NCMI

Business Context and Reporting Period

Company: National Cinemedia, Inc. (NCM, Inc.)
Filing Type: Form 10-Q (Quarterly Report)
Reporting Period: Quarter and nine months ended September 25, 2008
Business Overview: NCM operates the largest digital in-theatre network in North America, distributing advertising, business meetings, and Fathom event services. The company operates under long-term Exhibitor Services Agreements (ESAs) with founding members (AMC, Regal, Cinemark) and network affiliates. As of September 25, 2008, NCM, Inc. owned 42.3% of NCM LLC membership units.

Key Financial Metrics

Material Changes vs. Prior Period

• Revenue Growth: Total revenue increased 10.3% in Q3 2008 compared to Q3 2007, driven by a 9.9% increase in advertising revenue and a 17.7% increase in meetings and events revenue. National advertising revenue rose due to a 17.2% increase in CPM (cost per thousand impressions).
• Expense Increases: Total operating expenses rose 15.3% year-over-year. Advertising operating costs surged 90.0% due to a 132% increase in the affiliate network and associated revenue-sharing payments. Network costs increased 21.6% due to internet initiatives and network expansion.
• Profitability: Net income increased 18.5% in Q3 2008 ($10.9M vs $9.2M). This was aided by a $2.2 million credit to interest expense resulting from the change in status of an interest rate hedge following the Lehman Brothers bankruptcy.
• Liquidity: Cash and cash equivalents increased to $44.5 million from $20.8 million at the end of 2007, supported by strong operating cash flows of $73.6 million for the nine-month period.

Guidance, Outlook, Risks, and Unusual Items

• Lehman Brothers Default: Lehman Brothers Holdings Inc. filed for Chapter 11 bankruptcy on September 15, 2008. Lehman is the counterparty to $137.5 million of NCM's interest rate swaps. NCM notified Lehman of an event of default and withheld a $0.8 million payment. While NCM does not anticipate a material impact on liquidity, it is exploring options to replace the Lehman commitment within its credit facility.
• Dividend Declaration: On October 28, 2008, the company declared a cash dividend of $0.16 per share (approx. $6.8 million), payable December 4, 2008.
• Contractual Amendments: On November 5, 2008, NCM and founding members amended ESAs to clarify digital programming definitions, allowing founding members to book digital programming directly with studios while keeping NCM financially indifferent.
• Seasonality: Management notes that results are seasonal, with higher revenues typically occurring in Q2, Q3, and Q4 due to film release cycles and marketing expenditures.
• Outlook: Management stated that national advertising bookings for the remainder of 2008 and for 2009 are higher than at the same time last year, despite a difficult macro-economic climate affecting local revenue growth.

Investor Verification Checklist

• Lehman Exposure: Verify the status of the $137.5 million interest rate swap with Lehman Brothers and the progress of replacing this hedge to ensure compliance with debt covenants requiring 50% of the term loan to be hedged.
• Related-Party Transactions: Review the magnitude of revenue and expenses tied to founding members (AMC, Regal, Cinemark), which constitute a significant portion of the business model (e.g., $11.7M in beverage concessionaire revenue in Q3).
• Debt Covenants: Confirm continued compliance with the senior secured credit facility covenants, specifically the leverage ratio and hedging requirements, given the Lehman default.
• Intangible Asset Amortization: Monitor the amortization schedule of the $116.1 million in intangible assets recorded in 2008 related to new theatre access rights, which will impact future earnings.
• Dividend Sustainability: Assess the ability to fund the declared dividend and future mandatory distributions to founding members given the current cash flow and debt service obligations.