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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 the conference over to Mr. Brad Wechsler.

Brad Wechsler

Thank you very much, operator. Good morning, everybody and thanks for joining us today on our conference call. Joining me as usual is my partner, co-Chairman and co-CEO, Rich Gelfond. Also with us are our CFO, 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(a) and 10-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 certain non-GAAP financial measures as defined by Regulation G of the Securities and Exchange Commission. A discussion of management’s views of these measures and reconciliations to GAAP measures are contained in the company's earnings release and our 10-K(a) for fiscal 2006, as well as our 10-Q for the third quarter of fiscal 2007, which as I said, will be filed later today.

The full text of the earnings release, along with supporting financial tables, is available on our website, Today's conference call is being webcast in its entirety on our website.

I would like to begin by discussing where IMAX stands today from a strategic point of view and where we go from here, particularly with respect to our pending transition to digital. Over the last decade, IMAX has recognized and discussed the benefits of transitioning from a film-based system to a digital format. We have had some false starts, as well as promising breakthroughs. Several weeks ago, we announced a seminal event: the formal launch of our digital projection system set for late in the second quarter of 2008. This date reflects a significant shift forward from our previously announced timeframe of the end of 2008 to mid '09, and we believe that digital's accelerated debut will drive significant benefits to the business that much more quickly.

Our digital prototype, which has been operating for the last few months near our corporate headquarters in Ontario, has demonstrated to our satisfaction that the IMAX digital projector will deliver the same “wow” factor that IMAX moviegoers have come to expect from the IMAX experience worldwide. We have completed the most difficult part of the development plan and are now focusing on systems integration. We expect to have prototypes in the field and operating within six to seven months, paving the way for a larger scale rollout two to three months later.

So why is this digital product so important to IMAX? The answer is that we expect our digital transition will not only facilitate a more rapid 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 to digital is what will enable us to show more films, up to as many as ten to 12 year compared to the six or seven now, and also enjoy enhanced programming flexibility. Indeed, over the next few years, we look forward to being able to show live-action events such as the Super 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 sales and joint venture models. Studios will enjoy a higher rate of return on each picture with no print costs, which provides an incentive for the studios to release even more films in IMAX. The exhibitors will also be the beneficiaries of more films, which will mean higher revenues and greater per-theater profitability.

Why was the recent announcement so important? First, moving up our target digital launch date reduced any uncertainty about our ability to deliver the digital system to the market in a timely fashion.

Second, the pending reality of digital spurred signings and continues to do so. With regard to installs, it is now clearer to exhibitors when the digital system will be available to them, which helps them get into the queue with fixed dates.

Moreover, the announcement means that we believe we have successfully capped the majority of our R&D digital spend and that this is not likely to be a significant financial drain on the company beyond the launch date.

As for P&L benefits, we now see digital system margins are potentially higher than we had originally projected as costs of goods sold are less than with the film system. As noted above, many of our exhibition clients have now seen our digital prototype and the response has been unanimously positive.

This enthusiastic reaction helped us secure 18 signings in Q3, which is equal to the number we had in the first half of the year. Of the recently announced deals, in our Regal deal, three of the five systems will be digital and in our recent China deal, there will be seven digital systems out of the total of 10 signed. In general, the level of interest in an IMAX digital product is very strong and we are encouraged by general exhibitor sentiment. Over the next several weeks, many more exhibitors will see IMAX digital for the first time.

Before Rich updates you on joint venture and film and how it fits with our digital initiative, let me take you through our third quarter financial results. As we have stated before, as a result of the combination of high R&D related to the digital initiative, high SG&A largely related to accounting and regulatory issues, as well as slow film-based system installations, 2007 continues to be a challenging year from a financial point of view.

Total revenues for the third quarter came in at $29.8 million compared to $31 million last year. We recorded a net loss from continuing operations of $0.19 per share for the quarter, compared to a restated loss from continuing operations of $0.12 a share for the third quarter a fiscal '06. However, we signed 18 deals in Q3 of this year compared to five a year ago and we believe this signing strength reflects the enthusiasm for our digital and joint venture initiatives that we are seeing gain traction with exhibitors.

System revenue came in at $14.9 million in Q3 '07 compared to $17.6 million last year. We recognized sales and sales by lease revenues on five installations compared to seven in the third quarter of last year. We should also point out that two installs originally scheduled for the third quarter slipped within just days of the fourth quarter, which had an adverse impact of $2 million on the quarter. While slippages do remain a part of our business, we note that these systems will be recognized in the fourth quarter as the theaters are now open to the public.

During the third quarter, we installed one additional system for which we recognized no revenue under the sales arrangement because under our accounting protocol, the revenue is deferred until we can establish fair value or install the contracted-for digital upgrade. As a reminder, cash payments on these systems are not affected by the accounting deferral.

It is important to keep in mind that we also installed one joint venture in the third quarter of 2007 whereas last year, we didn't install any. These JVs had only a minimal financial impact in the third quarter, but will provide recurring revenues on an ongoing basis.

As we look ahead, we expect we will ultimately see less choppiness in the systems revenue as we transition to having more recurring revenues from joint ventures and are less dependent on sales. The same should go for overall revenues as well as in the digital world, the ability to show ten to 12 films per year over an increasingly larger network should translate into a very strong recurring DMR box office of which IMAX typically receives 10% to 15%.

We should also point out that the anticipated universe of required upgrades should get significantly smaller with the acceleration of our digital launch date. It is important to try to quantify this a little. In general, we provide upgrades on film-based systems signed after Q3 2006 and installed before our digital product is delivered, a date now expected to be the latter half of 2008 as opposed to sometime in '09.

The total universe of deals signed and installed in this shortened period is about 13 systems and the cost of converting a film-based IMAX system to a digital system is approximately $300,000.

Our backlog at the end of the third quarter consisted of 90 systems with a value of $126.4 million, including seven joint venture arrangements which carry no backlog value; two systems subject to certain conditions; and seven systems under which clients have opt-out rights under certain circumstances. This compares with 78 total systems with a value of $125.8 million at the end of the year-ago period.

Our third quarter film revenue was $9.5 million compared to $7.7 million in Q3 '06, which largely reflects the record-breaking DMR performance of Harry Potter and the Order of the Phoenix. Harry Potter is a good example of how, as our network grows and IMAX awareness grows, our revenue per film should grow as well.

Our first Harry Potter movie, The Prisoner of Azkaban, grossed $14 million on 90 IMAX screens in 2D. The next installment of the series, Harry Potter and the Goblet of Fire, grossed more than $20 million in 2D in 109 IMAX theaters worldwide. Harry Potter and the Order of the Phoenix, which included 20 minutes of IMAX 3D footage, has grossed to date $37.8 million on 142 screens. Harry Potter and the Half-Blood Prince is scheduled for release to theaters in November 2008 and we once again expect IMAX to be part of that release.

Notably, strong film performance is clearly reflected in our DMR revenues, which increased 84% in the third quarter compared to Q3 of last year and 71% in the first nine months of '07 compared to last year. We believe that the slowdown in installs, as well as our inability to recognize revenues due 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 operation revenues and other revenues were flat for the third quarter at $4.4 million versus $4.7 million in the third quarter of '06 and other revenues came in at about $1 million.

Gross margin for the third quarter of 2007 was $9.7 million compared to $12.2 million in margin for the third quarter of '06. This was obviously affected by the two delayed installs and the installation and margin deferral associated with the digital upgrade.

On the expense side, SG&A was approximately $10.3 million in the third quarter, up from $9.8 million a year ago. $2.7 million of the SG&A recorded in the quarter was related to legal, accounting and professional fees. R&D expenses for the quarter were $1.6 million, up from $900,000 last year due to investments in our digital technology.

Turning to the balance sheet, we ended the quarter with $18.2 million in cash and short-term investments, which was roughly flat when compared to $18.5 million at the end of the second quarter. Our senior notes allow us to borrow up to $30 million on a senior secured basis. We have not utilized that carve out to draw down anything under our credit facility to date other than for letters of credit, which is also specifically allowed for under the senior notes, separate from the $30 million. $27.7 million remains available under the facility's borrowing base calculation.

Looking ahead, we expect cash at the end of the year to be approximately $15 million. Cash expenditures associated with legal, accounting and professional fees will be approximately $12 million and R&D-related cash expenditures will be approximately $8 million in all of '07.

With that, I would like to turn it over to Rich to review our film slate and provide a more detailed update on our strategic and operating initiatives, as well as the role digital is playing in positioning IMAX for the future.

Rich Gelfond

Thanks, Brad. We believe that the beginning of our digital rollout will usher in the beginning of the end of our difficult financial transition period. The last year and the next few quarters have been and will be negatively impacted in part by issues arising out of the digital transition from increased R&D to delayed installations to our inability to recognize revenue on systems where we provide a digital upgrade. When we move into our full rollout of digital systems in the third and fourth quarters of 2008, we should see a marked improvement in financial performance.

The indices which will be the key drivers in creating earnings 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 to release Beowulf in IMAX 3D. This film looks amazing and is visually stunning as a result of the next generation of the Polar Express-type CGI technology used by Robert Zemeckis. The junket press screenings were held exclusively in IMAX 3D -- that means not in 35 millimeter and not in digital 3D --and generated enthusiastic reactions. As we indicated on our last call, 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 the two and believe the pricing in box office numbers will bear out that the IMAX experience delivers the best, most differentiated, movie-going experience in cinema.

After Beowulf, we will release I Am Legend with Warner Brothers Pictures on December 14. This highly anticipated film stars Will Smith as a brilliant scientist who is the last human survivor of a virus that has wiped out all but the mutant victims of the plague. He must race against time to find a way to reverse the effects of the virus, using his own immune blood. We think that this compelling science fiction story and action-packed adventure will play particularly well on IMAX screens and draw the coveted tech savvy demographic group.

Looking ahead to our 2008 film slate, we announced last week that we would be partnering with Paramount Pictures to release The Spiderwick Chronicles, a fantasy adventure based on the best-selling series of books. The film is slated for release on February 15 and marks the fourth film agreement between IMAX and Paramount in the past five months. We believe Paramount's continuing enthusiasm for IMAX reflects our growing appeal as a distribution platform and are excited to reach millions of Spiderwick fans with the unique IMAX experience.

We also set a new release date for the Rolling Stones concert film, Shine A Light, which is directed 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 already have four films in place for our 2008 slate and we have identified and are actively negotiating films for the remaining slots of the year.

Turning now to our next important metric for measuring our growth, film performance. Our trailing 12-month DMR box office for all domestic theaters was $105.9 million from 125 theaters as of the end of the third quarter, compared to $65.1 million from 109 theaters at 3Q06, a 63% increase in DMR box office on only a 15% increase in theaters showing DMR domestically.

On a same-store basis, which might be a more interesting comparison, which tracks only those theaters showing DMR films that were opened a year ago and therefore strips out the growth of the network, gross box office increased 60% to $1.3 million in revenues per screen. We think this truly reflects moviegoers' growing appetite for the unique and immersive experience IMAX provides.

Brad already touched on the impact that our pending digital rollout is having on our overall signings, so I would like to take it to the next metric and review our progress on joint ventures. As we've stated previously, we believe our transition to digital helps our joint venture initiative as it stimulates interest in IMAX that in turn will enable us to expand the network more quickly.

As a reminder, 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 currently have nine JVs installed: four with AMC, two with 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 approximately two years, the returns on the venture are in the 45% to 50% range. The initial performance of the newer JVs is even more better.

It is crucial to note that these returns have been generated in a film world. In a digital world, the investment should go down because of lower installation and operating costs and revenue should go up because of more films and more film flexibility. We are in many discussions for JVs both in the US and abroad with existing and new customers and continue to be encouraged by the positive reception to our joint venture initiative.

Before taking your questions, we just want to reiterate the importance of the significant progress we made on the digital front. After many years of both disappointments and successes, we are delighted to be on the threshold of the formal launch of IMAX's digital projection system and the next exciting chapter in the company's growth. The successful transition to a digital IMAX is like the Holy Grail for the company and it is expected to benefit the business in many ways. But most importantly, we believe it will ultimately lead to a business model with strong recurring revenues.

We think that the beginning of our digital rollout represents the beginning of the end of our transitional financial period and that the levers that will generate improve financial performance in a digital environment -- film slate, film performance, signings, JV signings and theater performance -- are all showing solid momentum.

We look forward to reporting to you on our continued progress. With that, we would like to open it up for some of your questions.

Question-and-Answer Session


(Operator Instructions) Your first question comes from Rich Ingrassia - Roth Capital Partners.

Brad Wechsler

Rich, we can't hear you.


Mr. Ingrassia, is your line on mute, sir? We will go to the next question.

Brad Wechsler



Hi, sir.

Brad Wechsler

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 and accounting fees of $12 million and $8 million on R&D. What should we think about into '08? How much of that legal and accounting fee won't be there next year? How much do you think is centered just purely on this year to get the filings up to speed and all that? How much digital spend would be left for 2008?

Brad Wechsler

Eric, let me answer that a little differently, because I think you are asking obviously a very important question. Before we had our regulatory issues and before we were doing our digital R&D, I think you might see legal and professional 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 $3.5 million.

Now '08 is a hybrid year, meaning we are still going to be spending some money on R&D development certainly through the early parts of next year and we are also going to be continuing with the regulatory inquiries. I think our expectation obviously is that we hit the high points in this previous year and it starts tailing down, and we hit hopefully a normalized run rate towards the end of next year.

So that is not quantifying the answer for '08, but it just means I think you have seen the peak in '07 and I gave you some sense of what the normal run rate is.

Eric Wold –Merriman Curhan Ford

I gather, obviously, that with the digital install coming or the digital projector available around the middle of the year, obviously as you talked about, you are probably not going to see a lot of installs in the first half of the year. People wait and obviously for your sense, it's probably not worth installing something you are going to upgrade anyway in a few months.

Knowing that, you are probably going to see a pretty back-weighted year for installs into '08. What is your capacity to get those installs done? What are your thoughts on if you do get almost all the installs kind of pushed into the last two quarters, how difficult will that be to get complete?

Rich Gelfond

Eric, our technology group has said that they could install as much as demand requires in the second half of the year. With that said, we are in the process of quantifying that and weaning it down, but it does not appear that the supply chain should be an obstacle.

Eric Wold –Merriman Curhan Ford

Is it safe then to assume there should fairly minimal, if any, installs in the first half?

Brad Wechsler

Yes, it is going to be small, but I think the “if any” is wrong. I mean there should definitely be installs in the first half and these are obviously film-based systems, some of which we will have an obligation to upgrade, some of which frankly we won't have an obligation to upgrade. Some will be domestic and a bunch will be international.

Eric Wold –Merriman Curhan Ford

In that backlog number you gave out, what is the number that are scheduled to be installed during the fourth quarter, including the two that were moved?

Brad Wechsler

The fourth quarter of this year?

Eric Wold –Merriman Curhan Ford

Correct. Current quarter.

Rich Gelfond

I think it is about seven, Eric.

Eric Wold –Merriman Curhan Ford

Including those two?

Brad Wechsler

Including the two that slipped.

Rich Gelfond



(Operator Instructions) There are no questions at this time.

Brad Wechsler

Why don't Rich and I just make a couple of closing remarks? Mine are unbelievably simple and it's a function of one of the things that we emphasized in the speech and it is actually a function of one of the questions that we got.

When we look forward, obviously Rich and I are very enthusiastic about the effects on our business with the transition to digital in and of itself, and also, I think we are very bullish on joint ventures and what they can do for us in terms of deployment of capital and return on investment.

On the other side, we see significant decreases in cash expenditures and P&L expenditures with respect to SG&A and R&D and all of this really should begin to coalesce into our financials towards the second half of next year. But basically, the financials at IMAX tend to lag and I think what Rich and I are seeing on the ground on an operating basis is pretty positive with respect to our business.

Rich, your comments?

Rich Gelfond

It is consistent, Brad. The only thing I would like to add is that at various times in a business' history, things look better on the inside or worse on the inside than they look on the outside. At the moment, there is somewhat of a disconnect between the level of business activity both from studios and exhibitors and as we are talking about the performance of the theaters, same-store sales up 60% versus what our reported financials are; and as Brad said, there is a lag between our business activity and what gets reported.

I guess I would just like to convey a personal view, which Brad shares, is that right now things under the hood and inside the car look a lot better than they do looking at the car from the outside. We are confident that over time, particularly with the launch of digital, things will look as good on the outside as they now do on the inside.

With that, we would like to thank you for joining us.

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