IMAX Corporation (NYSE:IMAX)
F3Q07 Earnings Call
November 9, 2007 8:30 am ET
Brad Wechsler - Co-Chairman and Co-CEO
Rich Gelfond - Co-Chairman and Co-CEO
Rob Lister - General Counsel
Joe Sparacio – CFO
Eric Wold – Merriman Curhan Ford
Welcome to the IMAX quarterly earnings conference call. Today's call is being recorded. At this time, I would like to turn theconference over to Mr. Brad Wechsler.
Thank you very much, operator. Good morning, everybody and thanks forjoining us today on our conference call. Joining me as usual is my partner, co-Chairmanand co-CEO, Rich Gelfond. Also with usare our CFO, Joe Sparacio and General Counsel, Rob Lister.
Before we begin, let me remind you of the followinginformation regarding forward-looking statements. Our comments and answers toyour questions on this call may include statements that are forward-looking inthat they pertain to future results or occurrences. Actual future results oroccurrences may differ materially from these forward-looking statements. Pleaserefer to our SEC filings for a more detailed discussion of some of the factorsthat could affect our future results and occurrences, including the 10-K(a) and10-Q(a) we filed on Tuesday and the 10-Q we will be filing later today.
During today's call, references will be made to certainnon-GAAP financial measures as defined by Regulation G of the Securities andExchange Commission. A discussion ofmanagement’s views of these measures and reconciliations to GAAP measures arecontained in the company's earnings release and our 10-K(a) for fiscal 2006, aswell as our 10-Q for the third quarter of fiscal 2007, which as I said, will befiled later today.
The full text of the earnings release, along with supportingfinancial tables, is available on our website, www.imax.com. Today's conference call is being webcast inits entirety on our website.
I would like to begin by discussing where IMAX stands todayfrom a strategic point of view and where we go from here, particularly withrespect to our pending transition to digital. Over the last decade, IMAX hasrecognized and discussed the benefits of transitioning from a film-based systemto a digital format. We have had some false starts, as well as promisingbreakthroughs. Several weeks ago, we announced a seminal event: the formallaunch of our digital projection system set for late in the second quarter of2008. This date reflects a significant shift forward from our previouslyannounced timeframe of the end of 2008 to mid '09, and we believe thatdigital's accelerated debut will drive significant benefits to the businessthat much more quickly.
Our digital prototype, which has been operating for the lastfew months near our corporate headquarters in Ontario,has demonstrated to our satisfaction that the IMAX digital projector willdeliver the same “wow” factor that IMAX moviegoers have come to expect from theIMAX experience worldwide. We have completed the most difficult part of thedevelopment plan and are now focusing on systems integration. We expect to have prototypes in the field andoperating within six to seven months, paving the way for a larger scale rollouttwo to three months later.
So why is this digital product so important to IMAX? Theanswer is that we expect our digital transition will not only facilitate a morerapid build out of the IMAX network by removing print costs from the system,but will result in many other significant benefits as well. The transition todigital is what will enable us to show more films, up to as many as ten to 12year compared to the six or seven now, and also enjoy enhanced programmingflexibility. Indeed, over the next fewyears, we look forward to being able to show live-action events such as theSuper Bowl in IMAX.
Importantly, digital also lowers installation costs by about$100,000 which, with more films, should also help drive the return in our salesand joint venture models. Studios willenjoy a higher rate of return on each picture with no print costs, whichprovides an incentive for the studios to release even more films in IMAX. Theexhibitors will also be the beneficiaries of more films, which will mean higherrevenues and greater per-theater profitability.
Why was the recent announcement so important? First, moving up our target digital launchdate reduced any uncertainty about our ability to deliver the digital system tothe market in a timely fashion.
Second, the pending reality of digital spurred signings andcontinues to do so. With regard to installs, it is now clearer to exhibitorswhen the digital system will be available to them, which helps them get intothe queue with fixed dates.
Moreover, the announcement means that we believe we havesuccessfully capped the majority of our R&D digital spend and that this isnot likely to be a significant financial drain on the company beyond the launchdate.
As for P&L benefits, we now see digital system marginsare potentially higher than we had originally projected as costs of goods soldare less than with the film system. As noted above, many of our exhibitionclients have now seen our digital prototype and the response has beenunanimously positive.
This enthusiastic reaction helped us secure 18 signings inQ3, which is equal to the number we had in the first half of the year. Of the recently announced deals, in our Regaldeal, three of the five systems will be digital and in our recent Chinadeal, there will be seven digital systems out of the total of 10 signed. In general, the level of interest in an IMAXdigital product is very strong and we are encouraged by general exhibitorsentiment. Over the next several weeks, many more exhibitors will see IMAXdigital for the first time.
Before Rich updates you on joint venture and film and how itfits with our digital initiative, let me take you through our third quarterfinancial results. As we have stated before, as a result of the combination ofhigh R&D related to the digital initiative, high SG&A largely relatedto accounting and regulatory issues, as well as slow film-based systeminstallations, 2007 continues to be a challenging year from a financial pointof view.
Total revenues for the third quarter came in at $29.8million compared to $31 million last year. We recorded a net loss fromcontinuing operations of $0.19 per share for the quarter, compared to arestated loss from continuing operations of $0.12 a share for the third quartera fiscal '06. However, we signed 18 deals in Q3 of this year compared to five ayear ago and we believe this signing strength reflects the enthusiasm for ourdigital and joint venture initiatives that we are seeing gain traction withexhibitors.
System revenue came in at $14.9 million in Q3 '07 comparedto $17.6 million last year. We recognized sales and sales by lease revenues onfive installations compared to seven in the third quarter of last year. Weshould also point out that two installs originally scheduled for the thirdquarter slipped within just days of the fourth quarter, which had an adverseimpact of $2 million on the quarter. While slippages do remain a part of our business, we note that thesesystems will be recognized in the fourth quarter as the theaters are now opento the public.
During the third quarter, we installed one additional systemfor which we recognized no revenue under the sales arrangement because underour accounting protocol, the revenue is deferred until we can establish fair valueor install the contracted-for digital upgrade. As a reminder, cash payments onthese systems are not affected by the accounting deferral.
It is important to keep in mind that we also installed onejoint venture in the third quarter of 2007 whereas last year, we didn't installany. These JVs had only a minimalfinancial impact in the third quarter, but will provide recurring revenues onan ongoing basis.
As we look ahead, we expect we will ultimately see lesschoppiness in the systems revenue as we transition to having more recurringrevenues from joint ventures and are less dependent on sales. The same shouldgo for overall revenues as well as in the digital world, the ability to show tento 12 films per year over an increasingly larger network should translate intoa very strong recurring DMR box office of which IMAX typically receives 10% to15%.
We should also point out that the anticipated universe ofrequired upgrades should get significantly smaller with the acceleration of ourdigital launch date. It is important to try to quantify this a little. In general, we provide upgrades on film-basedsystems signed after Q3 2006 and installed before our digital product isdelivered, a date now expected to be the latter half of 2008 as opposed tosometime in '09.
The total universe of deals signed and installed in thisshortened period is about 13 systems and the cost of converting a film-basedIMAX system to a digital system is approximately $300,000.
Our backlog at the end of the third quarter consisted of 90systems with a value of $126.4 million, including seven joint venturearrangements which carry no backlog value; two systems subject to certainconditions; and seven systems under which clients have opt-out rights undercertain circumstances. This compareswith 78 total systems with a value of $125.8 million at the end of the year-agoperiod.
Our third quarter film revenue was $9.5 million compared to$7.7 million in Q3 '06, which largely reflects the record-breaking DMRperformance of Harry Potter and the Orderof the Phoenix. Harry Potter is agood example of how, as our network grows and IMAX awareness grows, our revenueper film should grow as well.
Our first Harry Potter movie, The Prisoner of Azkaban, grossed $14 million on 90 IMAX screens in2D. The next installment of the series, HarryPotter and the Goblet of Fire, grossed more than $20 million in 2D in 109IMAX theaters worldwide. Harry Potter and the Order of the Phoenix,which included 20 minutes of IMAX 3D footage, has grossed to date $37.8 millionon 142 screens. Harry Potter and the Half-Blood Prince is scheduled for release totheaters in November 2008 and we once again expect IMAX to be part of thatrelease.
Notably, strong film performance is clearly reflected in ourDMR revenues, which increased 84% in the third quarter compared to Q3 of lastyear and 71% in the first nine months of '07 compared to last year. We believethat the slowdown in installs, as well as our inability to recognize revenuesdue to digital upgrades -- both of which were related to our digital transition-- have made it difficult to see the growth in recurring revenues.
With respect to our other revenue lines, theater operationrevenues and other revenues were flat for the third quarter at $4.4 millionversus $4.7 million in the third quarter of '06 and other revenues came in atabout $1 million.
Gross margin for the third quarter of 2007 was $9.7 millioncompared to $12.2 million in margin for the third quarter of '06. This was obviously affected by the twodelayed installs and the installation and margin deferral associated with thedigital upgrade.
On the expense side, SG&A was approximately $10.3million in the third quarter, up from $9.8 million a year ago. $2.7 million of the SG&A recorded in thequarter was related to legal, accounting and professional fees. R&D expenses for the quarter were $1.6million, up from $900,000 last year due to investments in our digitaltechnology.
Turning to the balance sheet, we ended the quarter with$18.2 million in cash and short-term investments, which was roughly flat whencompared to $18.5 million at the end of the second quarter. Our senior notesallow us to borrow up to $30 million on a senior secured basis. We have not utilized that carve out to drawdown anything under our credit facility to date other than for letters ofcredit, which is also specifically allowed for under the senior notes, separatefrom the $30 million. $27.7 millionremains available under the facility's borrowing base calculation.
Looking ahead, we expect cash at the end of the year to beapproximately $15 million. Cash expenditures associated with legal, accountingand professional fees will be approximately $12 million and R&D-relatedcash expenditures will be approximately $8 million in all of '07.
With that, I would like to turn it over to Rich to reviewour film slate and provide a more detailed update on our strategic andoperating initiatives, as well as the role digital is playing in positioningIMAX for the future.
Thanks, Brad. Webelieve that the beginning of our digital rollout will usher in the beginningof the end of our difficult financial transition period. The last year and thenext few quarters have been and will be negatively impacted in part by issuesarising out of the digital transition from increased R&D to delayedinstallations to our inability to recognize revenue on systems where we providea digital upgrade. When we move into our full rollout of digital systems in thethird and fourth quarters of 2008, we should see a marked improvement infinancial performance.
The indices which will be the key drivers in creatingearnings in our digital environment include film slate, film performance,signings, JV signings and theater performance. Let's start with a look at our film slate. Next week, we are excited torelease Beowulf in IMAX 3D. This film looks amazing and is visuallystunning as a result of the next generation of the Polar Express-type CGI technology used by Robert Zemeckis. Thejunket press screenings were held exclusively in IMAX 3D -- that means not in 35 millimeter and not indigital 3D --and generated enthusiasticreactions. As we indicated on our lastcall, this is the first time a film will be released simultaneously in IMAX 3D,as well as conventional theater digital 3D. We welcome the opportunity to compare the per-screen box office of thetwo and believe the pricing in box office numbers will bear out that the IMAXexperience delivers the best, most differentiated, movie-going experience incinema.
After Beowulf, wewill release I Am Legend with WarnerBrothers Pictures on December 14. Thishighly anticipated film stars Will Smith as a brilliant scientist who is thelast human survivor of a virus that has wiped out all but the mutant victims ofthe plague. He must race against time to find a way to reverse the effects ofthe virus, using his own immune blood. We think that this compelling science fiction story and action-packedadventure will play particularly well on IMAX screens and draw the coveted techsavvy demographic group.
Looking ahead to our 2008 film slate, we announced last weekthat we would be partnering with Paramount Pictures to release The Spiderwick Chronicles, a fantasyadventure based on the best-selling series of books. The film is slated forrelease on February 15 and marks the fourth film agreement between IMAX and Paramountin the past five months. We believe Paramount'scontinuing enthusiasm for IMAX reflects our growing appeal as a distributionplatform and are excited to reach millions of Spiderwick fans with the unique IMAX experience.
We also set a new release date for the Rolling Stonesconcert film, Shine A Light, which isdirected by Academy Award-winning director, Martin Scorsese. This film is now slated to follow Spiderwick with a release date of April 4, 2008. This means we alreadyhave four films in place for our 2008 slate and we have identified and areactively negotiating films for the remaining slots of the year.
Turning now to our next important metric for measuring ourgrowth, film performance. Our trailing12-month DMR box office for all domestic theaters was $105.9 million from 125theaters as of the end of the third quarter, compared to $65.1 million from 109theaters at 3Q06, a 63% increase in DMR box office on only a 15% increase intheaters showing DMR domestically.
On a same-store basis, which might be a more interestingcomparison, which tracks only those theaters showing DMR films that were openeda year ago and therefore strips out the growth of the network, gross box officeincreased 60% to $1.3 million in revenues per screen. We think this trulyreflects moviegoers' growing appetite for the unique and immersive experienceIMAX provides.
Brad already touched on the impact that our pending digitalrollout is having on our overall signings, so I would like to take it to thenext metric and review our progress on joint ventures. As we've statedpreviously, we believe our transition to digital helps our joint ventureinitiative as it stimulates interest in IMAX that in turn will enable us toexpand the network more quickly.
As a reminder, we continue to believe that by significantlylowering the capital cost to exhibitors by contributing the system, with theexhibitor putting up retrofit costs, we can expand the network more rapidly andreceive a more significant part of the IMAX box office from the theaters, aswell as a continuing piece of the IMAX film revenue from the studio.
We currently have nine JVs installed: four with AMC, twowith Regal, two with Muvico, and one with Pathe ArenA in Amsterdam.We have been very pleased to-date with the performance of existing JVs. For the joint ventures opened approximatelytwo years, the returns on the venture are in the 45% to 50% range. The initialperformance of the newer JVs is even more better.
It is crucial to note that these returns have been generatedin a film world. In a digital world, the investment should go down because oflower installation and operating costs and revenue should go up because of morefilms and more film flexibility. We are in many discussions for JVs both in theUS and abroadwith existing and new customers and continue to be encouraged by the positivereception to our joint venture initiative.
Before taking your questions, we just want to reiterate theimportance of the significant progress we made on the digital front. After manyyears of both disappointments and successes, we are delighted to be on thethreshold of the formal launch of IMAX's digital projection system and the nextexciting chapter in the company's growth. The successful transition to adigital IMAX is like the Holy Grail for the company and it is expected tobenefit the business in many ways. But most importantly, we believe it willultimately lead to a business model with strong recurring revenues.
We think that the beginning of our digital rolloutrepresents the beginning of the end of our transitional financial period andthat the levers that will generate improve financial performance in a digitalenvironment -- film slate, film performance, signings, JV signings and theaterperformance -- are all showing solidmomentum.
We look forward to reporting to you on our continuedprogress. With that, we would like to open it up for some of yourquestions.
(Operator Instructions) Your first question comes from RichIngrassia - Roth Capital Partners.
Rich, we can't hear you.
Mr. Ingrassia, is your line on mute, sir? We will go to the next question.
We can't hear anything. Are you putting through the questions?
Your next question comes from Eric Wold –Merriman Curhan Ford. Mr. Wold, please go ahead.
Eric Wold –Merriman Curhan Ford
You gave the amount you are spending this year on legal andaccounting fees of $12 million and $8 million on R&D. What should we think about into '08? How muchof that legal and accounting fee won't be there next year? How much do you think is centered just purelyon this year to get the filings up to speed and all that? How much digitalspend would be left for 2008?
Eric, let me answer that a little differently, because Ithink you are asking obviously a very important question. Before we had our regulatory issues andbefore we were doing our digital R&D, I think you might see legal andprofessional fees, legal and accounting/professional fees, in the $3 million to$4 million range. I think you would also see a run rate of R&D of $3.5million.
Now '08 is a hybrid year, meaning we are still going to bespending some money on R&D development certainly through the early parts ofnext year and we are also going to be continuing with the regulatoryinquiries. I think our expectationobviously is that we hit the high points in this previous year and it startstailing down, and we hit hopefully a normalized run rate towards the end ofnext year.
So that is not quantifying the answer for '08, but it justmeans I think you have seen the peak in '07 and I gave you some sense of whatthe normal run rate is.
Eric Wold –Merriman Curhan Ford
I gather, obviously, that with the digital install coming orthe digital projector available around the middle of the year, obviously as youtalked about, you are probably not going to see a lot of installs in the firsthalf of the year. People wait andobviously for your sense, it's probably not worth installing something you aregoing to upgrade anyway in a few months.
Knowing that, you are probably going to see a prettyback-weighted year for installs into '08. What is your capacity to get those installs done? What are your thoughts on if you do getalmost all the installs kind of pushed into the last two quarters, howdifficult will that be to get complete?
Eric, our technology group has said that they could installas much as demand requires in the second half of the year. With that said, we are in the process of quantifyingthat and weaning it down, but it does not appear that the supply chain shouldbe an obstacle.
Eric Wold –Merriman Curhan Ford
Is it safe then to assume there should fairly minimal, ifany, installs in the first half?
Yes, it is going to be small, but I think the “if any” iswrong. I mean there should definitely be installs in the first half and theseare obviously film-based systems, some of which we will have an obligation toupgrade, some of which frankly we won't have an obligation to upgrade. Some will be domestic and a bunch will beinternational.
Eric Wold –Merriman Curhan Ford
In that backlog number you gave out, what is the number thatare scheduled to be installed during the fourth quarter, including the two thatwere moved?
The fourth quarter of this year?
Eric Wold –Merriman Curhan Ford
I think it is about seven, Eric.
Eric Wold –Merriman Curhan Ford
Including those two?
Including the two that slipped.
(Operator Instructions) There are no questions at this time.
Why don't Rich and I just make a couple of closing remarks? Mine are unbelievably simple and it's afunction of one of the things that we emphasized in the speech and it isactually a function of one of the questions that we got.
When we look forward, obviously Rich and I are veryenthusiastic about the effects on our business with the transition to digitalin and of itself, and also, I think we are very bullish on joint ventures andwhat they can do for us in terms of deployment of capital and return oninvestment.
On the other side, we see significant decreases in cashexpenditures and P&L expenditures with respect to SG&A and R&D andall of this really should begin to coalesce into our financials towards thesecond half of next year. But basically, the financials at IMAX tend to lag andI think what Rich and I are seeing on the ground on an operating basis ispretty positive with respect to our business.
Rich, your comments?
It is consistent, Brad. The only thing I would like to add is that at various times in abusiness' history, things look better on the inside or worse on the inside thanthey look on the outside. At the moment,there is somewhat of a disconnect between the level of business activity bothfrom studios and exhibitors and as we are talking about the performance of thetheaters, same-store sales up 60% versus what our reported financials are; andas Brad said, there is a lag between our business activity and what getsreported.
I guess I would just like to convey a personal view, whichBrad shares, is that right now things under the hood and inside the car look alot better than they do looking at the car from the outside. We are confident that over time, particularlywith the launch of digital, things will look as good on the outside as they nowdo on the inside.
With that, we would like to thank you for joining us.
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