EXHIBIT 99.4
RISKS RELATED TO OUR BUSINESS
MANY OF OUR BUSINESS RISKS WILL BECOME MORE SIGNIFICANT IF WE ACQUIRE ARTISAN
ENTERTAINMENT.
If we acquire Artisan Entertainment, our assets and business will both
materially increase and our financial condition and results of operations will
be significantly and materially affected. Consequently, many of the business
risks we face that are described in this offering circular will become more
significant. In particular, our revenues, results of operations and the trading
price of the notes and Lions Gate's common share price may be subject to even
greater fluctuations. We intend to assume certain outstanding debt of Artisan
Entertainment, and any indebtedness incurred or assumed in any such transaction
may or may not increase our leverage relative to our earnings before interest,
income taxes, amortization, minority interests, gain on dilution of investment
in a subsidiary and discontinued operation, or EBITDA, or relative to our equity
capitalization.
Because we are subject to a confidentiality agreement and certain
confidentiality obligations under the merger agreement with Artisan
Entertainment, we are not providing you or any current investors in Lions Gate
with any confidential information, financial or otherwise, relating to Artisan
Entertainment or a combined Lions Gate and Artisan Entertainment. No such
information will be available until after the closing of this offering and we
are not offering holders of the notes rescission rights upon our public
disclosure of Artisan Entertainment financial information or pro forma financial
statements of a combined Lions Gate and Artisan Entertainment. We cannot assure
you that any information, financial or otherwise, of Artisan Entertainment that
is currently available is accurate or complete.
WE HAVE HAD LOSSES, AND WE CANNOT ASSURE FUTURE PROFITABILITY.
We have reported operating income for fiscal years 2000, 2001 and 2003
and operating losses for fiscal years 1999 and 2002. We have reported net income
for fiscal years 2001 and 2003 of $5.8 million and $1.1 million, respectively,
and net losses for fiscal years 1999, 2000 and 2002. Our accumulated deficit was
$122.2 million at September 30, 2003. We cannot assure you that we will continue
to operate profitably, and if we do not, we may not be able to meet our debt
service requirements, working capital requirements, capital expenditure plans,
anticipated production slate or other cash needs. The revenues and net income of
Cinegroupe, an animation company in which we have a 30% ownership and majority
voting power, have been declining for the past several years. These revenues and
income accounted for approximately 10% of our revenues and profit in fiscal 2003
and approximately 5% of revenue and did not generate a profit in the first six
months of fiscal 2004. If these declines continue, Cinegroupe will need to
consider alternatives including decrease in workforce, refinancings or
reorganization. Our inability to meet those needs could have a material adverse
effect on our business, results of operations and financial condition.
WE FACE SUBSTANTIAL CAPITAL REQUIREMENTS AND FINANCIAL RISKS.
Our business requires a substantial investment of capital. The
production, acquisition and distribution of motion pictures and television
programs require a significant amount of capital. A significant amount of time
may elapse between our expenditure of funds and the receipt of commercial
revenues from or government contributions to our motion pictures or television
programs. This time lapse requires us to fund a significant portion of our
capital requirements from our revolving credit facility and from other financing
sources. Although we intend to continue to reduce the risks of our production
1
exposure through financial contributions from broadcasters, distributors, tax
shelters, government and industry programs and other studios, we cannot assure
you that we will continue to implement successfully these arrangements or that
we will not be subject to substantial financial risks relating to the
production, acquisition, completion and release of future motion pictures and
television programs. If we increase (through internal growth or acquisition) our
production slate or our production budgets, we may be required to increase
overhead, make larger up-front payments to talent and consequently bear greater
financial risks. Any of the foregoing could have a material adverse effect on
our business, results of operations and financial condition.
Our substantial leverage could adversely affect our financial condition.
We are highly leveraged and expect to continue to be highly leveraged upon the
closing of this offering and upon the closing of the Artisan Entertainment
acquisition. Our primary source of capital is our revolving credit facility. The
amount we have available to borrow under this facility depends upon our
borrowing base, which in turn depends on the value of our existing library of
films and television programs, as well as accounts receivable and cash held in
collateral accounts. We have entered into a Commitment Letter with JPMorgan for
a new $350 million revolving credit facility that is scheduled to close
concurrently with the closing of the Artisan Entertainment acquisition. We
expect these same risks to be associated with the new facility. If several of
our larger motion picture productions are commercial failures or our library
declines in value, our borrowing base could decrease. Such a decrease could have
a material adverse effect on our business, results of operations and financial
condition. For example, it could:
- require us to dedicate a substantial portion of our cash flow to the
repayment of our indebtedness, reducing the amount of cash flow
available to fund motion picture and television production,
distribution and other operating expenses;
- limit our flexibility in planning for or reacting to downturns in our
business, our industry or the economy in general;
- limit our ability to obtain additional financing, if necessary, for
operating expenses, or limit our ability to obtain such financing on
terms acceptable to us; and
- limit our ability to pursue strategic acquisitions and other business
opportunities that may be in our best interests.
Our revolving credit facility contains certain covenants and financial
tests that limit the way we conduct business. Our revolving credit facility
contains, and we expect our replacement credit facility to contain, various
covenants limiting our ability to incur or guarantee additional indebtedness,
pay dividends and make other distributions, pre-pay any subordinated
indebtedness, repurchase preferred shares, make investments and other restricted
payments, make capital expenditures, make acquisitions and sell assets. These
covenants may prevent us from raising additional financing, competing
effectively or taking advantage of new business opportunities. Under our
revolving credit facility, we are also required to maintain specified financial
ratios and satisfy certain financial tests. If we cannot comply with these
covenants or meet these ratios or other tests, it could result in a default
under our revolving credit facility, and unless we are able to negotiate an
amendment, forbearance or waiver, we could be required to repay all amounts then
outstanding, which could have a material adverse effect on our business, results
of operations and financial condition. We expect our replacement credit facility
to contain similar covenants.
2
Borrowings under our revolving credit facility also are, and under our
new facility would be, secured by liens on substantially all of our assets and
the assets of our subsidiaries. If we are in default under one of these credit
facilities, the lenders could foreclose upon all or substantially all of our
assets and the assets of our subsidiaries. We cannot assure you that we will
generate sufficient cash flow to repay our indebtedness, and we further cannot
assure you that, if the need arises, we will be able to obtain additional
financing or to refinance our indebtedness on terms acceptable to us, if at all.
Any such failure to obtain financing could have a material adverse effect on our
business, results of operation and financial condition.
Budget overruns may adversely affect our business. Our business model
requires that we be efficient in the production of our motion pictures and
television programs. Actual motion picture and television production costs often
exceed their budgets, sometimes significantly. The production, completion and
distribution of motion pictures and television productions are subject to a
number of uncertainties, including delays and increased expenditures due to
creative differences among key cast members and other key creative personnel or
other disruptions or events beyond our control. Risks such as death or
disability of star performers, technical complications with special effects or
other aspects of production, shortages of necessary equipment, damage to film
negatives, master tapes and recordings or adverse weather conditions may cause
cost overruns and delay or frustrate completion of a production. If a motion
picture or television production incurs substantial budget overruns, we may have
to seek additional financing from outside sources to complete production. We
cannot make assurances regarding the availability of such financing on terms
acceptable to us, and the lack of such financing could have a material adverse
effect on our business, results of operations and financial condition.
In addition, if a motion picture or television production incurs
substantial budget overruns, we cannot assure you that we will recoup these
costs, which could have a material adverse effect on our business, results of
operations and financial condition. Increased costs incurred with respect to a
particular film may result in any such film not being ready for release at the
intended time and the postponement to a potentially less favorable time, all of
which could cause a decline in box office performance, and thus the overall
financial success of such film. Budget overruns could also prevent a picture
from being completed or released. Any of the foregoing could have a material
adverse effect on our business, results of operations and financial condition.
Production costs and marketing costs are rising at a faster rate than
increases in either domestic admissions to movie theatres or admission ticket
prices, leaving us more dependent on other media, such as home video, television
and foreign markets, and new media. If we cannot successfully exploit these
other media, it could have a material adverse effect on our business, results of
operations and financial condition.
OUR REVENUES AND RESULTS OF OPERATIONS MAY FLUCTUATE SIGNIFICANTLY.
Revenues and results of operations are difficult to predict and depend
on a variety of factors. Our revenues and results of operations depend
significantly upon the commercial success of the motion pictures and television
programming that we distribute, which cannot be predicted with certainty.
Accordingly, our revenues and results of operations may fluctuate significantly
from period to period, and the results of any one period may not be indicative
of the results for any future periods. In recent years, our revenues and results
of operations have been significantly impacted by the success of critically
acclaimed and award winning films, including Academy Award winners and nominees.
We cannot assure you that we will manage the production, acquisition and
distribution of future motion pictures as successfully as we have done with
these recent critically acclaimed and award winning films or that we will
produce or acquire
3
motion pictures that will receive similar critical acclaim or perform as well
commercially, which could have a material adverse effect on our business,
results of operations and financial condition.
We lack output agreements with cable and broadcast channels. We have an
agreement with one cable broadcast channel to exhibit our films, and that
agreement does not cover films released theatrically after 2003. While similar
broadcasters exhibit our films, they license such rights on a film-by-film,
rather than an output, basis. We cannot assure you that our one agreement will
be renewed or that we will be able to secure other output agreements on
acceptable terms, if at all. Without multiple output agreements that typically
contain guaranteed minimum payments, our revenues may be subject to greater
volatility, which could have a material adverse effect on our business, results
of operations and financial condition.
Our revenue sharing agreements might not be renewed. Our two revenue
sharing agreements with respect to the distribution of our library on home video
and DVD, one of which accounts for approximately 10% of our gross revenue,
expire in December 2004. The failure to renew these agreements on similar terms
could have a material adverse effect on our business, results of operations and
financial condition.
We rely on a few major customers in realizing our filmed and television
content library distribution revenues. A small number of retailers account for a
significant percentage of our filmed and television content library distribution
revenues. We do not have long-term agreements with any of these customers. We
cannot assure you that we will continue to maintain favorable relationships with
these customers or that they will not be adversely affected by economic
conditions. If any of these customers reduces or cancels a significant order, it
could have a material adverse effect on our business, results of operations and
financial condition.
Our revenues and results of operations are vulnerable to currency
fluctuations. We report our revenues and results of operations in U.S. dollars,
but a significant portion of our revenues is earned outside of the United
States. Our principal currency exposure is between Canadian and U.S. dollars,
although this exposure is partially mitigated through the structuring of our
revolving credit facility as a Canadian dollar facility and a U.S. dollar
facility. Each facility is borrowed and repaid in the respective country of
origin, in local currency. We cannot accurately predict the impact of future
exchange rate fluctuations between the Canadian dollar and the U.S. dollar or
other foreign currencies on revenues and operating margins, and fluctuations
could have a material adverse effect on our business, results of operations and
financial condition.
From time to time we may experience currency exposure on distribution
and production revenues and expenses from foreign countries, which could have a
material adverse effect on our business, results of operations and financial
condition.
Accounting practices used in our industry may accentuate fluctuations in
operating results. In addition to the cyclical nature of the entertainment
industry, our accounting practices (which are standard for the industry) may
accentuate fluctuations in our operating results. In accordance with Canadian
generally accepted accounting principles and industry practice, we amortize film
and television programming costs using the "individual-film-forecast" method.
Under this accounting method, we amortize film and television programming costs
for each film or television program based on the following ratio:
4
Revenue earned by title in the current period
Estimated total revenues by title
We regularly review, and revise when necessary, our total revenue
estimates on a title-by-title basis. This review may result in a change in the
rate of amortization and/or a write-down of the film or television asset to
estimated fair value. Results of operations in future years depend upon our
amortization of our film and television costs. Periodic adjustments in
amortization rates may significantly affect these results. In addition, we are
required to expense film advertising costs as incurred, but are also required to
recognize the revenue from any motion picture or television program over the
entire revenue stream expected to be generated by the individual picture or
television program.
FAILURE TO MANAGE FUTURE GROWTH MAY ADVERSELY AFFECT OUR BUSINESS.
We are subject to risks associated with pending and other possible
acquisitions, business combinations, or joint ventures, including our pending
acquisition of Artisan Entertainment. From time to time we engage in discussions
and activities with respect to possible acquisitions, business combinations, or
joint ventures intended to complement or expand our business. We are actively
pursuing several potential acquisitions or business combinations, including our
pending acquisition of Artisan Entertainment. We may not realize the anticipated
benefit from any of the transactions we are pursuing. Regardless of whether we
consummate any such transaction, the negotiation of the potential transaction as
well as the integration of the acquired business could require us to incur
significant costs and cause diversion of management's time and resources. Any
such transaction could also result in impairment of goodwill and other
intangibles, development write-offs and other related expenses. Any of the
foregoing could have a material adverse effect on our business, results of
operations and financial condition.
We may be unable to integrate any business that we acquire or with which
we combine. Integrating any business that we acquire or with which we combine,
including a company the size of Artisan Entertainment, will be distracting to
our management and disruptive to our business and may result in significant
costs to us. We may face challenges in consolidating functions and integrating
procedures, information technology and accounting systems, personnel and
operations in a timely and efficient manner. If any such integration is
unsuccessful, or if the integration takes longer than anticipated, there could
be a material adverse effect on our business, results of operations and
financial condition. We may have difficulty managing the combined entity in the
short term if we experience a significant loss of management personnel during
the transition period after the acquisition.
Claims against us relating to any acquisition or business combination
may necessitate our seeking claims against the seller for which the seller may
not indemnify us or that may exceed the seller's indemnification obligations.
There may be liabilities assumed in any acquisition or business combination,
including our possible acquisition of Artisan Entertainment, that we did not
discover or that we underestimated in the course of performing our due diligence
investigation. Although a seller generally will have indemnification obligations
to us under an acquisition or merger agreement, these obligations usually will
be subject to financial limitations, such as general deductibles and maximums,
as well as time limitations. We cannot assure you that our right to
indemnification from any seller will be enforceable, collectible or sufficient
in amount, scope or duration to fully offset the amount of any undiscovered or
underestimated liabilities that we may incur. Any such liabilities, individually
or in the aggregate, could have a material adverse effect on our business,
results of operations and financial condition.
5
We may not be able to obtain additional funding to meet our
requirements. Our ability to grow through acquisitions, business combinations
and joint ventures, to maintain and expand our development, production and
distribution of motion pictures and television programs and to fund our
operating expenses depends upon our ability to obtain funds through equity
financing, debt financing (including credit facilities) or the sale or
syndication of some or all of our interests in certain projects or other assets.
If we do not have access to such financing arrangements, and if other funding
does not become available on terms acceptable to us, there could be a material
adverse effect on our business, results of operations and financial condition.
OUR ABILITY TO EXPLOIT OUR FILMED AND TELEVISION CONTENT LIBRARY MAY BE LIMITED.
A significant portion of our filmed and television content library
revenues comes from a small number of titles. We depend on a limited number of
titles for the majority of the revenues generated by our filmed and television
content library. In addition, many of the titles in our library are not
presently distributed and generate substantially no revenue. If we cannot
acquire new product and the rights to popular titles through production,
distribution agreements, acquisitions, mergers, joint ventures or other
strategic alliances, it could have a material adverse effect on our business,
results of operations and financial condition.
We are limited in our ability to exploit a portion of our filmed and
television content library. Our rights to the titles in our filmed and
television content library vary; in some cases we have only the right to
distribute titles in certain media and territories for a limited term. We cannot
assure you that we will be able to renew expiring rights on acceptable terms,
and any such failure could have a material adverse effect on business, results
of operations and financial condition.
OUR SUCCESS DEPENDS ON EXTERNAL FACTORS IN THE MOTION PICTURE AND TELEVISION
INDUSTRY.
Our success depends on the commercial success of motion pictures and
television programs, which is unpredictable. Operating in the motion picture and
television industry involves a substantial degree of risk. Each motion picture
and television program is an individual artistic work, and unpredictable
audience reactions primarily determine commercial success. Generally, the
popularity of our motion pictures or programs depends on many factors, including
the critical acclaim they receive, the format of their initial release, for
example, theatrical or direct-to-video, the actors and other key talent, their
genre and their specific subject matter. The commercial success of our motion
pictures or television programs also depends upon the quality and acceptance of
motion pictures or programs that our competitors release into the marketplace at
or near the same time, critical reviews, the availability of alternative forms
of entertainment and leisure activities, general economic conditions and other
tangible and intangible factors, many of which we do not control and all of
which may change. We cannot predict the future effects of these factors with
certainty, any of which factors could have a material adverse effect on our
business, results of operations and financial condition.
In addition, because a motion picture's or television program's
performance in ancillary markets, such as home video and pay and free
television, is often directly related to its box office performance or
television ratings, poor box office results or poor television ratings may
negatively affect future revenue streams. Our success will depend on the
experience and judgment of our management to select and develop new investment
and production opportunities. We cannot make assurances that our motion pictures
and television programs will obtain favorable reviews or ratings, that our
motion pictures will
6
perform well at the box office or in ancillary markets or that broadcasters will
license the rights to broadcast any of our television programs in development or
renew licenses to broadcast programs in our library. The failure to achieve any
of the foregoing could have a material adverse effect on our business, results
of operations and financial condition.
Licensed distributors' failure to promote our programs may adversely
affect our business. Licensed distributors' decisions regarding the timing of
release and promotional support of our motion pictures, television programs and
related products are important in determining the success of these pictures,
programs and products. As with most companies engaging in licensed distribution,
we do not control the timing and manner in which our licensed distributors
distribute our motion pictures or television programs. Any decision by those
distributors not to distribute or promote one of our motion pictures, television
programs or related products or to promote our competitors' motion pictures,
television programs or related products to a greater extent than they promote
ours could have a material adverse effect on our business, results of operations
and financial condition.
We could be adversely affected by strikes or other union job actions.
The motion picture and television programs that we produce generally employ
actors, writers and directors who are members of the Screen Actors Guild,
Writers Guild of America and Directors Guild of America, respectively, pursuant
to industry-wide collective bargaining agreements. The collective bargaining
agreement with the Writers Guild of America was successfully renegotiated and
became effective as of May 2, 2001 for a term of three years. The collective
bargaining agreements with the Screen Actors Guild and Directors Guild of
America were each successfully renegotiated and became effective as of July 1,
2002 for terms of three years. Many productions also employ members of a number
of other unions, including, without limitation, the International Alliance of
Theatrical and Stage Employees, the Teamsters and the Alliance of Canadian
Cinema, Television and Radio Artists. A strike by one or more of the unions that
provide personnel essential to the production of motion pictures or television
programs could delay or halt our ongoing production activities. Such a halt or
delay, depending on the length of time, could cause a delay or interruption in
our release of new motion pictures and television programs, which could have a
material adverse effect on our business, results of operations and financial
condition.
WE FACE SUBSTANTIAL COMPETITION IN ALL ASPECTS OF OUR BUSINESS.
We are smaller and less diversified than many of our competitors. As an
independent distributor and producer, we constantly compete with major U.S. and
international studios. Most of the major U.S. studios are part of large
diversified corporate groups with a variety of other operations, including
television networks and cable channels, that can provide both the means of
distributing their products and stable sources of earnings that may allow them
better to offset fluctuations in the financial performance of their motion
picture and television operations. In addition, the major studios have more
resources with which to compete for ideas, storylines and scripts created by
third parties as well as for actors, directors and other personnel required for
production. The resources of the major studios may also give them an advantage
in acquiring other businesses or assets, including film libraries, that we might
also be interested in acquiring. The foregoing could have a material adverse
effect on our business, results of operations and financial condition.
The motion picture industry is highly competitive and at times may
create an oversupply of motion pictures in the market. The number of motion
pictures released by our competitors, particularly the major U.S. studios, may
create an oversupply of product in the market, reduce our share of box office
receipts and
7
make it more difficult for our films to succeed commercially. Oversupply may
become most pronounced during peak release times, such as school holidays and
national holidays, when theatre attendance is expected to be highest. For this
reason, and because of our more limited production and advertising budgets, we
typically do not release our films during peak release times, which may also
reduce our potential revenues for a particular release. Moreover, we cannot
guarantee that we can release all of our films when they are otherwise
scheduled. In addition to production or other delays that might cause us to
alter our release schedule, a change in the schedule of a major studio may force
us to alter the release date of a film because we cannot always compete with a
major studio's larger promotion campaign. Any such change could adversely impact
a film's financial performance. In addition, if we cannot change our schedule
after such a change by a major studio because we are too close to the release
date, the major studio's release and its typically larger promotion budget may
adversely impact the financial performance of our film. The foregoing could have
a material adverse effect on our business, results of operations and financial
condition.
The limited supply of motion picture screens compounds this product
oversupply problem. Currently, a substantial majority of the motion picture
screens in the U.S. typically are committed at any one time to only 10 to 15
films distributed nationally by major studio distributors. In addition, as a
result of changes in the theatrical exhibition industry, including
reorganizations and consolidations and the fact that major studio releases
occupy more screens, the number of screens available to us when we want to
release a picture may decrease. If the number of motion picture screens
decreases, box office receipts, and the correlating future revenue streams, such
as from home video and pay and free television, of our motion pictures may also
decrease, which could have a material adverse effect on our business, results of
operations and financial condition.
Technological advances may reduce our ability to exploit our motion
pictures and television programs. The entertainment industry in general and the
motion picture industry in particular continue to undergo significant
technological developments, including video-on-demand. This rapid growth of
technology combined with shifting consumer tastes could change how consumers
view our motion pictures and television programs. For example, an increase in
video-on-demand could decrease home video rentals. Other larger entertainment
distribution companies will have larger budgets to exploit these growing trends.
While we have an interest in CinemaNow, it is a company in its infancy whose
commercial success is impossible to predict. We cannot predict how we will
financially participate in the exploitation of our motion pictures and
television programs through these emerging technologies or whether we have the
right to do so for certain of our library titles. If we cannot successfully
exploit these and other emerging technologies, it could have a material adverse
effect on our business, results of operations and financial condition.
THE LOSS OF KEY PERSONNEL COULD ADVERSELY AFFECT OUR BUSINESS.
Our success depends to a significant degree upon the efforts,
contributions and abilities of our senior management. Although we have
employment agreements with many of our key personnel, 10 employment agreements
with senior management have expired or will expire within one year from the date
of this offering circular and such agreements must be renegotiated. In addition,
the employment agreement of Mr. Burns, our Vice Chairman, has expired. Although
he is employed on a month-to-month basis, his employment agreement has been
renegotiated and formal documentation is currently being finalized. We cannot
assure you that the services of our key personnel will continue to be available
to us or that we will be able to successfully renegotiate such employment
agreements. The loss of services of any of these
8
employees could have a material adverse effect on our business, results of
operations and financial condition.
WE FACE RISKS FROM DOING BUSINESS INTERNATIONALLY.
We distribute motion picture and television productions outside the
United States and Canada through third party licensees and derive revenues from
these sources. As a result, our business is subject to certain risks inherent in
international business, many of which are beyond our control. These risks
include:
- changes in local regulatory requirements, including restrictions
on content;
- changes in the laws and policies affecting trade, investment and
taxes, including laws and policies relating to the repatriation
of funds and to withholding taxes;
- differing degrees of protection for intellectual property;
- instability of foreign economies and governments;
- cultural barriers;
- wars and acts of terrorism; and
- the spread of severe acute respiratory syndrome, or SARS.
Any of these factors could have a material adverse effect on our business,
results of operations and financial condition.
PROTECTING AND DEFENDING AGAINST INTELLECTUAL PROPERTY CLAIMS MAY HAVE A
MATERIAL ADVERSE EFFECT ON OUR BUSINESS.
Our ability to compete depends, in part, upon successful protection of
our intellectual property. We do not have the financial resources to protect our
rights to the same extent as major studios. We attempt to protect proprietary
and intellectual property rights to our productions through available copyright
and trademark laws and licensing and distribution arrangements with reputable
international companies in specific territories and media for limited durations.
Despite these precautions, existing copyright and trademark laws afford only
limited practical protection in certain countries. We also distribute our
products in other countries in which there is no copyright or trademark
protection. As a result, it may be possible for unauthorized third parties to
copy and distribute our productions or certain portions or applications of our
intended productions, which could have a material adverse effect on our
business, results of operations and financial condition.
Litigation may also be necessary in the future to enforce our
intellectual property rights, to protect our trade secrets, or to determine the
validity and scope of the proprietary rights of others or to defend against
claims of infringement or invalidity. Any such litigation could result in
substantial costs and the diversion of resources and could have a material
adverse effect on our business, results of operations and financial condition.
We cannot assure you that infringement or invalidity claims will not materially
adversely affect our business, results of operations and financial condition.
Regardless of the validity or the success of the assertion of these claims, we
could incur significant costs and diversion of resources in
9
enforcing our intellectual property rights or in defending against such claims,
which could have a material adverse effect on our business, results of
operations and financial condition.
PIRACY OF MOTION PICTURES, INCLUDING DIGITAL AND INTERNET PIRACY, MAY REDUCE THE
GROSS RECEIPTS FROM THE EXPLOITATION OF OUR FILMS.
Motion picture piracy is extensive in many parts of the world, including
South America, Asia, the countries of the former Soviet Union and other former
Eastern bloc countries. Additionally, as motion pictures begin to be digitally
distributed using emerging technologies such as the internet and online
services, piracy could become more prevalent, including in the U.S., because
digital formats are easier to copy. As a result, users can download and
distribute unauthorized copies of copyrighted motion pictures over the internet.
In addition, there could be increased use of devices capable of making
unauthorized copies of motion pictures. As long as pirated content is available
to download digitally, many consumers may choose to download such pirated motion
pictures rather than pay to view motion pictures. Piracy of our films may
adversely impact the gross receipts received from the exploitation of these
films, which could have a material adverse effect on our business, results of
operations and financial condition.
WE ARE DEFENDING AGAINST A LITIGATION CLAIM WHICH IF RESOLVED ADVERSELY TO US
COULD HAVE A MATERIAL ADVERSE AFFECT ON US.
We are currently involved in an arbitration proceeding with The Funny
One LLC, which alleges, among other things, that we caused it substantial harm
by failing to release a film theatrically that it produced. The Funny One LLC
further maintains that we were contractually obligated to do so and has claimed
damages of up to $35 million. The Funny One LLC alleges that had we released the
film theatrically, it would have achieved the commercial success of a film that
was similar in genre. We do not believe, and have denied that, we had an
obligation to release the film theatrically and we have also denied that it
would have also achieved the commercial success of a film similar in genre. We
have asserted that we maximized revenue for The Funny One LLC based on the
manner in which we released the film, and therefore, The Funny One LLC has not
been damaged. Closing arguments were held in October 2003 and a final ruling is
expected in the third quarter. Failure to prevail in this matter could have a
material adverse effect on our business, results of operation and financial
condition.
WE MAY LOSE CERTAIN BENEFITS BY FAILING TO MEET CERTAIN CANADIAN REGULATORY
REQUIREMENTS.
We may lose investment funds, tax credits and other benefits if we fail
to meet Canadian regulatory requirements. Certain programs that we produce are
contractually required to be "Canadian content" programs in accordance with the
requirements established from time to time by the Canadian Radio-Television and
Telecommunications Commission, or CRTC, the Canadian Audio-Visual Certification
Office, the Income Tax Act (Canada) and the regulations thereunder. If a program
does not qualify under the applicable requirements, we would be in default of
our commitments made in connection with these contracts. Any default on these
commitments could result in the reduction or elimination of license fees from
the Canadian broadcasters, reduced or eliminated government incentives and/or
future ineligibility for Canadian government incentive programs.
The Canadian federal government and a number of its provincial
counterparts have established refundable tax credit programs based on eligible
labor expenditures of qualifying production entities. We expect that certain of
our motion picture and television productions will incorporate these refundable
tax
10
credits as elements of production financing. If such productions do not
ultimately qualify for anticipated refundable tax credits, the relevant
production may require additional funds for completion, which may not be
available from other sources.
For our motion picture and television productions to continue to qualify
for several refundable tax credits, we must remain Canadian-controlled pursuant
to the Investment Canada Act (Canada), or ICA, among other statutory
requirements. The ICA is administered by the Minister of Industry and, in the
case of investments that are cultural in nature, by the Minister of Canadian
Heritage. The ICA contains rules, the application of which determines whether an
entity (as the term is defined in the ICA) is Canadian-controlled. Under these
rules, an entity is presumed to be a non-Canadian in certain circumstances,
including where Canadians own less than a majority of voting interests of an
entity. This presumption may be rebutted, for example, if a corporation
establishes that it is not controlled in fact through the ownership of its
voting interests and that two-thirds of the members of its board of directors
are Canadians.
Although we believe we are currently a Canadian-controlled entity under
the ICA, there can be no assurance that the Minister of Canadian Heritage will
not determine that we are out of compliance with the ICA, or that events beyond
our control will not result in our ceasing to be Canadian-controlled pursuant to
the ICA. The ICA provides the Minister of Canadian Heritage with discretion to
make a determination that an entity engaged in a business activity prescribed
under the ICA as relating to Canada's cultural heritage or national identity
(which includes a business engaged in the production, distribution, sale or
exhibition of film or video products, hereinafter referred to as a "cultural
business") is not a Canadian-controlled entity, if the Minister is satisfied,
after considering any information or evidence submitted by the entity or
otherwise made available to the Minister or the Director of Investments, that
the entity is controlled in fact by one or more non-Canadians. If we cease to be
Canadian-controlled under the ICA, we would no longer qualify for or be entitled
to access these refundable tax credits and other Canadian government and private
motion picture industry incentives that are restricted to Canadian-controlled
corporations, including the ability to produce under Canada's official
co-production treaties with other countries.
Such a change in status would require us to return tax credits
previously received, reducing our cash balance. In addition, because under
Canadian GAAP tax credits were included in revenues prior to March 31, 2003, we
would take a charge to earnings for any tax credits received prior to March 31,
2003 in the period in which the change in status was determined. From April 1,
2003, tax credits for all new series or productions will be recorded as an
offset to investment in films and television programs and any returned tax
credits would increase such investment in films and television programs in the
period in which the change in status was determined. There are currently no
transfer restrictions on our common shares as a class, and we accordingly may
not be able to prevent an acquisition of control by non-Canadians. In addition,
certain provincial refundable tax credits require that the applicant be
provincially controlled. If any of our affiliates that accesses or intends to
access such credits ceases to be provincially controlled, we would no longer be
entitled to access the applicable provincial refundable tax credit.
For all of the foregoing reasons, the loss of our Canadian status could
have a material adverse effect on our business, results of operations and
financial condition.
We face other risks in obtaining production financing from private and
other international sources. For some productions, we finance a portion of our
production budgets from incentive programs from such agencies as Telefilm
Canada, as well as international sources in the case of our international treaty
co-productions. There can be no assurance that local cultural incentive programs
that we may access in
11
Canada and internationally, as a result of our Canadian-controlled status, will
not be reduced, amended or eliminated. Any change in policies in connection with
incentive programs may have an adverse impact on us. In addition, we could lose
our ability to exploit such incentive programs in Canada if we cease to qualify
as "Canadian." Certain programs produced by us will be contractually required to
be certified as "Canadian Film and Video Production." If a program does not
qualify for such certification, we would be in default on commitments made in
connection with government incentive programs and licenses to
broadcasters/distributors. In addition, to the extent we do not qualify as
"Canadian" as a result of a merger, an acquisition or an unconstrained share
transfer to one or more non-Canadians, we would no longer qualify for such
incentives/tax credits and may be liable to repay certain benefits to the
applicable authorities. The foregoing could have a material adverse effect on
our business, results of operations and financial condition.
An investment by non-Canadians in our business is potentially reviewable
by the Minister of Canadian Heritage. Under the ICA, the Minister of Canadian
Heritage has discretion to determine, after considering any information or
evidence submitted by the entity or otherwise made available to the Minister or
the Director of Investments, that an investment by a non-Canadian in a cultural
business may constitute an acquisition of control by that non-Canadian,
notwithstanding the provisions in the ICA that state that certain investments do
not or may not constitute an acquisition of control that would require
notification or review under the ICA. In the event that the Minister of Canadian
Heritage exercises her discretion and deems an investment by a non-Canadian in a
cultural business to be an acquisition of control, the investment is potentially
subject to notification and/or review. If the investment is subject to review,
the Minister must be satisfied that the investment is likely to be of net
benefit to Canada. Such a determination is often accompanied by requests that
the non-Canadian provide undertakings supportive of Canadian cultural policy.
These undertakings may, in some circumstances, include a request for financial
support of certain initiatives. The determination by the Minister of whether a
proposed investment is of net benefit to Canada also includes consideration of
sector specific policies of the Canadian federal government. One such policy
prohibits takeovers of Canadian owned and controlled film distribution
businesses by non-Canadians. This prohibition is not contained in the ICA nor in
the regulations made under the ICA, but is a separate foreign investment policy
relating to the Canadian film distribution sector. If an investment by a
non-Canadian in our business is deemed by the Minister to be an acquisition of
control and ultimately subject to review, the current policy of the Canadian
federal government prohibiting the takeover of a Canadian owned and controlled
film distribution business would be applied in the context of the Minister's
determination of whether the proposed investment would be of net benefit to
Canada, with the result that the Company's film distribution business in Canada
may have to be divested to a Canadian purchaser, which could have a material
adverse effect on our business, results of operations and financial condition.
A failure to meet Canadian programming restrictions may decrease the
time slots or amount of license fees and incentive programs available to us.
Canadian broadcasters, including all conventional, specialty and television
services, are typically required, as a condition of their license, to broadcast
significant minimum amounts of Canadian content programming on their overall
schedule and in prime time. The CRTC enforces compliance with these
requirements, and failure to comply can result in fines or in the revocation of
a broadcaster's license, or more restrictive terms on license renewal. The CRTC
has issued detailed criteria that must be met for a television production to
qualify as a "Canadian program." The criteria require, among other things, that
Canadians perform a minimum level of key creative functions and that specified
minimum production costs be paid to Canadians or Canadian companies. If our
productions cease to qualify as Canadian programs under existing CRTC
regulations, or if these regulations
12
should change on further review by the CRTC, we may find it more difficult to
secure time slots in Canada for our productions, or the amount of the license
fees we may generate in Canada may decrease if our programs do not qualify as
Canadian programs. In addition, if our productions cease to meet minimum
Canadian content requirements, we may be unable to access various federal and
provincial motion picture and television incentive programs, including
refundable tax credits, as discussed below. There could be a material adverse
effect on our business, results of operations and financial condition if any
change in the policies of the Canadian or provincial governments in connection
with their incentive programs occurs.
13