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Executives

Rich Gelfond - CEO

Greg Foster - Chairman & President, Filmed Entertainment

Analysts

Ben Swinburne - Morgan Stanley

IMAX Corporation (IMAX) Morgan Stanley Technology, Media & Telecom Conference Call February 25, 2013 4:20 PM ET

Ben Swinburne - Morgan Stanley

Okay, good afternoon everybody. My name is Ben Swinburne; I am Morgan Stanley’s Media Analyst. We are thrilled to have with us from IMAX, Rich Gelfond, the CEO. Rich has been Chief Executive at IMAX since April 2009 and co-CEO since May of 1996 and Greg Foster, Chairman and President of the Filmed Entertainment business responsible for seeing all aspects of the company's global film business and thank you Rich and Greg for coming back again this year. Thanks for being here.

Rich Gelfond

Thanks.

Ben Swinburne - Morgan Stanley

Maybe at a high level we could start out with just a brief overview of the growth opportunity in front of IMAX today, as you guys see it looking out over the next couple of years and particularly have the businesses evolving on the revenue front.

Rich Gelfond

Sure. So IMAX is, let me just talk about the business model for a second and then talk about the growth opportunities. IMAX has a dual revenue stream. When an IMAX theater opens anywhere in the world there is one or two models, either we lease the system for an upfront gross margin of around 50% or we joint venture with a partner and where we joint venture with a partner, we put up the equipment at a cost of around $0.5 million and we get roughly 20% from the exhibitors. So one side of the revenue equation is what we get paid by the exhibitor and when I say 20% that's of the gross box office.

The other side of the equation is we take Hollywood movies or increasingly movies in different countries and we convert them into IMAX either originally by filming them with the IMAX cameras or we have proprietary algorithms that turn them into IMAX and we get roughly 12.5% of the box office from the studio for doing that. The only reason I said roughly as it could vary in certain countries.

But in general, if you think about the model, we don't put up the cost of making the movie; we don't market the movie in general, but we build the infrastructure of the theater and we put up the capital to convert the movie and we make around the third of the box office where we have these joint venture attributes. So that's the model at kind of a micro level.

At a macro level it’s really a question of scale for IMAX. So it just depends on, since the cost of converting a movie or using our proprietary equipment as a fixed cost the more theaters you open, the larger the revenue base and the larger the recurring revenue base. So just to give you a perspective on our growth, in the year 2009 when we played, was it ’08 or ’09?

Greg Foster

’08.

Rich Gelfond

2008 when we played The Dark Knight, Chris Nolan’s movie, we had a 150 commercial theaters in the world and when we played The Dark Knight Rises, in 2012, we had roughly 550 commercial theaters and its now around 600. So the network has quadrupled grown on a 25% to 30% compound rate over that period of time. And when you look at the financial characteristics over that period of time gross margins have expanded, EPS has expanded, EBITDA expands and the way the closest analogy I can think of is like an HBO which has a fixed cost of content and as its subscriber base grows, obviously a lot more cash goes to the bottomline. So that's sort of a simple way to look at it from a high level as a business model.

In terms of opportunities around the world, as I said we have around 600 commercial theaters opened right now in 53 countries. We have that target market today of around 1700 theaters in the world; that number gets analyzed on a yearly basis and as the developing economies continue to develop generally that number has been going up over the last couple of years. So if you want to boil down the answer to it's simplest terms, we want to try and grab the network as quickly as we can in different markets and we want to continue to choose both Hollywood and other movies that will increase the per screen averages at the box office.

Ben Swinburne - Morgan Stanley

I think it was a year ago, right around this time when the WTO announcement around China had just happened. I think it was roughly around here and we've been talking about China as an opportunity for the media industry for many years, but not a lot of dollars; it feels like it's actually started to turn particularly for you. Can you talk about that market and then maybe we could touch on Russia next for IMAX?

Rich Gelfond

Yeah, I mean China has been a very good market for IMAX. We as a company and we personally started to go in China about 15 years ago, before really western companies were going there and one of the reasons was at that time IMAX played mostly bears, whales and seals kinds of movies. So it felt culturally safe to me. It's so like we were waiting into a battle over US, however, Hollywood, it wasn’t that controversial.

So we built relationships over really the next decade. We built theaters out over the next decade and as we started to transition our strategy away from these documentary films towards Hollywood films, we had a lot of relationships in China, both with the government and with private enterprise, as well as with state-owned enterprises and that enabled us because they have gotten to know us and we created win-win situations and enabled us to have a lot friends there and a lot of people supported it and maybe more importantly we understood the meaning of a win-win relationship.

So we weren’t in China for the short run. We were in China for the long-term and we made movies in China. We had plans to distribute Chinese movies outside of China to the United States and we even have one playing in Russia right now. We have figured out a way to meet their needs while they can meet our needs and that’s paid off for us extremely well. We now have a 104 theatres open in Greater China. We have a 130 in backlog; just as we can, The Hobbit opened in China and we did about $2.1 million or about 12% of the whole box office in the country on our 104 screens versus there were about 3000 screens there.

To give another sense of China, we are now doing five or six movies a year in China, local Chinese movies ones that your kids probably wouldn’t have know the names of, but nonetheless they are contributing nicely in revenue, so we had a movie last weekend called the Journey West, we played it for like 10 days; it did $7 million; its now around $8 million in box office in China, we think it will sort of end up at $10 million. So it’s really worked nicely for hand in hand and you know I do think it’s possible for media companies to make money in China; I think you just have to put the timing and you have to make sure not just talk to talk but it really has to be a win-win situation.

Ben Swinburne - Morgan Stanley

You did the thing on your earnings call last week, but how are your economics in China today; per screen averages versus the rest last of your portfolio; where do you see that going?

Rich Gelfond

Well, China had been at the high end of our portfolio in terms of per screen averages, but last year there were a number of interesting things that happened both good and bad and it turned out the best thing to happen probably turned into the worst thing that happened last year. And the best thing was the WTO agreement was made and announced, there used to be only 20 films that would allow Hollywood films that can be played in China, but the new agreement allowed an additional 14 films as long as those films were “IMAX or 3D” films like they literally named our company as having a special allocation under the quota. And what happened was, so many films got in the first half of the year and they did so well that in fact by June or July about 80% of the Chinese box office was Hollywood films and only 20% of the revenues were from Chinese films.

So in the second half of the year, the Chinese government really restricted the number of U.S. films that could come into the country and those that they did allow and it something called double-dating, and so they took like The Dark Night Rises and Spiderman and they booked on the same weekend in an effort to kind of keep down the U.S. box office and keep up the Chinese box office. So the ways we responded to that by doing more Chinese films which we’re doing, we did last year and we are doing this year and they are performing fairly well.

And the second thing is, in the world of unattended consequences, while the Chinese were hoping to keep the U.S. box office down, they also kept their overall box office down. So people just weren't going to the movies, and they weren’t go to shopping malls and they weren't going to entertainment and we all know that for the Chinese government there are many agendas and having more Chinese films is one of them and an interesting one, but probably keeping the economy going is a more interesting one and getting people in shopping malls.

So this year they have gone the other way and so Hobbit was played separately from Skyfall which is played a couple of weeks ago with some Chinese films in the middle. So I believe overtime, it will go back to a more normal place, those of who do any business in China know its not an exact predictable place, they are always ups and downs, but I think the trend lines are the right way, so whereas last year it was lower than the year before I would think and hope with our response about more Chinese films and with the changes in programming that we will hit back our previous levels.

Ben Swinburne - Morgan Stanley

Greg, let me shifting gears over on to the theatrical production side, we just add Michael Burns before us (inaudible) I think Catching Fire. Of course he mentioned you guys positively. What's the impact of director shooting with IMAX cameras on the business and why is that an important part of what you are seeing in terms of film production in the US?

Greg Foster

So everything that we try to do is to enhance the experience and to preferably differentiate it with IMAX front and center. And part of that is because we are premium ticket priced and so to justify the cost for the consumer in terms of spending that extra amount, we want them to have an experience that makes sense.

And on the other hand, it’s to create an experience that elevates the movie overall. So what we've seen and so much of it has been driven by the filmmaker support that we have and we work with basically 15 or 20 filmmakers, that's about it. And once they get into the mix, they tend to keep coming back for more, so for instance we did Hunger Games 1 now as Michael mentioned, we are doing Hunger Games 2 and a big portion of it is shooting with our cameras.

Same thing is true for J.J. Abrams and all the movies that he does including the next Star Trek which comes out in May and a good portion of the movie whenever they are outside of the enterprise used our cameras. Chris Nolan shoots all of his movies with IMAX and that's again the reason why its valuable not only for us but for the film is because you have to justify a blockbuster these days with blockbuster content.

It has to really be something that you can't get anywhere else and the DNA of our camera in terms of the resolution that it provides, in terms of the way that you can use the extra boost of energy from a marketing point of view to elevate that film in the marketplace is really critical.

Blockbusters tend to come out within a similar timeframe. They come out of it in spring break, they come out during summer, they come out on Thanksgiving or they come out at Christmas and so what we think happens with a movie like Skyfall for instance which used the specially formatted IMAX aspect ratio to have the entire screen in IMAX with image about 26% more image than in a regular screen. It was a clutter buster.

It separated Skyfall from the rest of the movies in the marketplace. Maybe it’s a coincidence, maybe it’s just a part of the contribution but the last James Bond movie was the highest grossing Bond movie that had ever come out. Domestically, it did about $165 million. This one went over $300 million.

Same thing can be said about Mission Impossible 4: Ghost Protocol. The last one did a $135 million to $140 million prior to 4. Ghost Protocol or 4 was shot with IMAX cameras. It went over $200 million. So there's a tendency and we think Star Trek will be the same way.

When our cameras are used, it again just provides an extra level of box office and marketing energy that helps the film and of course also helps us by differentiating that content.

Ben Swinburne - Morgan Stanley

I want to ask about actually the technology, that's the key point of the company obviously, in your backlog I think the outlook is mostly for digital and then I think you are also working on laser projectors, can you talk about the evolution of the actual screen experience as it relates to IMAX?

Rich Gelfond

Sure, so I've been with the company about 18 to 19 years something like that. When I got to the company all of our technology was film projectors and it was largely film projectors for very, very large screens and it was a phenomenal experience as I said mostly in the institutional niche but the problem with it was the film projectors were extremely expensive.

The size of rooms you needed was extremely expensive. So the addressable market in the world was very limited. So we really spent the good part of almost two decades, engineering down the cost of being in the IMAX business. So we figured out ways to go from film to digital, we figured out ways to go from extremely large theaters to retrofit theaters within multiplexes and those are largely the reasons for the network growth.

So the next evolution for us and I will give one tip which is quite interesting is so IMAX films was this big platters and for one copy of one 3D film, it cost $40,000 per theater. So if someone wanted to see a 3D film at the Metreon, one print was $40,000. Now it's $150. So that partly explains why the network has grown so rapidly because we sucked out a lot of cost.

So the next place we're going is using laser projection. So right now, our digital projectors used Xenon light bulbs which are terrific if you've been to an IMAX theater. You know, you would see how great the image looks but if you go to a screen like here at the Metreon, it's so large that we can’t generate the amount of light output that you need to.

So Kodak had been working on this proprietary patent for a very long time. We acquired them about 18 months ago and we've been working with Texas Instruments and Barco to design a proprietary system that can light screens up to 120 feet, maybe more than that. That also has kind of the contrast and the resolution, the quality of an IMAX film projector.

So that should be available to show people at the end of 2013 and to rollout kind of the second half of 2014. It really is going to be a game changer for these very large theatres because again they are still spending $20,000 to $40,000 per print and that’s going to go to $150. So that will drive their cost way down enable them to play more movies, enable us to get more revenues on both the film side and the studio side because there will be more revenues coming into the theatre.

Overtime, I am sure at some point we will engineer down that very large experience into a smaller experience replacing our existing digital network. But what that does is it gives us a much larger debt differentiator that exists today. So people know IMAX is really special today. But in the next five to 10 years let’s see we can be more special than it is.

Greg Foster

On the digital laser side, the other thing it does, is just gives us more flexibility in programming. So a theatre like the Metreon which currently film based is going to play somewhere between 10 and 12 films a year. Because you can’t justify a one week release of a movie with a $40,000 cost of a print, when we go laser which is digital, we will be able to play anywhere between the 25 and 35 movies that we play per year now in those locations which will allow us to churn out more box office we will have less of a tail, so the vast majority of the box office of a movie happens in the first two weeks of that release.

There is some movies the Avatars, the Chris Nolan movies, the Transformers, etcetera that we will program for a longer window may be three or four weeks in certain cases. But when we are churning out in the shoulder periods those week or two week runs it’s great to have the flexibility of the $150 print versus the $40,000 one.

Ben Swinburne - Morgan Stanley

Great. I'll ask one more question and then I will the audience an opportunity to ask some questions, (inaudible) for microphone when you raise your hand. When we talk about China the other big market that I know your focus is on Russia, can you give us a sense for your extensions plans in that market, how good that business is today and what the trends are?

Rich Gelfond

When you say the other big market there are obviously we are focused on many markets around the world including India, Western Europe was significantly under penetrated and South America we really just begun to scratch the surface but looking back over the last few years, you are definitely right, Russia has been a very good market for us. So we have over 30 theatres opened in Russia including our backlog, it’s over 40 theatres, our per screen average is in Russia are among the highest in the world and it’s a really movie loving public and its one that really loves premium movie experiences. So Russia is the only market in the world where we have an IMAX VIP theatre, that has 80 seats and we charge about $80 of ticket there and does not include the popcorn, I know that was your follow-up question. God knows what…

Ben Swinburne - Morgan Stanley

It doesn't include.

Rich Gelfond

I don't want to know. But Russia has been a terrific market for us both in terms of per screen and the rollout and I do think there is a lot of activity to go there, as you know, in general, it has become a very strong film market but I think that's the way to go.

Greg Foster

This year we have announced our first Russian based language title which is Stalingrad which will come out in Russia and in parts of the rest of the world in October. We have announced Rich was talking about India our first Bollywood title which is Dhoom 3 which comes out at the end of this year. We have our first Japanese title which is called Dragon Ball Z that comes out at the end of March, so we are being again very programmatically focused on individual territories.

Rich Gelfond

Just to follow-up, because he’s making an important point we missed this. Our box office was up 50% last year from the year before, while the kind of conventional box office was up 6% and one thing people could say well, you know your screen count grew by around 23% and that does account for it. But still you look at the first screen which increases well, that's quite a significant number, and one reason is being in the 53 or 54 countries we can program every screen in every territory differently to optimize the box office and if you look the US box office has been relatively stagnant, while the international box office is just really exploded and its exploded with Hollywood films but it’s also exploded with local content. We think we are one of the few companies that's really focused on how to capitalize on that.

Ben Swinburne - Morgan Stanley

Sure, great, let's see if we have any questions from the audience.

Question-and-Answer Session

Unidentified Analyst

Since you are in so many markets do you have any FX exposure.

Rich Gelfond

Yes, there is some FX exposure. Most of the fees are payable in US dollars, so in general not as much as you would think. Fortunately its been a good thing for us, so our ticket price in Japanese yen converted to dollars is like $22 and in England its like $21 so we've been on a very good where its been said we've been a beneficiary there. We are looking at sort of a risk management profile in a way to minimize that. A lot of our costs are in Canadian dollars because a lot of our manufacturing is in Toronto and that we're completely hedged against.

Unidentified Analyst

The laser technology from Kodak, does that enhance the 3D capabilities of your business and give you an area of differentiation to the normal theaters that are out there, because one of the issues that 3D has been the, come out of light that and experienced from that, does that really take you to the next level.

Rich Gelfond

You made a really good point which is that the light levels from the laser are far superior to anything that's coming out of the digital projector today or even an IMAX film projector, and the problem with 3D as you point out is, you are kind of watching it with something akin to sunglasses. So if you had looked at Alice in Wonderland, for example, and took off your glasses, you saw all these phenomenal colors that popped out but they got washed away by the glasses and the laser system will really enhance that experience.

Unidentified Analyst

Hi, I know that personally speaking one of the real reasons to get me to go to an IMAX theaters is as you said when the directors actually used the IMAX cameras. I was wondering do you provide any kind of incentive for them to use that technology or does it just do they use it because it’s superior.

Rich Gelfond

It’s a collaborative process ultimately film makers are way more focused on quality than they are on anything else and the biggest issue that we face with our cameras is we don't have enough for the demand. Right now there are about 14 movies in the next 12 months that would like to shoot with our cameras, and we have the ability to probably furnish two or three of those films with our cameras. So we have a supply-demand issue which isn't the worst problem to have, but it’s often a problem. It trails down and kind of filters down on the waterfall in many ways.

We don't give people our cameras for free, but we are not as focused on making a buck on the actual camera rental as perhaps we used to be. Because what happens is when a film is shot with our cameras again it filters or trickles down into having more marketing, having often an early release window, having more people especially the fan boys who have become our core audience, become aware of it. The film makers get out there and evangelize about how much IMAX means to the way they shop the films and that ends up having a positive impact on our joint venture theaters and on our DMR box office as well as just the overall brand.

So it's not something that we do for free, but at the same time, it's not just the bucket of camera rentals that contributes to the bottom line. That’s a very, very small part of the advantage that we have from all of these filmmakers wanting to shoot with our cameras.

Unidentified Analyst

I know you guys talked about having a second IMAX screen in some locations just wanted to see how that was progressing, and also besides China, which area do you think is the biggest opportunity for growth?

Rich Gelfond

In terms of second screens in theaters, we started to do it mostly in French speaking Canada. So we have dual screens where one of the theaters is showing it in English and the other is showing it in France and that’s actually working out very well. You know, better than I would have thought. In terms of a broad based effort, I think we will test it but it's a little too early to say because if you have a film like the Dark Knight Rises or The Hobbit are really big film, you can see it filling both screens to capacity and it’s really working. In the more shoulder periods when you are showing Hansel and Gretel or are Die Hard, it's harder to gamble on the fact that that’s really going to happen. I think there is opportunity there but not a huge opportunity.

Unidentified Analyst

Growth opportunity, other than China

Rich Gelfond

Other than China, you know, I am personally incredibly excited about India. As I said, we have about 230 theaters in China including our backlog. India, there is a couple of things that are coalescence. One, there is a lot of mall development. Two, there is a lot of modern multiplex development. Three, the ticket prices have gone way up. So where it used to be $2 a ticket in a modern multiplex now it’s about $8 a ticket.

As Greg mentioned we are starting to do Bollywood content there with Dhoom 3 this year. And we also have three or four different exhibitors interested in IMAX business. And that’s usually a key that wouldn’t be obvious from the outside. But when you have one in the market tends to develop fairly slowly, when you have multiple competitors then you tend to go at more. So I don’t know that’s going to happen within the next year but longer term it’s exciting.

Greg Foster

And also what’s interesting in India’s often exhibitors are also producers. So they both make, market and distribute films. So that might be an advantage as well.

Rich Gelfond

This is about three or four open or may be another 10 backlog or something like that.

Ben Swinburne - Morgan Stanley

Great. Take a one last one right there.

Unidentified Analyst

Can you guys talk about the sort of relaunch marketing. I think it’s probably like six months or nine months right since it started that and what’s work, what hasn’t work for you things coming down the pipe.

Rich Gelfond

So historically we haven’t marketed that much other than following the studios, which put on the posters see it in IMAX. And we really started a focus to get more towards brand marketing rather than just film marketing, and actually we have third area of theatre marketing. So we are in the middle of recruiting for, we are actually at side of we have narrowed the number of prospects, a really good cheap marketing officers to sort of integrate those efforts brand marketing, film marketing, theatre marketing and we have a fair amount in a budget this year to that.

I think one of the reasons that we are going to start mostly domestically because the first screens are lower domestically than they are internationally. I think that’s going to prove to be a really good investment for us if we get the right person and hopefully in the next couple of months we will reinitiate that.

Ben Swinburne - Morgan Stanley

Great, we are out of time, Greg, Rich thanks so much.

Rich Gelfond

Thank you.

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