NCMI

Business Context and Reporting Period

Company: National CineMedia, Inc. (NCM, Inc.)
Filing Type: Form 10-Q (Unaudited)
Period Ended: July 1, 2010 (Second Quarter)
Business Overview: NCM operates the largest digital in-theatre network in North America, distributing advertising and Fathom entertainment programming. The company operates under long-term Exhibitor Services Agreements (ESAs) with founding members (AMC, Regal, Cinemark) and network affiliates. As of July 1, 2010, NCM, Inc. owned 38.3% of NCM LLC, with the founding members holding the remaining 61.7%.

Key Financial Metrics

Note: Total Debt includes $725.0 million term loan and $52.0 million revolving credit facility balance as of July 1, 2010.

Material Changes vs. Prior Period

• Revenue Growth: Total revenue increased 6.7% in Q2 2010 compared to Q2 2009, driven by a 7.9% increase in advertising revenue. This was partially offset by a 5.3% decline in Fathom Events revenue.
• Advertising Performance: National advertising revenue (excluding beverage) rose 9.9% due to a 6.7% increase in CPMs and improved inventory utilization (92.5% vs. 81.3%). Local advertising revenue increased 7.2%.
• Net Income Decline: Despite an 8.5% increase in operating income, Net Income attributable to NCM, Inc. decreased 35.2% in Q2 2010. This was primarily due to a $9.0 million swing in non-cash derivative fair value charges (expense of $4.5 million in 2010 vs. credit of $4.5 million in 2009).
• Intangible Assets: Intangible assets increased significantly from $134.2 million to $282.1 million due to the issuance of membership units to AMC for the Kerasotes acquisition ($111.5 million) and annual unit adjustments ($39.8 million).
• Liquidity: Cash and cash equivalents decreased $37.3 million over the six-month period, primarily due to financing activities including debt repayments and distributions to founding members.

Guidance, Outlook, and Risks

• Outlook: Management expects theatre access fees to increase in the second half of 2010 due to the Kerasotes acquisition and digital cinema deployment. Adjusted OIBDA is expected to increase approximately $3.5 million in 2010 and $5.0 million on a full-year basis due to the Kerasotes integration.
• Seasonality: Revenue is seasonal, with Q1 typically lower than other quarters. Advertising spending correlates with new product releases and marketing cycles.
• Dividends: On August 3, 2010, the company declared a cash dividend of $0.18 per share, payable September 2, 2010.
• Risks:
  • Interest Rate Risk: The company has hedged $550 million of its $725 million term loan. A 100 basis point fluctuation in market rates would impact cash interest expense by approximately $2.6 million annually on the unhedged portion.
  • Derivative Valuation: Significant volatility in net income is driven by changes in the fair value of interest rate swaps not designated as hedging instruments.
  • Attendance: Lower than expected attendance in certain ratings (e.g., PG-13) impacted inventory utilization and resulted in a $4.6 million make-good reserve.

Investor Verification Checklist

• Derivative Impact: Verify the sensitivity of Net Income to interest rate fluctuations and the specific accounting treatment of the $76.9 million interest rate swap liability.
• Noncontrolling Interest: Confirm the allocation of net income between NCM, Inc. and founding members, noting that NCM, Inc. retained only ~21% of consolidated net income in Q2 2010.
• Debt Covenants: Review the consolidated net senior secured leverage ratio (3.9x vs. 6.75x limit) and ensure compliance with the requirement to hedge 50% of the term loan (currently 76% hedged).
• Make-Good Reserves: Assess the $4.6 million reserve for unmet attendance guarantees and the likelihood of its recognition as revenue in Q3/Q4 2010.
• Related Party Transactions: Review the $13.4 million in theatre access fees paid to founding members and the $9.6 million in beverage concessionaire revenue received from them.