December 12, 2006
Ms. Angela Crane
Branch Chief
Division of Corporation Finance
Securities and Exchange Commission
Washington, DC 20549
USA
Re: IMAX Corporation
FORM 10-K FOR THE FISCAL YEAR ENDED DECEMBER 31, 2005 (THE "FORM 10-K"),
AND FORM 10-Q FOR THE FISCAL QUARTER ENDED JUNE 30, 2006 (THE "FORM 10-Q")
FILE NO. 000-24216
Dear Ms. Crane:
IMAX Corporation ("IMAX" or the "Company") refers to the comment letter dated
September 20, 2006 from the staff (the "Staff") of the Division of Corporation
Finance of the U.S. Securities and Exchange Commission (the "Commission")
concerning the above-captioned filings by the Company.
IMAX acknowledges that it is responsible for the adequacy and accuracy of the
disclosure in the filings and that Staff comments or changes to disclosure in
response to Staff comments do not foreclose the Commission from taking any
action with respect to the filings. IMAX also acknowledges that it may not
assert Staff comments as a defense in any proceeding initiated by the Commission
or any person under the federal securities laws of the United States.
IMAX is pleased to provide the following responses to the Staff's comments. For
ease of reference, the Company has set forth a verbatim reproduction of the
Staff's comments, followed by its response. IMAX will include revised
disclosures in future filings where appropriate. Unless otherwise indicated, all
dollar amounts are expressed in U.S. dollars.
FORM 10-K FOR THE FISCAL YEAR ENDED DECEMBER 31, 2005
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS, PAGE 31
SALES BACKLOG, PAGE 32
1. We note on page 32 that the company believes "that the contractual
obligation for system installations...are valid and binding commitments."
Please note that Item 303(a) of Regulation S-K requires you to disclose all
significant obligations under non-cancelable long-term contracts. With a
view towards compliance, please describe to us the material terms of your
contractual obligation for system installation with your customers.
IMAX acknowledges the requirements of Item 303(a) of Regulation S-K,
including the tabular disclosure of contractual obligations. This table,
which can be found on page 53 of the Management's Disclosure and Analysis
("MD&A") section of the Form 10-K, sets out, as required under Item
303(a)(5), the amounts of payments due under specified categories of
contractual obligations for specified time periods.
The "contractual obligations for system installations" described on page 32
of the MD&A section of the Form 10-K are contracts with customers who have
agreed to lease or purchase IMAX theater systems. The Company includes
these contracts in its sales backlog number because it believes they are
valid and binding commitments by those customers to lease or purchase its
products and services. These contracts do not constitute payment
obligations of the Company that fall into any of the specified categories
required under Item 303(a)(5).
The material contractual terms of the Company's system lease and sale
agreements with its customers are described below. This description of the
arrangements was also included on page 6 of the Business section of the
2005 Form 10-K.
THEATER SYSTEM LEASE AND SALE AGREEMENTS. The Company's system leases
generally have 10- to 20-year initial terms and are typically renewable by
the customer for one or more additional 5- or 10-year terms. As part of the
lease agreement, the Company advises the customer on theater design and
custom assemblies, supervises the installation of the theater system,
provides training in using the equipment to theater personnel and, for a
separate fee, provides ongoing maintenance to the system. Prospective
theater owners are responsible for providing the theater location, the
design and construction of the theater building, the installation of the
system and any other necessary improvements, as well as the marketing and
programming at the theater. Under the terms of the typical lease agreement,
the title to all systems components (including the screen, the projector
and the sound system components) remains with the Company. The Company has
the right to remove the equipment for non-payment or other defaults by the
customer. The contracts are generally not cancelable by the customer unless
the Company fails to perform its obligations. In certain circumstances, the
Company enters into sale agreements with its customers. In these instances,
the title to the systems components remains with the customer; however, the
Company retains the first right to purchase the system back at the end of
the trademark license term. Recently, the Company has entered into joint
profit-sharing arrangements, where the Company receives a large portion of
a theater's box office revenue in exchange for contributing the systems
components to the venue. The Company's contracts are generally denominated
in US dollars, except in Canada, Japan and parts of Europe, where contracts
are denominated in the local currency.
The typical systems component lease agreement provides for three major
sources of revenue and cash flows for the Company: initial rental fees,
ongoing minimum and additional rental payments, and ongoing maintenance
fees. Ongoing minimum and additional rental payments and maintenance fees
are generally received over the life of the contract and are usually
adjusted annually based on changes in the local consumer price index. The
terms of each lease agreement vary according to the system technology
provided, the geographic location of the customer and the number of systems
contracted for on the specific transaction.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA, PAGE 54
CONSOLIDATED STATEMENTS OF OPERATIONS, PAGE 58
2. We note that you currently disclose revenues from the sale of IMAX systems,
films, theater operations and other. We also note that you appear to have
revenues from sales of products and services that exceed 10 percent of
total revenues. Please tell us how your current presentation complies with
the guidance in Rules 5-03(b)(l) and (2) of Regulation S-X which would
require you to present these amounts, along with the related cost of sales
and costs of services, separately on the face of this statement.
2
The Company understands that Rules 5-03(b)(1) and (2) of Regulation S-X
state that both revenues and costs related to (a) net sales of tangible
products, (b) income from rentals, (c) revenues from services, and (d)
other revenues should be stated separately on the face of the income
statement.
The Company's current presentation of revenues in its income statements
reflects the revenues on an operating segment basis, which the Company
believes is useful information to portray the source of its revenues. We
also disclose in note 22, information about product and service revenues
and costs of revenues and in note 4, information about components of
revenue from leases including income from rentals. The Company believes
both these sets of disclosures meet the requirements of SFAS No. 131 to
disclose revenues of operating segments and about products and services.
The Company believes the combination of these disclosures provides the
relevant information to meet the objectives of the disclosures required by
Rules 5-03(b)(1) and (2). However, for the Company's 2006 annual financial
statements and future filings, the Company will revise its presentation to
present this information on the face of the income statement.
CONSOLIDATED STATEMENTS OF CASH FLOWS, PAGE 59
3. Please explain how your classification of "investment in film assets" as
operating activities complies with the guidance provided in paragraphs 15
through 24 of SFAS 95.
As indicated below, Statement of Position 00-2, Accounting by Producers and
Distributors of Films ("SoP 00-2"), issued by the American Institute of
Certified Public Accountants, paragraph 55, provides guidance on the
classification of cash flows related to investment in film assets and
indicates that such activity should be presented as an operating activity.
.55 An entity should report cash outflows for film costs,
participation costs, exploitation costs, and manufacturing costs as
operating activities in the statement of cash flows, and it should
include the amortization of film costs in the reconciliation of net
income to net cash flows from operating activities.
Statement of Financial Accounting Standard No. 139, paragraph 3, endorses
SoP 00-2 as the applicable guidance for a producer or distributor of films.
Accordingly, the Company believes the presentation on investment in film
assets as an operating activity is appropriate.
NOTE 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES, PAGE 61
(J) GOODWILL, PAGE 62
4. We see that goodwill is approximately 16% of your total assets at December
31, 2005. Please tell us the specific facts, assumptions and estimates that
you considered in your goodwill impairment analysis supporting your
conclusion that no impairment of goodwill existed at December 31, 2005. For
reference see paragraphs 19 through 22 of SFAS 142.
The Company completes its annual test for goodwill impairment in December.
If events occur or circumstances change between the annual impairment tests
that would more likely than not reduce the fair value of a reporting unit
below its carrying value, the Company would also test goodwill for
impairment.
As discussed in detail in the response to comment #5, as at December 31,
2005, the Company has six reporting units. All of the Company's goodwill
has been assigned to the IMAX Systems reporting unit. The Company's
goodwill as of December 31, 2005 arose from two business combinations: (i)
the 1994
3
acquisition of IMAX Corporation, and (ii) the 1999 acquisition of the
remaining 49% of Sonics Associates Inc., a manufacturer of sound systems.
The majority of the goodwill that remains on the books as of December 31,
2005 arose from the acquisition of IMAX Corporation in 1994. Consistent
with the guidance in SFAS No. 142, paragraph 49 and EITF D-100, no
adjustment was made to the goodwill balance related to this acquisition.
The remainder of the goodwill arose on the acquisition of the remaining
interests in Sonics Associates Inc.
The Company's application of the first step of the goodwill impairment test
for the 2005 fiscal year reflected the results outlined in the attached
Exhibit A.
As the test indicated that the fair value of the reporting unit exceeded
its carrying value, no further analysis was required.
DETERMINING THE FAIR VALUE OF REPORTING UNITS
In determining the fair value of its reporting units, the Company relies
upon the guidance of SFAS 142, paragraph 24, which suggests that "...a
present value technique is often the best available technique with which to
estimate the fair value of a group of net assets (such as a reporting
unit)," and FASB Statement of Financial Accounting Concepts 7: Using Cash
Flow Information and Present Value in Accounting Measurements.
The Company's cash flows, for purposes of calculating the fair value of the
reporting units, are based on the Company's detailed one-year budget and a
more general forecast for the second year. The preparation of the one-year
budget involves operations personnel responsible for revenue generation and
related costs, as well as functional department heads for departmental
expenses. The budget process is managed by the Vice-President; Finance and
Planning. The budgets are approved by departmental managers, the Chief
Financial Officer, the Co-Chief Executive Officers and the Board of
Directors. The budget is developed to capture all anticipated cash inflows
and outflows from the Company's operations and is based on the Company's
signed backlog arrangements and estimated new signings that will be
installed in the period and other business factors. For the forecast for
the second year, the majority of revenues are forecasted on the same basis
as the budgeting process. Certain costs such as SG&A are extrapolated based
on the one-year budget. The forecast is reviewed and approved by the Chief
Financial Officer.
For purposes of the impairment test, the Company determines the earnings
before interest, taxes, depreciation and amortization ("EBITDA") for each
reporting unit. The EBITDA calculation includes budgeted revenues, costs of
sales and research and development expenses. Selling, general and
administrative expenses are allocated to each reporting unit based on the
gross margin of each reporting unit compared to the aggregate gross margin
of all reporting units combined for each respective year. The EBIDTA for
each reporting unit is adjusted for expected capital expenditures and net
changes in working capital to determine the expected cash flow related to
the reporting unit. For cash flows beyond the two-year period, the Company
uses the cash flows for the second year for purposes of determining a
terminal value.
The Company uses a discount rate of 15% to discount the cash flows
determined as noted above. The Company determined this rate by reference to
discount rates used by third-party market analysts to prepare valuations of
the Company for their analysts' reports. For determining the terminal
value, the Company uses a rate of 12%, which effectively adjusts the
discount rate by 3% for the growth rate. This terminal rate was determined
by reference to third party market analysts' reports.
4
By discounting the cash flows, the Company determined the net present value
of the estimated future cash flows before any allocation of debt and cash,
which the Company refers to as the Enterprise Value.
The Enterprise Value for each reporting unit was adjusted to allocate a
portion of the Company's debt and cash. The Company allocated the book
value of its debt to each reporting unit based on each reporting unit's
Enterprise Value to the aggregate Enterprise Value of all the of the
reporting units. While the Company's debt had a fair value of $166 million
as at December 31, 2005, the Company only allocated $160 million. The
Company has determined that the fair value should have been allocated;
however, the incremental fair value that would be allocated to each
reporting unit would not have affected the outcome of the impairment
testing. Cash held by subsidiaries involved in the film or theater
operations was allocated to the respective film or theater operations
reporting units with the residual cash all allocated to IMAX Systems. In
reviewing the calculation, the Company noted that short-term investments
were not allocated to any of the reporting units; however, this oversight
does not have any impact on the outcome of the impairment testing.
DETERMINING THE CARRYING VALUE OF THE REPORTING UNITS
For purposes of determining the carrying value of the reporting units, the
Company originally determined their carrying value as of January 1, 2002.
For periods subsequent to that date, the Company derived the year-end
carrying value of the reporting units by adjusting the January 1, 2002
carrying value for earnings or losses of the reporting units and an
allocation of corporate overhead, interest income, interest expense, gain
on retirement of notes, recovery of long-term investments, recovery of
income taxes, net earnings from discontinued operations, cumulative effect
of changes in accounting principles, capital stock changes, other equity
changes and changes in accumulated other comprehensive income. All of the
items noted in the preceding sentence except for corporate overhead, were
allocated based on the respective reporting unit's Enterprise Value to the
aggregate Enterprise Value of all of the reporting units. Corporate
overhead was allocated based on the gross margin of each respective
reporting unit to the aggregate gross margin of all of the reporting units.
The Company acknowledges that these calculations of carrying values of the
reporting units only approximate the carrying value of assets and
liabilities that would be assigned to each reporting unit; however, based
on the fact that the Company's overall market value as at December 31, 2005
was $283.9 million compared to a shareholders' deficit of $23 million and
the significant excess of the fair values of each reporting unit over the
allocated carrying value, the Company believes that a more precise
assignment of assets and liabilities to reporting units would not result in
a different outcome to step one of the impairment testing.
SENSITIVITY ANALYSIS
The Company also performs a sensitivity analysis by adjusting the discount
rates to ensure that the fair values are well within an acceptable range.
5. Explain how your conclusions regarding reporting units are consistent with
the guidance in paragraphs 30 and 31 of SFAS 142. Please note that a
reporting unit may be a level below an operating segment. In supporting
your conclusions, explain the concept of reporting units and identify those
of the company.
In the response to comment #4, the Company has indicated that it has six
reporting units. As the Company has allocated goodwill as at January 1,
2002 to the IMAX Systems reporting unit only, the analysis related to
determining the other five remaining reporting units has been provided to
indicate the general nature of those reporting units. The Company's main
focus in applying its impairment testing for goodwill is to ensure that the
cash flows attributed to the IMAX Systems reporting unit is reasonable and
supportable and does not include cash flows attributable to other reporting
units.
5
In accordance with SFAS 142, a reporting unit is either (a) an operating
segment as defined under SFAS 131, paragraph 10; or (b) one level below an
operating segment, which is referred to as a component.
In note 22 of the Company's consolidated financial statements, the Company
sets out its operating segments.
The Company has identified its two Co-Chief Executive Officers as being the
Chief Operating Decision Makers (the "CODM").
The Company's CODM is provided a monthly reporting package which provides
information at different levels. Level 1 information is by group, Level 2
is by line of business and Level 3 is by project. The following table
outlines the Levels:
LEVEL 1 LEVEL 2 LEVEL 3
- ------- ------- -------
Systems Sales Type Lease Customer project
Maintenance n/a
Finance Income n/a
Operating Lease n/a
Sounds Systems n/a
Additional Rent n/a
Film Film production Project
Film distribution Major film
DMR Project
Film post-production Type of service
Theatre Operations Vancouver IMAX Theatre n/a
Nyack IMAX Theatre n/a
Sacramento IMAX Theatre n/a
Chicago IMAX Navy Pier Theatre n/a
Minnesota Zoo Imax Theatre n/a
Tempe IMAX Theatre n/a
Providence IMAX Theatre n/a
Joint ventures IMAX Theatres n/a
Management fees for third party Imax Theatres n/a
Other Camera Rentals n/a
Other Inventory type
As the CODM receives multiple sets of information, the Company has referred
to paragraphs 13 and 14 of SFAS 131 to determine its operating segments.
Within the Systems Group, the revenues and results reported for all of the
lines except maintenance are derived from the sale or lease of the systems
components. The maintenance and extended warranty services are, however,
related to the sale or lease of the systems components as it is provided
solely on the system components sold or leased by IMAX. The Executive Vice
President; Theater Development is responsible for sales activities related
to the System Group while the Executive Vice President; Technology is
responsible for the cost centers related to research and development,
manufacturing and maintenance. The Company considers the CODM to be the
segment manager for this group. The individual line items for sales and
lease inflows and related costs are not the primary basis of allocating
resources or measuring performance; rather the overall revenues and costs
are considered in those assessments by the CODM. While maintenance is a
different type of activity, the maintenance and extended warranty services
does depend in part on the knowledge base and other development
6
completed in the research and development and manufacturing processes. For
these reasons, the Company determined that the Level 2 information for the
Systems Group did not represent operating segment data.
Within the Films Group, there are two managers that have responsibilities
for managing the business activities. The Chairman and President; Filmed
Entertainment is responsible for Film Production, Film Distribution and DMR
(digital remastering services) while the President; DKP 70MM Inc., is
responsible for Film Post-production. While there were two managers
reporting to the CODM, the activities related to Film Production, DMR and
Film Post-Production are all similar in nature as they involve different
elements of preparing the film content prior to delivery to the
distributors. On this basis, the Company considered the Level 2 information
to be supplementary information. Accordingly, the Company determined that
the Films Group was the appropriate level for purposes of operating segment
disclosures.
Within the Theater Operations Group, the Company manages its own IMAX
theaters (seven theaters) and IMAX theaters owned by other third parties
(two theaters). The Group also participates in the results of two theaters
referred to as joint venture theaters. In this latter case, the Company has
contributed the equipment components to the theater and participates in the
profits and losses from those theaters. These operations are the
responsibility of the Executive Vice President; Theater Operations. Also,
all of these operations involve the theaters that use the IMAX system
components and exhibit films to theatergoers. The Company considered the
Level 2 information to be supplementary. Accordingly, the Company
determined the Theater Operations Group was the appropriate level for
purposes of operating segment disclosures.
Within the Other Group, the Company includes its camera rental activities
whereby the Company rents 3-D and 2-D cameras and related accessories to
studios and other filmmakers for the purpose of filming in the 15/70
format. Also included in this group is the aftermarket sale of accessories
and other parts such as reels, platters, lenses, screens and 3-D viewing
glasses. The Company considers this to be an inventory type function and
considers the Level 2 information to be similar to product line
information. Accordingly, the Company determined that the Other Group was
the appropriate level for purposes of operating segment disclosures.
Based on the operating segments, the Company considered which of the Level
2 information represented components. As required by paragraph 30 of SFAS
142, the Company aggregated two or more components into a single reporting
unit if the components had similar economic characteristics, and as
indicated in footnote 20 to SFAS 142, the Company considered paragraph 12
of SFAS 131 as well as the guidance in EITF D-101.
As a result of considering the factors set out in SFAS 131 and EITF D-101,
the Company aggregated certain components of the operating segments into a
single reporting unit as follows and for the following reasons:
IMAX SYSTEMS
As noted above, all of the line items under the Systems Group relate to the
delivery and supervision of installation of systems component parts either
manufactured directly by IMAX or others to customers under sales,
sales-type lease or operating lease arrangements. The products delivered
are similar in nature in that they involve equipment components to exhibit
filmed content in theaters. The various line items merely reflect the form
of the transaction (e.g., sale versus lease). The manufacturing processes
and the sales processes are the same and are conducted by the same Company
personnel.
7
While the margins earned by maintenance are lower than those on systems
components and the service is different than the manufacture of the
equipment, the two activities are economically interdependent-- the class
of customers is the same; the arrangement for maintenance and extended
warranty services are negotiated by the same sales and business affairs
staff and are typically included within the sales or lease arrangements;
and the maintenance services group cost centre operates under the
responsibility of the Executive Vice President, Technology and shares the
resources of the Technology department.
Based on the above factors, the Company considered it appropriate to
aggregate the maintenance and other lines within the Systems Group as a
single reporting unit.
FILM PRODUCTION AND DIGITAL REMASTERING
The Company believes film production and digital remastering services,
which the Company refers to as "DMR" are similar because both of the
processes involve the preparation of film content prior to distribution.
These services are generally provided to studios or production houses. The
processes involved use IMAX supported technology to produce filmed content
and are similar. Both activities have the ultimate intention of displaying
final film content within the IMAX network of theaters, but the film
copyright is often owned by a third party.
FILM DISTRIBUTION
Due to the fact that this component involves the licensing of films in the
Company's library to IMAX theaters, this component is considered to be a
separate reporting unit.
FILM POST-PRODUCTION SERVICES
This component is managed by a manager that is separate from the above two
reporting units and is considered to be a separate reporting unit on that
basis.
OWNED AND OPERATED THEATERS, JOINT VENTURE THEATERS AND MANAGEMENT FEES FOR
OTHER THEATERS
The Company believes its seven owned and operated IMAX theaters can be
aggregated, as the manner in which the theaters operate their business and
the nature of those operations are the same. As well, the component
businesses share significant corporate resources involving the procurement
of films and concessions. The nature of the operations of the Company's
joint venture theaters, and the nature of the theaters for which the
Company receives management fees are also similar.
CAMERA AND OTHER REVENUES
These components do not fall into any other reporting units, and the
Company has aggregated these components into "Other Revenues".
(N) REVENUE RECOGNITION, PAGE 64
6. We note that your revenue recognition policy does not currently address
each of the sources from which you earn revenue. With a view towards
clearer disclosure for investors, please provide us with a clear discussion
of each material source of revenue, including a brief description of the
good, service or activity from which you generate such income, and a clear
description of your policy for recognizing revenues from that source.
Please include a clear discussion of the activities that would indicate
that the revenue recognition criteria outlined in SAB 104 has been met.
8
Address all rights granted to your customers as part of your sales
contracts, including the right of return, customer acceptance, etc. and
explain how those terms impact the timing of revenue from each source.
NOTE:
The Company has provided a detailed analysis of its revenue arrangements in
response to your comments #7 to #14. When your comments have been general
in nature, such as this comment, the Company has provided information based
on the standard or more common aspects of its revenue arrangements.
However, there may be circumstances when Company arrangements include
distinctive provisions that are not standard. The Company's response to
this comment has not covered any non-standard provisions.
The Company has identified and discussed below sources of revenue that
individually exceeded 5% of total revenues in 2005. Where a more complete
discussion of the Company's revenue recognition policies specific to an
individual source of revenue is included elsewhere in the letter,
references to that response have been included without duplication
hereunder. The Company's comments are provided on the segments of A) IMAX
Systems, B) Films and C) Theater Operations. Revenues from camera rentals
and other revenues included in the Other segment have not been described
below as revenues for each individually are below the 5% threshold
discussed above.
A. IMAX SYSTEMS REVENUE:
"IMAX systems" revenue as presented in the Company's 2005 Consolidated
Statement of Operations includes revenue from the following sources and
elements:
1. Sales and leases of projection systems, sound systems, screen
systems and glasses cleaning systems, and
2. Provision of maintenance and extended warranty services.
Other revenues related to "IMAX systems" consist of training services and
sale of 3-D viewing glasses which are individually less than 5% of total
revenues and as such have not been discussed further here.
The above elements are often combined in a single arrangement. The Company
has provided detailed comments on its accounting for multiple elements in
the response to comment #7.
1. SALES AND LEASES OF SYSTEMS COMPONENTS:
The Company's sales and lease arrangements typically involve the
delivery of four systems components including the projection system,
the sound system, the screen system and the glasses cleaning system.
These are all tangible products. In conjunction with the sale or lease
of this equipment, the Company provides advice on theater design and
project management, supervision of installation of the equipment and
on-site testing of the equipment. A further description of this
revenue source is included in Item 1 of the Company's Form 10-K under
the caption "IMAX Systems." In the response to comment #7, the Company
has outlined that these services are not considered separate
deliverables from the Company's perspective. For more detail on the
specifics of the systems components and the services, please see
Schedule A of the Sample Contract attached as Exhibit B. Items 1 to 4
and 6 to 8 provide greater detail about these component systems.
For example, in a typical MPX sale or lease arrangement (based on all
MPX arrangements installed through to December 31, 2005), the Company
receives significant initial payments or initial rent
9
which generally are paid in installments commencing on the date the
contract is entered into and up to theater opening date. These initial
payments or "initial rent" average 67% of the total fixed contract
value on an undiscounted basis. The Company often obtains letters of
credit from customers for some of the initial rent that provides for
payment upon the presentation of a standard commercial invoice and/or
other documents by the Company. The Company also typically receives
ongoing amounts over the term of the arrangement known as "additional
rent" or "additional payment". These amounts can include a fixed
annual amount along with an incremental amount if the customer's sales
exceed specified amounts. The fixed amount of the additional rent
averages 33% of the fixed contract value on an undiscounted basis of a
typical MPX arrangement. The incremental amounts, which are contingent
fees, have represented approximately 5% of the overall "IMAX Systems"
revenue in the last three fiscal years (2003 to 2005).
Since the arrangements include multiple deliverables, the Company
considers multiple elements accounting to apply as further discussed
in the response to comment #7.
The Company's accounting for sales arrangements are in accordance with
the guidance in EITF 00-21 and SAB 104, as explained in the Company's
response to your comments #7, #10 and #14.
The Company's accounting for sales-type lease arrangements are in
accordance with the guidance in EITF 00-21, SFAS 13 and SAB 104 as
explained in the Company's responses to your comments #7 and #9 to
#12.
For arrangements that are classified as operating leases, initial rent
and the fixed amount of additional rent are recognized as revenue on a
straight-line basis over the lease term. Additional rent in excess of
minimum fixed annual amounts are recognized as revenue when the
Company determines the aggregate box office income exceeds the fixed
annual amount, provided that collection is reasonably assured. The
Company's accounting for operating lease arrangements is consistent
with SFAS 13, paragraph 19.
The Company earns finance income on its sales and sales-type lease
arrangements. The accounting for finance income for sales type leases
is covered in the Company's response to your comment #9. For sales
arrangements, the accounting for finance income is covered in the
response to comment #14.
In certain cases, sales and lease arrangements may be amended or
terminated. The accounting effect of changes to arrangements and/or
amounts received as a result of amendments or terminations are more
fully discussed in the responses to comments #11 and #12. The Company
refers you to those particular responses.
2. MAINTENANCE AND EXTENDED WARRANTY SERVICES:
The Company typically includes in its arrangements with customers a
one-year free maintenance period on the systems components from the
date of installation. The fair value of this element of the
arrangement is deferred and is amortized on a straight-line basis over
a period of time. While the contract refers to a one year period, the
period of the free maintenance ends one year from the Date of
Acceptance as explained further in the responses to comments #7 and
#15. Accordingly, the period may be longer than one year as the
Company's maintenance obligation commences once supervision of
installation of the individual systems components is complete.
However, for convenience, the Company typically begins recognition of
this element upon opening of the theater. Maintenance revenues are
recognized on a straight-line basis over the maintenance period
indicated in the arrangements. A further discussion of this revenue
source is in the responses to comments #7 and #15.
10
For separately priced/extended warranty arrangements, the Company
follows the guidance of FTB 90-1. The terms and conditions for these
arrangements are covered in its contracts with the customer. A
customer can select either a full service program or a shared service
partnership program. The contract sets out the annual maintenance fee
and index for adjusting the annual amount in the contract.
B. FILMS REVENUES:
"Films" revenue, as presented in the Company's 2005 Consolidated Statement
of Operations, includes revenue from the following sources:
1. Film Distribution revenue
2. DMR Film revenue
For the periods presented, revenues from film post-production services and
film production services are individually less than 5% and have not been
discussed further.
1. FILM DISTRIBUTION REVENUE:
Film distribution revenues arise from arrangements where the Company
licenses to theaters or sub-distributors, films that are used in
conjunction with the IMAX projection and sound system, or films that
can be used in other media, for example, television or DVD
distribution. A further description of this revenue stream is included
in Item 1 of the Company's Form 10-K under the caption Film
Production, Distribution and Post-Production. The Company distributes
films that it has produced or co-produced or whose distribution rights
it has acquired. Under separate license agreements with it customers,
the Company either receives fixed fees, variable fees based on a
percentage of the customer's the box office revenue or a combination
of fixed and variable fees. Films that the Company distributes are
typically shipped from its Santa Monica facility.
Revenue from the licensing of films is recognized in accordance with
the guidance in SoP 00-2, Accounting by Producers and Distributors of
Films. Revenue is recognized when a contractual licensing arrangement
exists, the film has been completed and delivered, the license period
has begun, the fee is fixed or determinable and collection is
reasonably assured. Where the license fees are based on a share of the
customer's revenue, and all other revenue recognition criteria stated
in the preceding sentence are met, the Company recognizes revenue
based on reports received from the customer as the customer exhibits
the film, provided collection is reasonably assured.
2. DMR FILM REVENUE:
DMR service involves optimizing and enhancing digitally 35mm films to
convert them into 15/70 format to be exhibited using IMAX projection
and sound systems. A further description of this revenue source can be
found under Item 1 of the Company's Form 10-K under the subcaption
Digital Remastering (IMAX DMR). The Company enters into an arrangement
with a film studio to remaster the studio's film and deliver a master
film negative in 15/70 format to the studio for distribution by the
film studio or the film studio's appointed distributors. In certain
circumstances, the Company also distributes the DMR film. In this
latter case, the film distribution revenue and the related costs of
the DMR remastering process is accounted for as described above under
Film Distribution Revenue.
For projects where the studio or the studio's appointed distributors
distribute the film, the Company generally receives a variable fee
based on the gross box office resulting from the film's distribution
in 15/70 format. In certain cases, the Company may receive a fixed
fee. The Company typically
11
absorbs the costs of the DMR remastering process and will amortize the
costs as variable fees are earned based on gross box office results
using the individual film forecast method.
When the Company receives a fixed processing fee, the fee is
recognized when a contractual arrangement exists, the DMR process is
complete and the master negative has been delivered to the studio, the
fee is fixed and determinable, and collection is reasonable assured.
When revenues are based on a percentage of gross box office, revenue
is recognized when the amount of gross box office receipts is reported
by the studio to the Company, provided that collection is reasonably
assured.
C. THEATER OPERATIONS REVENUE:
"Theater Operations" includes revenues from the Company's owned and
operating theaters; the Company's share of profits from two theaters where
the Company provides the projection, sound, glass cleaning and screen
systems in return for a share of the theaters' profits and losses; and
management fees received to manage theaters owned by third parties. The
latter two revenue streams are individually less than 5% and have not been
discussed further. As at December 31, 2005, the Company owned and operated
seven theaters for which the substantial majority of the revenues sources
are in respect of cash transactions for theater admissions and sales of
food and beverages through theater concessions.
The revenue recognition policy for the Company's owned and operated
theaters are explained in further detail in the response to your comment
#8.
CUSTOMER RIGHTS WITHIN AN ARRANGEMENT:
Customers may have several rights under an IMAX systems arrangement,
as set out in the Sample Contract attached to this letter as Exhibit
B. The Company also licenses films to customers under separate
agreements. These arrangements have not been discussed further with
respect to customer rights.
The rights in an IMAX systems arrangement may include:
1. Renewal rights
2. Maintenance and extended warranty services
3. Improvements and modifications to the system components at
the customer's expense
4. All improvements to system components until the date of
installation
5. Use of the IMAX name
6. Indemnity on installation and maintenance services provided
by the Company
7. Termination of arrangement and payment of certain costs when
IMAX is in default of its material obligations under the
arrangement for a specified period of time.
The Company provides the following comments on each of the rights
indicated above:
1. RENEWAL RIGHTS
Consistent with guidance in SFAS 13, paragraph 17(f), any
renewals by the customer are treated as a new agreement.
Accordingly, the renewal right does not affect the initial
revenue recognition. For sales arrangements that contain a future
payment on renewal, the Company does not include these amounts in
its original assessment of revenue and only includes it upon the
customer's renewal, when collectibility is also reasonably
assured.
2. MAINTENANCE AND EXTENDED WARRANTY SERVICES
Maintenance and extended warranty services generally include the
first year of free regularly scheduled maintenance, attendance at
the customer's annual preventative maintenance checks,
12
emergency services, replacement parts, 24-hour help line and
service history database. These rights are accounted for as
separate revenue streams, as required under SFAS 13, EITF 00-21,
SAB 104, and FTB 90-1. As described in the response to your
comment #7, these services are accounted for as separate
elements. Please also refer to the response to comment #15.
3. IMPROVEMENTS AND MODIFICATIONS TO SYSTEMS COMPONENTS AT THE
CUSTOMER'S EXPENSE
If and when requested to perform these services, the Company
would account for these as separate revenue transactions. This
right does not affect the accounting for the initial elements in
the arrangement. The customer is generally charged at existing
fair market values for such services or improvements.
4. ALL IMPROVEMENT TO SYSTEMS COMPONENTS UNTIL THE DATE OF
INSTALLATION
This provision has resulted in the Company recognizing revenue
when the installation of the systems components is substantially
complete as opposed to when the systems components are physically
delivered. See the responses to your comments #9 and #14.
5. USE OF THE IMAX NAME
The Company does not consider this to be a right separate and
apart from the right to use the Company's systems components.
Further comments are provided in the Company's response to your
comment #7.
6. INDEMNITY ON INSTALLATION AND MAINTENANCE SERVICES PROVIDED BY
THE COMPANY
This is a standard clause indemnifying the customer from
instances that may arise from the installation or maintenance of
the system components. The Company does not believe this clause
precludes revenue, as any actions resulting from this clause
would be accounted for under SFAS 5. SFAS 5, paragraph 30
indicates that the mere exposure to these types of losses does
not represent a present liability.
7. TERMINATION OF ARRANGEMENT AND PAYMENT OF CERTAIN COSTS WHEN IMAX
IS IN DEFAULT OF ITS MATERIAL OBLIGATIONS UNDER THE ARRANGEMENT
FOR A SPECIFIED PERIOD OF TIME.
The arrangements with customers are generally non-cancelable,
unless the Company fails to perform its obligations. As to rights
of return or refund in its arrangements, the Company has assessed
these rights in the context of SAB 104 as follows:
a. Under the agreements with customers (the "Agreement"), the
customer could not receive a refund or reject the delivered
systems components for the Company's ("IMAX") failure to
complete an outstanding task.
(I) THERE IS TYPICALLY NO RIGHT TO ANY REMEDY UNDER THE
AGREEMENT ABSENT A MATERIAL OR OTHER SPECIFIC DEFAULT.
The Agreement provides for exclusive remedies available to the
customer upon an IMAX default (see (b) below), but those remedies
are only available if (i) "IMAX is in default of its MATERIAL
OBLIGATIONS under this Agreement" and the customer notifies IMAX
of such MATERIAL DEFAULT which goes uncured for 60 days, (ii) if
IMAX fails to meet required shipping dates, or (iii) if the
installation of the system is delayed solely due to the actions
of IMAX. As detailed in the responses to comment #14, IMAX's
remaining obligations after installation of the systems
components are substantially complete or are not material. No
remedies under the Agreement are available to the customer for
IMAX's failure to complete the outstanding tasks where the
remaining obligations are not material.
13
(II)CUSTOMER HAS THE RIGHT TO TERMINATE THE AGREEMENT AND
SEEK A REFUND UPON A DEFAULT BY IMAX, BUT ONLY IF SUCH
DEFAULT IS MATERIAL, ONLY IF CUSTOMER PROVIDES NOTICE TO
IMAX OF A MATERIAL DEFAULT AND ONLY IF IMAX DOESN'T CURE.
Other than where IMAX has not met a shipping date or delayed
installation (in which case the customer is entitled to limited
liquidated damages), the Agreement provides that there are two
remedies available to the customer: (i) termination of the
Agreement, upon which IMAX must remove the system and refund
monies to the customer, or (ii) the customer can perform the
unperformed material obligations and IMAX would reimburse the
customer for its costs for doing so. Both of these remedies are
expressly available only in the event of a breach of IMAX's
material obligations. As noted above, however, where there is no
default of IMAX's material obligations under the Agreement, or
where the customer did not ever notify IMAX of a material default
there are no rights to termination and refund.
b. Even if the customer were to try and seek a remedy for an
immaterial breach outside of the Agreement, it could not
receive a refund or reject the delivered product for IMAX's
failure to complete the outstanding tasks.
(I) THE AGREEMENT PRECLUDES A REMEDY FOR AN IMMATERIAL
BREACH WHICH COURTS WILL LIKELY RESPECT.
As noted above, the Agreement precludes a remedy for the
customer except in the event of a material default (and
notice and non-cure), which is typically not the case. If
the customer were to try and sue IMAX for an immaterial
breach, courts would likely enforce the well-known contract
principle of looking within the "four corners of the
contract" to determine the parties' rights and uphold the
Agreement's preclusion of a remedy for an immaterial breach.
CUSTOMER ACCEPTANCE:
As for customer acceptance provisions within the Company's
arrangements, the agreements typically define the date of acceptance
of the systems components (which is further defined in the schedules
to the agreement and enumerates the various separate theater
components under the arrangement) as follows:
"DATE OF ACCEPTANCE" means the earlier of: (a) the date on which
IMAX certifies to Client, and Client is in agreement (which
agreement will not be unreasonably withheld or delayed) that the
training of personnel, installation and run-in testing of the
System is complete; (b) the date on which the Theater is opened
to the public; and (c) [Specified Date];
The Company has provided further comments about acceptance in the
response to your comment #14.
The Company is reviewing its disclosures in light of this comment.
7. We note that your theater system sales and lease transaction typically
involve the delivery of several product and services and when these
elements meet the criteria for treatment as separate units of accounting,
you allocate revenue to each element based on its relative fair value. To
assist us in understanding your revenue recognition for theater system
sales and lease transactions and with a view towards revised clearer
disclosure for investors, please address the following:
14
- Confirm that you are now accounting for these arrangements pursuant to
EITF 00-21, Revenue Arrangements with Multiple Deliverables and, as we
do not see similar disclosure in your 2004 10-K, tell us the period in
fiscal 2005 in which you changed your revenue recognition policy.
- Provide us with your analysis supporting your conclusion that the
arrangements contained multiple deliverables that should be accounted
for pursuant to EITF 00-21. For instance, tell us how you considered
the guidance in paragraph 9 in concluding that the delivered items of
your theater systems have value to the customer on a standalone basis
and that there is objective and reliable evidence of the fair value of
undelivered items including the screen, the sound system, maintenance,
etc.
- Tell us whether you sell the identified deliverables separately and if
not, explain how you established fair value under paragraph 12 of EITF
00-21.
- Discuss how you considered the guidance in paragraph 4(a) of EITF
00-21 and EITF 01-8 in concluding that EITF 00-21 and not SFAS 13 is
the authoritative literature you should follow in accounting for your
sales-type leases which you believe contain multiple element
arrangements.
- Highlight for us all other authoritative guidance that supports your
accounting for these transactions.
- We may have farther comment after reviewing your response.
APPLICATION OF EITF 00-21 TO THE COMPANY
The Company currently accounts for multiple elements in its revenue
arrangements by reference to EITF 00-21, SAB 104 and SFAS 13, as
applicable. EITF 00-21 was applicable to arrangements entered into in
fiscal periods beginning after June 15, 2003. Accordingly, the Company
applied EITF 00-21 for periods beginning July 1, 2003. Prior to that date,
the Company applied the multiple element guidance in SAB 101.
The change in the wording of the Company's accounting policies surrounding
revenue recognition of components of theater systems arrangements has not
resulted from a change to how the Company recognizes revenue compared to
previous periods. Prior to 2005, the Company did not have any arrangements
in which all the components were not installed or substantially completed
in the same quarter. During 2005, the Company requested customers to
proceed with installations prior to the quarter in which the theater was
scheduled to open and in certain cases, components of the arrangements were
installed prior to the end of the Company's reporting periods. As a result
of these changes in circumstances, the Company enhanced its disclosure of
the related accounting policies.
The Company did not separately account for theater components in the first
three quarters of 2005 but did separately account for the other elements in
the arrangement (for instance, film license arrangements and first year
free maintenance). During the fourth quarter of 2005, the Company performed
a retrospective review of all installations in the first three quarters of
2005 and noted two occasions where the screen component was not
substantially complete in the same quarter. The Company analyzed the effect
of separately accounting for the screen system component in these two
instances in each of the quarters it affected and concluded that the
adjustment required would have been immaterial (an adjustment of less than
0.35% of total revenues for the two quarters affected) to the quarters
affected.
As described in the Company's accounting policies in the years prior to
2005, the guidance in EITF 00-21 effective for periods beginning after July
1, 2003 has been applied to those arrangements that included deliverables
in addition to the equipment and maintenance components (see note 2(m) of
the 2004 Form 10-K).
15
MULTIPLE ELEMENTS IN AN IMAX ARRANGEMENT:
A typical IMAX arrangement includes several components consisting of
projection equipment, sound system, screen system, glasses cleaning system,
design and project management services, supervision of installation,
testing, training and maintenance services. An arrangement can also include
other elements such as the sale of 3-D viewing glasses and film licensing
arrangements or marketing credits.
The Company's arrangements will include equipment that is either sold or
leased to the customer.
DETERMINATION OF DELIVERABLES:
EITF 00-21, paragraph 1, indicates that multiple solutions may be offered
to customers that "involve the delivery and performance of multiple
products, services or rights to use assets, and performance may occur at
different points of time or over different periods of time." Paragraph 4
indicates that the EITF applies to "all deliverables (that is, products,
services, or rights to use assets) within contractually binding
arrangements (whether written, oral or implied, and hereinafter referred to
as 'arrangements') in all industries under which a vendor will perform
revenue-generating activities ..." This scope paragraph then refers to
other higher level literature that may take precedence over the guidance in
EITF 00-21.
EITF 00-21 does not include an explicit definition of deliverables.
Paragraph 4 of EITF 00-21 indicates that deliverables are products,
services or rights to use assets. The Company understands that the
identification of the deliverables requires substantial judgment.
Accordingly, the Company determined that each equipment system, as set out
in the schedule to the arrangements (i.e., the projection system, the sound
system, the screen system and the glasses cleaning equipment), represents a
separate deliverable to the customer. In addition, 3-D glasses, training
services, maintenance services and extended warranty services, marketing
credits and film licenses are considered to be separate deliverables.
However, the Company does not consider certain support services related to
theater design, project management services and supervision of installation
to be deliverables. Theater design and project management relates to
advising and consulting with the customer on the optimal cinematic and
acoustical design and construction of the theater (i.e., to assist the
customer with Company defined specifications for the theater that would
accommodate the various hardware components: the final design and
construction of the theater itself is a customer specific obligation).
Supervision of installation involves the carrying out of a visual
inspection of the equipment prior to installation to ensure all packing is
properly removed and equipment is not damaged, and advising the
customer-hired contractors or staff on appropriate installation procedures,
and connection of services to the components delivered. The contracts
generally require the Company to incorporate all necessary technical
improvements developed by the Company to the date of installation. These
items are not considered deliverables as they are assistance provided to
the customer to ensure that the appropriate Company-defined specifications
are followed and maintained for theater design, that the equipment meets
all Company specifications before installation, and that the installation
is carried out in an approved manner by the customer's hired contractors.
The Company does not perform the actual installation of the equipment
components.
The Company considers the testing services to also be a related support
service to the equipment components supplied and not a separate
deliverable. This is because the equipment components are already
thoroughly tested at its facility before delivery to ensure each component
will meet the Company defined equipment specifications upon delivery and
installation by the customer. Upon installation of the equipment by the
customer's contractors, the Company will test each component by
16
performing a functional start-up and test procedure to ensure proper
operation as well as perform a review of the installation work itself and
adjust any critical components where necessary. Upon completion of the
theater interior space by the customer (as it is not an obligation of the
Company), the Company will also calibrate the sound system for the finished
theater environment. Functional testing is usually done at the time of
equipment installation and calibration is completed when the theater
interior is finished by the customer. The Company considers this testing to
be inconsequential and perfunctory as the related costs of the testing are
not material, time to perform is not lengthy, testing does not
significantly alter the capability of the equipment as it is thoroughly
tested in advance of shipment, the equipment is tested again as part of the
supervision of installation, and the Company has a demonstrated history of
completing these remaining tasks in a timely manner upon final completion
of the theater interior by the customer.
The contract for an arrangement includes certain clauses to protect the
Company's rights to its software. The Company has also considered guidance
under SOP 97-2 paragraph 2, footnote 2, and concluded that the software
inherent in the projector and sound system is incidental to the product and
therefore should not be separated and scoped into SOP 97-2. The Company
believes that the software is not a key influence in the customer's
decision to acquire the projector equipment and sound system. The software
is embedded in the projector equipment and sound system and is not marketed
separately. The marketing does not focus on the software features of the
equipment.
The contract for an arrangement also provides the customer with the right
to use the Company's trademarks. The Company does not consider this to be a
separate deliverable, as the trademark is inextricably linked with the
equipment components and is to be used predominately in conjunction with
the ultimate usage of the equipment components under the arrangements. The
trademark has never been separately licensed apart from the equipment
components on a stand alone basis.
The contract for an arrangement can also provide the customer with film
licensing rights to certain films the Company distributes as well as
provide for the sale of 3-D viewing glasses. It is also possible for
customers to purchase 3-D viewing glasses from vendors other than the
Company under the arrangement. Where included in the arrangements, these
are also viewed as separate deliverables.
It is also possible that the contract for an arrangement can include
certain marketing credits, whereby the Company agrees to provide direct
consideration to the customer to encourage the customer to open the theater
or to assist the customer with its marketing launch of the theater upon or
near to its opening. The Company also provides this type of credit as an
incentive for the customer to install the equipment at the earliest dates
possible. The Company treats these incentives or marketing credits as a
reduction of the overall consideration. This accounting is consistent with
the requirements of EITF 01-9, Accounting for Consideration Given by a
Vendor (Including a Reseller of the Vendor's Products).
DETERMINING THE UNITS OF ACCOUNT FOR ARRANGEMENTS INVOLVING THE SALE OF
EQUIPMENT:
If the arrangement involves a sale of equipment as opposed to a lease of
equipment, the Company would apply the guidance in paragraph 9 of EITF
00-21 to determine the units of account for revenue recognition. This
analysis generally would cover the following elements:
- projection equipment,
- sound system,
- screen system,
- glasses cleaning system,
- initial and separately priced maintenance services and extended
warranty,
- 3-D viewing glasses,
17
- training services, and
- film licenses.
The application of paragraph 9 is discussed later in this response.
Further, it should be noted that separately priced maintenance and extended
warranty services are covered by FTB 90-1 which is higher level GAAP and
therefore, these services are separated from the other elements in an
arrangement involving a sale in accordance with the guidance in paragraph
4(a). That paragraph requires the fair value be allocated between FTB 90-1
elements and all other elements in the arrangement based on fair values.
DETERMINING UNITS OF ACCOUNT FOR ARRANGEMENTS INVOLVING THE LEASE OF
EQUIPMENT
For arrangements including a lease of equipment, the Company has considered
the guidance in paragraph 4(a) and 9 of EITF 00-21 and paragraph 15 of EITF
01-8 to determine the units of account for revenue recognition.
In considering multiple elements in an arrangement that involves the lease
of equipment, the Company has referred to paragraphs 4(a) of EITF 00-21 and
paragraph 15 of EITF 01-8. Those paragraphs require that if an arrangement
contains a lease and executory costs, the lease elements (consisting of the
equipment components and the executory costs) should be accounted for in
accordance with SFAS 13. Footnote 3 to paragraph 4(a)(II) of EITF 00-21
considers an arrangement that includes the lease of equipment under an
operating lease, the maintenance of the leased equipment throughout the
lease term (executory costs) and the sale of additional equipment unrelated
to the leased equipment. The footnote indicates that the leased equipment
and the related maintenance are SFAS 13 deliverables. The SFAS 13 guidance
is also applied to separate the maintenance services from the lease
equipment.
The Company notes that SFAS 13 does not explicitly define executory costs.
However, paragraphs 5(j), 7(d) and 17(a) provide examples of executory
costs, which include insurance, maintenance and taxes in connection with
the leased equipment. The Company understands that executory costs are
those associated with owning and operating the equipment, but do not
include other services that may be related to the leased equipment.
Paragraph 5(j) indicates executory costs are not minimum lease payments and
paragraph 7(d) indicates that executory costs should be excluded in
determining the net present value of minimum lease payments for purposes of
lease classification. Paragraph 17(a) and 17(c) indicate that executory
costs should be excluded from the gross investment in the lease and the
sales price, respectively.
Based on the above, in an arrangement entered into by the Company involving
the lease of equipment, the SFAS 13 elements generally would include the
following:
- lease of the projection system,
- lease of the sound system,
- lease of the screen system,
- lease of the glasses cleaning system, and
- initial maintenance services.
The elements not covered by SFAS 13 generally would be:
- the sale of 3-D viewing glasses,
- training services,
- separately priced maintenance and extended warranty, and
18
- film licenses
Maintenance contracts have been included as both SFAS 13 elements and
non-SFAS 13 elements. The Company's contracts often provide for the initial
year's maintenance to be included at no charge and future years are subject
to separately priced arrangements. The initial maintenance services
embedded in the lease component are subject to the SFAS 13 requirements
related to executory costs; whereas the separately priced maintenance
arrangements are subject to FTB 90-1, Accounting for Separately Priced
Extended Warranty and Product Maintenance Contracts. Generally, the
separately priced maintenance and extended warranty arrangements are billed
on at least an annual basis commencing after the initial maintenance period
ends.
FTB 90-1 is higher level literature which requires revenue from separately
priced maintenance contracts to be deferred and recognized in income over
the term of the contract. FTB 90-1 defined a separately priced contract to
be one that specifies an expressly stated price for the services separate
from the price of the product. Accordingly, for those contracts, the unit
of account and the pricing are in accordance with FTB 90-1.
In accordance with the method described in footnote 3 to paragraph 4(a) of
EITF 00-21, the arrangement consideration is allocated between the SFAS 13
element, as a whole, and the non-SFAS 13 elements, as a whole. This is done
based on relative fair values of the two groups of elements.
Within the SFAS 13 elements, the Company allocates an amount to maintenance
services included in the arrangement based on guidance in paragraph 17(c),
which requires the costs plus any profit thereon to be separated from the
sales price of the leased equipment. The Company considers the costs plus
any profit to be equivalent to the fair value of such maintenance services.
In this regard, the Company uses an amount that approximates the average
price charged for separately priced maintenance services as the amount that
is allocated to the maintenance services offered in the initial period at
no charge.
For allocation of individual pieces of equipment in the lease arrangement,
the Company notes that specific guidance provided in SFAS 13 is limited to
guidance on allocating amounts to land and building in paragraph 26(b)(ii)
and to equipment and building in paragraph 27. Under paragraph 27, the
minimum lease payments applicable to the equipment are to be estimated by
whatever means are appropriate in the circumstances.
SFAS 13 is also silent as to whether multiple pieces of equipment covered
by a single master lease agreement should be viewed separately or bundled
together and viewed as one lease for purposes of recognition. FTB 88-1,
Issues Relating to Accounting for Leases, Question 1, Time Pattern of the
Physical Use of the Property in an Operating Lease indicates that if rents
escalate as a result of gaining access to and control over additional
leased property at the time of escalation, the revenue should be attributed
to the additional leased property based on the relative fair value of the
additional property.
Based on the general guidance provided in these paragraphs, the Company
concluded it would be appropriate to apply the EITF 00-21 guidance to
determine whether and which SFAS 13 lease equipment elements should be
accounted for as separate units of account.
APPLYING THE CRITERIA OF EITF 00-21 TO DETERMINE UNITS OF ACCOUNT
Paragraph 9 of EITF 00-21 states that delivered items(s) should be
considered a separate unit of accounting if all of the following criteria
are met:
19
a. The delivered item(s) has value to the customer on a stand alone
basis. That item(s) has value on a stand alone basis if it is sold
separately by any vendor or the customer could resell the delivered
item(s) on a stand alone basis. In the context of a customer's ability
to resell the delivered item(s), the Task Force observed that this
criterion does not require the existence of an observable market for
the deliverable(s).
b. There is objective and reliable evidence of the fair value of the
undelivered item(s).
c. If the arrangement includes a general right of return relative to the
delivered item, delivery or performance of the undelivered item(s) is
considered probable and substantially in the control of the vendor.
For purposes of this letter, the analysis is based on the following facts
and circumstances relating to the deliverables noted above:
a. The Company generally has delivered the projection system, sound
system and glasses cleaning system at the same time. These components
with the exception of the glasses cleaning system are assembled and
inspected at the Company's facilities, before shipment to the
customers. The components are disassembled for shipment and
reassembled at the customer site. However, as the Company has a
continuing obligation to ensure that all necessary technical
improvements are incorporated into the equipment up to the
installation date, the Company does not recognize revenue until
installation has been substantially completed. On occasion, the
Company has sold each of the components separately either when
customers need to replace certain components or wish to acquire
certain components themselves.
b. The glasses cleaning system is manufactured by a third party supplier
and arrives at the Company's facility fully assembled and tested from
the supplier and requires no further testing on the Company's part
prior to shipment. Since the glasses cleaning machine is a
self-contained unit, its installation procedure is relatively simple
requiring connection to plumbing and electrical systems.
c. The screen systems are manufactured by other suppliers and are
generally shipped by the supplier under delivery instructions provided
by the Company to the customer site. Installation of screens may be
delayed if for example the customer's theater interior is not
completed to the extent required for the final screen to be installed
without risk of damage to the sheet. In certain situations, the
Company may paint the screen at the customer site to make it
compatible with 3-D viewing. In the remaining instances, the final
screen sheet is delivered pre-painted.
d. 3-D glasses are glasses worn by customers of the theater to obtain
certain 3-D effects of certain movies. While these items can be reused
with proper care and cleaning by the theater owner, the Company
considers these items to be an inventory consumable item. 3-D glasses
are not required for 2-D film screenings by the customer. Also, the
theater exhibitor has the ability to purchase these 3-D glasses from
other suppliers if they choose to do so.
e. Projectionist training services involve approximately one to one and a
half man weeks of time to fully train and qualify a customer's
projectionists on the use and general maintenance of the equipment
components. The time period varies based on the skill and language
level of the customer-hired projectionist. The fair value of the
component has been assessed by the Company as generally less than
$10,000. Due to immateriality, the Company has not accounted for this
element separately and will accrue these costs upon installation of
the projector equipment and sound system.
f. Films generally are licensed separately. In certain arrangements, the
Company may offer, as an incentive, a limited number of films at
discounted or no fees.
For arrangements involving leases, the Company applies the guidance in EITF
00-21 separately to the equipment components in the SFAS 13 elements and to
the deliverables in the non-SFAS 13 elements, except for the separately
priced maintenance and extended warranty arrangements. For the separately
priced maintenance and extended warranty arrangements, the arrangements are
accounted for separately based on the price specified in the contract in
accordance with FTB 90-1. For sales transactions, the
20
criteria below are applied to all elements of the arrangement except for
the ongoing maintenance, which is accounted for using FTB 90-1.
1. STAND ALONE VALUE TO THE CUSTOMER
Each of the projection system, sound system, screen system and glasses
cleaning system have been sold individually to customers. While these
sales may not be frequent, they occur when customers need to replace
certain components or the customer wishes to install certain of their
own components. However, while the sound system is capable of
independent operations, since it is interlocked with the projection
system, the Company has not accounted for the projection system
component and sound system component as separate unit of accounts,
except in those cases when it has sold each of those systems
independently of the other.
As indicated in Exhibit C, the Company has outlined the instances
where the Company sold or leased separately the projector equipment,
sound system and screen. Since January 1, 2005 there are five
instances where components were sold separately. The Company has
included at the bottom half of Exhibit C, other instances prior to
January 1, 2005 where equipment components were sold or leased
separately.
As outlined in the last column of Exhibit C in relation to the
Company's sales-type leases, there are instances where the customer
did purchase separately components from third parties.
Further, as noted above, the glasses cleaning machines are
manufactured by a third party supplier, and resold by the Company
without further modification.
The screen systems are not manufactured by the Company. The screen
systems are sourced from other manufacturers who do sell screens to
others. For 3-D effects, the screen needs to be painted which is done
either by the Company or third parties. Accordingly, these add-on
features could be performed by others.
While a significant number of the Company's arrangements involve
leases that do not permit the customer to resell the individual
components, the Company believes each of the components could be
resold by the customer on a stand alone basis for the following
reasons:
i. the projection system could operate with another sound
system;
ii. the sound system could operate independently of the
projection system;
iii. the glasses cleaning machine does not depend on any of the
other pieces of equipment to function;
iv. the screen could be left intact in a theater to be used with
other projection equipment not provided by the Company. The
screen is a passive component and does not interact
electronically or in any other fashion with the projection
system. At the termination of a lease of the Company's
equipment, the Company generally does not take possession of
the screen.
Accordingly, none of the component systems are functionally
interdependent except for the projection and sound system.
Based on the above, the Company believes that the following component
systems have a stand alone value:
1. the projection system component combined with the sound
system component;
2. the glasses cleaning system; and
21
3. the screen system.
3-D glasses are sold by the Company separately without system sales as
the glasses are a consumable and need to be replaced periodically by
the theater owner due to wear and tear and loss. Further, they are
also sold by others.
Films are licensed by the Company on a regular basis to theater
owners.
Accordingly, each of the items or group of items noted above that are
delivered throughout the arrangement has stand alone value to the
customer as either the Company sells the item or group of items
separately or the customer could purchase the item from others.
2. OBJECTIVE AND RELIABLE EVIDENCE OF FAIR VALUE OF UNDELIVERED ITEMS
As noted above, the projection system, sound system and glasses
cleaning system are usually the first items delivered and are
generally delivered as a group and installation generally is
substantially completed for these component systems at the same time.
Accordingly, for the future undelivered items, objective and reliable
evidence of fair value exists as follows:
a. Screens - Fair value of screens has been determined by reference
to market prices for painted silver screen sheets and frames
based on arm's length commercial pricing available to any
customer from the Company's screen suppliers. These values do not
assume discounts that might be available to the Company due to
its ongoing relationship with the suppliers. The fair value of
screens also includes the arm's length pricing of installation
supervision based on pricing obtained from third party
installers.
b. 3-D glasses - The Company sells 3-D glasses on a stand alone
basis and the values for glasses are determined based on its
selling prices to customers.
c. Films - The Company licenses films on a stand alone basis and the
values for films are determinable based on its selling prices to
customers.
Accordingly, criterion B is met as the Company has objective and
reliable evidence of fair value as provided by other suppliers of the
relevant elements where applicable or based on its own sales
transactions with other customers.
3. RIGHT OF RETURN OF DELIVERED ITEMS
a. The Company's revenue arrangements generally do not include a
right of return in the absence of a material breach or default by
the Company. In response to your comment #6 under the heading of
Customer Rights within an Arrangement, it was noted that a
customer may receive a refund under a material breach of the
arrangement. As noted in that response, the Company has not
experienced any recent situations that resulted in such
occurrence. Once any of the equipment components are installed
the customer is not able to return the delivered item(s).
Further, the Company's contracts with customers generally require
that the customer take delivery of the contracted items. The
Company has been successful in enforcing these provisions either
by specific performance or by a return of the equipment without
refund
b. Consideration of whether the delivery and installation of the
screen is probable and substantially controlled by the Company,
does not require further consideration as the contracts do not
provide a general right of return of the projection system, sound
system and other equipment. The Company has not experienced any
situations where the screens ordered were not delivered when the
projection system, sound system and other equipment had been
installed. The Company has not experienced any significant delays
in obtaining screens from its suppliers. The delays in completing
the screen component generally relate to interior conditions at
the customer's theater, which is solely the obligation of the
customer. As a general matter, the
22
Company will not install the final screen sheet until interior
conditions in the theater are suitable and controlled for
temperature and dust so as to not damage the final screen sheet.
These conditions only exist after completion of the interior fit
and finishes of the theater, again which is solely the obligation
of the customer. It is also possible that even though the theater
construction is complete and the screen is installed, the opening
of the theater may be delayed due to other factors beyond the
Company's control; however, these delays do not affect the
Company's obligations related to the revenue arrangement.
Accordingly, as there is no general right of return, criterion C has
been met.
Based on the above analysis, the Company has concluded that the combined
projector and sound system component, the glasses cleaning machine
component, and the screen system component in the SFAS 13 elements and all
other deliverables (excluding the maintenance and extended warranty
elements which are covered by FTB 90-1) would meet the criteria for
separate units of account at the initial date of recognition of revenue for
some elements and at later dates as revenue is recognized for other
elements.
The Company is reviewing its disclosures in light of this comment.
8. We note that you recognized revenue of $17.5 million in fiscal year 2005
for theater operations. Please tell us your accounting policies for
recognizing revenues from theaters you own and operate.
The Company recognizes revenue from its owned and operated theaters
resulting from box office ticket and concession sales as tickets are sold
and upon the sale of various concessions. These are recognized in
accordance with SAB 104. The sales generally are cash sales transactions
with theatergoers based on fixed prices per seat or per concession item.
The revenue is recognized when the theatergoer is admitted to the theater
to watch the film or when the theatergoer purchases beverages or other food
items.
As noted in the response to your comment #6, the Company recognizes certain
amounts related to profit sharing arrangements on two theaters owned by
others and management services provided to theaters owned by third parties.
For the year ended December 31, 2005, these revenues combined represented
0.5% of total revenues and therefore are not material.
SALES-TYPE LEASES OF THEATER SYSTEMS, PAGE 64
9. To assist us in understanding your sales-type leases and with a view
towards revised clearer disclosure for investors, please address the
following:
- Explain in greater detail your accounting methodology for sales-type
leases under SFAS 13 and clarify for us how your accounting is
consistent with U.S. GAAP.
- Describe the contractual terms entered into with the customer and
provide a sample contract for our review.
- Discuss how you determined how these leases should be classified
according to the provisions of paragraph 6 through 8 of SFAS 13 and
how the accounting and reporting for your sales-type leases complies
with paragraph 17 of SFAS 13.
- Tell us how you considered the fact that collectibility of the
payments for the theater lease systems is not certain, when you
applied the accounting and reporting standards of SFAS 13. We note the
disclosure on page 32.
- Explain to us who has insurable risk in your sale-type leases.
GENERAL CONTRACTUAL TERMS OF LEASES
23
As noted in the response to responses to comments #6 and #7, the Company's
arrangements include multiple elements. Some of the elements would
represent a lease of equipment as defined by SFAS 13 and EITF 01-08, while
other elements of the arrangements would not covered by SFAS 13:
- The lease component of the arrangement involves and covers
several hardware items generally consisting of a projection
system, sound system, screen system and glasses cleaning system.
These components are specifically identified in the arrangement.
- The customer has the ability and the right to operate the
hardware components or direct others to operate them in a manner
determined by the customer.
- Lease terms are typically non-cancelable for 10 to 20 years with
renewal provisions.
- The leases generally do not contain an automatic transfer of
title at the end of the lease term.
- Minimum lease payments as defined in paragraph 5(j)(ii) of SFAS
13 include:
1. Fixed payments ("initial rents" as defined in the
agreements) required to be paid in installments over a
period of time commencing with the signing of the
contract covering the arrangements and generally ending
on or near that date the theater opens.
2. Ongoing rental payments ("additional rents" as defined
in the agreements), which are typically equal to the
greater of a percentage of theater admissions and fixed
annual amounts. The fixed annual amounts are included
in minimum lease payments while any excess amounts over
the fixed annual amount are considered to be contingent
rent.
- The customer is required to pay for executory costs such as
insurance, maintenance and taxes, except for maintenance and
extended warranty for the first year.
- There are typically no contractual requirements committing the
Company to protect the lessee from obsolescence of the leased
components. (There are no residual value guarantees.)
A copy of a sample lease is provided as Exhibit B to this letter.
CLASSIFICATION OF LEASES
Most of the Company's leases are classified as sales-type leases because
they meet each of the following criteria:
1. 90 PERCENT RECOVERY TEST.
The 90 percent recovery test is set out in paragraph 7(d) of SFAS
13--the present value at the beginning of the lease term of the
minimum payments, excluding that portion of the payment representing
executory costs (that is, the maintenance services to be provided at
no charge) at fair value, equals or exceeds 90% of the fair value of
the leased property.
In applying the 90 percent recovery test, the Company tests all the
components as one unit of account. This is done as a matter of
convenience, as the lease arrangements typically do not specify any
specific rental payments for the individual components and the lease
terms for each of the components in a lease are identical.
Accordingly, any allocation of lease payments among the individual
components would be based on the relative fair values of the
components.
For purposes of the classification, minimum lease payments include
only the initial rents and the fixed annual amounts noted above.
Consistent with Question 4 of EITF 96-21, Implementation Issues in
Accounting for Leasing Transactions Involving Special Purposes
Entities, payments made prior to the commencement of the lease term
are considered to be minimum lease payments. While EITF 96-21 requires
these payments made prior to the beginning of the lease term be at
their future value (that is, the time value of money is accreted from
the payment date to the beginning of the
24
lease term using the rate implicit in the lease), the Company has not
included any notional amounts for the time value of money in its
calculation for the purposes of the 90 percent recovery test. The
minimum lease payments also exclude the fair value of maintenance
services included in the leasing arrangement. Any contingent rents
receivable under the ongoing rental payments are also excluded. The
leasing arrangements generally do not include any guarantees by the
lessee or any other party of the residual value of the equipment at
the end of the lease term or any penalties for failure to renew or
extend a lease at the end of the lease term.
The minimum lease payments are discounted at the implicit rate in the
lease. The implicit rate is as defined in paragraph 5(k) of SFAS 13,
as the discount rate that when applied to the minimum lease payments
excluding executory costs paid by the lessor, together with profit
thereon, and the unguaranteed residual value accruing to the benefit
of the lessor, causes the aggregate present value at the beginning of
the term to equal the fair value of the leased equipment to the lessor
at the inception of the lease.
Fair Value:
The fair value of the equipment under lease is defined in paragraph
5(c) of SFAS 13 as the amount of consideration that would be agreed
upon in an arm's-length transaction between willing parties.
As previously indicated, the Company also sells its theater systems
components to customers and has on occasion sold individual components
to customers as well. As such, the Company uses its sales transactions
as the basis to derive fair value of the same or similar components
under lease. The Company will also make allowances for pricing
variations applicable to different geographic territories (for
example, North America as opposed to Asia or Europe) and the pricing
impact of different configurations of the various components in
assessing fair value. As an indication of volume in a given year, of
the 45 arrangements signed for the sale or lease of theater components
in 2005, 29 of these arrangements were sales transactions.
Unguaranteed Residual Value:
The unguaranteed residual value is also deducted from minimum lease
payments in deriving the implicit interest rate in the lease. In
assessing the unguaranteed residual value at the end of the lease
term, the Company looks to the approximate salvage value of the
equipment taken back at the end of the typical lease term. In the
Company's estimation, this residual value is no greater than the cost
of certain component parts of the equipment leased that can be used or
salvaged to maintain the existing installed base. The Company
currently estimates this amount to be no greater than $50,000 at the
end of a typical lease term.
2. COLLECTIBILITY OF THE MINIMUM LEASE PAYMENTS IS REASONABLY PREDICTABLE
AS OF THE INCEPTION OF THE LEASE.
SFAS 13, paragraph 8(a) indicates that collectibility of minimum lease
payments should be "reasonably predictable". At the same time, it
indicates that a lessor shall not be precluded from classifying a
lease as a sales-type lease simply because the receivable is subject
to an estimate of uncollectability based on experience with groups of
similar receivables.
The assessment of collectibility is to be done at the time of entering
into a lease arrangement. Where issues of potential collectibility
arise subsequent to this point in time, these factors do not change
the original assessment of lease classification under SFAS 13. When
the Company enters into a lease arrangement, it performs a credit
review on the customer to assess the collectibility of the lease
25
payments as contemplated under the arrangement when compared to the
risk associated with collection of similar receivables. The outcome of
this review and the signing of a new agreement to enter into an
arrangement support these criteria.
3. NO IMPORTANT UNCERTAINTIES SURROUND THE AMOUNT OF UNREIMBURSEABLE
COSTS YET TO BE INCURRED BY THE COMPANY UNDER THE LEASE.
The assessment of this third criterion is done again at lease
inception and requires a specific review of the arrangement at the
time of inception. Generally, the Company will not guarantee
performance of the equipment beyond its typical representations and
warranties outlined in the sample agreement. These representations and
warranties are also discussed in more detail to the response to
comment #15. The costs associated with these representation and
warranties are nominal and not material. The Company also does not
guarantee or commit to product upgrades in its typical leasing
arrangements post installation of the equipment. The equipment
components leased are standard products, the costs of which are known
at the time of lease inception. Even though the Company is the
manufacturer of certain components under lease, SFAS 23, paragraph 7
indicates that the criterion in paragraph 8(b) shall be applied at the
date construction of the leased equipment is complete or acquired by
the lessor. At that point, the Company has no uncertainties as to the
costs of the equipment provided under the lease.
OTHER CRITERIA:
The lease components of the arrangement generally do not transfer the
ownership of the equipment to the customer at the end of the lease term or
include bargain purchase options. In some cases, the lease term is equal to
75 percent or more of the economic life of the leased properties. The
Company recently has determined the economic life generally to be 10 to 15
years, based on technological developments of the equipment. However, in
the past, the Company considered the economic life to be 20 years as
supported by the life of equipment in the existing installed base that has
been in operation for that period of time. Depending on the individual
lease, in certain cases, leases would also qualify as sales-type leases if
the criteria in paragraph 7(c) of SFAS 13 are met. However, the Company
rarely uses the lease term test for classification purposes.
If a lease does not meet the criteria for classification as a sales-type
lease, it is accounted for as an operating lease.
Installments of initial rent received prior to supervision of installation
of the theater components are recorded on the balance sheet as deferred
revenue and are also determined to be minimum rent payments as defined in
SFAS 13 as indicated above.
ACCOUNTING FOR SALES-TYPE LEASES
The following paragraphs explain how the amounts were recorded in the
accounts of the Company. The recognition point for recording these amounts
is discussed later in this section.
As previously noted in this letter, the payment streams associated with the
Company's arrangements include payments received prior to the delivery of
systems components and performance of services and payments received
subsequent to delivery of some or all of the systems components and
performance of some of the services. For convenience, the Company allocates
all future payments to be received (initial rent and the fixed portion of
additional rent) to the initial deliverables in the contract, generally the
leased systems components. Amounts related to future deliverables (i.e.,
maintenance services, future equipment or film deliveries, marketing
credits, etc.) are allocated and deferred against initial rent
26
payments received and therefore are retained in deferred revenue until the
future deliverables are performed. As explained in the response to comment
#7, the aggregate amounts would be allocated between SFAS 13 elements and
non-SFAS 13 elements based on relative fair values. Within the leased
property components under SFAS 13, the Company follows the guidance in EITF
00-21 and allocates the leased property consideration between future
deliverables and delivered items. Future deliverables are valued at fair
value as outlined in the response to your comment #7. The residual amount
of the consideration is allocated to the delivered items. The Company
believes it is appropriate and consistent with the guidance in SFAS 13,
paragraph 27 that the Company estimate the amount applicable to each
component based on whatever means are appropriate in the circumstances.
In accordance with paragraph 17(a) of SFAS 13, the Company generally
recorded as a gross investment all of the future ongoing minimum lease
payments. The Company has determined upon further review that the gross
investment as at December 31, 2005, included both the unguaranteed residual
value of all the component systems and the related future minimum lease
payments, even though the recognition point for certain of the component
systems had not occurred. The Company also has determined that total
initial rent amounts not yet due under the arrangements were included in
accounts receivable as at December 31, 2005.
Both the initial rent amounts not yet due and the fixed portion of the
additional rents related to only the delivered equipment should have been
included in the gross investment. A portion of these future minimum lease
payments and a portion of the residual value related to equipment for which
the recognition point had not occurred should not have been included in the
balance sheet until the recognition point had occurred. The Company has
concluded these differences would not be material (as the effects would be
an overstatement of assets and deferred revenue of $154,000, as at December
31, 2005).
In accordance with paragraph 17(b) of SFAS 13, the Company initially
recorded unearned income as the difference between the gross investment as
noted above and the net present value of the fixed portion of additional
rent and the unguaranteed residual value of all component systems. These
computations should have only included the unearned income related to the
initial rent payments not yet due and the fixed portion of additional rent
for the component systems for which the amounts were recognized during the
period. The majority of initial rent payments not yet due as at December
31, 2005, were due within one year after period-end, thus the Company
believes that present valuing these payments would not have a material
impact on the balance sheet at December 31, 2005. While the total amount of
the gross investment and unearned income disclosed in the notes to the
consolidated financial statements are understated and overstated
respectively, the Company does not believe this to be material (the
additional amount of the gross investment and unearned income, including
initial rent recorded in accounts receivable, should have been $233,000 and
$118,000, respectively).
In accordance with paragraph 17(c) of SFAS 13, the Company records as
revenue the net present value of the fixed amount of additional rent for
all component systems plus the total initial rent under the contract less
the amounts allocated to future deliverables such as initial maintenance
(based on fair value of such services) and future equipment (such as screen
systems based on the fair values of such equipment). The costs of sales are
recorded for costs of the component parts delivered less the net present
value of the unguaranteed residual value of all of the component parts. In
addition, all initial direct costs related to the arrangement are reflected
in the cost of sales when the revenue related to the initial deliverables
is recorded.
Paragraph 17 of SFAS 13 does not address the recognition point for leased
property. Further, the Company has not found any other specific reference
to the recognition point for sales-type leases. The Company has noted that
FTB 88-1, Issues Related to Accounting for Leases, indicates that a lessee
27
should consider the lease term to commence when the lessee has control and
possession of the leased equipment. Due the lack of explicit guidance in
SFAS 13 for the recognition point for sales-type leases, the Company has
referred to the delivery and performance guidance in SAB 104.
For leased property, as the Company has an obligation to provide the
customer with any technical improvements developed up to the installation
date, the Company has viewed the installation date as the appropriate
recognition point as the Company will have substantially completed its
obligations related to the specific components. While the Company may be
obligated to complete certain testing and alignments subsequent to that
date, the Company views these items as being perfunctory and
inconsequential. See the detailed response to comment #7 and the sections
captioned "Substantially complete, Remaining obligations and Acceptance
provisions" in comment #14 for a further explanation of this point.
While its arrangements refer to customer acceptance, the Company does not
view acceptance as a critical factor in determining the recognition point
because the components leased are subject to Company determined
specifications for the equipment, which have been met and tested for in the
Company's facility before shipment of the leased components. As outlined in
SAB 104, Topic 13.A.3.b, the SEC staff acknowledged that formal customer
sign-off is not always necessary. The Company's situation is similar to
form (c) in the question in that the specifications are objective criteria
established by the Company. For further discussion on acceptance, see the
Company's response to your comment #14.
For initial maintenance services, the Company recognizes such revenue on a
straight line basis over the period of the no-charge services. This
approach is consistent with FTB 90-1. All costs to perform the maintenance
services are expensed as incurred.
Finance income on sales-type leases is recognized over the terms of the
lease using an effective interest rate method as required under SFAS 13,
paragraph 17(b).
Modifications to sales-type leases are covered in comments #11 and #12.
COLLECTIBILITY ISSUES
As disclosed on page 32 of the Company's 2005 Form 10-K, there are certain
risks that future payments may not be collectible due to changes in
circumstances and credit conditions with respect to the Company's
customers. The Company has addressed how it analyzes these matters when
classifying leases at the time of lease inception.
When issues of potential collectibility arise subsequent to commencement of
the lease term, the valuation of both the Company's accounts receivable and
net investment in leases ("NIL") are assessed following the requirements of
FASB Statement No. 5, Accounting for Contingencies. Lease receivables are
specifically excluded from the scope of FASB Statement 114, Accounting by
Creditors for Impairment of a Loan, and the Company therefore does not
apply that statement to its assessment of collectibility of the NIL.
In conjunction with financial difficulties faced by its customers (as noted
in more detail on page 32 of the 2005 Form 10-K), the Company recorded
provisions of $13.6 million in 2001 against existing NIL. All of these
provisions were against leases where the equipment components were
previously installed. Many of these customers have since recapitalized or
their leases were modified or amended with subsequent accounting effects
noted in SFAS 13, paragraph 17(f). At the time of lease inception,
collectibility was reasonably predictable.
28
INSURABLE RISK
The Company's contracts with its customers require the customer to obtain
insurance coverage for the equipment commencing on the date the equipment
is delivered and ending on the date the equipment is delivered back to the
Company at the termination or expiration of the lease. Delivery date is
typically defined in the contracts to mean the delivery date of the system,
the components of which are specified in the contract or a date agreed to
between the Company and the customer. These dates generally correspond to
the date the equipment is received by the customer.
The Company is reviewing its disclosures in light of this comment.
10. We note that "ongoing rental payments ...are generally equal to the greater
of a fixed minimum amount per annum and a percentage of box office income."
Please tell us how this meets the requirements of SAB 104, that fees must
be fixed and determinable in order to be recognized as revenue.
As noted above in the response to comment #6, the substance of the ongoing
rental payments is a base minimum rental amount that is required to be paid
by theater owners irrespective of the volume of sales with an incremental
amount if box office income exceeds the base minimum.
For leasing arrangements, the Company believes that, consistent with the
guidance in paragraph 1 of SAB 104 that requires application of specific
authoritative literature that covers a transaction, the relevant guidance
to consider for rental payments is SFAS 13. SFAS 13, paragraph 5(n) defines
contingent rentals.
SFAS 29 amended SFAS 13 by adding paragraph 5(n) which states, in part and
clarifies that "lease payments that depend on a factor directly related to
the future use of the leased property, such as machine hours of use or
sales volume during the lease term, are contingent rentals ..." Further,
paragraph 17(b) of SFAS 13, as amended by SFAS 29, states that "contingent
rentals shall be included in the determination of income when accruable".
In SAB 104, under the topic of contingent rental income, the Staff stated
that contingent rent income should be recognized when changes in the
factors on which the contingent lease payments are based actually occur.
The Company includes only the fixed minimum amount in its determination of
minimum lease payments in classifying the lease and recognizing either
sales revenue under sales type leases or rental income on a straight-line
basis under operating leases. The Company only recognizes additional
ongoing rental income from the incremental percentage of box office income
when theaters report that minimum amounts are exceeded and collection is
reasonably assured. This is consistent with guidance in SFAS 13 and SAB
Topic 13A, Revenue Recognition - Selected Revenue Recognition Issues,
Question 8 which indicates base rents may be included in minimum lease
payments; however contingent rents should generally be excluded and only
recognized when the change in the factors on which the contingent lease
payments are based actually occur.
For sales transactions that have similar provisions for contingent payments
based on box office income, the Company recognizes revenue on the same
basis as the Company does for contingent rental payments. The Company
believes this accounting is consistent with the guidance in SAB 104, that
contingent revenue should be recorded in the period in which the
contingency is resolved.
11. We see that in certain situations, you and the lessee agree to change the
terms of the lease agreements, other than by renewal or extension.
29
- Describe your accounting for the change in terms of the lease and cite
the accounting literature upon which you relied.
- Tell us what terms are typically changed.
- Quantify the impact these modifications have had on your statement of
operations and balance sheet in the period presented.
- We may have additional comments after reviewing your response.
For purposes of this comment, the Company has considered only change in
provisions to leases other than renewals or extensions permitted under the
existing lease arrangements. Terms that may typically be changed in a lease
arrangement include:
1. Change in timing and amount of payments;
2. Offering incentives (such as marketing credits or films) to
induce the customer to commence timely installation of the
component systems;
3. Termination of the lease after the lease term has commenced;
4. Termination of lease arrangements before the lease term has
commenced; and,
5. Changes in the equipment to be provided under a lease before the
original component systems are delivered.
Items 4 and 5 are covered in the response to comment #12.
Any changes in the timing and amount of minimum lease payments require the
Company to consider the guidance in paragraph 9 of SFAS 13. The provision
of any incentives, such as marketing credits, to induce customers to
install equipment is considered to be a change in the amount of the minimum
lease payments and is deducted from minimum lease payments. In accordance
with paragraph 9, the Company will reconsider the classification of the
leases as of the original inception date with the original terms in effect
from the inception of the lease to the date of the change, and the revised
terms in effect from the date of the change to the end of the lease. The
assumptions used in this reconsideration such as fair value and residual
are the same as those used in the original analysis at the inception of the
lease. The Company will also consider whether the classification of the
lease would be different from the date of the change forward, as if the
arrangement was a new lease. The assumptions used to consider the
classification to the new lease are those relevant at the inception of the
change. If both these two tests are passed then the Company will continue
to account for the arrangement as a sales-type lease.
For sales-types leases, the Company accounts for any modification to
provisions of the lease in accordance with the provisions of SFAS 13,
paragraph 17(f)(i). If the classification of the lease does not change
(i.e., the lease is still a sales-type lease), the Company will adjust the
balance of minimum lease payments receivable, if applicable, and the
estimated residual value, if affected, and the net adjustment is charged or
credited to unearned income. If the classification of the lease does change
to an operating lease, the Company will remove the remaining net investment
from its accounts, record the leased property at the lower of original
cost, fair value or present carrying value and charge any net adjustment to
income.
Lease terminations after installation of the systems components are
accounted for in accordance with SFAS 13, paragraph 17(f)(iii) whereby the
net investment in the lease is removed from the accounts, the leased asset
returned is recorded at the lower of original cost, present fair value or
present carrying value, and any net adjustment is reflected in the income.
The impact on the financial statements due to the modifications or
terminations of leases is as follows in the periods presented:
30
2005 2004 2003
---------- --------- ---------
P&L IMPACT - GAIN (LOSS)
- Impact from change in payment terms 700,750 1,683,804 3,769,096
- Impact from lease terminations 658,923 83,600 --
- Impact from change in lease term -- -- --
- Impact from lease terminations due to sale 3,333,777 581,148 --
of equipment to customer
---------- --------- ---------
4,693,450 2,348,552 3,769,096
P&L PRESENTATION - GAIN (LOSS)
- IMAX systems revenue 6,256,390 1,915,317 --
- IMAX systems cost of sales (2,156,880) (618,852) (33,539)
- Receivables provision net of recoveries 593,940 1,052,087 3,802,635
---------- --------- ---------
4,693,450 2,348,552 3,769,096
BALANCE SHEET IMPACT - DR (CR)
- Cash and A/R 7,997,077 3,444,495 430,690
- Inventory 96,632 427,245 387,822
- Fixed Assets (1,795,934) (835,775) 149,035
- NIL (1,604,325) (687,413) 2,801,549
---------- --------- ---------
4,693,450 2,348,552 3,769,096
12. We note that you recorded $11.7 million and $12.3 million in fiscal 2005
and 2004, respectively, relating to "consensual lease buyouts." Please
address the following:
- Tell us in detail how you account for these lease buyouts and cite the
accounting literature upon which you relied. Specifically distinguish
between leases in default and upgrades to MPX systems.
- Explain why presentation as a component of operating income versus
non-operating income is appropriate.
- Describe any expenses associated with the lease buy-outs and explain
where they are recorded.
CONSENSUAL BUYOUTS
The Company considers each contract in backlog to represent a binding and
valid agreement with a customer. From time to time, the Company has had
customers who, for a number of reasons including the inability to obtain
certain consents, approvals or financing, were unable to proceed with
theater construction. Once the determination was made that the customer
would not proceed with installation of the theater components, the
arrangement with the customer was generally terminated and removed from
backlog.
As explained in the previous responses in this letter, a customer would
have typically made upfront payments under the arrangements, which were
included deferred revenue. This deferred revenue is generally
non-refundable, however, in certain cases, refunds of some of the amounts
may have been made.
Where contracts are terminated or settled in advance of installation of the
component systems, any non-refunded deferred revenue in respect of this
contract is recognized in income. The Company applies the requirements of
SFAS 140, Accounting for Transfers and Servicing of Financial Assets and
31
Extinguishment of Liabilities, in determining the recognition point for
such amounts. Paragraph 16 of SFAS 140 states that a liability can only be
derecognized when "the debtor is legally released from being the primary
obligor under the liability, either judicially or by the creditor".
Paragraph 315 of SFAS 140 indicates this pronouncement should apply to all
types of liabilities (including deferred revenue by the definition in FASB
Con. 5, paragraph 84 noted above). As such, the Company only recognizes
deferred revenues on termination or cancellation of its lease and sale
contracts when the provisions of SFAS 140 have been satisfied. In the case
of a consensual buyout, this occurs when both parties have agreed in
writing to release each other of its liability or a settlement has been
agreed to. Where additional cash amounts are to be paid under the
settlement, these amounts are recorded when settled and received.
Lease terminations after installation of the theater components are
accounted for in accordance with SFAS 13, paragraph 17(f)(iii), as
applicable.
LEASE AGREEMENTS IN DEFAULT
In addition, the Company will have customers who fail to comply with the
terms and conditions of their agreement, resulting in a default under the
agreement. In these cases, the Company exercises its rights under the
agreement to terminate the agreement. When the Company is judicially
released of its obligations under the agreement or a settlement is awarded
or negotiated, the Company will derecognize its liabilities under SFAS 140.
The main difference here is that the release of obligations under the lease
or sale is done judicially, by court settlement, or by an award under
binding arbitration.
UPGRADE TO MPX SYSTEMS
In 2003, the Company introduced a new type of projector system referred to
as the MPX system. Both the features and size of the components have
resulted in certain customers requesting to terminate the original
agreement and enter into a new agreement for the MPX components. When these
transactions occur, the Company has generally legally terminated the
original agreement related to the 3DSR and 3DGT equipment components and
entered into a new lease for the MPX system. As a result, where the new
arrangement is a new lease, the Company has applied the applicable
paragraphs of SFAS 13 to determine the classification of the lease and
record the lease arrangement. At the inception of the MPX lease, the
Company applies the guidance in SFAS 13 to determine the classification of
the lease and the relevant accounting for the lease.
The Company acknowledges that its facts and circumstances are not
specifically addressed in SFAS 13 and that it is often difficult to
differentiate between a termination and a modification of a lease contract.
The Company considered a number of additional factors in determining that
the leases related to the 3DSR and 3DGT equipment were terminated and new
leases were entered into for the MPX equipment as follows:
- While both leases relate to projection components, the nature,
size and functionality of the 3DSR and 3DGT projector components
and the MPX components are different. The MPX components are
significantly smaller than the 3DSR and 3DGT components and have
been designed for specific use in existing multiplex theaters.
Accordingly, a stand alone, separately specified and constructed
theater is no longer required. The MPX components were designed
based on new non-mechanical technologies versus the older more
mechanical 3DSR and GT components. The operating costs of the MPX
components are also significantly lower than the 3DSR and GT
systems. Accordingly, the Company does not consider the new lease
to be for the same or substantially the same asset.
32
- The fair values of the equipment under the original lease (fair
values range from $2.3 million to $3.6 million as of the date of
the original lease signings) and the MPX components under the new
lease (fair values range from $1.4 million to $1.5 million as of
the date of this letter) in these transactions under discussion
are substantially different. The fair values for the MPX
components in these transactions are comparable to sales of MPX
components where no other deliverables, concessions or
terminations were involved.
- The present value of the cash flows required under the original
lease using the implicit rate in that lease and the present value
of cash flows required under the new lease using the implicit
rate under the old lease were substantially different. If the
present values under each of the leases differed by more than
10%, the Company considered the old lease to be terminated. The
Company based this analysis on literature similar to the
accounting for the modification or exchange of debt instruments
(EITF 96-19).
Based on the above factors, the Company concluded that the two leases were
substantially different, and that the old lease was terminated. All these
upgrades have occurred prior to any installation of the 3DSR and 3DGT
component systems to the respective customers. As a result, the Company
would not have recorded any net investment in the lease. In considering the
accounting for these terminations, the Company referred to paragraph 17(f)
(iii) of SFAS 13. This paragraph contemplates the removal of the accounts
related to the terminated lease (e.g. the net investment in the lease) and
recognition of the assets exchanged for the lease (e.g. the returned
property). Applying this guidance by analogy, the Company effectively
removed the accounts related to the old lease and recorded the accounts
related to the new lease. The change effectively resulted in the deferred
revenue originally related to the 3DSR or the 3DGT systems being reduced to
the amount that would have been expected to be received if the original
order was for a MPX system. The resulting difference was reflected as a
gain in the income statement. The Company believes that since the customer
has agreed to no longer receive the 3DSR or 3DGT equipment, to terminate
the existing lease and to enter into a new lease for the MPX components,
the Company's original obligation to provide the 3DSR or 3DGT equipment has
been extinguished, as the Company is legally released by the customer.
Consistent with SFAS 140, paragraph 16, the Company believes it has
extinguished its liability under the old lease and should derecognize this
obligation.
CLASSIFICATION OF INCOME
Because these types of transactions have been a recurring part of the
Company's business, related revenues generated are classified as a
component of operating income. The Company has provided transparency on
these amounts by including disclosure in the notes to the financial
statements.
EXPENSES RELATED TO SETTLEMENT REVENUES
It is the Company's policy to defer incremental costs related to a sales
transaction when revenue is deferred until the installation of the relevant
system components is substantially complete. These costs included sales
commissions and project management costs, such as architectural design
services and consultations on theater specifications and design, travel
costs and salaries of appointed project managers for the theater in
question. All of these identified costs are system specific and are
incurred between the signing date and termination of the arrangement in
question. The Company assesses the identified deferred costs at the date of
settlement to determine whether certain costs are eligible for deferral as
they relate to the MPX installation.
The Company has noted one exception to the above-noted policy in 2004, when
$65,000 of costs primarily related to sales commissions earned were
expensed instead of being deferred until the revenue was recognized under
the new arrangement.
33
In all other cases, costs ranging from $58,000 to $157,000 were deferred,
as the Company believes these costs are direct incremental costs of
originating the lease arrangement.
In addition, there are significant costs to negotiate the original terms of
the arrangement, prepare and process the legal documents, close the
transactions, monitor the customer's progress in construction of the
theater, monitor the customer's other obligations under the contract and
investigate options for both parties when the customer can not meet its
original obligations under the arrangement. Since these are internal costs
(e.g. salary and benefits), the costs are expensed as incurred. These types
of costs are not treated as origination fees in the arrangements but are
simply treated as a period cost.
The specific costs noted above also do not include the costs that are
charged to inventory to construct the original equipment components. The
costs of constructing the original equipment components continue to be
carried in the Company's inventory after the arrangement is terminated, as
the system can be used to satisfy obligations to deliver and install
against backlog contracts with different customers. The Company reassesses
net realizable value of the related inventory at the point the original
lease is terminated to ensure the original equipment components can be
redeployed.
SALES OF THEATER SYSTEMS, PAGE 65
13. We note on page 31, that ten theater systems have been installed in 2005
and are expected to open in 2006. Please tell us when you recognized
revenue for these systems and cite the authoritative literature upon which
you based your accounting.
The Company has prepared a chart, attached as Exhibit D, that lists the
revenues for the ten installations noted where certain elements of the
contracts were recognized in 2005 and opening of the theater was not
expected until 2006.
The Company refers you to the detailed responses to comments #7 and #9 and
#14 with respect to the main authoritative literature it has relied on in
accounting for these components installed in 2006.
14. In this regard, we note that you recognize revenue from sales of theater
system elements when installation of the system is substantially complete.
- Please explain what you mean by "substantially."
- Describe all remaining installation obligations and explain your
reasons for concluding that they are not essential to the
functionality of the theater.
- Describe any contractual acceptance provisions you have with the
customer.
- Document for us how you have met the criteria outlined in SAB 104 to
recognize revenue.
SUBSTANTIALLY COMPLETE
For purposes of recognizing revenue for sales-type leases and sales, the
Company considers the installation process for the individual theater
systems components, as identified in the response to comment #7, to be
substantially complete when the following criteria have been met when
measured against the agreement between the Company and the customer, which
determines the Company's responsibilities and obligations:
- Obligations identified in the governing agreement with the customer
have been satisfied such that any residual obligation meets the
definition of inconsequential and perfunctory, as set out below.
34
- The Company's technology department determines that the systems
components, as installed by the customer, will function in accordance
with their specification, as detailed in Schedule A.
- All significant issues raised by the customer have been resolved.
Insignificant issues meet the definition of inconsequential or
perfunctory, as set out below.
In assessing whether the installation is substantially complete, the
Company considers its obligations in the contract between Company and the
customer. The Company assesses these obligations and determines whether the
Company has substantially satisfied its obligations to the customer. Upon
substantial satisfaction of the obligations, as they relate to the
individual components of the theater system, the Company recognizes revenue
for that individual component, otherwise revenue is deferred until
substantial satisfaction is achieved.
REMAINING OBLIGATIONS
In the process of supervising an installation, the Company's personnel may
determine certain parts are defective or damaged and require replacement or
repair. The Company considers such situations to be part of the Company's
warranty.
For other remaining obligations, the Company considers whether the
obligations are inconsequential or perfunctory. To be inconsequential or
perfunctory, the completion of the remaining obligation cannot
significantly change or alter the agreed-to performance capabilities of the
theater systems' components. In other words, the obligation to be completed
must not be essential to the functionality of any of the components to be
provided by the Company under contract. SEC Topic SAB 104 A.3.c., Questions
1, 2, and 3 further clarifies the definition of an inconsequential or
perfunctory obligation as one where:
- The Company has a demonstrated history of completing these remaining
tasks in a timely manner and can reliably estimate the remaining
costs;
- The skills or equipment required to complete these tasks are not
specialized and are readily available in the marketplace; and,
- The time required to complete these tasks is not lengthy and the
remaining costs are insignificant and not material based on an
assessment of revenues, margins and operating income.
The following outlines the outstanding installation obligations as at
December 31, 2005 relating to the delivered components for the Company's
ten theater arrangements for which revenue was recognized in the 2005
financial year and for which the obligations were considered to be
perfunctory and inconsequential or part of the Company's warranty:
35
LABOR AND PARTS COST
THEATER SYSTEM TO COMPLETE OR TO
OUTSTANDING OBLIGATION COMPONENT COMMENTS SUPERVISE COMPLETION
- ---------------------- -------------- -------- --------------------
WARRANTY ITEMS
Digital Disk Player Projection DDP interface issues with a new 3-D projector $225 to $300
(DDP) interface repair System will be fixed on the first service call.
These issues do not affect operation and are
very minor repairs. The interface repair does
not affect functionality of the projector
system component as the theater in question
was open and showing films on January 2,
2006. This item is considered to be a
warranty item.
Cosmetic Coolant Projection Minor cosmetic-only repairs were required to $1,300 to $1,600
Conditioning Unit System the projector's CCU unit. These repairs were
(CCU) repairs to be performed at the first service call.
This was considered to be a warranty item.
Retest lower lens Projection The Company was to retest the focal length of $75 to $150
focal length System the lower lens of the projector unit to
ensure that a perfectly focused image
appeared on the final screen, subject to the
screen's installation. The existing lens
setup projected an image that was in focus to
the human eye, but the Company's advanced
diagnostic tools had indicated a
non-discernable variance in the focal
lengths. The variance would not impede the
showing of films to the public. The Company
views any adjustments to the focal length of
its lenses to be a warranty item.
LABOR COST TO
THEATER SYSTEM COMPLETE OR TO
OUTSTANDING OBLIGATION COMPONENT COMMENTS SUPERVISE COMPLETION
- ---------------------- -------------- -------- --------------------
INCONSEQUENTIAL OR PERFUNCTORY TASK
Projector lens exchange Projection On occasion, the projector system component's See Comments for
System lenses may require an adjustment, or an time frame. Cost is
on-site inspection of the customer's theater minimal.
interior reveals that a different lens would
perform better. The Company's lenses are
designed to be quickly replaced by the
projectionist with a time estimate of a few
minutes, and as such, the Company views the
exchange of projector lenses to be an
inconsequential and perfunctory task. The
lenses, which were on site as at December 31,
2005, provided an adequate image that
performed to the original specification.
Replacement was required in this instance as
the customer requested a larger screen than
originally specified and installed.
36
GCM hookup Glasses The machine required hookup to electrical $300 to $450
Cleaning power and plumbing. The Company views this as
Machine perfunctory and inconsequential given that
the machine was on-site, expertise is not
required to hook up the machine (the hook up
is rudimentary and relatively simple), the
time required to supervise and review the
hook up of the machine is not lengthy, and
the remaining related costs of supervision
are not significant on an assessment of
revenues, margins and operating income.
Final alignment and Projection Upon installation of the final screen system $3,600 to $6,300
tuning System and component, the alignment of the projector
Sound System must be rechecked. In addition, upon
completion of the interior of the theater by
the customer, sound system levels must be
adjusted. The Company has performed these
steps at the majority of the installations in
the network; therefore, it can demonstrate
its history of completing this task on a
timely basis with known costs. Third party
vendors are also available to perform these
remaining obligations and have done so in the
past, and the costs of the alignment and
tuning are not significant to the
arrangement's revenues, margins or operating
income. The estimated costs of the alignment
and tuning were accrued at December 31, 2005,
where applicable.
Supervision of the Sound System The rear speakers could not be placed in $1,200
hanging of rear their final position due to the customer's
speakers ongoing work on the theater's interior
finishings (a specified customer obligation).
The rear speakers were fully wired and
functional. The Company views this obligation
as inconsequential and perfunctory, as the
supervision of the speaker hanging process is
simple and expertise is not required for the
task to be performed, the cost of supervision
is insignificant to the arrangement's
revenues, margins and operating income, and
the lapsed time between wiring and
installation of the sound system component
and the hanging of the rear speakers was not
significant. Again, the Company simply
supervises the installation thereof.
Install Polarizers Projection The customer had not indicated at the time of See Comment for time
System shipment which of the two types of 3-D frame. Cost is
glasses the theater would be using. As a minimal.
result, the appropriate polarizering filters
could not be installed on the projector
before the projector had been shipped to the
customer. The appropriate polarizers were on
site at the recognition date. The
installation of polarizers is a simple manual
process that involves placing the filter in
front of the lens and can be performed
rapidly, as all the projector systems are
designed for the rapid exchange of polarizers
on the lenses. The projector system component
was functional at this time.
37
Quick Turn Reel Unit Projection The projection system's QTRU unit was $600
(QTRU) Positioning System installed with the projector; however, final
positioning of the unit was undetermined. The
Company views this remaining obligation to
reposition the QTRU as inconsequential and
perfunctory as the cost of completing the
obligation is insignificant to the
arrangement's revenues, margins and operating
income. Again, the Company simply supervises
the installation thereof.
The above table represents the total cost of the labor hours and parts
required by the Company's installation supervisor to complete, or to
supervise the completion of, the remaining warranty repair on an individual
item basis and the total cost of the labor hours required by the Company's
installation supervisor to complete, or to supervise the completion of, the
remaining obligation. The cost above do not include any other charges that
may have been incurred during the trip to finalize the items above, such as
travel time, travel costs such as airfare, accommodation and per diems,
final project management documentation, freight charges or any other costs.
These additional costs were accrued at period end.
The above table also does not include training services, which were
considered to be separate elements for which the services were not
completed but revenue was recognized in the year ended December 31, 2005.
As explained in the Company's response to your comment #7, the amounts
related to these services were not considered material. The table also does
not include the Company's obligation to potentially re-install the
components of one arrangement for which the fair value related to the
revenue for re-installation was deferred, nor the Company's obligations to
deliver and supervise the installation of the screen component, where that
unit of account was considered not substantially complete by the Company.
ACCEPTANCE PROVISIONS
As set out in the Sample Contract (Exhibit B), the contract includes a
definition of "Date of Acceptance" which means "the earlier of (a) the date
on which IMAX certifies to Client and Client is in agreement (which
agreement will not be unreasonably withheld or delayed) that the training
of personnel, installation and run-in testing of the System is complete;
(b) the date on which the Theater is opened to the public; and (c) [Date]".
The date in (c) generally would be a specified date agreed to by the
Company and the customer. This Date of Acceptance is used to determine
certain end dates or pricing adjustment dates (see clauses 3.02, 3.03,
4.01(a), 4,02(b), 6.01(a), 6.01(b), 6.02, 6.04 and 6.05(e)). The only other
reference to acceptance is in the Schedule accompanying the Sample
Contract, section 3.3.5, which sets out certain acceptance criteria to be
used by IMAX to determine whether the theater is acceptable. While the term
is used as noted in the preceding sentences, the contract does not require
a written acknowledgement from the customer on any of the theater
components or services. While the Company does document the acceptance by
the customer of the theater components, the Company does not consider this
to be a substantive acceptance procedure for purposes of determining the
revenue recognition point for the various system components. SAB 104, Topic
13.A.3.b, Question 1(c) discusses in detail that formal customer sign-off
is not necessary to recognize revenue provided that the seller can
objectively demonstrate that the criteria specified in the acceptance
provisions are satisfied. In advance of delivery to the customer, the
Company builds, tests and performs run-in testing of the projector and
sound system components in accordance with its specifications pre-shipment
by replicating conditions under which the customer intends to use the
components. The Company inspects the unpacking of its systems components at
the customer site. The Company also performs testing at the customer site
in
38
order to ensure the components meet the specifications outlined in the
contract. Based on years of experience in the design and construction of
the theater components and supervision of installation of the same, the
Company believes that it can demonstrate that the delivered products will
meet the Company's specifications in advance of its final installation.
Based upon these factors noted, the Company does not consider that formal
customer acceptance is required in order to recognize revenue under SAB 104
consistent with the guidance in Topic13.A.3.b.Question 1, (c), Acceptance
provisions based on seller-specified objective criteria.
OTHER RIGHTS UNDER THE CONTRACT
In the response to your comment #6, the Company has outlined other rights
typically included in a contract and has provided comments as to the impact
of those rights on the recognition of revenue.
COMPLIANCE WITH SAB 104 CRITERIA
In accordance with SAB 104, the Company recognizes revenue related to sales
of theater components when the installation process is substantially
complete and all of the following criteria have been met:
- Persuasive evidence of an arrangement exists;
- Delivery has occurred or services have been rendered by the Company,
irrespective of the eventual commencement date of the customer's
revenue-producing activities;
- The seller's price to the buyer is fixed or determinable; and,
- Collectibility is reasonably assured.
The Company believes that it has satisfied all the criteria outlined within
SAB 104 to recognize revenues related to the sale of theater components
under its arrangements as explained below.
PERSUASIVE EVIDENCE OF AN ARRANGEMENT
The Company has fully negotiated and executed original agreements for each
revenue arrangement that outlines all material terms and conditions of an
arrangement between the Company and its customers. Where terms of the
original agreements are amended in advance of the substantial completion of
installation of the system components, the material terms and conditions of
the amendment have been negotiated and agreed to before the point of
revenue recognition and have been ultimately documented and signed either
before the point of revenue recognition or shortly thereafter. In certain
instances, including in the fourth quarter of 2005, the Company agreed to
the material terms of modifications with the customer during the period,
but the documentation was finalized after the period ended. With respect to
one such instance, the written amendment to the agreement reflected a
marketing credit in the amount of $31,000, while the Company had reached an
agreement with the customer to provide a marketing credit of $25,000 at the
end of the quarter. The additional $6,000 represented a credit reimbursing
the customer for certain priority shipping costs, which was agreed upon
prior to December 31, 2005. For administrative ease, this reimbursement was
included in the amendment to the agreement. Accordingly, the Company
believes it has persuasive evidence of an arrangement.
AMOUNTS ARE FIXED AND DETERMINABLE
The amounts due to the Company are stipulated in the contract and any
related amendments where applicable. The amounts include fixed amounts, as
well as incremental amounts that are based on sales volume of the customer.
The timing of such payments is explained in the Company's response to your
comment #6. Contingent payments based on sales volumes over a specified
threshold are only recognized when the Company is advised of the related
sales volume and the sales volume exceeds the specified threshold. Any
payments not yet received on the date of recognizing revenue generally are
39
discounted using an interest rate as prescribed by APB 21, Interest on
Receivables and Payables. Accordingly, revenue is only recognized based on
fixed or determinable amounts.
The Company follows the guidance in EITF 00-21 and allocates the
arrangements consideration between future deliverables and delivered items.
Future deliverables are valued at fair value as outlined in the response to
your comment #7. The residual amount of the consideration is allocated to
the delivered items.
Finance income on long-term accounts receivable (included within "financing
receivables") is recognized over the term of the arrangement using an
effective interest rate method as required by APB 21, paragraph 15.
DELIVERY HAS OCCURRED
For each component, delivery is considered to have occurred when the
services related to supervision of installation for the components are
substantially complete. The Company's response to your comment # 7 provides
additional information on the Company's deliverables in each arrangement.
The Company has outlined the criteria it assesses to determine that
delivery has occurred earlier in this response to comment #14. The
applicability of acceptance criteria has been discussed earlier in this
response. Accordingly, the Company concluded that it is appropriate to
recognize revenue for the respective units of account for systems
components (as explained in the Company's response to your comment #7) when
the installation process is substantially complete. Upon substantial
completion and recognition of the revenue, the Company will accrue any
remaining costs of performance for that particular unit of accounting. The
Company's obligations under the contract are independent of the customer's
theater opening schedule, therefore situations can arise where systems
components can be fully recognized and all contractual obligations
satisfied prior to the date of the customer's theater opening to the
public.
COLLECTION IS REASONABLY ASSURED
The Company also assesses collectibility of any remaining payments at the
time of recognition of revenue. As noted elsewhere in this letter, the
Company receives approximately 50% to 70% of the total consideration in an
arrangement prior to the revenue recognition point. The Company carries out
credit procedures at the time of entering into the arrangement with the
customer to be satisfied with the customer's credit worthiness and reviews
any previous payment history to assess whether reasonable assurance of
collection of outstanding amounts can be made. Any new information about a
customer's credit worthiness is taken into account at each date revenue is
recognized under the arrangement.
15. Please tell us what you mean by the disclosure on page 78 that says "the
company has estimated under its lease and sale arrangements that there will
be no costs associated with contractual warranty provisions." Also tell us
how you account for the one year free maintenance period. If you have any
warranty costs explain how they are estimated at the time of shipment.
The Company provides representations and warranties in conjunction with the
specifications relating to the sale or lease of its systems components. It
also provides the customer with full service maintenance generally during
the first year of operations, as part of the overall arrangement
consideration. The Company typically provides the following representations
and warranties:
- Upon installation, the equipment components will operate in accordance
with the specifications, as defined in the arrangement ("product
warranty"). It is the Company's policy to inspect all
40
components and subassemblies, complete the final assembly and then
subject the components to comprehensive testing prior to shipment of
the components.
- If the customer participates in the Company's full-service maintenance
program, the Company warrants that the equipment will continue to
operate to certain specifications, which are defined in the
arrangement, for the duration of the customer's participation in the
program ("extended warranty").
The Company has historically not incurred any material costs in complying
with these representations and warranties as the Company's experience with
defective components is minimal. Any replacement of defective parts or
repairs under warranty has not been material. (The warranty items noted
above represent 0.01% of total costs of equipment installed for the year
ended December 31, 2005.) Therefore, the Company has not historically
set-up an accrual for warranty costs when the various components of a
system are recognized.
The Company defers revenue equal to the fair value of the free maintenance
service and extended warranty included in the overall arrangement
consideration and recognizes the revenue on a straight line basis over the
related maintenance period, as discussed in the responses to comments #6,
#7 and #9.
Further, the full service maintenance program includes both a product
maintenance contract as well as an extended warranty. The contract is
subject to separate annual renewal payments and is accounted for in
accordance with FTB 90-1. The revenue is deferred upon receipt and
recognized in income on a straight line basis over the contractual period.
The Company has not had to recognize a loss on these contracts as the sum
of its expected costs under the contracts has not exceeded any related
unearned revenue.
For clarification, in conjunction with the preparation of its 2006 annual
financial statements and in future filings, the Company will revise its
disclosure to state: "... no material costs associated with contractual
warranty provisions".
NOTE 4. FINANCING RECEIVABLES, PAGE 69
16. To assist us in understanding your financing receivables transactions and
with a view towards revised clearer disclosure for investors, please
address the following:
- Describe to us the facts and circumstances leading to the recovery of
financial receivables in all periods presented.
- Describe to us the transactions that resulted in the loans settled on
December 29, 2005 in exchange for payments to be received in the first
quarter of 2006, as discussed in footnote 2 of your Schedule II.
- Tell us whether the residual value is guaranteed. Refer to paragraph
23 of SFAS 13.
- Explain the accounting literature you are relying upon to include
"finance income on sales-type leases" under theater sale revenue.
- Tell us what "long-term receivables" of $8.8 million represents and
why the amount is included in financing receivables.
- Explain why your projectors have an economic life of 10-15 years, but
your lease term extends to twenty years.
- Provide a general description of the lessor leasing arrangement. Refer
to paragraph 23(c) of SFAS 13.
41
RECOVERY OF FINANCING RECEIVABLES
During the years ended December 31, 2000 and 2001, the Company recorded a
valuation allowance against its receivables (including lease receivables)
in the amount of $13.1 million and $18.1 million respectively. The Company
considered these allowances to be the Company's best estimate of the most
likely loss that would be incurred with respect to those receivables.
During the 2000 and 2001 periods, many of the commercial theater customers
were experiencing financial difficulties, with several of the customers
commencing Chapter 11 proceedings.
During the period from 2002 through to 2005, several of the customers
emerged from Chapter 11 proceedings. During this period of time, the
Company was successful in negotiating amendments to several of its
arrangements with certain customers, which resulted in the receipt of
payments, the termination of certain leases and the modification of other
leases. In addition, the restructuring of its customers' businesses
resulted in improved financial circumstances for those customers. In making
its reassessment of the allowance, the Company reversed allowances only
after the applicable modified arrangements were complete or settlements had
occurred.
SETTLED LOANS
The $1.7 million recovery set forth in Schedule II and discussed in
footnote 2 represents principal payments received in 2005, or shortly after
period end, from Digital Projection International (DPI). Please refer to
the responses to comments #21 and #23 for further detail on this
transaction.
The transaction is more fully described in note 26(b) of the 2005 financial
statements.
RESIDUAL VALUES
The residual values are not guaranteed as per SFAS 13, paragraph
23(a)(i)(b). These are disclosed in the table in note 4(a) to the 2005
financial statements.
FINANCE INCOME ON SALES-TYPE LEASES
The Company is not aware of any specific accounting literature regarding
the presentation of finance income in the income statement or notes to the
financial statements. One of the Company's principal methods of selling its
equipment is through the use of leasing transactions. Accordingly, the
Company views finance income on these leases as revenue. In the response to
comment #2, it was noted that the Company presented its revenues on the
face of the income statement based on its operating segments; accordingly,
the Company has included the finance income in the IMAX Systems operating
segment. Note 4(b) of the financial statements disclosed components of the
IMAX Systems revenues that were not sales and included "Finance income on
sales-type leases". This disclosure provided information about the nature
of the revenues. Further it is noted that finance income is less than 10%
of total revenues. As noted in the response to comment #2, the Company will
revise its presentation of revenues for 2006 and will consider whether to
present finance income as a separate line or combined with other revenues
that are less than 10% of total sales.
LONG-TERM RECEIVABLES
Long-term receivables of $8.8 million represent the long-term portion of
amounts due on sales arrangements that are due over time. Since these
amounts represent financing provided to its customers, the Company believes
the amount is appropriately included in financing receivables on the
balance sheet. The Company has noted that the caption for note 4(a) is
mislabeled and should be "Net carrying
42
value of financing receivables". The Company will revise this caption in
its 2006 financial statements and future filings.
PROJECTOR ECONOMIC LIFE
SFAS 13, paragraph 5(g) defines the estimated economic life of leased
property as the estimated remaining period during which the property is
expected to be economically usable by one or more users, with normal
repairs and maintenance, for the purpose for which it was intended at the
inception of the lease, without limitation by the lease term. The Company
has determined that the estimated economic life of the Company's projector
system is less than twenty years due to factors such as the introduction of
new technologies (digital) and the increasing competition for audiences in
commercial venues.
The Company's lease terms reflect the technological expectations of the
Company's customers at the time of lease signing. Prior to the early 2000s,
there was no expectation of significant technological innovation in the
marketplace, and as such, twenty-year lease terms were common. More
recently, however, with the focus on digital content as an example,
customers are reluctant to commit to such long terms, and ten years became
the new standard for the Company.
The projector's economic life is not considered a key criterion for the
Company's sales-type lease test, as substantially all of its sales-type
leases qualify under the 90% investment recovery test.
LESSOR LEASING ARRANGEMENT
The Company notes the disclosure requirements under SFAS 13, paragraph
23(c). The Company has provided extensive disclosures about its leasing
arrangements in Item 1, Business and Item 7, MD&A, General, sections of the
Form 10-K. The Company will include a similar general description of its
leasing arrangements in its 2006 financial statements and future filings,
as required under SFAS 13 paragraph 23(c).
17. We note that you have additional rentals in excess of minimum amounts on
sales-type and operating leases. Please tell us whether you consider these
to be contingent rentals and, if so, tell us your consideration of
paragraph 23a(iv) of SFAS 13 in accounting for the transactions.
The Company considers additional rentals in excess of minimum amounts on
sales-type and operating leases to be contingent rentals, since the
additional rentals are only earned if and when the customer exceeds the
minimum amounts stipulated in the contract. In accordance with paragraph
23a(iv) of SFAS 13, the Company discloses these contingent rentals related
to lease arrangements and contingent amounts related to sales arrangements
in note 4(b) of the financial statements for each period for which an
income statement is presented. The Company recently noted that the
contingent amounts received on sales arrangements, totaling $483,000, are
included in the "additional rentals in excess of minimum amounts on
operating leases" disclosed in note 4(b). For its 2006 annual financial
statements and future filings, the Company will change its reference in
note 4(b) from "additional rent" to "contingent rent" for sales-type leases
and operating leases and will exclude from those amounts contingent
receipts on sales arrangements.
NOTE 6. FILM ASSETS, PAGE 70
18. Describe to us the nature of the $2.1 million that you expect to pay in
2006.
43
Films produced by the Company will typically involve many participating
third parties including financiers (referred to as film sponsors),
co-producers and directors. The copyright and distribution rights to such
films may be held by the film sponsors and/or the Company.
Where the Company holds the copyright or distribution rights to the film,
the Company may be required under a contract arrangement to make payments
to these participating third parties based on the financial results of
film. These are referred to as participation payments. Participation costs
are defined in SOP 00-2 paragraph 134 as follows:
"Parties involved in the production of a film may be compensated in
part by contingent payments based on the financial results of a film
pursuant to contractual formulas (participations)and by contingent
amounts due under provisions of collective bargaining agreement
(residuals). Such parties are collectively referred to as
participants, and such costs are referred to collectively as
participation costs. Participations may be given to creative talent,
such as actors or writers, or to entities from whom distribution
rights are licensed."
In compliance with SOP 00-2, paragraph 34, the Company has accrued the
participation costs of $2.1 million and expected to pay such amounts in
2005. In accordance with paragraph 54 of SOP 00-2, the Company has
disclosed the amount of these costs.
NOTE 22. SEGMENTED AND OTHER INFORMATION, PAGE 84
(B) GEOGRAPHIC INFORMATION, PAGE 85
19. Tell us how your current presentation complies with paragraph 38 of SFAS
131 which requires you to disclose long-lived assets by geographic area.
This disclosure should present tangible assets only and should not include
intangibles or investments. See also Question 22 in the FASB Staff
Implementation Guide to Statement 131.
The Company notes that the FASB staff indicated they believed that the term
long-lived assets implies hard assets that cannot readily be removed, which
would appear to exclude intangibles. However, the Company believes its
disclosure in note 22 of the financial statements provides additional
useful information about certain valuable assets of the Company and with
which facilities and operations they are associated. The Company believes
this is consistent with the purpose of the enterprise-wide disclosures as
noted in Question 22 in the FASB Staff Implementation Guide to Statement
131, which is to provide information about risks and uncertainties in
certain geographic areas. For example, its patents are used in the IMAX
Systems and Film business units, which principally operate from the
Company's Mississauga, Canada facility.
For clarity, the Company included a description of the components of
"Long-lived assets" to ensure that users of the financial statements
clearly understand what was included in the disclosure. In addition, the
note disclosed that goodwill was allocated to Canada. Accordingly, readers
could determine the amount of long-lived assets excluding goodwill.
To further strengthen this disclosure for the 2006 annual financial
statements, the Company will amend its disclosure to identify the
geographic areas containing intangible assets and the related amounts.
20. We note that you combine the geographic information for Europe and Asia.
Tell us how your current presentation complies with paragraph 38(a) of SFAS
131 which requires that if revenues derived from any particular foreign
country are material, then the name and the amount of revenue from the
country should be disclosed separately.
44
The Company has used an internal benchmark of 10% of revenues to evaluate
whether the revenues derived from any particular foreign country are
material and therefore would require separate disclosure under SFAS 131,
paragraph 38(a).
The Company's use of a 10% benchmark for this particular disclosure is
consistent with other measures used for disclosures about revenues, such as
major customers under paragraph 39 of SFAS 131 and Regulation S-X, Rule
5-03 (second paragraph), as well as the quantitative thresholds for
operating segments in paragraph 18(a) of SFAS 131.
In the Europe and Asia regions, revenues attributable to any individual
country did not exceed the 10% benchmark the Company uses. As indicated in
the last sentence to paragraph 38 of SFAS 131, the Company has provided
disclosures about revenues relating to groups of countries.
NOTE 26. DISCONTINUED OPERATIONS, PAGE 89
21. We note that you reported the sale of Digital Projection International as
discontinued operations. Given the loan receivables of $12.7 million that
remained outstanding after the sale of these operations, please explain how
you met the criteria in paragraph 42(b) of SFAS 144 to record as a
discontinued operation.
Digital Projection International ("DPI"), a former subsidiary of the
Company, was sold on December 11, 2001. SFAS 144 was effective for fiscal
years beginning after December 15, 2001. At that time, the Company was
required to apply APB No. 30, "Reporting the Results of
Operations-Reporting the Effects of Disposal of a Segment of a Business and
Extraordinary, Unusual and Infrequently Occurring Events and Transactions",
in measuring and accounting for the sale.
Since the DPI business was considered a separate business segment of the
Company in 2001, the Company presented the results of operations and the
loss on disposal of DPI within net loss from discontinued operations.
The Company also considered the guidance noted in SEC topic SAB 5E in order
to conclude that a divestiture had taken place for accounting purposes. As
a result of the legal sale, the Company had no continuing involvement with
DPI. The sale transaction did not provide the Company with any veto rights
over customer contracts for DPI, voting rights on the board of directors of
DPI, managerial responsibilities or other rights similar to ownership of
DPI. The Company's only form of relationship was as the financier of the
convertible loans, which represented a potential recovery of the investment
the Company had made in DPI. DPI was required to provide the Company with
monthly financial statements, no different than the provisions normally
found in a lending arrangement. Under the terms of the loan arrangements,
DPI was also required to make payments to the Company when certain cash
balance levels were achieved.
22. In addition, as it also appears that one of these loans is convertible upon
occurrence of certain events, into shares representing 49% of the total
share capital of DPI. Please tell us in detail why you believe that these
continuing activities do not constitute a significant continuing
involvement that precludes treatment of the components as discontinued
operations.
As discussed above in the response to comment #21, the Company did not have
any continuing involvement in the operations of DPI following its sale in
2001. At the time of disposal, DPI was unprofitable and in an uncertain
financial condition. The Company recorded a significant loss on the
disposal. As a result of these conditions and uncertainty about the future
collectibility of the DPI loans, the Company included the convertible
feature as additional security for the Company. However, the
45
Company did not contemplate exercising this right. While the Company had
the right to convert, as noted in its response to comment #21, the Company
did not have any rights to make decisions about the operations of DPI. The
Company essentially held a debt instrument to which it had assigned a nil
value.
23. In this regard, we note that you recorded $3.5 million in income from
discontinued operations related to the settlement of this debt. Please
explain why this settlement of debt should be recorded as income and cite
the accounting literature upon which you relied.
While the Company applied APB 30 at the time, the Company notes that SFAS
144, paragraph 44 states that "adjustments to amounts previously reported
in discontinued operations that are directly related to the disposal of a
component of an entity in a prior period shall be classified separately in
the current period in discontinued operations. The nature and amount of
such adjustments shall be disclosed."
In 2001, when DPI was sold, the Company did not consider the $12.7 million
loan receivables to be collectable based on DPI's financial situation at
the time. In 2001, the Company recorded the loans from DPI at an amount of
nil, which was considered by the Company to be its fair value. Subsequent
to the disposal, the Company received certain payments from DPI. The
Company recognized a gain within discounted operations when the amounts
were either realized or realizable (based on payment shortly after
period-end and before the completion of the period's financial statements),
which were recognized when received, or when realizable, based on payment
shortly after period-end.
On December 29, 2005, the Company and DPI entered into an agreement to
settle the arrangement in exchange for two payments to be received in the
first quarter of 2006, totaling $3.5 million. The Company still considered
that there was some uncertainty associated with the collectibility of the
$3.5 million because DPI was still struggling financially. Since the
Company received $1.2 million of the settlement shortly after year-end
before the completion of the annual financial statements, $1.2 million of
the settlement was recorded on December 29, 2005 as a gain on discontinued
operations. The balance of the settlement was recorded as a gain on
discontinued operations during the first quarter of 2006, the point in time
when the remaining amount was received.
FORM 10-Q FOR THE QUARTER ENDED JUNE 30, 2006
ITEM 4. CONTROLS AND PROCEDURES, PAGE 54
EVALUATION OF DISCLOSURE CONTROLS AND PROCEDURES, PAGE 54
24. We see that you have concluded that your disclosure controls and procedures
were not effective due to a material weakness related to the controls
surrounding the analysis and recording of complex film accounting
transactions in the three months ended June 30, 2006. Please provide us
with a clear description of the facts and circumstances surrounding this
material weakness, and specifically address the following:
- The nature of the material weakness identified.
- When the material weakness was identified, by whom it was identified
and when the material weakness first began.
- The specific steps that the company has taken, if any, to remediate
the material weakness.
- Whether you believe the material weakness still existed at the end of
the period covered by the report.
- In light of what they know now regarding the existence of a material
weakness, whether the officers continue to believe that the Company's
disclosure controls and procedures were effective as of the periods
ended December 31, 2005 and March 31, 2006.
46
During the course of the review of the Company's financial statements for
the second quarter of 2006, the Company's external auditors expressed
concerns with respect to the initial accounting treatment for a new complex
film transaction that occurred during the quarter. Under the terms of the
arrangement, the Company was to provide two main services: (a)
post-production processing of the film to convert some part of it from 2-D
to 3-D live action, the first time the Company has performed such a
service; and (b) digitally remastering of the film (referred to by the
Company as DMR). As is common in the industry, the Company created a wholly
owned subsidiary, a film production company, to legally hold the film
production while the services were being rendered to the customer. Other
legal entities within the corporate structure of IMAX provided personnel
and other services to the film production company to complete the product
thus creating inter-company charges between entities. The Company provided
funding for a portion of the process. The Company was compensated for the
services rendered through an initial fee plus a certain percentage of the
box office receipts. The film was released on June 28, 2006.
The Company recognized the revenue and costs into the income statement by
analogy to the concepts under SOP 00-2, including using the film forecast
method to recognize the costs. However, under the initial accounting the
Company did not properly eliminate inter-company profit margins included in
the costs. Also, the total revenues used in the film forecast calculation
were incomplete. Management reassessed the accounting for the transaction
prior to the release of the quarterly earnings. The impact of the
reassessment was:
DIFFERENCE
REVISED AND REPORTED AS
ORIGINALLY CONSISTENT WITH A MATERIAL
RECORDED THE FORM 10-Q WEAKNESS
---------- --------------- -----------
Revenue $4,544,083 $2,893,363 $1,650,720
Costs $2,379,489 $1,492,705 $ 886,784
Margin $2,164,594 $1,400,658 $ 763,936
Related Film Asset $2,673,017 $1,909,081 $ 763,936
The adjustment related solely to the three-month period from April 1, 2006
to June 30, 2006, and was isolated to this particular film transaction. No
similar arrangements were entered into during the periods ending December
31, 2005 or March 31, 2006. Accordingly, the officers continue to believe
that the Company's disclosure controls and procedures were effective as of
the periods ended December 31, 2005 and March 31, 2006.
The material weakness still existed at the end of the period covered by the
report, however, the Company is taking the following actions to remediate
the material weakness:
- Internal accounting policy documentation around complex film
transactions is being clarified and redistributed to film accounting
personnel;
- Supervisory film accounting personnel will be included in technical
accounting update sessions and sent for outside training and updates
in U.S. GAAP matters; and
- An analysis of the appropriate accounting for each complex film
transaction entered into after June 30, 2006 is being prepared and
will be reviewed by outside experts and by a designated internal
Company individual of sufficient seniority and experience prior to the
finalization of the journal entries to record the transaction.
* * *
47
Should you require clarification or have any further questions, please
contact me at (905) 403-6404. The Company stands ready to assist the Staff in
any way possible in connection with the matters addressed in this letter.
Thank you,
/s/ G. Mary Ruby
- ----------------
G. Mary Ruby
Senior Vice President,Legal Affairs & Corporate Secretary
cc: Kevin Kuhar, Staff Accountant, Division of Corporation Finance, Securities
and Exchange Commission
Jodie Hancock, Senior Accountant, Corporate Finance Branch, Ontario
Securities Commission
48
EXHIBIT A
[Omitted pursuant to a request for confidential treatment and submitted
separately with the Commission]
49
EXHIBIT B
[Omitted pursuant to a request for confidential treatment and submitted
separately with the Commission]
50
EXHIBIT C
[Omitted pursuant to a request for confidential treatment and submitted
separately with the Commission]
51
EXHIBIT D
[Omitted pursuant to a request for confidential treatment and submitted
separately with the Commission]
52
