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RLD > SEC Filings for RLD > Form 10-Q on 7-Aug-2013All Recent SEC Filings

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Form 10-Q for REALD INC.


7-Aug-2013

Quarterly Report


ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Cautionary note on forward-looking statements

The following discussion and analysis should be read in conjunction with our interim condensed consolidated financial statements and the related notes that appear elsewhere in this Form 10-Q. These discussions contain forward-looking statements reflecting our current expectations that involve risks and uncertainties. In some cases, you can identify forward-looking statements by terminology such as "intends," "may," "will," "should," "expects," "plans," "anticipates," "believes," "estimates," "predicts," "potential," "continue" or the negative of these terms or other comparable terminology, but the absence of these words does not necessarily mean that a statement is not forward-looking. Forward-looking statements include, but are not limited to: statements regarding the extent and timing of future licensing, products and services revenue levels and mix, expenses, margins, net income (loss) per diluted share, income taxes, tax benefits, acquisition costs and related amortization, and other measures of results of operations; our expectations regarding demand and acceptance for our technologies; 3D motion picture releases and conversions scheduled for fiscal year 2014 ending March 31, 2014 and beyond, their commercial success and consumer preferences that, in recent periods, have trended in favor of 2D over 3D; our ability to increase the number of RealD-enabled screens in domestic and international markets and market share; our ability to supply our products to our customers on a timely basis; RealD relationships with exhibitor and studio partners and the business model for 3D eyewear in North America; the progress, timing and amount of expenses associated with our research and development activities; market and industry growth opportunities and trends in the markets in which we operate, including in 3D content; our plans, strategies and expected opportunities; the deployment of and demand for our products and products incorporating our technologies; and competitive pressures in domestic and international cinema markets impacting licensing and product revenues. Actual results may differ materially from those discussed in


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these forward-looking statements due to a number of factors, including the risks set forth in the section entitled "Risk Factors" in Part II, Item 1A of this Quarterly Report on Form 10-Q and elsewhere in this filing. Although we believe that the expectations reflected in the forward-looking statements are reasonable, we cannot guarantee future results, levels of activity, performance or achievements. Moreover, neither we nor any other person assumes responsibility for the accuracy and completeness of these forward-looking statements. We are under no duty to update any of the forward-looking statements after the date of this Quarterly Report on Form 10-Q to conform our prior statements to actual results.

Overview

We are a leading global licensor of 3D technologies. Our extensive intellectual property portfolio is used in applications that enable a premium 3D viewing experience in the theater, the home and elsewhere. We license our RealD Cinema Systems to motion picture exhibitors that show 3D motion pictures and alternative 3D content. We also provide our RealD Display, active and passive eyewear, and RealD Format technologies to consumer electronics manufacturers, content providers and distributors to enable the delivery and viewing of 3D content on a variety of visual displays and devices.

For financial reporting purposes, we currently have one reportable segment. We have three operating segments: cinema, consumer electronics and professional within which we market our various applications. Operating segments are defined as components of an enterprise about which separate financial information is available that is evaluated regularly by the chief operating decision maker, or decision-making group, in deciding how to allocate resources and in assessing performance. Our chief operating decision maker is our Chief Executive Officer. We aggregate our three operating segments into one reportable segment based on qualitative factors, including similar economic characteristics and the nature of the products and services. Our product portfolio is used in applications that enable a premium 3D viewing experience across these segments. We currently generate substantially all of our revenue from the license of our RealD Cinema Systems and the use and sale of our eyewear.

Key business metrics

Our management regularly reviews a number of business metrics, including the following key metrics to evaluate our business, monitor the performance of our business model, identify trends affecting our business, determine the allocation of resources, make decisions regarding corporate strategies and evaluate forward-looking projections. The measures that we believe are the primary indicators of our quarterly and annual performance are as follows:

RealD box office. Estimated domestic box office on RealD-enabled screens represents the estimated 3D box office generated on RealD-enabled domestic screens. Estimated international box office on RealD-enabled screens is the estimated 3D box office generated on RealD-enabled international screens. RealD's estimates of box office on RealD-enabled screens rely on box office tracking data. International box office reflects RealD's estimates of international box office generated on RealD-enabled screens in 20 foreign countries where box office tracking is available. RealD estimates these countries represent approximately 85% of RealD's international license revenues.

Number of 3D motion pictures. Total 3D motion pictures are the number of 3D motion pictures released domestically in North America during the relevant period.

Number of screens. Domestic screens are motion picture theater screens in the United States or Canada enabled with our RealD Cinema Systems. International screens are motion picture theater screens outside the United States and Canada enabled with our RealD Cinema Systems.

Number of locations. Domestic locations are motion picture exhibition complexes in the United States or Canada with one or more screens enabled with our RealD Cinema Systems. International locations are motion picture exhibition complexes outside the United States and Canada with one or more screens enabled with our RealD Cinema Systems.

Adjusted EBITDA. We use Adjusted EBITDA as a supplemental measure of our performance. We define Adjusted EBITDA as net income (loss), plus net interest expense, income taxes, other income, depreciation and amortization and share-based compensation expense, as further adjusted to eliminate the impact of certain other items that we do not consider indicative of our core operating performance. We consider our core operating performance to be that which can be affected by our managers in any particular period through their management of the resources that affect our underlying revenue and profit generating operations for that period. However, Adjusted EBITDA is not a recognized measurement under U.S. GAAP and should not be considered in isolation or as a substitute for performance measures calculated in accordance with U.S. GAAP. For a reconciliation of Adjusted EBITDA to U.S. GAAP net income (loss) and for further discussion regarding Adjusted EBITDA, see ''Non-U.S. GAAP discussion.''


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The following table sets forth additional performance highlights of key business metrics for the periods presented (approximate numbers):

                                                            Three months ended
                                                       June 30,           June 22,
(approximate numbers, in millions)                       2013               2012
Estimated box office on RealD screens (generated
during the period)
Estimated box office on RealD domestic screens         $      431        $        444
Estimated box office on RealD international
screens                                                       407                 489
Total estimated box office on RealD screens            $      838        $        933




                                                          Three months ended
                                                       June 30,        June 22,
(approximate numbers)                                    2013            2012
Number of 3D motion pictures (released
domestically during period)                                     8              10

                                                       June 30,        June 22,
                                                         2013            2012
Number of RealD enabled screens (at period end)
Total domestic RealD enabled screens                       13,100          12,000
Total international RealD enabled screens                  10,400           8,700
Total RealD enabled screens                                23,500          20,700
Number of locations with RealD enabled screens (at
period end)
Total domestic locations with RealD enabled
screens                                                     2,900           2,700
Total international locations with RealD enabled
screens                                                     2,700           2,500
Total locations with RealD enabled screens                  5,600           5,200

Performance highlights for Adjusted EBITDA, another key business metric and a Non-U.S. GAAP financial measure, are presented below under the caption "Non-U.S. GAAP discussion."

Beginning in the first quarter of fiscal 2014 ended on June 30, 2013, we modified our definition of Adjusted EBITDA for financial reporting purposes to align with the Adjusted EBITDA definition under the Credit Agreement (see "Liquidity and capital resources" caption below). As a result, we no longer add back sales and use tax and property tax to calculate Adjusted EBITDA for financial reporting purposes.

Opportunities, trends and factors affecting comparability

We have rapidly evolved and expanded our business since we acquired ColorLink in March 2007. This expansion has included hiring most of our senior management team, acquiring and growing our research and development facilities in Boulder, Colorado, and building infrastructure to support our business. These investments in and changes to our business have allowed us to significantly increase our revenue and key business metrics. Almost all of our revenue is currently dependent upon both the number of 3D motion pictures released and the commercial success of those 3D motion pictures. We expect to continue to invest for the foreseeable future in expanding our business as we increase our direct sales and marketing presence in the United States, Europe, Asia, Latin America, Russia and other geographic regions, enhance and expand our technology and product offerings and pursue strategic acquisitions. For example, in 2012, we established a RealD sales and operating presence in Russia and, in 2013, we established a RealD sales and operating presence in Latin America.

Cinema

The shift in the motion picture industry from analog to digital over the past decade has created an opportunity for new and transformative 3D technologies. As of June 30, 2013, there were approximately 23,500 RealD-enabled screens worldwide as compared to approximately 20,700 RealD-enabled screens worldwide as of June 22, 2012, an increase of 2,800 RealD-enabled screens or 14%. Based on the slate announced by motion picture studios, we anticipate that approximately 35 3D motion pictures will be released worldwide in our fiscal year 2014, including sequels to successful major motion picture franchises, such as Iron Man, Thor, The Hobbit, Star Trek, 300, Monsters, Despicable Me, The Smurfs and Cloudy with a Chance of Meatballs.

Other visual display technologies

We have recently made available our RealD Display, active and passive eyewear, and RealD Format technologies to consumer electronics manufacturers and content distributors to enable 3D in high definition televisions, laptops, tablets, smartphones and other displays in the home and elsewhere. We believe that the recent success of major 3D motion pictures, including The Avengers, The Hobbit:
An Unexpected Journey, The Amazing Spider-Man, Madagascar 3: Europe's Most Wanted, Life of Pi, Iron Man 3 and Star Trek Into Darkness is leading to the creation and distribution of 3D content for consumer electronics. The development of these technologies represents a significant opportunity for new revenue.


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Results of operations

The following table sets forth our condensed consolidated statements of operations and other data for each of the periods indicated:

                                                              Three months ended
                                                            June 30,      June 22,
(in thousands)                                                2013          2012
Consolidated statements of operations data:
Revenue                                                      $ 59,219      $ 68,178
Cost of revenue                                                31,038        36,833
Gross margin                                                   28,181        31,345
Operating expenses:
Research and development                                        5,544         4,898
Selling and marketing                                           7,338         6,895
General and administrative                                     14,422        11,262
Total operating expenses                                       27,304        23,055
Operating income (loss)                                           877         8,290
Interest expense, net                                            (489 )        (313 )
Other loss, net                                                  (209 )        (353 )
Income before income taxes                                        179         7,624
Income tax expense                                              1,715         4,677
Net income (loss)                                              (1,536 )       2,947
Net (income) loss attributable to noncontrolling interest           2            32
Net income (loss) attributable to RealD Inc.
common stockholders                                          $ (1,534 )    $  2,979

Other data:
Adjusted EBITDA (1)                                          $ 16,027      $ 21,996



(1) Adjusted EBITDA is not a recognized measurement under U.S. GAAP. For a definition of Adjusted EBITDA and reconciliation to net income (loss), the comparable U.S. GAAP item, see "Non-U.S. GAAP discussion".

Three months ended June 30, 2013 compared to three months ended June 22, 2012

Revenue



                      Three months ended
                    June 30,      June 22,       Amount       Percentage
(in thousands)        2013          2012         change         change
Revenue:
License revenue      $ 37,306      $ 41,189      $ (3,883 )         (9%)
Product and other      21,913        26,989        (5,076 )        (19%)
Total revenue        $ 59,219      $ 68,178      $ (8,959 )        (13%)

The decrease in revenue recorded during the three months ended June 30, 2013 compared to the three months ended June 22, 2012 was primarily due to lower domestic eyewear usage and lower international eyewear sales, reductions of average eyewear revenue per unit for domestic usage and international eyewear sold, and a decrease in license revenues resulting from a decrease in box office performance. Our international markets comprised approximately 45% of total revenue for the three months ended June 30, 2013 as compared to 46% for the three months ended June 22, 2012. The decrease in revenues attributable to international markets was driven by a decrease in sales of RealD eyewear.

For the three months ended June 30, 2013, there were 11 motion pictures that contributed greater than $1.0 million of admission-based fees to license revenue. License revenue for the three months ended June 30, 2013 includes admission-based fees related to the following motion pictures: Iron Man 3 ($8.6 million), Star Trek 2: Into Darkness ($3.1 million), Man of Steel ($3.1 million), The Croods ($2.6 million), The Great Gatsby ($2.1 million), G.I. Joe 2: Retaliation ($1.9 million), Epic ($1.8 million), Monsters University ($1.5 million), World War Z ($1.5 million), Jurassic Park (3D re-release) ($1.2 million) and Oz: The Great & Powerful ($1.1 million).


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For the three months ended June 22, 2012, there were nine motion pictures that contributed greater than $1.0 million of admission-based fees to license revenue. License revenue for the three months ended June 22, 2012 includes admission-based fees related to the following motion pictures: The Avengers ($12.8 million), Titanic 3D ($3.7 million), Men in Black III ($3.4 million), Wrath of the Titans ($3.2 million), Madagascar 3: Europe's Most Wanted ($2.5 million), Prometheus ($1.7 million), The Lorax ($1.3 million), Ghost Rider 2:
Spirit of Vengeance ($1.3 million) and The Pirates! Band of Misfits ($1.1 million).

License revenues comprised 63% and 60% of total revenues for the three months ended June 30, 2013 and June 22, 2012, respectively. International license revenues comprised of $20.7 million, or 55% of total license revenues and $23.2 million, or 56% of total license revenue for the three months ended June 30, 2013 and June 22, 2012, respectively.

The decrease in our product and other revenue in the three months ended June 30, 2013 as compared to the three months ended June 22, 2012, was primarily a result of a decrease in the volume of RealD eyewear consumed or sold to our domestic and international markets as well as from a reduction in average eyewear revenue per unit sold. The decrease in RealD eyewear volume internationally compared to the prior period resulted from a growing trend among consumers to reuse RealD eyewear for multiple viewings, as well as exhibitor buying patterns relative to the film slate and purchases by certain international exhibitors from alternative suppliers, including authorized resellers of RealD eyewear. International product revenues comprised of $5.9 million, or 27% of total product revenues and $8.4 million, or 31% of total product revenues for the three months ended June 30, 2013 and June 22, 2012, respectively. International product and other revenues were 28% of international license revenue for the three months ended June 30, 2013 as compared to 36% for the three months ended June 22, 2012.

We expect our future revenue, particularly in our license business, will be driven by the number of RealD-enabled screens and motion pictures released in 3D and the box office performance of those films.

Cost of Revenue





                           Three months ended
                         June 30,       June 22,       Amount       Percentage
(in thousands)             2013           2012         change         change
Revenue                  $ 59,219       $ 68,178       $ (8,959 )        (13%)
Cost of revenue:
License                    10,818         10,013            805             8%
Product and other          20,220         26,820         (6,600 )        (25%)
Total cost of revenue    $ 31,038       $ 36,833       $ (5,795 )        (16%)
Gross profit             $ 28,181       $ 31,345       $ (3,164 )        (10%)
Gross margin                   48%            46%

For the three months ended June 30, 2013, our cost of revenue decreased primarily due to higher recycle mix and lowered eyewear cost. Cost of revenue decreased, as a percentage of revenue, to 52% for the three months ended June 30, 2013, as compared to 54% for the three months ended June 22, 2012.

License cost of revenue increased $0.8 million quarter-over-quarter primarily as a result of a $0.8 million increase in depreciation expense resulting from an increase in RealD-enabled screens. Included in license cost of revenue for the three months ended June 30, 2013 and June 22, 2012 is depreciation expense of $7.7 million and $6.9 million, respectively. Depreciation expense as a percentage of total license revenue increased to 21% for the three months ended June 30, 2013 from 17% for the three months ended June 22, 2012.

Product and other gross profit increased $1.5 million quarter-over-quarter, primarily as a result of optimizing eyewear product mix and thereby lowering costs and more than offsetting lower demand. Product and other gross margin increased to 8% for the three months ended June 30, 2013 as compared to 1% for the three months ended June 22, 2012.

Costs associated with our eyewear recycling program have been expensed in the period incurred. Recycling costs totaled $2.3 million for the three months ended June 30, 2013 and $2.2 million for the three months ended June 22, 2012, and included the cost to transport RealD eyewear between theaters and the recycling production facility and costs to process the RealD eyewear for reuse. The percentage of usage of recycled eyewear may decrease in future periods resulting in lower gross profit and gross margin.


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Our cost of revenue as a percentage of revenue, as well as our gross profit and gross margin, will be affected in the future by the relative mix of license and product revenue, the mix of domestic and international product revenues, the relative mix of products and any new revenue sources, impairment charges and the percentage usage of recycled eyewear. Impairment charges in future periods may increase as a result of system upgrades and replacements as well as changes in product offerings and new technology. As the number of RealD-enabled screens and the number of 3D motion pictures and attendance increase, our total cost of revenue may continue to increase.

Operating Expenses



                               Three months ended
                             June 30,      June 22,       Amount      Percentage
(in thousands)                 2013          2012         change        change
Research and development      $  5,544      $  4,898      $   646             13 %
Selling and marketing            7,338         6,895          443              6 %
General and administrative      14,422        11,262        3,160             28 %
Total operating expenses      $ 27,304      $ 23,055      $ 4,249             18 %

Research and development. Our research and development expenses increased primarily due to $0.4 million higher personnel expenses, $0.3 million higher depreciation and amortization, and $0.3 million higher stock-based compensation, which were partially offset by $0.3 million lower supplies expense. We expect to continue to increase our research and development expenses to support our anticipated growth in consumer electronics projects and initiatives, primarily for additional personnel, consultants and prototype and materials costs, as well as for continued investment in our cinema business.

Selling and marketing. Our selling and marketing expenses increased primarily due to $0.4 million higher personnel expenses. We expect to incur additional selling and marketing expenses, aside from personnel related costs, as we increase our international marketing efforts, particularly in Asia, Latin America and Russia, to build our consumer electronics business worldwide and market future 3D films.

General and administrative. Our general and administrative expenses increased primarily due to a $0.8 million change in bad debt expense to $0.2 million versus a prior year credit of $0.6 million, $0.7 million higher sales and use taxes and property taxes, $0.6 million higher personnel expenses, $0.4 million higher outside services, $0.4 million higher depreciation expense, and $0.2 million higher rent expense.

Historical operating expense is not necessarily indicative of future expenses for a changing business.

Other

Interest expense, net. Net interest expense was $0.5 million and $0.3 million for the three months ended June 30, 2013 and June 22, 2012, respectively. The increase in net interest expense was primarily due to increased borrowings under our Credit Agreement.

Income tax. Our income tax expense for the three months ended June 30, 2013 was $1.7 million compared to $4.7 million for the three months ended June 22, 2012, primarily due to differences in net income and the effective tax rate estimate used. For the three months ended June 30, 2013, we used the actual effective year-to-date tax rate to calculate the interim effective tax rate for the US jurisdiction, as a reliable estimate of the annual effective tax rate could not be made. For the three months ended June 22, 2012, the tax rate at the end of the period was calculated using an estimate of the annual effective tax rate expected to be applicable for the full fiscal year.

We have net operating losses that may potentially offset taxable income in the future. We expect to incur an increasing amount of income tax expenses that relate primarily to federal and state income tax and international operations. We file federal income tax returns and income tax returns in various state and foreign jurisdictions. Due to the net operating loss carryforwards, our United States federal and state returns are open to examination by the Internal Revenue Service and state jurisdictions for all years since inception.

Seasonality and quarterly performance

Our operations are generally subject to seasonal trends based on the number of 3D motion pictures released and the box office of those 3D motion pictures. As is the case with other participants in the motion picture exhibition industry, we expect that our fiscal quarters during the summer period generally will tend to show stronger box office performance and higher revenues due to the summer movie-going season, when many of the largest grossing films in any given year are typically released. By comparison the quarter ending in March traditionally does not benefit from the same box office performance due to the number and nature of the motion pictures released in this seasonal period. We expect to experience seasonal fluctuations in results of operations as a result of these trends. Our quarterly financial results have fluctuated in the past and may continue to fluctuate in the future based on a number of other factors in addition to these seasonal trends, many of which are beyond our control. Factors that may cause our operating results to vary or fluctuate include those discussed in Part II, Item 1A below under the caption "Risk factors."


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Liquidity and capital resources

Since our inception and through June 30, 2013, we have financed our operations through the proceeds we received in connection with our IPO, the sale of redeemable convertible preferred stock, borrowings under our previous credit facility agreement and our current Credit Agreement with City National and . . .

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