IMAX

IMAX Corporation 10-Q Summary: Period Ended September 30, 2006

Business Context and Reporting Period

This Form 10-Q covers the quarterly period ended September 30, 2006, and the nine-month period ended on that date. IMAX Corporation designs, manufactures, and sells/leases giant screen theater systems, produces and distributes large format films, and operates theaters. As of September 30, 2006, there were 280 IMAX theaters operating in 40 countries. The company is listed on the TSX and NASDAQ.

Key Financial Metrics

Material Changes vs. Prior Period

• Revenue Decline: Total revenue decreased 37.9% in Q3 and 13.7% for the nine months ended September 30, 2006, compared to the prior year. Systems revenue dropped significantly (63.8% in Q3) due to fewer system installations and the absence of settlement revenues ($2.4 million in Q3 2005 vs. $0 in Q3 2006).
• Profitability Reversal: The company swung from net earnings in 2005 to a net loss in 2006. Operating loss for Q3 2006 was $5.2 million compared to operating earnings of $6.1 million in Q3 2005.
• Margin Compression: Gross margin percentage fell from 47.3% in Q3 2005 to 29.9% in Q3 2006, driven by lower system margins and film impairments.
• Cash Flow: Operating cash flow turned negative, using $7.4 million in the first nine months of 2006, compared to providing $3.4 million in the same period in 2005.

Guidance, Outlook, Risks, and Unusual Items

• Outlook: Management anticipates system installation slippages, with 24 systems scheduled for 2007. The company plans to introduce joint box office sharing arrangements to accelerate network expansion and is developing a digital projection system for delivery by mid-to-late 2008.
• Unusual Items:
  • Discontinued Operations: A net loss of $0.9 million in Q3 2006 related to the closed Miami IMAX theater (accrued $0.8 million). Conversely, $2.3 million in income was recognized in Q1 2006 from the settlement of Digital Projection International (DPI) loans.
  • Accounting Changes: Adoption of FAS 123R (Share-Based Payment) on Jan 1, 2006, resulted in $0.4 million (Q3) and $1.2 million (9M) in stock-based compensation expense.
  • Tax Provision: A $1.6 million increase in the valuation allowance against deferred tax assets was recorded in Q3 2006 due to revised earnings projections.
• Risks and Contingencies:
  • Legal Proceedings: The company faces eight U.S. class action lawsuits and one Canadian class action alleging securities fraud regarding revenue recognition practices. Additionally, an arbitration with Electronic Media Limited (EML) regarding $21.5 million in damages is pending a final decision on the amount.
  • SEC Inquiry: The company is responding to an informal SEC inquiry regarding the timing of revenue recognition for theater system installations.
  • Internal Controls: Management identified a material weakness in internal controls over financial reporting related to complex film accounting transactions, which has been remediated with third-party expert engagement.

Investor Verification Checklist

• Verify the status and potential financial impact of the pending class action lawsuits regarding revenue recognition.
• Monitor the outcome of the ICC arbitration against EML/E-Citi for the $21.5 million in claimed damages.
• Assess the company's ability to meet the minimum EBITDA and cash collection covenants of its $40 million Credit Facility.
• Review the progress of the digital projection system development and its impact on future capital expenditures.
• Confirm the timeline for the 24 systems currently scheduled for installation in 2007 to gauge future revenue recovery.