Good day, everyone, and welcome to the Half Year 2017 Conference Call for IMAX China. All participants are currently in a listen-only mode. Following the presentation, we will conduct a question and answer session, at which time you will be requested to press star one to ask a question. As a reminder, today's conference is being recorded.
At this time, I would like to turn the conference over to Jessica Kourakos . Please go ahead.
Good morning, everyone, and thank you for joining us on IMAX China's half year 2017 earnings conference call. Joining me today is our Chairman, Rich Gelfond, CEO, Jiande Chen, and Jim Athanasopoulos, our CFO and COO, who will have prepared remarks. Also joining us today is Greg Foster, IMAX China board member and head of IMAX Entertainment, who will be available for Q&A. For the purpose of this call, all financial figures will be provided in U.S. dollar unless stated otherwise. Furthermore, the financials we provide you today will follow IFRS accounting standards which may differ in some respects to U.S. GAAP.
I would also like to remind you of the following information regarding forward-looking statements. Our comments and answers to your questions on this call may include statements that are forward-looking and that they pertain to future results or outcomes. Actual future results or occurrences may differ materially from these forward-looking statements. The full text of our half year 2017 earnings release, along with supporting financial statements, are available on our website, imax.cn. Today's conference call is also being webcast in its entirety on our website.
With that, let me now turn the call over to Rich Gelfond.
Thanks, Jess. As you can hear from the sound of my voice, I am struggling a bit with laryngitis. Actually, more than a bit. In order to ensure that investors and analysts can hear my remarks on the call, I have asked Mike Mougias of Investor Relations to read my portion of today's remarks. Anything said in this portion should be attributed to me. At the conclusion of my remarks, Mike will turn over the call to Jiande Chen to discuss the film business, and Jim Athanasopoulos will present the financials. I will be available at the conclusion of the prepared remarks for Q&A.
Mike?
Good morning, everyone, and thank you for joining us today. When I think about IMAX China, I believe the leading contributor to long-term value creation lies in our expanding network. This network, which has grown 39% in the last year alone, now encompasses 443 commercial screens in more than 160 cities in China. This doesn't include our backlog, which should serve to add an additional 381 screens to our footprint over the next several years. On the signings front, we continue to see strong activity from both new and existing partners. We signed agreements for 83 new theaters in the first half of 2017, on top of the record 238 signings we achieved last year. In fact, we are now partnered with nine of the top 10 exhibitors in China. As a result of these signings and our growing backlog, our installation pace continues to operate at strong levels.
We installed 36 new IMAX theater systems in the first half and continue to believe we will install roughly 120 new theater systems this year, slightly above the record installations we achieved last year. On the box office front, we continue to take a portfolio approach to our film slate and believe over the long term, PSAs tend to settle into a range similar to what we have seen in other mature markets such as the U.S. There are titles that resonate and titles that don't, and China is no exception, where several titles underperformed our expectations. However, in the U.S., IMAX Corp just launched Dunkirk, which did over $19 million opening weekend on 634 IMAX screens. Domestically, the film indexed an incredible 23% of the total box office, underscoring the demand from consumers to see the best films in the most exciting way possible.
Needless to say, we are excited for this film to release in Mainland China on September 1st. While we continue to believe growing the IMAX footprint is a key driver to long-term earnings growth, we recognize that recent network growth has not translated to the bottom line to the extent we expected. Fortunately, we believe there are steps we can take to not only increase the revenue generation of our theaters, but also help facilitate greater correlation between revenue generation and operating leverage in the future. Another key factor impacting our box office recently has been the ramp-up of our new build theaters. In fact, 28% of our 443 commercial theater network was installed in the last 12 months, and a large majority of these locations are new builds, which take time to mature.
Moreover, when you couple new build theaters with weaker content, you are likely seeing an exacerbation of this ramp-up effect. Nevertheless, there are strategies we are implementing to increase the revenue generation and productivity of our theaters. For starters, we continue to refine our process of selecting films. While we have played the biggest film most of the weekends of the year, we believe there are improvements we can continue to make in certain areas. For example, we will look to play multiple titles during high box office weekends like Chinese New Year and better tailor our slate for different cities in China as consumer preferences for films vary city to city. We also intend to shorten our windows, allotting just one-week runs for many films versus the two to three-week runs we had been allocating to films in the past.
Moreover, in an effort to further differentiate our format, we will continue to add IMAX DNA into more films, which provides additional differentiation to the IMAX version of the film. For instance, if you see Star Wars: Episode 8 in IMAX, you will see approximately 25% more image on those big action sequences. Historically, films that contain IMAX DNA have tended to over-index in IMAX. On the installation front, with 45,000 screens open in China, we are seeing more and more retrofit opportunities. These types of installations provide greater transparency into potential box office performance and don't require the same ramp-up period we see from new build locations. This is a strategy IMAX Corporation implemented exceptionally well on a global basis. While overall box office has underperformed year-to-date, we have seen several encouraging trends in China.
For one, we have seen no slowdown in signings momentum and network growth. Existing partners and some of the biggest players in the industry continue to come back for more IMAX screens. On the studio front, Hollywood Titles secured six of the top 10 films in H1 2017, and we were involved in five of these titles. Overall, we secured the number one films for 21 of the 26 weeks in H1 2017, and we expect this trend to continue, if not improve, in the second half. We have seen exceptional demands from Chinese local studios to secure IMAX slots during the summer season. Wu Kong kicks off our summer Chinese slate, and Jiande will discuss all of these films and the exciting Hollywood slate that will follow the summer season in a moment.
It is also worth noting that the macro demographics in China should be conducive to long-term growth in box office. For example, despite having significantly larger population with a growing middle class, China's per capita screen count is still significantly less than that of the U.S. While these trends won't turn box office around overnight, we believe they will drive box office longer term. The second area that has hindered earnings growth in the past has been our cost structure. As many of you saw, we took a significant first step toward mitigating this impact going forward. Jim will get into the specifics. However, last month, IMAX Corporation announced a cost reduction initiative aimed at streamlining its business and introducing a more efficient cost structure, enabling the company to scale more efficiently to deliver greater operating leverage and better withstand varying box office levels.
While this initiative was largely focused at the parent level, we were able to eliminate some redundancies and non-essential costs from the China business, which should facilitate greater operating leverage going forward. While our business is still not immune to box office, we believe this exercise was critical to reducing the impact of box office ups and downs to our bottom line and puts IMAX in a better position to increase shareholder value. Moving on, I would like to briefly touch on one of our new business initiatives, virtual reality. Earlier this year, we signed an agreement with our longstanding exhibitor partner, JinYi, to install the first IMAX VR center in China. We anticipate opening this location in one of their multiplexes in Shanghai later this year. While IMAX Corp has just two locations open in the U.S., the initial results from these locations have been encouraging.
When you couple the preliminary results of those U.S. locations with our brand power in China, it is safe to say that we are looking forward to having our first pilot center up and running in China. Another exciting aspect about this venture is its inherent scalability, given our 443 commercial theater network and existing partnerships with virtually every major exhibitor in China. All in all, we remain encouraged by the continued momentum we have seen on the signings and installations front. While box office has been weak recently, we continue to take a portfolio approach to managing our business, understanding certain titles resonate with consumers and others do not. Moreover, as our theaters mature and as our cost savings are realized, we are well-positioned to achieve greater operating leverage and profitability in the future.
With that, I will turn the call over to Jiande. Jiande?
Thank you, and good morning, everyone. I will start off by briefly providing our box office results for the first half before providing information on what's ahead from a content standpoint. In the first half of 2017, we delivered a China box office of $ 167 million, which resulted in a first-half PSA of $ 411,000. On a constant currency basis, box office in PRC was down roughly 2.5% versus 2016 when excluding booking fees, which we largely attribute to weaker than expected content. Looking to the second half, the third quarter is off to a solid start. We did $ 4.6 million on Despicable Me 3 and $ 5.4 million on Wu Kong. As many of you know, we are now entering a blackout period in China, and we will be focusing on Chinese local language films.
This weekend, we will be playing The Founding of an Army from Bona, followed by Once Upon a Time on August 3rd from [Inline] Media, and The Adventures and the Legend of Naga Pearls, August 11 through August 25th. We anticipate the blackout period will end in the late August and hope to launch anxiously awaited films such as Spider-Man: Homecoming and of course, Dunkirk, which, as Rich said, has done exceptionally well. It grossed $90 million this weekend and indexed 23% in IMAX. Chris Nolan is very popular in China, and we anxiously await the release of this movie and other blockbuster films. Looking at the fourth quarter, while we have not confirmed all of those titles yet, we expect a number of potential blockbuster titles to hit the big screen in China. Films such as Kingsman: The Golden Circle, Blade Runner 2049, and Justice League.
We are also looking at several Chinese titles, including Operation Red Sea, The Foreigner, Southern Face of Kunlun, and The Legend of the Demon Cat. Also, while we do not have official confirmation yet, we are hearing that titles such as Spider-Man: Homecoming and other Hollywood blockbusters are soon to be announced for the month of September. Overall, we have an exciting mix of films ahead of us, and we look forward to launching these on the big screen.
With that, I will pass it over to Jim.
Thanks, Jiande, and thanks, everyone, for joining us today. As Rich mentioned, we continue to see strong demand for IMAX theaters from both new and existing partners. The level of signings activity we have achieved over the last 18 months is particularly encouraging when you consider that the large majority of these signings have been with longstanding partners who continue to come back for more IMAX theaters. Looking at the first half signings activity in a bit more detail, we signed agreements for 83 new theaters. Of these signings, 40 were hybrids and 43 were sale arrangements. Our continued signings momentum and growing backlog provides us with greater visibility into future installations and demonstrates the confidence exhibitors and developers have, both in the industry space and with IMAX as the premium differentiated platform within their respective complex.
Notwithstanding box office headwinds and increased competitive offerings, IMAX, in the last 18 months, has signed 321 new theater contracts and has installed 155 theaters. Our network serves as a platform for recurring revenue, established cash flow, and opportunities for new business initiatives like virtual reality or original content. We view our scale as a significant competitive advantage in the market. As a result of this sustained demand, our backlog now sits at a record 381 systems. It is also worth noting that roughly 40% of our identified backlog is in Tier 3 and 4 markets, which is comparable to our existing network of 43%. While expansion to these new markets has yielded lower PSAs early on, we continue to believe in the long-term growth potential in these markets through a more tailored programming approach.
Overall, we believe Tier 3 and 4 cities represent a large box office market and growth opportunity. It is also worth noting that while new purpose-built IMAX theaters have been the foundation of our network growth in China to date, a vastly larger China multiplex network affords IMAX the opportunity to retrofit theaters. As Rich indicated earlier, this strategy is something our parent has been very successful implementing in the U.S. market over the past ten years. These types of installations provide greater box office transparency, quicker ramp-up periods, and can be installed more quickly than their new build counterparts. Getting into the more specific first half details, we installed 36 new theaters in the first half of 2017. 20 of which were full revenue-sharing arrangements, four were hybrid, and 12 were for sale arrangements.
Our installation activity has not slowed down, and we look forward to delivering 120 new theater installations in 2017 that we previously guided to earlier in the year. Before I dive into our financials, let me first mention that we have made some changes around our reporting structure. We believe the new framework better reflects how we view the business today while also providing greater transparency to our investors. Our parent company adopted this format at the beginning of the year, and it seems to have been appreciated by investors. With the new changes, we have started breaking out our business on a consolidated core and new business basis.
Our core business consists of our network business, which is comprised of all box office sharing revenue from exhibitors and studio partners, theater sales and maintenance, which consists primarily of one-time revenue associated with system sales and upfront revenue from hybrids, as well as ongoing maintenance revenue. To summarize, any variable revenue tied to box office is included in the network business, while any revenue not tied to box office is included in theater sales and maintenance. We believe this structure simplifies our revenue breakdown and better illustrates how we view the business today. In terms of new business, as Rich mentioned, we signed an agreement to open our first VR center in Shanghai by the end of 2017 and look forward to closely monitoring the economics of this pilot center with additional facilities to follow.
We're looking to potentially leverage our large footprint of locations across 160 cities in Mainland China to make the new business segment a more meaningful earnings driver. Using this framework, let me now review some of the key financial results and highlights for the first half of 2017. Network business revenue was $25.7 million in the first half and generated margins of 62%, compared to $29.6 million and a 75% gross margin in the year-ago period. The decrease in both revenue and margin is primarily the result of weaker box office in the first half of 2017, driven by the underperformance of certain films, a temporary reduction in Wanda's take rate as a result of their original rollout being nearly three years ahead of their contractual schedule, and general pressure put on per-screen averages from the number of new complexes opening up that need time to ramp up.
Theater business revenue was $25.8 million in the first half, generating a gross margin of 64%. This compares to revenue of $25.5 million and a gross margin of 48% in the first half of 2016. Last year, margins were impacted negatively by three higher-cost Laser GT installations. Total revenues for the first half were $51.6 million, resulting in gross profits of $32.6 million. Year-on-year, revenue and gross profits were down 6% and 4% respectively, driven primarily by the weakness in box office and factors that I mentioned earlier. Gross profit margin of 63% remains quite healthy and increased slightly from the prior year's gross profit margin of 62%. SG&A for the first half of 2017, excluding stock-based compensation, was $6.8 million, down 10% as compared to the $7.5 million in the first half of 2016, driven by adjustments in certain discretionary spends as a result of weaker box office.
Consolidated adjusted EBITDA was $30.3 million for the first half and $29.2 million in the comparable period, an increase of nearly 4%. Our tax expense for the first half came in at $4.8 million, or 22.5% for the first half of 2017. We expect our estimated average annual tax rate to be comparable to the 2016 rate of 22%. Our adjusted net profit for the first half of 2017 was $17.7 million, or 34% adjusted net margin. Our CapEx for the first half was $11.6 million and was mainly the result of the continued rollout of full JV theaters. Our operating cash flow generation was $17.2 million in the first half, which I believe serves as a testament to the efficiency and leverage in our business model. On the balance sheet, we ended the first half with a cash balance of $112.9 million.
As Rich also mentioned, IMAX Corporation announced a cost restructuring initiative last month. As part of this cost review process, we hope to realize annual run rate savings of approximately $2.4 million. Nonetheless, we did incur a one-time $600,000 charge related to severance payments, facilities, and other employee-related termination benefits in the first half. We felt that evaluating the cost side of our business was a responsible, necessary step to take at this time and believe the company will emerge stronger as a result and is better positioned to scale more efficiently and better withstand fluctuating box office environments. For the full year of 2017, we expect SG&A, excluding stock-based comp, to increase at a low single-digit rate compared to that of fiscal 2016.
In closing, while the current weakness in box office environment has pressured the top line, we believe the foundation of our business model remains solid. We generated over $17 million in operating cash flow, gross margins in excess of 60%, adjusted EBITDA more than $30 million or nearly 59% of total revenues, and an adjusted net profit of nearly $18 million or 34% of total revenues. The scale of our network continues to demonstrate its ability to generate ongoing cash and profitability in spite of recent box office challenges.
In addition, continued demand from all local and Hollywood studios to secure films in IMAX, coupled with record signings and record installation, continues to build the foundation of our business and sets the table to take advantage of future industry and box office growth and leverage future new business ventures.
With that, I will pass the call back to the operator for Q&A.
Thank you. Ladies and gentlemen, we will now begin the question-and-answer session. As a reminder, if you have a question, please press the star followed by the one on your touch-tone phone. We ask that you please limit yourself to one question. If you would like to withdraw your question, please press the star followed by the two. If you are using speaker equipment, you will need to lift the handset before making your selection. And once again, that is star one, and we will pause a brief moment. Once again, everyone, it is star one if you have a question or comment at this time. We will take our first question from Timothy Lee with CLSA.
Hi, management. Can you hear me?
Yes.
Yes, we can hear you.
All right. Thanks so much. I have two questions. First of all, I would like to know regarding the box office performance in this first half. Actually, management also commented it's not really performing very well. May I just know what's management view for the key reasons? Is it due to some of the movies which performed very well, we didn't really have an IMAX format? Is that because of the movie selections? Or is it because of the new screen installation, which is apparently too fast so that the PSA is under pressure. I would like to know what's the management view on that.
Secondly, I would like to know about the future new installation guidance, like in 2018 and onwards. Thank you.
Yeah. Going to box office performance. In terms of film selection, I think 21 of the 26 weeks this year selected a top-performing title, and we selected six of the top 10 performing titles so far in the first half of the year. The ones that we didn't select, three of them were all of the New Year period, and we had already selected "To the West," which was the number two title during the period and a very successful selection in that part. So, we're getting access to all the films. We're selecting the right films. Having said that, we're always reviewing, we're always tailoring, we're always trying to make things better. We'll continue to do that going forward. It's not specifically because of the film selection.
In terms of new screens and are we adding too quickly, definitely as new screens are added, we added about 117 new screens last year, and we added 36 screens this year. A significant number of new screens have come online in greenfield developments, and they just take time to ramp up. A significant chunk of our network has been built up the last two years, and we're just taking a little bit of time to kind of grow those as we move forward. We talked about earlier on the call looking at retrofit theaters versus new build opportunities. The market's got a significant number of screens right now, and globally we've been very successful at executing that strategy.
We think there's no reason why a similar approach can't be dealt with in China, which will result in greater box office transparency for complexes that we're going into, as well as quicker ramp-up periods to maximize per-screen averages as soon as possible. With that, those are some of the reasons in terms of what's going on with PSAs.
Just a reminder to our audience, it is star one if you have a question or comment. We'll move next to Wayne Wang with HSBC.
Thank you management for taking my question. I have noticed that there was a small revenue contribution in the first half from new business and others. Can management elaborate more about what's that revenue and how should we look at the VR centers revenue contribution in the future? Also, could management give us more color maybe on the laser new system and how the progress now currently and how should we look at that in the future? Thank you very much.
Yeah. Just quickly on your first question, the new business and other, it's a very small number. It's got to do with a certain type of film distribution revenue for institutional films that we've been playing. Again, it's very nascent and new right now, so it's got nothing to do with VR. In terms of VR, we're opening up, like we said, a pilot site in Shanghai. We've opened up pilot sites, or IMAX Corporation has opened up pilot sites in Los Angeles and in New York. We're actually anticipating opening them up in Manchester and in Shanghai and other markets as well. Having said all that, they're pilots, and we're going to watch them and understand how they work in the market, understand what the local tastes are, what the pricing is. We're going to evaluate how those work.
We're excited in terms of how they've performed up until now. We'll review that in China, and we'll take some time to understand it before we kind of move forward with any sort of a heavy rollout. Finally, with respect to the new laser system, again, just want to stress the new laser system that we're developing is, it's a commercial laser system. It's not the laser system that we've currently developed, which is intended for much larger screens and much larger complexes. It's definitely something tailored to a smaller screen, where the cost of goods sold are sort of in the margins that would be comparable to kind of where we're operating at right now. That's sort of where we're at with laser, and it's coming along on schedule, and we're looking forward to hopefully rolling it out in the near future.
Thank you.
Next, we'll move to [Brian Dai] with Goldman Sachs.
Thank you. Hi, management. Recently, the market has had some anxiety over the investigation of Wanda Group. And since Wanda is a big client of us, how does that impact our future installations of the IMAX theaters in Wanda malls, including new signings? Thank you very much.
Wanda has consistently run ahead in installations of their previous agreements. In fact, the last agreement, they were three years ahead or four years ahead. This current agreement, where there are about 200 in backlog, the installations this year are running way ahead of schedule. Historically, that's never been an issue. I'm not aware of an investigation of Wanda. What I'm aware of is there were restrictions imposed on their ability to use money from China to refinance or finance acquisitions abroad. The Wanda footprint is all in China, so there's nothing that I know of that restricts their ability at all to do their rollout.
I met with the CEO and the management team of Wanda Cinema live three weeks ago in China. We met with them again last week, and we're planning the rollout as scheduled, so I don't see anything that impacts our rollout with Wanda.
I just want to add one more thing to Rich's comment. That is, Chairman Wang made it very clear to us, his major business development focus is still in China. With that, I think our business as we know and it all goes based mostly with Wanda.
Thanks.
That does conclude our question and answer session and our conference call. We do thank you for your participation. You may now disconnect.