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IMAX Corporation (NYSE:IMAX)

Q1 2014 Earnings Conference Call

April 24, 2014 8:30 AM ET

Executives

Teri Loxam – VP, IR

Rich Gelfond – CEO

Joe Sparacio – EVP and CFO

Greg Foster – Senior EVP; CEO, IMAX Entertainment

Analysts

Townsend Buckles – JPMorgan

Eric Handler – MKM Partners

Aravinda Galappatthige – Canaccord Genuity

James Marsh – Piper Jaffray

Eric Wold – B. Riley

Ben Mogil – Stifel

Steven Frankel – Dougherty

Vasily Karasyov – Sterne Agee

Colin Moore – Credit Suisse

Daniel Ernst – Hudson Square

Operator

Good day and welcome to the IMAX Corporation First Quarter 2014 Earnings Conference Call. All participants are currently in a listen-only mode. Following the presentation, we will conduct a question-and-answer session. (Operator Instructions). Today’s conference is being recorded. At this time, I would like to turn the conference over to Ms. Teri Loxam, Vice President of Investor Relations. Please go ahead.

Teri Loxam

Thanks Michelle. Good morning and thanks for joining us on today’s first quarter 2014 conference call. Joining me today is our CEO, Rich Gelfond, and our CFO, Joe Sparacio, who will have prepared remarks. Also here today is Greg Foster, our Senior Executive VP of IMAX Corp, and Rob Lister, our Chief Legal Officer who will be part of our Q&A.

I would like to remind you the following information regarding forward-looking statements. Our comments and answers to your questions on this call may include statements that are forward-looking and that they pertain to future results or outcomes. Actual future results or occurrences may differ materially from these forward-looking statements. Please refer to our SEC filings for a more detailed discussion of some of the factors that could affect our future results and outcomes.

During today’s call, references may be made to certain non-GAAP financial measures as defined by Regulation G of the Securities and Exchange Commission. Discussion of management’s use of these measures and a definition of these measures, as well as reconciliations to adjusted EPS and adjusted EBITDA, as defined by our credit facility, are contained in this morning’s press release. The full text of our first quarter earnings release, along with supporting financial tables, is available on our website, IMAX.com. Today’s conference call is being webcast in its entirety on our website.

With that, let me turn the call over to Rich Gelfond.

Rich Gelfond

Thanks Teri. The first quarter was about setting the foundation for the remainder of the year and driving continued progress for our long term growth strategy. In particular, we made significant progress in Europe and showed up some key films with our long term Disney partnership. From a financial perspective the first quarter box office was seasonally light as it’s typically the case given the lack of 10 poor films released during this time of the year. We also had fewer sales-type installations scheduled for the first quarter due to timing differences installed schedules compared to last year.

On the strategic front, I’m very pleased with our achievements for the quarter, which we believe will contribute to – will continue to contribute to IMAX’s future growth. In particular, there was a strong quarter for theatre signings; we have 36 new theatre deals, 23 of which were for locations in Europe. Some of these signings will translate into installations this year, while others will build out pipeline for future deals. It was also strategically important quarter for our film business. We signed a multi-picture agreement with Disney that includes their most highly anticipated killer titles includes Marvel’s Captain America 2, Guardians of the Galaxy and Avengers 2 as well as Lucas films Star Wars: Episode VII.

On a technology front, we achieved an important milestone in the development of our next generation IMAX laser projection systems. Also at the start of the second quarter, we announced a deal with strategic investors to help maximize the growth and future success of IMAX China.

Let me discuss each of these in a bit more detail. In terms of our network the 36 signings in the quarter represented a good level of activity for us and of significance these signings were across 17 different countries and were with both new and existing customers. Even more noteworthy is the fact that’s 23 of the signings were in Europe.

Historically, we had struggled to gain traction in the Europe; however we have really started to breakthrough over the past couple of years. As we mentioned before typically our strategy has been to open a reference theatre in a particular market which will showcase IMAX differentiation and the value to the exhibitor. This theatre often acts as a catalyst for additional signings, as the exhibitors in that area to the incremental benefits of the IMAX theatre to their complex and the box office potential of our theatres compared to what they could do with their own theatres.

We use this build out strategy in North America and moved down to penetrating Asia particularly China and now we are seeing progress throughout Europe. In addition to the discussions that develop organically as exhibitors hit a success of our theatres, we also had a full schedule with new and existing partners at CinemaCon, a global entertainment conference that we attended in March where many deals were discussed for new theatres around the world. In addition, we hosted an exclusive industry sum at this quarter, were executives on top exhibitors around the world studios and industry leaders gathered to discuss the state of the industry and key trends.

Based on these discussions, we feel strongly that IMAX is well positioned to continue helping studios and exhibitors, capturing growth the premium entertainment market globally.

Moving on to the partnership with Disney, this agreement is strategically significant for a number of reasons. First, rather than a series of one-off arrangements which we’ve done in the past, this is more comprehensive agreement helps to start two companies coordinate marketing strategies for the films well in advance. Second, it allows the filmmakers additional lead time that enables them to design and create the vision for their movies with IMAX differentiation inline.

And third, visibility in for the IMAX film slate, helps us coordinate dates and releases within the Hollywood ecosystem and also helps existing the potential new exhibitor partners to plan their businesses. We are very pleased to strengthen our partnership with Disney and Marvel and we look forward to working with some of the most talented directors, who work on some of the industry’s biggest brands and to value of the quality differentiation and the incremental revenue that the IMAX experience brings to their films.

During the quarter, we also made progress on our laser initiative. IMAX is always been an innovator, leading technological change for the past 40 plus years and pushing the industry to new levels, is what this spirit of innovation that we are driving yet another leap in technology with our new ways of projection systems. It is important to note that the IMAX laser projectors goes beyond just replacing the light source, it is a ground up entirely new system.

And in addition, improving the bright and adding addition to improving the brightness, we’re also leveraging patterns that we purchased from Kodak a few years ago to enhance the contrast and color gamut even beyond what we could do with our current leading projectors.

Our first generation laser projector is focused on the larger screens in the network those with sizes greater than 80 feet in width. These theatres represent some of the largest most profitable theatres in our network. While the rest of our network was upgraded to digital over the past several years, these large theatres had to remain film based as the current generation of digital projectors can generate enough light to illuminate screens that large.

Our laser system will allow us to convert these large theatres to digital with the quality that we expect from IMAX and allow them to play our full portfolio films each year without the high cost of film prints. I’m happy to say that we achieved an important milestone in our laser development in Q1.

We assemble the critical component, the projector for the first time and we’re very pleased with the preliminary results, which exceeded our original specifications. We still need to let the system run for longer period of time tested across different scenarios and fully assemble the prototype. While we are still an R&D which comes with risk, we believe there is milestone products an important step closely to the finish line and we remain on track to begin our initial rollout at the end of this year.

In terms of IMAX China, we recently announced the two prominent Chinese investors CMC one of China’s leading media investment funds run by Li Ruigang and FountainVest, one of China’s largest private equity firms bought aggregate 20% in our IMAX China business for $80 million. In addition to the cash that this transit action provides which will give us additional financial flexibility. We believe the addition of these investors along with our other industry partners in China, such as Wanda, TCL, WASU and almost all of the local studios and help us maximize the growth of our business in china potentially lead to an initial public offering or the IMAX China business within the next five years.

I spent last week in Beijing and I was very pleased and encouraged with the local reaction and the positioning of this announcement has delivered for us so far. Together with our partners, we held the press announcement in China that guarded over 250 press members which was driven in part by our partners’ reputation and prominent to the country.

Switching to our film performance, we played nine new movies in the first quarter and we also played nine additional previously released films and we plugged into various markets different times throughout the quarter to fill in the gas and release schedules educated cultural preferences across the 58 countries in which we operate.

We generated approximately $130 million in global box office, the two thirds of our box office coming from international markets, in particular China had a very strong quarter, generating over a quarter of our total box office. We played eight titles in that country, two of which were local language films including The Monkey King, which set a new opening day record in China for IMAX $1.8 million breaking the previous record of $1.5 million set by Iron Man 3.

Local titles generated about one third of the China box office with Hollywood titles generating the remaining two thirds. Hollywood standout in the country included the second Hobbit and Disney’s Need for Speed, another international region beyond China that stands out, this quarter was Western Europe, where markets including the U.K., Netherlands, Germany and France were also very strong.

Newer markets like Switzerland and Portugal also delivers, delivered promising results in their first full quarter open. As we look forward to the rest of the year and the blockbuster season ahead, we’re excited about many upcoming films including The Amazing Spider-Man 2, which is already opened quite nicely in several international territories including the U.K., Australia and Mexico and which opens domestically next week. Godzilla which opens in May, Transformers

Age of Extinction in June, which is filmed in part with IMAX’s new 3D digital camera, Marvel’s Guardians of the Galaxy in late July, Chris Nolan’s new movie Interstellar in November, which also add significant portions filmed with our cameras and the final installment of The Hobbit in December.

In addition to these, we have many other exciting movies planned for both the domestic and international markets throughout the year to round out our annual portfolio including the recently announced DreamWorks Animation and Fox’s How To Train Your Dragon 2, which we’re playing in some key international market starting in June.

And with that let me turn it over to Joe to go through some of the financial details from the quarter.

Joe Sparacio

Thanks Rich. Total revenues of $48.2 million in the first quarter decreased by 3% compared to last year, largely driven by IMAX system revenue from sales and sales-type leases which was $5.3 million less than Q1 last year, resulting in roughly a 4% impact on EPS.

The difference primarily reflects the installation of three full new theatre systems on the sales and sales-type lease arrangements in the most recent first quarter compared to 6 in the first quarter of 2013. The company also installed two digital system upgrades in the first quarter of 2014 compared to 7 upgrades in the same period last year. This was partially offset by higher recurring revenues from DMR and our joint revenue sharing arrangements which together grew 10% compared to Q1 of last year.

Total gross margin of $26.4 million came in slightly ahead of last year’s $26.2 million resulting in a gross margin percentage of 54.8%, a 200 basis point increase over Q1 last year. The expansion in total gross margin was primarily driven by higher box office and lower DMR cost from having only released one digital, only released digital films this quarter which drove an increase of almost 900 basis points in the DMR margin to 72.9% from 64.2% in Q1 last year.

Global box office at $138.5 million was up almost 8% compared to Q1 last year. As Rich mentioned, two thirds of our box office were $91.1 million came from international markets in the quarter and the remaining one third were $47.4 million from the domestic market. The international box office represents a 19% increase in comparison to Q1 of 2013 largely driven by network growth.

Our global PSA was a 197,000 with an international PSA of 266,000, two times that of the domestic PSA. We also saw margin expansion on our joint revenue sharing lines this quarter with our JV margin increasing from 65.7% in Q1 last year to 67% this year.

In addition, we installed one hybrid JV this quarter which comes with a relatively low margin. If we exclude the hybrid to be consistent with Q1 last year with there were no hybrids installed, the JV margin for this year’s first quarter would have actually come close to 70%. This margin improvement primarily resulted from higher revenues generated by continued network growth.

Moving on to operating expenses SG&A excluding stock-based comp was $18.1 million in the first quarter of this year versus $14.7 million last year or $16.9 million after the one-time or after excluding the one-time $2.2 million benefit related to the curtailment of our Canadian post retirement plan gain.

Included in SG&A this quarter was an FX translation charge of approximately 700,000 largely related to the weakening of the Canadian dollar in the first quarter. If you back out the impacts from FX the year-over-year increase in SG&A would have been around 3%.

We continue to expect our full year 2014 SG&A excluding stock-based comp and curtailment benefit to increase probably 5% to 8% compared to the full year in 2013. in terms of phasing, we continue to expect the SG&A expense to be pretty evenly spaced across the remaining quarters in 2014.

Stock-based comp for Q1 was $3.2 million and our full year expectation for stock-based comp is approximately $16 million. Our R&D expense for the first quarter was $3.6 million primarily reflecting our continued development of our laser projection initiative. We continue to expect our full year 2014 R&D expense to be about $15 million.

In terms of tax we finished the first quarter with a tax rate of 27.3%, we continue to expect our full year 2014 tax rate to be around 28% and an estimated $10 million to 412 million of cash taxes. At the end of the first quarter, we had $24.4 million of tax assets remaining.

Also note that starting in the second quarter; we will be introducing a non-controlling interest line on the P&L, but net income to account for the minority interest resulting from the 20% sale of our IMAX China business.

As we discussed that the time of the announcement, this transaction will close in two equal parts with the first closing having occurred on April 8 and the second closing expected to occur in February 2015. Therefore, the non-controlling interest line for the remainder of 2014 will reflect the 10% minority interest which will change – change to the full 20% starting next year when the final closing occurs.

We anticipate roughly a penny in dilution per quarter so the remainder of 2014 as a result of the China investors minority interest. I would also like to remind everyone that in addition to the proceeds that IMAX Corp receive from this transaction, IMAX China will also pay to IMAX Corp an ongoing technology and trademark royalty equivalent to 5% of gross revenue along with several other fees including cost plus 10% for equipment maintenance and local DRM content.

In terms of our network, we installed eight new theatres in the first quarter, with three sales-type lease installations and five JVs of which one was a hybrid. This brings our total commercial network to 707 theatres of which 388 or 55% are JVs. In addition, we signed deals for 36 theatres of which 35 were for new systems and one upgrade. 23 of these signings were in – theatres in Europe, 6 in Asia Pac, 3 in Latin America, 2 in the Middle East and 2 in the U.S.

As a result our backlog as increased to a record 431 systems, which gives us visibility to many years of new installations. About 90% of the theatres in the backlog are slated to be installed in international markets and about 90% are also new-builds. For the full year, we continue to expect to install a similar number of new theatres in 2014 that as we did in 2013.

As we discussed on the Q4 call in February, we expect the pace of our 2014 installations to be similar to that of 2013 roughly half install scheduled for the fourth quarter. We also continue to anticipate about two thirds of our full year installs to be JVs, including 20 hybrids with about 15 currently scheduled for the third and fourth quarters.

For Q2, we currently anticipate installing around 20 new theatres with about five of them currently expected to be sales-type and about 15 to be JVs on which we currently expect five to be hybrids.

With that, I will turn it over to Q&A.

Question-and-Answer Session

Operator

Thank you. (Operator Instructions). Our first question comes from Townsend Buckles of JPMorgan. Please go ahead.

Townsend Buckles – JPMorgan

Thanks, great to see the breakthrough in Europe. Can you talk a bit more of which country these deals have come in and where the pipeline stands now? Do you see a good signing pace continuing with this more of a spurt?

Rich Gelfond

Before I answer that, Joe just wanted to add one little bit thing.

Joe Sparacio

Yes. At the opening, it indicated that the reduction in systems revenue at $5.3 million resulted in 4% impact on EPS that should have been a $0.04 impact in EPS. I apologize for any misunderstanding.

Rich Gelfond

A lot of the signings in Europe were in different countries, but the biggest one of all was the U.K. where we did 7 additional theatres and what was 7 or 8 I think it is. And what was noteworthy about that, is a company IT International, which is run Moshe Greidinger and had been a partner of ours for close to 15, 20 years acquired Cineworld, and after the acquisition they introduced all those new theatres in addition to theatres in other countries. So they had never participated, but Cineworld had but IT had not participated in the U.K. So that was really good to see that going on and we have two theatres operating in Germany, right now one of which is doing okay, one is doing really well.

During the quarter, I’m just trying to remember where else in Europe the territories were. Russia was a very big territory for us, I think we had maybe 7 or 8 signings in Russia that was one in Eastern Europe, but it was spread out pretty nicely and what makes that even more noteworthy for us is that not only, as I talked about in my script does that lead to more theatres in those signings, but there is lots of other activity going on. So in regions like Scandinavia where we have no theatres, there has been a fair amount of activity going on.

In Turkey, where we just opened a number of theatres, there is more activity going on. In France, there is a number of things we look at again, just to be clear I’m not promising that any of this is going to happen or happen overnight. But in Italy where we just have a few theatres, there is discussions going on. So it’s pretty much content and why and maybe more impressively as I mentioned in the remarks, some of the new markets like Switzerland and Portugal are posting really impressive numbers. So, as you said it’s taken us a while to crack it. But I think we’re cracking it at two levels, one with the exhibitors getting more theatres out there and most importantly with the consumers were the numbers are pretty good.

Townsend Buckles – JPMorgan

Good to hear. And for Greg, if you could give an update on the local side on the film pipeline, both China which is clearly been a big boost as well as other markets were last year and again some success is Stalingrad and Dome are you seeing IMAX worthy local films and countries outside of China?

Greg Foster

Well, first of all, China is obviously the big producer of best films for us and we’ll continue to do that. But as you ask about other countries, yes we’ll continue to have sourcing in markets like Japan, Korea and also Russia becomes an important market for us that we are spending a lot of time focused on. We have a meeting in a couple of weeks regarding Russia in particular, there are couple of titles that look very promising for the next, not this summer but starting in the fall.

So I think you will be able to look over the course of the next year, see us consistently generate between 8 and 10 local language titles globally. The vast majority of them will be Asia, but you will also see three or four coming from other parts of the world and we continue to look at Bollywood, although Bollywood we look at in a little bit of a different way, because of everything that’s been going on in that market. I think again the focus is more going to be on Russia, Asia and then pick up here or two in some other markets.

Rich Gelfond

[indiscernible] in China and we have an announced films that we kind of have handshakes on and some of those are really exciting and, when I was over there last week people were talking about it, one or two of the ones that I think we’re going to do as being on par with the Hollywood blockbusters and in terms of their box office potential in China.

Townsend Buckles – JPMorgan

Great, thank you.

Operator

Thank you. The next question comes from Eric Handler, MKM Partners. Please go ahead.

Eric Handler – MKM Partners

Yes, good morning, thanks for taking my question. As probably question for Greg, can you talk about how the World Cup might grow – impact the number of your theatres globally and is this mostly going to be a European, Latin American phenomena and how big of an impact it might have in the film slate in Asia? And then secondly I just wonder if you could talk a little bit more about India, I know Rich, this is an area that you’ve been very intrigue by quite a bit over the last – talking lot more about in the last 12 to 18 months. What’s your view on how big of a potential this market could be, and what you’ve seen following Dhoom:3?

Greg Foster

So first of all the FIFA World Cup impact, it’s always been there. It’s been there for, the last 20 years that I’ve been aware of it. And it will continue to be in some degree. However, the studios all get the joke and clearly in Latin America and Europe in particular they program around it. So some exhibitors ask for get family-oriented films which is part of the reason why we’re very excited that we’re doing How To Train Your Dragon part 2, because How To Train Your Dragon part 2 is going to continue to come out during World Cup times in certain markets.

Some markets it will move to late July and early August, but others it will be in June and July. So that will help fill in gap and it’s nice to be back in business with DreamWorks Animation and it’s nice that it’s only an international release for us, but it’s also nice, its Fox title. Other titles will move around accordingly depending on the degree that the World Cup they think will affect certain territories, our Transformers opening up in some markets as early as I think its June 25 and then you have other Transformers core markets that are opening up the very end of July or early August. So of course there will some kind of impact, but we’ll always fill it in with additional titles, because it’s not like the business is going to go away, but there is going to be a little bit of a period of time, where in those markets in those territories that are football crazy they will be watching their movies and counter program with movies that won’t necessarily appeal to that exactly the same crowd.

Rich Gelfond

So in terms of India Eric, as you know we have a kind of strategy that will impact every territory in the world, which is first build reference theatres, then get the PSAs to a point, where they are going to attractive to that exhibitor then bring in competitors to that exhibitor and then release local language films. So in India we did all of those four and we did them all very successfully, unfortunately last year, because of the decrease in the value of the rupee and also because of the election was coming up and factors you know it’s going right now, the market more or less came to a haul. We didn’t follow-on as we have in every country all the time.

The encouraging thing is that this year’s, as the election lines down we seem to see activity picking up again one anomaly as two beautiful theatres were build by one of our partners called Satyam Cinemas and they were done a year ago Thanksgiving and for a lot of political grievance that only people in India could really understand the theatres haven’t open and they are among the nicest IMAX theatres in the world. I believe they are supposed to open in the next couple of weeks and that operators also expanding in other places in India. So the pieces are on place, I recon, I think at some point once the economy stabilizes we should do pretty well there.

In terms of our model, I think we said the territory can support up to 70 theatres and either open or in backlog now we probably have about 15. So that gives you an idea, however, I think if India gets its act together in the way China did, I think we probably could do better than that, but that’s what we’ve modeled out.

Eric Handler – MKM Partners

Great, thank you very much.

Operator

Thank you. (Operator Instructions). The next question comes from Aravinda Galappatthige from Canaccord Genuity. Please go ahead.

Aravinda Galappatthige – Canaccord Genuity

Good morning and thanks for taking my questions. Just a couple from me, first of all on with respect to the North American market, the recent signings to be [indiscernible] mainly extensions would be original and see legal deals. Maybe just talk to the potential to growing North America, specifically with respect to the infilling opportunities with the smaller regional changes that you get in the market?

Greg Foster

So I’ll take this one, this is one of my favorite topics, because you guys heard me talking about it last quarter and I’m going to do it again, because they just keep going. The Galaxy theatre in Sparks, Nevada is the best example of what can happen with a smaller regional player, as well as what we’ve talked about over the past with Warren theatres in Wichita, Kansas and Moore, Oklahoma. So these guys, the Galaxy Guys, [Rave Cohen] [ph] in particular who runs that company have come in and completely changed the market. And they now own the product in Sparks, Nevada, they are getting all the films that’s a competitive zone. They’re print screen averages are huge, building IMAX theatre, they are using IMAX theatre has the hub not only for movie going in that complex, but literally for movie going in that DMA.

And that DMA has moved in terms of ranking from something like a 125th in the country to the top 5, 10, 15 almost every movie not almost every movie, every movie that we play. And it’s been a great example of what can happen, when someone has the strategy implements it markets at appropriately and really makes their theatre particularly their IMAX theatre look different from every other theatre in that market. And so it’s a strategy in a lot of different areas that we’re focusing on and our sales guys are particularly focused on it in a certain kind of mid-western region and in the west where we maybe have some under representation in places like Missoula, Montana and Lincoln, Nebraska and Fargo et cetera. It’s proven to be a very good strategy on one that I think we’re going to execute on – very nicely over the next couple of years.

Rich Gelfond

Yes. And what Greg means by competitive zone is in certain zones everybody gets the film product and at competitive zone it goes to different exhibitors like one will be across the street, from the other and it rotates back and forth. But in this case the theatre has done so well that they’ve gotten away disproportionate share then in this case its cinema, but it could be anybody, a disproportionate share then they although gotten. So it’s a double benefit, it’s not only that the IMAX theatre is doing well, but they are also getting the product at their regular theatres and increasing their market share.

Aravinda Galappatthige – Canaccord Genuity

Thanks for that. And just on the also just switching gears to the TCL joint venture, looking at the recent press release as you are making progress there, maybe just touch on sort of the roadmap from here to the point where you would be able to sort of launch the product together with TCL, I just wanted an updated there? Thanks.

Greg Foster

Sure. So, we’re in the process of finalizing the specs and putting out like a demo of what the product looks like, and we’re aiming to do that sometime in the middle of the summer. Once we have the product all spec out, then we plan on doing some limited showings of the product, we announced as you know Aravinda, that we partnered with Wasu several weeks ago when I was in China and Wasu is a content provider.

So in China if you want to put through content, it doesn’t work, just look it up to a cable and anyone puts it in, they are licensed content providers. And Wasu is one of the best as in fact part of Wasu is owned by Jack Ma and Alibaba, they are really a very top operator. And so we’re in the process besides doing the hardware of integrating that software into the system not only software which they currently distribute, but day and day movies in Hollywood and in China through PRIMA. And over the second half of this year we will be putting that together and then I think provided everything goes okay, we launched a product in 2015.

Aravinda Galappatthige – Canaccord Genuity

Great, thanks, I’ll pass the line.

Operator

Thank you. (Operator Instructions). The next question comes from James Marsh of Piper Jaffray. Please go ahead.

James Marsh – Piper Jaffray

Great, thanks very much. Just two quick questions here, first is if you could discuss the PSAs, I guess I’m trying to understand the decline here, is there anything in particular that you guys would highlight and try to reconcile, if its, timing of films or the nature of the films or some type of mix shift? And then the follow-up which new comments regarding laser, you mentioned I guess the key component or a key assembly that you guys put together for the first time, are there any other key components or manufacturing milestones that we should think about for laser in the coming months or at this stage it’s simply testing the product that we have?

Rich Gelfond

So it’s on your first one James as you know over the last five years we’ve averaged between $1.1 million to $1.2 million in PSA except for one year while we’re significantly higher, because of Avatar and when you look at where the first quarter ended out, we did an analysis of what the last nine months did for the last three years, and the last nine months for the last three years did $900,000. So you look at where we are and we’re still on target under that portfolio theory for getting in the same range. So the slight reduction in domestic PSA and the mix really, I don’t think is material to the year on the portfolio theory. If you ask me why North American looking a little bit stronger, I think it has to do with the fact that the two leading movies of the quarter were Frozen and the LEGO movie and looking at our historic criteria that neither really plays for theoretically plays to our strength, because there are more family animated movies and traditionally we don’t do those.

With that said, the breakout success of Frozen, if we would look at Frozen 2 right now, we probably would given how much more that its peers and even if we index lower, we’d still probably get a better results. But that’s the primary reason that’s the way biggest two movies or movies that didn’t hit our demographic.

In terms of the laser, I’m going to try to explain that in kind of maybe simpler terms that I did during the script, but there are two parts to the laser. One part is the optical path and that uses a lot of our proprietary technology uses the codec technology and that does things other than brightness, which the laser is key on brightness, so that makes the contrast better, that makes the blacks blacker, that’s make the color gamut brighter. And that’s the part that we’ve been focusing our development on and that’s the part that has performed very well and that was the milestone that I referred to.

The other part is more the laser light engine, and that more of that is Barco’s shoulders as our joint venture partner than on our shoulders and that’s where – the front-end of it we return on the laser to take this data that we’re feeding in and turns it into this laser driven brighter image. So technically when you sketch it out, it all seems to be fine and we should be able to make the deliveries by the end of the year. But the reason this milestone is so important and I apologize for the length of this answer, but it’s important is that what you do is you spec out all kind of pieces and then you subcontract them out and you hope you got the specs right and you hope they interrelate right and then they get delivered which they did and you turn on this switch and it works.

But until you get the pieces back from the subcontractors and until you turn the switch on you are not sure you’ve designed them all properly and you are not sure how they fit all together. So theoretically we should be in very good shape now and the light edge and it should be able to be built and it should fit together and it should all work. One reason I took their time is, there is a difference between working in a theoretical universe with design specs versus where you fit the two pieces together and you turn the switch on.

James Marsh – Piper Jaffray

Yes, understood. Thanks very much, that’s helpful Rich.

Operator

Thank you. (Operator Instructions). The next question comes from Eric Wold of B. Riley. Please go ahead.

Eric Wold – B. Riley

And hey good morning. Just a follow-up question on the film slates, looking at the press release obviously you still your – we announced official films for Q3 remains light, maybe just give us a sense of how many titles maybe you kind of soft penciled with the studios coming just working out the various international regions they’ll move into? And/or I think Greg you also mentioned, kind of seeing more of local language content films is kind of around the fall, so as you may give little more confidence in terms of how Q3 I think will shape up as you get closer towards it?

Greg Foster

So first of all strategically, we made a decision that in let’s call them shoulder periods, we’re going to a little, do a little bit more diligence and take a little bit more time to pick the titles, because it was aren’t necessarily blockbuster times, so there is really no reason to announce September title a year before it comes out. Why not wait several months, actually deal whether see the films to pick from, because we’re offered all the movies and be able to go with the ones that we know we’re going to do the best, because we’ve actually seen them with our own eyes.

So I think you’re going to find going forward in the Septembers, in the Octobers, in the Januarys and the Februarys that we’ll be announcing those titles later in the process. So we’re able to again have a little bit more intelligence on which ones we want to pick. As it relates to the summer, there are a handful of titles that are available to us for July and August and we’ll be announcing those titles probably in the next two to four weeks, we’ve got plenty of time, I think everyone knows that obviously we’re doing Transformers 4 very excited about Michael shots, the whole bunch of the movie with our new 4K 3D camera he is really happy about it. The footage by the way that everyone saw in CinemaCon that movie looked like great. Obviously, our Guardians of the Galaxy title, the Marvel title we’re very excited about as well.

But I think you’ll see couple of other titles that will be announced for the July and August timeframe. So we’ll have the same number of titles that we had over the past in fact maybe then in July more than we did last year, because remember we played Pac Rim for the vast majority of July and we’ll have more than one this year. We’re also going to play the Transformers 4 probably for a little bit longer than the traditional two week period again because, we’re so excited about the movie and because looks, because of the features of the IMAX cameras.

For the fall on the local language stuff will definitely have a Chinese title, I think there is a very good shot that we’re also going to have a Japanese title. But again we’re going to make those decisions going forward, after we’ve actually seen the movies which I think, gives us a lot more cover on making sure that they work. So, I hope that answers the question.

Eric Wold – B. Riley

That’s perfect. Thanks Greg.

Operator

Thank you. (Operator Instructions). The next question comes from Ben Mogil of Stifel. Please go ahead.

Ben Mogil – Stifel

Hi good morning and thanks for taking my question. I wanted to look at the gross margins a little bit, so we saw a really good gross margin improvement in quarter and, certainly looking back comparing to other shoulder season quarter, for getting very good gross margins. But it looks like depreciation was a lot lower in the quarter, is there anything in the quarter that sort of help depreciation is there run rate going forward trying to get a sense of that?

Greg Foster

I think with the lowering of our DMR cost, because of moving to digital only releases, I think you are seeing work its way through the P&L and lower depreciation and amortization. Also I mentioned in the JV business the incremental depreciation on new installs from last year was almost completely muted because of the extension of the terms with AMC last year. So, if you look at the JV business, we had an increase in box office and the result of revenue, but really our costs were pretty flat year-on-year. So I think those are the two primary factors.

Ben Mogil – Stifel

Joe, I’m not ever trying to paint a guidance, but sort of is it fair to say just sort of qualitatively going forward that the depreciation and what we saw this quarter, kind of whole its going forward and at the same time you start to see the same thing on the, you see it corresponding with the gross margins if you will?

Greg Foster

I think on the JV business it will normalize towards the middle of the year, once on apples-to-apples basis as it relates to DMR, that’s really going to be a transitional item. And our movement away from printing only, print and digital release to just solely digital, I think we’ve talked in the past that over time our cost base should reduce as we move away from print release. So, I don’t want to give a hard and fast answer on this, because we may decide to do prints on a particular movie. But certainly, we’re moving in the direction that we’ve tripped off in the past.

Ben Mogil – Stifel

Okay, thanks. And then I guess other Rich or for Joe. As you sort of looking the second half of year and transaction with China closes, have your thoughts regarding capital structure allocation et cetera changed to that?

Rich Gelfond

No I don’t think so, I think to add on the only issue is maybe it’s a good opportunity to take your questions as to answer in a slightly different way, which is that I think access to the capital markets in China within the five year period of time is something that, we’re going to do kind of when that’s available to us. And I think it’s a very nuance hard situation to explain, but for example in China you need to get in a queue to do an IPO. And, if we walked in from New York and Toronto and we raised our flag and said we want to get in a queue, we wouldn’t rush necessarily to the front of the queue. We have welcome Chinese partners and you meet the task and you go in and you say I want to go to the front of the queue, you suddenly go to the front of the queue.

So I think what we did China gives us an opportunity to obtain additional liquidity hopefully at a significantly higher evaluation sooner than we wanted to. In terms of the cash from the deal, roughly half of it is going to come back to Canada to parent company, I think a little bit more and the rest will stay in China and that has dual implications in China, we unlikely we’re going to have more cash in there. And that will be completely self-funding even though we have a significant number of JVs to invest in.

In North America, I’ve said for a long time that, at some point we look at different ways to deploy that cash and whether that, similarly we can fund JVs completely and everything is on the table in terms of what the ideas might be to do with the cash, I think the fact that we’ll have an extra $40 million or $50 million will give us more comfort as we go down those roads.

Ben Mogil – Stifel

That’s great, Rich. Thank you very much.

Operator

Thank you (Operator Instructions). The next question comes from Steven Frankel of Dougherty. Please go ahead.

Steven Frankel – Dougherty

Good morning. Greg or Rich, wonder if you might give us some insight on these pending distribution changes in China and how that might impact either the volume of films or the film runs that you and your partners would say?

Rich Gelfond

I think it’s really unlikely that there are significant distribution changes in China as I mentioned a few minutes I was there last week and I map with China Film Group which is the state-owned enterprise and I met with the China Film Bureau which is the Government Regulatory scheme. And I think it’s very unclear that there are going to be changes in distribution, I think lot of information comes out of there and some of its true and some it’s not true. But I just didn’t have the sense that there were going to be significant changes.

Steven Frankel – Dougherty

And how about an update on Latin America, have things gotten any clear there?

Rich Gelfond

Yeah, I mean, I think we’re doing better than we’ve done previously in Latin America. I don’t actually, I don’t remember, but either the – either included in the numbers are early in the second quarter, we signed somewhere within 2 and 4 deals in Latin America. So, I think that’s a place like Europe where we’ve been going, relatively slowly, we put a lot more resources behind it and its going better. We have a bunch of reference theatres there almost every IMAX theatre that’s open is doing really well, really strong PSAs you have a competitive environment there where there a number of players and I think we’ll continue to do pretty well down there.

Steven Frankel – Dougherty

Okay, thank you.

Operator

Thank you. (Operator Instructions). The next question comes from Vasily Karasyov of Sterne Agee. Please go ahead.

Vasily Karasyov – Sterne Agee

Thank you. Good morning. Rich, I wanted to follow-up on your comments on family films, you said that the PSA in the quarter was affected by, you are not participating in Frozen and the LEGO movie and if you remember last year Despicable Me 2 was had a similar kind of impact probably a little smaller. So I was wondering and now you have long conversations with Disney, did they say anything to you that could change your mind maybe not all family films that created equal or could you be more flexible, if it opens really big, can you go and play it after its already open and its clear that’s it’s going to a big title. So I was wondering if there is a way to minimize going forward this kind of fluctuations in PSAs because of families are performing.

Greg Foster

So this is Greg and I’ll take that one. And the short answer to both of your questions are yes and yes. We have had conversations with Disney about it. We’ve had conversations with DreamWorks about it. We’ve had conversations with Universal about it. And of course it makes sense. What are the things we really try and do is, be in perspective and evolve. We used to be almost exclusively in the family business, we now build out this, this pretty amazing fan-based in the fan boy world.

But as our network grows and particularly with international being such an important partner of the box office, it makes sense for us to take a look back which is what we’re doing at family-oriented films. And it’s certainly not going to become a huge chunk of our business, but I think it can’t become an important part of our business especially opportunistically whether as a title that has breakout potentially.

So that we obvious question what you’re trying to getting at is, on an indexing basis what we rather do 5% or 6% of a $200 million title or 15% of the $50 million title and obviously the math is math. So, the longer answer goes back to the short one which is yes it’s something that we have spoken with our partners about and we’ll be looking into going forward.

Vasily Karasyov – Sterne Agee

And I have a quick follow-up. I know that you have been undertaking a serious markets that is recently, anything interesting came out, the kids care about whether they are TRIMAX or not IMAX does IMAX mean some added deal for children a lot, I was wondering if you have any earlier results of that.

Greg Foster

We really don’t, we’re in the middle of still doing some of those studies, but I can tell you anecdotally if you walk to like Lincoln Square on the opening night of a fan blood movie lots of people plan for weeks if not months going to those early evening opening showings, a very good friend of mine who is probably around 80 years old, said he felt like a fish out of water, because everyone was reunited, it was like their thing to do was when a blockbuster Hollywood movie comes out, it goes to those early screenings. But that’s still anecdotal we’re still gathering the data.

Vasily Karasyov – Sterne Agee

All right, thank you.

Operator

Thank you. (Operator Instructions). The next question comes from Colin Moore of Credit Suisse. Please go ahead.

Colin Moore – Credit Suisse

Thanks, good morning. It doesn’t sound like, but it’s just worth asking if there is a – given the political tension we’re seeing in Russia and Ukraine, is there is a reasonable sales scenario that would keep you up [indiscernible] as far as any impact on your on that region?

Greg Foster

No, I mean let’s just say if the world change completely and it was the cold war again I might add to that differently. But in the current environment, the PSAs in Russia are very strong, it’s an important part of their economy, entertainment is an important asset in the country. I have spoken to several of our exhibitors in Russia, there aren’t even enough Russian films made to really fill schedule in Russia. So, basically that have to close the theatres or they have to show Chinese films which I don’t think could work that well. So I think as a practical matter the risks are very small.

Colin Moore – Credit Suisse

Great. And you mentioned your backlog about 90% is new build, if I would suggest you may be have an opportunity optimize the size of the auditorium the projection and so forth, are you seeing that benefit and being able to work with theatres that they build out from the scratch? And maybe within to respond if you could provide an update on how conversations with laser and new builds are progressing?

Greg Foster

Yes, absolutely. I mean you’re making completely good point, which is if you can build the theatre, you’re not going to strain by the limitations of the existing box, so you can build the bigger screen, you could build the more IVO aspect ratio, so yes answer is that you will have theatres that have better sidelines and more intelligent sound systems and it should provide overall a better experience.

And the second part of your question was about laser and how that’s going, it continues to go pretty well, I mean there is some segment of our customer base that wants to see what it looks like on a screen before they sign a contract. I think we have if you add Wanda which is out to 40, I think we have around 60 signings something like that already which by the way is more than the rest of the world that has announced, by like 50. We are the only ones that have launched the product in any meaningful way. But I think we are planning on having test towards the end of this year and I think once we can show those test and people can look at them and they can see it and feel it, then I think your more like to see more signings come.

Colin Moore – Credit Suisse

Thank you.

Operator

Thank you. (Operator Instructions). The next question comes from Daniel Ernst of Hudson Square. Please go ahead.

Daniel Ernst – Hudson Square

Yes, good morning. Thanks for taking my call. Two questions if I may. Rich, a couple of years ago you talked about how IMAX and sort crossed the inflection point with the scale of your network allowed IMAX. So you don’t have to worry quarter-to-quarter, weekend-to-weekend these accolades how and even given the film is to, and I think looking at your film revenue that’s actually played out quite nicely. But looking at your earnings progression, it’s a way moments in the mix of installs quarter-to-quarter is always going to impact that.

But your sort of more trailing 12 or into projection we’re not really seeing that scale and I’m wondering if you have perspective on what level of size of the network or growth rate to be – obviously get to that we see more consistent northward bound earnings? And then second question obviously the install and backlog in international markets remains exceptionally strong. But, we are seeing a slowdown domestically if you have any thoughts about, reasons behind that or opportunities to regain growth in installs in terms of just revenues and performance for IMAX here in the U.S?

Rich Gelfond

Yeah so I would say in terms of your second question international versus domestic, I mean it’s a question of market penetration where much penetrated in domestic markets, so we are in the international market. So the logical that you would have less ongoing sales in the domestic market than the internationals, in terms of box office in the domestic market versus the international markets part of it relates to the last question which is the domestic markets have a disproportionate number of retrofits versus new builds and so there are larger systems internationally, purpose build I think that’s one of the factors. The other one which I think we have a very good had along is I being talking about the fact that we put together a marketing department on top slide 1, over the last year or so and we have some great plans and we have campaigns, we have social media and a lot of things ready to go. But the first quarter wasn’t at the time to do that because as you point out. There is a lot of operating leverage in the business so you wouldn’t spend your marketing dollars when the films just aren’t going to perform. But I think you will see that and I think that will make a significant difference in the domestic market. I’m looking forward to that plus obviously what I talked about in the films in terms of your first question. I mean, you are asking about progression, I mean in the fourth quarter last year, by $0.10. This was a quarter that historically weak the first quarter. I think everyone who covers the film industry all the analyst know that the first quarter is weak.

I remember ending the last quarter call by saying we are not a quarter horse, we run a race that’s a year. And I think if you looked at the results last year and you looked at the progression of earnings, you would see very positive result. And finally, you seem very low – very small contained SG&A growth which we said we would do last year. We said we would get cost under control and we did. And if you saw the first quarter and you backed out special one-time charges you saw roughly a 2% growth rate which we did. So I think the answer is, we have passed that inflection point. And we are now in that period of time, I think over the period of the year it will play out.

So I would like to just make some closing remarks at this point. As we said many times in fact I just said it 30 seconds ago, we view our business as a yearly portfolio. There will always be seasonality in the install schedule as well as film release timing as was the case this quarter. But, we managed on an annual basis as a portfolio, the business model drives expanding margins as we saw this quarter and bottom line growth which we expect will continue this year and into the future.

So with that thanks everybody and we will talk to you in a quarter.

Operator

Ladies and gentlemen, this does conclude the conference call for today. You may now disconnect your line and have a great day.

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Source: IMAX Corporation's CEO Discusses Q1 2014 Results - Earnings Call Transcript

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