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10 Aug 2001
MOODY'S DOWNGRADES IMAX DEBT RATINGS - SR TO Caa2 AND SUB TO Ca; OUTLOOK NEGATIVE
Moody's Investors Service downgraded its ratings for IMAX Corporation (IMAX), as indicated below, concluding its review which began December 2000. The rating outlook continues to be negative.
$200 million of 7-7/8% Senior Unsecured Notes due 2005 - to Caa2 from B2
$100 million of 5-3/4% Convertible Subordinated Notes due 2003 - to Ca from Caa1
Senior Implied Rating - to Caa2 from B2
Issuer Rating - to Caa2 from B2
The downgrades, which follow prior reductions in the company's debt ratings when our initial review began December 2000, broadly reflect continued deterioration of the company's core credit profile at a more material level than previously anticipated, and the absence of any evidence suggesting that this negative trend is likely to abate any time soon. Specifically, Moody's noted material diminution of the company's operating performance, and generally limited future new business prospects in the rating agency's estimation. Additionally, IMAX has realized substantial erosion of its previously sizeable liquidity position over the last year, and consequently is presently characterized as having a comparatively much greater probability of default on its debt obligations and a higher likelihood of reduced recovery values for creditors in the event of default.
The company remains more exposed to the financially distressed commercial exhibition industry sector than originally thought. Although this group of customers constitutes only around 30% of the company's existing deployed base of theater systems, it represents more than 90% of the current order backlog. Whereas the company's debt ratings had previously garnered support from a very large order backlog as evidence of likely future cash flows, Moody's now expects that the backlog will shrink materially and deems much of it to be potentially unrealizable as contracts fail to be honored by distressed exhibitors and leases on existing systems located in theaters operating under bankruptcy court protection are potentially rejected altogether in many instances. Additionally, commercial exhibition had previously been expected to represent the company's primary growth market, due principally to the effective saturation that largely exists already within the institutional market segment. However, the structural and financial weakness experienced by this customer grouping over the past 12-to-24 months, and the likely recovery period of another 18-to-24 months or longer, suggests that further expansion within this niche sector is increasingly unlikely and will probably reverse to negative growth, effectively depriving IMAX of its main source of operating cash flow growth historically.
Also of concern has been the rapid dissipation of the company's liquidity position. The company's debt ratings had previously drawn support from a significant liquidity cushion. Because the company's digital projection subsidiary (DPI) is not expected to generate operating cash flow in the near future, and because of uncertainties related to the order backlog, the company's remaining cash flow from operations may not be sufficient to cover its cash burn. Given the declining credit profile, Moody's believes that the company will have difficulty accessing the public (and private) capital markets for additional capital. As a result, the company will likely face a liquidity shortfall.
Moody's also continues to make note of its prior contentions that the company is likely to require additional and potentially much larger asset write-offs related to receivables from the financially struggling commercial exhibitors, in addition to the presumed need for additional asset write-downs related to film carrying values, inventory (both current and that which may be reclaimed from defaulted customers), and aggressive revenue recognition practices in the context of the high probability of not delivering on a large portion of its sales backlog.
Moreover, the negative outlook incorporates the likelihood that the company will remain capital-constrained for the foreseeable future given its deteriorating operating performance and the likely need for restructuring. Moody's believes that a material and growing percentage of IMAX's asset value is now derived from DPI, with the remainder contributed by the recurring revenue to be realized from the long-term lease contracts associated with the company's more financially solvent installed institutional customer base. Due to the deterioration of the commercial theatrical exhibitors, Moody's ascribes little value to IMAX's commercial contracts and views the theatre backlog, which is dominated by commercial exhibitors, as a much less predictable measure of future revenue than it had historically. These factors will likely lead to loss absorption of a material amount for convertible subordinated noteholders. And while senior unsecured noteholders are still expected to receive reasonably high levels of principal recovery, further deterioration is possible for this class of debt as well.
The recent adoption of a new standard for revenue recognition serves to highlight to some degree the company's predicament. Previously, the company had recognized revenue upon delivery of a new system. Under the new standard guideline, however, revenue is not recognized until system installment. Clearly, this is the more conservative approach, and indeed Moody's has been manually adjusting the company's reported financial performance to analyze the data in a manner more consistent with such conservatism. This includes the elimination of the company's practice of incorporating the discounted present value of future minimum royalty and lease payments into its revenue base, which Moody's believes to be an aggressive practice, particularly given the uncertainties surrounding the viability of much of its customer base. As commercial exhibitors seek bankruptcy protection, fewer systems are actually installed, even though they may have been delivered, leading to decreased revenues. Moody's suggests that a significant number of systems, both those that have already been delivered and those that remain subject to delivery but are counted in the backlog, may never be installed, which will serve to further constrain revenue moving forward.
At the same time, operating costs and SG&A have been increasing as a percentage of revenues, leading to significantly decreased EBITDA. As a result, EBITDA for 2000 was $33mm, down from $89mm in 1999. For the first quarter of 2001, EBITDA was $3.2mm, down from $14.2mm during the comparable prior year period. EBITDA coverage of interest for this period was inadequate at 0.6x and leverage was substantial at more than 23x, comparing very negatively to 3.4x and 4.1x, respectively, just two years ago and 9.2x and 1.5x, respectively, at this point last year. And while the company's cash position had previously provided a measure of support for coverage, cash balances fell from over $120mm at year end 1999 to $20mm at the end of the first quarter of 2001.
Moody's does not expect any meaningful (if any) reversal of these negative trends to be evidenced in the second quarter results, or for the balance of this year. During the course of our open review period, the company has thus far been unable to deliver on various proposed initiatives to bolster its liquidity position, and we do not anticipate sufficient (if any) improvements in this critical area to be forthcoming at the present time. Even if the company scales back its spending relative to historical cash consumption levels, as management has indicated that it can and will, Moody's now believes that there exists fundamental weakness in IMAX's business model, which is likely to evolve in an entirely different direction than in the past, with potentially material changes from the present composition, and a high likelihood of additional funding requirements with uncertain sources over a more extended period of time.
IMAX Corporation is a global provider of giant-screen theater equipment, digital image delivery devices, and large format films. The company maintains its headquarters in Mississauga, Ontario, Canada.
No Related Data.
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