2006 in Review: IMAX

As investors, we never know when dark storm clouds will begin gathering on the horizon. They come in an endless variety of forms: SEC probes, poor product launches, adverse litigation, deteriorating performance, and on and on.

And much like the weather, both the timing and duration of these events are difficult to prognosticate. However, it is safe to say that stocks rarely encounter the type of "perfect storm" that has battered IMAX (NASDAQ:IMAX) over the past six months.

Let's review the radar imagery and see just how this one came together.

Red sky at night, sailor's delight
Early in the year, there wasn't even a hint of the impending deluge that would soon rain down on IMAX -- quite the opposite, in fact.

In mid-February, the shares gained ground after the company announced that its year-end 2005 numbers were likely to come in bigger and better than previous expectations. Thus, few were surprised when the company posted annual profits of $0.40 per share, an impressive 54% increase over the prior year.

IMAX capped off that performance by cruising past Wall Street's fourth-quarter targets and installing 14 theaters during the period -- a new company record.

Meanwhile, the bigger trend appeared even more promising. Revenues were marching higher, margins were expanding, and the runaway success of movies like The Polar Express (which raked in more than $10 million in box-office revenues within 19 days on just 61 IMAX screens) was opening the eyes of quite a few cinema owners, fueling a steady flow of system orders from major chains like AMC, Cinemark, and Regal Entertainment (NYSE:RGC).

In fact, between 2003 and 2005, annual orders climbed from 25 to 36 to 45. Throw in an ambitious release schedule, including surefire summer blockbuster Superman Returns, and it looked to be smooth sailing ahead.

Sending out an S.O.S.
But management was about to unveil a curious plot twist that few saw coming: plans to put the company on the auction block.

By no means was IMAX in desperate need of a partner, as is often the case when the phrase "strategic alternatives" is used in a press release. However, several unsolicited offers had already trickled in, so it only made sense for management to shop the firm around.

Plus, the company's stretched balance sheet was limiting its expansion strategy, and joining forces with a deep-pocketed ally could help bring the IMAX experience to the masses that much faster.

Names like Sony (NYSE:SNE) and Time Warner (NYSE:TWX) were tossed around, and some speculated that the shares could garner a generous premium, possibly fetching a price as high as $14.

Calm before the storm
So when the company announced its first-quarter results in May, investors were anxiously awaiting the latest word on the search process. Unfortunately, management had little to report, aside from fairly lackluster quarterly results.

With bleak box-office results and a lull in theater installations, revenues for the period plunged 34% to $20.4 million. Stay tuned; that exact same combination walloped the stock six months later -- but not before many shareholders abandoned ship near the end of the summer.

On Aug. 10, IMAX reported fairly robust second-quarter numbers. Revenues jumped 34% (the same degree they fell three months earlier) to $41.4 million, while earnings from continuing operations quadrupled to $0.08 per share. Both measures easily hurdled analysts' expectations, but any operational improvements were quickly forgotten amid a larger (and more telling) announcement.

Red sky at morning, sailors take warning
Apparently, all of the earlier interest from potential suitors amounted to little more than casual flirting, because management was forced to admit that the search for a buyer had come up empty, leaving the board in the unenviable position of revisiting lowball bids that it might have scoffed at earlier.

As might be expected, the skies turned ominous after that admission, but unfortunately, another tempest was brewing in another direction -- one that pointed straight to the SEC.

Along with the disappointing news on the buyout front, IMAX also revealed that the SEC was launching a probe into the company's revenue recognition practices, which can be tricky where leasing is involved. It should be noted that there is no dispute regarding the amount of the firm's revenues, only the timing.

However, that distinction mattered little to those bailing out. As the two storms collided, the howling winds of investor discontent carried away more than 40% of the firm's market cap, pushing the stock all the way down to $5.48.

From there, the company could do little but drift with the market's current, but another rogue wave was right around the corner.

In early November, IMAX demonstrated once again how unpredictable film revenues and choppy theater installations can lead to "hit-or-miss" quarterly revenues -- and this one was definitely a miss. The company booked revenues from just one new theater, which, coupled with the weak showing of The Ant Bully, caused revenues to plummet 38% for the period. Meanwhile, earnings swung from a $2 million gain to an $11 million loss.

The timing couldn't have been worse. A year ago, investors may have shrugged off the gloomy results as nothing more than a passing shower. In this case, though, they viewed the shortfall as yet another sign that IMAX might have trouble staying afloat.

The stock surrendered another 30% on the news, falling all the way back to $3.39.

What the audience thinks
Despite the rough seas, IMAX could still take its shareholders on a profitable voyage. Judging by the overwhelming optimistic sentiment within our CAPS community, now might be a good time to climb aboard. Of the 400 members who have registered an opinion on the stock, the bulls outnumber the bears by a wide 10-to-1 margin.

TMFBreakerTAllan summed up the situation like this:

"Less people may be going to the movies, but more and more are paying more to see those movies on the big screen. This trend will continue, and that is why IMAX will outperform the market from here."

Charting the course
A failed buyout, an SEC inquiry, a class-action lawsuit, and now weak quarterly results -- a lot of problems to converge on one company at one time.

However, with dozens of revenue-sharing joint venture deals on the way, a switch to more cost-efficient digital technology in the works, and Harry Potter set to work his box-office magic, the long-range forecast looks much brighter -- but we'll save that for the sequel. You can check out my thoughts in our 2007 IMAX preview.

Check out the other companies featured in "The Motley Fool's 2006 in Review and 2007 Preview" special.

IMAX is a Motley Fool Rule Breakers selection. To see why, you can take a 30-day free trial. Time Warner is a Motley Fool Stock Advisor pick.

Fool contributor Nathan Slaughter would drive out of state to see an IMAX 3-D film, but he owns none of the companies mentioned. The Fool has a disclosure policy.