IMAX

IMAX Corporation 10-Q Summary: Quarter Ended March 31, 2005

Business Context and Reporting Period

This Form 10-Q covers the quarterly period ended March 31, 2005. IMAX Corporation designs, manufactures, and leases giant screen theater systems, produces and distributes large format films, and operates theaters. As of the reporting date, there were 250 IMAX theaters operating in 36 countries. The company is incorporated in Canada and listed on the TSX and NASDAQ.

Key Financial Metrics

Material Changes vs. Prior Period

• Revenue Growth: Total revenue increased 26.2% year-over-year. IMAX Systems revenue rose 38.0% to $22.1 million, driven by six system installations (vs. two in 2004) and higher consensual lease buyout revenue ($6.9 million vs. $2.9 million).
• Profitability: The company returned to profitability with net earnings of $1.2 million, compared to a net loss of $0.9 million in Q1 2004. This turnaround was aided by a $0.2 million income tax recovery and the absence of the $0.8 million loss on note retirement recorded in Q1 2004.
• Cash Flow: Operating cash flow dropped significantly to $0.1 million from $5.7 million in the prior year, primarily due to a $2.6 million increase in accounts receivable and a $1.0 million increase in inventories.
• Investing Activities: Net cash used in investing activities was $15.6 million, largely due to a $15.0 million purchase of short-term investments.

Outlook, Risks, and Management Commentary

• Guidance: Management anticipates higher revenues and gross margins throughout 2005 compared to 2004, driven by system installations and the release of five new films, including Robots, Batman Begins, and Harry Potter and the Goblet of Fire.
• Settlement Revenue: While MPX backlog upgrades may continue, management expects revenue from consensual lease buyouts and terminations to decrease in 2005 compared to 2004.
• Legal Contingencies:
  • Muvico: Settlement reached in May 2005 regarding misrepresentation and fraud claims.
  • In-Three: Patent infringement lawsuit filed in March 2005 regarding 2D-to-3D conversion; counterclaims filed by defendant.
  • Germany Litigation: Ongoing disputes with Big Screen (Berlin) and Siewert (insolvent) regarding rental payments and antitrust defenses.
  • Arbitration: Seeking $3.7 million from EML and $17.8 million from E-Citi for breach of lease agreements.
• Accounting Changes: The company expects to adopt FAS 123R (stock-based compensation) in 2006, estimating a pre-tax expense of approximately $0.6 million for that year.
• Liquidity: The company has a $20.0 million credit facility with no current drawdown but $6.2 million in outstanding letters of credit. Management believes existing cash and borrowing capacity are sufficient for foreseeable needs.

Investor Verification Checklist

• Revenue Quality: Verify the sustainability of revenue from "consensual lease buyouts" ($6.9 million in Q1), as management expects this to decline in 2005.
• Cash Conversion: Investigate the sharp decline in operating cash flow despite net earnings, specifically the $2.6 million increase in accounts receivable.
• Debt Covenants: Confirm compliance with the $20 million credit facility covenants, which require minimum EBITDA and cash collection levels.
• Legal Exposure: Monitor the outcomes of the In-Three patent litigation and the German antitrust disputes, which could impact future collections or result in damages.
• Valuation Allowance: Review the $45.1 million valuation allowance against deferred tax assets; any change in future profitability estimates could materially impact the effective tax rate.