluctuations in our sales may adversely affect the Fund’s results from operations and cash flows, as the Fund will be required to employ more capacity to meet the increased compression.
Work stoppages or other labour disruptions affecting key customers Labour disruptions affecting our key customers, particularly work stoppages and disputes involving those associated with the music recording or film industries, could affect demand for our products. Any prolonged strikes or other forms of labour protests or disputes affecting the businesses of our customers will likely have a material impact on the Fund’s financial condition and results of operations.
Environmental and consumer safety laws Our manufacturing facilities are subject to a range of federal, state, provincial, local and foreign laws and regulations relating to the environment. These include laws and regulations that govern discharges into the air, water and land, the handling and disposal of hazardous substances and wastes, and the remediation of contamination associated with our facilities and off-site disposal locations. In addition, many of our products are covered by the requirements imposed by the recently enacted Consumer Product Safety Improvement Act (CPSIA), which limits the amount of lead and other harmful products in products intended for children 12 and under. Compliance with existing and future environmental and product safety laws and regulations and enforcement policies may require that we incur capital and other costs, which may materially adversely affect our future financial condition. In addition, if we are found not to be in compliance with applicable environmental or product safety laws and regulations, we may be subject to fines and penalties that could be significant. Our customers also may require us to meet additional environmental or consumer safety requirements, which may require that we incur capital and other costs or result in our inability to provide the products in the manner required.
Other services and products The Fund is seeking to expand its service offerings into complementary areas, such as the expansion into distribution of products in the wireless market and digital distribution. In addition, the Fund is expanding its ancillary services to its studio clients in the areas of compression and authoring, app development, enhanced content creation for movies, music, games and books. These new service offerings will likely require additional capital expenditures by the Fund that may not be available when needed or, if available, may not be on terms that are acceptable to the Fund. In addition, there can be no assurance that any of these new services or products will meet with success in the marketplace.
Risks concerning the Refinancing and Recapitalization On January 25, 2011 Cinram International Income Fund announced the proposed Refinancing and Recapitalization with its lenders. A majority of the Fund’s unitholders have consented in writing to the Refinancing and Recapitalization and related transactions, including the issuance of new equity units and warrants. In addition, Cinram agreed to the material terms that will form the basis for further agreements with a major customer for a term of three years; those agreements are inter-conditional with the Refinancing and Recapitalization. The Fund has received 100% lender support for the Refinancing and Recapitalization and the arrangements with Cinram’s major customer. The transactions are scheduled to be completed in March 2011. Consummation of the transaction is subject to settlement of mutually acceptable documentation and other customary conditions. There can be no assurance that the transactions will be successfully completed, or if successfully completed as to the timing for completion. Failure to complete these transactions in a timely manner would have material adverse consequences to the Fund.
Fluctuations in quarterly and annual operating results A number of factors, many of which are outside our control, may cause or contribute to significant fluctuations in our quarterly and annual revenue and operating results. These fluctuations may make financial planning and forecasting more difficult. In addition, these fluctuations may result in unanticipated decreases in the Fund’s available cash, which could negatively impact our business and prospects. As discussed more fully below, these fluctuations could also increase the volatility of the price of the Fund’s units.
Cinram 2010 Annual Report 35 MANAGEMENT’S DISCUSSION AND ANALYSIS
Factors that may cause or contribute to fluctuations in our operating results and revenue include:
• The loss of any major customer; • The impact of current economic conditions; • Fluctuations in demand for our products; • Increased compression with the industry; • Introduction or enhancement of products and technologies by our competitors, and market acceptance of these new or enhanced products and technologies; • Events and conditions in the motion picture and music industries that affect the number of movies or television shows produced and distributed on home video and the number of CD albums sold, the popularity of motion pictures, and strikes by motion picture and music industry participants; • Consolidation by participants in the markets in which we compete, which could result in, among other things, pricing pressure; • The amount and timing of our operating costs and capital expenditures, including those related to the expansion of our business, operations and infrastructure; • Variations in the time-to-market of our technologies in the entertainment industries in which we operate; • Seasonal product purchasing patterns by consumers; • The impact of, and our ability to react to, interruptions in the entertainment distribution chain, including as a result of work stoppages at our facilities, our customers’ facilities and other points throughout the entertainment distribution chain; • The impact of, and our ability to react to, political instability, natural disasters, war and/or events of terrorism; • Adverse outcomes of litigation or governmental proceedings, including any foreign, federal, state or local tax assessments or audits; • Claims or adjustments with respect to patent royalties payable with respect to our products; and • Costs of litigation.
One or more of the foregoing or other factors may cause the Fund’s operating expenses to be disproportionately higher or lower or may cause the Fund’s revenue and operating results to fluctuate in any particular quarterly or annual period. Results from prior periods are thus not necessarily indicative of the results of future periods.
Events and conditions in the motion picture industry Our DVD sales tend to fluctuate based on the underlying trends in the motion picture industry and are driven in part by the release of hit films on DVD. When box office receipts for the motion picture industry increase, we have typically seen sales of related DVDs increase as well. The number of films that are produced can be affected by a number of factors, including strikes and work stoppages within the motion picture industry, as well as by the tax incentive arrangements that many foreign governments provide filmmakers to promote local filmmaking.
A significant competitive advantage currently enjoyed by those who distribute movies via physical pre-recorded media, such as DVDs, over most other movie distribution channels, except theatrical release, is the early timing of the DVD release “window.” This window is exclusive against most other forms of non-theatrical movie distribution, such as pay-per-view, video-on-demand, premium television, basic cable, and network and syndicated television. The length of the window for DVDs varies, typically ranging from 30 to 90 days for North American domestic releases and from 120 to 180 days for international releases. Thereafter, movies are made sequentially available to television distribution channels. As some studios have begun to experiment with collapsing this window, we may be materially adversely affected if the length of the DVD release window is shortened or if the DVD release window is no longer as exclusive and newly released movies are made available earlier through other distribution channels. As a result, consumers would no longer need to wait until after the DVD release window to view a newly released movie on other media, which could have a material adverse effect on our financial condition and results of operations.
Failure to maintain internal controls We have a complex business organization that is international in scope. Ensuring that we have adequate internal financial, accounting and information technology controls and procedures in place to help ensure that we can produce accurate financial statements on a timely basis is a costly and time-consuming effort that needs to be re-evaluated frequently.
36 Cinram 2010 Annual Report MANAGEMENT’S DISCUSSION AND ANALYSIS
Any failure to maintain adequate internal controls, or consequent inability to produce accurate financial statements on a timely basis, could increase the Fund’s operating costs and could materially impair our ability to operate our business. In addition, investors’ perceptions that the Fund’s internal controls are inadequate or that we are unable to produce accurate financial statements may adversely affect the price of the Fund’s units.
Due to our participation in multi-employer pension plans, we may have exposure under those plans that extends beyond what our obligations would be with respect to our employees We or members of our controlled group contribute to several multi-employer pension plans. In the event of a partial or complete withdrawal by us from any such plan which is under-funded, we would be liable for a proportionate share of such plan’s unfunded vested benefits. Based on the limited information available from plan administrators, which we cannot independently validate, we believe that in the case of a withdrawal by us or one of our subsidiaries from certain of such multi-employer plans, or of the termination of such a plan, the resulting liability would be material to our financial position and results of operations. In the event that any other contributing employer withdraws from any plan which is under-funded, and such employer (or any member in its controlled group) cannot satisfy its obligations under the plan at the time of withdrawal, then we, along with the other remaining contributing employers, would bear the economic cost of such shortfall, through an increase in our future contributions and in our contingent withdrawal liability. We have no current intention of taking any action that would subject us to any withdrawal liability but cannot provide assurance that no other contributing employer will take such action.
In addition, if a multi-employer plan fails to satisfy the minimum funding requirements, the Internal Revenue Service, pursuant to Section 4971 of the Internal Revenue Code of 1986, as amended, referred to herein as the Code, will impose an excise tax of five (5%) percent on the amount of the accumulated funding deficiency. Under Section 413(c)(5) of the Code, the liability of each contributing employer, including us, will be determined in part by each employer’s respective delinquency in meeting the required employer contributions under the plan. The Code also requires contributing employers to make additional contributions in order to reduce the deficiency to zero, which may, along with the payment of the excise tax, have a material adverse impact on our financial results.
15.2 RISKS RELATING TO THE FUND’S UNITS
Unpredictability and volatility of unit price A publicly traded income trust will not necessarily trade at values determined by reference to the underlying value of its business. The prices at which the Fund’s units will trade cannot be predicted. The market price of the Fund’s units could be subject to significant fluctuations in response to variations in quarterly operating results, distributions and other factors. In November 2007, the Fund announced a suspension of its distribution due to numerous factors. Accordingly, the Fund experienced a significant reduction in the unit price. In addition, the securities markets have experienced significant price and volume fluctuations from time to time in recent years that often have been unrelated or disproportionate to the operating performance of particular issuers. These broad fluctuations may adversely affect the market price of the units.
Nature of units The Fund’s units are not “deposits” within the meaning of the Canada Deposit Insurance Corporation Act and are not insured under the provisions of that Act or any other legislation. Furthermore, the Fund is not a trust company and, accordingly, is not registered under any trust and loan company legislation as it does not carry on or intend to carry on the business of a trust company. In addition, the Fund is not a “mutual fund” as defined by applicable securities legislation.
Securities like the units are hybrids in that they share certain attributes common to both equity securities and debt instruments. The units do not represent a direct investment in Cinram ULC or the business of Cinram International Inc. and should not be viewed by investors as shares or interests in Cinram ULC, Cinram International Inc. or any other company or entity. The units do not represent debt instruments and there is no principal amount owing to unitholders under the units. Unitholders do not have the statutory rights normally associated with ownership of shares of a corporation including, for example, the right to bring “oppression” or “derivative” actions. Each unit represents an equal, undivided, beneficial interest in the Fund. The Fund’s principal assets are trust units and notes of CII Trust. The price per unit is a function of the Fund’s anticipated distributable cash at any time, which is in turn dependent on the distributable cash distributed upstream by its subsidiaries.
Cinram 2010 Annual Report 37 MANAGEMENT’S DISCUSSION AND ANALYSIS
Structural subordination of the units In the event of a bankruptcy, liquidation or reorganization of subsidiaries of the Fund, holders of certain of their indebtedness and certain trade creditors will generally be entitled to payment of their claims from the assets from such entities before any assets are made available for upstream distribution, eventually to the Fund. The units are effectively subordinated to the credit facility and most of the other indebtedness and liabilities of the Fund.
Limitation on non-resident ownership and liquidity The Fund’s Declaration of Trust imposes various restrictions on unitholders. Non-resident Canadian unitholders are prohibited from beneficially owning more than 45% of the outstanding units (on a non-diluted and fully-diluted basis). Certain units are subject to U.S. withholding tax obligations. These restrictions may limit (or inhibit the exercise of) the rights of certain persons to acquire units, to exercise their rights as unitholders and to initiate and complete takeover bids in respect of the units. As a result, these restrictions may limit the demand for units from certain unitholders and thereby adversely affect the liquidity and market value of the units held by the public. In addition, if the Fund determines that there is a risk that non-residents of Canada would beneficially own units in excess of the stipulated maximum set out in the Fund’s Declaration of Trust, it is entitled to take a number of actions under the Declaration of Trust, including to require unitholders that it believes are non-residents of Canada to sell their units, which action may have an adverse effect on the market price of the units. Under the proposed Refinancing and Recapitalization the Fund agreed to seek unitholder approval for the removal of the limitations on non-resident ownership.
Redemption right It is anticipated that the redemption right will not be the primary mechanism for unitholders to liquidate their investment. Upon a redemption of units or termination of the Fund, the Fund’s Trustees may distribute the trust units and/or the notes of CII Trust owned by it or any other assets of the Fund or of any of its other direct or indirect subsidiaries directly to the unitholders, subject to obtaining any required regulatory approvals and complying with the requisite terms and conditions of such approvals. Assets so distributed may not be qualified investments for trusts governed by tax-exempt plans such as RRSPs, RRIFs and RESPs, depending upon the circumstances at the time.
Additionally, such securities will not be listed on any stock exchange and no established market is expected to develop in such securities, and they may be subject to resale restrictions under applicable securities laws.
Dilution The Fund’s Declaration of Trust authorizes the Fund to issue an unlimited number of units for consideration and on those terms and conditions as are established by the Trustees without the approval of unitholders. The unitholders have no pre-emptive rights in connection with such further issues. Any further issuance of units will dilute the interests of existing unitholders.
Under the proposed Refinancing and Recapitalization and related transactions, there will be dilution for existing unitholders if successfully implemented. The number of units issuable may vary significantly depending on various factors, including (a) the degree to which the Mandatory Exchangeable Notes are exchanged (and any equity financing to raise funds to repay these notes in whole or in part would also have a substantial dilutive effect on the current unitholders), (b) the timing of any equity financing to repay the Mandatory Exchangeable Notes (with regard to the component of the consent fee payable in June 2011 to the extent that the notes have not been repaid, and in general terms), (c) the degree to which interest on the amended debt and/or the Mandatory Exchangeable Notes is paid in kind, and (d) the time of closing. The maximum number of units issuable under the Refinancing and Recapitalization and related transactions is 443,746,205 which would result in the current unitholders owning approximately 15% of the Fund following completion of the Refinancing and Recapitalization if all such units were issued.
In addition, Cinram International Limited Partnership (Cinram LP) is permitted to issue additional exchangeable partnership units for any consideration and on any terms and conditions.
Future sales of units The sales of a substantial number of units in the public market or otherwise by unitholders could adversely affect the prevailing market price of the units and could impair the Fund’s ability to raise additional capital through an offering of its equity securities.
38 Cinram 2010 Annual Report MANAGEMENT’S DISCUSSION AND ANALYSIS
Distribution of CII Trust units and notes on termination of the Fund Upon termination of the Fund, the Trustees may distribute the trust units and notes of CII Trust owned by it and any other downstream assets owned directly by any of the Fund’s subsidiaries (and, therefore, indirectly by the Fund) directly to the unitholders, subject to obtaining all required regulatory and other approvals. There is currently no market for CII Trust units, CII Trust notes or any of the other foregoing assets. In addition, none of the foregoing assets are freely tradable, nor are any of them currently listed on any stock exchange or quotation system or qualified investments for tax-exempt plans, such as RRSPs, RRIFs and RESPs.
Unitholder liability The Fund’s Declaration of Trust provides that no unitholder shall be subject to any liability whatsoever to any person in connection with a holding of units. In December 2004, the Trust Beneficiaries’ Liability Act (Ontario) received Royal Assent. That Act provides that unitholders of the Fund are not liable, as beneficiaries of a trust, for any act, default, obligation or liability of the Fund or the Fund’s Trustees, arising after its enactment. That Act has not yet been judicially considered and it is possible that reliance on the Act by a unitholder could be successfully challenged on jurisdictional or other grounds.
Holders of exchangeable limited partnership units of Cinram LP may lose their limited liability in certain circumstances, including by taking part in the control or management of the business of Cinram LP. The principles of law in the various jurisdictions of Canada recognizing the limited liability of the limited partners of limited partnerships subsisting under the laws of one province but carrying on business in another province have not been authoritatively established. If limited liability is lost, there is a risk that holders of LP Units may be liable beyond their contribution of capital and share of undistributed net income of Cinram LP in the event of judgment on a claim in an amount exceeding the sum of the net assets of Cinram LP’s general partner and the net assets of Cinram LP. Holders of LP Units remain liable to return to Cinram LP for such part of any amount distributed to them as may be necessary to restore the capital of Cinram LP to the amount existing before such distribution if, as a result of any such distribution, the capital of Cinram LP is reduced and Cinram LP is unable to pay its debts as they become due.
Leverage and restrictive covenants in current and future indebtedness The degree to which the Fund is leveraged could have important consequences to the unitholders, including: (i) that the Fund’s ability to obtain additional financing in the future for working capital, capital expenditures or acquisitions may be limited; (ii) that a significant portion of the Fund’s cash flow from operations may be dedicated to the payment of the principal of, and interest on, its indebtedness,(iii) that certain of the Fund’s borrowings will be at variable rates of interest, which exposes the Fund to the risk of increased interest rates; and (iv) that the Fund may be more vulnerable to economic downturns and limited in its ability to withstand competitive pressures.
The Fund’s credit facility and the subordinated promissory note (the U.S. Note) issued by a Fund subsidiary, Cinram (U.S.) Holding’s Inc. (CUSH), in favour of another subsidiary, Cinram 886 LLC, contain numerous restrictive covenants limiting the discretion of management with respect to certain business matters. These covenants effectively prohibit the payment of distributions on the units and LP units and place significant restrictions on, among other things, the ability of the Fund to create liens or other encumbrances, to make certain other payments, investments, loans and guarantees and to sell or otherwise dispose of assets and merge or consolidate with another entity. In addition, the credit facility and the U.S. Note contain a number of financial covenants that will require the Fund to meet certain financial ratios and financial condition tests. A failure to comply with the obligations in the credit facility or the U.S. Note could permit acceleration of the relevant indebtedness. If the indebtedness under the credit facility or the U.S. Note, including any possible hedge contracts with the lenders, were to be accelerated, there can be no assurance that the assets of the Fund would be sufficient to repay that indebtedness in full.
Although the current Refinancing and Recapitalization contemplates an amendment and extension of the existing credit facility to December 31, 2013, the Fund will have to refinance its available credit facilities or other debt in three years. There can be no assurance that the Fund will be able to do so, or as to the terms on which it may be able to do so. If the Fund is unable to refinance its credit facilities or other debt, or is only able to refinance these credit facilities or other debt on unfavourable and/or restrictive terms, this may have a material adverse effect on the Fund’s financial position. In addition, the terms of any new credit facility or debt may be less favourable or more restrictive than the terms of the existing credit facilities or other debt, which may adversely affect the Fund’s financial condition.
The Fund’s substantial consolidated indebtedness could negatively impact the business The Fund has a substantial amount of indebtedness totaling $367 million. In addition, the U.S. Note and the credit facility permit future further indebtedness provided that certain restrictive covenants are satisfied.
Cinram 2010 Annual Report 39 MANAGEMENT’S DISCUSSION AND ANALYSIS
The degree to which the Fund on a consolidated basis incurs indebtedness could have important consequences to the holders of units, including:
• The Fund’s ability in the future to obtain trade credit from vendors, performance bonds from surety companies or additional financing for working capital, capital expenditures or other purposes may be limited; • A significant portion of the Fund’s cash flow (on a consolidated basis) is likely to be dedicated to the payment of the principal of and interest on the Fund’s indebtedness, thereby reducing funds available for future operations, capital expenditures and/or other purposes; • The Fund may be more vulnerable to economic downturns and be limited in its ability to withstand competitive pressures; • The Fund may be limited in its ability to plan for or react to changes in its business or the industry in which it operates; and • The Fund may be at a competitive disadvantage to its competitors that have less indebtedness.
The Fund has repaid indebtedness in the past, and disclosed an intention to continue to do so. There can be no assurance that the Fund will be able to repay indebtedness, or as to the timing of any repayment. In particular, under the Refinancing and Recapitalization Cinram has a right to repay all or part of the $90 million Mandatory Exchangeable Notes prior to December 31, 2011; there is no assurance that the Fund will be able to raise funds to repay all or any part of the Mandatory Exchangeable Notes or on what terms. Any such financing may materially dilute the unitholders of the Fund; additionally, failure to repay the Mandatory Exchangeable Notes would result in their mandatory exchange which would result in very substantial dilution of the unitholders.
Changes in the Fund’s creditworthiness may affect the value of the units The perceived creditworthiness of the Fund or its subsidiaries may affect the market price or value and the liquidity of the units.
CUSH may not be able to repurchase the indebtedness under the U.S. Note upon a change of control or to make required principal payments on the U.S. Note Upon the occurrence of certain specific kinds of change of control events, CUSH will be required to offer to repurchase outstanding indebtedness under the U.S. Note at amounts greater than their principal amount plus accrued and unpaid interest, if any, to the date of repurchase. The U.S. Note will mature 10 years after the date of issuance. It is possible that CUSH will not have or be able to raise sufficient funds to make any of the required repurchases of or repayments on the U.S. Note, or that restrictions in the credit facility may not allow for such repurchases or repayments. Failure to make any such payments would constitute a default under the U.S. Note, which, in turn would constitute a default under the credit facility.
15.3 TAX-RELATED RISKS
Canadian income tax matters There can be no assurance that the Fund’s units will continue to be qualified investments under the Income Tax Act (Canada) (the “Tax Act”) for trusts governed by registered retirement savings plans, registered retirement income funds, deferred profit sharing plans, registered education savings plans, registered disability savings plans, and tax-free savings accounts each as defined in the Tax Act. The Tax Act imposes penalties or other tax consequences for the acquisition or holding of non-qualified investments. In addition, there can be no assurance that Canadian federal income tax laws and administrative policies respecting the treatment of mutual fund trusts will not be changed in a manner that adversely affects unitholders. If the Fund ceases to qualify as a “mutual fund trust” under the Tax Act, the income tax considerations described in the Fund’s public disclosures would be materially and adversely different in certain respects.
Currently, a trust will not be considered to be a mutual fund trust if it is established or maintained primarily for the benefit of non-residents of Canada unless all or substantially all of its property is property other than taxable Canadian property as defined in the Tax Act. The Fund’s Declaration of Trust contains mechanisms to ensure that the Fund is not maintained primarily for the benefit of non-residents of Canada. On September 16, 2004, the Minister of Finance (Canada) released draft amendments to the Tax Act. Under the draft amendments, a trust would lose its status as a mutual fund trust if the aggregate fair market value of all units issued by the trust held by one or more non-resident persons or partnerships that are not “Canadian partnerships” (as defined in the Tax Act) is more than 50% of the aggregate fair market value of all the units issued by the trust where more than 10% (based on fair market value) of the trust’s property is “taxable Canadian property” or certain other types of property. If the draft amendments are enacted as proposed, and if, at any time, more than 50% of the aggregate fair market value of units of the Fund were held by non-residents of Canada and partnerships other than Canadian partnerships, the Fund would thereafter cease to be a mutual fund trust. The draft amendments do not currently provide any means of rectifying a loss of mutual fund trust status. On December 6, 2004, the Department of Finance tabled a Notice of Ways and Means Motion that did not include these
40 Cinram 2010 Annual Report MANAGEMENT’S DISCUSSION AND ANALYSIS
proposed changes. The issue of ownership of units of mutual fund trusts by non-resident persons and partnerships other than Canadian partnerships has not been addressed in any subsequent Federal Budget or proposed changes to the Tax Act. The Department of Finance indicated that the implementation of the proposed changes would be suspended pending further consultation with interested parties.
On June 22, 2007, Bill C-52, which modifies the income tax rules applicable to certain publicly traded or listed trusts and partnerships, received Royal Assent. In particular, certain income of (and distributions made by) these entities will be taxed in a manner similar to income earned by (and distributions made by) a corporation. These rules (SIFT rules) will be effective with respect to trusts that commence public trading after October 31, 2006. For trusts that were publicly traded or listed prior to November 1, 2006, the application of the SIFT rules will be delayed to the earlier of (i) the trust’s 2011 taxation year, and (ii) a taxation year of the trust in which the trust exceeds normal growth as determined by reference to the normal growth guidelines, as amended from time to time, unless that excess arose as a result of a prescribed transaction.
On December 15, 2006, the Department of Finance released guidance for income trusts and other flow-through entities that qualify for the four-year transitional relief. The guidance, as amended from time to time, establishes objective tests with respect to how much an income trust is permitted to grow without jeopardizing its transitional relief. If the limits described in the normal growth guidelines are exceeded, the Fund may lose its transitional relief and thereby become immediately subject to the SIFT rules.
On March 12, 2009, Bill C-10 – Budget Implementation Act, 2009, which further modifies the rules applicable to certain publicly traded or listed trusts and partnership, received Royal Assent. In particular, Bill C-10 provided new rules intended to exempt from the SIFT rules a subsidiary partnership that is not publicly traded and that is wholly owned by a SIFT trust or partnership, a taxable Canadian corporation, a REIT, an excluded subsidiary entity or a combination of these entities. Although Cinram International Limited Partnership is not publicly traded, the new rules do not appear to exempt a partnership with individual partners (and it is assumed that, as of the date hereof, there are individual partners of Cinram International Limited Partnership). However, the Fund believes that Cinram International Limited Partnership will not be subject to tax under the SIFT rules prior to January 2011, assuming compliance with the normal growth guidelines. Bill C-10 also introduced rules to facilitate the conversion of an income trust into a corporation on a tax-deferred basis (the “Conversion Rules”). The Conversion Rules provide income trusts with tax efficient structuring options to convert to corporate form in advance of their 201 1 taxation.
On March 4, 2010 the Department of Finance announced the Federal Budget which involved changes to the rules applicable to SIFTs. These measures will impose restrictions on the use of losses when units of a SIFT Trust or SIFT partnership are exchanged for shares of a corporation and will ensure that the acquisition of control rules do not inappropriately restrict the use of losses when a SIFT trust is wound-up and distributes shares of a corporation it holds. Management is reviewing the Conversion Rules to assess their implications to the Fund.
The Fund is considering the possible impact of the legislative changes to the Fund. As currently drafted, taxable dividends received by the Fund are not subject to the new rules. Based on the current structure of the Fund, management believes that the new rules will not have an impact on the distributable cash flow of the Fund or Cinram LP (including, for greater certainty, after the four year transitional period expires) regardless of the level of any distributions being paid. The legislative changes may, however, adversely affect the marketability of the Fund’s units and the ability of the Fund to undertake financings and acquisitions.
Income fund structures generally involve significant amounts of inter-company or similar debt, generating substantial interest expense, which serves to reduce earnings and therefore income tax payable. There can be no assurance that taxation authorities will not seek to challenge the amount of interest expense deducted. If such a challenge were to succeed against the Fund, it would materially adversely affect the amount of cash available to the Fund for distribution to unitholders. The Fund believes that the interest expense inherent in the structure of the Fund is supportable and reasonable. On October 31, 2003, the Department of Finance released, for public comment, proposed amendments to the Tax Act that relate to the deductibility of interest and other expenses for income tax purposes. In general, the proposed amendments may deny the realization of losses in respect of a business if there is no reasonable expectation that the business will produce a cumulative profit over the period that the business can reasonably be expected to be carried on. As part of the release of the February 23, 2005, federal budget, the Minister of Finance (Canada) announced that many commentators had expressed concern with the October 31, 2003, proposals; in particular that a codification of the “reasonable expectation of profit” test might inadvertently limit the deductibility of a wide variety of ordinary commercial expenses. The Department of Finance has sought to respond by developing a more modest legislative initiative that would respond to those concerns while still achieving the Government’s objectives. The Department of Finance indicated that it will release an alternative proposal for public comment at its earliest opportunity. The Fund does not believe that the amendments as proposed on October 31, 2003, will have a material effect on its tax position.
Cinram 2010 Annual Report 41 MANAGEMENT’S DISCUSSION AND ANALYSIS
Certain United States income tax matters There can be no assurance that United States federal income tax laws and the U.S. Internal Revenue Service (IRS) administrative policies respecting the United States federal income tax consequences described herein will not be changed or applied in a manner that adversely affects unitholders.
In December 2007, the Fund undertook a series of transactions to transfer Cinram International LLC to Cinram International (Hungary) Rt., (Cinram Hungary.) Cinram International LLC subsequently dissolved into Cinram Hungary which acquired the U.S. Note. However, there is a risk that the IRS may take the position that the transfer of Cinram International LLC and the U.S. Note resulted in a taxable gain to U.S. resident unitholders. As a part of this internal restructuring to transfer the U.S. Note to Cinram Hungary, Management received advice that the fair market value of the U.S. Note did not exceed its principal amount so that no gain would be recognized by U.S. resident unitholders. After transfer of the Note, interest payments on the U.S. Note by CUSH to Cinram Hungary are exempt from withholding tax under the U.S.-Hungary Tax Treaty. There is a risk that the IRS may take the position that the interest payments on the U.S. Note are not eligible for an exemption from withholding tax under the U.S.-Hungary Tax Treaty. In the event that the IRS is successful in asserting that the U.S. – Hungary Tax Treaty is inapplicable interest payments on the U.S. Note during 2009 and 2008 may be subject to withholding tax under the U.S.-Canada Tax Treaty at a rate of 7% and 4%, respectively. In December 2009, the Fund undertook transactions to transfer the U.S. note from Cinram Hungary to Cinram 886 LLC.
There is a risk that the U.S. Note could be treated for United States federal income tax purposes as equity rather than debt, in which case the otherwise deductible interest on the U.S. Note would be treated, in effect, as non-deductible distributions. The risk would be increased if any of Cinram International LLC, Cinram Hungary or Cinram 886 LLC fails to exercise its creditor rights under the U.S. Note in a manner consistent with the conduct of an arm’s length lender. In addition, even if the U.S. Note is characterized as debt, there is a risk that the interest rate may be found to be in excess of an arm’s length rate. In such event, the excess amount of interest over an arm’s length amount would be re-characterized as non-deductible distributions. CUSH’s inability to deduct all or a portion of the interest on the U.S. Note could materially increase its taxable income and thus, its United States federal income tax liabilities. This would reduce CUSH’s after-tax income available for distribution. No IRS ruling has been requested as to whether the U.S. Note should be treated as debt for United States federal income tax purposes.
Various proposals have been considered by the United States Congress to amend the existing “earnings stripping” rules under U.S. Internal Revenue Code (Code) Section 163(j). The Budget of the United States Government, Fiscal Year 2007 included a proposal to amend Code Section 163(j) to further limit the deductibility of interest paid to related persons by lowering the 50% adjusted taxable income threshold. If any of these changes are enacted while the U.S. Note is outstanding, it could affect the deduction of the interest on the U.S. Note under Code Section 163(j). However, as of the date of this MD&A, there is no information as to if and in what form any such proposed amendments would be enacted. In addition, the American Jobs Creation Act of 2004 requires a comprehensive study of the earnings stripping provisions of Code Section 163(j) to be completed by June 30, 2005. As of the date of this MD&A, this study was completed on November 28, 2007 and recommended the creation of a new IRS tax form to obtain additional information from U.S. corporations subject to Code Section 163(j).
42 Cinram 2010 Annual Report MANAGEMENT’S DISCUSSION AND ANALYSIS
16. 2010 FOURTH QUARTER PERFORMANCE
Key performance metrics
Reconciliation of EBITA and EBIT to net earnings (loss) Three months ended December 31 (unaudited, in thousands of U.S. dollars) ’10 ’09
EBITA excluding other charges $ 46,246 $ 87,960
Other charges (income), net 16,382 (630)
EBITA* $ 29,864 $ 88,590
Impairment of long lived assets and goodwill — 82,234 Amortization of property, plant and equipment 13,857 20,946 Amortization of intangible assets 1,285 10,515
EBIT* $ 14,722 $ (25,105)
Interest expense and financing charges 7,964 9,221 Other interest and financing charges, net 3,432 4,932 Foreign exchange gain (169) (1,129) Gain on repurchase of debt — (14,965) Investment income (56) (14) Income taxes (recovery) (3,859) (13,836)
Net earnings (loss) from continuing operations $ 7,410 $ (9,314)
* See definition of EBITA and EBIT on the first page of this MD&A under non-GAAP financial measures
Consolidated revenue in the fourth quarter ended December 31, 2010 decreased by 41% to $300.1 million from $504.9 million in 2009, primarily due to the loss of revenue associated with the WHV contract termination on July 31, 2010. While Cinram continued to perform DVD offload services for Technicolor with respect to WHV titles during the quarter, the volume was significantly lower than the prior year. This combined with lower average selling prices led to the year-over-year revenue decline. Revenue from our Video Game segment revenue decreased by $13.0 million during the 2010 fourth quarter compared to the prior year, and wireless revenue was consistent over the comparable period.
EBITA excluding other charges for the fourth quarter of 2010 decreased to $46.2 million from $88.0 million in 2009. However, EBITA margins as a percentage of consolidated revenue were 15%, compared with 17% in 2009. 2010 fourth quarter EBITA margins were adversely impacted by lower DVD volumes associated with the loss of the WHV account effective July 31, 2010. This was partially offset by direct material, labour and overhead efficiencies as we continued to rationalize and reduce our global footprint.
During the fourth quarter of 2010, we performed our annual long-lived asset and goodwill impairment testing. The long-lived asset impairment test determined that the carrying value of property, plant and equipment and customer supply agreements was not impaired and, as a result, no impairment charge was recorded. With respect to goodwill, the impairment test determined that the fair value of goodwill exceeded its carrying value and, accordingly, no impairment charge was recorded. During the fourth quarter of 2009, we recorded combined long-lived asset and goodwill impairment charges of $82.2 million.
Net earnings from continuing operations were $7.4 million in the 2010 fourth quarter, compared to a net loss of $9.3 million in the prior year period.
Cinram 2010 Annual Report 43 MANAGEMENT’S DISCUSSION AND ANALYSIS
16.1 SEGMENTED RESULTS
16.1.1 REVENUE BY SEGMENT
Three months ended December 31 (in thousands of U.S. dollars) ’10 ’09
Pre-recorded multimedia products $ 261,948 87% $ 456,291 90% Video Game 20,173 7% 33,204 7% Other 17,947 6% 15,418 3%
$ 300,068 100% $ 504,913 100%
Due to several factors, including the termination of the WHV service contract effective July 31, 2010, the Fund revisited its business and operations in the fourth quarter of 2010. As a result, the Fund reorganized internally to consolidate its sales, manufacturing and distribution functions. As part of the internal reorganization, reporting for the Home Video and CD business lines were combined, on the basis that the sales, manufacturing and distribution requirements for both of these segments possess similar management, operational and cost structures. Accordingly, the Fund has concluded it is appropriate to disclose its Home Video and CD segments as Pre-Recorded Multimedia Products. The Fund has restated its presentation of its operating segments for each of the years ended December 31, 2010 and December 31, 2009.
Pre-recorded multimedia products The pre-recorded multimedia products segment manufactures and distributes DVDs, Blu-ray discs and CDs. The Video Game segment includes results from Cinram Games (Ditan), and the Other segment primarily includes logistics and Cinram Retail Services (handset distribution and Vision).
In the fourth quarter ended December 31, 2010, DVD revenue (which includes replication and distribution of DVDs and Blu-ray discs) decreased 45% to $224.8 million from $410.3 million in 2009. DVD replication revenue decreased 50% to $145.2 million in the fourth quarter of 2010 from $291.4 million in 2009, while Blu-ray replication revenue increased to $13.1 million from $7.8 million in the prior year. DVD revenue accounted for 75% of consolidated revenue, compared with 81% in the prior year period.
Revenue from CDs (which includes replication and distribution of CDs and CD-ROM) decreased 19% in the fourth quarter of 2010, to $37.2 million from $46.0 million in 2009 due to declining sales of physical music. CD sales represented 12% of consolidated sales in the fourth quarter ended December 31, 2010, up from 9% in the prior year period. CD replication revenue was $26.9 million in 2010, down from $37.7 million in 2009.
Video Game Video Game revenue was $20.2 million in the fourth quarter of 2010, compared with $33.2 million in 2009 due to a general decline in consumer spending and the loss of several customers. This segment accounted for 7% of consolidated revenue in the fourth quarter of 2010 consistent with the prior year period.
Other Revenue from our wireless division related to logistics services was $11.9 million during the fourth quarter of 2010, consistent with the prior year period. Revenue from other activities, including revenue associated with Vision, increased to $6.1 million for the three month period ending December 31, 2010, compared to $3.5 million in the comparable 2009 period.
The Other segment represented 6% of consolidated 2010 fourth quarter revenue, up from 3% in the prior year period.
16.1.2 GEOGRAPHIC SEGMENTS REVENUE Three months ended December 31 (in thousands of U.S. dollars) ’10 ’09
North America $ 178,603 60% $ 265,004 52% Europe 121,465 40% 239,909 48%
Total $ 300,068 100% $ 504,913 100%
44 Cinram 2010 Annual Report MANAGEMENT’S DISCUSSION AND ANALYSIS
North America North American revenue decreased 33% in the fourth quarter to $178.6 million from $265.0 million in 2009, principally due to lower DVD and CD revenues resulting from declining unit sales combined with lower selling prices. Revenues associated with video game customers were also lower when compared to the prior year.
North American revenue accounted for 60% of consolidated revenue in the fourth quarter of 2010, compared with 52% in 2009.
Europe European revenue decreased 49% in the fourth quarter of 2010 to $121.5 million from $239.9 million in 2009. The change in revenue was due to lower DVD unit shipments and distribution revenue related to the termination of the WHV contract in July 2010. European DVD revenue (including related distribution) was $96.2 million in the fourth quarter of 2010, compared to $211.3 million in 2009.
CD revenue (including related distribution) for the fourth quarter decreased 25% to $16.8 million from $22.5 million in 2009 as a result of lower CD unit shipments and distribution revenues.
As a percentage of consolidated sales, European revenue decreased to 40% in the fourth quarter of 2010 from 48% in the prior year.
16.2 GROSS PROFIT
Gross profit for the fourth quarter of 2010 decreased to $65.0 million from $111.2 million in the comparable 2009 period. Gross profit in the current year was impacted by lower volumes in our core DVD business as a result of the loss of the WHV contract, combined with lower average selling prices. As a percentage of revenue, gross profit was 22%, consistent with 2009.
Amortization expense from property, plant and equipment, which is included in cost of goods sold, decreased to $13.9 million in the fourth quarter from $20.9 million in the comparable 2009 period, as a result of lower net book value of property, plant and equipment.
During the fourth quarter ended December 31, 2010, foreign exchange related to operations, which is included in cost of goods sold, was a gain of $0.2 million, compared to a gain of $0.6 million in the prior year period.
16.3 AMORTIZATION OF INTANGIBLE ASSETS
We recorded amortization of intangible assets of $1.3 million in the fourth quarter of 2010 compared with $10.5 million in the prior year. The reduction in amortization expense relates to the WHV supply agreement that was fully amortized by July 2010.
16.4 SELLING, GENERAL AND ADMINISTRATIVE EXPENSES
Selling, general and administrative expenses decreased to $32.6 million in the fourth quarter of 2010 from $44.2 million in 2009, primarily due to savings associated with headcount reductions combined with reduced consulting fees. As a percentage of consolidated revenues, selling, general and administrative expenses were 11% in the fourth quarter of 2010, up from 9% from the corresponding 2009 period.
16.5 OTHER CHARGES
For the fourth quarter ended December 31, 2010, the Fund recorded a charge of $16.4 million in other charges related to restructuring charges recorded in both North America and Europe associated with facility rationalizations and related headcount reductions.
16.6 INTEREST EXPENSE
Interest expense for the 2010 fourth quarter decreased to $8.0 million, compared with $9.2 million in the fourth quarter of 2009 due to lower interest rates and lower loan balances compared to the same period in 2009.
Cinram 2010 Annual Report 45 MANAGEMENT’S DISCUSSION AND ANALYSIS
16.7 EARNINGS / (LOSS)
We recorded net earnings from continuing operations of $7.4 million for the fourth quarter of 2010, compared with net loss of $9.3 million in the fourth quarter of 2009, primarily due to the $82.2 million impairment charge recorded in the prior year. On a per unit basis, we reported basic net earnings from continuing operations of $0.14 for the quarter ended December 31, 2010, compared with a net loss of $0.17 per share in the comparable prior year period.
17. CRITICAL ACCOUNTING POLICIES AND ESTIMATES
We prepare our financial statements in accordance with Canadian GAAP. The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the year. Actual results could differ from those estimates. Significant accounting policies and methods used in preparing the financial statements are described in Note 2 to the 2010 audited consolidated financial statements.
Significant changes in the assumptions, including those with respect to future business plans and cash flows, could materially change the recorded carrying amounts.
17.1 REVENUE RECOGNITION
Revenue is comprised of product sales and service revenue earned from fulfillment and logistics services. Revenue from product sales is recognized upon shipment since title to the product is transferred to the customers, persuasive evidence of an arrangement exists, the selling price is fixed and determinable, and collectability is reasonably assured. The Fund’s customers cannot return any previously purchased inventory, with the exception of defective product, which occurs very rarely, nor do customers have a right of refusal on purchases made. Volume rebates are recorded as a reduction of revenue at the time of shipment. Contractual payments to acquire sales contracts are amortized against revenue over the term of the contract where there is a guaranteed minimum volume commitment.
Service revenue is recognized as services are performed. The Fund offers certain products and services as part of multiple deliverable arrangements. The Fund divides multiple deliverable arrangements into separate units of accounting. Components of multiple deliverable arrangements are separately accounted for provided the delivered elements have stand-alone value to the customer and the fair value of the undelivered elements can be objectively and reliably determined. Consideration for these units is then measured and allocated amongst the separate units based upon their relative fair values, and then the Fund’s relevant revenue recognition policies are applied to them.
17.2 LONG-LIVED ASSETS
Intangible assets are comprised of customer supply agreements arising from the customer contracts associated with the 2007 acquisitions of Ditan and Vision. On February 1, 2010, the Fund announced that it received written notice from WHV that WHV was exercising its option to terminate its service agreements on July 31, 2010. As a result, commencing in the first quarter of 2010, any unamortized amount related to the WHV supply contracts was amortized by July 31, 2010.
The Ditan and Vision intangible assets are being amortized on a straight-line basis over a period of five to six years.
The Fund reviews tangible and intangible assets subject to amortization (long-lived assets) for impairment annually, or more frequently, if events or changes in circumstances indicate that the carrying amount may not be recoverable. Absent any triggering factors during the year, the Fund conducts its long-lived asset assessment in the fourth quarter to correspond with its planning cycle. Recoverability is assessed by comparing the carrying amount to the projected undiscounted future net cash flows that the long-lived assets are expected to generate. If the sum of undiscounted future cash flows expected to result from the use and disposition of a group of assets is less than its carrying amount, then a second step is required. In the second step, a present value technique is used to estimate the fair value and is compared to the carrying value of the assets. An impairment loss is measured as the amount by which the carrying amount of a group of assets exceeds its fair value, the amount of consideration that would be agreed upon in an arms-length transaction between knowledgeable, willing parties.
During 2010, no impairment charge was recorded (2009 — $59.8 million) on the long-lived assets as described in Notes 4 and 5 to the consolidated financial statements.
46 Cinram 2010 Annual Report MANAGEMENT’S DISCUSSION AND ANALYSIS
17.3 GOODWILL
Goodwill is the residual amount that results when the purchase price of an acquired business exceeds the sum of the amounts allocated to the tangible and intangible assets acquired less liabilities assumed, based on their fair values. When the Fund enters into a business combination, the purchase method of accounting is used. Goodwill is assigned as of the date of the business combination to reporting units that are expected to benefit from the business combination. Goodwill is not amortized but instead tested for impairment annually or more frequently if events or changes in circumstances indicate that the asset might be impaired. Absent any triggering factors during the year, the Fund conducts its goodwill assessment in the fourth quarter of the year to correspond with its planning cycle. The impairment test is carried out in two steps. In the first step, the carrying amount of the reporting unit, including goodwill, is compared with its fair value. When the fair value of the reporting unit exceeds its carrying value, goodwill of the reporting unit is not considered to be impaired and the second step of the impairment test is unnecessary. The second step is carried out when the carrying amount of a reporting unit exceeds its fair value, in which case, the implied fair value of the reporting unit’s goodwill is determined in the same manner as the value of goodwill is determined in a business combination, and is compared with its carrying amount to measure the amount of the impairment loss, if any.
During 2010, no goodwill impairment charge was recorded (2009 — $22.5 million) as described in Note 5 to the consolidated financial statements.
17.4 INVENTORY VALUATION
Inventories are valued at the lower of cost and net realizable value, with cost determined on a first-in, first-out basis. Net realizable value is the estimated selling price in the ordinary course of business less the estimated costs of completion and the estimated costs necessary to make the sale.
Inventories include the cost of materials purchased, the cost of conversion, as well as other costs required to bring the inventories to their present location and condition. Inventory costs, including the allocation of fixed production overhead, are based on normal production capacity of the manufacturing facilities.
17.5 PENSION BENEFITS
The Fund accrues its obligations under employee defined benefit plans and the related costs, net of plan assets. The cost of pensions earned by employees is actuarially determined using the projected benefit method prorated on service and management’s best estimates of expected plan investment performance, salary escalation, compensation levels at time of retirement, and retirement ages of employees. Changes in these assumptions could impact future pension expense. For the purpose of calculating the expected return on plan assets, assets are valued at fair value. Actuarial gains or losses are amortized over the average remaining service period of active employees. Pension assets are recorded as other assets while pension liabilities are recorded as accrued pension benefits within accrued liabilities and other long-term liabilities.
The Fund recognizes curtailment losses in income when it is probable that a curtailment will occur and the net effects can be reasonably estimated. Curtailment gains are recognized in income when an event giving rise to a curtailment has occurred. The Fund recognizes settlement gains or losses in income in the period in which a settlement occurs.
For all other pension and non-pension employment benefit plans, expenses are recorded as the Fund’s contributions become payable.
17.6 ASSET RETIREMENT OBLIGATIONS
Asset retirement obligations are legal obligations associated with the retirement of tangible long-lived assets that result from their acquisition, lease, construction, development or normal operation. The Fund records the present value of the estimated fair value of a liability for an asset retirement obligation in the year in which it is incurred and when a reasonable estimate of fair value can be made. The fair value of a liability for an asset retirement obligation is the amount at which that liability could be settled in a current transaction between willing parties, that is, other than in a forced liquidation transaction.
The fair value is estimated using a credit-adjusted risk-free rate as at the date when the liability is incurred. The Fund subsequently allocates the asset retirement cost to expense using a systematic and rational method over the asset’s useful life, and records the accretion of the liability as a charge to the consolidated statements of earnings.
The adjustment to leasehold improvements in respect of asset retirement costs is amortized into income on a straight-line basis over the remaining term of the leases.
Cinram 2010 Annual Report 47 MANAGEMENT’S DISCUSSION AND ANALYSIS
17.7 UNIT-BASED COMPENSATION
The Fund determines the fair value of unit-based compensation granted to employees using: (i) the Black-Scholes option pricing model for equity settled unit-based compensation and (ii) intrinsic value for cash settled unit-based compensation. The Fund records unit-based compensation expense over the vesting period with a corresponding increase in contributed surplus or an adjustment to accrued liabilities, as applicable.
17.8 INCOME TAXES
The Fund follows the asset and liability method of accounting for income taxes. Under the asset and liability method, future income tax assets and liabilities are recognized for the estimated future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases.
Future income tax assets and liabilities are measured using enacted or substantively enacted tax rates in effect for the year in which those temporary differences are expected to be recovered or settled. The effect on future income tax assets and liabilities of a change in tax rates is recognized in earnings in the year that includes the enactment or substantive enactment date. Future income tax assets are recognized, and if realization is not considered “more likely than not,” a valuation allowance is provided. Income tax expense is the sum of the Fund’s provision for current income taxes and the difference between opening and ending balances of future income tax assets and liabilities.
The Fund is a mutual fund trust for income tax purposes, and is taxable in any given year on any amount not distributed to unitholders.
17.9 EARNINGS (LOSS) PER UNIT
Basic earnings (loss) per unit is calculated by dividing net earnings (loss) available to unitholders by the weighted average number of units outstanding during the year. Diluted earnings (loss) per unit is calculated using the treasury stock method, which assumes that all options with exercise prices below the market prices are exercised, with the proceeds used to purchase units of Cinram at the average market price during the period and all deferred units and all units associated with the employee unit purchase loans will be redeemed for units of the Fund.
17.10 USE OF ESTIMATES
The preparation of financial statements requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the period. Actual results could differ from those estimates.
Significant estimates are used in determining, but not limited to, revenue recognition, including the identification of separate units of accounting under multiple deliverable arrangements, provisions for volume rebates, royalty accruals, including judgment required in determining royalty obligations related to certain patents, the allowance for doubtful accounts, inventory valuation, income tax valuation allowances, restructuring costs, contingencies and other provisions, assets and obligations related to employee future benefits, unit-based compensation, withdrawal liabilities for pension funds, estimation of credit spreads for determination of the fair value of derivative instruments, the useful lives of all depreciable assets, the recoverability of property, plant and equipment and long-lived assets and the valuation of goodwill that require estimates of future cash flows and discount rates.
Royalty charges are incurred as a result of the use of third party replication technologies. The royalty charge is recorded as cost of goods sold at the time of shipment. The royalty rates are on a per unit basis and based on contractual terms and conditions or management’s best estimate of the royalty obligation in situations where formal license agreements are not in place. These estimates are reviewed periodically and, as adjustments become necessary, they are made in the period in which they become known. A significant change in the royalty rates used could have a material impact on the cost of goods sold and the provision for royalties.
Significant changes in the assumptions, including those with respect to future business plans and cash flows, could materially change the recorded carrying amounts.
48 Cinram 2010 Annual Report MANAGEMENT’S DISCUSSION AND ANALYSIS
17.11 FINANCIAL AND DERIVATIVE INSTRUMENTS
(i) Financial instruments: Cash and cash equivalents are classified as held-for-trading. Held-for-trading financial assets are recorded at fair value on the consolidated balance sheets with changes in fair value recorded in the consolidated statements of earnings.
The Fund’s other financial assets are classified as available-for-sale or loans and receivables. Available-for-sale investments are carried at fair value on the balance sheet, with changes in fair value recorded in other comprehensive income, until such time as the investments are disposed of or an other-than-temporary impairment has occurred, in which case, the impairment is recorded in net earnings. Loans and receivables and all financial liabilities are carried at amortized cost using the effective interest method. The Fund determined that none of its non-derivative financial assets are classified as held-to-maturity and none of its non-derivative financial liabilities are classified as held-for-trading. Transaction costs paid to a lending institution relating to the bank credit facility are deferred and amortized over the term of the facility.
Derivative financial instruments are utilized to reduce interest rate risk on the Fund’s debt. The Fund does not enter into financial instruments for trading or speculative purposes. The Fund’s policy is to formally designate each derivative financial instrument as a hedge of a specifically identified debt instrument.
All derivatives, including embedded derivatives that must be separately accounted for, are measured at fair value with changes in fair value recorded in the consolidated statements of earnings unless they are effective cash flow hedging instruments.
When hedge accounting is applied, the Fund formally documents the relationship between derivative instruments and the hedged items, as well as its risk management objective and strategy for undertaking various hedge transactions. At the instrument’s inception, the Fund also formally assesses whether the derivatives are highly effective at reducing or modifying interest rate or foreign exchange risk related to the future anticipated interest and other cash outflows associated with the hedged item. Effectiveness requires a high correlation of changes in fair values or cash flows between the hedged item and the hedging item. On a quarterly basis, the Fund confirms that the derivative instruments continue to be highly effective at reducing or modifying interest rate or foreign exchange risk associated with the hedged items. The changes in fair value of cash flow hedging derivatives are recorded in other comprehensive income, to the extent effective, until the hedged asset or liability is recognized in the consolidated statements of earnings. The Fund has established net investment hedges.
For those instruments that do not meet the above criteria, changes in their fair values are recorded in net earnings.
Interest rate swap The Fund previously entered into an interest rate swap to hedge interest rate risk. The fair value of the Fund’s interest rate swap is determined using an estimated credit adjusted mark-to-market valuation which takes into consideration the Fund and the counterparty credit risk.
The interest rate swap agreement, which is scheduled to expire in August 2011, involves the periodic exchange of payments without the exchange of the notional principal amount upon which the payments are based, and is recorded as an adjustment of interest expense on the hedged debt instrument. The related amount payable to or receivable from the counterparties is included as an adjustment to accrued interest.
In the event of early extinguishment of the debt obligation, any realized or unrealized gain or loss from the swap would be recognized in net earnings at the time of extinguishment. For those instruments that did not meet the effectiveness criteria, variations in their fair values were marked to market on a current basis, with the resulting gains or losses recorded in or charged against net earnings.
Net investment hedges The Fund designated its U.S. dollar-denominated long-term debt in Canada as a hedge of the foreign currency risk related to the principal amount of its net investment in U.S. subsidiaries. The U.S. subsidiaries are considered self-sustaining for accounting purposes and, as a result, gains or losses on translating the third party debt in Canada from U.S. to Canadian dollars are recorded in other comprehensive income to the extent the debt is considered an effective hedge. As at December 31, 2010 and 2009, the hedge is effective and both the U.S. dollar- denominated long-term debt in Canada and the investment in the U.S. subsidiaries are re-measured at spot rates at each period end.
Cinram 2010 Annual Report 49 MANAGEMENT’S DISCUSSION AND ANALYSIS
(ii) Fair value measurements The Fund provides disclosure of the three-level hierarchy that reflects the significance of the inputs used in making the fair value measurements. Fair value of financial assets and financial liabilities included in Level 1 are determined by reference to quoted prices in active markets for identical assets and liabilities. Financial assets and financial liabilities in Level 2 include valuations using inputs based on observable market data, either directly or indirectly other than quoted prices. Level 3 valuations are based on inputs that are not based on observable market data.
CHANGES IN AND RECENT CANADIAN ACCOUNTING PRONOUNCEMENTS:
International Financial Reporting Standards (IFRS): In 2008, the Canadian Accounting Standards Board confirmed that Canadian profit-oriented publicly accountable entities would be required to adopt IFRS for fiscal periods beginning on or after January 1, 2011. The Fund’s first IFRS financial statements will be for the year ending December 31, 2011 and will include the comparative period for 2010.
18. DISCLOSURE CONTROLS AND PROCEDURES OVER FINANCIAL REPORTING
Management is responsible for establishing and maintaining disclosure controls and procedures as defined under National Instrument 52-109. As of December 31, 2010, we carried out an evaluation under the supervision and with the participation of our management, including our chief executive officer and chief financial officer, of the effectiveness of the design and operation of our disclosure controls and procedures. Based upon that evaluation and as of December 31, 2010, the chief executive officer and chief financial officer concluded that the disclosure controls and procedures were effective to provide reasonable assurance that information required to be disclosed in the reports the Fund files and submits under applicable securities laws is recorded, processed, summarized and reported as and when required under applicable securities legislation.
19. MANAGEMENT’S REPORT ON OPERATING EFFECTIVENESS OF INTERNAL CONTROLS OVER FINANCIAL REPORTING
At December 31, 2010, an evaluation was carried out of the effectiveness of internal controls over financial reporting to provide reasonable assurance regarding the reliability of financial reporting. These evaluations were conducted in accordance with the standards of COSO, a recognized control model, and the requirements of National Instrument 52-109. Based on this evaluation, the chief executive officer and chief financial officer concluded that internal controls over financial reporting have been appropriately designed and operating effectively to provide reasonable assurance regarding the reliability of financial reporting and that the preparation of financial statements for external purposes is in accordance with Canadian generally accepted accounting principles.
During the financial year ended December 31, 2010, there were no changes in our internal controls over financial reporting that have materially affected, or are reasonably likely to materially affect, our internal controls over financial reporting.
20. INTERNATIONAL FINANCIAL REPORTING STANDARDS (IFRS)
In 2008, the Canadian Accounting Standards Board (AcSB) confirmed that IFRS will be mandatory in Canada for profit-oriented publicly accountable entities for fiscal periods beginning on or after January 1, 2011. The Fund’s first audited IFRS financial statements will be for the year ending December 31, 2011 and will include the comparative period for 2010. Starting in the first quarter of 2011, the Fund will provide unaudited consolidated financial information in accordance with IFRS, including comparative figures for 2010. These consolidated financial statements will include restated unaudited 2010 annual and interim financial statement information to be consistent with the new IFRS basis, as well as reconciliations of equity and net earnings for the previously reported Canadian GAAP amounts.
We have developed a detailed project plan for the conversion to IFRS and we have finalized our evaluation of what the accounting policy differences between Canadian GAAP and IFRS are as at January 1, 2010. For the year ended December 31, 2010, we have finalized our evaluation of the accounting policy differences, and are working towards finalization of the implementation procedures pursuant to the Fund’s IFRS changeover plan, based on management’s current understanding of what those standards will be for the year ended December 31, 2011.
50 Cinram 2010 Annual Report MANAGEMENT’S DISCUSSION AND ANALYSIS
The table below illustrates key elements of our IFRS changeover plan, significant milestones, and progress to date. Our conversion plan is organized in phases over time and by area. We expect to meet all remaining milestones through to completion of the conversion.
Effort accomplished by December 31, 2010 and Key Activity Milestones/Deadlines projected for the quarter ended March 31, 2011
PREPARATION: • Identify differences in Canadian GAAP/ IFRS • Senior management and audit committee sign- • Identification of significant differences between accounting policies. off on significant ongoing accounting policy IFRS policies and Canadian GAAP has been • Select the Fund’s ongoing IFRS policies. decisions, IFRS 1 accounting policy choices and completed. • Select the Fund’s IFRS 1 accounting financial statement format during 2009. • Selection of all significant IFRS accounting policy choices. • Quantification of effects of change for IFRS 1 policy decisions was completed. • Develop financial statement format. disclosures and 2010 comparative quarterly • Approval of all IFRS 1 policy choices have been • Quantify effects of IFRS 1 disclosures on 2010 financial statements including note disclosures made for optional elections. financial statements. by end of Q1 2011. • Analysis and quantification of ongoing IFRS policies at January 1, 2010 is complete. • Finalization of quantification of IFRS differences for Q1, Q2, Q3 and Q4 2010 to be completed by the end of Q1 2011.
INFRASTRUCTURE: Define and introduce appropriate level of IFRS • Appropriate level of expertise as needed • Leadership in the form of a Steering expertise for each of the following: throughout the conversion project established Committee and project management • Operating division accounting staff. by Q4 2010. function was established. • Head office and consolidation group. • Project team has completed extensive training. • Senior executives and Board, including • Training of operating divisions and head Audit Committee. office accounting staff was conducted in December 2010. • Training of Board (including Audit committee) members completed in Q2 2010. • Training of senior executives is ongoing.
INFRASTRUCTURE: Make information technology fully IFRS compliant • Ready for parallel processing of 2010 • Identification of issues completed. for all of: general ledgers. • Information technology resources identified and • Systematic processing changes. engaged where required. • Program upgrades/changes. • System calculations associated with the opening • One-off calculations (transition to IFRS, IFRS balance sheet as at January 1, 2010 have including IFRS 1). been finalized. • Gathering data for disclosures. • Targeted data gathering from site locations • Scope of consolidation package. addressing IFRS differences from Canadian • Budget/plan/forecast monitoring process. GAAP has been completed. • Integration of IFRS differences in the Fund’s budgeting/forecasting processes were finalized in Q4 2010.
BUSINESS POLICY ASSESSMENT: Financial Covenants • Identify necessary covenant implications • Identification of GAAP-related • Identify impact on financial covenants and by June 30, 2010. covenants completed. business practices. • Covenant implications of IFRS adjustments were • Complete any required renegotiations/changes. assessed at March 31, June 30, September 30, and December 31 2010.
Cinram 2010 Annual Report 51 MANAGEMENT’S DISCUSSION AND ANALYSIS
Effort accomplished by December 31, 2010 and Key Activity Milestones/Deadlines projected for the quarter ended March 31, 2011
CONTROL ENVIRONMENT: ICFR • Conduct implementation audit by Internal Audit • Policy manual and documentation • For all accounting policy changes identified, during first half of 2011. team assembled. assess ICFR design and effectiveness • Update CEO/CFO certification process during • Internal audit has initiated planning for implications. first half of 2011. their audit. • Implement appropriate changes.
CONTROL ENVIRONMENT: New systems/processes • Conduct implementation audit by Internal Audit • Internal audit has initiated planning for • Complete documentation of changes to or new by Q1 2011. their audit. systems/processes/controls.
CONTROL ENVIRONMENT: DC&P • Identify Key Performance Indicators and assess • The Fund has identified EBITA as the main Key • For all accounting policy changes identified, impact in the Q3 2010 MD&A. Performance Indicator and will disclose results assess DC&P design and effectiveness • Publish revised 2010 results in the MD&A by under IFRS as they become finalized. implications. March 31, 2011. • In this Q4 MD&A the Fund is disclosing its • Implement appropriate changes, in particular: consolidated IFRS opening balance sheet as at - Ensure 2011 investor communications fully January 1, 2010. IFRS compliant re: guidance and expected earnings. - Revise MD&A communications package. - Ensure investor relations process can respond to IFRS-related queries.
Our date of transition to IFRS will be January 1, 2010 (the “Transition Date”). Although IFRS accounting policies and elections have been approved by the Steering Committee and the Audit Committee, such approval is based upon expectations regarding the IFRS standards that are effective for the Fund at the Transition Date.
In the period leading up to the changeover, which will be finalized with the published results for the year ended December 31, 2011, the AcSB has issued new accounting standards that are converged with IFRS, thus mitigating the impact of adopting IFRS at the changeover date. The International Accounting Standard Board (IASB) will also continue to issue new accounting standards during the conversion period, and as a result, the final impact of IFRS on the Fund’s consolidated financial statements will be known with greater certainty when it publishes its first audited financial statements for the year ended December 31, 2011.
Initial adoption of IFRS IFRS 1, First-time Adoption of International Financial Reporting Standards, sets forth that the adoption of IFRS occurs in the first annual financial statements in which the entity adopts IFRS by making an unreserved and explicit statement in those financial statements of compliance with IFRS. IFRS 1 requires that comparative financial information be provided and that the same accounting policies be applied throughout all periods presented. As the IFRSs and IFRS Interpretations Committee (IFRIC) interpretations that will be applicable at December 31, 2011 are not known with certainty at this time, our 2010 and interim 2011 IFRS financial statements may be adjusted for the impacts of new standards that become effective for us prior to December 31, 2011. The policy choices and elections that we have made and are presented below are also subject to change.
IFRS 1 provides for certain optional exemptions and certain mandatory exceptions for first time IFRS adopters. The Fund has decided to take the following elections provided by IFRS 1. All other available elections are either considered not applicable or not material to the Fund.
52 Cinram 2010 Annual Report MANAGEMENT’S DISCUSSION AND ANALYSIS
Business combinations: IFRS 3, Business Combinations, may be applied retrospectively or prospectively. The Fund will be electing not to retrospectively apply IFRS 3 to any business combinations that occurred prior to January 1, 2010 and such business combinations will not be restated.
There will be no impact on the opening balance sheet or on the profit and loss for the period ending December 31, 2010.
Cumulative translation differences (CTA): Retrospective application of IFRS would require us to determine cumulative currency translation differences (CTA) in accordance with IAS 21, The Effects of Changes in Foreign Exchange Rates, from the date a subsidiary or associate was formed or acquired. IFRS 1 permits cumulative translation gains and losses to be reset to zero at the Transition Date. The Fund will be electing to recognize all CTA of the foreign subsidiaries into opening retained earnings as of January 1, 2010.
The effect of this adjustment on the opening balance sheet will be an increase to retained earnings of $115.4 million with a reduction for the same amount to accumulated other comprehensive income. Therefore, there is no effect to Unitholders’ equity at the Transition Date.
Changes to existing decommissioning, restoration IFRS 1 allows for either the retrospective or prospective adoption from the date of transition of IFRIC 1, and similar liabilities included in the cost of Changes in Existing Decommissioning, Restoration and Similar Liabilities. The Fund will be electing not property, plant and equipment: to retrospectively recognize changes to liabilities that would have occurred prior to the Transition Date.
Instead, an estimate of the decommissioning liabilities under IFRS will be made at January 1, 2010. Any adjustments will include the estimated impact on property, plant and equipment carrying values.
There is no effect on the opening balance sheet at the Transition Date.
Borrowing costs: IAS 23, Borrowing Costs, may be applied retrospectively or prospectively for capitalization of borrowing costs directly attributable to the acquisition, construction or production of qualifying assets. The Fund will be electing to apply this standard prospectively from January 1, 2010.
There is no effect on the opening balance sheet at the Transition Date.
Fair value or revaluation as deemed cost: IFRS 1 provides a choice between measuring individual items of property, plant and equipment, investment property and intangible assets at their fair value at the date of transition and using those amounts as deemed cost or using the historical valuation under the prior GAAP. The Fund will be electing to use the fair value as deemed cost on all of the land and building classified as property, plant and equipment at January 1, 2010. For all other assets, the Fund will use the historical bases under Canadian GAAP as deemed costs under IFRS at the Transition Date, subject to any required adjustments.
On the transition date, land and building values will be increased by $40.5 million as a result of the deemed cost election on assets classified as property, plant and equipment.
Depreciation expense in future periods under IFRS will be impacted; however, these changes have not been finalized at this time.
Employee benefits – actuarial gains and losses: IAS 19, Employee Benefits, allows actuarial gains and losses to be either deferred and amortized, according to the corridor method, or immediately recognized through equity. The Fund will elect to recognize all cumulative actuarial gains and losses that existed at the Transition Date in opening retained earnings for all of its employee benefit plans.
On the transition date, prepaid expenses, current employee benefits and non-current employee benefits will be adjusted by $0.8 million, $0.6 million and $0.3 million, respectively, with a decrease to retained earnings of $1.7 million.
Employee benefits – early retirement plans: The Fund has certain employee benefits associated with early retirement plans in Europe in which expenditures were not to be recognized until realized at a future date under Canadian GAAP. IAS 19, Employee Benefits, establishes criteria for benefits classified as termination benefits. Under IFRS, certain of these benefits were classified as termination benefits which require immediate recognition.
As a result, the Fund recognized a $1.7 million reduction to retained earnings, as well as a $1.7 million increase to non-current employee benefit liabilities.
Cinram 2010 Annual Report 53 MANAGEMENT’S DISCUSSION AND ANALYSIS
The mandatory exemptions that are applicable to the Fund under IFRS 1 include:
1. H edge accounting: As required by IAS 39, Financial Instruments, Recognition and Measurement, at the date of transition to IFRSs, Cinram is prohibited from retrospectively designating hedging relationships prior to the transition date. As a result, only hedging relationships that satisfied the hedge accounting rules at the Transition Date will be reflected in the Fund’s results. There will be no effect on the opening balance sheet as at the Transition Date. 2. E stimates: Hindsight is not used to create or revise estimates. Estimates previously made under Canadian GAAP cannot be revised for application of IFRS except where necessary to reflect any difference in accounting policies.
ADDITIONAL SIGNIFICANT CHANGES IN ACCOUNTING POLICIES ON THE TRANSITION DATE TO IFRS
Employee benefits: IAS 19, Employee Benefits, requires an entity to make an accounting policy choice regarding the treatment of actuarial gains and losses. The Fund intends to adopt the option of recording all actuarial gains and losses immediately to Other Comprehensive Income, with no impact on profit or loss. Under Canadian GAAP, the Fund recognizes actuarial gains and losses into profit or loss using the corridor method.
IAS 19 also requires the past service element of defined benefit plans be expensed on a straight-line basis until the benefits become vested. Any past service costs that are already vested are expensed immediately. Under Canadian GAAP, past service costs are amortized over the average remaining service life of the active employees benefiting from the plan.
Under IAS 19 Employee Benefits, the Fund is required to separately disclose, on the face of its statement of financial position, all assets and liabilities which pertain to employee benefits.
As a result, the Fund reclassified $53.9 million from current accrued liabilities to current employee benefits, as well as $21.1 million from other non-current liabilities to non-current employee benefits.
Leases: IAS 17, Leases, requires that gains and losses resulting from sale and leaseback transactions are recognized immediately when the resulting lease is accounted for as an operating lease and the sale occurred at market prices. Under Canadian GAAP, a portion of the gains are deferred and amortized over the term of the leases.
On the transition date, decreases of $2.9 million, and $8.7 million will be made to accrued liabilities and other long-term liabilities, respectively, with an increase to retained earnings of $11.6 million.
Joint ventures: The IASB is currently considering Exposure Draft 9, Joint Arrangements, (ED 9), which is intended to eliminate the option to apply proportionate consolidation and require the use of equity accounting for joint ventures. The final policy is expected to be issued in early 2011 and be effective before the end of 2011. Currently under Canadian GAAP, the Fund uses proportionate consolidation to account for its joint venture in Mexico which it disposed of at June 30, 2010. This policy change is not expected to impact the Fund as a result for Mexico, but may impact future joint ventures, as the Fund would use the equity method to account for its interest in future joint venture arrangements.
Impairment of assets: IAS 36, Impairment of Assets, requires that an asset be impaired if the recoverable amount is lower than the asset’s carrying amount. The recoverable amount is defined as the higher of the asset’s fair value less cost to sell and its value-in-use. The value-in-use calculation involves discounting the expected future cash flows to be generated by the asset to their net present value. In accordance with IAS 36, Impairment of Assets, the Fund utilized fair value less cost to sell in determining the recoverable amount for certain of its assets.
On the other hand, Canadian GAAP applies a two-step approach to measure impairment. In step one, a recoverability test is performed by comparing the expected undiscounted future cash flows to be derived from the asset with its carrying amount. If the asset fails the recoverability test, step two is triggered, and the entity must record an impairment loss calculated as the excess of the asset’s carrying amount over its fair value. The net result is that an impairment charge is more likely under IFRS than it is under Canadian GAAP.
54 Cinram 2010 Annual Report MANAGEMENT’S DISCUSSION AND ANALYSIS
However, while Canadian GAAP does not permit the reversal of impairment losses, IFRS requires a reversal of previous impairment charges, other than on goodwill, where conditions have changed.
The Fund recognized an impairment of $38.6 million to property, plant and equipment, and $11.1 million to intangible assets as a result of the difference in standards under IFRS as opposed to Canadian GAAP as at January 1, 2010, with an offsetting reduction of $49.7 million to retained earnings.
Property, plant and equipment: While Canadian GAAP requires that all property, plant and equipment be carried at cost and amortized over their expected useful lives, IFRS provides an option to use the revaluation model where specific classes of assets are revalued annually to fair value. Cinram is electing to continue to apply the cost model in accordance with IAS 16, Property, Plant and Equipment, with the fair value at the Transition Date as the deemed cost for certain assets (see Initial Adoption of IFRS – Fair value or revaluation as deemed cost) and the Fund continuing to depreciate (as opposed to revalue) its property, plant and equipment.
Investment property: Under Canadian GAAP, investment properties were included as part of property, plant and equipment measured on a cost basis and depreciated over their remaining useful lives.
IFRS requires that investment property be separately disclosed on the balance sheet. Similar to property, plant and equipment, IFRS provides an option to use the revaluation model or the cost model. However, IFRS requires that the fair value of investment property be disclosed either by revaluing the assets on the balance sheet, through profit or loss (under the revaluation model), or through note disclosure (under the cost model).
The Fund will continue to report investment property using the cost basis, but where fair value is materially different from the carrying value, this difference will be disclosed in the notes to the consolidated financial statements.
A total of $6.2 million was reclassified from Property, Plant & Equipment to Investment Property at the Transition Date, and certain property classified as Investment Property under IFRS was increased $1.0 million as a result of differentials in depreciation pertaining to componentization under IFRS as opposed to Canadian GAAP. In addition, retained earnings also increased $1.0 million as a result.
Early payment discounts: Under IFRS, the Fund is required to recognize early payment discounts at the time of sale if it is reasonable to expect a customer to utilize the early payment discount, whereas this is not required under Canadian GAAP.
The Fund recognized a reduction of $0.5 million to retained earnings, along with a $0.5 million reduction to its trade and other receivables balance at the Transition Date.
Deferred tax assets and liabilities: Under IFRS, all deferred taxes are to be classified as non-current, and in instances where an entity has a deferred tax asset and liability in the same tax jurisdiction, and the entity intends to settle the amounts on a net basis, the entity is permitted to net these amounts.
As a result, the Fund has reclassified its deferred tax assets as non-current at the Transition Date. In addition, the Fund has netted $0.9 million of deferred tax assets and liabilities. The impact to current deferred tax assets is a decrease from $6.0 million to nil, and non-current deferred tax assets increase from nil to $5.1 million. Non-current deferred tax liabilities decrease $0.9 million going from $6.6 million to $5.7 million.
Provisions: Under IAS 37, Provisions, the Fund is required to reclassify any of its accrued liabilities which meet the definition of a provision under IFRS, which is a liability of uncertain timing or amount.
As a result, the Fund reclassified $6.3 million from current accrued liabilities to current provisions, and $4.7 million from other non-current liabilities to non-current provisions. These amounts were composed of asset retirement obligations, restructuring and certain royalty accruals.
Cinram 2010 Annual Report 55 MANAGEMENT’S DISCUSSION AND ANALYSIS
Share-based payment: The Fund is required to recognize unit-based compensation in accordance with IFRS 2, Share-based Payment. The Fund has classified its unit-based payments to be cash settled as defined by IFRS 2, Share-based Payment. Under IFRS, when issuing new unit-based payments, the Fund is required to recognize a charge to profit and loss along with a corresponding liability at fair value as at the grant date. Until the liability is settled, the Fund is required to re-measure the fair value of the liability at the end of each reporting period and at the date of settlement, with any changes in fair value recognized in profit or loss for the period. The Fund will utilize the Black-Scholes Model to determine the fair value of its unit-based compensation both at inception, and on an ongoing basis until settlement.
Under Canadian GAAP, certain of the Fund’s unit-based compensation was determined to be both cash settled and equity settled. For those classified as cash settled, the Fund utilized the intrinsic value method of measuring the fair value of the unit-based compensation, whilst the Fund used the Black-Scholes model for equity settled share-based payments. In addition, no subsequent remeasurement in interim periods prior to the settlement date was required.
As a result of the differences between IFRS and Canadian GAAP, the Fund recognized a $1.2 million reduction to opening retained earnings, an additional $2.0 million in other long-term liabilities, and a $0.8 million reduction in its contributed surplus balance.
Exchangeable LP Units: Under IAS 39, Financial Recognition and Measurement, as well as IAS 32, Financial Statements: Presentation, the Fund has assessed that it is required to present the exchangeable LP units as a non-current liability, and not as Fund units as per Canadian GAAP.
This resulted in a $0.1 million increase to other long-term liabilities, along with a reduction of $0.1 million to Fund units.
Inventory: Canadian GAAP requires that any fixed costs not absorbed to inventory during the quarters be capitalized to inventory to the extent that management expects these amounts will be absorbed to inventory by the end of the year. No unabsorbed fixed costs are included in inventory at the end of the year. IAS 34, Interim Financial Reporting, on the other hand, has a general rule that amounts should only be included as an asset on the balance sheet at the end of any interim periods if it would be appropriate to classify them as an asset at the end of the year. Therefore, under IFRS, all unabsorbed fixed costs at the end of each interim period will be expensed to cost of goods sold in that period.
As a result, there is no impact to the opening balance sheet, but there will be an expected impact in quarters subsequent to the transition date. The quantification of these amounts has not been finalized at this time.
Opening IFRS Statement of Financial Position — Summary adjustments The following shows the summary adjustments related to all differences to reconcile excerpts of the previously disclosed December 31, 2009 balance sheet under Canadian GAAP to IFRS as at January 1, 2010. Excerpts of the following unaudited consolidated financial statements show the expected impact of the above noted differences between IFRS and Canadian GAAP as at January 1, 2010.
56 Cinram 2010 Annual Report MANAGEMENT’S DISCUSSION AND ANALYSIS
January 1, 2010
Canadian Reclassification Adjustment to GAAP, as for IFRS Unitholders’ (In thousands of U.S. dollars) reported presentation equity IFRS Assets Deferred tax assets (1) $ 6,007 $ (6,007) $ — $ — Other current assets (2) 454,267 — (1,289) 452,978
Current assets 460,274 (6,007) (1,289) 452,978
Property, plant and equipment (3) 234,684 (6,234) 1,900 230,350 Investment property (4) — 6,234 971 7,205 Intangible assets (5) 27,537 — (11,056) 16,481 Deferred tax assets (6) — 5,097 — 5,097 Other non-current assets 62,205 — — 62,205
Total non-current assets 324,426 5,097 (8,185) 321,338
Total assets $ 784,700 $ (910) $ (9,474) $ 774,316
Liabilities and Unitholders’ Equity Current employee benefits (7) $ — $ 53,941 $ 612 $ 54,553 Current provisions (8) — 6,278 — 6,278 Accrued liabilities (9) 226,856 (60,219) (2,895) 163,742 Other current liabilities 140,911 — — 140,911
Total current liabilities $ 367,767 $ — $ (2,283) $ 365,484
Non-current employee benefits (10) — 21,072 2,017 23,089 Non-current provisions (11) — 4,716 — 4,716 Other long-term liabilities (12) 43,637 (25,788) (6,629) 11,220 Deferred tax liabilities (13) 6,638 (910) — 5,728 Other non-current liabilities 390,958 — — 390,958
Total non-current liabilities 441,233 (910) (4,612) 435,711
Unitholders’ Equity (24,300) — (2,579) (26,879)
Total Liabilities and Unitholders’ Equity $ 784,700 $ (910) $ (9,474) $ 774,316
Notes: (1) Please refer to Additional significant changes in accounting policies on the Transition Date to IFRS (“Additional Policies”) – Deferred tax assets and liabilities. (2) Please refer to Initial Adoption of IFRS (“Initial Adoption”) – Employee benefits – actuarial gains and losses, and Additional Policies – Early payment discounts. (3) Please refer to Initial Adoption – Fair value or revaluation as deemed cost, Additional Policies – Impairment of assets, and Additional Policies – Investment property. (4) Please refer to Additional Policies – Investment property. (5) Please refer to Additional Policies – Impairment of assets. (6) Please refer to Additional Policies – Deferred tax assets and liabilities. (7) Please refer to Initial Adoption – Employee benefits – actuarial gains and losses, and Additional Policies – Employee benefits. (8) Please refer to Additional Policies – Provisions. (9) Please refer to Additional Policies – Leases, Additional Policies – Provisions, and Additional Policies – Employee benefits. (10) Please refer to Initial Adoption – Employee benefits – actuarial gains and losses, and Initial Adoption – Employee benefits – early retirement plans. (11) Please refer to Additional Policies – Provisions. (12) Please refer to Additional Policies – Leases, Additional Policies – Share-based payment, Additional Policies – Exchangeable LP Units, Additional Policies – Provisions, and Additional Policies – Employee benefits. (13) Please refer to Additional Policies – Deferred tax assets and liabilities.
21. ADDITIONAL INFORMATION Copies of publicly filed documents of the Fund, including our annual information form, can be found through the SEDAR website at www.sedar.com.
Cinram 2010 Annual Report 57 MANAGEMENT’S RESPONSIBILITY FOR FINANCIAL STATEMENTS
The accompanying consolidated financial statements have been to review the consolidated financial statements, as well as the prepared by management and approved by the Trustees of Cinram adequacy of its internal controls, audit process and financial International Income Fund (the Fund). Management is responsible reporting with management and with the external auditors. The for the information and representations contained in these Audit Committee reports to the Trustees prior to the approval of the consolidated financial statements. audited consolidated financial statements for publication.
We maintain appropriate processes to ensure that we produce KPMG LLP, our independent auditors appointed by trust unitholders relevant and reliable financial information. The consolidated financial at the last annual meeting, have audited the consolidated financial statements have been prepared in accordance with Canadian statements. Their report is presented below. generally accepted accounting principles. The significant accounting policies, which management believes are appropriate for the Fund, are described in note 2 to the consolidated financial statements.
The Trustees are responsible for reviewing and approving the consolidated financial statements and overseeing management’s STEVEN G. BROWN JOHN H. BELL performance of its financial reporting responsibilities. The Trustees Chief Executive Officer Chief Financial Officer appoint an Audit Committee of three non-management Trustees Toronto, Canada March 2, 2011
INDEPENDENT AUDITORS’ REPORT
To the Unitholders of Cinram International Income Fund including the assessment of the risks of material misstatement of the consolidated financial statements, whether due to fraud We have audited the accompanying consolidated financial or error. In making those risk assessments, we consider internal statements of Cinram International Income Fund (“the Fund”), which control relevant to the entity’s preparation and fair presentation comprise the consolidated balance sheets as at December 31, 2010 of the consolidated financial statements in order to design audit and 2009, the consolidated statements of earnings, comprehensive procedures that are appropriate in the circumstances, but not earnings (loss), unitholders’ deficiency and cash flows for the for the purpose of expressing an opinion on the effectiveness years then ended, and notes, comprising a summary of significant of the entity’s internal control. An audit also includes evaluating accounting policies and other explanatory information. the appropriateness of accounting policies used and the Management’s Responsibility for the Consolidated reasonableness of accounting estimates made by management, Financial Statements as well as evaluating the overall presentation of the consolidated Management is responsible for the preparation and fair presentation financial statements. of these consolidated financial statements in accordance with We believe that the audit evidence we have obtained in our audits is Canadian generally accepted accounting principles, and for such sufficient and appropriate to provide a basis for our audit opinion. internal control as management determines is necessary to enable the preparation of consolidated financial statements that are free Opinion from material misstatement, whether due to fraud or error. In our opinion, the consolidated financial statements present fairly, in all material respects, the consolidated financial position of the Auditors’ Responsibility Fund as at December 31, 2010 and 2009, and the results of its Our responsibility is to express an opinion on these consolidated consolidated operations and its consolidated cash flows for the financial statements based on our audits. We conducted our years then ended in accordance with Canadian generally accepted audits in accordance with Canadian generally accepted auditing accounting principles. standards. Those standards require that we comply with ethical requirements and plan and perform the audits to obtain reasonable assurance about whether the consolidated financial statements are free from material misstatement.
An audit involves performing procedures to obtain audit evidence Chartered Accountants, Licensed Public Accountants about the amounts and disclosures in the consolidated financial March 2, 2011 statements. The procedures selected depend on our judgment, Toronto, Canada
58 Cinram 2010 Annual Report CONSOLIDATED BALANCE SHEETS
(In thousands of U.S. dollars) December 31 ’10 ’09 ASSETS
Current assets: Cash and cash equivalents $ 164,399 $ 122,072 Accounts receivable, net of an allowance for doubtful accounts of $3,270 (2009 — $4,149) 178,066 273,243 Inventories (note 3) 24,109 31,985 Income taxes receivable 706 5,005 Prepaid expenses 11,841 15,915 Assets held for sale (note 4) — 6,047 Future income taxes (note 14) — 6,007
379,121 460,274
Property, plant and equipment (note 4) 181,849 234,684 Intangible assets (note 5) 11,511 27,537 Goodwill (note 5) 40,634 40,634 Other long-term assets 25,701 21,571
$ 638,816 $ 784,700
LIABILITIES AND UNITHOLDERS’ DEFICIENCY
Current liabilities: Accounts payable $ 60,585 $ 90,282 Accrued liabilities 150,952 226,856 Income taxes payable 13,749 20,277 Current portion of long-term debt (note 7) 131,525 28,624 Derivative instruments (note 7) 11,087 — Current portion of obligations under capital leases (note 8) 1,141 1,728
369,039 367,767
Long-term debt (note 7) 234,402 363,396 Obligations under capital leases (note 8) 1,086 2,337 Other long-term liabilities 36,921 43,637 Derivative instruments (note 7) — 25,225 Future income taxes (note 14) 1,229 6,638
Unitholders’ deficiency (note 9) (3,861) (24,300)
$ 638,816 $ 784,700
Lease commitments (note 8) Contingent liabilities and guarantees (note 15) Subsequent events (notes 7 and 23) See accompanying notes to consolidated financial statements. On behalf of the Board of Trustees:
WILLIAM ANDERSON JAMES S.A. MACDONALD Trustee Trustee
Cinram 2010 Annual Report 59 CONSOLIDATED STATEMENTS OF EARNINGS
(In thousands of U.S. dollars, except per unit/exchangeable limited partnership unit amounts) Years ended December 31 ’10 ’09
Revenue $ 1,108,790 $ 1 , 4 5 3 , 0 3 1 Cost of goods sold 892,393 1,190,892
Gross profit 216,397 262,139 Selling, general and administrative expenses 137,728 164,992 Amortization of intangible assets (note 5) 15,146 41,465 Impairment of long-lived assets and goodwill (notes 4 and 5) — 82,234 Other charges, net (note 12) 17,544 2,483
Earnings (loss) before the undernoted 45,979 (29,035) Interest on long-term debt 32,618 37,584 Other interest and financing charges, net (note 13) (306) 6,101 Gain on repurchase of debt (note 7) — (38,440) Foreign exchange gain (956) (15,179) Investment income (317) (429)
Earnings (loss) from continuing operations before income taxes 14,940 (18,672) Income tax expense (recovery) (note 14): Current (4,332) (9,985) Future 832 (2,692)
(3,500) (12,677)
Earnings (loss) from continuing operations 18,440 (5,995) Loss from discontinued operations (note 22) (5,134) (16,033)
Net earnings (loss) $ 13,306 $ (22,028)
Earnings (loss) per unit from continuing operations (note 10): Basic $ 0.34 $ (0.11) Diluted 0.33 (0.11)
Earnings (loss) per unit (note 10): Basic $ 0.25 $ (0.40) Diluted 0.24 (0.40)
Weighted average number of units and exchangeable limited partnership units outstanding (in thousands) (note 10): Basic 54,000 54,785 Diluted 55,756 54,785
See accompanying notes to consolidated financial statements.
60 Cinram 2010 Annual Report CONSOLIDATED STATEMENTS OF COMPREHENSIVE EARNINGS (LOSS)
(In thousands of U.S. dollars) Years ended December 31 ’10 ’09
Net earnings (loss) $ 13,306 $ (22,028) Other comprehensive income, net of tax (note 11): Unrealized loss on translating financial statements of self-sustaining foreign operations (17,369) (43,402) Unrealized gain on hedges of net investment in self-sustaining foreign operations 5,897 35,135 Partial release of cumulative translation adjustment (notes 13 and 22(a)) 3,759 —
Unrealized foreign exchange translation loss, net of hedging activities (7,713) (8,267) Net unrealized gain on derivatives designated as cash flow hedges — 1,067 Release of other comprehensive income due to de-designation of hedge (note 13(a)) 14,636 3,840
6,923 (3,360)
Comprehensive earnings (loss), net of tax $ 20,229 $ (25,388)
See accompanying notes to consolidated financial statements.
Cinram 2010 Annual Report 61 CONSOLIDATED STATEMENTS OF UNITHOLDERS’ DEFICIENCY
(In thousands of Accumulated Total U.S. dollars) Exchangeable limited Employee other unitholders’ Years ended Fund units partnership units unit purchase Contributed comprehensive equity December 31 Amount Number (000s) Amount Number (000s) loans surplus Deficit income (loss) (deficiency)
Balance, December 31, 2008 $ 175,990 55,223 $ 100 33 $ — $ — $ (272,625) $ 99,115 $ 2,580 Loss for the year — — — — — — (22,028) — (22,028) Deferred units issued (note 9(c)) — — — — — 816 — — 816 Limited partnership units exchanged for Fund units 12 4 (12) (4) — — — — — Employee unit purchase loans (note 9(a)) — — — — (2,315) 7 — — (2,308) Other comprehensive loss (note 11) — — — — — — — (3,360) (3,360)
Balance, December 31, 2009 176,002 55,227 88 29 (2,315) 823 (294,653) 95,755 (24,300) Earnings for the year — — — — — — 13,306 — 13,306 Deferred units issued (note 9(c)) — — — — — 335 — — 335 Deferred units exchanged for Fund units (note 9(c)) 40 18 — — — (40) — — — Extinguishment of deferred units — — — — — (12) — — (12) Employee unit purchase loans (note 9(a)) — — — — (137) 24 — — (113) Other comprehensive income (note 11) — — — — — — — 6,923 6,923
Balance, December 31, 2010 $ 176,042 55,245 $ 88 29 $ (2,452) $ 1,130 $ (281,347) $ 102,678 $ (3,861)
See accompanying notes to consolidated financial statements.
62 Cinram 2010 Annual Report CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands of U.S. dollars) Years ended December 31 ’10 ’09
Cash provided by (used in): Operations: Earnings (loss) from continuing operations $ 18,440 $ (5,995) Items not involving cash: Amortization of property, plant and equipment 54,733 86,641 Amortization of intangible assets 15,146 41,465 Future income taxes 598 (2,750) Gain on repurchase of debt — (38,440) Partial release of cumulative translation adjustment (note 13) (548) — Impairment of long-lived assets and goodwill (notes 4 and 5) — 82,234 Release of accumulated other comprehensive income due to de-designated hedge (note 13) 14,636 3,840 Mark-to-market adjustment of derivative liability (note 13(b)) (14,138) (419) Non-cash interest expense (note 7) 2,402 2,466 Hedge ineffectiveness (note 13) — 124 Gain on disposition of property, plant and equipment (note 12(b)) (7,460) (859) Other 387 827 Change in non-cash operating working capital (note 18) 5,786 133,636
89,982 302,770 Financing: Transaction costs and loan fees (notes 7 and 23(b)) (6,134) (1,521) Repayment/repurchase of long-term debt and bank indebtedness (28,624) (213,324) Decrease in obligations under capital leases (1,856) (2,956) Financing of employee unit purchase loan (note 9(a)) 24 (2,315)
(36,590) (220,116) Investments: Purchase of property, plant and equipment (14,701) (42,179) Payment of acquisition earn-out amount (note 5(a)(i)) — (16,131) Proceeds on disposition of property, plant and equipment 13,671 29,483 Decrease in other assets 1,838 2,987 Decrease in other long-term liabilities (6,717) (6,433)
(5,909) (32,273) Cash used in discontinued operating activities (note 22) (1,824) (17,419) Cash provided by (used in) discontinued investing activities (note 22) (736) 11,179 Foreign currency translation gain (loss) on cash held in foreign currencies (2,596) 4,582
Increase in cash and cash equivalents 42,327 48,723 Cash and cash equivalents, beginning of year 122,072 73,349
Cash and cash equivalents, end of year $ 164,399 $ 122,072
Cash and cash equivalents are comprised of: Cash $ 94,406 $ 88,846 Cash equivalents 69,993 33,226
$ 164,399 $ 122,072
Supplemental cash flow information: Interest paid $ 31,815 $ 38,109 Income taxes recovered (1,915) (17,012)
See accompanying notes to consolidated financial statements.
Cinram 2010 Annual Report 63 NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (IN THOUSANDS OF U.S. DOLLARS, EXCEPT UNITS, PER UNIT INFORMATION AND WHERE OTHERWISE STATED) YEARS ENDED DECEMBER 31, 2010 AND 2009
1. DESCRIPTION OF THE FUND:
On April 28, 2006, the shareholders of Cinram International Inc. (the Company or Cinram) approved a Plan of Arrangement (the Arrangement) filed by the Company under Section 192 of the Canada Business Corporations Act, which provided for the capitalization of Cinram International Income Fund (the Fund) as a publicly traded income trust. The Arrangement resulted in the Company’s shareholders transferring their shares to the Fund in consideration for Fund units or, in the case of electing shareholders, transferring all or a portion of their shares to Cinram International Limited Partnership (the LP) in consideration for Class B exchangeable limited partnership units (exchangeable LP units) of the LP on the basis of one share for one unit or exchangeable LP unit.
The Fund is an unincorporated, open-ended, limited purpose trust, established under the laws of the Province of Ontario by Declaration of Trust dated March 21, 2006, as amended and restated on May 5, 2006. The Fund was established to acquire, invest in, hold, transfer, dispose of and otherwise deal with securities and/or assets of the Cinram International Income Trust, Cinram International General Partner Inc., and other corporations, partnerships or persons engaged, directly or indirectly, in the business of the manufacture, packaging, distribution, sale and provision of multimedia products and related logistics services, as well as activities related or ancillary thereto, and such other investments as the Trustees may determine, and the borrowing of funds for that purpose.
2. SIGNIFICANT ACCOUNTING POLICIES:
(a) Basis of presentation: These consolidated financial statements include the accounts of the Fund and its subsidiaries, and have been prepared in accordance with Canadian generally accepted accounting principles (GAAP). The results of subsidiaries acquired are consolidated from the date of acquisition. All intercompany balances and transactions have been eliminated on consolidation.
As disclosed in note 22(a), on June 30, 2010 the Fund completed the sale of its share of the joint venture Cinram LatinoAmericana, S.A. de C.V. (Mexico). Also, as disclosed in note 22(b), on April 9, 2009, the Fund completed the sale of substantially all of the assets and liabilities of Ivy Hill Corporation (Ivy Hill). As a result, both Mexico and Ivy Hill’s results of operations have been excluded from the Fund’s continuing operations for the years ended December 31, 2010 and 2009.
The functional currency of the Fund is the Canadian dollar. The Fund’s operations in the U.S., the United Kingdom, France, Germany and Spain are considered to be self—sustaining. Assets and liabilities are translated using year-end exchange rates and revenue and expenses are translated at weighted average exchange rates. Exchange gains and losses arising from the translation of the financial statements of self-sustaining foreign operations are deferred in the “foreign currency translation adjustment” account included as a component of accumulated other comprehensive income. When there is a reduction in the Fund’s net investment in its self-sustaining foreign operations, the proportionate amount of the cumulative translation adjustment is recognized in earnings.
The Fund’s reporting currency is the U.S. dollar. The Fund uses the current rate method to translate the consolidated Canadian dollar results into U.S. dollars for both the current and prior years. Under the current rate method, the assets and liabilities are translated into U.S. dollars at the rate of exchange in effect at the balance sheet date; revenue and expenses, as well as cash flow items, are translated at weighted average exchange rates for the year. Any resulting exchange gain or loss is charged or credited to the “foreign currency translation adjustment” account included as a separate component of accumulated other comprehensive income.
(b) Revenue recognition: Revenue is comprised of product sales and service revenue earned from fulfillment and logistics services.
Revenue from product sales is recognized upon shipment since title to the product is transferred to the customers, persuasive evidence of an arrangement exists, the selling price is fixed and determinable, and collectibility is reasonably assured. The Fund’s customers cannot return any previously purchased inventory, with the exception of defective product, which occurs very rarely, nor do customers have a right of refusal on purchases made.
64 Cinram 2010 Annual Report NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
Volume rebates are recorded as a reduction of revenue at the time of shipment. Contractual payments to acquire sales contracts are amortized against revenue over the term of the contract where there is a guaranteed minimum volume commitment.
Service revenue is recognized as services are performed.
The Fund offers certain products and services as part of multiple deliverable arrangements. The Fund divides multiple deliverable arrangements into separate units of accounting. Components of multiple deliverable arrangements are separately accounted for provided the delivered elements have stand-alone value to the customer and the fair value of the undelivered elements can be objectively and reliably determined. Consideration for these units is then measured and allocated amongst the separate units based upon their relative fair values, and then the Fund’s relevant revenue recognition policies are applied to them.
(c) Inventories: Inventories are valued at the lower of cost and net realizable value, with cost determined on a first-in, first-out basis. Net realizable value is the estimated selling price in the ordinary course of business less the estimated costs of completion and the estimated costs necessary to make the sale.
Inventories include the cost of materials purchased, the cost of conversion, as well as other costs required to bring the inventories to their present location and condition. Inventory costs, including the allocation of fixed production overhead, are based on normal production capacity of the manufacturing facilities.
(d) Property, plant and equipment: Property, plant and equipment are recorded at cost and are amortized over their estimated useful lives. Cost represents acquisition or construction costs, including preparation, installation and testing charges incurred with respect to property, plant and equipment until they are ready for commercial production. Major renewals and improvements are capitalized, while maintenance and repairs are charged to operations as incurred. Gains or losses arising from the disposition of property, plant and equipment are reflected in net earnings.
Property, plant and equipment are amortized on a straight-line basis, commencing when the asset is entered into use. Amortization expense for property, plant and equipment is recorded in cost of goods sold. Estimated useful lives for the principal asset categories are as follows:
Buildings 20 — 40 years Machinery and equipment 4 — 13 years Computer equipment 3 — 5 years Furniture 5 years Leasehold improvements Over shorter of estimated useful life and lease term
Spare parts, which are classified as property, plant and equipment, are recorded at cost and are amortized on a straight-line basis. The rates of amortization are intended to fully amortize the assets over three years, which approximates their useful lives.
(e) Goodwill and intangible assets: (i) Goodwill: Goodwill is the residual amount that results when the purchase price of an acquired business exceeds the sum of the amounts allocated to the tangible and intangible assets acquired, less liabilities assumed, based on their fair values. When the Fund enters into a business combination, the purchase method of accounting is used. Goodwill is assigned as of the date of the business combination to reporting units that are expected to benefit from the business combination.
Cinram 2010 Annual Report 65 NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
Goodwill is not amortized but instead is tested for impairment annually, or more frequently, if events or changes in circumstances indicate that the asset might be impaired. Absent any triggering factors during the year, the Fund conducts its goodwill assessment in the fourth quarter of the year to correspond with its planning cycle. The impairment test is carried out in two steps. In the first step, the carrying amount of the reporting unit, including goodwill, is compared with its fair value. When the fair value of the reporting unit exceeds its carrying amount, goodwill of the reporting unit is not considered to be impaired and the second step of the impairment test is unnecessary. The second step is carried out when the carrying amount of a reporting unit exceeds its fair value, in which case, the implied fair value of the reporting unit’s goodwill is determined in the same manner as the value of goodwill is determined in a business combination, and is compared with its carrying amount to measure the amount of the impairment loss, if any.
(ii) Intangible assets: Intangible assets acquired in a business combination are initially recorded at their fair values and are tested for impairment as described in note 2(f). Amortization is provided on a straight-line basis over the estimated useful lives of the assets as follows:
Customer supply agreements 5 — 7 years Acquired technology 3 years
(f) Long-lived assets: The Fund reviews tangible and intangible assets subject to amortization (long-lived assets) for impairment annually, or more frequently, if events or changes in circumstances indicate that the carrying amount may not be recoverable. Absent any triggering factors during the year, the Fund conducts its long-lived asset assessment in the fourth quarter to correspond with its planning cycle. Recoverability is assessed by comparing the carrying amount to the projected undiscounted future net cash flows that the long-lived assets are expected to generate. If the sum of undiscounted future cash flows expected to result from the use and disposition of a group of assets is less than its carrying amount, then a second step is required. In the second step, a present value technique is used to estimate the fair value and is compared to the carrying value of the assets. An impairment loss is measured as the amount by which the carrying amount of a group of assets exceeds its fair value, the amount of consideration that would be agreed upon in an arms-length transaction between knowledgeable, willing parties.
(g) Pension benefits: The Fund accrues its obligations under employee defined benefit plans and the related costs, net of plan assets. The cost of pensions earned by employees is actuarially determined using the projected benefit method prorated on service and management’s best estimates of expected plan investment performance, salary escalation, compensation levels at time of retirement, and retirement ages of employees. Changes in these assumptions could impact future pension expense. For the purpose of calculating the expected return on plan assets, assets are valued at fair value. Actuarial gains or losses are amortized over the average remaining service period of active employees. Pension assets are recorded as other assets while pension liabilities are recorded as accrued pension benefits within accrued liabilities and other long-term liabilities.
The Fund recognizes curtailment losses in income when it is probable that a curtailment will occur and the net effects can be reasonably estimated. Curtailment gains are recognized in income when an event giving rise to a curtailment has occurred. The Fund recognizes settlement gains or losses in income in the period in which a settlement occurs.
For all other pension and non-pension employment benefit plans, expenses are recorded as the Fund’s contributions become payable.
66 Cinram 2010 Annual Report NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(h) Asset retirement obligations: Asset retirement obligations are legal obligations associated with the retirement of tangible long-lived assets that result from their acquisition, lease, construction, development or normal operation. The Fund records the present value of the estimated fair value of a liability for an asset retirement obligation in the year in which it is incurred and when a reasonable estimate of fair value can be made. The fair value of a liability for an asset retirement obligation is the amount at which that liability could be settled in a current transaction between willing parties, that is, other than in a forced liquidation transaction. The fair value is estimated using a credit-adjusted risk-free rate as at the date when the liability is incurred. The Fund subsequently allocates the asset retirement cost to expense using a systematic and rational method over the asset’s useful life, and records the accretion of the liability as a charge to the consolidated statements of earnings.
The adjustment to leasehold improvements in respect of asset retirement costs is amortized into income on a straight-line basis over the remaining term of the leases.
(i) Unit-based compensation: The Fund determines the fair value of unit-based compensation granted to employees using: (i) the Black-Scholes option pricing model for equity settled unit-based compensation and (ii) intrinsic value for cash settled unit-based compensation. The Fund records unit-based compensation expense over the vesting period with a corresponding increase in contributed surplus or an adjustment to accrued liabilities, as applicable.
(j) Income taxes: The Fund follows the asset and liability method of accounting for income taxes. Under the asset and liability method, future income tax assets and liabilities are recognized for the estimated future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Future income tax assets and liabilities are measured using enacted or substantively enacted tax rates in effect for the year in which those temporary differences are expected to be recovered or settled. The effect on future income tax assets and liabilities of a change in tax rates is recognized in earnings in the year that includes the enactment or substantive enactment date. Future income tax assets are recognized, and if realization is not considered “more likely than not,” a valuation allowance is provided. Income tax expense is the sum of the Fund’s provision for current income taxes and the difference between opening and ending balances of future income tax assets and liabilities.
The Fund is a mutual fund trust for income tax purposes, and is taxable in any given year on any amount not distributed to unitholders.
On June 22, 2007, the Canadian federal government enacted legislation to significantly modify the income tax rules applicable to publicly traded income trusts and partnerships. Under the legislation, income earned by these entities will be taxed in a manner similar to income earned and distributed by a taxable corporation. Although the legislation was effective for the 2007 taxation year, application of the tax rules is postponed until the 2011 taxation year with respect to trusts that were publicly traded prior to November 1, 2006 if certain guidelines are respected.
As currently drafted, and based on the current organizational structure of the Fund and its subsidiaries, the Fund believes that the new legislation will not have an impact on current or future earnings.
On March 12, 2009, the Canadian federal government enacted legislation to facilitate the conversion of mutual fund income trusts into corporations on a tax-deferred basis in advance of their 2011 taxation year.
Management is reviewing these conversion rules to assess their implications to the Fund.
Cinram 2010 Annual Report 67 NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(k) Earnings (loss) per unit: Basic earnings (loss) per unit is calculated by dividing net earnings (loss) available to unitholders by the weighted average number of units outstanding during the year. Diluted earnings (loss) per unit is calculated using the treasury stock method, which assumes that all options with exercise prices below the market prices are exercised, with the proceeds used to purchase units of Cinram at the average market price during the period, and all deferred units and all units associated with the employee unit purchase loans will be redeemed for units of the Fund.
(l) Use of estimates: The preparation of financial statements requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the period. Actual results could differ from those estimates.
Significant estimates are used in determining, but not limited to, revenue recognition, including the identification of separate units of accounting under multiple deliverable arrangements, provisions for volume rebates, royalty accruals, including judgment required in determining royalty obligations related to certain patents, the allowance for doubtful accounts, inventory valuation, income tax valuation allowances, restructuring costs, contingencies and other provisions, assets and obligations related to employee future benefits, unit-based compensation, withdrawal liabilities for pension funds, estimation of credit spreads for determination of the fair value of derivative instruments, the useful lives of all depreciable assets, the recoverability of property, plant and equipment and long-lived assets and the valuation of goodwill that require estimates of future cash flows and discount rates.
Royalty charges are incurred as a result of the use of third-party replication technologies. The royalty charge is recorded as cost of goods sold at the time of shipment. The royalty rates are on a per unit basis and based on contractual terms and conditions or management’s best estimate of the royalty obligation in situations where formal license agreements are not in place. These estimates are reviewed periodically and, as adjustments become necessary, they are made in the period in which they become known. A significant change in the royalty rates used could have a material impact on the cost of goods sold and the provision for royalties.
Significant changes in the assumptions, including those with respect to future business plans and cash flows, could materially change the recorded carrying amounts.
(m) Cash and cash equivalents: The Fund considers all highly liquid investment instruments with original maturities of three months or less to be cash equivalents.
(n) Financial and derivative instruments: (i) Financial instruments: Cash and cash equivalents are classified as held-for-trading. Held-for-trading financial assets are recorded at fair value on the consolidated balance sheets with changes in fair value recorded in the consolidated statements of earnings.
The Fund’s other financial assets are classified as available-for-sale or loans and receivables. Available-for-sale investments are carried at fair value on the balance sheet, with changes in fair value recorded in other comprehensive income, until such time as the investments are disposed of or an other-than-temporary impairment has occurred, in which case, the impairment is recorded in net earnings. Loans and receivables and all financial liabilities are carried at amortized cost using the effective interest method. The Fund determined that none of its non-derivative financial assets are classified as held-to-maturity and none of its non-derivative financial liabilities are classified as held-for-trading. Transaction costs paid to a lending institution relating to the bank credit facility are deferred and amortized over the term of the facility.
Derivative financial instruments are utilized to reduce interest rate risk on the Fund’s debt. The Fund does not enter into financial instruments for trading or speculative purposes. The Fund’s policy is to formally designate each derivative financial instrument as a hedge of a specifically identified debt instrument.
68 Cinram 2010 Annual Report NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
All derivatives, including embedded derivatives that must be separately accounted for, are measured at fair value with changes in fair value recorded in the consolidated statements of earnings unless they are effective cash flow hedging instruments.
When hedge accounting is applied, the Fund formally documents the relationship between derivative instruments and the hedged items, as well as its risk management objective and strategy for undertaking various hedge transactions. At the instrument’s inception, the Fund also formally assesses whether the derivatives are highly effective at reducing or modifying interest rate or foreign exchange risk related to the future anticipated interest and other cash outflows associated with the hedged item. Effectiveness requires a high correlation of changes in fair values or cash flows between the hedged item and the hedging item. On a quarterly basis, the Fund confirms that the derivative instruments continue to be highly effective at reducing or modifying interest rate or foreign exchange risk associated with the hedged items. The changes in fair value of cash flow hedging derivatives are recorded in other comprehensive income, to the extent effective, until the hedged asset or liability is recognized in the consolidated statements of earnings. The Fund has established net investment hedges.
For those instruments that do not meet the above criteria, changes in their fair values are recorded in net earnings.
Interest rate swap: The Fund previously entered into an interest rate swap to hedge interest rate risk. The fair value of the Fund’s interest rate swap is determined using an estimated credit-adjusted mark-to-market valuation which takes into consideration the Fund and the counterparty credit risk.
The Fund also assesses the interest rate swap accounted for as hedges for ineffectiveness on a quarterly basis. The measurement of ineffectiveness is recorded in net earnings.
The interest rate swap agreement is used as part of the Fund’s program to manage the fixed and floating interest rate mix of the Fund’s total debt portfolio and related overall cost of borrowing. The interest rate swap agreement involves the periodic exchange of payments without the exchange of the notional principal amount upon which the payments are based, and is recorded as an adjustment of interest expense on the hedged debt instrument. The related amount payable to or receivable from the counterparties is included as an adjustment to accrued interest.
In the event of early extinguishment of the debt obligation, any realized or unrealized gain or loss from the swap would be recognized in net earnings at the time of extinguishment. For those instruments that did not meet the effectiveness criteria, variations in their fair values were marked to market on a current basis, with the resulting gains or losses recorded in or charged against net earnings.
Net investment hedges: The Fund designated its U.S. dollar-denominated long-term debt in Canada as a hedge of the foreign currency risk related to the principal amount of its net investment in U.S. subsidiaries. The U.S. subsidiaries are considered self-sustaining for accounting purposes and, as a result, gains or losses on translating the third party debt in Canada from U.S. to Canadian dollars are recorded in other comprehensive income to the extent the debt is considered an effective hedge. As at December 31, 2010 and 2009, the hedge is effective and both the U.S. dollar-denominated long-term debt in Canada and the investment in the U.S. subsidiaries are remeasured at spot rates at each period end.
(ii) Fair value measurements: The Fund provides disclosure of the three-level hierarchy that reflects the significance of the inputs used in making the fair value measurements. Fair value of financial assets and financial liabilities included in Level 1 are determined by reference to quoted prices in active markets for identical assets and liabilities. Financial assets and financial liabilities in Level 2 include valuations using inputs based on observable market data, either directly or indirectly other than quoted prices. Level 3 valuations are based on inputs that are not based on observable market data.
Cinram 2010 Annual Report 69 NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(o) Changes in and recent Canadian accounting pronouncements: International Financial Reporting Standards (IFRS): In 2008, the Canadian Accounting Standards Board confirmed that Canadian profit-oriented publicly accountable entities will be required to adopt IFRS for fiscal periods beginning on or after January 1, 2011. The Fund’s first IFRS financial statements will be for the year ending December 31, 2011 and will include the comparative period for 2010. Starting in the first quarter of 2011, the Fund will provide unaudited consolidated financial statements in accordance with IFRS. These consolidated financial statements will include restated unaudited 2010 annual and interim financial statement information to be consistent with the new IFRS basis, as well as reconciliations of equity and net earnings for the previously reported Canadian GAAP amounts.
3. INVENTORIES:
’10 ’09
Raw materials $ 17,008 $ 17,714 Work in process 6,399 14,154 Finished goods 702 117
$ 24,109 $ 31,985
Inventory costs included in cost of goods sold for the year ended December 31, 2010 were $560,778 (2009 — $662,877).
During the year ended December 31, 2010, the Fund recorded inventory write-downs in cost of goods sold of $6,732 (2009 — $8,024), and reversals of previously written-down amounts of $4,407 (2009 — $3,719). Work in process and finished goods produced without customer orders are written down to a net realizable value of nil and subsequently written up when a valid customer order is received.
4. PROPERTY, PLANT AND EQUIPMENT:
Accumulated Net book ’10 Cost amortization value
Land $ 9,917 $ — $ 9,917 Buildings 128,078 55,837 72,241 Machinery and equipment 788,589 699,551 89,038 Computer equipment 42,461 39,841 2,620 Furniture 25,772 22,379 3,393 Leasehold improvements 39,303 34,994 4,309 Construction in progress 331 — 331
$ 1,034,451 $ 852,602 $ 181,849
70 Cinram 2010 Annual Report NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
Accumulated Net book ’09 Cost amortization value
Land $ 13,768 $ — $ 13,768 Buildings 130,728 49,322 81,406 Machinery and equipment 954,714 827,249 127,465 Computer equipment 48,194 41,058 7,136 Furniture 27,352 22,475 4,877 Leasehold improvements 52,330 46,514 5,816 Construction in progress 263 — 263 Assets held for sale (a) (11,825) (5,778) (6,047)
$ 1,215,524 $ 980,840 $ 234,684
During the year ended December 31, 2010, the Fund wrote off cost and accumulated amortization totalling $163,398 of property, plant and equipment which was fully amortized.
(a) In December 2009, the Fund finalized an agreement to dispose of the distribution facility located in Simi Valley, California. At December 31, 2009, the criteria had been met for these assets to be classified as held for sale and, accordingly, these assets were reclassified on the consolidated balance sheet. The sale closed in January 2010, resulting in a gain of $7,460 (note 12(b)).
(b) Included in the above are assets under capital lease with a cost of $19,736 and a net book value of $3,160 (2009 — $20,473 and $4,588), which are being amortized on a straight-line basis over their anticipated economic life, which is 20 years for buildings and 4 years for machinery and equipment.
(c) Amortization of property, plant and equipment for the year ended December 31, 2010 amounted to $54,733 (2009 — $86,641).
(d) The impairment of property, plant and equipment related to the following segments:
’10 ’09
Reportable business segments: Pre-Recorded Multimedia Products $ — $ 34,081
$ — $ 34,081
Reportable geographic segments: .S.U $ — $ 29,097 Europe — 4,984
$ — $ 34,081
2010: Based on future cash flow projections in the Fund’s 2011 budget and multi-year projections for 2012 through 2014, during the fourth quarter of 2010, the Fund determined that there was no impairment of property, plant and equipment as the estimated undiscounted cash flows exceeded the carrying value.
2009: Based on future cash flow projections in the Fund’s 2010 budget and multi-year projections for 2011 through 2014, during the fourth quarter of 2009, the Fund determined that the carrying value of certain property, plant and equipment was in excess of the associated estimated undiscounted cash flows. As a result, property, plant and equipment was written down by $34,081 to estimated fair value based on a combination of a market approach and discounted cash flows.
Cinram 2010 Annual Report 71 NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
The write-down of property, plant and equipment of $34,081 for the year ended December 31, 2009 was in the Fund’s Pre-Recorded Multimedia Products segment. The write-down includes machinery and equipment, as follows:
(i) DVD replication and distribution assets in France in the amount of $4,984.
(ii) DVD replication, packaging and distribution assets in the U.S. in the amount of $29,097.
In January 2010, the Fund was notified by Warner Home Video (WHV) of its intention to terminate its supply contract effective July 31, 2010. This was a principal factor to the write-down of $34,081 of property, plant and equipment in 2009.
5. GOODWILL AND INTANGIBLE ASSETS:
(a) Goodwill: Goodwill of $40,634 relates to the 2007 acquisition of the assets of Ditan Corporation (Ditan) in the U.S. The results of Ditan are included in the Video Games segment (note 19).
Goodwill arising from the 2003 acquisition of the assets of Time Warner Inc.’s DVD and CD manufacturing and physical distribution businesses in Germany (Germany) were fully impaired in 2009, primarily as a result of advanced notice received in January 2010 of the termination of the WHV contract effective July 31, 2010 (note 4(d)).
Furthermore, goodwill arising from the 2007 acquisition of substantially all of the assets of Vision Worldwide Management LLC (Vision) were fully impaired in 2009, primarily as a result of forecasted reductions in revenues due to decreasing customer demand. Goodwill associated with the acquisition of these assets related to the U.S.
Goodwill, December 31, 2008 $ 64,737 Effect of foreign exchange 532 Adjustment related to earn-out (i) (2,869) Impairment charge (iii) (22,455) Other (ii) 689
Goodwill, December 31, 2009 and 2010 $ 40,634
(i) At December 31, 2008, a preliminary estimate of $19,000 was recorded in goodwill and accrued liabilities relating to the 2008 earn-out for the acquisition of Ditan. In 2009, the Fund agreed to pay $16,131 to the former shareholders of Ditan relating to the 2008 earn-out based on the achievement of certain performance metrics. This resulted in an adjustment to reduce goodwill and accrued liabilities by $2,869 during 2009.
(ii) In 2009, goodwill was increased by $689 to correct a misclassification between goodwill and current liabilities as of the acquisition date of Ditan. The balance sheet misclassification had no effect on loss for the year in 2009.
(iii) The Fund tests impairment using the two-step method, at the reporting unit level, by comparing the reporting unit’s carrying amount to its fair value (step one). To the extent a reporting unit’s carrying amount exceeds its fair value, the Fund may have an impairment of goodwill. The Fund measures impairment by comparing the implied fair value of goodwill, determined in a manner similar to a purchase price allocation, to its carrying amount (step two).
72 Cinram 2010 Annual Report NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
2010: In 2010, the Fund completed its step one analysis using a discounted cash flow model for the Video Games reporting unit. The discounted cash flow model includes projections covering the 2011 through 2014 periods to determine fair value. For 2012 through 2014, the Fund utilized industry data combined with management estimates to complete the projections, including estimates of revenue and costs. The terminal value of Video Games was determined by applying an EBITDA (defined as earnings before interest expense, foreign exchange translation gains/losses, investment income, gain on repurchase of debt, impairment charges, depreciation and amortization, other charges and income taxes) multiple of four or a terminal growth rate of 2.7%. The projections were discounted using a rate of 18%. The discount rate takes into consideration the economic environment, the ability to forecast future demand and the risk and uncertainty in the video game markets.
Based on the analysis, management concluded that the goodwill balance was not impaired as of December 31, 2010.
2009: In 2009, the Fund completed its step one analysis using a discounted cash flow model. The discounted cash flow model included projections covering the 2010 through 2014 periods to determine fair value. For 2011 through 2014, the Fund utilized industry data combined with management estimates to complete the projections, including estimates of revenue and costs. The terminal values of the reporting units were determined by applying terminal growth rates of (5)% for Germany and plus 2% for Vision and Video Games. The five year projections were discounted using a rate of 14% for Time Warner and 17% for Vision and Video Games. These discount rates took into consideration the economic environment, the ability to forecast future demand and the risk and uncertainty in the markets.
The results of the step one analysis indicated an impairment in Germany and Vision and step two was required for these two reporting units. The process of determining fair value was subjective and required management to exercise a significant amount of judgment in determining future growth/decline rates, discount rates and tax rates, among other factors. Management performed the second step of the goodwill impairment assessment to determine and quantify the amount of impairment. This included the calculation of implied fair value of goodwill, determined in a manner similar to a purchase price allocation, and comparing the residual amount to the carrying amount of goodwill. Based on the analysis, management concluded that the goodwill balance was impaired by $22,455 for Germany and Vision resulting in a balance of $40,634 as of December 31, 2009.
The impairment related to the following segments: ’10 ’09
Reportable business segments: Pre-Recorded Multimedia Products $ — $ 16,865 Other — 5,590
$ — $ 22,455
Reportable geographic segments: .S. U $ — $ 4,260 Europe — 18,195
$ — $ 22,455
(b) Intangible assets: Customer supply agreements were acquired as part of the 2003 acquisition of certain of the assets of Germany. Customer supply agreements were being amortized on a straight-line basis over a period of six years, which represented the exclusive term in which the Fund would manufacture, print, package and physically distribute DVDs and CDs for WHV and Warner Music Group in North America and Europe, and for New Line Home Entertainment Inc. in North America. The amortization period was extended by an additional year in the fourth quarter of 2007 due to a contract extension. Due to the termination of the WHV contract, effective July 31, 2010 (note 4(d)), intangible assets related to the WHV contracts were fully amortized by July 31, 2010.
Cinram 2010 Annual Report 73 NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
Customer supply agreements were also acquired as part of the acquisition of the assets of Ditan and Vision. Customer supply agreements are being amortized on a straight-line basis over a period of five to six years. As part of the acquisition of Vision, the Fund acquired the rights to the internally developed technology/software owned by Vision. This asset was being amortized on a straight-line basis over three years. Effect of Accumulated foreign Net book ’10 Cost amortization exchange Impairment value
Customer supply agreements (i) $ 416,100 $ 407,560 $ 2,971 $ — $ 11,511 Acquired technology 400 400 — — —
$ 416,500 $ 407,960 $ 2,971 $ — $ 11,511
Effect of Accumulated foreign Net book ’09 Cost amortization exchange Impairment value
Customer supply agreements (i) $ 416,100 $ 366,815 $ 3,851 $ (25,698) $ 27,438 Acquired technology 400 301 — — 99
$ 416,500 $ 367,116 $ 3,851 $ (25,698) $ 27,537
(i) An impairment loss of nil (2009 — $25,698) relating to customer supply agreements in the Pre-Recorded Multimedia Products segment was recorded. Amortization of intangible assets for the year ended December 31, 2010 amounted to $15,146 (2009 — $41,465).
6. ASSET RETIREMENT OBLIGATIONS:
The Fund records deferred asset retirement costs and an offsetting accrued liability for the estimated present value of the costs of retiring leasehold improvements at the maturity of the facility leases. The following table details the changes in the leasehold retirement liability:
December 31, 2008 $ 5,211 Additions 212 Retirement (1,193) Accretion charges during 2009 274 Foreign exchange 212
December 31, 2009 4,716 Additions 247 Retirement (60) Accretion charges during 2010 278 Foreign exchange (110)
December 31, 2010 $ 5,071
The accretion charges are recorded in cost of goods sold. The undiscounted amount of the obligations is $6,015 (2009 — $5,828) and is expected to be paid out in one to seven years. For the year ended December 31, 2010, the Fund recorded amortization expense of $391 (2009 — $441) in cost of goods sold.
74 Cinram 2010 Annual Report NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
7. LONG-TERM DEBT:
Amounts outstanding under the credit facilities are shown in the table below:
’10 ’09
Credit agreement: Term loan $ 366,739 $ 395,364 Unamortized transaction costs (812) (3,344)
365,927 392,020
Less current portion 131,525 28,624
$ 234,402 $ 363,396
On May 5, 2006, in connection with the conversion to an income trust, a five-year term senior secured credit facility (Credit Facility) of $825,000 was executed, maturing on May 6, 2011. The Credit Facility consisted of a $675,000 term loan, a $100,000 U.S. revolving credit facility and a $50,000 Canadian revolving credit facility that bore interest at LIBOR plus 175 basis points subject to, in the case of revolving credit borrowings, financial ratios. The term loan under the credit facility required principal repayments at the rate of 1% per annum, on a quarterly basis. In addition, the Fund may, at its option, prepay principal amounts outstanding without incurring penalties. The amounts outstanding under the facilities are secured by substantially all of the assets of the Fund. At December 31, 2010, the Fund has unamortized transaction costs relating to this loan of $377 (2009 — $1,552).
During 2007, the Fund amended certain provisions under the Credit Facility, primarily to provide for a buyback of a specified number of units with an aggregate acquisition cost of up to $100,000 and to increase flexibility under certain financial covenants. Concurrently, the associated interest rate on borrowings increased from LIBOR plus 175 basis points to LIBOR plus 200 basis points. At December 31, 2010, the Fund has unamortized transaction costs of $188 (2009 — $775) in connection with this amendment.
On March 30, 2009, the Fund amended certain provisions under the Credit Facility, primarily to permit the Fund to use cash on hand of up to $150,000 to repurchase term advances outstanding under the Credit Facility at prices below par through one or more “modified Dutch” auctions during a one-year period ending March 29, 2010 subject to total debt repurchases not exceeding 25% of total credit commitments. Concurrently, the Fund agreed to the following conditions:
(a) term loan repayment of $35,000 to be made on March 30, 2009 upon amendment effectiveness;
(b) increase in the quarterly term loan principal repayments to $10,000 commencing with the June 30, 2009 payment;
(c) suspension of all unit distributions and unit buybacks until the May 5, 2011, scheduled maturity of the Credit Facility; and,
(d) reduction in the revolving credit commitment by $50,000 to $100,000. The reduction was allocated ratably to both the U.S. and Canadian revolving credit facilities.
There were no amendments to the financial covenants nor changes to the interest rate spread on borrowings. At December 31, 2010, the Fund has unamortized transaction costs of $247 (2009 — $1,017) in connection with this amendment.
Cinram 2010 Annual Report 75 NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
During the year ended December 31, 2009, the Fund repurchased $169,660 of term advances through several “modified Dutch” auctions for cash proceeds of $131,220. The difference of $38,440 was recorded as a gain on repurchase of debt. On January 6, 2010, upon reaching the maximum 25% repurchase threshold, the Fund announced that it completed its debt repurchase program.
As of December 31, 2010, the revolving credit facilities were undrawn, except for issued letters of credit totalling approximately $14,100.
The terms of the Credit Facility require the Fund to comply with certain financial and other covenants over the term of the facility on a calendar quarterly basis. As at December 31, 2010 and 2009, the Fund was in compliance with all the terms of its Credit Facility.
The Credit Facility and related amendments have the following significant covenants:
(a) leverage not to exceed 3.00 x EBITA (defined as earnings before interest expense, foreign exchange translation gains/losses, investment income, gain on repurchase of debt, impairment charges, amortization, other charges and income taxes);
(b) minimum interest coverage ratio of 4.00:1.00;
(c) annual capital expenditures not to exceed $150,000;
(d) suspension of distributions and unit buyback until maturity of the Credit Facility;
(e) minimum liquidity condition consisting of: (i) cash on hand and revolver availability of $37,500 at all times, and (ii) cash on hand and revolver availability of $100,000 prior to offering to repurchase debt at an amount below par; and
(f) restricted payment covenants.
Under the terms of the Credit Facility, the Fund is obliged to make a mandatory offer to prepay the credit facilities from the following, subject to certain customary exceptions:
(a) 75% of net cash proceeds of non-ordinary course asset sales subject to certain reinvestment rights;
(b) 50% of net proceeds of debt issuances;
(c) 75% of certain insurance proceeds in excess of $5,000 subject to exceptions including replacement and repair of affected assets; and
(d) 50% of net proceeds of equity issuances.
The weighted average interest rate for the year ended December 31, 2010, was 7.7% (2009 — 6.1%).
Subsequent event: As the term on the Fund’s current Credit Facility expires on May 5, 2011, the Fund has reclassified $234,402 of its long-term debt from a current classification to a long-term classification at December 31, 2010, on the basis that it has obtained unanimous lender consent for a Refinancing and Recapitalization (note 23(b)) during the first quarter of 2011. At December 31, 2010, the Fund has $812 of unamortized transaction costs associated with its current Credit Facility, and $6,134 in unamortized transaction costs associated with the Refinancing and Recapitalization.
Pursuant to the Refinancing and Recapitalization, future estimated minimum repayments of long-term debt, net of debt repurchased are due in the fiscal years ending December 31, 2011, 2012 and 2013 in the amounts of $132,337, $18,505 and $215,897, respectively.
Based on current internal forecasts, the Fund anticipates remaining compliant with its debt covenants included in the Refinancing and Recapitalization for the term of this Credit Facility.
76 Cinram 2010 Annual Report NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
Derivative financial instruments: The Fund previously entered into a five-year, $400,000 swap agreement fixing the interest rate on the term loan at 5.55% plus 200 basis points, resulting in a rate of 7.55%. This hedge provided protection against interest rate volatility. On December 15, 2009, the Fund ceased hedge accounting and as a result, $14,636 (2009 — $3,840) has been recognized in other interest and financing charges (note 13(a)). The credit adjusted fair value of the interest rate swap liability as at December 31, 2010 was $11,087 (2009 — $25,225).
Transaction costs and loan fees:
Balance, December 31, 2008 $ 4,076 Increase in transaction fees 1,525 Amortization (2,466) Foreign exchange 209
Balance, December 31, 2009 3,344 Amortization (2,402) Foreign exchange (130)
Balance, December 31, 2010 $ 812
8. LEASE COMMITMENTS:
Future minimum rental commitments for all non-cancellable operating and capital leases as at December 31, 2010 are as follows:
Capital Operating Total 2011 $ 1,238 $ 40,143 $ 41,381 2012 639 29,323 29,962 2013 498 16,183 16,681 2014 — 10,382 10,382 2015 — 10,203 10,203 2016 and thereafter — 17,199 17,199
2,375 $ 123,433 $ 125,808 Less interest 148
2,227
Less current portion 1,141
$ 1,086
Operating lease expense for the year ended December 31, 2010 amounted to $48,312 (2009 — $53,990).
Cinram 2010 Annual Report 77 NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
9. UNITHOLDERS’ DEFICIENCY:
The Fund is authorized to issue an unlimited number of units.
(a) Employee Unit Purchase loans: During the year ended December 31, 2009, the Fund entered into two separate agreements to advance up to Cdn. $3,250 to named officers for the purpose of buying units of the Fund on the open market. During the year ended December 31, 2009, Cdn. $2,419 (U.S. $2,240) was advanced for the purchase of 1,268,400 units. For accounting purposes, the employee unit purchase loans are included as a reduction of unitholders’ equity. Interest is calculated at the rate prescribed for purposes of the Income Tax Act (Canada), which for 2010 was 1% (2009 — 1%). The balances outstanding are secured by the units purchased or any proceeds realized upon sale of the units. At December 31, 2010, the market value of the units held as collateral was Cdn. $1,712. The loans were originally repayable in four equal annual installments commencing in the second quarter of 2011 or earlier under certain specified conditions, however, during the fourth quarter of 2010, the repayment of the loans was extended to commence in the second quarter of 2012. Also, in the fourth quarter of 2010, Cdn. $1,860 (U.S. $1,860) has been placed into escrow to offset any potential personal tax liabilities of the named officers related to these loans. The funds in escrow are included in other long-term assets.
Interest of $24 for the year ended December 31, 2010 (2009 — $7) is recorded as a capital transaction which increases contributed surplus by the same amount.
Balance, December 31, 2008 $ — Issuance of unitholder loans 2,240 Interest 7 Foreign currency adjustment 68
Balance, December 31, 2009 2,315 Interest 24 Foreign currency adjustment 113
Balance, December 31, 2010 $ 2,452
(b) Long-Term Incentive Plan (LTIP): As of December 31, 2009, no participation units were outstanding. The Board terminated the LTIP effective April 12, 2010.
(c) Deferred Unit Plan: In 2006, the Fund implemented a deferred unit compensation plan (the Deferred Unit Plan) for the grant of deferred trust units (Deferred Units) to non-management Trustees of the Fund and non-management directors of Cinram.
Pursuant to the Deferred Unit Plan, non-management Trustees and non-management directors of Cinram are required to have all of their fees paid in Deferred Units. A number of Deferred Units will be allocated to the eligible participant in lieu of cash payment of remuneration based on the market value of the units at the time of the allocation.
Additional Deferred Units are granted to eligible participants holding Deferred Units based on cash distributions paid by the Fund on the units (and calculated using the market price of a unit on the date the distribution is paid).
The Deferred Unit Plan provides that once an eligible participant ceases to be a trustee of the Fund and/or a director, officer or employee of Cinram (and of their respective subsidiaries), they will be entitled to receive the number of units equal to the number of Deferred Units held at the time of retirement (net of any applicable withholding taxes).
The aggregate number of units that may be issued from treasury under the Deferred Unit Plan is limited to a floating maximum equal to 2% of the total number of units outstanding from time to time.
During the year ended December 31, 2010, the Fund recorded net compensation expense of $335 (2009 — $816), with an offsetting credit to contributed surplus when 304,326 (2009 — 268,846) Deferred Units were issued under the Deferred Unit Plan.
78 Cinram 2010 Annual Report NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
During the year ended December 31, 2010, 22,281 Deferred Units were redeemed for units of the Fund under the terms of the Plan for $40 (2009 — nil).
As at December 31, 2010, there are 670,783 (2009 — 388,738) deferred units outstanding.
10. BASIC AND DILUTED EARNINGS (LOSS) PER UNIT/LIMITED PARTNERSHIP UNIT:
Basic and diluted earnings (loss) per unit have been calculated using the weighted average and maximum dilutive number of units outstanding during the year.
The following table sets forth the computation of basic and diluted earnings (loss) per unit/limited partnership unit:
’10 ’09
Numerator: Earnings (loss) from continuing operations $ 18,440 $ (5,995) Loss from discontinued operations (5,134) (16,033)
Net earnings (loss) $ 13,306 $ (22,028)
Denominator (in thousands): Weighted average units outstanding — basic 54,000 54,785 Effect of dilutive securities: Weighted average Deferred Units 488 — Weighted average units associated with outstanding unit purchase loans 1,268 —
Weighted average units outstanding — diluted 55,756 54,785
Earnings (loss) per unit from continuing operations: Basic $ 0.34 $ (0.11) Diluted 0.33 (0.11)
Loss per unit from discontinued operations: Basic $ (0.10) $ (0.29) Diluted (0.09) (0.29)
Earnings (loss) per unit: Basic $ 0.25 $ (0.40) Diluted 0.24 (0.40)
During the year ended December 31, 2009, there were 807,682 weighted average outstanding deferred units and units associated with outstanding employee unit purchase loans excluded from the computation of diluted loss per unit as they were anti-dilutive.
Cinram 2010 Annual Report 79 NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
11. ACCUMULATED OTHER COMPREHENSIVE EARNINGS: ’10 ’09
Foreign currency translation adjustment account: Balance, beginning of year $ 115,403 $ 123,670 Change in foreign currency translation account (11,472) (8,267) Partial release of foreign currency account to net earnings (notes 13 and 22(a)) 3,759 —
Balance, end of year 107,690 115,403
Unrealized net loss of cash flow hedges: Balance, beginning of year (19,648) (24,555) Net unrealized gain on derivatives designed as cash flow hedges — 1,067 Release of other comprehensive income due to de-designated hedge (note 13(a)) 14,636 3,840
Balance, end of year (5,012) (19,648)
Accumulated other comprehensive earnings $ 102,678 $ 95,755
The net tax effect on the items in accumulated other comprehensive earnings is nil (2009 — nil) because the net future income tax asset was reduced by a valuation allowance.
It is estimated that, during 2011, $5,012 will be released from accumulated other comprehensive income to earnings related to the settlement of the interest rate swap.
12. OTHER CHARGES, NET:
’10 ’09
Facility restructuring (a) $ 25,004 $ 4,229 Gain on sale of property, plant and equipment (b) (7,460) (1,746)
$ 17,544 $ 2,483
(a) Facility restructuring charges: Severance Facility exit Other costs costs costs Total
December 31, 2008 accrued balances $ 4,132 $ — $ 379 $ 4,511 Add expenditures 2,991 1,238 — 4,229 Deduct payments (4,686) (807) — (5,493)
December 31, 2009 accrued balances 2,437 431 379 3,247 Add expenditures 17,275 6,006 1,723 25,004 Deduct payments (9,149) (1,275) (1,734) (12,158)
December 31, 2010 accrued balances $ 10,563 $ 5,162 $ 368 $ 16,093
In 2010, the Fund conducted a rationalization of several of its facilities, primarily as a result of the termination of the WHV service contract effective July 31, 2010 (note 4(d)), and net costs of $25,004 related to severance, facility exit and other costs were recorded as other charges. For North American operations, a restructuring charge of $14,656 was recorded, which was comprised of $8,254, $6,006 and $396 for severance, facility exit and other costs, respectively. For European operations, a restructuring charge was recorded of $10,348, which was comprised of $9,021 and $1,327 for severance, and other costs, respectively.
80 Cinram 2010 Annual Report NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
In 2009, the Fund recorded restructuring charges of $4,229 related to severance, facility exit and other costs and these were recorded as other charges. For North American operations, there were $3,713 of facility restructuring charges, which related primarily to severance costs, as well as facility exit costs. For European operations, there were $516 of facility restructuring charges, which was composed entirely of severance costs.
The Fund had $15,377 (2009 — $3,247) in accrued liabilities and $716 (2009 — nil) in other long-term liabilities, respectively, as at December 31, 2010 associated with facility restructuring charges. It is anticipated that the majority of accrued facility restructuring liabilities will be paid in 2011.
(b) Gain on sale of property, plant and equipment: In January 2010, the Fund completed the sale of its owned distribution centre in Simi Valley, California for cash proceeds of $14,000 less transaction costs, resulting in a gain of $7,460 which was recorded to other charges.
In January 2009, the Fund completed a sale-leaseback transaction of its facility in Aurora, Illinois for net cash proceeds of $22,957. An immediate gain of $1,746 was recorded to other charges on the transaction. A further gain of $9,548 has been deferred and will be amortized over the minimum lease term of five years. For the year ended December 31, 2010, $1,909 (2009 — $1,751) of the deferred gain has been amortized with the credit recorded to cost of goods sold.
13. OTHER INTEREST AND FINANCING CHARGES, NET:
’10 ’09
Release of other comprehensive income due to de-designation of hedge (a) $ 14,636 $ 3,840 Mark-to-market adjustment of derivative liability (b) (14,138) (419) Partial release of cumulative translation adjustment (548) — Capital lease interest 1 19 359 Hedge ineffectiveness of U.S. dollar-denominated debt — 124 Other (447) 2,197
$ (306) $ 6,101
(a) On December 15, 2009, the Fund ceased to account for the interest rate swap as a hedge, as a result of the significant repurchases and repayments of debt during 2009 and the anticipated repayments until maturity. As a result of the discontinuation of hedge accounting, a release of accumulated other comprehensive income of $14,636 (2009 — $3,840) was recorded. The balance of accumulated other comprehensive income at December 31, 2010 of $5,012 will be amortized on a straight-line basis to interest expense from January 1, 2011 to the maturity of the related debt in May 2011.
(b) As a result of ceasing to account for the interest rate swap as an effective hedge on December 15, 2009, the Fund is required to record the derivative liability at its fair value through the consolidated statements of earnings at each reporting period. Therefore, a mark-to- market gain of $14,138 (2009 — $419) was recorded in 2010.
Cinram 2010 Annual Report 81 NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
14. INCOME TAXES:
Income tax expense (recovery) varies from the amounts that would be computed by applying the statutory income tax rate to earnings (loss) from continuing operations before income taxes as follows:
’10 ’09
Basic rate applied to pre-tax earnings (loss) $ 4,631 31.0% $ (6,162) 33.0% Increase (decrease) in taxes resulting from: Changes in valuation allowance (13,791) (92.3)% 7,099 (38.0)% Tax rates in other jurisdictions 3,949 26.4% (41,220) 220.7% Change in Canadian tax rate 24 0.2% 5,604 (30.0)% Other items (5,795) (38.8)% 12,552 (67.2)% Permanent differences due to cumulative translation adjustments 7,482 50.1% 9,450 (50.6)%
$ (3,500) (23.4)% $ (12,677) 67.9%
The tax effect of temporary differences that give rise to significant portions of the future tax assets and future tax liabilities at December 31, 2010 and 2009 are presented below:
’10 ’09
Future tax assets: Non-capital income tax loss carryforwards $ 82,928 $ 87,943 Capital loss carryforward 10,579 — Deferred interest deductions 24,286 24,286 Accruals not deductible in the current year 15,383 17,973 Property, plant and equipment — difference in net book value and undepreciated capital costs 12,377 11,921 Goodwill and intangible assets 130,338 141,910 Other — 4,026
275,891 288,059 Less valuation allowance (250,091) (266,968)
25,800 21,091 Future tax liabilities: Property, plant and equipment — difference in net book value and undepreciated capital costs (5,964) — Goodwill and intangible assets (3,698) (3,352) Deferred gain on debt repurchase (12,474) (12,642) Other (4,893) (5,728)
(27,029) (21,722)
Net future tax liabilities $ (1,229) $ (631)
Reconciliation of future income taxes: Current future income tax assets $ — $ 6,007 Long-term future income tax liabilities (1,229) (6,638)
Net future tax liabilities $ (1,229) $ (631)
82 Cinram 2010 Annual Report NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
In assessing the realizability of future income tax assets, management considers whether it is more likely than not that some portion or all of the future income tax assets will be realized. The ultimate realization of future income tax assets is dependent upon the generation of future taxable income during the years in which the temporary differences are deductible. Management considers the scheduled reversals of future income tax liabilities, the character of the income tax assets and the tax planning strategies in place in making this assessment. To the extent that management believes that the realization of future income tax assets does not meet the more likely than not realization criterion, a valuation allowance is recorded against the future tax assets.
The Fund believes that it has adequately provided for income taxes based on all of the information that is currently available. The calculation of income taxes in many cases, however, requires significant judgment in interpreting tax rules and regulations. The Fund’s tax filings are subject to audits which could materially change the amount of current and future income tax assets and liabilities, and could, in certain circumstances, result in the assessment of interest and penalties.
At December 31, 2010, the Fund has non-capital loss carryforwards of $75,601 in Europe. A valuation allowance has been established in relation to these losses as it is not more likely than not that the Fund will be able to utilize these losses in the future.
The non-capital losses in Europe expiring in the years ending December 31 are as follows:
2013 $ 1,906 2014 2,770 2015 2,521 2016 475 2017 and thereafter 67,929
$ 75,601
At December 31, 2010, the Fund has non-capital loss carryforwards of $75,841 in the U.S., which will expire in 2028. A valuation allowance has been established in relation to these losses as it is not more likely than not that the Fund will be able to utilize these losses in the future.
The Fund has non-capital loss carryforwards in Canada of $99,015, of which $19,537 will expire in 2015 and $79,478 will expire in and after 2026. A valuation allowance has been recorded in respect of these losses as it is not more likely than not that the Fund will be able to utilize these losses in the future.
At December 31, 2010, the Fund has net capital loss carryforwards of $84,637 in Canada. A valuation allowance has been established in relation to these losses as it is not more likely than not that the Fund will be able to utilize these losses in the future.
15. CONTINGENT LIABILITIES AND GUARANTEES:
In the normal course of operations, the Fund becomes involved in various legal actions and other claims mostly related to labour issues, potential royalty obligations and contractual disputes. While the final outcome with respect to actions outstanding or pending as at December 31, 2010 cannot be predicted with certainty, it is management’s opinion that their resolution will not have a material adverse effect on the Fund’s financial position, results of operations or cash flows.
Royalty charges are incurred as a result of the use of third party replication technologies. The royalty charge is recorded as cost of goods sold at the time of shipment. The royalty rates are specified on a per unit basis and based on contractual terms and conditions or management’s best estimates in situations where formal license agreements are not in place. These estimates are reviewed periodically and, as adjustments become necessary, they are made in the period in which they become known. A significant change in the royalty rates used could have a material impact on cost of goods sold, the provision for royalties and net earnings (loss).
In the normal course of business, the Fund has entered into agreements that contain features that meet the definition of a guarantee under GAAP. These include business sale and business combination agreements, sales of products and services, purchases and development of property, plant and equipment, and indemnifications.
Cinram 2010 Annual Report 83 NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
The Fund is unable to make a reasonable estimate of the maximum potential amount it would be required to pay counterparties. The amount also depends on the outcome of future events and conditions, which cannot be predicted. No amount has been accrued in the consolidated balance sheets relating to these types of indemnifications or guarantees at December 31, 2010 or 2009. Historically, the Fund has not made any significant payments under these indemnifications or guarantees.
16. RELATED PARTY TRANSACTIONS:
The Fund entered into the following related party transactions:
In 2010, a total of $613 (2009 — $1,065) was paid to a law firm in which the Senior Vice President and General Counsel of the Fund was a former partner. The Senior Vice President and General Counsel of the Fund remained a partner in this law firm until January 31, 2008 and is currently of counsel to the firm. The Fund has been advised that the Senior Vice President and General Counsel received no credit or compensation with respect to the amounts paid by the Fund to the firm since the Senior Vice President and General Counsel’s commencement date.
In 2010, as a result of the relocation of the Chief Executive Officer (CEO) pursuant to his employment agreement, during the second quarter of 2010, the Fund agreed to purchase his principal residence for $1,325, representing estimated fair market value at the time of purchase. This transaction was reviewed and approved by the Board of Trustees, without the participation of the CEO.
These transactions were recorded at the exchange amount, being the amount agreed to by the related parties.
17. PENSION AND NON-PENSION EMPLOYMENT BENEFIT PLANS:
(A) Defined benefit plans:
U.S.:
Cinram Music Union Pension Plan:
Certain union employees of the Fund participate in the Cinram Music Union Pension Plan (Music Union Plan). Pension benefits under the Music Union Plan are based on formulas that reflect the employee’s years of service multiplied by a specified dollar amount negotiated in collective bargaining.
The Fund’s Music Union Plan pension expense amounted to $69 for the year ended December 31, 2010 (2009 — $207).
(a) Investment strategy and policy: The Fund has adopted a balanced growth objective, which balances risk and return. Under this investment strategy, the Fund’s long- term allocation for equity and debt securities is 65% and 35%, respectively.
84 Cinram 2010 Annual Report NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(b) Asset allocation: Pension fund assets consist of fixed income and equity mutual funds, valued at market value. The percentages of the fair value of total plan assets by each major type of plan asset as of the December 31 measurement date are as follows:
Percentage of plan assets Asset category ’10 ’09
Debt securities 41.0% 43.6% Equity securities 59.0% 56.4%
100.0% 100.0%
Equity securities do not include any of the Fund’s units as at December 31, 2010 and 2009, respectively.
Long-term historical returns for indexed equity and debt securities are used as the basis to determine the overall expected long-term rate of return on assets assumption for the mutual fund investments held in the Music Union Plan. The weighted average historical return on equity and debt securities is 8%.
Cash contributions of $121 are expected to be made in fiscal 2011.
(c) Estimated future benefit payments: The benefits expected to be paid in each year from 2011 to 2015 are $60, $76, $81, $87 and $90, respectively. The aggregate benefits expected to be paid in the five years from 2016 to 2020 are $946. The expected benefits to be paid are based on the same assumptions used to measure the Fund’s benefit obligation at December 31, 2010 and include estimated future employee service.
The most recent actuarial valuation was completed as at December 31, 2010 and the next valuation will be completed before the end of 2011.
Germany:
Cinram GmbH, Alsdorf defined benefit plan:
The Fund’s defined benefit pension plan covers certain existing and former employees who have signed specific agreements related to pension benefits, including members of senior and middle management. The pension contributions are based on German tax law requirements and, therefore, the plan remains unfunded.
(a) Estimated future benefit payments: The benefits expected to be paid in each year from 2011 to 2015 are $1,110, $1,090, $1,069, $1,105 and $1,099, respectively. The aggregate benefits expected to be paid in the five years from 2016 to 2020 are $5,401.
The most recent actuarial valuation was completed as at December 31, 2010 and the next valuation will be completed before the end of 2011.
Cinram 2010 Annual Report 85 NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
Funded status:
A reconciliation of the funded status of the defined benefit plans to the amounts recorded in the consolidated financial statements follows:
U.S. Germany Total ’10 ’09 ’10 ’09 ’10 ’09
Plan assets, at fair value $ 3,550 $ 3,143 $ — $ — $ 3,550 $ 3,143 Accrued benefit obligations (4,229) (3,774) (18,019) (19,049) (22,248) (22,823)
Deficiency of plan assets over benefit obligation (679) (631) (18,019) (19,049) (18,698) (19,680) Unamortized past service cost 76 88 9 65 543 735 631 Unamortized actuarial loss (gain) 1,500 1,354 (170) (254) 1,330 1,100
Accrued benefit asset (liability) $ 897 $ 811 $ (17,530) $ (18,760) $ (16,633) $ (17,949)
The assets and liabilities are included in the Fund’s consolidated balance sheets as follows: U.S. Germany Total ’10 ’09 ’10 ’09 ’10 ’09
Prepaid expenses $ 897 $ 811 $ — $ — $ 897 $ 811 Accrued liability — — (1,128) (1,231) (1,128) (1,231) Other long-term liabilities — — (16,402) (17,529) (16,402) (17,529)
The following information is provided on pension fund assets: U.S. Germany Total ’10 ’09 ’10 ’09 ’10 ’09
Fair value of plan assets, beginning of year $ 3,143 $ 82 $ — $ — $ 3,143 $ 82 Actual return on plan assets 302 644 — — 302 644 Employer contributions 156 2,508 — — 6 15 2,508 Actual benefits paid (51) (91) — — (51) (91)
Fair value of plan assets, end of year $ 3,550 $ 3,143 $ — $ — $ 3,550 $ 3,143
86 Cinram 2010 Annual Report NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
Benefit obligations are outlined below:
U.S. Germany Total ’10 ’09 ’10 ’09 ’10 ’09
Benefit obligations, beginning of year $ 3,774 $ 3,887 $ 19,049 $ 17,397 $ 22,823 $ 21,284 Current service cost — — 261 261 261 261 Interest cost 226 232 868 989 1,094 1,221 Actual benefits paid (51) (91) (1,125) (1,200) (1,176) (1,291) Actuarial loss (gain) 280 (254) 66 1,134 346 880 Impact of foreign exchange — — (1,100) 468 (1,100) 468
Benefit obligations, end of year $ 4,229 $ 3,774 $ 18,019 $ 19,049 $ 22,248 $ 22,823
Elements of defined benefit costs recognized in the year:
U.S. Germany Total ’10 ’09 ’10 ’09 ’10 ’09
Components of net periodic benefit cost: Current service cost $ — $ — $ 261 $ 261 $ 261 $ 261 Interest cost 226 232 868 989 1,094 1,221 Actual return on plan assets (302) (644) — — (302) (644) Actuarial loss (gain) 280 (254) 66 1,134 6 34 880 Amortization of past service costs — — 113 71 113 71
Costs 204 (666) 1,308 2,455 1,512 1,789
Adjustments to recognize the long-term nature of employee future benefit costs: Difference between expected return and actual return on plan assets for the year 46 448 — — 46 448 Difference between actuarial loss (gain) recognized for the year and actual actuarial loss (gain) on accrued benefit obligation for the year (193) 413 (66) (1,134) (259) (721) Amortization of past service cost 12 12 — — 12 12
Defined benefit costs recognized $9 6 $ 207 $ 1,242 $ 1,321 $ 1,311 $ 1,528
Cinram 2010 Annual Report 87 NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
Actuarial assumptions for the years ended December 31:
U.S. Germany ’10 ’09 ’10 ’09
Weighted average actuarial assumptions used to determine benefit costs: Discount rate 6.04% 5.95% 4.90% 5.00% Rate of compensation increase — — 3.00% 3.00% Expected return on plan assets 8.00% 8.00% — — Weighted average actuarial assumptions used to determine benefit obligation: Discount rate 5.57% 6.04% 4.90% 5.00%
(B) Multi-employer plans:
U.S.:
Responsibility for the multi-employer plans was transferred as part of the sale of the assets and liabilities of Ivy Hill in 2009 (note 22(b)).
(i) Graphic Communication Industry Union (GCIU) Pension:
The GCIU Retirement Fund was a multi-employer plan covering direct labour employees in certain printing facilities of a previously owned subsidiary of the Fund. In 2008, the Fund incurred a withdrawal liability of $1,400 due to the closure of the Ivy Hill Vernon facility. A balance of $1,336 is recorded in accrued liabilities at December 31, 2010.
The Fund’s GCIU pension expense, included in loss from discontinued operations, amounted to nil for the year ended December 31, 2010 (2009 — $316).
(ii) PACE U.S. Pension:
The PACE (Paper, Allied-Industrial, Chemical and Energy Workers International Union) U.S. Pension (PACE plan) was a multi-employer plan covering a portion of the direct labour in one of the Fund’s previously owned printing plant facilities.
The Fund’s PACE pension expense, included in loss from discontinued operations, amounted to nil for the year ended December 31, 2010 (2009 — $105).
(C) Defined contribution and other plans:
Canada:
Registered Savings Plan (RSP):
Certain employees participate in the defined pre-tax contribution plan (the RSP). The Fund’s contributions under the RSP are based upon a percentage of the employee’s elected contributions. In 2009, the Fund suspended the RSP matching benefit, which was effective for the year ended December 31, 2010. The Fund’s RSP expense amounted to nil for the year ended December 31, 2010 (2009 — $205).
88 Cinram 2010 Annual Report NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
U.S.:
401(k) Plan:
Certain non-union employees participate in a defined pre-tax contribution plan (the 401(k) Plan). The Fund’s contributions under the 401(k) Plan are based upon a percentage of the employee’s elected contributions. In 2009, the Fund suspended the 401(k) matching benefit, which was effective for the year ended December 31, 2010. The Fund’s 401(k) Plan expense amounted to nil for the year ended December 31, 2010 (2009 — $260).
United Kingdom:
Defined contribution plans:
Certain employees participate in several defined pre-tax contribution plans through the Fund’s facilities in the United Kingdom. The Fund’s contributions are based on a percentage of the employee’s elected contributions. The Fund’s expense amounted to $1,076 for the year ended December 31, 2010 (2009 — $1,082).
Germany:
(i) Early retirement plan:
The Fund has an early retirement agreement with its employee works council as part of a labour contract, whereby eligible employees are able to receive certain benefits during a period of reduced work prior to attaining standard retirement age and German state pension benefits. A liability of approximately $3,200 has been recorded as at December 31, 2010 (2009 — $3,543).
The Fund’s early retirement pension expense amounted to $915 for the year ended December 31, 2010 (2009 — $686).
The most recent actuarial valuation was completed as at December 31, 2010, and the next valuation will be completed before the end of 2011.
(ii) Jubilee plan:
The Fund also has an agreement with its employee works council as part of a labour contract, whereby employees receive years of service awards upon reaching their 10 and 25 year service anniversaries. Employment and income taxes associated with this award are paid by the Fund and a total liability of approximately $394 has been recorded as at December 31, 2010 (2009 — $421).
The Fund’s Jubilee pension expense amounted to $25 for the year ended December 31, 2010 (2009 — $70).
The Fund’s most recent actuarial valuation was completed as at December 31, 2010, and the next valuation will be completed before the end of 2011.
France:
Retirement benefit plan:
The Fund has a retirement benefit plan, whereby eligible employees are able to receive a certain lump sum benefit if they attain the statutory retirement age while still employed by the Fund. A liability of approximately $1,319 has been recorded as at December 31, 2010 (2009 — $1,400).
The Fund’s retirement benefit expense amounted to $22 for the year ended December 31, 2010 (2009 — $66).
The most recent valuation was completed as at November 30, 2010, and the next valuation will be completed before the end of 2011.
Cinram 2010 Annual Report 89 NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
18. CHANGE IN NON-CASH OPERATING WORKING CAPITAL:
’10 ’09
Decrease in accounts receivable $ 95,271 $ 221,408 Decrease (increase) in income taxes receivable 4,350 (865) Decrease in inventories 7,910 16,692 Decrease in prepaid expenses 4,034 6,076 Decrease in accounts payable and accrued liabilities (99,243) (118,292) Increase (decrease) in income taxes payable (6,536) 8,617
$ 5,786 $ 133,636
19. SEGMENTED INFORMATION:
The Fund’s reportable business segments are Pre-Recorded Multimedia Products, Video Games and Other.
Due to several factors, including the termination of the WHV service contract effective July 31, 2010 (note 12(a)), the Fund revisited its business and operations in the fourth quarter of 2010. As a result, the Fund reorganized internally to consolidate its sales, manufacturing and distribution functions. As part of the internal reorganization, reporting for the Home Video and CD business lines were combined, on the basis that the sales, manufacturing and distribution requirements for both of these segments possess similar management, operational and cost structures. Accordingly, in the fourth quarter of 2010, the Fund has concluded it is appropriate to disclose its Home Video and CD segments as Pre-Recorded Multimedia Products in accordance with CICA Section 1701, Segment Disclosures. The Fund has restated its presentation of its operating segments for each of the years ended December 31, 2010 and December 31, 2009.
The Pre-Recorded Multimedia Products segment manufactures and distributes DVDs, Blu-ray discs and CDs. The Video Games segment includes results from Ditan. The Other segment includes the wireless division, vendor-managed inventory services provided by Vision, as well as other non-core activities.
The accounting policies of the segments are the same as those described in the significant accounting policies. The Fund evaluates segment performance based on EBITA.
(a) Industry segments: Pre-Recorded Multimedia Video ’10 Products Games Other Total
Revenue from external customers $ 995,539 $ 59,049 $ 54,202 $ 1,108,790 EBITA 112,699 8,989 11,714 133,402 Goodwill — 40,634 — 40,634 Total assets 509,957 68,537 60,322 638,816 Amortization of property, plant and equipment 49,265 2,481 2,987 54,733 Amortization of intangible assets 9,921 4,369 856 15,146 Capital expenditures 12,832 100 1,769 14,701
90 Cinram 2010 Annual Report NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
Pre-Recorded Multimedia Video ’09 Products Games Other Total
Revenue from external customers $ 1,289,137 $ 91,608 $ 72,286 $ 1,453,031 EBITA 159,731 10,104 13,953 183,788 Goodwill — 40,634 — 40,634 Total assets 646,917 84,524 53,259 784,700 Amortization of property, plant and equipment 75,963 5,462 5,216 86,641 Amortization of intangible assets 36,304 4,369 792 41,465 Capital expenditures 40,732 215 1,232 42,179
(b) Geographic segments:
’10 U.S. Canada Europe Other Total
Revenue from external customers $ 557,184 $ 88,515 $ 463,091 $ — $ 1,108,790 Property, plant and equipment, goodwill and intangible assets 143,059 8,538 82,397 — 233,994
’09 U.S. Canada Europe Other Total
Revenue from external customers $ 728,813 $ 96,902 $ 627,316 $ — $ 1,453,031 Property, plant and equipment, goodwill and intangible assets 176,500 8,468 117,856 31 302,855
(c) Customer concentration: I n 2010, the Fund was dependent on three customers that accounted for approximately 28%, 21% and 14%, respectively, of consolidated revenue. At December 31, 2010, these customers represented approximately 31%, 4% and 11%, respectively, of consolidated accounts receivable. In 2009, the Fund was dependent on three customers that accounted for approximately 32%, 23% and 11%, respectively, of consolidated revenue. At December 31, 2009, these customers represented approximately 23%, 25% and 10%, respectively, of consolidated accounts receivable.
On January 29, 2010, WHV exercised its option to terminate various replication, distribution and print service agreements effective July 31, 2010.
20. FINANCIAL RISK MANAGEMENT AND FINANCIAL INSTRUMENTS:
(a) Overview: The Fund is exposed to credit risk, liquidity risk and market risk. The Fund’s primary risk management objective is to protect earnings, cash flows and unitholder value. Risk management strategies, as discussed below, are designed and implemented to ensure that the Fund’s risks and the related exposures are consistent with its business objectives and risk tolerance.
T he Board of Trustees has primary accountability for the establishment and oversight of the Fund’s financial risk management framework, and the Trustees delegate senior management with the responsibility for appropriate execution of related strategies. Within the Fund’s risk management framework and debt covenant requirements, senior management evaluates a variety of alternatives and financial products to augment the risk management process. The Board of Trustees reviews and approves all material transactions.
Cinram 2010 Annual Report 91 NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
The Fund’s risk management and treasury policies are intended to: establish acceptable risk boundaries and observe covenants; analyze and identify the risks and opportunities encountered by the Fund; monitor and manage the risk exposures due to market changes; and, maintain adherence to controls. These policies are reviewed periodically and adjusted accordingly based on the Fund’s activities and market conditions. Senior management’s risk and covenant compliance is monitored by the Fund’s Audit Committee which, with the assistance of the internal audit department, oversees the appropriateness and adequacy of the risk management framework as it relates to the risks faced by the Fund.
(b) Credit risk: Credit risk is a risk of financial loss arising from an unfulfilled contractual obligation due to the Fund by a customer or counterparty to a financial instrument. The carrying amount of financial assets represents the maximum credit exposure.
(i) Accounts receivable:
The Fund’s exposure to credit risk is subject to the concentration of its key customers. The Fund’s three largest receivable balances due from its customers represent 53% of consolidated accounts receivable at December 31, 2010. For 2009, the three largest customers represented 58% of consolidated accounts receivable. These customers have been transacting with the Fund for many years without any significant occurrence of losses to the Fund. The Fund believes that the credit risk is limited due to the financial stability of its larger customers and the long-standing relationships the Fund has with these customers.
The maximum exposure to credit risk for accounts receivable from the three largest customers are as follows:
’10 ’09
Customer A $ 54,281 $ 69,482 Customer B 20,201 63,588 Customer C 19,765 27,178
The maximum exposure to credit risk for accounts receivable by geographic region are as follows:
’10 ’09
Canada $ 13,519 $ 22,363 U.S. 82,293 97,695 Europe 82,254 149,521 Other — 3,664
The Fund does not require collateral in respect of accounts receivable given the long-term relationship with these customers.
The Fund records an allowance for doubtful accounts related to accounts receivable that are considered to be non-collectible. The allowance is based on the Fund’s knowledge of the financial condition of its customers, the aging of the receivables, current business environment, customer and industry concentrations, and historical experience.
The Fund has established various internal controls, such as credit checks, designed to mitigate credit risk and has also established procedures to suspend services when customers have fully utilized credit limits or have violated established payment terms.
While management believes that the Fund’s credit controls and processes have been effective in mitigating credit risk, these controls cannot eliminate credit risk and there can be no assurance that these controls will continue to be effective or that the Fund’s current credit loss experience will continue.
92 Cinram 2010 Annual Report NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
Total accounts receivable as at December 31, 2010 amounted to $178,066 (2009 — $273,243), net of an allowance for doubtful accounts totalling $3,270 (2009 — $4,149), which management believes adequately reflects the Fund’s credit risk. Of the reported accounts receivable, 12.6% (2009 — 11.0%) is determined to be past due, which is defined as amounts outstanding beyond normal credit terms and conditions for the respective customers.
The aging of the trade receivable balance as at December 31, 2010 was as follows:
Allowance Accounts for doubtful receivable accounts
Current $ 155,601 $ — Past due 0 — 30 days 17,791 — Past due 30 — 60 days 1,872 — Past due 60 — 90 days 1,399 — Past due 90 — 120 days 848 — Past due 120 — 180 days 562 (7) Past due over 180 days 3,263 (3,263)
181,336 $ (3,270)
Less allowance for doubtful accounts 3,270
$ 178,066
The aging of trade receivable balance as at December 31, 2009 was as follows: Allowance Accounts for doubtful receivable accounts
Current $ 243,073 $ — Past due 0 — 30 days 24,083 — Past due 30 — 60 days 4,087 — Past due 60 — 90 days 2,377 (377) Past due 90 — 120 days 1,208 (1,208) Past due 120 — 180 days — — Past due over 180 days 2,564 (2,564)
277,392 $ (4,149)
Less allowance for doubtful accounts 4,149
$ 273,243
The change in the allowance for doubtful accounts receivable during the year ended December 31, 2010 was a decrease of $879 (2009 — $3,190).
(ii) Derivatives:
The Fund limits its exposure to credit risk related to derivatives by transacting with counterparties that are stable and of high credit quality.
Cinram 2010 Annual Report 93 NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(c) Liquidity risk: Liquidity risk is the risk that the Fund will be unable to meet its financial obligations as they come due. The Fund manages its liquidity risk by managing its capital structure, as outlined in note 21 below, including forecasting cash flows and closely monitoring covenant levels and compliance. These are complemented with regular reviews of operations, business conditions and seasonality to ensure that adequate future liquidity needs are met with a level of certainty, and within acceptable risk exposure.
The Fund’s objective is to ensure that it has sufficient available cash on hand to meet normalized operating expenses. In addition, the Fund maintains revolving lines of credit of $100,000 (2009 — $100,000) that provide additional flexibility and liquidity during the Fund’s seasonal periods. At December 31, 2010, no amounts had been drawn on these revolving credit facilities, except for letters of credit issued for a total of $14,100.
The following are the contractual maturities of financial liabilities, including interest payments as at December 31, 2010:
Carrying Contractual amount cash flows <1 year 1 — 2 years 2 — 5 years
Non-derivative financial liabilities: Accounts payable and accrued liabilities $ 211,537 $ (211,537) $ (211,537) $ — $ — Obligations under capital leases 2,227 (2,375) (1,238) (639) (498) Long-term debt (note 7) 366,739 (366,739) (132,337) (18,505) (215,897) Interest on long-term debt 696 (73,184) (30,497) (22,470) (20,217) Derivative financial liabilities: Derivative instruments and related accrued interest of $3,335 (net) 11,087 (15,812) (15,812) — —
$ 592,286 $ (669,647) $ (391,421) $ (41,614) $ (236,612)
The following are the contractual payments as at December 31, 2009:
Carrying Contractual amount cash flows <1 year 1 — 2 years 2 — 5 years
Non-derivative financial liabilities: Accounts payable and accrued liabilities $ 317,138 $ (317,138) $ (317,138) $ — $ — Obligations under capital leases 4,065 (4,424) (1,930) (1,274) (1,220) Long-term debt 395,364 (395,364) (28,624) (366,740) — Interest on long-term debt 1,775 (16,310) (9,982) (6,328) — Derivative financial liabilities: Derivative instruments and related accrued interest of $3,369 (net) 25,225 (32,102) (20,510) (11,592) —
$ 743,567 $ (765,338) $ (378,184) $ (385,934) $ (1,220)
Other long-term liabilities, as reported on the December 31, 2010 and 2009 balance sheets, mainly consist of pension liabilities and are, therefore, excluded.
94 Cinram 2010 Annual Report NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(d) Market risk: Market risk is the risk that the fair value of future cash flows of a financial instrument will fluctuate due to changes in market prices, such as foreign exchange rates and interest rates, and it will affect the Fund’s income or the value of its holdings in financial instruments. The Fund’s primary objective when committing to any financial instrument is to manage and control market risk within stipulated constraints. Derivative financial instruments are utilized to reduce the interest rate risk on the Fund’s debt. The Fund does not enter into financial instruments for trading or speculative purposes.
(i) Currency risk:
The functional currency of the Fund is the Canadian dollar. The Fund’s operations in the U.S., the United Kingdom, France, Germany and Spain are considered to be self-sustaining. The Fund’s operations in foreign markets expose it to the risk of foreign currency fluctuations. Potential exposure relates to currency risk on sales, purchases and term loans that are denominated in a currency other than the respective functional currency of the Fund’s foreign and domestic operations. Currencies in which the Fund’s foreign operations mainly transact include the Canadian dollar, U.S. dollar, Euro and British pound.
Since the Fund’s operations predominantly transact their sales and purchases in their respective domestic currencies, the exposure is reduced and, therefore, the Fund typically does not hedge accounts receivable and accounts payable that may be denominated in a foreign currency.
(ii) Exposure to currency risk:
The following is the Fund’s exposure to foreign currency risk:
Currency of exposure (in U.S. dollars) U.S. British ’10 dollar Euro pound
Cash and cash equivalents 14,072 981 392 Accounts receivable 759 310 9,553 Accounts payable and accrued liabilities 12,160 837 339 Long-term debt 129,644 — —
Gross balance sheet exposure, excluding financial derivatives 156,635 2,128 10,284 Derivative instruments and related accrued interest of $3,335 15,793 — —
Net exposure 172,428 2,128 10,284
Currency of exposure (in U.S. dollars) U.S. British ’09 dollar Euro pound
Cash and cash equivalents 3,876 6,492 31,589 Accounts receivable 6,768 309 11,822 Accounts payable and accrued liabilities 30,044 5,041 2,039 Long-term debt 141,051 — —
Gross balance sheet exposure, excluding financial derivatives 181,739 11,842 45,450 Derivative instruments and related accrued interest of $3,369 31,923 — —
Net exposure 213,662 11,842 45,450
Cinram 2010 Annual Report 95 NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(iii) Sensitivity analysis:
A 10% increase in the U.S. currency would decrease the net earnings for 2010, increase the loss and increase other comprehensive loss for 2009. Alternatively, a 10% increase in the Euro would increase the net earnings for 2010 and decrease the loss for 2009. A 10% increase in the British pound would increase the net earnings for 2010 and decrease the loss for 2009.
Decrease in other Increase comprehensive (decrease) in ’10 income net earnings
U.S. dollar $ — $ (12,671) Euro — 51 British pound — 1,067
Decrease in other Increase comprehensive (decrease) in ’09 income net earnings
U.S. dollar $ (18,879) $ (2,495) Euro — 196 British pound — 4,597
The above analysis assumes that all other variables, i.e., interest rates, remain constant.
An assumed 10% depreciation in the currency of exposure would have had an equal but opposite effect on the above currencies to the amounts shown above, on the basis that all other variables remain constant.
(iv) Interest rate risk:
The amounts outstanding under the Fund’s Credit Facility bear interest at variable rates with fixed interest rate spreads. To comply with the governing Credit Facility, the Fund hedged approximately 60% of the exposure to fluctuations in interest rates by entering into a $400,000, pay-fix, receive-floating interest rate swap. While the initial transaction hedged approximately 60% of the initial amount borrowed under the credit facility, future increases in interest rates will not affect the amount of cash required to service the indebtedness associated with the swap.
Up to December 15, 2009, the Fund designated derivatives (interest rate swaps) as hedging instruments under the cash flow hedge accounting model. As at December 31, 2010, long-term debt outstanding totalled $366,739 (2009 — $395,364); therefore, leaving a nil balance (2009 — nil) without a corresponding hedge and exposed to cash flow risk due to fluctuations in interest rates.
A change in interest rate will also affect the fair value of the swap. An increase of 25 basis points in interest rates as at the reporting date would have decreased the fair value of the swap liability by approximately $783 and as a result of hedge de-designation it would increase net earnings by the same amount. A decrease of 25 basis points in interest rates as at the reporting date would have Increased the fair value of the swap liability by approximately $771 and decrease net earnings by an equal amount.
96 Cinram 2010 Annual Report NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(v) Fair values versus carrying amounts:
At December 31, 2010, the fair values of financial assets and liabilities, along with the carrying amounts presented in the balance sheet are as follows:
’10 Carrying amount Fair value
Held for trading: Cash and cash equivalents $ 164,399 $ 164,399 Loans and receivables: Accounts receivable 178,066 178,066 Derivative instruments, including accrued interest of $3,335 (11,087) (11,087) Other financial liabilities: Capital lease obligations (2,227) (2,172) Accounts payable and accrued liabilities (211,537) (211,537) Long-term debt* (366,739) (283,306)
$ (249,125) $ (165,637)
’09 Carrying amount Fair value
Held for trading: Cash and cash equivalents $ 122,072 $ 122,072 Loans and receivables: Accounts receivable 273,243 273,243 Derivative instruments, including accrued interest of $3,369 (25,225) (25,225) Other financial liabilities: Capital lease obligations (4,065) (4,248) Accounts payable and accrued liabilities (317,138) (317,138) Long-term debt* (395,364) (347,919)
$ (346,477) $ (299,215)
*Long-term debt quoted at approximately 77% (2009 — 88%) per $100 as at December 31, 2010.
(vi) Basis for determining fair value:
The Fund has determined the fair value of its financial instruments as follows:
A) ( Current assets and liabilities: T he carrying amounts in the consolidated balance sheets of cash and cash equivalents, accounts receivable, accounts payable and accrued liabilities approximate fair values because of the short-term nature of these financial instruments.
B) ( Long-term debt and obligations under capital leases: The fair values of each of the Fund’s debt instruments are based on the period-end trading values.
T he fair values of the Fund’s obligations under capital leases are based on the amount of future cash flows associated with each instrument discounted using current year weighted average borrowing rates.
C) ( Derivative instruments: T he fair value of the Fund’s interest rate exchange agreement is based on the value quoted by the counterparty to the agreement and adjusted for respective credit spreads.
Cinram 2010 Annual Report 97 NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
Fair value estimates are made at a specific point in time, based on relevant market information and information about the financial instruments. These estimates are subjective in nature and involve uncertainties and matters of significant judgment and, therefore, cannot be determined with precision. Changes in assumptions could significantly affect the estimates.
The table below presents the Level in the fair value hierarchy into which the fair values of financial instruments that are carried at fair value on the consolidated balance sheets are categorized:
’10 ’09 Level 1 Level 2 Level 1 Level 2
Valuation Valuation technique technique Quoted using Quoted using market observable market observable price market inputs price market inputs
Financial assets: Cash and cash equivalents $ 164,399 $ — $ 122,072 $ —
Financial liabilities: Derivatives $ — $ 11,087 $ — $ 25,225
There were no financial instruments categorized In Level 3 (valuation technique using non-observable market inputs) as at December 31, 2010 and 2009.
There were no changes in categorization of financial assets and liabilities into the three Levels in the fair value hierarchy during the year.
21. CAPITAL RISK MANAGEMENT:
The Fund’s objectives in managing capital are to optimize its weighted average cost of capital, and hence, maximize unitholders’ value while balancing the interests of debt and unitholders.
Management’s strategy of concentrating on the Fund’s core business, while simultaneously diversifying into other businesses in which the Fund can leverage synergies and its core competencies, is considered concurrently with the use of capital. The Fund includes unitholders’ deficiency, long-term debt (including any associated hedging activities), other interest-bearing debt, such as the revolving line of credit, and cash and equivalents in its capital definition.
Continuous oversight and control of the capital structure is maintained by senior management and the Board of Trustees. Adjustments are made as a result of economic changes, opportunities and financial conditions by means of distributions paid to unitholders, repurchase of units for cancellation pursuant to normal course issuer bids (NCIBs), accelerated repayment of long-term debt, and the issuance of new units and/or debt. The Board of Trustees reviews and approves any material transactions, including proposals on acquisitions or dispositions, as well as capital and operating budgets. As disclosed in note 7 to the consolidated financial statements, the Fund has repurchased debt under the amended credit facility, which was established during the first quarter of 2009.
The Fund uses several metrics to monitor capital, including: leverage, interest coverage and liquidity. All of the metrics are also components used to determine compliance with external debt covenants, which management monitors closely to assess current and future compliance. Leverage is defined under the credit agreement, which is described in note 7 to the consolidated financial statements, as total debt to EBITA, interest coverage is defined as EBITA to cash interest, and liquidity is determined based on cash on hand along with availability under the revolving credit agreement.
98 Cinram 2010 Annual Report NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
The consequences of not meeting the credit agreement’s covenants could result in default of the credit facility.
The Fund’s capital structure changed significantly during 2009 as a result of debt reduction efforts. As disclosed in note 7 to the consolidated financial statements, the Fund repurchased a total of $169,660 of debt under the amended Credit Facility during the year ended December 31, 2009 using cash and cash equivalents on hand. The Fund also made mandatory and voluntary debt repayments of $28,624 and $82,100 during 2010 and 2009, respectively. The Fund did not declare any distributions to unitholders during 2010 and 2009, nor does it plan to make any distributions to its unitholders in the foreseeable future. The Fund’s strategy for capital risk management has not changed during the year ended December 31, 2010. The Fund is not subject to any externally imposed capital requirements, other than as outlined in its credit agreement, which includes covenant compliance.
22. DISCONTINUED OPERATIONS AND ASSETS HELD FOR SALE:
(a) Mexico: On June 30, 2010, the Fund completed the sale of its share of the Mexican joint venture, Cinram LantinoAmericana, S.A. de C.V., to the joint venture partner for total proceeds of $300. Accordingly, the Fund’s proportionate share of the results of operations of the joint venture were segregated and presented separately as discontinued operations in the consolidated financial statements for the year ended December 31, 2010 and prior periods have been reclassified on this basis.
P rior to the classification as a discontinued operation, these results were reported within the Pre-Recorded Multimedia Products segment.
The results of the discontinued operations are as follows: ’10 ’09
Revenue $ 6,219 $ 10,534
Earnings (loss) from discontinued operations $ (233) $ 227 Loss on sale of discontinued operations (594) — Release of cumulative translation adjustment (4,307) —
Total earnings (loss) from discontinued operations, net of income taxes $ (5,134) $ 227
There are no material amounts remaining on the consolidated balance sheet relating to the Mexico discontinued operations at December 31, 2010.
The cash flow from discontinued operations is as follows: ’10 ’09
Earnings (loss) from discontinued operations $ (5,134) $ 227 Loss on sale of discontinued operations 594 — Release of cumulative translation adjustment 4,307 — Change in non-cash working capital (45) (413)
Cash used in discontinued operating activities (278) (186) Purchase of property, plant and equipment — (32) Proceeds received on disposition 300 — Cash given up on disposition (1,036) —
Cash used in discontinued investing activities (736) (32)
Total cash flow used in discontinued operations $ (1,014) $ (218)
Cinram 2010 Annual Report 99 NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(b) Ivy Hill Corporation: On April 9, 2009, the Fund completed the sale of substantially all of the assets and liabilities of Ivy Hill, to Multi Packaging Solutions, Inc. (MPS) for net cash proceeds of $14,001, subject to working capital adjustments pursuant to the Asset Purchase Agreement. During the third quarter of 2009, the Fund recorded a working capital adjustment of $2,779, which resulted in a reduction in net cash proceeds from the sale to $11,222. Ivy Hill’s results, which comprised all of the North American printing business, were excluded from the Fund’s continuing operations for the year ended December 31, 2009.
In 2009, the Fund recorded a net loss on the sale of $4,685, which includes an obligation to indemnify the purchase for a possible withdrawal liability relating to the multi-employer pension plans. The present value at December 31, 2010 was estimated to be approximately $2,659 as at the date of the sale and is being accreted to the estimated settlement date. This net withdrawal liability obligation is partially offset by preferred shares of MPS which the Fund received as part of the proceeds of sale. These preferred shares have been placed in escrow to fund the withdrawal liability. During the third and fourth quarters of 2009, accretion charges of $110 per quarter were recorded. Furthermore, a mark-to-market gain of $844 was recorded subsequent to the sale, resulting in a net present value of the withdrawal liability obligation, net of the preferred shares, of $1,925 as at December 31, 2009.
In 2010, accretion charges of $215 were recorded. Furthermore, a market-to-market gain of $1,256 was recorded, resulting in a net present value of the withdrawal liability obligation, net of the preferred shares, of $884 as at December 31, 2010.
The withdrawal liability obligation will be settled no later than the second quarter of 2013.
The results of the Ivy Hill discontinued operations are as follows: ’10 ’09
Revenue $ — $ 26,253
Loss from discontinued operations, net of income taxes $ — $ (11,042) Loss on sale of discontinued operations — (4,685)
Total loss from discontinued operations, net of income taxes $ — $ (15,727)
The balance sheet information related to the Ivy Hill discontinued operations as at December 31, 2010 was $4,534 (2009 — $7,319) related to current liabilities.
These amounts have not been separately disclosed on the consolidated balance sheet as they are not considered material.
The cash flow from the Ivy Hill discontinued operations for the year ended December 31 is as follows: ’10 ’09
Loss from discontinued operations $ — $ (15,727) Gain on sale of discontinued operations — 4,685 Change in non-cash working capital (1,546) (6,089)
Cash used in discontinued operating activities (1,546) (17,131) Other investing activities — (11) Proceeds on disposition — 11,222
Cash provided by discontinued investing activities — 11,211
Total cash used in discontinued operations $ (1,546) $ (5,920)
100 Cinram 2010 Annual Report NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(c) Giant merchandising: On May 2, 2008, the Fund completed the sale of Giant Merchandising’s (Giant) assets connected with its retail license business to a division of Li & Fung for cash proceeds of $5,961. Giant’s remaining U.S. operations were liquidated during the second quarter of 2008 for proceeds of $264 and on June 30, 2008, the Fund completed a share sale of Giant’s subsidiary in Mexico to subsidiaries of Mias Fashion Manufacturing Company, Inc. for a nominal amount plus the assumption of certain liabilities and obligations in Mexico. Accordingly, the results of operations of Giant have been segregated and presented separately as discontinued operations in the consolidated financial statements.
The results of the discontinued operations are as follows: ’10 ’09
Loss from discontinued operations, net of income taxes $ — $ (533)
The cash flow from discontinued operations is as follows: ’10 ’09
Earnings (loss) from discontinued operations $ — $ (533) Change in non-cash working capital — 431
Cash used in discontinued operating activities $ — $ (102)
23. SUBSEQUENT EVENTS:
(a) Acquisition of One K Studios, LLC (1K): On January 31, 2011, the Fund announced the acquisition of the ownership interests of 1K. 1K specializes in building enhanced consumer experiences for movies, TV shows, music, books and games. 1K provides creative and technical services to these companies to help them release their content in different venues including digital downloads, mobile and tablet applications, advanced Blu-ray discs, stereoscopic 3D and social media.
(b) Refinancing and Recapitalization: On January 25, 2011, the Fund announced a proposed refinancing and recapitalization transaction (Refinancing and Recapitalization). In addition, the Fund has agreed to the material terms that will form the basis for further agreements with a major customer for a term of three years, subject to the completion of the Refinancing and Recapitalization.
On February 17, 2011, the Fund announced it had achieved unanimous lender consent, as well as consent from a majority of unitholders, for the Refinancing and Recapitalization.
The Refinancing and Recapitalization entails three new principal instruments which includes a new Amended Credit Facility, mandatorily exchangeable secured debt (Exchangeable Debt) and warrants (Warrants). The lenders for the Credit Facility and the Exchangeable Debt are the Fund’s current lenders under the existing Credit Facility, while the Warrants are being issued to a party other than the lenders. In connection with the Refinancing and Recapitalization, the lenders will receive a consent fee equal to their pro rata share (based on the full amount outstanding under the Credit Facility) of: (i) approximately $11,200; (ii) approximately 6.20 million units of the Fund; and (iii) if any portion of the Exchangeable Debt has not been repaid by June 30, 2011, approximately 3.65 million additional units of the Fund.
Cinram 2010 Annual Report 101 NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
The following is a summary of the Amended Credit Facility that will be comprised of a new term loan and new revolving facilities, with both being amended and extended until December 31, 2013.
Term Loan:
(a) A principal amount of approximately $247,000 which represents the existing long-term debt reduced by a $30,000 principal cash repayment, as well as $90,000 through the issuance of new Exchangeable Debt.
(b) Interest at LIBOR plus 800 basis points, plus 100 basis points to be paid in kind (PIK). LIBOR is established to have a floor of no less than 1.25%.
(c) Interest is to be paid quarterly.
(d) Additional interest will accrue if, as a result of certain minimum liquidity provisions, the Fund defers principal amortization or excess cash flow sweep payments or pays interest-in-kind with respect to all or a portion of the outstanding loans.
(e) Amortization of the term loan is 1.25% of the closing date principal amount per quarter, beginning in the first quarter of 2011. The amortization increases to 2.5% per quarter in the third quarter of 2012 and beyond, subject to certain minimum liquidity provisions.
Revolving Facilities:
(a) A total available amount of $35,000 in two tranches.
(b) The first tranche is for $14,000, which includes outstanding letters of credit that may be re-drawn for direct borrowing or for a replacement letter of credit to the extent any outstanding letters of credit are cancelled. The interest rate on this tranche is similar to that of the Term Loan.
(c) The second tranche is for $21,000, and can only be utilized after the $14,000 tranche is fully drawn. The interest rate on this tranche is LIBOR plus 625 basis points. LIBOR is established to have a floor of no less than 1.25%.
(d) Interest is payable on both tranches on a quarterly basis.
(e) There will be a commitment fee of 125 basis points on the undrawn portion of the Revolving Facilities.
The following is a summary of the terms of the Exchangeable Debt that will be provided to the current lenders of the Fund:
(a) An exchange of outstanding first-lien long-term debt in the amount of $90,000 is being made for $90,000 of newly issued Exchangeable Debt, which will represent second-lien secured debt that is to be repaid through proceeds derived from the issuance of new units of the Fund. If such proceeds are not derived and repaid to the holders of the Exchangeable Debt by December 31, 2011, the Exchangeable Debt becomes mandatorily exchangeable into units of the Fund on December 31, 2011.
(b) The security for the Exchangeable Debt is a second lien on all Credit Facility collateral.
(c) The interest rate will be 15% per annum, compounded on a quarterly basis, with paid-in-kind until December 31, 2011.
(d) Interest is paid in cash: (i) with respect to all or any portion of the principal repaid prior to December 31, 2011 or (ii) at December 31, 2011, subject to the Fund’s election not to pay interest in cash at maturity in certain circumstances, in which case, each lender has the option to exchange its ratable share of capitalized and accrued interest to units of the Fund at the same price as principal or to retain a continuing second lien debt claim (at 15% paid-in-kind interest per annum) until December 31, 2013, at which time the remaining balance shall be paid in cash.
(e) If the Exchangeable Debt becomes mandatorily exchangeable into units of the Fund on December 31, 2011, the price at which the Exchangeable Debt would be exchanged for units of the Fund is the lesser of: (i) $0.242 per unit, and (ii) the lowest price per unit at which additional equity is raised on or before December 31, 2011.
102 Cinram 2010 Annual Report NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
The following is a summary of the terms of the Warrants:
(a) The holder has the option to purchase 13 million units of the Fund.
(b) The initial strike price is $1.10 per unit; however, this will be recalculated and set at the lowest of: (i) $1.10, (ii) the lowest per unit price at which the Fund issues new units on or before December 31, 2011 as applicable, and (iii) the per unit price resulting from any exchange of the Exchangeable Debt, as applicable.
(c) The vesting of the Warrants is scheduled as follows:
(i) 50% upon closing of the Refinancing and Recapitalization;
(ii) 10% one year after closing;
(iii) 15% two years after closing; and
(iv) 25% three years after closing.
24. COMPARATIVE FIGURES:
Certain 2009 figures have been reclassified to conform with the financial statement presentation adopted in 2010.
Cinram 2010 Annual Report 103 FINANCIAL HIGHLIGHTS
(stated in thousands of U.S. dollars, except per share/unit data) 10 years ending December 31 ’10 ’09 ’08 ’07 ’06 ’05 ’04 ’03 ’02 ’01 STATEMENT OF EARNINGS Revenue 1,108,790 1,453,031 1,714,354 1,661,319 1,588,440 1,714,353 1,643,418 746,361 546,022 523,877 Revenue growth in % -24% -15% 3% 5% -7% 4% 120% 37% 4% 23% Cost of sales 892,393 1,190,892 1,398,708 1,339,690 1,186,162 1,362,582 1,290,823 587,315 446,838 450,085 Gross profit before amortization 271,130 348,780 416,551 443,642 544,641 487,084 480,845 218,982 146,255 116,104 Gross profit % before amortization 24% 24% 24% 27% 34% 28% 29% 29% 27% 22% Amortization of capital assets 54,733 86,641 100,905 122,013 142,363 135,313 128,250 59,936 47,071 42,312 Gross profit 216,397 262,139 315,646 321,629 402,278 351,771 352,595 159,046 99,184 73,792 Gross profit as a % of sales 20% 18% 18% 19% 25% 21% 21% 21% 18% 14% Selling, general and administrative expenses 137,728 164,992 159,782 145,431 136,804 125,410 128,457 57,706 49,709 49,078 Selling, general and administrative expenses as a % of revenue 12% 11% 9% 9% 9% 7% 8% 8% 9% 9% Amortization of intangible assets and transaction costs and loan fees (includes write-off of transaction costs and loan fees) 15,146 41,465 42,127 54,968 75,236 61,255 64,295 9,936 — — Impairment of long-lived assets and goodwill — 82,234 21,638 339,947 — — — — — — Goodwill amortization — — — — — — — — — 1,336 Research and development expenses — — — — — — — — — 64 Other charges, net 1 17,544 2,483 (2,148) 2,254 53,569 2,636 (1,713) 2,726 1,449 (2,563) EBITA (earnings before interest expense/income, foreign exchange gains/losses, investment income, impairment charges, amortization and income taxes) 115,858 181,305 258,917 295,957 354,268 359,038 354,101 158,550 95,097 68,189 EBITA % 10% 12% 15% 18% 22% 21% 22% 21% 17% 13% EBIT (earnings before interest expense/income, foreign exchange gains/losses, investment income and income taxes) 45,979 (29,035) 94,247 (220,971) 136,669 162,470 161,556 88,678 48,026 25,877 EBIT % 4% -2% 5% -13% 9% 9% 10% 12% 9% 5% Interest expense 32,312 43,685 49,296 53,742 48,832 51,148 53,102 13,743 3,305 6,209 Gain on repurchase of debt — 38,440 — — — — — — — — Foreign exchange gain (loss) 956 15,179 (12,312) 8,585 10,564 — — — — — Investment income 317 429 1,617 3,660 4,094 683 2,443 3,491 2,687 2,732 Income tax expense (recovery) (3,500) (12,677) 10,606 (13,220) 47,344 31,888 34,853 25,460 13,381 7,806 Earnings (loss) from continuing operations 18,440 (5,995) 23,650 (249,248) 55,151 80,117 76,044 52,966 34,027 14,594 Earnings (loss) from discontinued operations (5,134) (16,033) (55,178) (66,011) (3,398) 2,309 (220) 54 644 677 Net earnings (loss) 13,306 (22,028) (31,528) (315,259) 51,753 82,426 75,824 53,020 34,671 15,271 Earnings (loss) per unit from continuing operations: Basic 0.34 (0.11) 0.42 (4.30) 0.95 1.40 1.34 0.95 0.62 0.27 Diluted 0.33 (0.11) 0.42 (4.30) 0.96 1.39 1.33 0.94 0.62 0.27 Earnings (loss) per unit: Basic 0.25 (0.40) (0.56) (5.44) 0.89 1.44 1.34 0.95 0.63 0.28 Diluted 0.24 (0.40) (0.56) (5.44) 0.89 1.43 1.32 0.94 0.63 0.28
1 excluding write-off of transaction costs and loan fees in 2006 Certain prior period figures have been reclassified for discontinued operations. In addition, certain figures have been reclassified to conform with the financial statement presentation adopted in the current year or adjusted to correct a prior period error.
104 Cinram 2010 Annual Report (stated in thousands of U.S. dollars, except per share/unit data) 10 years ending December 31 ’10 ’09 ’08 ’07 ’06 ’05 ’04 ’03 ’02 ’01 STATEMENT OF EARNINGS Revenue 1,108,790 1,453,031 1,714,354 1,661,319 1,588,440 1,714,353 1,643,418 746,361 546,022 523,877 Revenue growth in % -24% -15% 3% 5% -7% 4% 120% 37% 4% 23% Cost of sales 892,393 1,190,892 1,398,708 1,339,690 1,186,162 1,362,582 1,290,823 587,315 446,838 450,085 Gross profit before amortization 271,130 348,780 416,551 443,642 544,641 487,084 480,845 218,982 146,255 116,104 Gross profit % before amortization 24% 24% 24% 27% 34% 28% 29% 29% 27% 22% Amortization of capital assets 54,733 86,641 100,905 122,013 142,363 135,313 128,250 59,936 47,071 42,312 Gross profit 216,397 262,139 315,646 321,629 402,278 351,771 352,595 159,046 99,184 73,792 Gross profit as a % of sales 20% 18% 18% 19% 25% 21% 21% 21% 18% 14% Selling, general and administrative expenses 137,728 164,992 159,782 145,431 136,804 125,410 128,457 57,706 49,709 49,078 Selling, general and administrative expenses as a % of revenue 12% 11% 9% 9% 9% 7% 8% 8% 9% 9% Amortization of intangible assets and transaction costs and loan fees (includes write-off of transaction costs and loan fees) 15,146 41,465 42,127 54,968 75,236 61,255 64,295 9,936 — — Impairment of long-lived assets and goodwill — 82,234 21,638 339,947 — — — — — — Goodwill amortization — — — — — — — — — 1,336 Research and development expenses — — — — — — — — — 64 Other charges, net 1 17,544 2,483 (2,148) 2,254 53,569 2,636 (1,713) 2,726 1,449 (2,563) EBITA (earnings before interest expense/income, foreign exchange gains/losses, investment income, impairment charges, amortization and income taxes) 115,858 181,305 258,917 295,957 354,268 359,038 354,101 158,550 95,097 68,189 EBITA % 10% 12% 15% 18% 22% 21% 22% 21% 17% 13% EBIT (earnings before interest expense/income, foreign exchange gains/losses, investment income and income taxes) 45,979 (29,035) 94,247 (220,971) 136,669 162,470 161,556 88,678 48,026 25,877 EBIT % 4% -2% 5% -13% 9% 9% 10% 12% 9% 5% Interest expense 32,312 43,685 49,296 53,742 48,832 51,148 53,102 13,743 3,305 6,209 Gain on repurchase of debt — 38,440 — — — — — — — — Foreign exchange gain (loss) 956 15,179 (12,312) 8,585 10,564 — — — — — Investment income 317 429 1,617 3,660 4,094 683 2,443 3,491 2,687 2,732 Income tax expense (recovery) (3,500) (12,677) 10,606 (13,220) 47,344 31,888 34,853 25,460 13,381 7,806 Earnings (loss) from continuing operations 18,440 (5,995) 23,650 (249,248) 55,151 80,117 76,044 52,966 34,027 14,594 Earnings (loss) from discontinued operations (5,134) (16,033) (55,178) (66,011) (3,398) 2,309 (220) 54 644 677 Net earnings (loss) 13,306 (22,028) (31,528) (315,259) 51,753 82,426 75,824 53,020 34,671 15,271 Earnings (loss) per unit from continuing operations: Basic 0.34 (0.11) 0.42 (4.30) 0.95 1.40 1.34 0.95 0.62 0.27 Diluted 0.33 (0.11) 0.42 (4.30) 0.96 1.39 1.33 0.94 0.62 0.27 Earnings (loss) per unit: Basic 0.25 (0.40) (0.56) (5.44) 0.89 1.44 1.34 0.95 0.63 0.28 Diluted 0.24 (0.40) (0.56) (5.44) 0.89 1.43 1.32 0.94 0.63 0.28
1 excluding write-off of transaction costs and loan fees in 2006 Certain prior period figures have been reclassified for discontinued operations. In addition, certain figures have been reclassified to conform with the financial statement presentation adopted in the current year or adjusted to correct a prior period error.
Cinram 2010 Annual Report 105 COMPARATIVE BALANCE SHEETS
10 years ending December 31 ’10 9 ’0 ’08 ’07 ’06 ’05 ’04 ’03 ’02 ’01
BALANCE SHEET Current ratio 1.03 1.25 1.37 1.16 1.56 1.23 1.02 1.05 1.65 1.45 Debt to equity ratio1 n/m* n/m* 460.72 24.59 2.22 2.69 3.31 4.34 0.80 0.84 Debt to assets ratio1 1.01 1.03 1.00 0.96 0.69 0.73 0.77 0.81 0.45 0.46 Equity to assets ratio n/m* n/m* 0.00 0.04 0.31 0.27 0.23 0.19 0.55 0.54 Accounts receivable turnover2 5 4 3 3 3 3 4 3 4 3 Days sales in accounts receivable2 74 7 9 115 123 129 118 99 125 99 106 Inventory turnover3 32 29 30 29 25 27 25 14 14 17 Days sales in inventory3 11 2 1 12 13 15 14 14 26 26 22 Asset turnover4 1.89 2.03 1.66 1.34 1.21 1.19 1.13 0.53 1.05 1.15 Return on equity5 (after other charges, net) n/m* n/m* 81% -80% 10% 16% 17% 16% 13% 6% Return on total assets6 (after other charges, net) 3% -1% 2% -15% 3% 4% 4% 4% 7% 3%
1consists of current and long-term liabilities including future income taxes 2two year average accounts receivable 3two year average inventory 4total assets excluding intangible assets and goodwill 5two year average equity and earnings from continuing operations 6two year average total assets and earnings from continuing operations *not meaningful due to negative equity
106 Cinram 2010 Annual Report TRADING OF UNITS: CRW.UN
(in Canadian dollars) Volume Years ended December 31 Quarter High Low Closing (’000)
’10 First $ 3.31 $ 0.91 $ 1.20 5,122 Second $ 1.50 $ 1.05 $ 1.19 1,400 Third $ 1.18 $ 0.95 $ 1.00 604 Fourth $ 1.51 $ 0.95 $ 1.35 692 Year $ 3.31 $ 0.91 $ 1.35 7,818
’09 First $ 1.75 $ 0.61 $ 0.88 6,306 Second $ 2.21 $ 0.83 $ 1.94 3,678 Third $ 2.23 $ 1.51 $ 2.15 2,623 Fourth $ 2.99 $ 1.80 $ 2.75 9,288 Year $ 2.99 $ 0.61 $ 2.75 21,895
’08 First $ 6.45 $ 5.11 $ 5.77 14,813 Second $ 7.00 $ 5.61 $ 5.81 8,419 Third $ 5.99 $ 3.50 $ 4.02 7,357 Fourth $ 4.01 $ 1.23 $ 1.52 8,492 Year $ 7.00 $ 1.23 $ 1.52 39,081
Fund units outstanding at December 31, 2010: 55,245,320 LP units outstanding at December 31, 2010: 29,000
Weighted average number of units for 2010 Basic: 54,000,388 Diluted: 55,756,735
Cinram 2010 Annual Report 107 TRUSTEES OF CINRAM INTERNATIONAL INCOME FUND
WILLIAM ANDERSON ANDREW BRENTON 1 JAMES S.A. MACDONALD 1* ROBERT POILE 1, 2 Chairman of the Board Trustee Trustee Trustee Cinram International Income Chief Executive Officer Corporate Director Lead Portfolio Strategist Fund Turtle Creek Group Polar Securities Inc. Portfolio Strategist, Polar ROBERT NORMANDEAU 2* Securities Inc. STEVEN G. BROWN Trustee Trustee Director, President and HENRI A. ABOUTBOUL 2 President and Chief Executive Officer Trustee Chief Executive Officer Clarke Inc. Cinram International Income Cinram International Fund Income Fund
1 Audit committee 2 Corporate governance and compensation committee * Committee chair
SENIOR MANAGEMENT TEAM
STEVEN G. BROWN JOHN BARNETT PIERRE FAGUER FRED RUDOLPH President and Chief Executive Vice-President, Managing Director, Executive Vice-President, Officer Global Procurement France Key Accounts
JOHN BELL HOWARD BERMAN JEFFREY FINK KLAUS SCHRAMM Chief Financial Officer Senior Vice-President and Executive Vice-President, Managing Director, Germany General Counsel Sales and Studio Relations DAVID ASHTON JOHN TINO Executive Vice-President, JOHN CROSIER BILL MUELLER Vice-President, Finance Manufacturing North America Senior Vice-President, Executive Vice-President, and Treasurer Digital Architecture and Delivery Distribution North America NEIL BALLANTINE Executive Vice-President and Managing Director, Europe
CORPORATE INFORMATION
CORPORATE HEADQUARTERS TRANSFER AGENT AUDITORS ANNUAL MEETING 2255 Markham Road Computershare Investor KPMG LLP Cinram International Income Toronto, Ontario Services Inc. Yonge Corporate Centre Fund’s Annual meeting will be held Canada M1B 2W3 100 University Avenue, 4100 Yonge Street, Suite 200 at 10:00a.m. on May 12, 2011, at Tel: 416.298.8190 9th Floor Toronto, Ontario the Hockey Hall of Fame: Fax: 416.332.2403 Toronto, Ontario M2P 2H3 M5J 2Y1 Brookfield Place INVESTOR RELATIONS Tel: 1.800.564.6253 30 Yonge Street, Lower Level 2255 Markham Road E-mail: Toronto, Ontario Toronto, Ontario [email protected] Canada M1B 2W3 Unitholders are welcome to attend Tel: 416.298.8190 this meeting. E-mail: [email protected]
108 Cinram 2010 Annual Report WORLDWIDE LOCATIONS
CANADA Cinram Wireless EUROPE 5300 Westport Parkway Cinram International Inc. Fort Worth, TX 76177 Cinram Logistics (UK) Ltd. 2255 Markham Road Tel: 817.490.7300 Rabans Lane, Aylesbury Toronto, Ontario Fax: 817.491.0356 Buckinghamshire Canada M1B 2W3 United Kingdom HP19 8TS Tel: 416.298.8190 Cinram Games (Ditan Distribution LLC) Tel: 44.1296.426.151 Fax: 416.332.2403 7901 Stoneridge Drive, Suite 300 Fax: 44.1296.481.009 Pleasanton, California 5590 Finch Avenue USA 94588 Cinram Logistics (UK) Ltd Toronto, Ontario Tel: (925) 965-2100 Unit 2 Prologis Park Canada M1B 1T1 Fax: (925) 965-2011 Arenson Way Tel: 416.298.8190 Dunstable Fax: 416.332.9035 5445 Old Dixie Road, Suite 100 Bedfordshire Forest Park, Georgia United Kingdom LU5 4RZ 400 Nugget Avenue USA 30297 Tel: 44.1296.486.461 Toronto, Ontario Tel: (404) 362-0060 Fax: 44.1582.472.432 Canada M1S 4A4 Fax: (404) 362-0880 Tel: 416.298.8190 Cinram Operations (UK) Ltd. Fax: 416.321.7861 90 Whitaker Road, Suite A 2 Central Avenue, Ransomes Europark Plainfield, Indiana Ipswich, Suffolk UNITED STATES USA 46168 United Kingdom 1P3 9SL Tel: (317) 838-9912 Tel: 44.147.327.1010 Cinram Inc. U.S. Fax: (317) 838-9942 Fax: 44.147.327.1040 4905 Moores Mill Road Huntsville, Alabama 5150 Interchange Way Cinram France USA 35811 Louisville, Kentucky Les Granges Tel: 256.859.9042 USA 40229 B.P. 48 Fax: 256.859.9932 Tel: (502) 968-8626 Champenard Fax: (502) 968-8704 27608 Gaillon Cedex 948 Meridian Lake Drive France Aurora, Illinois 6529 South 216th Street Tel: 33.2.32.21.47.00 USA 60504 Kent, Washington Fax: 33.2.32.21.47.04 Tel: 630.375.2200 USA 98032 Fax: 630.375.2356 Tel: (253) 395-0391 Cinram Optical Discs SAS Fax: (253) 872-9073 26 Avenue Winston Churchill 1400 East Lackawanna Avenue B.P. 615 Olyphant, Pennsylvania Cinram Retail Services (Vision) 27406 Louviers Cedex USA 18448 340 E. Big Beaver Road France Tel: 570.383.3291 Troy, Michigan Tel: 33.2.32.25.72.00 Fax: 570.383.6722 USA 48083 Fax: 33.2.32.25.72.22 Tel: 248.584.4300 437 Sanford Road Fax: 248.584.2440 Cinram Logistics France LaVergne, Tennessee 4 rue Désir Prévost USA 37086 1K Studios Zone Industrielle Tel: 615.287.3800 3400 W. Olive Avenue La Grande Brèche Fax: 615.287.3866 Burbank, CA 91505 91070 Bondoufle Tel: 818.531.3800 France Fax: 818.531.3801 Tel : 33.1.69.91.77.00 Fax : 33.1.69.91.76.99
Cinram GmbH Max-Planck-Strasse 1-9 52477 Alsdorf Germany Tel: 49.2404.58.0 Fax: 49.2404.58.111 Design: Interbrand Printed in Canada 2255 Markham Road Toronto Ontario Canada M1B 2W3 t 416.298.8190 e [email protected] f 416.332.2403 cinram.com