TMCnet News
IMAX CORP - 10-Q - Management's Discussion and Analysis of Financial Condition and Results of Operations(Edgar Glimpses Via Acquire Media NewsEdge) OVERVIEW IMAX Corporation, together with its wholly-owned subsidiaries (the "Company"), is one of the world's leading entertainment technology companies, specializing in motion picture technologies and presentations. The Company refers to all theaters using the IMAX theater system as "IMAX theaters." IMAX offers a unique end-to-end cinematic solution combining proprietary software, theater architecture and equipment to create the highest-quality, most immersive motion picture experience for which the IMAX® brand has become known globally. Top filmmakers and studios utilize IMAX theaters to connect with audiences in innovative ways, and, as such, IMAX's network is among the most important and successful theatrical distribution platforms for major event films around the world. There were 880 IMAX theater systems (751 commercial multiplexes, 19 commercial destinations, 110 institutional) operating in 60 countries as of September 30, 2014. This compares to 785 theater systems (653 commercial multiplexes, 19 commercial destinations, 113 institutional) operating in 55 countries as of September 30, 2013. IMAX theater systems combine: • IMAX DMR (Digital Re-Mastering) movie conversion technology, which results in higher image and sound fidelity than conventional cinema experiences; • advanced, high-resolution projectors with specialized equipment and automated theater control systems, which generate significantly more contrast and brightness than conventional theater systems; • large screens and proprietary theater geometry, which result in a substantially larger field of view so that the screen extends to the edge of a viewer's peripheral vision and creates more realistic images; • sound system components, which deliver more expansive sound imagery and pinpointed origination of sound to any specific spot in an IMAX theater; and • specialized theater acoustics, which result in a four-fold reduction in background noise. Together these components cause audiences in IMAX theaters to feel as if they are a part of the on-screen action, creating a more intense, immersive and exciting experience than in a traditional theater. As a result of the immersiveness and superior image and sound quality of The IMAX Experience, the Company's exhibitor customers typically charge a premium for IMAX DMR films over films exhibited in their other auditoriums. The premium pricing, combined with the higher attendance levels associated with IMAX DMR films, generates incremental box-office for the Company's exhibitor customers and for the movie studios releasing their films to the IMAX network. The incremental box-office generated by IMAX DMR films has helped establish IMAX as a key premium distribution and marketing platform for Hollywood blockbuster films. In the second quarter of 2014, the Company announced the creation of the IMAX Original Film Fund (the "Film Fund") to co-finance a portfolio of 10 original large-format films. The Film Fund, which is intended to be capitalized with up to $50.0 million, will finance an ongoing supply of original films that the Company believes will be more exciting and compelling than traditional documentaries. The initial investment in the Film Fund was committed to by a third party in the amount of $25.0 million, with the possibility of contributing additional funds. The Company, which will contribute $9.0 million to the Film Fund over five years, anticipates the Film Fund will be self-perpetuating, with a portion of box office proceeds reinvested into the Film Fund to generate a continuous, steady flow of high-quality documentary content. As one of the world's leaders in entertainment technology, the Company strives to remain at the forefront of advancements in cinema technology. Accordingly, one of the Company's key short-term initiatives is the development of a next-generation laser-based digital projection system, which it plans to begin rolling out by the end of 2014. In order to develop the laser-based digital projection system, the Company obtained exclusive rights to certain laser projection technology and other technology with applicability in the digital cinema field from Eastman Kodak Company ("Kodak") in 2011 and entered a co-development arrangement with Barco N.V. ("Barco") to co-develop a laser-based digital projection system that incorporates Kodak technology in 2012. Furthermore, in the second quarter of 2014, the Company announced an agreement with Necsel IP, Inc. ("Necsel") to be the exclusive worldwide provider of specified lasers for IMAX's laser projection systems in exchange for preferred pricing and supply terms. The Company believes that these arrangements with Kodak, Barco and Necsel will enable IMAX laser projectors to present greater brightness and clarity, a wider color gamut and deeper blacks, and consume less power and last longer than existing digital technology. The Company also believes 42 -------------------------------------------------------------------------------- Table of Contents that a laser projection solution will be the first IMAX digital projection system capable of illuminating the largest screens in its network. The Company is undertaking new lines of business, particularly in the area of in-home theater entertainment. In 2013, the Company announced two new initiatives in the area of in-home entertainment, including a joint venture with TCL Multimedia Technology Holding Limited ("TCL") to design, develop, manufacture and sell a premium home theater system, and an investment in PRIMA Cinema Inc. ("Prima"), a developer of a proprietary system that transmits current theatrical releases for secure home viewing. The Company and TCL expect to launch the new home theater system, which will incorporate components of IMAX's projection and sound technology adapted for a broader home environment as well as PRIMA technology, in China and other select global markets in 2015. In April 2014, the Company, TCL and Wasu Digital TV media group ("WASU") announced a joint-venture partnership whereby WASU will license and distribute IMAX-enhanced Hollywood and Chinese current theatrical and other content to the new home theater system. The Company also recently began marketing and selling the IMAX Private Theatre, a cinema-grade, ultra-premium home theater system, and has signed agreements for 8 of such theaters to date. Important factors that the Company's Chief Executive Officer ("CEO") Richard L. Gelfond uses in assessing the Company's business and prospects include: • the signing, installation and financial performance of theater system arrangements (particularly its joint revenue sharing arrangements); • film performance and the securing of new film projects (particularly IMAX DMR films); • revenue and gross margins from the Company's operating segments; • operating leverage; • earnings from operations as adjusted for unusual items that the Company views as non-recurring; • short- and long-term cash flow projections; • the continuing ability to invest in and improve the Company's technology to enhance its differentiation of presentation versus other cinematic experiences; • the overall execution, reliability and consumer acceptance of The IMAX Experience; and • the success of new business initiatives. The primary revenue sources for the Company can be categorized into two main groups: theater systems and films. On the theater systems side, the Company derives revenues from theater exhibitors primarily through either a sale or sales-type lease arrangement or a joint revenue sharing arrangement. Theater exhibitors also pay for associated maintenance and extended warranty services. Film revenue is derived primarily from film studios for the provision of film production and digital re-mastering services for exhibition on IMAX theater systems around the world. The Company derives other film revenues from the distribution of certain films and the provision of post-production services. The Company also derives a small portion of other revenues from the operation of its own theaters, the provision of aftermarket parts for its system components, and camera rentals. IMAX Theater Systems: IMAX Systems (Sales and Sales-type Leases), Joint Revenue Sharing Arrangements and Theater System Maintenance One of the Company's principal businesses is the design, manufacture and delivery of premium theater systems ("IMAX theater systems"). The theater system equipment components (including the projection system, sound system, screen system and, if applicable, 3D glasses cleaning machine), theater design support, supervision of installation, projectionist training and the use of the IMAX brand are all elements of what the Company considers the system deliverable. IMAX theater systems are based on proprietary and patented technology developed over the course of the Company's 47-year history. The Company provides IMAX theater systems to customers through sales, long-term leases or under joint revenue sharing arrangements. The Company's customers who purchase, lease or otherwise acquire the IMAX theater systems through joint revenue sharing arrangements are theater exhibitors that operate commercial theaters (particularly multiplexes), museums, science centers, or destination entertainment sites. The Company generally does not own IMAX theaters, but licenses the use of its trademarks along with the sale, lease or contribution of the IMAX theater system. 43 -------------------------------------------------------------------------------- Table of Contents IMAX Systems Sales and Sales-Type Lease Arrangements The Company provides IMAX theater systems to customers on a sales or long-term lease basis, typically with an initial 10-year term. These agreements typically require the payment of initial fees and ongoing fees (which can include a fixed minimum amount per annum and contingent fees in excess of the minimum payments), as well as maintenance and extended warranty fees. The initial fees vary depending on the system configuration and location of the theater. Initial fees are paid to the Company in installments between the time of system signing and the time of system installation, which is when the total of these fees, in addition to the present value of future annual minimum payments, are recognized as revenue. Ongoing fees are paid over the term of the contract, commencing after the theater system has been installed, and are equal to the greater of a fixed minimum amount per annum or a percentage of box-office receipts. Contingent payments in excess of fixed minimum ongoing payments are recognized as revenue when reported by theater operators, provided collectibility is reasonably assured. Typically, ongoing fees are indexed to a local consumer price index. Finance income is derived over the term of a financed sale or sales-type lease arrangement as the unearned income on that financed sale or sales-type lease is earned. Under the Company's sales agreements, title to the theater system equipment components passes to the customer. In certain instances, however, the Company retains title or a security interest in the equipment until the customer has made all payments required under the agreement. Under the terms of a sales-type lease agreement, title to the theater system equipment components remains with the Company. The Company has the right to remove the equipment for non-payment or other defaults by the customer. The revenue earned from customers under the Company's theater system sales or lease agreements varies from quarter to quarter and year to year based on a number of factors, including the number and mix of theater system configurations sold or leased, the timing of installation of the theater systems, the nature of the arrangement and other factors specific to individual contracts. Joint Revenue Sharing Arrangements The Company also provides IMAX theater systems to customers under joint revenue sharing arrangements. The Company has two basic types of joint revenue sharing arrangements: traditional and hybrid. Under a traditional joint revenue sharing arrangement, the Company provides the IMAX theater system in return for a portion of the customer's IMAX box-office receipts and, in some cases, concession revenues, rather than requiring the customer to pay a fixed upfront payment or annual minimum payments. Payments, which are based on box-office receipts, are required throughout the term of the arrangement and are due either monthly or quarterly. Certain maintenance and extended warranty services are provided to the customer for a separate fixed annual fee. The Company retains title to the theater system equipment components, and the equipment is returned to the Company at the conclusion of the arrangement. Under a hybrid joint revenue sharing arrangement, by contrast, the customer is responsible for making upfront payments prior to the delivery and installation of the IMAX theater system in an amount that is typically half of what the Company would receive from a straight sale transaction. As with a traditional joint revenue sharing arrangement, the customer also pays the Company a portion of the customer's IMAX box-office receipts over the term of the arrangement, although the percentage of box-office receipts owing to the Company is typically half that of a traditional joint revenue sharing arrangement. The Company generally retains title to the theater system equipment components, and the equipment is returned to the Company at the conclusion of the arrangement. In limited instances, however, title to the theater system equipment components passes to the customer. Under the significant majority of joint revenue sharing arrangements (both traditional and hybrid), the initial non-cancellable term of IMAX theater systems is 10 years or longer, and is renewable by the customer for one to two additional terms of between three to five years. The Company has the right to remove the equipment for non-payment or other defaults by the customer. The contracts are non-cancellable by the customer unless the Company fails to perform its obligations. The introduction of joint revenue sharing arrangements has been an important factor in the expansion of the Company's commercial theater network, which has grown by approximately 330% since the beginning of 2008. Joint revenue sharing arrangements allow commercial theater exhibitors to install IMAX theater systems without the significant initial capital investment required in a sale or sales-type lease arrangement. Joint revenue sharing arrangements drive recurring cash flows and earnings for the Company, as customers under joint revenue sharing arrangements pay the Company a portion of their ongoing box-office. The Company funds its joint revenue sharing arrangements through cash flows from operations and the Company's credit facility. As at 44-------------------------------------------------------------------------------- Table of Contents September 30, 2014, the Company had 422 theaters in operation under joint revenue sharing arrangements, a 20.2% increase as compared to the 351 joint revenue sharing arrangements open as at September 30, 2013. The Company also had contracts in backlog for an additional 248 theaters under joint revenue sharing arrangements as at September 30, 2014. The revenue earned from customers under the Company's joint revenue sharing arrangements can vary from quarter to quarter and year to year based on a number of factors including film performance, the mix of theater system configurations, the timing of installation of these theater systems, the nature of the arrangement, the location, size and management of the theater and other factors specific to individual arrangements. Theater System Maintenance For all IMAX theaters, theater owners or operators are also responsible for paying the Company an annual maintenance and extended warranty fee. Under these arrangements, the Company provides proactive and emergency maintenance services to every theater in its network to ensure that each presentation is up to the highest IMAX quality standard. Annual maintenance fees are paid throughout the duration of the term of the theater agreements and are typically indexed to a local consumer price index. Other Theater Revenues The Company derives a small portion of its revenues from other sources. As at September 30, 2014, the Company had three owned and operated IMAX theaters (December 31, 2013 - four owned and operated theaters). On January 30, 2014, the Company discontinued the operations of one of these owned and operated theaters in Nyack, New York. In addition, the Company has a commercial arrangement with one theater resulting in the sharing of profits and losses and provides management services to two theaters. The Company also rents its proprietary 2D and 3D large-format film and digital cameras to third party production companies. The Company maintains cameras and other film equipment and also offers production advice and technical assistance to both documentary and Hollywood filmmakers. Additionally, the Company generates revenues from the sale of after-market parts and 3D glasses. Revenue from theater system arrangements is recognized at a different time from when cash is collected. See "Critical Accounting Policies" in Item 7 of the Company's Form 10-K for the year ended December 31, 2013 (the "2013 Form 10-K") for further discussion on the Company's revenue recognition policies. IMAX Theater Network The following table outlines the breakdown of the theater network by type and geographic location as at September 30: 2014 Theater Network Base 2013 Theater Network Base Commercial Commercial Commercial Commercial Multiplex Destination Institutional Total Multiplex Destination Institutional Total United States 325 6 50 381 306 6 54 366 Canada 35 2 8 45 33 2 7 42 Greater China(1) 176 - 22 198 131 - 21 152 Asia (excluding Greater China) 66 3 6 75 57 3 7 67 Western Europe 52 7 11 70 44 7 11 62 Russia & the CIS 42 - - 42 39 - - 39 Latin America(2) 29 - 11 40 20 - 11 31 Rest of the World 26 1 2 29 23 1 2 26 Total 751 19 110 880 653 19 113 785 (1) Greater China includes China, Hong Kong, Taiwan and Macau. (2) Latin America includes South America, Central America and Mexico. The Company currently believes that over time its commercial multiplex theater network could grow to approximately 1,700 IMAX theaters worldwide from 751 commercial multiplex IMAX theaters operating as of September 30, 2014. While the Company 45 -------------------------------------------------------------------------------- Table of Contents continues to grow in the United States and Canada, it believes that the majority of its future growth will come from international markets. As at September 30, 2014, 51.6% of all IMAX systems in operation were located within international markets (defined as all countries other than the United States and Canada), up from 48.0% as at September 30, 2013. Risks associated with the Company's international business are outlined in Risk Factors - "The Company conducts business internationally, which exposes it to uncertainties and risks that could negatively affect its operations, sales and future growth prospects" in Item 1A of the Company's 2013 Form 10-K. Greater China continues to be the Company's second-largest and fastest-growing market. As at September 30, 2014, the Company had 198 theaters operating in Greater China with an additional 247 theaters (which includes one upgrade) in backlog that are scheduled to be installed in Greater China by 2021. The Company's backlog in Greater China represents 56.3% of the Company's overall current backlog. The Company continues to invest in joint revenue sharing arrangements with select partners to ensure ongoing revenue in this key market. In 2013, the Company and Wanda Cinema Line Corporation ("Wanda") announced amendments of the parties' original 2011 joint revenue sharing arrangement for an additional 120 IMAX theaters to be located throughout China. The most recent expansion brings Wanda's total commitment to 210 IMAX theater systems, of which 195 are under the parties' joint revenue sharing arrangement. The Company believes that the China market presents opportunities for additional growth with favorable market trends, including government initiatives to foster cinema screen growth, to support the film industry and to increase the number of Hollywood films distributed in China, including a 2012 agreement with the U.S. to permit 14 additional IMAX or 3D format films to be distributed in China each year and to permit distributors to receive higher distribution fees. The Company cautions, however, that its expansion in China faces a number of challenges. See Item 1A Risk Factors in Part II - "The Company faces risks in connection with the continued expansion of its business in China". On April 8, 2014, the Company announced the investment (the "IMAX China Investment") in its Greater China business by CMC Capital Partners ("CMC"), an investment fund that is focused on media and entertainment, and FountainVest Partners ("FountainVest"), a China-focused private equity firm. The IMAX China Investment provides for the sale and issuance of 20% of the shares of IMAX China Holding, Inc. ("IMAX China") to entities owned and controlled by CMC and FountainVest, with the intent of further strengthening the Company's competitive position in China. The sale price for the interest was $80.0 million, to be paid by the investors in two equal installments. The first installment was received on April 8, 2014, and the second installment is due in February 2015. IMAX China remains a consolidated subsidiary of the Company. The Company anticipates a number of financial, strategic and operating benefits resulting from the IMAX China Investment. In particular, the Company believes that the investors' knowledge of, and influence in, the Chinese media and entertainment industry will enable the continued expansion of IMAX's theater network in China, the sustained performance in the marketplace of IMAX's Hollywood and Chinese titles, and the further strengthening of the Company's government and industry relationships within China. 46-------------------------------------------------------------------------------- Table of Contents The following table outlines the breakdown of the Commercial Multiplex theater network by arrangement type and geographic location as at September 30: 2014 2013 IMAX Commercial Multiplex Theater Network IMAX Commercial Multiplex Theater Network Sale / Sales- Sale / Sales- JRSA type lease Total JRSA type lease Total Domestic Total (United States & Canada) 248 112 360 223 116 339 International: Greater China 105 71 176 73 58 131 Asia (excluding Greater China) 34 32 66 28 29 57 Western Europe 31 21 52 27 17 44 Russia & the CIS - 42 42 - 39 39 Latin America - 29 29 - 20 20 Rest of the World 4 22 26 - 23 23 International Total 174 217 391 128 186 314 Worldwide Total 422 329 751 351 302 653 As at September 30, 2014, 248 (2013 - 223) of the 422 (2013 - 351) theaters under joint revenue sharing arrangements in operation, or 58.8% (2013 - 63.5%) were located in the United States and Canada, with the remaining 174 (2013 - 128) or 41.2% of arrangements being located in international markets. The Company continues to seek to expand its network of theaters under joint revenue sharing arrangements, particularly in select international markets. Sales Backlog The Company's current sales backlog is as follows: September 30, 2014 September 30, 2013 Number of Dollar Value Number of Dollar Value Systems (in thousands) Systems (in thousands) Sales and sale-type lease arrangements 191 $ 244,216 162 $ 195,567 Joint revenue sharing arrangements 248 51,151 194 50,499 439 (1)(2) $ 295,367 356 (1)(3) $ 246,066 (1) Includes 69 laser theater system configurations (2013 - 18), including upgrades. The Company is in the process of developing its laser projection system. See "Research and Development" in Item 2 of this Part I for additional information. (2) Includes 26 upgrades to a digital theater system in existing IMAX theater locations (3 xenon and 23 laser, of which 4 are under joint revenue sharing arrangements). (3) Includes 23 upgrades to a digital theater system in existing IMAX theater locations (5 xenon and 18 laser, of which 3 are under joint revenue sharing arrangements). The number of theater systems in the backlog reflects the minimum number of commitments under signed contracts. The dollar value fluctuates depending on the number of new theater system arrangements signed from quarter to quarter, which adds to backlog, and the installation and acceptance of theater systems and the settlement of contracts, both of which reduce backlog. Sales backlog typically represents the fixed contracted revenue under signed theater system sale and lease agreements that the Company believes will be recognized as revenue upon installation and acceptance of the associated theater. Sales backlog includes initial fees along with the estimated present value of contractual ongoing fees due over the lease term; however, it excludes amounts allocated to maintenance and extended warranty revenues as well as fees in excess of contractual ongoing fees that may be received in the future. 47-------------------------------------------------------------------------------- Table of Contents The value of sales backlog does not include revenue from theaters in which the Company has an equity interest, operating leases, letters of intent or long-term conditional theater commitments. The value of theaters under joint revenue sharing arrangements is excluded from the dollar value of sales backlog, although certain theater systems under joint revenue sharing arrangements provide for contracted upfront payments and therefore carry a backlog value based on those payments. The Company believes that the contractual obligations for theater system installations that are listed in sales backlog are valid and binding commitments. From time to time, in the normal course of its business, the Company will have customers who are unable to proceed with a theater system installation for a variety of reasons, including the inability to obtain certain consents, approvals or financing. Once the determination is made that the customer will not proceed with installation, the agreement with the customer is terminated or amended. If the agreement is terminated, once the Company and the customer are released from all their future obligations under the agreement, all or a portion of the initial rents or fees that the customer previously made to the Company are recognized as revenue. The following table outlines the breakdown of the total backlog by arrangement type and geographic location as at September 30: 2014 2013 JRSA Sale / Lease Total JRSA Sale /Lease Total Domestic Total (United States & Canada) 34 29 63 36 25 61 International: Greater China 186 61 247 132 43 175 Asia (excluding Greater China) 16 23 39 13 24 37 Western Europe 9 9 18 9 5 14 Russia & the CIS - 28 28 - 19 19 Latin America - 28 28 - 39 39 Rest of the World 3 13 16 4 7 11 International Total 214 162 376 158 137 295 Worldwide Total 248 191 439 (1)(2) 194 162 356 (1)(3) (1) Includes 69 laser theater system configurations (2013 - 18), including upgrades. The Company is in the process of developing its laser projection system. See "Research and Development" in Item 2 of this Part I for additional information. (2) Includes 26 upgrades to a digital theater system in existing IMAX theater locations (3 xenon and 23 laser, of which 4 are under joint revenue sharing arrangements). (3) Includes 23 upgrades to a digital theater system in existing IMAX theater locations (5 xenon and 18 laser, of which 3 are under joint revenue sharing arrangements). Approximately 86% of IMAX theater system arrangements in backlog as at September 30, 2014 are scheduled to be installed in international markets. 48-------------------------------------------------------------------------------- Table of Contents For the Three Months For the Nine Months Ended September 30, Ended September 30, 2014 2013 2014 2013 Theater System Signings: Full new sales and sale-type lease arrangements 22 6 (3) 71 (4) 38 (4) New joint revenue sharing arrangements 14 82 20 92 Total new theaters 36 88 91 130 Upgrades of IMAX theater systems 6 (1)(2) 11 (1)(2) 11 (5)(6) 28 (5)(6) Total theater signings 42 99 102 158 For the Three Months For the Nine Months Ended September 30, Ended September 30, 2014 2013 2014 2013 Theater System Installations: Full new sales and sale-type lease arrangements 6 6 (7) 20 23 (7) New joint revenue sharing arrangements 14 13 38 35 Total new theaters 20 19 58 58 Upgrades of IMAX theater systems - 9 (2) 6 (2) 17 (6) Total theater installations 20 28 64 75 (1) Includes one signing for the installation of a laser-based digital systems in an existing theater location (2013 - six signings). (2) Includes one signing of an upgrade to a xenon-based digital system under a short-term operating lease arrangement (2013 - 4 signings, 3 installations). (3) Includes one signing which replaced a theater under an existing arrangement in backlog. (4) Includes three signings which replaced theaters under an existing arrangement in backlog (2013 - three signings). (5) Includes three signings for the installation of laser-based digital systems in existing theater locations (2013 - 13 signings). (6) Includes two signings and two installations of upgrades to xenon-based digital systems under short-term operating lease arrangements (2013 - 9 signings, 5 installations). (7) Includes one full xenon-based digital system under a short-term operating lease arrangement. The Company estimates that it will install a similar number of new theater systems (excluding digital upgrades) in 2014 as the Company installed in 2013. The Company's installation estimates includes scheduled systems from backlog, as well as the Company's estimate of installations from arrangements that will sign and install in the same calendar year. The Company cautions, however, that theater system installations may slip from period to period over the course of the Company's business, usually for reasons beyond its control. Films: Digital Re-Mastering (IMAX DMR) and other film revenue Digital Re-Mastering (IMAX DMR) In 2002, the Company developed a proprietary technology to digitally re-master Hollywood films into IMAX digital cinema package format or 15/70-format film for exhibition in IMAX theaters at a modest cost that is incurred by the Company. This system, known as IMAX DMR, digitally enhances the image resolution of motion picture films for projection on IMAX screens while maintaining or enhancing the visual clarity and sound quality to levels for which The IMAX Experience is known. This technology enabled the IMAX theater network to release Hollywood films simultaneously with their broader domestic release. The development of this technology was critical in helping the Company execute its strategy of expanding its commercial theater network by establishing IMAX theaters as a key, premium distribution platform for Hollywood films. In a typical IMAX DMR film arrangement, the Company receives a percentage, which ranges between 10-15%, of net box-office receipts of any commercial films released in the IMAX network from the applicable film studio for the conversion of the film to the IMAX DMR format and for access to the Company's premium distribution platform. IMAX films benefit from enhancements made by individual filmmakers exclusively for the IMAX release, and filmmakers and studios have sought IMAX-specific enhancements in recent years to generate interest in and excitement for their films. Such 49 -------------------------------------------------------------------------------- Table of Contents enhancements include shooting selected scenes with IMAX cameras to increase the audience's immersion in the film and taking advantage of the unique dimensions of the IMAX screen by shooting the film in a larger aspect ratio and early release windows exclusively in IMAX. Several recent films have featured select sequences shot with IMAX cameras including Transformers Age of Extinction: An IMAX 3D Experience, released June in 2014, Star Trek Into Darkness: An IMAX 3D Experience, released in May 2013 and The Hunger Games: Catching Fire: The IMAX Experience in November 2013 as well as The Dark Knight Rises: The IMAX Experiencein July 2012, which featured over an hour of footage shot with IMAX cameras. In addition, Interstellar, Christopher Nolan's newest film, set to be released in November 2014, has several extensive sequences filmed with IMAX cameras. Several other recent movies, including Oblivion: The IMAX Experience in 2013 and Skyfall: The IMAX Experience in 2012 have featured footage that take advantage of the larger projected IMAX aspect ratio. The original soundtrack of a film to be released to the IMAX network is re-mastered for the IMAX five or six-channel digital sound systems in connection with the IMAX DMR release. Unlike the soundtracks played in conventional theaters, IMAX re-mastered soundtracks are uncompressed and full fidelity. IMAX sound systems use proprietary loudspeaker systems and proprietary surround sound configurations that ensure every theater seat is in a good listening position. The Company believes that the growth in international box-office is an important driver of future growth for the Company. During the nine months ended September 30, 2014, 61.6% of the Company's gross box-office from IMAX DMR films was generated in international markets, as compared to 55.7% in the nine months ended September 30, 2013. To support growth in international markets, the Company has sought to bolster its international film strategy, supplementing the Company's film slate of Hollywood DMR titles with appealing local IMAX DMR releases in select markets. During 2013, the Company released nine local language IMAX DMR films, including five in China and one in each of Japan, Russia, France, and India. Thus far in 2014, the Company has released three local language IMAX DMR films in China. The Company expects to announce additional local language IMAX DMR films to be released to the IMAX network in 2014 and beyond. In addition to the 27 IMAX DMR films released to the IMAX theater network during the first nine months of 2014, 7 additional IMAX DMR films have been announced so far to be released in the remaining three months of 2014: • Bang Bang: The IMAX Experience (Fox Star Studios, October 2014, India only); • Dracula Untold: The IMAX Experience (Universal Studios, October 2014); • John Wick: The IMAX Experience (Summit Entertainment, October 2014); • Fury: The IMAX Experience (Sony Pictures Entertainment, October 2014, select international markets); • Interstellar: The IMAX Experience (Paramount Pictures and Warner Bros. Pictures, November 2014); • The Hobbit: The Battle of the Five Armies: An IMAX 3D Experience (Warner Bros. Pictures, December 2014); and • Gone with the Bullets: An IMAX 3D Experience (Dongwang Yibudaowei Films Co., December 2014, China only). In addition, in conjunction with Warner Bros. Pictures ("WB"), the Company released an IMAX original production, Island of Lemurs: Madagascar, on April 4, 2014. To date, the Company has announced the following 8 titles to be released to the IMAX theater network in 2015: • Seventh Son: An IMAX 3D Experience (Universal Studios, February 2015); • Fast & Furious 7: The IMAX Experience (Universal Studios, April 2015); • The Avengers: Age of Ultron: An IMAX 3D Experience (Walt Disney Studios, May 2015); • Tomorrowland: The IMAX Experience (Walt Disney Studios, May 2015); • Jurassic World: An IMAX 3D Experience (Universal Studios, June 2015); • Everest: An IMAX 3D Experience (Universal Studios, September 2015); • Crimson Peak: The IMAX Experience (Universal Studios, October 2015); and • Star Wars: Episode VII: An IMAX 3D Experience (Walt Disney Studios, December 2015). The Company remains in active negotiations with all of the major Hollywood studios for additional films to fill out its short and long-term film slate, and anticipates that a similar number of IMAX DMR films will be released to the IMAX network in 2015 to the 34 slated for release in 2014 and the 38 films that were released to the IMAX network in 2013. 50-------------------------------------------------------------------------------- Table of Contents Other Film Revenues: Film Distribution and Post-Production The Company is also a distributor of large-format films, primarily for its institutional theater partners. The Company generally distributes films which it produces or for which it has acquired distribution rights from independent producers. The Company receives either a percentage of the theater box-office receipts or a fixed amount as a distribution fee. In the second quarter of 2014, the Company announced the creation of the Film Fund to co-finance a portfolio of 10 original large-format films. The Film Fund, which is intended to be capitalized with up to $50.0 million, will finance an ongoing supply of original films that the Company believes will be more exciting and compelling than traditional documentaries. The initial investment in the Film Fund was committed to by a third party in the amount of $25.0 million, with the possibility of contributing additional funds. The Company, which will contribute $9.0 million to the Film Fund over five years, anticipates the Film Fund will be self-perpetuating, with a portion of box office proceeds reinvested into the Film Fund to generate a continuous, steady flow of high-quality documentary content. The Company anticipates that the Film Fund will finance a number of Company-produced films going forward. Previously, films produced by the Company were typically financed through third parties, whereby the Company generally received a film production fee and a distribution fee in exchange for producing and distributing the film. The ownership rights to such films were held by the film sponsors, the film investors and/or the Company. The Company utilizes third-party funding for the majority of original films it produces and distributes. In 2012, the Company, along with WB and MacGillivray Freeman Films, Inc. ("MFF"), released an original title, To the Artic 3D. In 2011, the Company, along with WB, released Born to be Wild 3D. In January 2013, the Company announced an agreement with MFF to jointly finance, market and distribute up to four films (with an option for four additional films) produced by MFF to be released exclusively to IMAX theaters. The agreement will ensure IMAX's institutional theater partners access to a steady flow of the highest-quality, large-format documentaries over the years to come. One of the four films produced under the MFF agreement, Journey to the South Pacific had a limited release in November 2013 and a broader release in early 2014. IMAX Post/DKP Inc. (formerly David Keighley Productions 70MM Inc.), a wholly-owned subsidiary of the Company, provides film post-production and quality control services for large-format films (whether produced internally or externally), and digital post-production services. 51-------------------------------------------------------------------------------- Table of Contents CRITICAL ACCOUNTING POLICIES AND ESTIMATES The Company prepares its consolidated financial statements in accordance with United States Generally Accepted Accounting Principles ("U.S. GAAP"). The preparation of these consolidated financial statements requires management to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses. On an ongoing basis, management evaluates its estimates, including those related to selling prices associated with the individual elements in multiple element arrangements; residual values of leased theater systems; economic lives of leased assets; allowances for potential uncollectibility of accounts receivable, financing receivables and net investment in leases; write-downs for inventory obsolescence; ultimate revenues for film assets; impairment provisions for film assets, long-lived assets and goodwill; depreciable lives of property, plant and equipment; useful lives of intangible assets; pension plan and post retirement assumptions; accruals for contingencies including tax contingencies; valuation allowances for deferred income tax assets; and estimates of the fair value and expected exercise dates of stock-based payment awards. Management bases its estimates on historical experience, future expectations and other assumptions that are believed to be reasonable at the date of the consolidated financial statements. Actual results may differ from these estimates due to uncertainty involved in measuring, at a specific point in time, events which are continuous in nature, and differences may be material. The Company's significant accounting policies are discussed in Item 7 of the Company's 2013 Form 10-K. Impact of Recently Issued Accounting Pronouncements In May 2014, the Financial Accounting Standards Board ("FASB") issued ASU No. 2014-09, "Revenue from Contract with Customers (Topic 606)" ("ASU 2014-09"). The purpose of the amendment is to clarify the principles for recognizing revenue and developing common revenue standards between US GAAP and IFRS, through the application of a single comprehensive model for companies to use in accounting for revenue arising from contracts with customers. Under this amended standard, the Company will recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the Company expects to be entitled in exchange for those goods or services. For public entities, the amendments are effective for interim and annual reporting periods beginning after December 15, 2016. The Company is currently assessing the impact of ASU 2014-09 on its consolidated financial statements. Other than ASU No. 2014-09, the adoption of new accounting policies and recently issued FASB accounting standard codification updates were not material to the Company's condensed consolidated financial statements for the period ended September 30, 2014. Discontinued Operations On January 30, 2014, the Company's lease with respect to its owned and operated Nyack IMAX theater ended and the Company decided not to renew the lease. In the three and nine months ended September 30, 2014, revenues for the Nyack IMAX theater were $nil and less than $0.1 million, respectively (2013 - $0.2 million and $1.0 million, respectively) and the Company recognized income of $nil and $0.4 million, net of a tax expense of $nil and $0.2 million, respectively, in 2014 (2013 - loss of $0.1 million and loss of $0.3 million, net of tax recovery of $0.1 million and $0.1 million, respectively) from the operation of the theater. The transactions are reflected as a discontinued operation. See note 19(b) to the interim condensed consolidated financial statements in Item 1 for more information. Non-GAAP Financial Measures In this report, the Company presents adjusted net income attributable to common shareholders and adjusted net income attributable to common shareholders per diluted share as supplemental measures of performance of the Company, which are not recognized under U.S. GAAP. The Company presents adjusted net income attributable to common shareholders and adjusted net income attributable to common shareholders per diluted share because it believes that they are important supplemental measures of its comparable controllable operating performance and it wants to ensure that its investors fully understand the impact of its stock-based compensation (net of any related tax impact) on net income attributable to common shareholders. The Company presents adjusted gross margin from its joint revenue sharing arrangements segment excluding initial launch costs because it believes that it is an important supplemental measure used by management to evaluate ongoing joint revenue sharing arrangement theater performance. Management uses these measures to review operating performance on a comparable basis from period to period. However, these non-GAAP measures may not be comparable to similarly titled amounts reported by other companies. Adjusted net income attributable to common shareholders and adjusted net income attributable to common shareholders per diluted share should be considered in addition 52 -------------------------------------------------------------------------------- Table of Contents to, and not as a substitute for, net income attributable to common shareholders and other measures of financial performance reported in accordance with U.S. GAAP. RESULTS OF OPERATIONS Management, including the Company's CEO, who is the Company's Chief Operating Decision Maker (as defined in the Segment Reporting Topic of the FASB ASC), assesses segment performance based on segment revenues, gross margins and film performance. Selling, general and administrative expenses, research and development costs, amortization of intangibles, receivables provisions (recoveries), write-downs net of recoveries, interest income, interest expense and tax (provision) recovery are not allocated to the segments. As identified in note 15 to the accompanying condensed consolidated financial statements in Item 1, the Company has the following seven reportable segments identified by category of product sold or service provided: • IMAX Theater Systems • The IMAX systems segment, which is comprised of the design, manufacture, sale or lease of IMAX theater projection system equipment. • The theater system maintenance segment, which iscomprised of the maintenance of IMAX theater projection system equipment in the IMAX theater network. • The joint revenue sharing arrangements segment, which is comprised of the provision of IMAX theater projection system equipment to exhibitors in exchange for a certain percentage of box-office receipts, and in some cases, concession revenue and/or a small upfront or initial payment. • The other segment, which includes certain IMAX theaters that the Company owns and operates, camera rentals and other miscellaneous items. • Film • The film production and IMAX DMR segment, which iscomprised of the production of films and performance of film re-mastering services. • The film distribution segment, which includes the distribution of films for which the Company has distribution rights. • The film post-production segment, which includes theprovision of film post-production and film print services. The Company's Management's Discussion and Analysis ("MD&A") of Financial Condition and Results of Operations has been organized by the Company into two primary reporting groups - IMAX Theater Systems and Film. Each of the Company's reportable segments, as identified above, has been classified into one of these broader reporting groups for purposes of MD&A discussion. The Company believes that this approach is consistent with management's view of the business and is not expected to have an impact on the readers' ability to understand the Company's business. Management feels that a discussion and analysis based on its reporting groups is significantly more relevant as the Company's consolidated statements of operations captions combine results from several segments. 53-------------------------------------------------------------------------------- Table of Contents Three Months Ended September 30, 2014 Versus Three Months Ended September 30, 2013 The Company reported net income attributable to common shareholders of $4.9 million or $0.07 per basic and diluted share for the third quarter of 2014, as compared to $1.6 million or $0.02 per basic and diluted share for the third quarter of 2013. Net income attributable to common shareholders for the third quarter of 2014 includes a $3.4 million charge, or $0.04 per diluted share (after-tax), for stock-based compensation (2013 - $2.8 million or $0.04 per diluted share (after-tax)). Adjusted net income attributable to common shareholders, which consists of net income attributable to common shareholders excluding stock-based compensation expense and the related tax impact, was $7.8 million, or $0.11 per diluted share, in the third quarter of 2014, as compared to adjusted net income attributable to common shareholders of $4.4 million, or $0.06 per diluted share, for the third quarter of 2013. A reconciliation of net income attributable to common shareholders, the most directly comparable U.S. GAAP measure, to adjusted net income attributable to common shareholders and adjusted net income attributable to common shareholders per diluted share is presented in the table below: September 30, 2014 September 30, 2013 Net Income Diluted EPS Net Income Diluted EPS Reported net income attributable to common shareholders $ 4,858 $ 0.07 (1) $ 1,609 $ 0.02 Adjustments: Stock-based compensation 3,425 0.05 2,838 0.04 Tax impact of items listed above (464 ) (0.01 ) (85 ) - Adjusted net income attributable to common shareholders $ 7,819 $ 0.11 (1) $ 4,362 $ 0.06 Weighted average diluted shares outstanding 69,602 69,116 (1) Includes impact of $0.1 million of accretion charges associated with redeemable common stock. The following table sets forth the breakdown of revenue and gross margin by category: Revenue Gross Margin Three Months Three Months (In thousands of US dollars) Ended September 30, Ended September 30, 2014 2013 2014 2013 IMAX Theater Systems IMAX Systems Sales and sales-type leases(1) $ 6,644 $ 6,419 $ 4,246 $ 3,928 Ongoing rent, fees, and finance income(2) 3,501 3,483 3,352 3,277 Other 3,165 1,995 (218 ) (108 ) 13,310 11,897 7,380 7,097 Theater System Maintenance 8,516 8,103 3,208 3,218 Joint Revenue Sharing Arrangements 15,238 11,960 9,382 7,153 Film Production and IMAX DMR 18,350 14,547 13,469 8,596 Film distribution and post-production 5,328 5,000 2,003 1,388 23,678 19,547 15,472 9,984 $ 60,742 $ 51,507 $ 35,442 $ 27,452 (1) Includes initial payments and the present value of fixed minimum payments from equipment, sales and sales-type lease transactions. (2) Includes rental income from operating leases, contingent rents from operating and sales-type leases, contingent fees from sales arrangements and finance income. 54 -------------------------------------------------------------------------------- Table of Contents Revenues and Gross Margin The Company's revenues for the third quarter of 2014 increased by 17.9% to $60.7 million from $51.5 million in the same period last year, primarily due to an increase in revenues from the IMAX systems, joint revenue sharing arrangements and film segments. The gross margin across all segments in the third quarter of 2014 was $35.4 million, or 58.3% of total revenue, compared to $27.5 million, or 53.3% of total revenue in the third quarter of 2013. IMAX Systems IMAX systems revenue increased 11.9% to $13.3 million in the third quarter of 2014, as compared to $11.9 million in the third quarter of 2013. Revenue from sales and sales-type leases increased 3.5% to $6.6 million in the third quarter of 2014 from $6.4 million in the third quarter of 2013. The Company recognized revenue on 6 full, new theater systems which qualified as either sales or sales-type leases in the third quarter of 2014, with a total value of $6.4 million, as compared to 5 full, new theater systems in the third quarter of 2013, with a total value of $6.1 million. The Company anticipates that its installations will vary from quarter to quarter given that a large portion of its theater systems in backlog are slated to be installed in newly built theaters or multiplexes. The installation of theater systems in newly built theaters or multiplexes depends primarily on the timing of the construction of those projects, which is not under the Company's control. The Company did not recognize any revenue from xenon-based digital upgrades and there were no used system recognitions in the three months ended September 30, 2014 and 2013, respectively. Average revenue per full, new sales and sales-type lease systems was $1.1 million for the three months ended September 30, 2014, as compared to $1.2 million for the three months ended September 30, 2013. The average revenue per full, new sales and sales-type lease systems varies depending upon the number of theater system commitments with a single respective exhibitor, an exhibitor's location or other various factors. The breakdown in mix of sales and sales-type lease and joint revenue sharing arrangements (see discussion below) installations by theater system configuration for the third quarter of 2014 and 2013 is outlined in the table below: Three Months Ended September 30, 2014 2013 New IMAX xenon-based digital theater systems - installed and recognized Sales and sales-types lease arrangements 6 5 Short-term operating lease arrangement - 1 (1) Joint revenue sharing arrangements 14 13 Total new theater systems 20 19 IMAX xenon-based digital theater system upgrades - installed and recognized Short-term operating lease arrangements - 6 (1) Joint revenue sharing arrangement - 2 (1) Total upgraded theater systems - 8 IMAX xenon-based digital theater system upgrades - installed and deferred - 1 (1) Total theater systems installed 20 28 (1) Includes a xenon-based digital system configuration, which will be upgraded to a laser-based digital system configuration at a future date. IMAX theater systems gross margin from full, new sales and sale-type leases was 61.2% in the third quarter of 2014 versus 63.8% in the third quarter of 2013. There were no xenon-based digital upgrades or used systems installed during the third quarter of 2014 and 2013, respectively. 55-------------------------------------------------------------------------------- Table of Contents Ongoing rent revenue and finance income was $3.5 million in the third quarter of 2014, and 2013, respectively. Gross margin for ongoing rent and finance income was relatively consistent at $3.4 million and $3.3 million in the third quarter of 2014 and 2013, respectively. Contingent fees included in this caption amounted to $0.7 million and $0.9 million in the three months ended September 30, 2014 and 2013, respectively. Other revenue increased to $3.2 million in the third quarter of 2014 compared to $2.0 million in the same period in 2013. Other revenue primarily includes revenue generated from the Company's theater operations, camera rental business and after-market sales of projection system parts and 3D glasses. The gross margin on other revenue was a loss of $0.2 million in the third quarter of 2014 as compared to a loss of $0.1 million in the third quarter of 2013. Theater System Maintenance Theater system maintenance revenue increased 5.1% to $8.5 million during the third quarter of 2014 as compared to $8.1 million in the third quarter of 2013. Theater system maintenance gross margin was consistent at $3.2 million in the third quarter of 2014 and 2013, respectively. Maintenance revenue continues to grow as the number of theaters in the IMAX theater network grows. Maintenance margins vary depending on the mix of theater system configurations in the theater network and the timing and the date(s) of installation and/or service. Joint Revenue Sharing Arrangements Revenues from joint revenue sharing arrangements increased 27.4% to $15.2 million in the third quarter of 2014 compared to $12.0 million in the third quarter of 2013. The Company ended the third quarter of 2014 with 422 theaters operating under joint revenue sharing arrangements, as compared to 351 theaters at the end of the third quarter of 2013. The increase in revenues from joint revenue sharing arrangements was primarily due to an increase in the number of theaters in operation and stronger film performance as compared to the prior year comparative period. During the quarter, the Company installed 14 full, new theaters under joint revenue sharing arrangements, as compared to 13 theaters in the prior year comparative period. The gross margin from joint revenue sharing arrangements in the third quarter of 2014 increased 31.2% to $9.4 million, as compared to $7.2 million in the third quarter of 2013. Included in the calculation of the third quarter gross margin were certain advertising, marketing and commission costs primarily associated with new theater launches of $0.9 million incurred in the third quarter of 2014 and 2013, respectively. Adjusted gross margin from joint revenue sharing arrangements, which excludes these expenses, was $10.3 million in the third quarter of 2014, as compared to $8.0 million in the third quarter of 2013, respectively. A reconciliation of gross margin from the joint revenue sharing arrangement segment, the most directly comparable U.S. GAAP measure, to adjusted gross margin is presented in the table below: Three Months Ended September 30, (In thousands of U.S. Dollars) 2014 2013 Gross margin from joint revenue sharing arrangements $ 9,382 $ 7,153 Add: Advertising, marketing and commission costs 875 890 Adjusted gross margin from joint revenue sharing arrangements $ 10,257 $ 8,043 Film Revenue from the Company's film segments increased 21.1% to $23.7 million in the third quarter of 2014 from $19.5 million in the third quarter of 2013 across the film production and DMR, distribution and post-production operations. Gross box-office generated by IMAX DMR films increased 27.5% to $169.0 million for the third quarter of 2014 from $132.5 million for the third quarter of 2013. Film production and IMAX DMR revenues increased 26.1% to $18.4 million in the third quarter of 2014 from $14.5 million in the third quarter of 2013. The increase in film production and IMAX DMR revenues was primarily due to an increase in the IMAX theater network and a stronger film slate in the third quarter of 2014 versus the prior year comparative period. Gross box-office per screen for the three months ended September 30, 2014 averaged $227,900 in comparison to $207,500 in the comparable period last year. In the 56-------------------------------------------------------------------------------- Table of Contents third quarter of 2014, gross box-office was generated primarily by the exhibition of 15 films (listed below), as compared to 17 films primarily exhibited during the third quarter of 2013: Three Months Ended September 30, 2014 - Films Exhibited Three Months Ended September 30, 2013 - Films Exhibited Godzilla: An IMAX 3D Experience Jurassic Park: An IMAX 3D Experience Maleficent: An IMAX 3D Experience Star Trek Into Darkness: An IMAX 3D Experience Edge of Tomorrow: An IMAX 3D Experience Fast & Furious 6: The IMAX Experience How to Train Your Dragon 2: An IMAX 3D Experience After Earth: The IMAX Experience Transformers: Age of Extinction: An IMAX 3D Experience Man of Steel: An IMAX 3D Experience Hercules: An IMAX 3D Experience World War Z: An IMAX 3D Experience Lucy: The IMAX Experience Despicable Me 2: An IMAX 3D Experience The White Haired Witch of Lunar Kingdom: An IMAX 3D White House Down: The IMAX Experience Experience Man of Tai Chi: The IMAX Experience Guardians of the Galaxy: An IMAX 3D Experience Lone Ranger: The IMAX Experience Teenage Mutant Ninja Turtles: An IMAX 3D Experience Pacific Rim: An IMAX 3D Experience The Expendables 3: The IMAX Experience Elysium: An IMAX 3D Experience Forrest Gump: The IMAX Experience The Mortal Instruments: City of Bones: An IMAX 3D The Maze Runner: The IMAX Experience Experience The Equalizer: The IMAX Experience Riddick: An IMAX 3D Experience Breakup Buddies: The IMAX Experience The Wizard of Oz: An IMAX 3D Experience Young Detective Dee: Rise of the Sea Dragon: An IMAX 3D Experience Metallica Through the Never: An IMAX 3D Experience Other revenues attributable to the film segment increased to $5.3 million in the third quarter of 2014 from $5.0 million in the third quarter of 2013. The three months ended September 30, 2014 include the performance of an IMAX original production, Island of Lemurs: Madagascar, whereas no original films were released in the prior year comparative period. The Company's gross margin from its film segments in the third quarter of 2014 increased to $15.5 million from $10.0 million in the third quarter of 2013. Film production and IMAX DMR gross margin increased to $13.5 million in the third quarter of 2014 from $8.6 million in the third quarter of 2013, primarily due to continued network growth and stronger film performance. Other gross margin attributable to the film segment for the third quarter of 2014 was $2.0 million as compared to $1.4 million in the prior year comparative period. Selling, General and Administrative Expenses Selling, general and administrative expenses were $23.5 million in the third quarter of 2014 as compared to the $19.8 million experienced in the third quarter of 2013. The following reflects the significant items impacting selling, general and administrative expenses in the third quarter of 2014 as compared to the prior year period: • a $1.9 million increase due to a change in foreign exchange rates. During the third quarter ended September 30, 2014, the Company recorded a foreign exchange loss of $1.1 million for net foreign exchange gains/losses related to the translation of foreign currency denominated monetary assets and liabilities as compared to a gain of $0.8 million recorded in the prior year comparative period; • a $0.8 million increase in staff costs, including salaries and benefits; • a $0.6 million increase in the Company's stock-based compensation; and • a $0.4 million net increase in other expenses, including professional fees, brand marketing and other general corporate expenditures. Research and Development Research and development expenses were $4.6 million in the third quarter of 2014, as compared to $4.0 million in the third quarter of 2013. The expenditures in the period are primarily attributable to the continued development of the Company's new laser-based digital projection system. The Company is developing its next-generation laser projector, which is expected to provide greater 57-------------------------------------------------------------------------------- Table of Contents brightness and clarity, a wider color gamut and deeper blacks, while consuming less power and lasting longer than existing digital technology, to ensure that the Company continues to provide the highest quality, premier movie going experience available to consumers. As of September 30, 2014, the Company had 69 laser-based digital theater systems in its backlog. A high level of research and development is expected to continue throughout 2014 as the Company continues its efforts to develop its new laser-based projection system. In addition, the Company plans to continue research and development activity in the future in other areas considered important to the Company's continued commercial success, including further improving the reliability of its projectors, developing IMAX theater systems' capabilities in both home and live entertainment, developing more IMAX cameras, enhancing the Company's 2D and 3D image quality, expanding the applicability of the Company's digital technology and delivery, and further enhancing the IMAX theater and sound system design through the addition of more channels, improvements to the Company's proprietary tuning system and mastering processes. Receivable Provisions, Net of Recoveries The Company recorded receivable provisions, net of recoveries, of less than $0.1 million for accounts receivable and financing receivables in the third quarter of 2014, compared to $0.2 million being recorded in the prior year comparative period. The Company's accounts receivables and financing receivables are subject to credit risk. These receivables are concentrated with the leading theater exhibitors and studios in the film entertainment industry. To minimize the Company's credit risk, the Company retains title to underlying theater systems leased, performs initial and ongoing credit evaluations of its customers and makes ongoing provisions for its estimate of potentially uncollectible amounts. Accordingly, the Company believes it has adequately protected itself against exposures relating to receivables and contractual commitments. Interest Income and Expense Interest income was $0.1 million in the third quarter of 2014, as compared to less than less than $0.1 million in the third quarter of 2013. Interest expense was consistent at $0.3 million in the third quarter of 2014 and 2013, respectively. Included in interest expense is the amortization of deferred finance costs of $0.1 million in the third quarter of 2014 and 2013, respectively. The Company's policy is to defer and amortize all the costs relating to debt financing which are paid directly to the debt provider, over the life of the debt instrument. Income Taxes The Company's effective tax rate differs from the statutory tax rate and varies from year to year primarily as a result of permanent differences, investment and other tax credits, the provision for income taxes at different rates in foreign and other provincial jurisdictions, enacted statutory tax rate increases or reductions in the year, changes due to foreign exchange, changes in the Company's valuation allowance based on the Company's recoverability assessments of deferred tax assets, and favorable or unfavorable resolution of various tax examinations. The Company released $0.6 million of its valuation allowance in the quarter after assessing its ability to utilize New York state loss carryforwards in conjunction with recent corporate state tax reform in the state and the Company's assessment of future profitability in the state. As at September 30, 2014, the Company had a gross deferred income tax asset of $25.1 million, against which the Company is carrying a $4.2 million valuation allowance. For the three months ended September 30, 2014, the Company recorded an income tax provision of $1.2 million, of which a provision of $0.1 million was related to an increase in its provisions for uncertain tax positions. The Company anticipates utilizing the majority of its currently-available tax attributes over the next year. Tax attributes covered by the majority of the existing valuation allowances originated through equity and therefore a related release of the valuation allowance would be recorded against other equity. Equity-Accounted Investments The Company accounts for investments in new business ventures using the guidance of the FASB ASC 323 "Investments - Equity Method and Joint Ventures" ("ASC 323"). At September 30, 2014, the equity method of accounting is being utilized for investments with a total carrying value of $3.4 million (December 31, 2013 - $0.4 million). In 2013, the Company contributed $1.4 million, net of its share of costs, to a new business venture in the early-stage of start-up. In the first quarter of 2014, this new business venture was 58-------------------------------------------------------------------------------- Table of Contents operational. For the three months ended September 30, 2014, gross revenues, cost of revenue and net loss for these investments were $0.8 million, $0.2 million and $1.5 million, respectively (2013 - $1.2 million, $3.1 million and $3.3 million, respectively). The Company recorded its proportionate share of the net loss which amounted to $0.3 million for the third quarter of 2014, compared to $0.3 million in the prior year comparative period. Discontinued Operations On January 30, 2014, the Company's lease with respect to its owned and operated Nyack IMAX theater ended and the Company decided not to renew the lease. In 2014, revenues for the Nyack IMAX theater were $nil (2013 - $0.2 million) and the Company recognized income of $nil (2013 - loss of $0.1 million, net of tax recovery of $0.1 million) from the operation of the theater. The transactions of the Company's owned and operated Nyack theater are reflected as discontinued operations. Non-Controlling Interests Beginning in the second quarter of 2014, the Company's condensed consolidated financial statements include the non-controlling interest in the net income of IMAX China resulting from the IMAX China Investment and the net proceeds are classified as redeemable non-controlling interest in temporary equity. In addition, in the second quarter of 2014, the Company recognized the impact of a non-controlling interest in its subsidiary created for the Film Fund activity. For the three months ended September 30, 2014, the net income attributable to non-controlling interests of the Company's subsidiaries was $0.4 million. 59-------------------------------------------------------------------------------- Table of Contents Nine Months Ended September 30, 2014 Versus Nine Months Ended September 30, 2013 The Company reported net income attributable to common shareholders of $18.7 million or $0.27 per basic and diluted share for the nine months ended September 30, 2014, as compared to $16.3 million or $0.24 per basic and diluted share for the nine months ended September 30, 2013. Net income attributable to common shareholders for the nine months ended September 30, 2014 includes a $11.3 million charge, or $0.13 per diluted share (after-tax), for stock-based compensation (2013 - $8.8 million or $0.12 per diluted share (after-tax)). Adjusted net income attributable to common shareholders, which consists of net income attributable to common shareholders excluding stock-based compensation expense and the related tax expense, was $28.3 million, or $0.40 per diluted share, in the nine months ended September 30, 2014, as compared to adjusted net income attributable to common shareholders of $24.9 million, or $0.36 per diluted share, for the nine months ended September 30, 2013. A reconciliation of net income attributable to common shareholders, the most directly comparable U.S. GAAP measure, to adjusted net income attributable to common shareholders and adjusted net income attributable to common shareholders per diluted share is presented in the table below: Ended September 30, 2014 Ended September 30, 2013 Net Income Diluted EPS Net Income Diluted EPS Reported net income attributable to common shareholders $ 18,744 $ 0.27 (1) $ 16,286 $ 0.24 Adjustments: Stock-based compensation 11,328 0.16 8,772 0.12 Tax expense of items listed above (1,807 ) (0.03 ) (159 ) - Adjusted net income attributable to common shareholders $ 28,265 $ 0.40 (1) $ 24,899 $ 0.36 Weighted average diluted shares outstanding 69,597 68,853 (1) Includes impact of $0.3 million of accretion charges associated with redeemable common stock. The following table sets forth the breakdown of revenue and gross margin by category: Revenue Gross Margin Nine Months Nine Months (In thousands of US dollars) Ended September 30, Ended September 30, 2014 2013 2014 2013 IMAX Theater Systems IMAX Systems Sales and sales-type leases(1) $ 25,629 $ 33,321 $ 14,161 $ 16,390 Ongoing rent, fees, and finance income(2) 10,272 10,111 9,799 9,758 Other 8,407 7,344 (202 ) 375 44,308 50,776 23,758 26,523 Theater System Maintenance 25,384 23,844 8,990 9,432 Joint Revenue Sharing Arrangements 45,457 39,672 30,043 26,796 Film Production and IMAX DMR 57,585 54,854 43,177 32,744 Film distribution and post-production 15,350 13,740 3,676 1,782 72,935 68,594 46,853 34,526 $ 188,084 $ 182,886 $ 109,644 $ 97,277 (1) Includes initial payments and the present value of fixed minimum payments from equipment, sales and sales-type lease transactions. 60 -------------------------------------------------------------------------------- Table of Contents (2) Includes rental income from operating leases, contingent rents from operating and sales-type leases, contingent fees from sales arrangements and finance income. Revenues and Gross Margin The Company's revenues for the nine months ended September 30, 2014 increased by 2.8% to $188.1 million from $182.9 million in the same period last year, primarily due to an increase in revenues from the Company's joint revenue sharing arrangements and film segments, partially offset by a decrease in revenues from the Company's IMAX systems segment. The gross margin across all segments in the nine months ended September 30, 2014 was $109.6 million, or 58.3% of total revenue, compared to $97.3 million, or 53.2% of total revenue, in the nine months ended September 30, 2013. IMAX Systems IMAX systems revenue decreased 12.7% to $44.3 million in the nine months ended September 30, 2014, as compared to $50.8 million in the nine months ended September 30, 2013, resulting primarily from the installation in 2014 of fewer systems under sales or sales-type lease arrangements versus the prior-year period and the revenue recognition in 2013 of a number of previously installed digital upgrade theater systems which had been deferred from a prior period. Revenue from sales and sales-type leases decreased 23.1% to $25.6 million in the nine months ended September 30, 2014 from $33.3 million in the nine months ended September 30, 2013. The Company recognized revenue on 20 full, new theater systems which qualified as either sales or sales-type leases in the nine months ended September 30, 2014, with a total value of $23.1 million, versus 22 full, new theater systems in the nine months ended September 30, 2013, with a total value of $25.8 million. The Company anticipates that its installations will vary from quarter to quarter given that a large portion of its theater systems in backlog are slated to be installed in newly-built theaters or multiplexes. The installation of theater systems in newly-built theaters or multiplexes depends primarily on the timing of the construction of those projects, which is not under the Company's control. Additionally, the Company recognized revenue on the installation of two xenon-based digital upgrades in the nine months ended September 30, 2014, with a total value of $1.7 million, as compared to 3 xenon-based digital upgrades in the nine months ended September 30, 2013, with a total value of $2.1 million. Digital upgrades typically have lower sales prices and gross margin than full theater system installations. The Company has decided to offer digital upgrades at lower selling prices for strategic reasons since the Company believes that digital systems increase flexibility and profitability for the Company's existing exhibition customers. There were no used system recognitions in the nine months ended September 30, 2014 and 2013. In the first nine months of 2013, the Company recognized revenue under a digital upgrade arrangement for 13 theater systems (10 sales and 3 operating leases) which were previously installed, but for which revenue recognition was deferred. The arrangement contained provisions providing the customer with standard digital upgrades, which were installed, and a number of as-of-yet undeveloped upgrades. The Company's policy is to defer revenue recognition until the upgrade right expires, if applicable, or a digital upgrade is delivered. In the nine months ended September 30, 2013, the upgrade right in the agreement expired such that contract consideration became fixed. Therefore, the Company recognized revenue and gross margin of $3.1 million and a loss of $0.3 million, respectively, from these 10 theater systems which qualify as sales. Revenue earned from the 3 theater systems, which qualify as operating leases, are included in the Company's ongoing rent revenue and finance income discussion below. In the nine months ended 2013, one of the Company's customers acquired an IMAX theater from another existing customer that had been operating under a joint revenue sharing arrangement. This theater was purchased from the Company under a sale arrangement. As a result of this sale transaction, the Company recorded revenue and margin of $0.9 million and $0.6 million, respectively. The above-referenced theater was included in the Company's 2013 signings total. Average revenue per full, new sales and sales-type lease systems was comparable at $1.2 million for the nine months ended September 30, 2014 and 2013, respectively. Average revenue per digital upgrade was $0.8 million for the nine months ended September 30, 2014, as compared to $0.7 million during the nine months ended September 30, 2013, respectively. The average revenue per full, new sales and sales-type lease systems varies depending upon the number of theater system commitments with a single respective exhibitor, an exhibitor's location or other various factors. The breakdown in mix of sales and sales-type lease and joint revenue sharing arrangements (see discussion below) installations by theater system configuration for the nine months ended September 30, 2014 and 2013 is outlined in the table below: 61 -------------------------------------------------------------------------------- Table of Contents Nine Months Ended September 30, 2014 2013 New IMAX xenon-based digital theater systems - installed and recognized Sales and sales-types lease arrangements 20 22 Short-term operating lease arrangement - 1 (1) Joint revenue sharing arrangements 38 35 Total new theater systems 58 58 IMAX xenon-based digital theater system upgrades - installed and recognized Sales and sales-types lease arrangements 2 3 Short-term operating lease arrangements 2 (1) 11 (1) Joint revenue sharing arrangements 2 2 (1) Total upgraded theater systems 6 16 IMAX xenon-based digital theater system upgrades - installed and deferred - 1 (1) Total theater systems installed 64 75 (1) Reflects xenon-based digital system configurations, which will be upgraded to a laser-based digital system configuration at a future date. Settlement revenue was $nil and $0.4 million for the nine months ended September 30, 2014 and 2013, respectively. IMAX theater systems gross margin from full, new sales and sale-type leases was 61.3% in the nine months ended September 30, 2014, which was consistent with the 61.3% experienced in the nine months ended September 30, 2013. Gross margin experienced from digital upgrades was consistent at $0.9 million in the nine months ended September 30, 2014 and 2013, respectively. In the first nine months of 2014, the Company donated, and recognized the associated costs, of a full, new xenon-based digital theater system to the University of Southern California's School of Cinematic Arts. The theater, which is the first teaching lab of its kind in a collegiate setting, will give students the opportunity to learn about the latest innovations in filmmaking, set design, sound and post-production. Ongoing rent revenue and finance income increased to $10.3 million in the nine months ended September 30, 2014 compared to $10.1 million in the nine months ended September 30, 2013. Gross margin for ongoing rent and finance income was $9.8 million in the nine months ended September 30, 2014 and 2013, respectively. Contingent fees included in this caption amounted to $2.0 million and $2.5 million in the nine months ended September 30, 2014 and 2013, respectively. Other revenue increased to $8.4 million in the nine months ended September 30, 2014, compared to $7.3 million in the same period in 2013. Other revenue primarily includes revenue generated from the Company's theater operations, camera rental business and after-market sales of projection system parts and 3D glasses. The gross margin on other revenue was a loss of $0.2 million in the nine months ended September 30, 2014 as compared to a margin of $0.4 million in the nine months ended September 30, 2013. Theater System Maintenance Theater system maintenance revenue increased 6.5% to $25.4 million during the nine months ended September 30, 2014, as compared to $23.8 million during the nine months ended September 30, 2013. Theater system maintenance gross margin was $9.0 million in the nine months ended September 30, 2014, as compared to $9.4 million in the nine months ended September 30, 2013. Maintenance revenue continues to grow as the number of theaters in the IMAX theater network grows. Maintenance margins vary depending on the mix of theater system configurations in the theater network and the timing and the date(s) of installation and/or service. 62 -------------------------------------------------------------------------------- Table of Contents Joint Revenue Sharing Arrangements Revenues from joint revenue sharing arrangements increased 14.6% to $45.5 million in the nine months ended September 30, 2014, as compared to $39.7 million in the nine months ended September 30, 2013. The Company ended the nine month period with 422 theaters operating under joint revenue sharing arrangements, as compared to 351 theaters at the end of the nine months ended September 30, 2013. The increase in revenues from joint revenue sharing arrangements was primarily due to an increase in the number of theaters in operation as compared to the prior year comparative period. During the nine months ended September 30, 2014, the Company installed 38 full, new theaters under joint revenue sharing arrangements, as compared to 35 new theaters in the prior year comparative period. The gross margin from joint revenue sharing arrangements in the nine months ended September 30, 2014 increased 12.1% to $30.0 million from $26.8 million in the nine months ended September 30, 2013. Included in the calculation of gross margin in the first nine months of 2014 were certain advertising, marketing and commission costs primarily associated with new theater launches of $2.1 million, as compared to $2.0 million incurred in the prior year comparative period. Adjusted gross margin from joint revenue sharing arrangements, which excludes these expenses, was $32.1 million in the nine months ended September 30, 2014, compared to $28.8 million in the year ago period. A reconciliation of gross margin from the joint revenue sharing arrangement segment, the most directly comparable U.S. GAAP measure, to adjusted gross margin is presented in the table below: Nine Months Ended September 30, (In thousands of U.S. Dollars) 2014 2013 Gross margin from joint revenue sharing arrangements $ 30,043 $ 26,796 Add: Advertising, marketing and commission costs 2,106 2,033 Adjusted gross margin from joint revenue sharing arrangements $ 32,149 $ 28,829 Film Revenue from the Company's film segments increased to $72.9 million in the nine months ended September 30, 2014 from $68.6 million in the nine months ended September 30, 2013, across the film production and DMR, distribution and post-production operations. Gross box-office generated by IMAX DMR films increased to $523.5 million for the nine months ended September 30, 2014 from $481.9 million for the nine months ended September 30, 2013, an 8.6% increase year-over-year. Film production and IMAX DMR revenues increased to $57.6 million in the nine months ended September 30, 2014 as compared to $54.9 million in the nine months ended September 30, 2013. Gross box-office per screen for the nine months ended September 30, 2014 averaged $727,800, in comparison to $777,200 in the comparable period last year. In 2014, gross box-office was generated primarily by the exhibition of 36 films to IMAX theaters (listed below), as compared to 33 films primarily exhibited during the nine months ended September 30, 2013: Nine Months Ended September 30, 2014 - Films Exhibited Nine Months Ended September 30, 2013 - Films Exhibited Despicable Me 2: An IMAX 3D Experience Skyfall: The IMAX Experience Gravity: An IMAX 3D Experience Life of Pi: An IMAX 3D Experience Thor: The Dark World: An IMAX 3D Experience CZ12: An IMAX 3D Experience Ender's Game: The IMAX Experience The Hobbit: An Unexpected Journey: An IMAX 3D The Hunger Games: Catching Fire: The IMAX Experience Experience The Hobbit: Desolation of Smaug: An IMAX 3D Experience Les Misérables: The IMAX Experience Dhoom 3: An IMAX 3D Experience The Grandmaster: The IMAX Experience Policy Story: An IMAX 3D Experience Hansel & Gretel: Witch Hunters: An IMAX 3D Experience Jack Ryan: Shadow Recruit: The IMAX Experience Journey to the West: Conquering the Demons: An IMAX 3D I, Frankenstien: An IMAX 3D Experience Experience The Monkey King: The IMAX Experience Top Gun: An IMAX 3D Experience Robocop: The IMAX Experience A Good Day to Die Hard: The IMAX Experience Stalingrad: An IMAX 3D Experience Jack the Giant Slayer: An IMAX 3D Experience 300: Rise of an Empire: An IMAX 3D Experience Oz: The Great and Powerful: An IMAX 3D Experience Need for Speed: An IMAX 3D Experience G.I. Joe: Retaliation: An IMAX 3D Experience Dragon Ball Z: Battle of the Gods: An IMAX 3D Experience 63 -------------------------------------------------------------------------------- Table of Contents Divergent: The IMAX Experience Jurassic Park: An IMAX 3D Experience Noah: The IMAX Experience Oblivion: The IMAX Experience Captain America: The Winter Soldier: An Iron Man 3: An IMAX 3D Experience IMAX 3D Experience Star Trek Into Darkness: An IMAX 3D Transcendence: The IMAX Experience Experience The Amazing Spider-Man 2: An IMAX 3D Fast & Furious 6: The IMAX Experience Experience After Earth: The IMAX Experience Godzilla: An IMAX 3D Experience Man of Steel: An IMAX 3D Experience Coming Home: The IMAX Experience World War Z: An IMAX 3D Experience Maleficent: An IMAX 3D Experience Despicable Me 2: An IMAX 3D Edge of Tomorrow: An IMAX 3D Experience Experience How to Train Your Dragon 2: An IMAX 3D White House Down: The IMAX Experience Experience Man of Tai Chi: The IMAX Experience Transformers: Age of Extinction: An IMAX Lone Ranger: The IMAX Experience 3D Experience Pacific Rim: An IMAX 3D Experience Hercules: An IMAX 3D Experience Elysium: An IMAX 3D Experience Lucy: The IMAX Experience The Mortal Instruments: City of The White Haired Witch of Lunar Kingdom: Bones: An IMAX 3D Experience An IMAX 3D Experience Riddick: An IMAX 3D Experience Guardians of the Galaxy: An IMAX 3D The Wizard of Oz: An IMAX 3D Experience Experience Teenage Mutant Ninja Turtles: An IMAX 3D Young Detective Dee: Rise of the Sea Experience Dragon: An IMAX 3D Experience The Expendables 3: The IMAX Experience Metallica Through the Never: An IMAX Forrest Gump: The IMAX Experience 3D Experience The Maze Runner: The IMAX Experience The Equalizer: The IMAX Experience Breakup Buddies: The IMAX Experience Other revenues attributable to the film segment increased 11.7% to $15.4 million in the nine months ended September 30, 2014 from $13.7 million in the nine months ended September 30, 2013. The nine months ended September 30, 2014 includes the broad release of two IMAX original productions, Journey to the South Pacific and Island of Lemurs: Madagascar, whereas no original films were released in the prior year comparative period. The Company's gross margin from its film segments increased 35.7% in the nine months ended September 30, 2014 to $46.9 million from $34.5 million in the nine months ended September 30, 2013. Film production and IMAX DMR gross margin increased to $43.2 million from $32.7 million in the nine months ended September 30, 2013, primarily due to film performance and lower DMR production and print costs. Other gross margin attributable to the film segment was $3.7 million in the nine months ended September 30, 2014 as compared to $1.8 million in the nine months ended September 30, 2013. Selling, General and Administrative Expenses Selling, general and administrative expenses increased to $68.3 million in the nine months ended September 30, 2014 as compared to $61.5 million experienced in the prior year comparative period. The following reflects the significant items impacting selling, general and administrative expenses as compared to the prior year period: • a $2.2 million increase in staff costs, including salaries and benefits; • a $2.6 million increase in the Company's stock-based compensation; • a $0.9 million increase due to a change in foreign exchange rates. During the nine months ended September 30, 2014, the Company recorded a foreign exchange loss of $1.0 million for net foreign exchange gains/losses related to the translation of foreign currency denominated monetary assets and liabilities as compared to a loss of less than $0.1 million recorded in the prior year comparative period; and • a $1.1 million net increase in other expenses, including brand marketing and other general corporate expenditures. Gain on Curtailment of Postretirement Benefit Plan In the nine months ended September 30, 2013, the Company amended the Canadian postretirement plan to reduce future benefits provided under the plan. As a result of this change, the Company recognized a pre-tax curtailment gain of $2.2 million. 64 -------------------------------------------------------------------------------- Table of Contents Research and Development Research and development expenses increased to $11.5 million in the nine months ended September 30, 2014 compared to $11.3 million in the nine months ended September 30, 2013. These expenses are primarily attributable to the continued development of the Company's new laser-based digital projection system. The Company is developing its next-generation laser projector, which is expected to provide greater brightness and clarity, a wider color gamut and deeper blacks, while consuming less power and lasting longer than existing digital technology, to ensure that the Company continues to provide the highest quality, premier movie going experience available to consumers. As of September 30, 2014, the Company had 69 laser-based digital theater systems in its backlog. A high level of research and development is expected to continue throughout 2014 as the Company continues its efforts to develop its new laser-based projection system. In addition, the Company plans to continue research and development activity in the future in other areas considered important to the Company's continued commercial success, including further improving the reliability of its projectors, developing IMAX theater systems' capabilities in both home and live entertainment, developing more IMAX cameras, enhancing the Company's 2D and 3D image quality, expanding the applicability of the Company's digital technology, and further enhancing the IMAX theater and sound system design through the addition of more channels, improvements to the Company's proprietary tuning system and mastering processes. Receivable Provisions, Net of Recoveries The Company recorded receivable provisions, net of recoveries for accounts receivable and financing receivables amounted to a net provision of $0.6 million in the nine months ended September 30, 2014 as compared to $0.3 million for the nine months ended September 30, 2013. The Company's accounts receivables and financing receivables are subject to credit risk. These receivables are concentrated with the leading theater exhibitors and studios in the film entertainment industry. To minimize the Company's credit risk, the Company retains title to underlying theater systems leased, performs initial and ongoing credit evaluations of its customers and makes ongoing provisions for its estimate of potentially uncollectible amounts. Accordingly, the Company believes it has adequately protected itself against exposures relating to receivables and contractual commitments. Asset impairments and Other Charges In the nine months ended September 30, 2014, the Company recognized a $0.7 million other-than-temporary impairment of its available-for-sale investment as the value is not expected to recover its cost. No such charge was recognized in 2013. In the nine months ended September 30, 2014, the Company recorded a charge of $0.5 million reflecting assets that no longer meet capitalization requirements. No such charges were recorded in 2013. Interest Income and Expense Interest income was $0.2 million in the nine months ended September 30, 2014 and less than $0.1 million in the prior year comparative period. Interest expense was $0.8 million in the nine months ended September 30, 2014, which decreased from the $1.0 million experienced in the nine months ended September 30, 2013. Included in interest expense is the amortization of deferred finance costs in the amount of $0.4 million in the nine months ended September 30, 2014, as compared to $0.3 million in the prior year comparative period. The Company's policy is to defer and amortize all the costs relating to debt financing which are paid directly to the debt provider, over the life of the debt instrument. Income Taxes The Company's effective tax rate differs from the statutory tax rate and varies from year to year primarily as a result of permanent differences, investment and other tax credits, the provision for income taxes at different rates in foreign and other provincial jurisdictions, enacted statutory tax rate increases or reductions in the year, changes due to foreign exchange, changes in the Company's valuation allowance based on the Company's recoverability assessments of deferred tax assets, and favorable or unfavorable resolution of various tax examinations. 65 -------------------------------------------------------------------------------- Table of Contents The Company released $0.6 million of its valuation allowance in the nine months ended September 30, 2014, after assessing its ability to utilize New York state loss carryforwards in conjunction with recent corporate state tax reform in the state and the Company's assessment of future profitability in the state. As at September 30, 2014, the Company had a gross deferred income tax asset of $25.1 million, against which the Company is carrying a $4.2 million valuation allowance. For the nine months ended September 30, 2014, the Company recorded an income tax provision of $6.7 million, of which a provision of $0.3 million was related to an increase in its provisions for uncertain tax positions. The Company anticipates utilizing the majority of its currently-available tax attributes over the next year. Tax attributes covered by the majority of the existing valuation allowances originated through equity and therefore a related release of the valuation allowance would be recorded against other equity. Equity-Accounted Investments The Company accounts for investments in new business ventures using the guidance of the FASB ASC 323. At September 30, 2014, the equity method of accounting is being utilized for investments with a total carrying value of $3.4 million (December 31, 2013 - $0.4 million). In 2013, the Company contributed $1.4 million, net of its share of costs, to a new business venture in the early-stage of start-up. In the first quarter of 2014, this new business venture was operational. For the nine months ended September 30, 2014, gross revenues, cost of revenue and net loss for these investments were $3.1 million, $1.9 million and $2.5 million, respectively (2013 - $5.4 million, $10.0 million and $9.8 million, respectively). The Company recorded its proportionate share of the net loss which amounted to $0.7 million for the nine months ended September 30, 2014, as compared to $1.0 million for the nine months ended September 30, 2013. Discontinued Operations On January 30, 2014, the Company's lease with respect to its owned and operated Nyack IMAX theater ended and the Company decided not to renew the lease. In 2014, revenues for the Nyack IMAX theater were less than $0.1 million (2013 - $1.0 million) and the Company recognized income of $0.4 million, net of a tax expense of $0.2 million (2013 - loss of $0.3 million, net of tax recovery of $0.1 million) from the operation of the theater. Upon the expiration of the lease, lease inducements contingent upon the completion of the full term of the lease were recognized as a reduction in rent expense of $0.8 million. The transactions of the Company's owned and operated Nyack theater are reflected as discontinued operations. Non-Controlling Interests Beginning in the second quarter of 2014, the Company's condensed consolidated financial statements include the non-controlling interest in the net income of IMAX China resulting from the IMAX China Investment and the net proceeds are classified as redeemable non-controlling interest in temporary equity. In addition, in the second quarter of 2014, the Company recognized the impact of a non-controlling interest in its subsidiary created for the Film Fund activity. For the nine months ended September 30, 2014, the net income attributable to non-controlling interests of the Company's subsidiaries was $0.9 million. 66-------------------------------------------------------------------------------- Table of Contents LIQUIDITY AND CAPITAL RESOURCES On February 7, 2013, the Company amended and restated the terms of its existing senior secured credit facility (the "Prior Credit Facility"). The amended and restated facility (the "Credit Facility"), with a scheduled maturity of February 7, 2018, has a maximum borrowing capacity of $200.0 million. The Prior Credit Facility had a maximum borrowing capacity of $110.0 million. Certain of the Company's subsidiaries serve as guarantors (the "Guarantors") of the Company's obligations under the Credit Facility. The Credit Facility is collateralized by a first priority security interest in substantially all of the present and future assets of the Company and the Guarantors. In 2014, the Company amended the terms of the Credit Facility ("Amendment No.1") to obtain consents from the lenders named therein to allow it to enter into certain corporate transactions, including the sale of a 20.0% interest in IMAX China Holding, Inc. Total amounts drawn and available under the Credit Facility at September 30, 2014 were $nil and $200.0 million, respectively (December 31, 2013 - $nil and $200.0 million, respectively). Under the Credit Facility, the effective interest rate for the three and nine months ended September 30, 2014 for the revolving loan portion was nil and nil, respectively, as no amounts were outstanding during the period (2013 - 1.95% and 2.26%, respectively). The Credit Facility provides that the Company will be required to maintain a Fixed Charge Coverage Ratio (as defined in the credit agreement) of not less than 1.1:1. The Company will also be required to maintain minimum EBITDA (as defined in the credit agreement) of $90.0 million on December 31, 2014, which requirement increases to $100.0 million on December 31, 2015. The Company must also maintain a Maximum Total Leverage Ratio (as defined in the credit agreement) of 2.00:1 on December 31, 2014, which requirement decreases to 1.75:1 on December 31, 2015. The ratio of total debt to EBITDA was nil:1 as at September 30, 2014, where Total Debt (as defined in the credit agreement) is the sum of all obligations evidenced by notes, bonds, debentures or similar instruments and was $nil. EBITDA is calculated as follows: For the For the 3 months ended 12 months ended EBITDA per Credit Facility: September 30, 2014 September 30, 2014(1) (In thousands of U.S. Dollars) Net income $ 5,297 $ 47,484 Add (subtract): Loss from equity accounted investments 297 2,480 Provision for income taxes 1,188 16,790 Interest expense, net of interest income 120 936 Depreciation and amortization, including film asset amortization 7,861 31,553 Write-downs net of recoveries including asset impairments and receivable provisions 174 2,810 Stock and other non-cash compensation 3,519 14,946 EBITDA attributable to non-controlling interests(2) (887 ) (1,776 ) $ 17,569 $ 115,223 (1) Ratio of total debt calculated using twelve months ended EBITDA (2) The EBITDA calculation specified for purposes of the minimum EBITDA covenant excludes the reduction in EBITDA from the Company's non-controlling interests 67 -------------------------------------------------------------------------------- Table of Contents Letters of Credit and Other Commitments As at September 30, 2014, the Company did not have any letters of credit and advance payment guarantees outstanding (December 31, 2013 - $nil), under the Credit Facility. The Company also has a $10.0 million facility for advance payment guarantees and letters of credit through the Bank of Montreal for use solely in conjunction with guarantees fully insured by EDC (the "Bank of Montreal Facility"). The Bank of Montreal Facility is unsecured and includes typical affirmative and negative covenants, including delivery of annual consolidated financial statements within 120 days of the end of the fiscal year. The Bank of Montreal Facility is subject to periodic annual reviews. As at September 30, 2014, the Company had letters of credit and advance payment guarantees outstanding of $0.3 million under the Bank of Montreal Facility (December 31, 2013 - $0.3 million). On October 6, 2014, IMAX PV Development Inc., a Delaware corporation ("Borrower") and direct wholly-owned subsidiary of IMAX U.S.A. Inc., a Delaware corporation and direct wholly-owned subsidiary of the Company, entered into a construction loan agreement with Wells Fargo Bank, National Association ("Wells Fargo"). The construction loan will be used to fund up to $25.7 million (the "Playa Vista Loan") of the costs of development and construction of the previously announced new West Coast headquarters of the Company, to be located in a new office facility in the Playa Vista neighborhood of Los Angeles, California (the "Playa Vista Project"). The total cost of development of the Playa Vista Project is expected to be approximately $50.0 million, with all costs in excess of the Playa Vista Loan being provided through funding by the Company. The Playa Vista Loan is secured by a deed of trust from Borrower in favor of Wells Fargo, granting a first lien on and security interest in the Playa Vista property and the Playa Vista Project, including all improvements to be constructed thereon, and other documents evidencing and securing the loan (the "Loan Documents"). The Loan Documents include absolute and unconditional payment and completion guarantees provided by the Company to Wells Fargo for the performance by Borrower of all the terms and provisions of the Playa Vista Loan and the construction and completion of the Playa Vista Project, and an environmental indemnity also provided by the Company. Unless converted from a construction to permanent loan as described below, the Playa Vista Loan will be fully due and payable on April 6, 2016 (the "Maturity Date"). Absent a default, the Playa Vista Loan will bear interest at a variable interest rate per annum equal to 2.25% above the 30-day LIBOR rate. The interest rate is subject to adjustment monthly based on the latest 30-day LIBOR rate. Prior to the Maturity Date, Borrower will be required to make monthly payments of interest only. The Playa Vista Loan may be prepaid at any time without premium, but with all accrued interest and other applicable payments. The Loan Documents require the completion of construction no later than 90 days prior to the Maturity Date, subject to delays for certain unforeseeable events. The Loan Documents contain affirmative, negative and financial covenants (including compliance with the financial covenants of the Company's outstanding revolving and term senior secured facility with Wells Fargo), agreements, representations, warranties, borrowing conditions, and events of default customary for development projects such as the Playa Vista Project. Borrower has the right to convert the Playa Vista Loan from a construction to a permanent loan with a term of 120 months (from the date of conversion), subject to the satisfaction of conditions to conversion including prior notice, the absence of a default under the Loan Documents, completion of the Playa Vista Project and the issuance of a certificate of occupancy or its legal equivalent. If Borrower converts the Playa Vista Loan to a permanent loan, Borrower will have the right, subject to certain conditions, to increase the principal balance of the loan up to but not in excess of $30.0 million. Upon conversion, the interest rate under the permanent loan will decrease from 2.25% to 2.0% above the 30-day LIBOR rate and Borrower will be required to make monthly payments of combined principal and interest sufficient to fully amortize the loan based on a 15-year straight line amortization. Cash and Cash Equivalents As at September 30, 2014, the Company's principal sources of liquidity included cash and cash equivalents of $93.7 million, the Credit Facility, anticipated collection from trade accounts receivable of $59.7 million including receivables from theaters under joint revenue sharing arrangements and DMR agreements with studios, anticipated collection from financing receivables due in the next 68-------------------------------------------------------------------------------- Table of Contents 12 months of $20.4 million and payments expected in the next 12 months on existing backlog deals. As at September 30, 2014, the Company did not draw down on its Credit Facility (remaining availability of $200.0 million). There were $nil letters of credit and advance payment guarantees outstanding under the Credit Facility and $0.3 million under the Bank of Montreal Facility. During the nine months ended September 30, 2014, the Company's operations provided cash of $71.9 million. The Company used cash of $42.6 million to fund capital expenditures, principally to build equipment for use in joint revenue sharing arrangements, to purchase other intangible assets, and to purchase property, plant, and equipment. Based on management's current operating plan for 2014, the Company expects to continue to use cash to deploy additional theater systems under joint revenue sharing arrangements, to fund DMR agreements with studios and to invest in the construction of the Playa Vista Project. Cash flows from joint revenue sharing arrangements are derived from the theater box-office and concession revenues and the Company invested directly in the roll out of 38 theater systems under joint revenue sharing arrangements during the nine months ended September 30, 2014. On April 8, 2014, the Company announced the sale and issuance of 20.0% of the shares in IMAX China to entities owned and controlled by investors CMC and FountainVest. The sale price for the interest was $80.0 million to be paid by the investors in two equal installments, the first of which was received on April 8, 2014. Approximately half of the net proceeds of the transaction will remain in IMAX China, to be used toward the continued build-out of the Company's business in China, including additional joint revenue sharing locations and other growth initiatives. The remaining funds will be available for general corporate purposes. In the second quarter of 2014, the Company announced the creation of the Film Fund to co-finance a portfolio of 10 original large-format films. The Film Fund, which is intended to be capitalized with up to $50.0 million, will finance an ongoing supply of original films that the Company believes will be more exciting and compelling than traditional documentaries. The initial investment in the Film Fund was committed to by a third party in the amount of $25.0 million, with the possibility of contributing additional funds. The Company, which will contribute $9.0 million to the Film Fund over five years, anticipates the Film Fund will be self-perpetuating, with a portion of box office proceeds reinvested into the Film Fund to generate a continuous, steady flow of high-quality documentary content. On June 16, 2014, the Company's Board of Directors approved a new $150.0 million share repurchase program for shares of the Company's common stock. Purchases under the program commenced during the third quarter of 2014. The share repurchase program expires June 30, 2017. The repurchases may be made either in the open market or through private transactions, subject to market conditions, applicable legal requirements and other relevant factors. The Company has no obligation to repurchase shares, and the share repurchase program may be suspended or discontinued by the Company at any time. The Company believes that cash flow from operations together with existing cash and borrowing available under the Credit Facility will be sufficient to fund the Company's business operations, including its strategic initiatives relating to existing joint revenue sharing arrangements for the next 12 months. The Company's operating cash flow will be adversely affected if management's projections of future signings for theater systems and film performance, theater installations and film productions are not realized. The Company forecasts its short-term liquidity requirements on a quarterly and annual basis. Since the Company's future cash flows are based on estimates and there may be factors that are outside of the Company's control (see "Risk Factors" in Item 1A in the Company's 2013 Form 10-K), there is no guarantee that the Company will continue to be able to fund its operations through cash flows from operations. Under the terms of the Company's typical sale and sales-type lease agreement, the Company receives substantial cash payments before the Company completes the performance of its obligations. Similarly, the Company receives cash payments for some of its film productions in advance of related cash expenditures. Operating Activities The Company's net cash provided by operating activities is affected by a number of factors, including the proceeds associated with new signings of theater system lease and sale agreements in the year, costs associated with contributing systems under joint revenue sharing arrangements, the box-office performance of films distributed by the Company and/or released to IMAX theaters, increases or decreases in the Company's operating expenses, including research and development, and the level of cash collections received from its customers. Cash provided by operating activities amounted to $71.9 million for the nine months ended September 30, 2014. Changes in other non-cash operating assets as compared to December 31, 2013 include: a decrease of $3.3 million in financing receivables; a decrease of $12.9 million in accounts receivable; an increase of $11.7 million in inventories; an increase of $1.8 million in prepaid expenses; 69 -------------------------------------------------------------------------------- Table of Contents and a decrease of $7.6 million in other assets which includes a $0.8 million increase in commission and other deferred selling expenses, a $11.0 million decrease in insurance recoveries receivable and a $2.6 million increase in other assets. Changes in other operating liabilities as compared to December 31, 2013 include: an increase in deferred revenue of $23.8 million related to backlog payments received in the current period, offset slightly by amounts relieved from deferred revenue related to theater system installations; a decrease in accounts payable of $2.8 million; and a decrease of $13.0 million in accrued liabilities. Investing Activities Net cash used in investing activities amounted to $45.1 million in the nine months ended September 30, 2014, which includes purchases of $24.7 million in property, plant and equipment, an investment in joint revenue sharing equipment of $15.9 million, an investment in new business ventures of $2.5 million and an increase in other intangible assets of $2.0 million. Included in the Company's purchase of property, plant and equipment for the nine months ended September 30, 2014 is $17.9 million for the purchase of land for and the commencement of the construction of the Playa Vista Project. Financing Activities Net cash provided by financing activities in the nine months ended September 30, 2014 amounted to $37.4 million as compared to cash used in financing activities of $1.5 million for nine months ended September 30, 2013. In the second quarter of 2014, the Company issued common shares net of related issuance costs of $37.2 million related to the IMAX China Investment by CMC and FountainVest, which represents a non-controlling interest in the Company's subsidiary. During the nine months ended September 30, the Company also received $3.7 million from the issuance of common shares resulting from stock option exercises offset by $2.4 million paid for the repurchase of common shares under the Company's share repurchase program. Capital Expenditures Capital expenditures, including the Company's investment in joint revenue sharing equipment, purchase of property, plant and equipment, net of sales proceeds, other intangible assets and investments in film assets, were $51.0 million for the nine months ended September 30, 2014 as compared to $41.1 million for the nine months ended September 30, 2013. The Company anticipates a higher level of capital expenditures in 2014 primarily as a result of the Playa Vista Project. As discussed above, a significant portion of the Playa Vista Project is expected to be financed through a construction loan and related office facility, which will offset the cash outlay associated with the project. CONTRACTUAL OBLIGATIONS Payments to be made by the Company under contractual obligations, as at September 30, 2014, are as follows: Payments Due by Period Total(In thousands of U.S. Dollars) Obligations 2014 2015 2016 2017 2018 Thereafter Pension obligations (1) $ 19,228 $ - $ - $ - $ 19,228 $ - $ - Operating lease obligations 12,555 1,836 4,242 2,218 1,620 1,596 1,043 Purchase obligations (2) 35,794 28,558 7,233 3 - - - Postretirement benefits obligations 2,750 27 111 123 139 149 2,201 $ 70,327 $ 30,421 $ 11,586 $ 2,344 $ 20,987 $ 1,745 $ 3,244 (1) The SERP assumptions are that Mr. Gelfond will receive a lump sum payment six months after retirement at the end of the current term of his employment agreement (December 31, 2016), although Mr. Gelfond has not informed the Company that he intends to retire at that time. (2) Includes the Company's budgeted investment for the construction of the Playa Vista Project. 70 -------------------------------------------------------------------------------- Table of Contents Pension and Postretirement Obligations The Company has an unfunded defined benefit pension plan (the "SERP") covering Messrs. Gelfond and Wechsler. As at September 30, 2014, the Company had an unfunded and accrued projected benefit obligation of approximately $18.5 million (December 31, 2013 - $18.3 million) in respect of the SERP. Effective January 1, 2014, the term of Mr. Gelfond's current employment agreement was extended through December 31, 2016, although Mr. Gelfond has not informed the Company that he intends to retire at that time. Under the terms of the arrangement, no compensation earned beginning in 2011 is to be included in calculating his entitlement under the SERP. The Company has a postretirement plan to provide health and welfare benefits to Canadian employees meeting certain eligibility requirements. As at September 30, 2014, the Company had an unfunded benefit obligation of $2.3 million (December 31, 2013 - $2.3 million). In the first quarter of 2013, the Company amended the Canadian postretirement plan to reduce future benefits provided under the plan. As a result of this change, the Company's postretirement liability was reduced by $2.6 million, resulting in a pre-tax curtailment gain in the first quarter of 2013 of $2.2 million. In July 2000, the Company agreed to maintain health benefits for Messrs. Gelfond and Wechsler upon retirement. As at September 30, 2014, the Company had an unfunded benefit obligation of $0.4 million (December 31, 2013 - $0.4 million). OFF-BALANCE SHEET ARRANGEMENTS There are currently no off-balance sheet arrangements that have or are reasonably likely to have a current or future material effect on the Company's financial condition. |