IMAX Corporation (NYSE:IMAX)
Q3 2012 Earnings Call
October 25, 2012 8:30 a.m. ET
Teri Loxam - Vice President of Investor Relations
Rich Gelfond - Chief Executive Officer
Joe Sparacio - Chief Financial Officer
Rob Lister - Chief Legal Officer
Greg Foster - Chairman & President of Filmed Entertainment
Townsend Buckles - JPMorgan
Drew Borst - Goldman Sachs
Benjamin Mogil - Stifel Nicolaus
James Marsh - Piper Jaffray
Eric Handler - MKM Partners
Richard Ingrassia - Roth Capital Partners
Vasily Karasyov - Susquehanna Financial Group
Aravinda Galappatthige - Canaccord Genuity
Steve Frankel - Dougherty & Co.
Daniel Ernst - Hudson Square Research
Jim Goss - Barrington Research
Martin Pyykkonen - Wedge Partners
Good day and welcome to the IMAX Corporation Third Quarter 2012 Earnings Conference Call. All participants are currently in a listen-only mode. (Operator Instructions) Today’s conference is being recorded. At this time, I would like to turn the call over to Ms. Teri Loxam, Vice President of Investor Relations. Please go ahead.
Thanks, Michelle. Good morning everyone and thanks for joining us on today’s third quarter 2012 conference call. Joining me today is our CEO, Rich Gelfond; our CFO, Joe Sparacio; and Rob Lister, our Chief Legal Officer. Also here today is Greg Foster, our Chairman & President of Filmed Entertainment, who will be joining us for the Q&A portion of the call.
I would like to remind you the following information regarding forward-looking statements. Our comments and answers to your questions on this call may include statements that are forward-looking and that they pertain to future results or outcomes. Actual future results or occurrences may differ materially from these forward-looking statements. Please refer to our SEC filings for a more detailed discussion of some of the factors that could affect our future results and outcomes.
During today’s call, references may be made to certain non-GAAP financial measures as defined by Regulation G of the Securities and Exchange Commission. Discussion of management’s use of these measures and the definition of these measures as well as reconciliations to adjusted EPS, adjusted EBITDA as defined by our credit facility and free cash flow are contained in this morning’s press release. The full text of our third quarter earnings release along with supporting financial tables is available on imax.com. Today’s conference call is being webcast in its entirety on our website.
With that let me turn the call over to Rich Gelfond.
Thanks, Teri. As you all know we have significantly evolved over the past five years. As we sit here today I see IMAX at an inflexion point between a company that has spent the last few years building and proving out a business model to a global enterprise that has created a differentiated product and global brand. We believe we have positioned ourselves to produce recurring revenues and cash flows and drive long-term growth.
We have achieved sufficient scale so that we now are able to evaluate our film performance as an annual portfolio. The scalability of our business is also evident in our network size, where adding incremental theatres results in margin expansion in our P&L. In sum, we are no longer simply a title-to-title, theatre-to-theatre story, but rather a network growth, recurring revenue growth company. Our third quarter results are strong evidence that IMAX’s evolved business model provides increasing top and bottom line growth.
During a time when the movie industry has suffered a down quarter at the box office versus last year, IMAX’s global box office was up 16% and our year-to-date box office is up over 45%. IMAX’s third quarter revenues of $81 million grew 20% versus the same period last year, driven by continued growth in our recurring revenues as well as revenues from sales type theatre installation.
Adjusted EBITDA increased by 59% to $34 million and adjusted EPS of $0.26 grew by 86% versus the same period last year. Even in a quarter in which the overall box office potential may not have lived up to expectations, we demonstrated not only decent top line growth but more importantly translated that to strong bottom line growth as well.
A key driver of our growth story is expanding our network and we continue to see significant demand for new IMAX screens in regions around the world. This quarter we installed 28 new theatre locations in a number of locations globally, including China, India, Russia, Egypt, Ecuador and Kazakhstan, to name a few. We also signed deals this quarter for 41 IMAX theatres and our pipeline for future theatre deals continues to be robust.
Let's spend a few moments going through our progress in each region. We have continued to see additional interest in the domestic market for a new as well as from existing partners, with a number of signings in North America this quarter. In fact, two of our largest partners, AMC and Regal, signed on to install additional IMAX theatres on the same terms as our existing JV agreement. AMCs signed on for a firm eight additional IMAX theatres with the potential for ten more on top of that. And Regal signed on for another ten sites.
In addition, Guzzo, one of our Canadian partners, signed on for another three theatres. Having this led our continued demand from our existing partners shows just how much value an IMAX theatres brings to exhibitors. In Greater China we installed 14 new theatres in Q3, bringing our total commercial network to 92 at the end of September with almost half now being joint ventures. We are in business with over 15 exhibitors in China and we continue to see high levels of demand for new IMAX theatres in the region. And IMAX continues to be a top choice for people entertainment dollars in China.
I was in China in September and was again impressed by the level of brand awareness and excitement for IMAX. The decision by China film bureau to play The Dark Knight Rises at the same time as The Amazing Spider-Man, did impact the performance of both titles. But my sense from the trip is that the intent of China film bureau was to free up more slots for Chinese movies. In my opinion, the unintended consequences of lower Hollywood box office may give China a cause to rethink this strategy longer-term.
China will likely continue to impose blackout periods at various times in the year, however we have been proactive about developing strategies to maximize our theatre performance in China. Such as the recent deal with high profile film producer, Huayi Bros., for four local language films to play in the back half of this year. China is an important growth region for us and we are pleased with the progress we continue to make there.
But our international story is not only about China. We have also continued to make progress in Europe. Earlier this year we brought on board Andrew Cripps, former President of Paramount International UIP to manage this region and his experience and connection have already been paying off. We have installed 11 new theatres this year in Europe including Russia. And we have signed deals for 14 new theatres in Europe this year as well. And we are encouraged with the performance of some of our new theatres in the region, especially in the UK, where our per screen average has been $1.5 million year-to-date.
In India, we signed a film deal last month for our Bollywood title. As you know about 90% of India’s box office is driven by Indian language films, so the release of Dhoom 3, from Yash Raj Films next winter will be an important proof of concept for us. In fact, at thanks giving this year I am going to India for about ten days to try and follow up on that activity. We currently only have four theatres open in India with another nine in backlog. But we believe this region represents a considerable opportunity for IMAX in the longer-term.
Moving on to Latin America, this is a region that has not progressed as quickly as I would have hoped. However, it is a region with significant potential growth for IMAX, so we are taking important steps to increase penetration. We currently have 19 commercial theatres open in this region and they have been performing very well. As we have seen in other regions, having strong reference leaders can help catalyze our growth. To leverage this momentum, we have increased our visits to the region, building relationships and talking with exhibitors as well real estate developments. We believe these efforts will start to payoff in a bigger way in 2013.
Turning to our film slate. We have more than 30 films playing across our network this year, including some local language content, which is about the number of films we expect to have in our portfolio each year going forward. We have announced ten films for 2013. However, the majority of our titles have been selected and we are just working through the final stages of discussions with the studios. We see the slate for 2013 as a strong portfolio of films for IMAX that are well spaced throughout the year, as you know an important point.
We are excited that several films next year will have IMAX DNA included in them. Such as Star Trek and The Hunger Games, sequels, portions of which have been filmed with our cameras. And Oblivion which was filmed to specifically take advantage of our enhanced aspect ratio and which will have an IMAX early release in April. We have found that movies that leverage IMAX differentiation, whether they are shot with our cameras, especially film for our unique aspect ratio, tend to drive higher box office results for us as well as for exhibitors and studio partners.
Good examples are The Dark Knight Rises, which has grossed over $110 million in IMAX, and Mission Impossible 4, which helped reinvigorate that franchise. As a result, we have seen an increase in demand from studios and film makers to incorporate some IMAX DNA into their movies. In fact, director Sam Mendes of SKYFALL was originally going to present only part of the movie in our unique aspect ratio, but after seeing the IMAX footage decided to utilize our aspect ratio throughout the entire movie.
As you can see, we had a lot of positive momentum at the company. We continue to install theatres that have good taste and demand for new IMAX screens continues to be strong. We feel very good about the health and fundamentals of our business and we are committed to continuing to take steps to maximize our long-term growth.
Before passing over to Joe I want to spend a couple of moments highlighting a few changes that you should expect on a communications front going forward. As I mentioned before, we have evolved as a company over the past few years and we are now at a point where we have scale on our film slate as well as scale in our network. We are rounding a corner to what we believe will be a period of long-term growth. In line with this evolution, we have decided to take a hard look at the metrics that we report and we plan to evolve our communications strategy to focus on a smaller number of key items that we think will help long-term investors assess how we are reviewing each year.
We recognize that there will always be quarterly volatility in this industry and while we still pay attention to the quarters, we think focusing on annual metrics is the best way to measure our long-term growth and the value we bring to shareholders. To that end, in the press release this morning we issued updated 2012 and 2013 installation guidance under a new definition. In the past we had guided installs only at a backlog. From now on we will give you our best estimate of the total number of installations we expect each year including from backlog as well as new signing installs. This will be an annual number. We do not intend to update this guidance each quarter unless there is a material change.
In addition, for our new signings you should expect that we will send our press releases for the larger deal but we do not intend to press release all the smaller deals. We will make sure that we will provide you with additional color on new theatre demand during our quarterly earnings calls. We are also evaluating the most appropriate metrics related to box office performance. Beginning next year we do not intend to issue mid-quarter updates. In our view there is minimal predictive value in these updates as there is variability each quarter in the timing of movie release dates. For example, in the fourth quarter this year Bond and Hobbit are back loaded towards the end of the quarter.
And in line with the change we made last quarter, we will not issue an end of quarter box office update for Q4. We have not made any final decisions yet on new box office metrics but we will make sure to communicate any future changes to you as needed. We welcome your feedback on the changes that we have already made or any potential ideas for changes going forward.
And with that, let me turn it over to Joe to go through some of our financial highlights from the quarter.
Thanks, Rich. We had another strong quarter across our financials with total revenue of $80.7 million and adjusted EPS of $0.26. We also generated roughly $30 million of free cash flow. Total revenues increased by 20% compared to third quarter last year driven by growth in our recurring revenues as well as additional sales type lease system installations.
We expanded our commercial network by 26% over the last 12 months and this resulted in continued growth in our recurring revenues. The joint revenue sharing and DMR revenue lines both grew over 30% this quarter versus last year to a combined $38.4 million in revenues in Q3. And importantly, the high margin on the line items of 70% for joint revenue sharing arrangements and 60% plus for DMR, allowed for a large portion of this revenue to drop to the bottom line.
The DMR rate, gross margin rate, was slightly lower this quarter compared to the same period last year as we incurred some additional expenses related to film prints. In addition, we had a strong quarter for sales type lease installations which generated $21.9 million of revenues at a 50% gross margin, helping to drive our top and bottom line growth. We installed 14 new sales type systems and 3 upgrades. Adding these to the 14 new and 2 upgraded JV theatres that we installed in Q3, our total installations for the quarter were 28 new installations and 5 upgrades.
As Rich mentioned earlier, we also signed deals this quarter for 41 theatres compared 30 signings during the same timeframe last year, which demonstrated the continued demand for IMAX systems globally. As you saw in our press release this morning, we are on track to meet our previously provided guidance of approximately 110 new theatre installations in 2012. This implies expected new installations of 46 in Q4 with approximately 14 expected to be sales type lease arrangements.
Also we want to note that of the Q4 installations, we expect 11 to be JV hybrid installs. We have also issued guidance that we expect a total of 110 to 125 new installations for 2013 with the mix skewing towards JVs for that year. As Rich mentioned, our 2012 and 2013 installation guidance are being provided under a new definition that we will be using going forward. Instead of only guiding from backlog, we are now giving guidance on the total expected installs for the year including backlog and projected signing installs.
Moving on to our operating expenses. We were able to come in lower this quarter than originally anticipated. SG&A excluding stock-based comp came in at $16.6 million which was in line with last quarter and lower than last year’s $18.9 million. But remember last year’s SG&A was artificially high as a result of the $4.1 million foreign exchange charge. For the full year 2012, we now expect SG&A from operations excluding stock-based comp to be about $65 million to $67 million, which implies Q4 SG&A of about $16 million to $18 million. This guidance is for less expenses than what we had given in Q2 due to timing and it also reflects greater discipline with regard to certain discretionary spending items.
We continue to expect stock-based compensations for the year to come in at around $13 million. Q3 R&D was $2.5 million, including about $425,000 of amortization. And we are guiding to $12 million to $14 million for the full year, including about $2 million of amortization, which implies Q4 R&D of about $4 million to $6 million. Q3 R&D was lower than expected due to timing of the spending on some of our laser development.
In terms of tax, we continue to estimate an effective tax rate of approximately 31% for the full year 2012, which includes expected cash taxes of only $3 million to $4 million because of the NOLs we still have. While we demonstrated strong revenue and earnings growth this quarter, even more importantly this robust growth was translated into cash flows. During the quarter we generated free cash flow of about $30 million of which we used $25 million to continue to pay down our bank debt which further improves our already healthy balance sheet. We believe that this pay down helps us ensure we will have maximum financial flexibility to continue to support the company’s anticipated strong growth going forward.
With that, I will turn it over to Rich for closing remarks.
We have created a truly differentiated brand and entertainment experience that is being embraced by exhibitors, studios and most importantly by movie goers around the world. To deliver continued long-term success, we remain focused on executing against all aspects of our business. Including expanding our network globally, selecting the best possible film portfolio and controlling expenses in order to maximize the scalability in our business.
This quarter’s signings and installs along with the strong financial results are further evidence that we have rounded the quarter at corner and are on the path towards a period of sustained growth. And with that we will open it up to any of your questions.
(Operator Instructions) We will now take our first question. The first question comes from Townsend Buckles of JPMorgan. Please go ahead.
Townsend Buckles - JPMorgan
A few questions. First for Joe. On your higher DMR fee and film prints in the quarter surrounding Dark Knight, should we expect to see this dynamic for the Hobbit and your bigger releases down the road? And are you planning to utilize your institutional screens more often. And then for Rich, good to see the acceleration in installs for 2013. Can you give us a rough sense of how these breakdown geographically and where Western Europe and Latin America fit into your outlook. Thanks.
I will answer my question first, Townsend, it’s Rich. The answer is that one of the things that happened in 2012 is that we had more in signings than we had originally budgeted. And some of those are even going into 2012. But what happened is because our backlog is more newbuild weighted than it has been in previous years, some of the 2012 slipped into 2013. So what you are seeing in 2013 is a continuation of some of the trends we have had before live installs in China. I think you will see North America where we had a very strong quarter. A lot in North America. Europe as I said has gotten off to a strong start. So I think you will see a lot going on in Europe.
I think Latin America as I mentioned, Townsend, is a bit of a longer term project. Again not to belabor the point, but we have a partner in Latin America and 2012 was sort of a transitional year where we participated alongside the partner. We got a lot of traction in terms of relationships but not that much in terms of actual sign deals. And I think in 2013 we think that will materialize. Again, I think Russia will also be fairly strong from an install point of view.
I will give you sort of a broad overview and then Joe can fill in the details on the film print issue. You know I think we don’t expect to see the same kind of movement on film prints overall. What happened during the quarter was in Spider-Man and The Dark Knight Rises, we played a role in financing the film print and it skewed some of the margins from the way they are reported during the quarter. Now you know in future quarters there are instances where we would be involved but I don’t think you should look at the quarter as ongoing guidance for new levels. Do want to add?
No, Rich, I would agree with that. I don’t think that that’s a blueprint for the future for sure. In terms of the second part of that question regarding institutional sites, I think the film has to be right film for those type of sites. So the Dark Knight lends itself well. We have played Harry Potter in some institutional sites. The Hobbit maybe in certain institutional sites. So it really depends upon the film that’s being released, whether it will go into those sites or not.
Thank you. The next question comes from Drew Borst of Goldman Sachs. Please go ahead.
Drew Borst - Goldman Sachs
Guys when I look at your JV revenue sharing revenue that was in the quarter, when you do that as a percent of the global box office it looked like it was a little bit lower in the third quarter than it has been in the first half of the year. So I think by my numbers it was about 7.5% in the third quarter and it was closer to 9%, 9.5%. Can you explain what was going on there?
I think you have a couple of things going on. In releasing the Dark Knight we had over a hundred print theatres which were not JV theatres. And they generated significant volumes. So if you are trying to apply the historical rate, it really depends upon where did the box office land. Was it on a Red Shirt Theater or was it on a sales type lease or a film theatre. And I think it has more to do with mix than anything else.
And to add to that, as I mentioned, the Dark Knight is one of the films we were involved in financing the prints and you have to remember Chris Nolan filmed it with IMAX theatres and it really took advantage of our aspect ratio in the IMAX film theatre. So those sort of over invest. But again it shows up on a different line as Joe said, because we subsidized some of the print cost, we got extra revenues in a number of those theatres. So when you blend it all together, we ended up in a very good place which just showed up on a different line.
Yeah, I think if you did the math on our DMR percentage this quarter you will see it’s higher than then the norm.
Drew Borst - Goldman Sachs
Okay. And then just quickly. Could you give us the breakdown of the box office between domestic and international?
So for the quarter, we were at -- domestic was 293, international was 339, and the aggregate was roughly 312.
No, he means gross box office, Joe.
Oh, gross box office, I am sorry. We did 173.2 versus last year of 149.5.
And how much of that was international and how much was domestic.
Let's see. International was 75.9 versus 77 last year. 97.3 million domestic versus 72.5 million last year.
Thank you. The next question comes from Ben Mogil of Stifel. Please go ahead.
Benjamin Mogil - Stifel Nicolaus
So two questions. In terms of the backlog or in terms of the installation guidance you are giving for next year, can you maybe breakdown how much of it is that of existing backlog and sort of how much of it is sort of your expectation around screen signings in the year. And then secondly, the DMR percentage, the percentage of the box office seems like 14.6%, so much higher than we have seen in past quarters are we seeing the new splits in China coupled with some China local films and maybe talk a little bit about some sort of commentary around that if you can.
Yeah, I think you are seeing somewhat of the impact on splits in China. In fact to remind all those on the call, because the take rate in China used to be 13% to 15% for the studios rather than 25% which it is today, we were able to push our share of the box office somewhat higher. So where if it used to be 6.5%, I think right now we are settling in like the 9% to 10% range and I would model that on a go-forward basis in thinking about it.
On the other hand during the quarter, it’s impact was a little more limited because again, films were played back to back with each other, such as Spider-Man and The Dark Knight. So that accounted for some of it. I don’t know if you want to add anything?
Yeah, the only piece I will add, Ben, is don’t forget that we had a higher split because of the print deals. So although you did have a higher top line, you did have some cost going against that.
Benjamin Mogil - Stifel Nicolaus
And then on the sort of issue with the backlog, I am sorry, with the installation guidance for next year. Do you think you can sort of parse out the 125 to make it easy. How much is roughly at a backlog and how much is out of screen signings?
Yeah, I think that we are not going to do that. I think we are going to look at it as a whole because we didn’t do that this quarter. Because essentially what happens every year if something slipped out of backlog and slipped into the next year which is what I mentioned happened this year. And then there is a certain amount of signing and installs. So I don’t think that’s that useful to do it. Although I will give you a general comment which is the number out of backlog is certainly consistent with what it’s been -- what it was in 2012.
Benjamin Mogil - Stifel Nicolaus
Okay. And then just lastly, your ASP I think on your systems sales was significantly higher than we have seen in the last couple of quarters. You know any kind of comments you can give around that?
You know it really depends upon the types of deals that you are doing and what margins they bring to the table. So some are little higher than others.
Including some of the hybrids which are in there.
The next question comes from James Marsh of Piper Jaffray. Please go ahead.
James Marsh - Piper Jaffray
Two quick questions here. First, I was hoping you guys could discuss a little bit about the Dolby Atmos initiative. I think (inaudible) be the third film in that I guess format, for lack of a better term. Could you talk a little about what their actually doing there. Is it just a remix or is it an up conversion? And maybe if you could talk a little bit about the partnering with some of the generic large formats and how that might impact the competitive environment. And the second question just relates to screen guidance for 2013. So many laser installs, and just to be clear, when you talk about true installs versus digital upgrades, I assume a laser upgrade would be true install, if you know what I mean.
Yes, it would be, James, because you are paying for both. You know kind of a revenue neutral kind of deal. But no, 2013 guidance does not include any laser installs and if that happens that would be crazy but not at that (inaudible).
Nor any other upgrades. So that number is pure of any -- there is no upgrades in there, laser or digital.
And in terms of Dolby Atmos which I think Dolby has done a good job in introducing a new product. I think we have done -- our technical people have taken a look at what they are doing and while we respect what they are doing, the Dolby Atmos system was not really designed for film makers. So we think that the specs that we use in our IMAX system are superior to what's being done with Dolby Atmos. And a number of the leading sound experts tend to agree with us. I think it’s a very good system and I think it’s a move forward and I think a number of people in the sound community are impressed with what they have done.
In terms of teaming up with existing PLS, I mean I think IMAX, James, is an end to end solution as you know very well. And it starts with whether the image is captured by our camera or is translated by a proprietary DMR technology. It has to do with the relationship with the filmmakers, to the movie. It has to do with the relationship of the studio. So the marketing is more and more part of this DNA of that. It had to do with the integrated solution on the end in terms of image and sound and marketing, and brand and experience. And I don’t think the fact that an upgraded sound system as parting with a PLS, is a particularly great threat to us. Greg, do you want to add anything?
Yeah, I think the key thing is that we continue to have a direct relationship with the filmmakers. And that includes the sound design of the IMAX release. We rebalance, remix every soundtrack specifically for the IMAX with the hands-on partnership of our filmmaker partners or their sound designer or mixer. So again, Rich is right. The Dolby Atmos group has done a nice job of marketing their system but our actual behind the scenes direct involvement with the filmmakers itself is unique relationship that I don’t believe anyone else has.
Thank you. The next question comes from Eric Handler of MKM Partners. Please go ahead.
Eric Handler - MKM Partners
Just looking at your free cash flow. You generated about $30 million for the first three quarters of this year. So let's call it about 30% of adjusted EBITDA and roughly 100% of your net income. Going forward, is that something that’s sustainable or how should we think about your free cash flow generation?
I think, Eric, it’s really going to be dependent upon the level of investments that we are making in our JV theatres. So if we get a lot of JV signings in a particular period, obviously it’s going to lower free cash flow. But if you are kind of at a steady state, given the critical mass that we have now achieved, you know I would anticipate that trend continuing forward.
I mean we were very pleased with the free cash flow during the quarter. That was part of my remarks about the scalability. And however, doing joint ventures that have IRRs that are quite attractive are not a bad thing for us. So I would say our primary goal is really to continue to grow the network and grow the recurring revenues and when that doesn’t happen we will have free cash flow and we will try and deploy it in other attractive ways.
Thank you. The next question comes from Richard Ingrassia of Roth Capital Partners. Please go ahead.
Richard Ingrassia - Roth Capital Partners
Question for Rich and a question for Joe. Rich, can you talk generally about how small and medium sized regional chains in the U.S. view IMAX these days and how the value proposition and the economics might differ in these smaller markets. And the, Joe, I know this is difficult to do, but if you are able to normalize for box office in some way, do you have sense for where gross margins go ultimately. By my estimates it looks like 60% could be consistently achievable by the end of next year but I wonder how you guys see it?
Rich, I will answer the first question, and we had some cut out here so please repeat the second question after I am done. But in terms of the small market exhibitor, I think they view us quite positively. I think a lot of the research, Rich, I don’t believe yours but other research, showed that how we were done in North America two years ago. And our sales have been very strong in North America. As a matter of fact we recently did a 10 theatre with Frank Theatres. With Guzzo during the quarter we have signed for three more, in Montreal. And (inaudible) Theatres, which is a regional exhibitor in Wichita, Kansas and Oklahoma City, is one of the most successful on a per screen basis in the country.
And I think what the small exhibitors have found is that having IMAX in a small area is, I don’t want to overstate this point, but it’s analogous in a way to having a baseball team with some kind of a sports franchise. Meaning that there is less competition for entertainment dollars in smaller markets and I think it brings even more prestige to a local multiplex. The other things is that the smaller operators tend to be more focused on marketing. For the bigger chains it more difficult to have a uniform marketing strategy. So there theatres are performing extremely well. As a matter of fact, to use Guzzo Theatres in Quebec as an example. They have got a second screen in one of their complexes. One is in French and one is in English, and the results were so encouraging that they are doing it again in another complex and there is not holding them back.
So I think a combination of their marketing ability, the nature of their markets, and their enthusiasm has been a promising development for us. And again, the second question which we lost, Rich?
Richard Ingrassia - Roth Capital Partners
Sorry about that. It was for Joe. And I know this is tough, but I was trying to get some sense for how you look at gross margins down the road. So an ultimate objective if you have one. I know it’s difficult because the influence of box office but by estimates it looks like 60% plus are achievable by the end of next year and I wonder if that sounds in the ballpark?
I think the only thing I will comment on, Rich, and it really will depend on your model, is that if you look at the [Red] share margins and if you just assume a $1.2 million in box it’s inherently an 80% margin business. So depending upon how much of that is in your mix that will drive you most likely higher. In the DMR business that’s obviously scalable so the more units you get online the better your profile. If you took a 1.2 million with roughly 500 screens, you are sitting in a mid to low-60 margin percentage today. But that continues to grow as we add more units. So, again, depending on your mix in terms of what you are assuming in terms of network growth is really going to drive where your margins land.
The next question comes from Vasily Karasyov of Susquehanna Financial Group. Please go ahead.
Vasily Karasyov - Susquehanna Financial Group
Rich, I have a question about China. Did you get the impression that what they did with Spider-Man and The Dark Knight Rises was a one-off or is that a policy going forward. And the related question is, how likely do you see other territories which you see as potential as growth territories to adopt something similar to what China did to those two movies. Thank you.
First of all the second part of your question, other territory. I think there is really no chance that happens. Because in China there is government regulation which kinds of controls when films could open and that kind of regulation doesn’t exist anywhere in the world. So other than in China, so I don’t really see that as an issue. In terms of your question whether it’s a one-off or a policy, you know it’s somewhere in the middle, which is I think that it’s not a one-off because there are others where it happened also. The Bourne Movie and Total Recall ran at the same time. And I think in the short run you are probably going to see a little bit more of it.
What I think happened was in the first half of 2012, the non-Chinese box offices, especially the Hollywood box office was extremely high. Was in like the 75% range. And the Chinese government wanted it to be closer to 50:50. And I think what they decided to do was to try and open more slots for Chinese movies to play. And one way they could have more slots was to take the U.S. movies and bunch them around a certain dates. I don’t believe they intended to hurt the box office of the U.S. movies as much as they intended to provide more playtime for the Chinese movies.
I was over there about a couple of week ago or a month ago and a I had a lot of discussions on this. I think in fact that the result that it did hurt the box office really was not good for a lot of constituencies in China, including China Film which imports and gets paid on the importation. Including the exhibitors which obviously weren’t happy that the box office in those films was done. But most importantly I think less people were going into malls and were going into movie theatres. And given that Chinese government’s objective of kind of keeping the internal economy growing and the consumer economy growing, my personal opinion is that at the end of the day that’s going to be more important than the particular plan between Chinese and U.S. box office.
So while that’s a short-term policy, most of the people I talked to over there felt that it was not going to be a long-term policy.
Thank you. The next question comes from Aravinda Galappatthige of Canaccord Genuity. Please go ahead.
Aravinda Galappatthige - Canaccord Genuity
Couple of quick questions. First of all on the signings front. On Investor Day in June you gave some pretty good visibility with respect to your pipeline. I think you mentioned about 91 deals under negotiation. Understanding that you may not want to give specific numbers, is there a general comment you could make about the strength of the pipeline on a relative basis. And then my second quarter is just a clarification, Joe. I think you mentioned 46 installations for Q4 and I think you said a number of systems sales, I missed that.
Systems sales was 14.
The deal pipeline Aravinda, remains quite strong. Every month we have a worldwide internal call where we go the regions and we see what their prospects are in the areas and it’s certainly consistent with the other quarters. We haven’t seen any slowdown whatsoever. So I feel pretty good about the tone of our business.
Thank you. The next question comes from Steve Frankel of Dougherty & Co. Please go ahead.
Steve Frankel - Dougherty & Co.
Rich, normally, your international screens significantly outperform the domestic screens on a PSA basis. This quarter that percentage was -- that performance was a lot smaller. I wonder if you might try to explain why that was and have you seen PSAs decline in Russia and China which helped drive a lot of that out performance in past quarters?
Steve, the answer is pretty simple. It’s China. It’s the issue we were just talking about. And the fact that Dark Knight Rises and Spider-Man ran on top of each other in China. If you back that out and you look at the rest of the world, the trends were very consistent with what we have seen in the past. So I wouldn’t make much of a trend out of that. The other thing would be that Dark Knight Rises did particularly well in the U.S. because of the film prints.
Thank you. The next question comes from Daniel Ernst of Hudson Square Research. Please go ahead.
Daniel Ernst - Hudson Square Research
I have a observation which beats into a question for Rich. Rich, in the past you have talked about the big drivers of your business big the size of the network, growing the network and putting compelling content into that network. I know that size of the business, that’s building the network, you have done a great job. You have invested in JVs. You created a new company in China and you produced a high quality product, as you say from the production level towards your management of the network and the QA process around that. And then just putting up good metrics which the operators find compelling and sign more deals with you.
On the content side, you talked a lot about how the more and more of Hollywood are embracing your format and you know people like Mendes and Owen are increasingly shooting bits of their films or larger statements of their films in IMAX, with IMAX camera or in the IMAX format, and so that’s great. But it seems to me that that side of the business, the content side of the business has kind of happened organically. You have a great products, people are kind of drawn to it.
I am wondering is there an opportunity for IMAX, or would you consider an opportunity at this stage, if you are at an inflection in building a big network, of actually taking a more active role in what content shows up. Potentially even investing in content to insure that IMAX is the format of choice or investing in more [camp] productions so that there is a great supply of that. Can you sort of comment on your views on getting higher quality content, more higher quality content into growing network.
First of all thanks for your comments about network growth. And again I want to reiterate some of the comments I made on the call about portfolio approach. And I think I know I had mentioned at Investor Day. I think I have done it on one of these calls. That we really have a different way of budgeting in a sense that we used to. We do kind of a top down way rather than a bottoms-up. Because if you look at the portfolio of films over the last three or four years, they have been incredibly consistent around the $1.2 million per screen. And if you look at this year, we are about $900,000 through the third quarter, so we are tracking specifically to that.
So I guess as a way of background, I think that when you look at the portfolio, it’s the movie business. So you get films like Avengers that breakout and certainly you get a number of films that underperform. So it’s my way of saying that I think there is limited bands that you could have an impact on. And from my point of view, using capital in a material way isn’t going to change those bands.
With that said, I think that where we are using our capital is on more IMAX DNA including investing in a new generation of cameras and trying to spur more unique differentiation to IMAX. Maybe Greg wants to talk a little bit more about that.
So, first of all, absolutely correct in terms of the amount of effort that we are spending to expand the diversification of our camera packages. Some people want to shoot movies with 2D, some people want to shoot movies with 3D, some people want to movies like Chris Nolan, in film. Some film want to shoot in digital. And it’s our role to be able to provide the technology for all of our core partners. On top of that, just like we don’t want to have an IMAX theatre on every street corner, we don’t want every single movie to have -- shot with IMAX cameras.
We are very very selective about who we work with and we are very selective about who we give the crown jewels of our image capture system too. So right now if we want to, we could probably shoot six to eight movies a year with IMAX cameras, and that’s not something that we want to do. We want to focus on being very selective about how uses our camera. And we want to be integrated into the design and DNA of the movie when in fact they do use our camera. That’s very much been the case with obviously a filmmaker like Chris Nolan. It’s very much the case with The Hunger Games Group on Catching Fire, and J.J. Abrams with the last Star Trek or the latest Star Trek movie, has done that as well too.
So it really goes back to our relationship with the core filmmakers that we tend to partner with and being selective about how we do that. But once we are in, we are usually all in.
The next question comes from [Cowan More] of Credit Suisse. Please go ahead.
Just two part question on China. Just curious, I know it’s still early stages, if you are seeing any impact from the gradual DMAX launch. If it’s still more of a supplement or just any thoughts on that market. And maybe, and sorry if I missed this, any thoughts around the economics of your converting additional China films and what type of opportunity that might provide.
In terms of your question, I think the name by the way is China Giant Screen now, not DMAX, but same thing. We really haven’t noticed a material effect from them. In fact we are in a number of negotiations in China for various transactions and really haven’t seen much of an impact. I go back to an answer I gave earlier which is the end to end solution point. That IMAX captures the image, converts the image, has proprietary technology, the brand, the marketing.
For example, one of the things I learned when I was in China which was quite interesting, on my recent trip, is that China Giant Screen is more a consortium than a company. So if your system goes down, like there is no one to call. You have to call the projector manufacturer, you have to call the server manufacturer. It could be a sound system problem. It’s not really an integrated thing.
Another thing that I learned which will make a lot of sense to you, is IMAX has a central control facility, where on day 100 the picture looks the same as it does on day 1, because we monitor the theatres in real time and we ensure the quality experience is upheld. The effort in China is not the same. So people can show something on day 1 and it could look very different day 100 or day 200 or whatever it is. So again, our end to end solution and our commitment to quality, I think is a huge differentiator and I think that not only the theatre operators but more importantly the consumers understand that. As a matter of fact even though there is not many China giant screens open, so you don’t want to overly make too much of this, but our per screen average is about 3 times what it is there.
A funny, slight off-topic anecdote is, I was interviewed a lot when I was in China, particularly by people over the internet. You know asking me about it. And when I would give my answer and the interview was over, the reporters in the tabloids maybe three times, would sort of say to me, sorry, I had to ask that question but IMAX is in a league of its own. And I think given how important the internet is there, I just don’t think that there is any buzz around it. And I don’t think it’s that important. I think, Greg, you want to add something to that?
No, just wanted to talk about the Chinese films that you mentioned. We see that as a big part of our business going forward in China. Using local language films to not only fill-in the gaps on the release schedule where there is not a Hollywood film, but also in terms of building relationships with filmmakers and it goes back to what we have done in the United States which we are going to start doing and have begun to do in China. Including, I think, in the next year or so, potentially seeing a Chinese movie that features certain IMAX DNA in the production process. I think you guys know that in the last month we announced a deal with four pictures with Huayi Bros., Tai Chi 0, Tai Chi Hero, which by the way is opening up today in China. One week early exclusively on IMAX.
And then we have the (inaudible) movie 1942, which is going to open at some point towards the end of the year and then the Jackie Chan movie in December [CG12]. So the Chinese DMR business is very important to us and or exhibitor partners and our relationship with movie goers. And they are recognizing in China that our brand means something and that we are also able like we did with (inaudible) to take those movies from the Chinese market and become the, for a lack of a better expression, good housekeeping seal of approval that takes them and helps them get distribution in the United States and outside of China. Which is something that we are also planning on doing in other markets including Indian language films.
The next question comes from Jim Goss of Barrington Research. Please go ahead.
Jim Goss - Barrington Research
Couple of things. One is one of the efforts you have been making is to improve your flexibility in terms of the contracts so that you can maybe cut a movie short if it’s not working, let it run if it is working. I know you have your legal person there. Perhaps you can talk about how frequently you have made use of the flexibility you have built into the contracts this year and how that went in dealing with the studios in those terms. Another area, with the discussion that’s been considerable about China, it does seem to be some concern that they would want to create a limiting factor which sort of reduces your flexibility in that particular market. On the other hand if you assert yourself to get into the other 50% with Chinese DMR films, perhaps that’s part of the response. But in a broader sense does that also change your viewpoint about bit you want China to be as part of the total global IMAX? And is that why you would want to step-up Latin America and Europe or are those just side areas?
On your first one, in terms of film flexibility, Jim. It’s less a contractual issue than it is a practical issue. And I think there is a long history of relationships between studios and exhibitors and [off land] studios and [off land] exhibitors. And I think a studio has no reason to be punitive if a film really isn’t working. They tend to be somewhat flexible in letting us play something else. And we have very good relationships with the studios and maybe equally or more importantly with the filmmakers. So I am not going to go through title numbers of this year. But certainly we went into the year with our Hunger Games and that became a big performer for us.
We went into the year with Avengers. And in fact Avengers was a extremely strong performer. And in that case to our other films in the slots and the exhibitors kind of conceded to get out of the way in a number of theatres to help it out. And it’s just much more on an informal basis, by way of example only, and that wasn’t the case this year. But if Paramount gets out of the way and let's Warner play one of its films that’s doing really well, you know in another instance Warner will get out of its way and let Paramount play one of its film. So there is no doubt, it’s been much more built into the model. But our General Counsel does happen to be with us, he doesn’t have to answer this question because it’s more of a course of the [eye] than it is a matter of legal thing.
In terms of China, people forget that this is also the year that China increased its quota by 14 films. You see word IMAX in its press release from the government. So again you remember it, Jim, you may know one of my favorite sayings is it’s never is going to [look] so is it bad as it seems. And when we did 14 films I didn’t -- when we got that loophole kind or that provision in the import quota, I didn’t run around saying, oh my god, every film in China is going to be an IMAX film. With that said, I don’t think that what you saw one or two times in China is the policy for the rest of time.
China is not a monolithic place. There are lots of voices, just like there are in the U.S., and there are lots of competing interests. So I think some of the short-term issues you are seeing in China will play themselves out overtime. And again I know it seems like the dark ages but it was only six months ago that they change the splits and they allowed the 14 extra films in which were over the top, good for IMAX. So no, nothing is really (inaudible) on in the Chinese market. I think if we went back a year ago and you told me our film split will be 50% higher than we budgeted at the beginning of the year and 14 films could only get in if they were in IMAX and 3D, and at least some challenges like the doubling up of movies. I would take, that’s consistent with my long-term view on China that some things are good, some things are bad. But in general our brand is really important there.
I think also you should know on the fact that we are helping export Chinese films like (inaudible) Flying Swords earlier, which is playing in the U.S. And as a matter of fact the MPA is hosting a Chinese delegation next week here and we are a big part of that. And in my meetings in China, the government officials made it abundantly clear that they really appreciate our efforts to help export Chinese films. So I remain extremely bullish on the Chinese market. And things like Latin America, they are just new opportunities for us, and western European and under-penetrated markets. And I think that’s accretive not replacing.
Thank you. The last question will come from Martin Pyykkonen of Wedge Partners. Please go ahead.
Martin Pyykkonen - Wedge Partners
Just two quick things. One for Rich. On Latin America again looking into next year, I know the timing is difficult but just want to compare and contrast to China which post Avatar opened up like a big fire hose in terms of the deal flow. Should linear, smaller deals and so forth when they do start to develop as opposed to something that’s more of a big onslaught and backend loaded. Just want to, as best as you can characterize that. And then just quickly for Joe, you got the question on gross margin, I was going to ask about JV gross margins. Kind of terminal or ultimate value, if you will, assuming mix of new screen deals over the next few years is predominantly JVs outside of places like Russia. How should we be thinking from a modeling standpoint of the JV segment, gross margin kind of ultimate, slash terminal kind of value. Thanks.
Yeah, so in terms of Latin America, we have made a lot of progress beneath the surface. And there are a number of negotiations going on that haven’t come to fruition as quickly as I would have hoped. And if you remember Martin I was a little cautious on how quickly it would happen. I always kind of said it was a 2013 issue rather than a 2012. So the progress hasn’t manifested itself with a lot of signings. We have made an awful lot of progress. I do think it will be more of one year than China and I don’t think it would surprise me if there was a 50 theatre deal in Latin America. I mean most of the Latin America is Brazil, as you know. But I just don’t think the structure of the market is that way or the structure of the film industry is that way.
On a very positive side, our theatres that we opened, including the newest one in Brazil at Sao Paulo, are incredibly successful. And the one in Sao Paulo, the multiplex is the number one multiplex in all of Brazil. And I think or theatre has been tracking to be number one theatre in all of Brazil. So certainly we have the characteristics of a ramp in theatres similar to what we had in China. However, one important fact and this is actually going to add to the ambiguity because you can take it both ways. In China we have 400 zones, in Latin America we have 75 zones. So that would really pour cold water on it. But I would like to remind you that when we started our efforts in China there were 90 zones. And it went so well that eventually we grew to 400 zones.
So for the short-term I think it is going to be more linier. But overtime let's see where it goes.
In terms of the JV margins, Martin, you know if you assume a level of box office of $1.2 million you are going to land at about an 80% margin which is, if you look at our numbers this morning when we released them, you will see if you add back the launch expenses that we incurred in the quarter, you are going to land pretty close to that level. So I think as you move forward, and if you are modeling in about $1.2 million, that’s kind of where you should land. And then you kind of overlay any launch expenses on top of that. Given the critical mass of the network on the JV side, even launch expenses over time will become less of a draw down on our margins as the network gets wider.
So thank you all for being on the call. I think in my closing remarks, I would just let you know that since 2008 our commercial network has grown by about four times. And with that came some necessary SG&A growth, including the $8 million we spent in China to build a while company in China that serves that market. We as a management team recently had a management meeting and I think we are highly focused at the moment in terms of how to get more out of the same resources and how to really prove the scalability of the business. I think when you are growing four times than that period of time, you kind of throw dollars and you throw bodies just to make sure you are doing a very good job in servicing your customers, particularly the end customer.
I think we have now been able to step back a little bit and take a breath and we will look at this issue of scalability. And what makes me particularly encouraged about the first three quarters of this year, but really this quarter, were to manifest itself as the scalability has really turned into profits and free cash flow. And that’s the direction we are following going forward. So with that, thank you all for your support.
Ladies and gentlemen, this does conclude the conference call for today. You may now disconnect your line and have a great day.
Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.
THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.
If you have any additional questions about our online transcripts, please contact us at: firstname.lastname@example.org. Thank you!