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<PAGE>
EXHIBIT 2
MANAGEMENT'S
RESPONSIBILITY FOR FINANCIAL STATEMENTS
The
accompanying consolidated financial statements have been prepared by
management
and approved by Cinram's Board of Directors. Management is
responsible
for the information and representations contained in these financial
statements
and in other sections of this annual report.
The
Company maintains appropriate processes to ensure that it produces relevant
and reliable
financial information. The consolidated financial statements have
been
prepared in accordance with accounting principles generally accepted in
Canada.
The significant accounting policies, which management believes are
appropriate
for the Company, are described in NOTE 1 to the consolidated
financial
statements.
The
Board of Directors is responsible for reviewing and approving the
consolidated
financial statements and overseeing management's performance of its
financial
reporting responsibilities. The Board appoints an audit committee of
three
non-management Directors to review the consolidated financial statements,
as well
as the adequacy of its internal controls, audit process and financial
reporting
with management and with the external auditors. The audit committee
reports
to the Directors prior to the approval of the audited consolidated
financial
statements for publication.
KPMG
LLP, our independent auditors appointed by shareholders at the last annual
meeting,
have audited the consolidated financial statements. Their report is
presented
below.
/s/
Isidore Philosophe /s/
Lewis Ritchie
ISIDORE
PHILOSOPHE LEWIS
RITCHIE
Chief
Executive Officer Chief
Financial Officer
March
1, 2005
AUDITORS'
REPORT TO THE SHAREHOLDERS
We have
audited the consolidated balance sheets of Cinram International Inc. as
at
December 31, 2004 and 2003 and the consolidated statements of earnings and
retained
earnings and cash flows for the years then ended. These financial
statements
are the responsibility of the Company's management. Our
responsibility
is to express an opinion on these financial statements based on
our
audits.
We
conducted our audits in accordance with Canadian generally accepted auditing
standards.
Those standards require that we plan and perform an audit to obtain
reasonable
assurance whether the financial statements are free of material
misstatement.
An audit includes examining, on a test basis, evidence supporting
the
amounts and disclosures in the financial statements. An audit also includes
assessing
the accounting principles used and significant estimates made by
management,
as well as evaluating the overall financial statement presentation.
In our
opinion, these consolidated financial statements present fairly, in all
material
respects, the financial position of the Company as at December 31, 2004
and
2003 and the results of its operations and its cash flows for the years
then
ended in accordance with Canadian generally accepted accounting principles.
/s/
KPMG LLP
Chartered
Accountants
Toronto,
Canada
March
1, 2005
COMMENTS
BY AUDITORS FOR U.S. READERS ON CANADA-U.S. REPORTING DIFFERENCES
In the
United States, reporting standards for auditors require the addition of
an
explanatory paragraph (following the opinion paragraph) when there is a
change
in accounting principles that has a material effect on the comparability
of the
Company's consolidated financial statements, such as the change in
accounting
policy related to stock-based compensation (note 1(k)). Our report to
the
shareholders of Cinram International Inc., dated March 1, 2005 is expressed
in
accordance with Canadian reporting standards which do not require a reference
to such
changes in accounting principles in the auditors' report when the change
is
properly accounted for and adequately disclosed in the consolidated financial
statements.
/s/
KPMG LLP
Chartered
Accountants
Toronto,
Canada
March
1, 2005
<PAGE>
CONSOLIDATED
BALANCE SHEETS
(In
thousands of U.S. dollars)
<TABLE>
<CAPTION>
As at December 31 2004 2003
-------------------------------------------------------------- ----------- -----------
<S>
<C> <C>
ASSETS
CURRENT
ASSETS
Cash and cash equivalents $ 41,789
$ 253,823
Accounts receivable, net of an allowance for
doubtful
accounts of $12,511 (2003 - $13,569) 518,216 369,901
Income taxes recoverable
8,356 -
Inventories (NOTE 3)
56,861 44,606
Prepaid expenses 26,573 11,341
Future income taxes (NOTE 12)
22,872 21,933
----------- -----------
674,667 701,604
Capital
assets (NOTE 4)
706,360 646,563
Goodwill
(NOTE 5)
328,393 279,426
Intangible
assets (NOTE 5)
315,247 376,393
Deferred
financing fees (NOTE 6)
24,344 28,083
Other
assets
36,218 22,488
Future
income taxes (NOTE 12)
11,804 4,657
----------- -----------
$ 2,097,033 $ 2,059,214
=========== ===========
LIABILITIES
AND SHAREHOLDERS' EQUITY
CURRENT
LIABILITIES
Accounts payable $ 213,876
$ 192,789
Accrued liabilities
377,323 375,293
Income taxes payable
- 2,131
Current portion of long-term debt (NOTE 7) 71,509 95,417
Current portion of obligations under capital
leases(NOTE 8) 850 1,058
----------- -----------
663,558 666,688
Long-term
debt (NOTE 7)
786,834 954,456
Obligations
under capital leases (NOTE 8) 4,603 5,911
Other
long-term liabilities
62,778 17,227
Future
income taxes (NOTE 12)
93,069 29,649
SHAREHOLDERS'
EQUITY
Capital stock (NOTE 9) 170,145 163,174
Contributed surplus
4,145 117
Retained earnings
240,367 172,564
Foreign currency translation adjustment 71,534 49,428
----------- -----------
486,191 385,283
Lease
commitments (NOTE 8)
----------- -----------
$ 2,097,033 $ 2,059,214
=========== ===========
</TABLE>
See
accompanying notes to consolidated financial statements.
On
behalf of the Board
/s/
Isidore Philosophe
/s/ Lewis Ritchie
ISIDORE
PHILOSOPHE LEWIS
RITCHIE
Director Director
32
CINRAM ANNUAL REPORT 2004
<PAGE>
CONSOLIDATED
STATEMENTS OF EARNINGS AND RETAINED EARNINGS
(In
thousands of U.S. dollars, except per share amounts)
<TABLE>
<CAPTION>
Years ended December 31 2004 2003
----------------------------------------------------------------------- ----------- ---------
<S>
<C> <C>
Revenue
$ 2,026,638 $ 826,893
Cost of
goods sold
1,615,542 655,374
----------- ---------
Gross
profit
411,096 171,519
Selling,
general and administrative expenses 177,372 68,883
Amortization
of intangible assets and deferred financing fees
(NOTES 5 and 6)
73,038 11,449
Unusual
items (NOTE 11)
(1,713) 2,726
----------- ---------
Earnings
before the undernoted
162,399 88,461
Interest
on long-term debt 51,642 13,264
Other
interest
1,460 479
Investment
income
(2,436) (3,583)
----------- ---------
Earnings
before income taxes
111,733 78,301
Income
taxes (NOTE 12):
Current 24,555 10,107
Future
11,354 15,174
----------- ---------
35,909 25,281
----------- ---------
Net
earnings 75,824 53,020
Retained
earnings, beginning of year
172,564 124,340
Effect
of a change in accounting policy related to stock-based
compensation (NOTE 1(k)) (2,759) -
Dividends
declared
(5,262) (4,796)
----------- ---------
Retained
earnings, end of year
$ 240,367 $ 172,564
=========== =========
Earnings
per share:
Basic $ 1.34
$ 0.95
Diluted
1.32 0.94
=========== =========
Weighted
average number of shares outstanding (in thousands) (NOTE 10):
Basic
56,589 55,628
Diluted
57,514 56,612
=========== =========
</TABLE>
See
accompanying notes to consolidated financial statements.
CINRAM ANNUAL REPORT 2004 33
<PAGE>
CONSOLIDATED
STATEMENTS OF CASH FLOWS
(In
thousands of U.S. dollars)
<TABLE>
<CAPTION>
Years ended December
31
2004 2003
---------------------------------------------------------------------- ---- ----
<S>
<C> <C>
Cash
provided by (used in):
OPERATIONS
Net earnings $
75,824 $ 53,020
Items not involving cash:
Amortization
219,735 75,156
Future income taxes 11,354 15,174
Stock-based compensation
1,269 -
Gain on disposition of capital assets
(2,330) (146)
Unrealized foreign exchange loss (gain)
(5,391) 1,599
Change in non-cash operating working capital
(NOTE 16)
(171,061) 213,849
-------- ----------
129,400 358,652
FINANCING
Increase in long-term debt 48,000 1,025,000
Repayment of long-term debt
(239,530) (9,225)
Deferred financing fees
(2,250) (28,627)
Decrease in obligations under capital
leases
(1,885) (630)
Issuance of common shares
6,971 6,230
Change in other long-term liabilities 10,931 45
Dividends paid
(5,262) (4,796)
-------- ----------
(183,025) 987,997
INVESTMENTS
Acquisition, net of cash acquired of $1,437
(NOTE 2)
- (1,149,052)
Transaction costs relating to Time Warner
acquired businesses
(890) -
Purchase of capital assets
(145,704) (80,226)
Proceeds on disposition of capital
assets 4,015 960
Decrease (increase) in other assets
(12,523) 3,020
-------- ----------
(155,102) (1,225,298)
Foreign
exchange gain (loss) on cash held in foreign currencies (3,307) 28,485
-------- ----------
Increase
(decrease) in cash and cash equivalents (212,034) 149,836
Cash
and cash equivalents, beginning of year 253,823 103,987
-------- ----------
Cash
and cash equivalents, end of year $
41,789 $ 253,823
======== ==========
Supplemental
cash flow information:
Interest paid
$ 52,540 $ 8,954
Income taxes paid 35,455 17,193
======== ==========
</TABLE>
See
accompanying notes to consolidated financial statements.
34
CINRAM ANNUAL REPORTS 2004
<PAGE>
NOTES
TO THE CONSOLIDATED FINANCIAL STATEMENTS
(In
thousands of U.S. dollars, except common shares and per share information)
Years
ended December 31, 2004 and 2003
1. SIGNIFICANT ACCOUNTING POLICIES
(a)
BASIS OF PRESENTATION
These consolidated financial
statements include the accounts of
Cinram International Inc. (the
"Company") and its wholly owned
subsidiaries, and have been
prepared in accordance with Canadian
generally accepted accounting principles
(GAAP) and, except as
outlined in NOTE 19, are, in all
material respects, in accordance
with United States GAAP. The
results of subsidiaries acquired are
consolidated from the date of
acquisition. All intercompany balances
and transactions have been
eliminated on consolidation.
The Company has historically
prepared its consolidated financial
statements in Canadian dollars.
Beginning with the first quarter of
2004, the Company changed its
reporting currency to U.S. dollars to
provide the financial statement
users with more relevant
information. The Company used 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 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 shareholders' equity.
The functional currencies of the
Company and each of its
subsidiaries remained unchanged.
The functional currency of the
Company is the Canadian dollar. The
Company's operations in the
United States, the United Kingdom,
France, Germany and Mexico are
considered to be self-sustaining.
Assets and liabilities are
translated using year-end exchange
rates and revenue and expenses
are translated at 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 separate
component of shareholders' equity.
The Company's borrowings, as
outlined in NOTE 7, are denominated
in U.S. dollars and the majority
represent a hedge of the Company's
net investment in its U.S.
operations. The Company formally
assesses the hedge's effectiveness
at the beginning of each quarter.
Certain 2003 comparative figures
have been reclassified to conform
with the financial statement
presentation adopted in 2004.
(b)
REVENUE RECOGNITION
Revenue is comprised of product
sales and service revenue earned
from fulfillment services. Revenue
from product sales is recognized
upon shipment since title to the
goods is transferred to customers,
persuasive evidence of an
arrangement exists, the selling price is
fixed and determinable and
collectibility is reasonably assured.
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.
Services revenue is recognized as
services are performed.
(c)
INVENTORIES
Raw materials are stated at the
lower of cost, on a first-in
first-out basis, and replacement
cost. Finished goods and work in
process are stated at the lower of
cost and net realizable value.
Cost includes materials and an
application of relevant manufacturing
labour and overhead.
(d)
CAPITAL ASSETS
Capital assets 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 capital
assets 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 capital
assets are reflected in net
earnings.
CINRAM ANNUAL REPORT 2004 35
<PAGE>
NOTES
TO THE CONSOLIDATED FINANCIAL STATEMENTS
(In
thousands of U.S. dollars, except common shares and per share information)
Years
ended December 31, 2004 and 2003
Capital assets are amortized on a
straight-line basis, commencing
when the asset is entered into use.
Estimated useful lives for the
principal asset categories are as
follows:
<TABLE>
<S> <C>
Buildings 20 - 40
years
Machinery
and equipment 3 -
13 years
Computer
equipment 3
- 5 years
Furniture 5
years
Leasehold
improvements Over term
of lease
</TABLE>
(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 Company 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 is tested for
impairment annually, or
more frequently, if events or
changes in circumstances indicate that the
asset might
be impaired. 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,
in the same manner that
value of goodwill is determined
in a business
combination, 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
recorded at their fair
values less accumulated
amortization.
Amortization is provided on a
straight-line basis as
follows:
<TABLE>
<S>
<C>
Customer
supply agreements 6 years
Cross-licensing
agreements
1 year
</TABLE>
(f)
IMPAIRMENT OF LONG-LIVED ASSETS
The Company reviews capital 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, the
Company conducts its long-lived
asset assessment in the fourth
quarter to correspond with its
planning cycle. 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.
At December 31, 2004 and 2003, no
impairments in the carrying value
of these assets existed.
(g)
PENSION BENEFITS
The Company accrues its obligations
under employee 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 estimate 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.
36
CINRAM ANNUAL REPORT 2004
<PAGE>
(h)
ASSET RETIREMENT OBLIGATIONS
Effective January 1, 2004, the
Company retroactively adopted the
Canadian Institute of Chartered
Accountants' (CICA) Handbook
Section 3110, "Asset
Retirement Obligations" (Section 3110), which
establishes standards for the
recognition, measurement and
disclosure of liabilities for asset
retirement obligations and the
associated retirement costs.
Section 3110 applies to legal
obligations associated with the
retirement of tangible long-lived
assets that result from their
acquisition, lease, construction,
development or normal operation.
The Company 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 Company
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 statement of
earnings.
As at January 1, 2004, the Company
recorded a liability of $2,886
for the estimated present value of
the costs of retiring leasehold
improvements at the maturity of the
facility leases and recorded
deferred asset retirement costs of
$2,886. The following table
details the changes in the
leasehold retirement liability:
<TABLE>
<S> <C>
January
1, 2004 $2,886
Accretion
charges 177
------
December
31, 2004 $3,063
======
</TABLE>
The adjustment to leasehold
improvements in respect of asset
retirement costs is amortized into
income on a straight-line basis
over the remaining life of the
leases. For the year ended December
31, 2004, the Company recorded
amortization expense of $543 in cost
of sales. The impact of this new accounting
standard was not
material for 2003.
(i)
DEFERRED FINANCING FEES
The costs of obtaining bank and
other debt financings are deferred
and amortized on a straight-line
basis over the term of the related
debt or debt facilities to which
they relate.
(j)
DERIVATIVE FINANCIAL INSTRUMENTS
Derivative financial instruments
are utilized to reduce interest
rate risk on the Company's debt.
The Company does not enter into
financial instruments for trading
or speculative purposes.
The Company's policy is to formally
designate each derivative
financial instrument as a hedge of
a specifically identified debt
instrument. The Company believes
the derivative financial
instruments are effective as
hedges, both at inception and over the
term of the instrument; as the term
to maturity, the (notional)
principal amount and the interest
rate basis in the instruments all
match the