IMAX F1Q07 (Qtr End 3/31/07) Earnings Call Transcript

Jul.20.07 | About: IMAX Corporation (IMAX)
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IMAX Corporation (NYSE:IMAX)

F1Q07 Earnings Call

July 20, 2007 8:30 am ET

Executives

Brad Wechsler - Co-Chairman and Co-CEO

Rich Gelfond - Co-Chairman and Co-CEO

Rob Lister - General Counsel

Analysts

Michael Kelman - Susquehanna Financial Group

Paul Tepish - Merrill Lynch

Presentation

Operator

Welcome to the IMAX Corporation conference call. Today's call is being recorded. At this time, I would like to turn the conference over to Mr. Brad Wechsler for opening remarks and introductions. Mr. Wechsler, please go ahead, sir.

Brad Wechsler

Thank you very much, operator. Good morning and thank you for joining us on today's conference call. Joining me today is my partner, Co-Chairman and Co-CEO, Rich Gelfond. Also with us are our interim CFO, Ed MacNeil; Executive Vice President of Finance, Joe Sparacio; and General Counsel, Rob Lister.

Before we begin, let me remind you of the following information regarding forward-looking statements. Our comments and answers to your questions on this call may include statements that are forward-looking, in that they pertain to future results or occurrences. 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 occurrences, including the 10-K we will be filing today.

During today's call, reference will 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 reconciliations to GAAP measures are contained in the Company's earnings release and our 10-K for fiscal 2006, as well as our 10-Q for the first quarter of fiscal 2007, which will be filed today. The full text of the earnings release, along with supporting financial tables, is available on our website, www.imax.com. Today's conference call is being webcast in its entirety on our website as well.

We are pleased to be hosting this call and filing our 10-K and 10-Q. In recent months, we've been working extremely hard to complete these filings and are pleased to be moving ahead unencumbered by the overhang of delayed filings. We would like to express our thanks to our finance department, audit committee and Board of Directors, for their tremendous hard work and dedication over the last few months as we tackled and resolved some difficult and complex issues.

As I go forward in today's presentation, everybody is going to hear that it is somewhat numbers heavy. So particularly in the numbers section, I am going to sort of slow down some of my speaking so everybody will have a chance to hopefully absorb what I am saying.

As you'll recall, we announced in March that as a result of certain identified accounting errors over the prior six years, we would be filing restated financial statements with respect to those years. These errors are related to issues such as film accounting and inventory capitalization and taxes. As we worked to complete these restatements, we also evaluated our accounting practices in light of comments received as part of the previously announced and ongoing informal inquiries of the Securities and Exchange Commission and the Ontario Securities Commission.

We ultimately decided that as part of the restatement process, the best course of action would be to broaden our review to attempt to proactively address the concerns raised by the SEC and OSC and incorporate the comments and questions we received during the comment process.

As a result of our analysis, we have concluded that certain accounting errors were made in prior years and codified a revised revenue recognition policy with regards to the sale and lease of our IMAX theater systems, which we have discussed in detail with the SEC and the OSC. We believe that correcting these errors and implementing the revised accounting policy will enable us to effectively implement our own best practices from an accounting perspective and our hope is that it leaves the Company in the position of having a clean slate going forward.

We would like to take a moment to walk you through the particulars of the policy we adopted, which is reflected in the restated results filed today. Our former method for recording revenues for theater transactions under multiple element accounting provided for the recognition of revenue when the projector and sound system were installed and deferred revenue recognition on the remaining elements, in particular the screen, until the installation of those remaining components.

To put it in a business context, on a sale that had a value of approximately $1.5 million of total value, a majority of which we had received, we would not delay revenue recognition of roughly $1.4 million, which is the total revenue associated with the system without the screen, because of a screen valued at between $100,000 and $125,000 had not been permanently installed.

Since the projector and sound system are delivered together, wired together and coordinated to provide a synchronized audio/video experience, we considered these two components to be a single deliverable. In other words, we believed that the projector and sound system were what comprised the essence of The IMAX Experience. We treated other components separately, such as the 3-D glasses cleaning machine and the screen system, because we viewed them as passive components that did not interact electronically with the other components. They are manufactured by third parties, and are generally shipped by the supplier.

The same goes for training of the customers' projectionists, a facet of the installation that at the time we did not consider integral to the essence of The IMAX Experience. Upon further consideration and careful evaluation, we determined that in recognizing revenue for our theater systems, we should've placed greater emphasis on the customer's perspective under a typical IMAX arrangement. Accordingly, the screen, glasses cleaning machine and customer training are now considered integral components of the installation.

This perspective places more focus on the qualitative characteristics of the business relationship between the Company and the customer. Whereas our prior view, placed more emphasis on the technical aspects of the equipment and their interdependence.

We concluded that it was an error to not include these components previously. Therefore, we revised our revenue recognition policy for theater transactions to reflect this view and we restated our financial results so that revenues were recognized only when the screen and glass cleaning machine were in place, customer training had occurred and the customer had formally accepted.

As part of this process, we analyzed a total of 127 theater installations that took place from 2002 through 2006. Today's press release details the exact specifics of the restatement, but the key points are that a total of 16 installations shifted between quarters in their originally reported years, impacting approximately $25.4 million of revenue and $14.1 million of margin. In addition, a total of 14 installations shifted between reported years, impacting an additional approximately $27.1 million of revenue and $14 million of margin.

The most significant number of these transactions occurred in 2005, where nine installations shifted between quarters and 10 installations shifted to a future year, eight to 2006 and two to 2007. By way of illustration, 14 out of the 30, or almost 50%, of the installations that shifted to a different quarter or different year related to the issue of the customers' projectionist training. In the case of these 14 installs, we concluded that revenue should be deferred to the date of theater opening because there was not a document in the installation file evidencing a formal acceptance by the customer of that projectionist training even if the Company may have believed it properly provided training of the customers' projectionists. Under our new accounting policy, this written acceptance is now required before revenue can be recognized.

The net impact of these timing adjustments was an overstatement of income over the period 2002 to 2005 of $10.4 million, with $7.4 million of the $10.4 million coming back into income in 2006. Meaning at the end of 2006 the total net impact of the errors was $3 million and the majority of that $3 million is expected to reverse into income in 2007. That has to do with the revenue recognition policy.

As part of our review of these transactions, we also identified certain other adjustments, including allocation of valued elements and accounting for finance income on leases. The net amount of these adjustments over the period through 2006 was an overstatement of income of $1.9 million, with the majority expected to reverse into 2007.

In addition, we had previously announced adjustments in other areas, such as inventory costs, film accounting and taxes. These adjustments resulted in a net overstatement of $1.5 million through 2006, which will reverse into 2007 and thereafter.

So, net-net when considering the impact of all of the adjustments over the six-year 2001 through 2006 period, income was lower by $6.4 million. Of that $6.4 million, $4 million is estimated to reverse into income into 2007, $1.5 million into 2008, and the remainder of less than $1 million will reverse into income in future years. And to reiterate, as we've said before, this restatement did not affect cash or liquidity.

We have communicated the changes in our accounting policy to the SEC and OSC. And as noted earlier, have interacted with both agencies and believe that while the comment process is still ongoing, our revised view and policies significantly address their comments received to date.

We're not going to spend a lot of time on our fourth quarter and fiscal 2006 results, as those results are spelled out in detail in the 10-K. Before updating you on our progress in 2007 to date, however, there are just a couple of items related to fiscal 2006 that bear mentioning.

Generally, our loss in 2006, which was $0.42 per share, included non-cash write-downs of $0.09 per share plus non-cash deferred tax write-down of $0.15 per share. Let me detail some key contributors to this loss. First, SG&A expenses were $12.6 million in the fourth quarter of '06, up from $8.3 million the previous year. $1.5 million of SG&A recorded in the fourth quarter were legal and accounting related fees associated with the ongoing SEC and OSC informal inquiries.

Additionally, in the fourth quarter, the Company incurred $2.3 million of legal and accounting fees related to its restatement. R&D expenses for the quarter were $1.2 million, up from $800,000 in the fourth quarter of the previous year due to investments in our digital technology.

As noted above, the second major factor impacting our 2006 results was a $6.2 million non-cash deferred tax write-down taken in the fourth quarter, which equates to approximately $0.15 per share. This write-down relates to the Company's current assessment that the ultimate utilization of certain tax assets that had previously been recorded on the balance sheet may not be realized within a two-year period.

Third, we took a non-cash write-down in the fourth quarter of $3.2 million, or $0.08 per share. The primary components of this write-down were $1.3 million in inventories and $1.1 million in property, plants and equipment.

Turning now to our performance in 2007, the three brightest spots have been the ongoing strength of our film slate, the early success of our newly-signed joint ventures and our progress in developing a digital IMAX system. We find this particularly encouraging as business momentum in these important areas has continued in spite of the uncertainty cast by our financial restatement process and related filing delays.

During the first quarter of fiscal 2007, total revenues came in at $27.2 million, compared to $23.3 million last year. We recorded a net loss from continuing operations of $0.12 per share for the quarter, compared to a restated net loss of $0.15 a share for the first quarter of fiscal '06. We signed 13 deals in Q1 of this year, three of which were subject to conditions compared to eight a year ago, and recognized revenue on four installations and one sale of an existing theater.

Let's take a look at what drove this year-over-year change. We enjoyed a record breaking performance from 300: The IMAX Experience during the first quarter. This film brought in $24 million on only 91 screens, a record for a 2D DMR release and substantially above our original estimates. This equates to revenues per screen of approximately $264,000 over the run of the film, an extremely impressive figure. The strong audience attendance for 300 in IMAX speaks favorably to increased word-of-mouth and repeat visitation to IMAX theaters. We were especially pleased to see it draw so much of the 15 to 24-year-old techie crowd that we've been cultivating.

Importantly, the success of 300 is seen not only in film revenues, but it flows through nearly every aspect of our business. Specifically, it drove strong returns for our owned and operated theaters, and helped bolster the early performance of our new joint ventures. We think that the performance of 300 gives us an early window on how the recurring revenues of our long-term business model will ultimately look. Sony's Spider-Man 3: The IMAX Experience was another hit for us. The film opened domestically on May 4 and to date has grossed a little over $24 million in IMAX theaters.

Notably, Spidey reached the $20 million milestone in just one month, faster than any other 2D digitally remastered IMAX release. We think the film's record breaking success is a testament to a formula involving event films that are well suited to IMAX's format, the IMAX WOW factor. And to the fact that the network has increased significantly since we released Spider-Man 2 to IMAX theaters three years ago, underscoring the success of our network growth strategy, which Rich will discuss in more detail a little later.

More recently, we've been absolutely thrilled with the record breaking performance of Warner Brothers' Harry Potter and the Order of the Phoenix, which opened last Wednesday in a record 126 IMAX theaters worldwide. Ultimately, this will be our widest release ever, playing on upwards of 140 screens this summer.

With respect to the box office performance, Order of the Phoenix enjoyed the largest worldwide opening week, generating $11.6 million in IMAX on 91 domestic and 35 international screens, and the largest per screen average ever for the first week of a DMR release, at $92,000. It was also our largest domestic five-day total ever recorded at $7.4 million.

The film's opening weekend domestic box office performance was double that of the opening weekend of the previous installment, Harry Potter and the Goblet of Fire. The film set several international records as well, including the best opening weekend at $1.4 million on 35 screens. This phenomenal opening combined with the huge advance ticket sales and sold out theaters we've seen really underscore how event films can reach a new level in IMAX, driving theater attendance and ticket sales.

With this unprecedented debut performance, it is clear that moviegoers continue to seek out and embrace our unique format. Additionally, audiences have responded enthusiastically to the film's 18-minute finale, which was digitally converted from 2D into live-action IMAX 3D. This kind of immersive experience is impossible to replicate at home or in any conventional theater. And we are thrilled to have brought Harry to life in a more awe-inspiring and exciting way than ever before.

As a reminder, our first Harry Potter movie, The Prisoner of Azkaban, grossed $14 million on 90 screens, or $155,000 on a per screen basis, over the run of the film. The next installment of the series, Harry Potter and the Goblet of Fire, grossed more than $20 million on 109 IMAX theaters worldwide, or $185,000 per screen, over the run of the film.

As we receive a percentage of the IMAX box office, it is not difficult to see how a growing network really helps the bottom line we can recognize from economies of scale, especially when you add in the joint venture splits we will discuss later. In just its first week Harry Potter and the Order of the Phoenix has grossed $11.6 million on 126 IMAX screens. Compare that to Goblet of Fire's first week, $5.5 million on 75 IMAX screens, and it underscores how our network expansion strategy is beginning to show results.

We are obviously tremendously excited about the new release, very pleased for our close partners at Warner Brothers. And given that it has the added appeal of 3D and is in about 20% more theaters, we are confident it will be our most successful Harry Potter film ever.

The strength of our film slate is best illustrated by our trailing 12-month DMR box office for domestic theaters, which is 50% higher at the end of the fiscal first quarter of 2007 compared to Q1 of 2006.

Now I would like to turn it over to Rich, who will discuss our film slate for the remainder of the year, update you on our joint venture and digital initiatives, and provide some thoughts about 2007.

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Rich Gelfond

Thanks Brad. Looking at the rest of our film slate, we announced on June 29 that we are partnering with Paramount Pictures, Warner Bros. Pictures International, and Shangri-La Entertainment to release Beowulf in IMAX 3D in November. This film is a CGI animated feature showcasing the performance capture technology of director/producer Robert Zemeckis, the acclaimed director of The Polar Express.

As you will recall, Polar Express did very well in IMAX, with a total box office of $45.1 million, or $519,000 per screen, in its first year of release and over $60 million in IMAX theaters to date. This film has become a perennial.

We're delighted to be expanding our studio relationships to include Paramount and are truly excited to be partnering with them on a project that is so well-suited to The IMAX Experience. Significantly, this is the first time a film will be released simultaneously in IMAX 3D as well as conventional theater digital 3D. There has been a lot of attention recently around digital 3D, which has delivered a new conventional theater experience, and we welcome the opportunity to compare simultaneous IMAX 3D and conventional digital 3D releases, as we continue to believe The IMAX Experience delivers the best, most differentiated movie going experience on the planet. Our view is that the per-screen box office performance of IMAX films to date, whether in 2D or 3D, clearly bears this out.

We're working on two other films for the year, one to follow Harry Potter and one around Christmas. We hope to announce more specifics shortly.

We're very excited about the 2008 film slate, which we are well into discussions as well. So far we have announced The Dark Knight, which is the next installment of the Warner Bros. Pictures Batman franchise, and again stars Christian Bale as Batman and Bruce Wayne, and is scheduled for release in July. There another five or six great prospects for 2008 and we are optimistic that will be able to fill the slate early. We look forward to disclosing more details in the near future.

Before I discuss our key strategic initiatives, I wanted to briefly discuss a few more first quarter specifics. As indicated earlier in our May update, we signed 13 theater systems in the quarter, two of which were joint venture arrangements and three of which were subject to certain conditions, compared to eight signings in the first quarter of 2006. We installed three theater systems in the first quarter, recognized revenue on a fourth as a result of the change in policy, and had one sale of an existing theater. This compares to three system installations in the first quarter of 2006 plus two sales of existing theaters.

Our backlog at the end of the first quarter consisted of 83 systems with a value of $128.4 million, including three joint venture arrangements, which carry no backlog value, compared with 78 systems with the value of $128.6 million, including one joint venture at the end of the year ago period. The second quarter, which is obviously over but we will discuss a greater detail on our Q2 conference call in August, saw six more signings and eight more system installations, three of which were joint ventures.

With respect to our other revenue lines, theater operation revenues for the first quarter were $4.5 million versus $3.7 million in the first quarter of '06. Other revenues were $0.5 million compared to $0.8 million in the year ago period. Gross margin for the first quarter of 2007 was $11.4 million, a 43% increase over the $8 million margin for the first quarter of 2006. An increase resulting in large part due to the quarter's strong DMR film performance, which as discussed above, flows through a large number of recurring revenue streams for the Company.

On the expense side, selling, general and administrative expenses were $10.3 million in the first quarter, down from $10.6 million a year ago. $800,000 of SG&A recorded in the first quarter were legal and accounting related fees associated with the ongoing SEC and OSC informal inquiries of the Company's revenue recognition practices. R&D expenses for the quarter were $1.5 million, up from $0.9 million last year due to investments in our digital technology, which I'll discuss in more detail in a moment.

It is important to note that in comparing year-over-year SG&A, the $10 million in Q1 2006 SG&A was significantly impacted by non-cash expenses related to the timing and announcement of our former sale process, including stock appreciation, option grants and other costs.

Turning to the balance sheet, we ended the first quarter with $27.4 million in cash and short-term investments, compared to $27.2 million at the end of fiscal 2006. At the end of the second quarter, we had approximately $17 million to $18 million in cash and short-term investments, having paid our biannual interest payment of $7.7 million. We have not drawn down on our credit facility, other than for letters of credit, and $21.5 million remains available under our borrowing base calculation.

Now let me turn to our primary strategic goals for the year, accelerating our joint venture strategy and launching our digital initiative. On the joint venture side, our record breaking film slate in 2007 has led to some notable successes I'll discuss in a moment. To the exhibitor, the positive to the idea of revenue sharing joint ventures is largely driven by the fact that it shifts upfront capital costs away from the exhibitor. We also believe our strong film performance and resulting theater results are facilitating positive exhibitor sentiment towards IMAX and our value proposition.

Four films in a row have all performed extremely well. Happy Feet grossed $17.3 million at IMAX, or $134,000 per screen. Night at the Museum did $18.2 million, or $163,000 per screen. 300 has done $24 million to date, or $264,000 per screen. And Spider-Man 3 has done $24 million, or $198,000 per screen. As we noted, we are optimistic this strength will continue as we enjoy the success of Harry Potter 5.

We currently have eight joint ventures installed, four with AMC, two with Regal, and two with MUVICO, which signed on during the second quarter. For the newer JVs, Regal and MUVICO, we projected total box office at around $800,000 a year and are encouraged that after just one film, these joint venture box offices were already at about $200,000.

When you consider the strong results we expect to see for these joint ventures with Harry Potter and the Order of the Phoenix and the success to date of our first JVs with AMC, which have an IRR to the venture of 41% to date, we believe there is reason for increased optimism with regard to our important JV initiatives.

We continue to believe that by significantly lowering the capital cost to exhibitors, by contributing the system with the exhibitor putting up retrofit costs, we can expand the network more rapidly and receive a more significant part of the IMAX box office from the theaters as well as a continuing piece of the IMAX film revenue from the studio.

We are in many discussions for joint ventures both in the U.S. and abroad with existing and new customers, and we believe our early results are helping these discussions. It is important to bear in mind that JVs are intended to supplement our existing sales lease model, not replace it. We believe joint ventures provide a compelling opportunity for us to add incremental momentum to our theater growth and more quickly realize the benefits of network economics.

As for our digital initiative, since we last had a call, there has been significant progress to report. Our cost of goods sold is lower than originally projected. Our anticipated delivery date of late 2008, early 2009 is on target. And current trends suggest that R&D costs will come in at or below our original estimates.

As we have indicated previously, preliminary consumer research has been encouraging and we believe that we are on the right track in terms of maintaining IMAX's WOW factor and ensuring that our digital product provides a differentiated experience to moviegoers that is consistent with what they've come to expect from the IMAX brand. We are excited to be having a prototype theater up and running in the next few weeks to show exhibitors, filmmakers and studios. And we will keep you apprised of our progress.

As we have emphasized, transitioning from a film-based platform to a digital platform is compelling to IMAX for a host of reasons. First, print savings to the studios are considerable, providing the studios even more incentive to release their films to IMAX theaters than they do today, as profitability per run increases. Second, economics also change favorably for the exhibitor, since lower print costs and increased programming flexibility should allow theaters to move from programming six or seven IMAX DMR films per year to 10 films per year in a digital environment. Thereby increasing consumer choice, total box office and we believe network growth.

Finally, a growing network is extremely beneficial to studios, as their costs are fixed and beneficial to us because we participate in a DMR box office in many ways, from studio participation to JV box office sharing. Finally, let's not forget that the introduction of a digital system can ultimately provide the opportunity to show IMAX live events, such as the Super Bowl, in a way they have never been seen before.

So the net effect of going digital is simple and significant. Both of our key customers should make more money. The studios because they will no longer have to pay for print costs that can easily eat up 40 percent of their profits, and the theaters because the studios can deliver more films, driving aggregate box office returns higher. In turn, IMAX should share in their incremental profitability, both directly through DMR fees, JV participations and royalties, and indirectly through selling, leasing and JVing more systems.

As stated previously, we intend to partially finance the transition from film to digital using virtual print fees, or VPFs. VPFs are a funding mechanism whereby a studio sets aside a portion of its print savings in a given year and makes these funds available to partially underwrite the costs of swapping out film-based systems for digital systems. We are currently in conversations with three studios about VPFs and expect to expand those conversations to other studios. We think that ultimately the studios can help fund a portion of the build-out of the IMAX network by leveraging their print savings into a bigger IMAX network. While working on digital, we are also making progress with our suppliers toward lowering existing print costs and we expect such costs to be at least 10% lower in fiscal 2007 compared to 2006.

As both our JV and digital initiatives take hold, 2007 is likely to be somewhat of a transitional year from a financial perspective. While we expect to show year-over-year improvement in fiscal 2007 compared to 2006, there will be some unique expenditures and charges that'll partially mask this progress on a reported basis.

To begin with, the SEC's and OSC's informal increase relating to the Company's timing of revenue recognition continue to increase our legal and accounting fees in 2007. Second, R&D costs related to the launch of digital are also going to impact our financial results in fiscal 2007.

In 2006, we spent approximately $3.6 million on R&D, $1.4 million of which was related to digital. For 2007, we expect to spend between $9 million and $9.5 million on R&D with at least $7 million of that for digital.

Finally, we expect that there will be some accounting issues related to our digital transition that will negatively impact our reported financial progress in fiscal 2007. For example, assume we sell a system for $1.2 million plus minimum royalties, and included in that deal is an agreement to swap out the client's system to digital when it becomes available. Under GAAP, some portion of the system revenues, maybe even all, will have to be deferred until the digital upgrade is complete.

It should be noted that this affects only reported earnings over a finite time during our transition, not cash, and in instances where we have agreed to provide a swap-out.

We are currently considering ways to provide information to help investors understand this accounting treatment of revenue where there is a digital swap-out. In instances where an MPX install is slated for late 2008 or 2009, we intend to install new digital systems in lieu of film-based systems, and this accounting impact will therefore obviously not be a factor, but may slightly delay the installation.

Before we open it up to questions, it’s worth reiterating that while 2007 is likely to remain somewhat transitional, we are encouraged by our progress to date and optimistic about IMAX's long-term growth prospects. We have navigated several challenges. We're delighted to finally move forward with our filings and restatements complete, well positioned to focus our energies on the underlying strength and momentum of the business. We are on track with the development of our digital platform and believe we will be able to introduce a system that delivers the premium IMAX experience people have come to expect from the brand.

We are aggressively implementing strategies designed to enhance network growth, improve network economics and drive recurring revenues going forward. To that end, we are pleased with the initial success of our joint venture theaters and we are enjoying positive studio and exhibitor sentiment toward IMAX on the heels of several top-performing films in a row and are optimistic about the anticipated performance of Harry Potter 5, Beowulf and the remainder of our '07 slate.

Finally, I want to add a small bit of perspective to where we stand right now as a company compared to where we were just a few years ago. It is true that the last year has been challenging and we would not have preferred to spend so much of it mired in financial and accounting issues. But as important as those things were for us to work through, it is even more important that we not let them mask what has transpired at IMAX in the last few years.

By almost any objective measure, we have dramatically changed the way moviegoers experience Hollywood films. Our groundbreaking technologies to convert 35-millimeter to IMAX, to bring the IMAX experience to the multiplex, to convert live action 2D to 3D, and soon to largely eliminate print costs entirely from IMAX digital theaters, are all contributing to more and more people across the globe being able to see the world's greatest blockbuster films in ways they have never been seen before, bigger, crisper, better sounding, more immersive, more entertaining in every way.

And yet, while the consumer response has been overwhelming, sold-out shows, long lines, huge per screen grosses, the progress has still not manifested itself to the bottom line in the way we know it can. We firmly believe that the ability to show incremental profit is a function of network growth, film performance, and the expansion of our digital and JV strategies.

And we believe our mission is clear. We will continue to work to push these initiatives and develop new ones in order to keep expanding our global reach, provide the IMAX experience to more of the world, and deliver the results of that expansion to our shareholders.

We want to particularly thank our employees, who have not only helped us complete financial statements, as Brad said, but also kept our business intact and humming during this very difficult period.

With that, we would like to thank all of you for listening and take any questions you might have.

Question-and-Answer Session

Operator

(Operator Instructions). Your first question comes from Michael Kelman, Susquehanna Financial Group. Please go ahead.

Michael Kelman - Susquehanna Financial Group

Thank, hi. Two quick questions for you. Rich, I think you just touched on the digital upgrade and including that in some of your contracts. And you talked about what the accounting issues to that may be. Can you talk a little more qualitatively how the upgrade to digital is impacting your theater system sales process? How you are including that in your contracts? And then also maybe touch on how existing theater system contracts that are currently in your backlog are looking towards the digital transition and how you address that?

And then the second question is with regards to the SEC and OSC investigations. Can you talk a little bit about where we are in the process of that? What other hurdles need to be met in order to move past that?

Rich Gelfond

Sure, Michael. In terms of the digital, starting in the fourth quarter of last year, we looked out into the future and we didn’t want our business to come to a halt as people waited for the digital system to come online. So we included a provision in the contracts that said, if they took delivery of a film-based projection system, we would upgrade them to digital at our cost.

Again, I would just like to run you through some numbers, Michael, so this makes some sense. The typical cost of an MPX system, including minimums, is around $1.5 million. The cost of goods sold of our film-based projector is around $600,000 to $650,000. And the digital upgrade costs around $350,000.

So in the worst-case scenario, if we had to pay the full cost of the digital upgrade, we would still make a pretty decent margin on that. However, as I said during my other comments, we have been in discussions with a number of studios. I actually said three in the script, but we have started to touch on it with a fourth. And we believe that the studios will pay for that upgrade at a virtual print fee. So at the end of the day, we don’t believe we're going to end up paying that, at least certainly not all of that cost.

The second part of the contract says that, if they are going to take delivery, let's say, in late 2008 and we are ready with a digital system, rather than putting in a film system and swapping out, we can put a digital system in, in lieu of the film system. Or we can have them delay by a few months so that we would put in the digital system, therefore eliminating the need for the upgrade.

Now in terms of how it has impacted business, as you can see from the first quarter signings and the second quarter signings, I don’t really think it has had much of a negative impact. I think it has probably had a little bit of a negative impact and that negative impact comes from the fact that people haven’t been able to see our digital products. That is going to be alleviated in the next couple weeks as -- in fact our digital prototype theater is now up and running in Toronto. Brad and I are going up on Monday to see it. We have seen some earlier iterations of it, but the reports we're getting from our senior management staff are extremely encouraging. And if what Brad and I see verifies that, I think we will start showing the digital system to customers and studios and exhibitors, and maybe even analysts and shareholders over the next couple weeks or couple of months. So whatever negative impact there was, I think will go away at that point.

In terms of the existing backlog, there really hasn’t been much of a dialogue between people in the existing backlog and digital. Here and there a little bit, but it really has not had much of an impact. I think Brad will answer your second question, Michael.

Brad Wechsler

Yeah, Michael, I think your second question was about the continuing interaction with the regulators. I guess the first comment that I would make is that the SEC and the OSC were extremely helpful both through the informal interactions and also through the comment letter and response process. But as we noted in our release, the interaction we believe will continue.

We still have more questions to answer in the comment letter and response process. And more generally, we believe that the OSC and the SEC both in [incorporating] and enforcement want to understand some aspects of our business better than they do now.

Michael Kelman - Susquehanna Financial Group

Okay, great. Thanks. One other follow-up question I wanted to ask with regards to the JV discussions you are having with other exhibitor partners. Can you talk a little bit more qualitatively in the discussions, what the exhibitors like about it? What they don't like about it? How they feel the economics of this compared to some of the other offerings that are out there in place, like you talked about digital 3D offerings? And if they use that as a comparable in terms of where they want to allocate their CapEx?

Rich Gelfond

I think the exhibitors very much understand the difference between digital 3D and IMAX 3D. For example, Regal and – I am not sure about MUVICO, but Regal which we just opened the two JVs with, also has digital 3D, and I think they like that business for what it is. But they understand that the IMAX business is a different business. I don’t really think that has been a factor.

What they like about it is the fact that we are putting up a significant amount of capital. They don’t have to. And what they also like about it is the fact that we are partners. I think intellectually from their point of view, they had some trouble with the fact that they were putting up the money and IMAX had the right to walk away metaphorically, even though we would never walk away. They like the fact that our interests are aligned. So, therefore, we have a stake in bringing in the best movies and we have a stake in making sure that it works well and that we are hand-in-hand in it.

I wouldn’t say there is much they do not like about it. I think what they don’t like is that they still have to put up $200,000, and if you are an exhibitor you'd rather put up nothing than $200,000. I think it’s more a matter of getting more and more empirical data. And as I said during the prepared remarks, Michael, as the film performance has been so consistent and as the existing JVs have turned out good numbers, I think we will overcome these issues. But exhibition by nature is a relatively conservative industry and I think they just want to see the numbers. And then I feel pretty good that a number of them will accept the joint venture idea.

Brad Wechsler

Michael, you also asked briefly about some of the competing 3D technologies. I think one of the things that they like about IMAX in general, and certainly that is true about the joint ventures, is the incrementality that we bring to the business, which is I think at this point highly verifiable through third party data in terms of incremental box office, as well as exclusivity. IMAX gives people exclusivity and we help them differentiate their multiplex from competitors. And I think those are two other aspects that appeal to the customers.

Michael Kelman - Susquehanna Financial Group

Perfect. Thanks very much.

Operator

Thank you. (Operator Instructions). Your next question comes from Paul [Tepish], Merrill Lynch.

Paul Tepish - Merrill Lynch

Hi, there. Congratulations on improved results from recent movies and thanks for the updates. My question relates to your '02, '05 period. Do you feel that your restatements now put you in compliance with the language in the indenture in the bonds?

Rich Gelfond

Sorry, we are having trouble hearing you.

Paul Tepish - Merrill Lynch

I will speak more loudly. My question pertains to the '02, '05 period. You feel this recent restatement today puts you in compliance with the indenture language in the bonds?

Brad Wechsler

I am going to turn that over to our General Counsel. I think I know the answer, but I'm going to turn it over to Rob.

Paul Tepish - Merrill Lynch

Thank you.

Rob Lister

Yes, as people that follow the Company are aware, we got consent from our bondholders back in April to file our financial statements by the end of June. And in addition to the June period there was a thirty-day cure period on top of that, which we have filed within. We also announced two consecutive extensions granted to us by our bank in conjunction with our credit facility, which took us through the end of July. So under both the indenture and under our credit facility, the Company believes it is in compliance with both reporting covenants.

Paul Tepish - Merrill Lynch

Okay. Will you need to have officer certificates signed on those statements or no, we're to take them at face value now, the new restatements?

Rob Lister

We're not going to get into all of the details, other than to simply say that the Company is quite confident that it is in compliance with all of its covenants under both its indenture and under its credit facility.

Paul Tepish - Merrill Lynch

Okay, that's great. Thank you very much.

Operator

Thank you. Gentlemen, there are no further questions at this time. I would like to turn conference back to you.

Brad Wechsler

Okay. Thank you very much. I think Rich and I both probably have some very brief concluding remarks. Obviously, like Rich, I want to thank everybody on the IMAX staff and Board and others in helping us get through this very time consuming process of restating our numbers and getting our filings in.

Like Rich, we need to still the IMAX business, JVs, digital, film performance, network growth, and I think these are the things that we've got to turn our -- they have been going well. They've been going very well, but I think we have to continue to focus on. And I think management will have more time and energy, hopefully, to continue pushing in that direction. Rich?

Rich Gelfond

As I said before, I think our company has performed quite well under the cloud of these statements having not been filed. But I actually think there were two clouds that are in the process of being lifted off. One is the financial reporting cloud by the filing today. And the second one is this digital transition. As I said, although Brad and I have not seen the final version, we're doing that.

The reaction from the people at the Company and the earlier versions we have seen, digital can either be a showstopper or a tremendous opportunity. And from where we sit, I think it’s going to be a very big opportunity for IMAX and we will be happy to share that with you all, as well as our other development shortly. So thank you very much.

Operator

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

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