Item 3. Quantitative and Qualitative Disclosures About Market Risk
Item 3. Quantitative and Qualitative Disclosures about Market Risk
The Company is exposed to market risk from foreign currency exchange rates and interest rates, which could affect operating results, financial position and cash flows. Market risk is the potential change in an instrument’s value caused by, for example, fluctuations in interest and currency exchange rates. The Company’s primary market risk exposure is the risk of unfavorable movements in exchange rates between the U.S. Dollar, the Canadian Dollar and the Chinese Yuan Renminbi. The Company does not use financial instruments for trading or other speculative purposes.
Foreign Exchange Rate Risk
A majority of the Company’s revenue is denominated in U.S. Dollars while a significant portion of its costs and expenses is denominated in Canadian Dollars. A portion of the Company’s net U.S. Dollar cash flows is converted to Canadian Dollars to fund Canadian Dollar expenses through the spot market. In addition, IMAX films generate box office in 85 different countries, and therefore unfavorable exchange rates between applicable local currencies and the U.S. Dollar could have an impact on the Company’s reported gross box office and revenues. The Company has incoming cash flows from its revenue generating theaters and ongoing operating expenses in China through its majority-owned subsidiary IMAX Shanghai. In Japan, the Company has ongoing Yen-denominated operating expenses related to its Japanese operations. Net RMB and Japanese Yen cash flows are converted to U.S. Dollars through the spot market. The Company also has cash receipts under leases denominated in RMB, Japanese Yen, Euros and Canadian Dollars.
The Company manages its exposure to foreign exchange rate risks through its regular operating and financing activities, when appropriate, through the use of derivative financial instruments. These derivative financial instruments are utilized to hedge economic exposures as well as reduce earnings and cash flow volatility resulting from shifts in market rates.
Certain of the Company’s subsidiaries held approximately RMB 454.4 million ($70.1 million) in cash and cash equivalents as of September 30, 2021 (December 31, 2020 — RMB 500.3 million or $76.7 million) and are required to transact locally in RMB. Foreign currency exchange transactions, including the remittance of any funds into and out of the PRC, are subject to controls and require the approval of the China State Administration of Foreign Exchange to complete. Any developments relating to the Chinese economy and any actions taken by the Chinese government are beyond the control of the Company; however, the Company monitors and manages its capital and liquidity requirements to ensure compliance with local regulatory and policy requirements.
For the three and nine months ended September 30, 2021, the Company recorded a foreign exchange net loss of $(0.6) million and net gain $1.1 million, respectively, as compared to a foreign exchange net gain of $0.2 million and a net loss of $(0.8) million for the three and nine months ended September 30, 2020, respectively, associated with the translation of foreign currency denominated monetary assets and liabilities.
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The Company has entered into a series of foreign currency forward contracts to manage the Company’s risks associated with the volatility of foreign currencies. The forward contracts have settlement dates throughout 2022. Foreign currency derivatives are recognized and measured in the Condensed Consolidated Balance Sheets at fair value. Changes in the fair value (gains or losses) are recognized in the Condensed Consolidated Statements of Operations except for derivatives designated and qualifying as foreign currency cash flow hedging instruments. Certain of these foreign currency forward contracts held by the Company as of September 30, 2021, are designated and qualify as foreign currency cash flow hedging instruments. The Company currently has cash flow hedging instruments associated with Selling, General and Administrative Expenses, Inventories and capital expenditures. For foreign currency cash flow hedging instruments related to Selling, General and Administrative Expenses, the effective portion of the gain or loss in a hedge of a forecasted transaction is reported in Other Comprehensive (Loss) Income and reclassified to the Condensed Consolidated Statements of Operations when the forecasted transaction occurs. For foreign currency cash flow hedging instruments related to Inventories, the effective portion of the gain or loss in a hedge of a forecasted transaction is reported in Other Comprehensive (Loss) Income and reclassified to Inventories on the Condensed Consolidated Balance Sheets when the forecasted transaction occurs. Any ineffective portion is recognized immediately in the Condensed Consolidated Statements of Operations.
The notional value of foreign currency cash flow hedging instruments that qualify for hedge accounting at September 30, 2021 was $24.6 million (December 31, 2020 — $26.4 million). A loss of $(0.8) million and a loss of $(0.2) million was recorded to Other Comprehensive (Loss) Income with respect to the change in fair value of these contracts for the three and nine months ended September 30, 2021, respectively (2020 — gain of $0.6 million and a loss of $(0.9) million, respectively). A gain of $0.3 million and a gain of $1.4 million was reclassified from Accumulated Other Comprehensive (Loss) Income to Selling, General and Administrative Expenses and Inventories for the three and nine months ended September 30, 2021, respectively (2020 — loss of $(0.1) million and a loss of $(0.8) million, respectively). An unrealized gain of less than $0.1 million and $0.3 million resulting from a change in the classification of certain forward contracts no longer meeting the requirements for hedge accounting were reclassified from Accumulated Other Comprehensive (Loss) Income to Selling, General and Administrative Expenses for the three and nine months ended September 30, 2021 (2020 — $nil). The notional value of forward contracts that do not qualify for hedge accounting at September 30, 2021 was $1.1 million (December 31, 2020 — $5.6 million).
For all derivative instruments, the Company is subject to counterparty credit risk to the extent that the counterparty may not meet its obligations to the Company. To manage this risk, the Company enters into derivative transactions only with major financial institutions.
At September 30, 2021, the Company’s Financing Receivables and working capital items denominated in Canadian Dollars, RMB, Japanese Yen, Euros and other foreign currencies translated into U.S. Dollars was $144.2 million. Assuming a 10% appreciation or depreciation in foreign currency exchange rates from the quoted foreign currency exchange rates at September 30, 2021, the potential change in the fair value of foreign currency-denominated financing receivables and working capital items would have been $14.4 million. A significant portion of the Company’s Selling, General, and Administrative Expenses is denominated in Canadian Dollars. Assuming a 1% change appreciation or depreciation in foreign currency exchange rates at September 30, 2021, the potential change in the amount of Selling, General, and Administrative Expenses would be $0.1 million.
Interest Rate Risk Management
The Company’s earnings are also affected by changes in interest rates due to the impact those changes have on its interest income from cash, and its interest expense from variable-rate borrowings. Specifically, the Company’s largest exposure with respect to variable interest rate debt on borrowings under the Credit Facility resulting from changes in LIBOR.
The Company had no variable rate debt instruments outstanding as of September 30, 2021.
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