National CineMedia, Inc. — Q2 2018 Form 10-Q Summary
Business context and reporting period
National CineMedia, Inc. reported unaudited results for the three and six months ended June 28, 2018, compared with June 29, 2017. NCM operates a U.S. cinema advertising network through National CineMedia, LLC, including the Noovie pre-show, lobby advertising, promotions, and online/mobile advertising. Long-term exhibitor services agreements with AMC, Regal and Cinemark had approximately 19 years of remaining term at quarter-end.
The company operates as one advertising segment. Results are seasonal, with generally higher advertising demand and theater attendance in the second through fourth fiscal quarters.
Financial performance and key metrics
| Metric | Q2 2018 | Q2 2017 | Change |
|---|---|---|---|
| Revenue | $113.7 million | $97.1 million | 17.1% increase |
| Operating income | $40.2 million | $28.3 million | 42.0% increase |
| Consolidated net income | $17.0 million | $14.6 million | 16.4% increase |
| Net income attributable to NCM, Inc. | $4.2 million | $5.2 million | 19.2% decrease |
| Diluted EPS | $0.05 | $0.09 | Decrease |
| Adjusted OIBDA | $52.3 million | $42.3 million | 23.6% increase |
| Adjusted OIBDA margin | 46.0% | 43.6% | Up 2.4 percentage points |
| Theater attendance | 194.1 million | 160.0 million | 21.3% increase |
| Metric | Six months 2018 | Six months 2017 | Change |
|---|---|---|---|
| Revenue | $193.9 million | $169.0 million | 14.7% increase |
| Operating income | $51.2 million | $33.4 million | 53.3% increase |
| Consolidated net income | $13.6 million | $8.8 million | 54.5% increase |
| Net income attributable to NCM, Inc. | $2.3 million | $3.9 million | 41.0% decrease |
| Diluted EPS | $0.03 | $0.06 | Decrease |
| Adjusted OIBDA | $75.6 million | $59.9 million | 26.2% increase |
| Adjusted OIBDA margin | 39.0% | 35.4% | Up 3.6 percentage points |
| Theater attendance | 371.1 million | 341.5 million | 8.7% increase |
Q2 revenue growth reflected national advertising revenue of $78.8 million, up 19.4%; local and regional revenue of $26.3 million, up 11.9%; and founding-member beverage advertising revenue of $8.6 million, up 13.2%. National advertising growth was driven by higher CPMs and impressions sold, although national inventory utilization declined from 112.1% to 101.5%. Six-month national advertising revenue increased 21.0%, while local and regional revenue increased 2.6%.
Operating expenses increased 6.8% in Q2 and 5.2% year to date, slower than revenue growth. Selling and marketing expense declined primarily because of lower investment impairment expense and share-based compensation, while administrative expense increased due to digital-service initiatives, personnel and bonus costs, and legal fees related to negotiating a shareholder settlement.
Cash flow, liquidity and capital structure
- Six-month operating cash flow was $66.2 million, compared with $68.6 million in the prior-year period.
- Investing cash flow was negative $9.1 million, including $7.2 million of capital expenditures and net purchases of marketable securities.
- Financing cash flow was negative $52.9 million, including $28.1 million of dividends, $46.1 million of distributions to founding members, and $6.3 million of debt issuance costs.
- Cash, cash equivalents and marketable securities totaled $65.6 million at June 28, 2018; $57.3 million was held by NCM, Inc. excluding NCM LLC.
- Total liquidity, including $140.0 million of revolving-credit availability, was $205.6 million.
- Total borrowings were $950.2 million, or $941.5 million net of debt issuance costs. Debt consisted of $400.0 million of 6.0% senior secured notes due 2022, $270.0 million of term loans, $30.2 million drawn on the revolving facility, and $250.0 million of 5.75% senior unsecured notes due 2026.
- Approximately 68% of borrowings carried fixed interest rates. Management estimated that a 100-basis-point change in rates on variable-rate debt would change annual cash interest expense by approximately $3.0 million.
- At quarter-end, net senior secured leverage was 2.9 times and net total leverage was 4.0 times, compared with applicable covenant levels of 4.50 times and 6.25 times, respectively.
Material changes, unusual items and outlook
- In June 2018, NCM LLC refinanced its senior secured credit facility with a $270.0 million term loan and a $175.0 million revolving facility. The term loan matures in 2025 and the revolver in 2023, subject to refinancing the 2022 notes by October 30, 2021; otherwise, both facilities mature in December 2021.
- Income tax expense increased to $16.0 million in Q2 and $17.0 million year to date, primarily because of a $10.0 million deferred tax expense associated with a state tax-law change and other tax effects. The six-month effective tax rate was 88.1%, compared with a negative 5.4% in the prior-year period.
- The company changed its accounting for the tax receivable agreement payable to founding members from a discounted to an undiscounted presentation and recast prior periods. It also corrected an immaterial tax-accounting error. The changes affected reported tax expense, deferred tax assets and the TRA payable but did not change historical cash TRA payments or their timing.
- A $7.7 million Q2 gain and $7.8 million year-to-date gain on remeasurement of the TRA payable reduced non-operating expense. The gain included a $16.3 million benefit from a state tax-law change, partly offset by an $8.6 million loss related to the error correction.
- NCM LLC issued 2.8 million net common membership units to founding members in the first quarter for theater additions and dispositions, recording a $15.9 million intangible asset. NCM, Inc.’s ownership of NCM LLC declined to 48.8% from 49.5% at year-end 2017.
- After quarter-end, on July 5, 2018, AMC sold its remaining NCM LLC units to Regal and Cinemark. Regal and Cinemark ownership increased to 26.1% and 25.1%, respectively. AMC remained party to certain commercial agreements and remained eligible for TRA payments, theater access fees and common-unit adjustments, but no longer received ordinary NCM LLC cash distributions absent a future ownership increase.
- Management stated that operating cash flow and cash on hand should fund working capital, debt service, capital expenditures and other investing needs for the next twelve months. Future dividends remain subject to board discretion and business, liquidity and lender considerations.
- The company declared a $0.17-per-share dividend after quarter-end, approximately $13.1 million, payable August 31, 2018.
Risks, contingencies and controls
- Advertising spending is cyclical and subject to macroeconomic conditions, customer budgets, competition from television, online/mobile and other video platforms, and volatility in CPMs, utilization and scatter-market demand.
- Lower movie attendance, shorter theatrical release windows, reserved seating, longer trailers, online ticketing or changing consumer viewing behavior could reduce pre-show viewership and require additional make-good advertising.
- Maximum potential future payments under network-affiliate minimum revenue guarantees were $79.5 million, although no payments were made in the periods presented.
- The company had a $2.5 million make-good provision at June 28, 2018 for undelivered advertising impressions.
- The company reported that disclosure controls were ineffective because a material weakness in internal control over financial reporting remained related to income-tax accounting under ASC 740, particularly deferred taxes and the TRA payable. Remediation controls were implemented and testing had begun, but management had not yet concluded that the weakness was remediated.
- There were no material changes to previously disclosed risk factors, and management stated that ordinary-course legal proceedings were not expected to have a material adverse effect.
Important facts for investors to verify
- Reconcile consolidated results with the substantially lower income attributable to NCM, Inc., given noncontrolling interests and changes in NCM LLC ownership.
- Assess the sustainability of revenue and margin growth after the unusually strong movie-attendance comparison and changes in national utilization and CPMs.
- Review the tax-rate and TRA accounting recasts, the $8.6 million error correction, and the status of the material weakness remediation.
- Confirm refinancing requirements for the 2022 notes and the resulting 2021 maturity risk if refinancing is not completed by October 30, 2021.
- Evaluate dividend coverage after interest, founding-member distributions, TRA payments, capital expenditures and taxes, noting that management acknowledged periodic funding deficits may occur.
- Review the post-quarter-end AMC unit sale and its effects on ownership, distributions, governance and related-party economics.