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Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 


 

FORM 10-Q

 


 

x

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the Quarterly Period Ended December 24, 2010

 

OR

 

o

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the transition period from ______ to ______.

 

Commission File Number: 001-34818

 

RealD Inc.

(Exact name of registrant as specified in its charter)

 


 

 

Delaware

77-0620426

(State or other jurisdiction of
incorporation or organization)

(I.R.S. Employer
Identification No.)

 

 

100 N. Crescent Drive, Suite 120
Beverly Hills, CA

90210

(Address of principal executive offices)

(Zip Code)

(310) 385-4000
(Registrant's telephone number, including area code)

 


 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such  filing requirements for the past 90 days.    Yes  x    No o

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (Section 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).
Yes 
o    No  o

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See  the definitions of “large accelerated filer,” “accelerated filer” and “smaller  reporting company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer

o

 

Accelerated filer

 

o

Non-accelerated filer

x  (Do not check if a smaller reporting company)

 

Smaller reporting company

 

o

 

Indicate by check mark whether the registrant is a shell company (as defined in  Rule 12b-2 of the Exchange Act).
Yes 
o    No  x

 

On February 1, 2011, the registrant had 51,302,056 shares of common stock, par value $0.0001 per share, outstanding.

 

 



Table of Contents

 

RealD Inc.

QUARTERLY REPORT ON FORM 10-Q
FOR THE QUARTER ENDED
December 24, 2010

 

 

TABLE OF CONTENTS

 

PART I – FINANCIAL INFORMATION

 

 

 

 

 

 

 

Page
Number

 

 

 

 

ITEM 1.

Financial statements

 

3

 

 

 

 

 

Condensed consolidated balance sheets as of December 24, 2010 (unaudited) and March 26, 2010

 

3

 

 

 

 

 

Condensed consolidated statements of operations (unaudited) for the three and nine months ended December 24, 2010 and December 25, 2009

 

4

 

 

 

 

 

Condensed consolidated statements of cash flows (unaudited) for the nine months ended December 24, 2010 and December 25, 2009

 

5

 

 

 

 

 

Notes to condensed consolidated financial statements (unaudited)

 

6

 

 

 

 

ITEM 2.

Management’s discussion and analysis of financial condition and results of operations

 

15

 

 

 

 

ITEM 3.

Quantitative and qualitative disclosures about market risk

 

31

 

 

 

 

ITEM 4.

Controls and procedures

 

32

 

 

 

 

PART II – OTHER INFORMATION

 

 

 

 

ITEM 1.

Legal proceedings

 

33

 

 

 

 

ITEM 1A.

Risk factors

 

33

 

 

 

 

ITEM 2.

Unregistered sales of equity securities and use of proceeds

 

43

 

 

 

 

ITEM 5.

Other information

 

43

 

 

 

 

ITEM 6.

Exhibits

 

43

 

2



Table of Contents

 

PART I – FINANCIAL INFORMATION

 

ITEM 1. – FINANCIAL STATEMENTS

 

RealD Inc.

Condensed consolidated balance sheets

(in thousands, except per share data)

 

 

 

December 24,

 

March 26,

 

 

 

2010

 

2010

 

 

 

(unaudited)

 

 

 

 

Assets

 

 

 

 

 

 

 

Current assets:

 

 

 

 

 

 

 

Cash and cash equivalents

 

  $

35,472

 

 

  $

13,134

 

 

Accounts receivable, net

 

59,258

 

 

51,184

 

 

Inventories

 

43,076

 

 

6,539

 

 

Deferred costs – eyewear

 

1,571

 

 

1,842

 

 

Deferred income taxes

 

4,349

 

 

4,349

 

 

Prepaid expenses and other current assets

 

4,913

 

 

1,128

 

 

Total current assets

 

148,639

 

 

78,176

 

 

Property and equipment, net

 

5,520

 

 

2,558

 

 

Cinema systems, net

 

95,254

 

 

40,623

 

 

Digital projectors, net-held for sale

 

10,809

 

 

25,521

 

 

Goodwill

 

10,657

 

 

10,657

 

 

Other intangibles, net

 

1,963

 

 

2,024

 

 

Other assets

 

184

 

 

2,587

 

 

Total assets

 

  $

273,026

 

 

  $

162,146

 

 

Liabilities, redeemable convertible preferred stock and equity (deficit)

 

 

 

 

 

 

 

Current liabilities:

 

 

 

 

 

 

 

Accounts payable

 

  $

57,055

 

 

  $

37,625

 

 

Accrued expenses and other liabilities

 

38,813

 

 

24,608

 

 

Deferred revenue

 

16,590

 

 

19,430

 

 

Credit facility agreement

 

 

 

20,066

 

 

Income taxes payable

 

1,420

 

 

1,254

 

 

Current portion of long-term debt

 

2,430

 

 

9,299

 

 

Total current liabilities

 

116,308

 

 

112,282

 

 

Deferred revenue, net of current portion

 

15,098

 

 

14,144

 

 

Virtual print fee liability and customer deposits

 

4,533

 

 

8,331

 

 

Long-term debt, net of current portion

 

486

 

 

2,031

 

 

Deferred tax liability

 

4,413

 

 

4,413

 

 

Commitments and contingencies

 

 

 

 

 

 

 

Series C mandatorily redeemable convertible preferred stock, no par value, 5,140 shares authorized; zero and 5,140 shares issued and outstanding; zero and $17.025 redemption value per share at December 24, 2010 and March 26, 2010, respectively

 

 

 

62,831

 

 

Equity (deficit)

 

 

 

 

 

 

 

Series A redeemable convertible preferred stock, no par value, 3,000 shares authorized; zero and 2,000 shares issued and outstanding at December 24, 2010 and March 26, 2010, respectively

 

 

 

1,978

 

 

Series B redeemable convertible preferred stock, no par value, zero and 2,418 shares authorized; zero and 2,417 shares issued and outstanding at December 24, 2010 and March 26, 2010, respectively

 

 

 

2,970

 

 

Series D redeemable convertible preferred stock, no par value, zero and 1,667 shares authorized; zero and 1,667 shares issued and outstanding at December 24, 2010 and March 26, 2010, respectively

 

 

 

19,952

 

 

Common stock, $0.0001 par value, 200,000 and 52,700 shares authorized; 50,321 and 24,691 shares issued and outstanding at December 24, 2010 and March 26, 2010, respectively

 

284,297

 

 

68,371

 

 

Other accumulated comprehensive loss

 

 

 

 

 

Accumulated deficit

 

(154,047

)

 

(137,291

)

 

Total RealD Inc. stockholders’ equity (deficit)

 

130,250

 

 

(44,020

)

 

Noncontrolling interest

 

1,938

 

 

2,134

 

 

Total equity (deficit)

 

132,188

 

 

(41,886

)

 

Total liabilities, mandatorily redeemable convertible preferred stock and equity (deficit)

 

  $

273,026

 

 

  $

162,146

 

 

 

 

 

 

 

 

 

 

 

 

 

See accompanying notes to condensed consolidated financial statements

 

3



Table of Contents

 

RealD Inc.

Condensed consolidated statements of operations (unaudited)

(in thousands, except per share data)

 

 

 

Three months ended

 

Nine months ended

 

 

 

December 24,

 

December 25,

 

December 24,

 

December 25,

 

 

 

2010

 

2009

 

2010

 

2009

 

 

 

 

 

 

 

 

 

 

 

Revenue:

 

 

 

 

 

 

 

 

 

License

 

  $

18,838

 

 

  $

4,269

 

 

  $

68,390

 

 

  $

25,993

 

 

Product and other

 

 

38,942

 

 

 

25,926

 

 

 

119,232

 

 

 

68,449

 

 

Total revenue

 

 

57,780

 

 

 

30,195

 

 

 

187,622

 

 

 

94,442

 

 

Cost of revenue:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

License

 

 

5,301

 

 

 

2,587

 

 

 

11,660

 

 

 

7,099

 

 

Product and other

 

 

46,341

 

 

 

29,040

 

 

 

138,099

 

 

 

77,586

 

 

Total cost of revenue

 

 

51,642

 

 

 

31,627

 

 

 

149,759

 

 

 

84,685

 

 

Gross margin

 

 

6,138

 

 

 

(1,432

)

 

 

37,863

 

 

 

9,757

 

 

Operating expenses:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Research and development

 

 

4,347

 

 

 

2,322

 

 

 

10,751

 

 

 

7,327

 

 

Selling and marketing

 

 

5,813

 

 

 

3,342

 

 

 

15,251

 

 

 

11,123

 

 

General and administrative

 

 

10,596

 

 

 

3,920

 

 

 

25,195

 

 

 

9,870

 

 

Total operating expenses

 

 

20,756

 

 

 

9,584

 

 

 

51,197

 

 

 

28,320

 

 

Operating loss

 

 

(14,618

)

 

 

(11,016

)

 

 

(13,334

)

 

 

(18,563

)

 

Interest expense

 

 

(71

)

 

 

(575

)

 

 

(873

)

 

 

(1,149

)

 

Other income (loss)

 

 

(431

)

 

 

(210

)

 

 

6,376

 

 

 

(670

)

 

Loss before income taxes

 

 

(15,120

)

 

 

(11,801

)

 

 

(7,831

)

 

 

(20,382

)

 

Income tax expense

 

 

1,648

 

 

 

478

 

 

 

3,299

 

 

 

1,431

 

 

Net loss

 

 

(16,768

)

 

 

(12,279

)

 

 

(11,130

)

 

 

(21,813

)

 

Net (income) loss attributable to noncontrolling interest

 

 

181

 

 

 

261

 

 

 

(692

)

 

 

726

 

 

Accretion of preferred stock

 

 

-

 

 

 

(3,093

)

 

 

(4,934

)

 

 

(9,278

)

 

Net loss attributable to RealD Inc. common stockholders

 

  $

(16,587

)

 

  $

(15,111

)

 

  $

(16,756

)

 

  $

(30,365

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Loss per common share:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Basic and diluted

 

  $

(0.34

)

 

  $

(0.61

)

 

  $

(0.43

)

 

  $

(1.24

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Shares used in computing earnings per common share:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Basic and diluted

 

 

48,760

 

 

 

24,607

 

 

 

38,689

 

 

 

24,454

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

See accompanying notes to condensed consolidated financial statements

 

4



Table of Contents

 

RealD Inc.

Condensed consolidated statements of cash flows (unaudited)

(in thousands)

 

 

 

Nine months ended

 

 

 

December 24,

 

December 25,

 

 

 

2010

 

2009

 

Cash flows from operating activities

 

 

 

 

 

 

Net loss

 

  $

(11,130

)

 

  $

(21,813

)

Adjustments to reconcile net loss to net cash provided by (used in) operating activities:

 

 

 

 

 

 

Depreciation and amortization

 

10,428

 

 

5,387

 

Deferred income tax

 

 

 

 

Non-cash interest expense

 

132

 

 

467

 

Non-cash stock compensation

 

5,988

 

 

2,230

 

Motion picture exhibitor option reduction in revenue

 

34,008

 

 

17,966

 

Gain on sale of digital projectors

 

(6,720

)

 

 

Impairment of long-lived assets

 

814

 

 

408

 

Changes in operating assets and liabilities:

 

 

 

 

Accounts receivable

 

(8,074

)

 

(22,107

)

Inventories

 

(36,537

)

 

(6,287

)

Prepaid expenses and other current assets

 

(3,785

)

 

(502

)

Deferred costs - eyewear

 

271

 

 

3,046

 

Other assets

 

2,382

 

 

(24

)

Accounts payable

 

19,625

 

 

7,852

 

Accrued expenses and other liabilities

 

14,139

 

 

6,193

 

Virtual print fee liability and customer deposits

 

1,791

 

 

1,798

 

Income taxes payable

 

166

 

 

922

 

Deferred revenue

 

(1,886

)

 

(2,451

)

Net cash provided by (used in) operating activities

 

21,612

 

 

(6,915

)

 

 

 

 

 

 

 

Cash flows from investing activities

 

 

 

 

 

 

Purchases of marketable securities

 

(6,849

)

 

 

Proceeds from sale of marketable securities

 

6,849

 

 

 

Purchases of property and equipment

 

(3,623

)

 

(1,055

)

Purchases of cinema systems and related components

 

(63,983

)

 

(18,220

)

Purchases of digital projectors

 

(418

)

 

(519

)

Proceeds from sale of digital projectors

 

15,612

 

 

 

Net cash used in investing activities

 

(52,412

)

 

(19,794

)

 

 

 

 

 

 

 

Cash flows from financing activities

 

 

 

 

 

 

Proceeds from common stock issuance, net of issuance costs

 

81,940

 

 

 

Noncontrolling interest distribution

 

(888

)

 

 

Proceeds from credit facility agreement - term loan

 

 

 

10,000

 

Repayments on credit facility agreement - term loan

 

(10,000

)

 

 

Repayments of long-term debt

 

(9,089

)

 

(1,104

)

Proceeds from credit facility agreement - revolving credit facility

 

5,000

 

 

5,000

 

Repayments on credit facility agreement - revolving credit facility

 

(15,150

)

 

 

Proceeds from exercise of stock options

 

951

 

 

31

 

Proceeds from exercise of warrants

 

363

 

 

 

Proceeds from exercise of motion picture exhibitor options

 

11

 

 

 

Net cash provided by financing activities

 

53,138

 

 

13,927

 

Net increase (decrease) in cash and cash equivalents

 

22,338

 

 

(12,782

)

Cash and cash equivalents, beginning of year

 

13,134

 

 

15,704

 

Cash and cash equivalents, end of year

 

  $

35,472

 

 

  $

2,922

 

 

 

 

 

 

 

 

Supplemental disclosures of cash flow information

 

 

 

 

 

 

Accretion of Series C preferred stock

 

  $

4,934

 

 

  $

9,278

 

 

See accompanying notes to condensed consolidated financial statements

 

5


 


Table of Contents

 

RealD Inc.

Notes to condensed consolidated financial statements (unaudited)

 

1. Business and basis of presentation

 

RealD Inc., including its subsidiaries (“RealD”), is a global licensor of stereoscopic 3D technologies.

 

The accompanying condensed consolidated financial statements are unaudited. These unaudited interim condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States (“GAAP”) and applicable rules and regulations of the Securities and Exchange Commission (“SEC”) regarding interim financial reporting and include all adjustments (consisting of only normal recurring adjustments, unless otherwise indicated), necessary for a fair presentation of our condensed consolidated financial statements. Interim results are not necessarily indicative of results for any subsequent quarter, the full fiscal year or any future periods. Certain information and note disclosures normally included in the financial statements prepared in accordance with GAAP have been condensed or omitted pursuant to such rules and regulations. Accordingly these interim condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and notes thereto contained in the Company’s Prospectus dated December 6, 2010 and filed pursuant to Rule 424(b) under the Securities and Exchange Act, as amended, with the SEC on December 7, 2010. The consolidated balance sheet as of March 26, 2010, included herein was derived from the audited financial statements as of that date, and the condensed notes to the condensed consolidated financial statements do not include all disclosures including notes required by GAAP.

 

The condensed consolidated financial statements include the accounts of RealD, its wholly owned subsidiaries and its majority owned subsidiaries. We do not have any interests in variable interest entities. For consolidated subsidiaries that are not wholly owned but are majority owned, the subsidiaries’ assets, liabilities, and operating results are included in their entirety in the accompanying condensed consolidated financial statements. The noncontrolling interests in those assets, liabilities, and operations are reflected as non-controlling interests in the condensed consolidated balance sheets under equity (deficit) and condensed consolidated statements of operations.

 

On April 8, 2010, we reincorporated in Delaware. Each class of our capital stock has a par value of $0.0001 per share.

 

On March 6, 2007, Digital Link II, LLC (“Digital Link II”) was formed between Ballantyne of Omaha, Inc. and RealD with member interests of 44.4% and 55.6%, respectively. Digital Link II was formed to fund the deployment of digital projector systems and servers to third-party exhibitors.

 

All significant intercompany balances and transactions have been eliminated in consolidation.

 

On June 28, 2010, we amended our certificate of incorporation, which increased our total authorized capital stock to 200 million shares (comprised of 150 million shares of common stock and 50 million shares of preferred stock), and effected a split of our common stock, which resulted in each share of our common stock splitting into one and one-half shares (or a 1-for-1.5 forward split). The accompanying condensed consolidated financial statements and notes to the condensed consolidated financial statements have been retroactively restated to reflect the stock split for all periods presented.

 

On July 21, 2010, we completed the initial public offering of our common stock in which we sold and issued 6 million shares of common stock at an issue price of $16.00 per share. A total of approximately $96 million in gross proceeds were raised from the initial public offering, or $81.9 million in net proceeds after deducting underwriting discounts and commissions of approximately $6.7 million and other offering costs of approximately $7.4 million.

 

We have evaluated the impact of subsequent events up to the filing date of these interim condensed consolidated financial statements.

 

2. Summary of significant accounting policies

 

Accounting period

Our fiscal year consists of four 13-week periods for a total of 52 weeks. The fiscal year for 2011 will end on March 25, 2011.

 

6



Table of Contents

 

Use of estimates

The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expense during the reporting period. Actual results could differ from those estimates.

 

Net loss per share of common stock

Basic loss per share of common stock is computed by dividing the net loss attributable to RealD Inc. common stockholders for the period by the weighted average number of shares of common stock outstanding during the period. Because the holders of our convertible preferred stock were entitled to participate in dividends and earnings of our company, we applied the two-class method in calculating our earnings per share for periods when we generated net income. The two-class method requires net income to be allocated between the common and preferred stockholders based on their respective rights to receive dividends, whether or not declared. No such dividends were paid. Because the convertible preferred stock was not contractually obligated to share in our losses, no such allocation was made for periods when we had net losses. Diluted loss per share of common stock was the same as basic loss per share of common stock for all periods presented because the effects of potentially dilutive items were anti-dilutive given our net losses.

 

The calculation of the basic and diluted loss per share of common stock for the three and nine months ended December 24, 2010 and December 25, 2009 was as follows:

 

 

 

Three months ended

 

Nine months ended

 

 

 

December 24,

 

December 25,

 

December 24,

 

December 25,

 

(in thousands, except per share data):

 

2010

 

2009

 

2010

 

2009

 

Numerator:

 

 

 

 

 

 

 

 

 

 

 

 

Net loss

 

  $

(16,768

)

 

  $

(12,279

)

 

  $

(11,130

)

 

  $

(21,813)

 

Net (income) loss attributable to noncontrolling interest

 

181

 

 

261

 

 

(692

)

 

726

 

Accretion of preferred stock

 

-

 

 

(3,093

)

 

(4,934

)

 

(9,278)

 

Net loss attributable to RealD Inc. common stockholders

 

  $

(16,587

)

 

  $

(15,111

)

 

  $

(16,756

)

 

  $

(30,365)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Denominator:

 

 

 

 

 

 

 

 

 

 

 

 

Weighted-average common shares outstanding

 

48,760

 

 

24,607

 

 

38,689

 

 

24,454

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Loss per common share:

 

 

 

 

 

 

 

 

 

 

 

 

Basic and diluted

 

  $

(0.34

)

 

  $

(0.61

)

 

  $

(0.43

)

 

  $

(1.24)

 

 

 

The weighted-average number of anti-dilutive shares excluded from the calculation of diluted loss per common share for the three and nine months ended December 24, 2010 and December 25, 2009 was as follows:

 

 

 

Three months ended

 

Nine months ended

 

 

 

December 24,

 

December 25,

 

December 24,

 

December 25,

 

(in thousands)

 

2010

 

2009

 

2010

 

2009

 

Options and warrants to purchase common stock

 

11,113

 

 

6,692

 

 

9,796

 

 

6,606

 

Conversion of convertible preferred stock

 

-

 

 

16,836

 

 

6,907

 

 

16,836

 

Total

 

11,113

 

 

23,528

 

 

16,703

 

 

23,442

 

 

The above anti-dilution table excludes 1,222,781 motion picture exhibitor options that vest upon the achievement of screen installation targets because the targets were not met as of December 24, 2010.

 

Marketable securities

 

We classify unrealized gains and losses reported as a component of accumulated other comprehensive income. As of December 24, 2010, the carrying value of our marketable securities approximated fair value primarily attributable to the short holding and maturity periods of the instruments. For the three and nine months ended December 24, 2010, the unrealized gains and losses from the available-for-sale securities were not significant.

 

The objectives of RealD investment policy are to preserve capital, provide sufficient liquidity to satisfy operating and investment purposes, and capture a market rate of return based on the company’s investment policy parameters and market conditions.  Our investment policy limits investments to certain types of debt and money market instruments issued by institutions with investment grade credit ratings and places restrictions on maturities and concentration by type and issuer.

 

7



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Derivative instruments

Our assets and liabilities associated with derivative instruments are recorded at fair value in other current assets or other current liabilities, respectively, in the condensed consolidated balance sheets. Changes in fair value are reported as a component of other income or loss on our condensed consolidated statements of operations. For all periods presented, none of our derivative instruments were designated as hedging instruments. We do not use foreign currency option or foreign exchange forward contracts for speculative or trading purposes.

 

We purchase foreign currency forward contracts, generally with maturities of six months or less, to reduce the volatility of cash flows primarily related to forecasted payments and expenses denominated in certain foreign currencies. As of December 24, 2010, we had outstanding forward contracts based in British pound sterling, Canadian dollars and Euro with notional amounts totaling $4.2 million. As of December 24, 2010 and March 26, 2010, the carrying amount of our foreign currency forward contracts was not significant and was classified as Level 2 fair value instruments, which was determined based on observable inputs that were corroborated by market data. For the three months ended December 24, 2010, the net gain related to the change in fair value of our foreign currency forward contracts was $0.1 million. For the nine months ended December 24, 2010, the net gain (loss) related to the change in fair value of our foreign currency forward contracts was not significant. For the three and nine months ended December 25, 2009, the net gain (loss) related to the change in fair value of our foreign currency forward contracts was not significant.

 

Accounts receivable

Accounts receivable consist of trade receivables, VAT receivable and other receivables. We extend credit to our customers, who are primarily in the movie production and exhibition businesses. We provide for the estimated accounts receivable that will not be collected. These estimates are based on an analysis of historical bad debts, customer concentrations, customer creditworthiness, current economic trends and changes in the customers’ payment terms and their economic condition. Collection of accounts receivable may be affected by changes in economic or other industry conditions and may, accordingly, impact our overall credit risk. The allowance for doubtful accounts and customer credits totaled $3.5 million and $1.2 million as of December 24, 2010 and March 26, 2010, respectively.

 

Inventories and deferred costs-eyewear

Inventories and deferred costs eyewear represent eyewear and are substantially all finished goods. Inventories and deferred costs eyewear are valued at the lower of cost (first-in, first-out method) or market value. At each balance sheet date, we evaluate ending inventories and deferred costs-eyewear for net realizable value. We also evaluate inventories for excess quantities and obsolescence. These evaluations include analyses of expected future average selling prices, projections of future demand and technology changes. In order to state inventories at lower of cost or market, we maintain reserves against such inventories. If our analyses indicate that market is lower than cost, a write-down of inventories is recorded in cost of revenue in the period the loss is identified.

 

For the three months ended December 24, 2010 and December 25, 2009, we recorded inventory impairments of $2.3 million and $1.3 million, respectively, as a result of our net realizable value analyses.  For each of the nine months ended December 24, 2010 and December 25, 2009, we recorded inventory impairments of $5.7 million and $4.3 million, respectively, as a result of our net realizable value analyses.

 

Domestically, we provide our RealD eyewear free of charge to motion picture exhibitors and then receive a fee from the motion picture studios for the usage of that RealD eyewear by the motion picture exhibitors’ consumers.

 

The number of domestic RealD-enabled screens and related usage of RealD eyewear is expected to grow. Accordingly, for RealD eyewear located at a motion picture exhibitor, we believe that it is not operationally practical to perform physical counts or request the motion picture exhibitor to perform physical counts and confirm quantities held to ensure that losses due to damage, destruction, and shrinkage are specifically recognized in the period incurred. We believe that the cost to monitor shrinkage or usage significantly outweighs the financial reporting benefits of using a specific identification methodology of expensing. We believe that utilizing a composite method of expensing RealD eyewear inventory costs provides a rational and reasonable approach to ensuring that shrinkage is provided for in the period incurred and that inventory costs are expensed in the periods that reasonably reflect the periods in which the related revenue is recognized. In doing so, we believe the following methodology reasonably and generally reflects periodic income or loss under these facts and circumstances:

 

·                  For an estimated period of time following shipment to domestic motion picture exhibitors, no expense is recognized between the time of shipment and until the delivery is made as the inventory unit is in transit and unused.

·                  The inventory unit cost is expensed on a straight-line basis over an estimated usage period beginning when we believe usage of the inventory unit has started. In estimating the expensing start date and related expense period, we consider various factors including, but not limited to, those relating to a 3D motion picture’s opening release date, a 3D motion picture’s expected release period, the number of currently playing 3D motion pictures, the motion picture exhibitor’s buying and stocking patterns and practices and the quantities shipped per inventory unit.

 

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We believe that the expensing methodology described above rationally and reasonably approximates the period the related usage occurs resulting in our RealD eyewear product revenue. The expensing start date following the date of shipment is meant to approximate the date at which usage begins. Additionally, as the expense recognition period has been and is expected to continue to be short, we believe it adequately recognizes inventory impairments due to loss and damage on a timely basis. We further believe that exposures due to loss or damage, if any, are considered normal shrinkage and a necessary and expected cost to generate the revenue per 3D motion picture earned through RealD eyewear usage. We continue to monitor the reasonableness of this methodology to ensure that it approximates the period over which the related RealD eyewear product revenue is earned and realizable. RealD eyewear inventory costs that have not yet been expensed are reported as deferred costs-eyewear.

 

Deferred offering costs

There was $7.4 million of deferred offering costs incurred through July 21, 2010,  which were offset against the proceeds of our initial public offering.

 

Impairment of long-lived assets

We review long-lived assets, such as property and equipment, cinema systems, digital projectors and intangibles, for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Factors or circumstances that could indicate the occurrence of such events include current period operating or cash flow losses combined with a history of operating or cash flow losses, a projection or forecast that demonstrates continuing operating or cash flow losses, or incurring costs in excess of amounts originally expected to acquire or construct an asset. If the asset is not recoverable, an impairment loss is recognized as the amount by which the carrying amount of the asset exceeds its fair value.

 

For the three months ended December 24, 2010 and December 25, 2009, impairment charges for impaired RealD Cinema Systems charged to cost of revenue totaled $0.5 million and $0.1 million, respectively. For the nine months ended December 24, 2010 and December 25, 2009, impairment charges for impaired RealD Cinema Systems charged to cost of revenue totaled $0.8 million and $0.4 million, respectively.

 

Revenue recognition and revenue reductions

We derive substantially all of our revenue from the license of our RealD Cinema Systems and the product sale of our RealD eyewear. We evaluate revenue recognition for transactions using the criteria set forth by the SEC in Staff Accounting Bulletin No. 104, Revenue Recognition (SAB 104) and Accounting Standards Codification Topic 605, Revenue Recognition (ASC 605). The revenue recognition guidance states that revenue is recognized when all of the following criteria are met: persuasive evidence of an arrangement exists, delivery has occurred or services have been rendered, the seller’s price to the buyer is fixed or determinable and collectability is reasonably assured.

 

License revenue

License revenue is accounted for as an operating lease. License revenue is primarily derived under per-admission, periodic fixed fee, or per-motion picture basis with motion picture exhibitors. Amounts received up front, less estimated allowances, are deferred and recognized over the lease term using the straight-line method. Additional lease payments that are contingent upon future events outside our control, including those related to admission and usage, are recognized as revenues when the contingency is resolved and we have no more obligations to our customers specific to the contingent payment received. Certain of our license revenue from leasing our RealD Cinema Systems is earned upon admission by the motion picture exhibitor’s consumers. Our licensees, however, do not report and pay for such license revenue until after the admission has occurred, which may be received subsequent to our fiscal period end. We estimate and record licensing revenue related to motion picture exhibitor consumer admissions in the quarter in which the admission occurs, but only when reasonable estimates of such amounts can be made. We determine that there is persuasive evidence of an arrangement upon the execution of a license agreement or upon the receipt of a licensee’s admissions report. Revenue is deemed fixed or determinable upon verification of a licensee’s admissions report in accordance with the terms of the underlying executed agreement or, in certain circumstances, receipt of a licensee’s admissions report. We determine collectability based on an evaluation of the licensee’s recent payment history.

 

Product revenue

We recognize product revenue, net of allowances, when title and risk of loss have passed and when there is persuasive evidence of an arrangement, the payment is fixed or determinable, and collectability of payment is reasonably assured. In the United States and Canada, certain of our product revenue from the sale of our RealD eyewear is earned upon admission and usage by the motion picture exhibitor’s consumers. Our customers, however, do not report admission or usage information until after the admission and usage has occurred, and such information may be received subsequent to our fiscal period end. We estimate and record such product revenue in the quarter in which the admission and usage occurs, but only when reasonable estimates of such amounts can be made.

 

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Revenue reductions

We record revenue net of motion picture exhibitor stock options and estimated revenue allowances. In connection with certain exhibitor licensing agreements, we issued the motion picture exhibitors a 10-year option to purchase shares of our common stock at approximately $0.00667 per share. The stock options vest upon the achievement of screen installation targets. Motion picture exhibitor stock options are valued at the underlying stock price at each reporting period until the targets are met. Amounts recognized are based on the number of RealD-enabled screens as a percentage of total screen installation targets. The stock options do not have net cash settlement features. Amounts recorded as a revenue reduction from motion picture exhibitor stock options totaled $22.0 million and $11.8 million for the three months ended December 24, 2010 and December 25, 2009, respectively. Amounts recorded as a revenue reduction from motion picture exhibitor stock options totaled $34.0 million and $18.0 million for the nine months ended December 24, 2010 and December 25, 2009, respectively. The reduction to revenue resulting from motion picture exhibitor stock options for the three and nine months ended December 24, 2010 reflects the price of our common stock of $28.42 per share and 3,749 deployed RealD Cinema Systems out of 4,500 RealD Cinema Systems set forth in the performance vesting targets. Reductions to revenue resulting from motion picture exhibitor stock options may increase as compared to a previous period as the stock price of our common stock and number of screen installations increase.

 

Shipping and handling costs

Amounts billed to customers for shipping and handling costs are included in revenue. Shipping and handling costs that we incur consist primarily of packaging and transportation charges and are recorded in cost of revenue. Shipping and handling costs recognized in cost of revenue were $2.2 million and $1.7 million for the three months ended December 24, 2010 and December 25, 2009, respectively. Shipping and handling costs recognized in cost of revenue were $8.7 million and $5.1 million for each of the nine months ended December 24, 2010 and December 25, 2009, respectively.

 

Recent accounting pronouncements

In January 2010, Accounting Standards Update 2010-6, Fair Value Measurements and Disclosures: Improving Disclosures About Fair Value Measurements (ASU 2010-6) was issued which requires entities to make new disclosures about recurring or nonrecurring fair value measurements including significant transfers into and out of Level 1 and Level 2 fair value measurements and information on purchases, sales, issuances and settlements on a gross basis in the reconciliation of Level 3 fair value measurements. We adopted ASU 2010-6 beginning in the first quarter of fiscal 2010, except for Level 3 reconciliation disclosures which are effective for us beginning in the first quarter of fiscal 2011. The adoption of the amended disclosure requirements for fair value measurements did not affect our disclosures because we did not transfer financial assets or liabilities between levels in the fair value hierarchy.

 

Accounting Standards Update No. 2009-13, Revenue Recognition (Topic 605)—Multiple-Deliverable Revenue Arrangements—a consensus of the Emerging Issues Task Force (ASU 2009-13) amends Accounting Standards Codification Subtopic 605-25, Revenue Recognition— Multiple-Element Arrangements (ASC 605-25). The amendments in ASU 2009-13 enable vendors to account for products or services separately rather than as a combined unit upon meeting certain criteria and establish a hierarchy for determining the selling price of a deliverable. In addition, a vendor can determine a best estimate of selling price, in a manner that is consistent with that used to determine the price to sell the deliverable on a standalone basis, if a vendor does not have vendor-specific objective evidence or third-party evidence of selling price. ASC 605-25 is also amended to eliminate the use of the residual method and requires a vendor to allocate revenue using the relative selling price method. The amendments in ASU 2009-13 will be effective prospectively, with an option for retrospective restatement of the financial statements, for revenue arrangements entered into or materially modified in fiscal years beginning on or after June 15, 2010 with early adoption permitted at the beginning of an entity’s fiscal year. We expect to prospectively adopt the amendments in ASU 2009-13 beginning in the first quarter of fiscal year 2012. We are currently evaluating the impact the adoption of new guidance will have on consolidated financial statements.

 

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3. Property and equipment, RealD Cinema Systems and digital projectors

 

Property and equipment, RealD Cinema Systems and digital projectors consist of the following:

 

 

 

December 24,

 

March 26,

 

(in thousands)

 

2010

 

2010

 

Cinema systems

 

  $

111,312

 

 

  $

48,508

 

 

Digital projectors

 

13,333

 

 

33,196

 

 

Leasehold improvements

 

698

 

 

719

 

 

Machinery and equipment

 

4,526

 

 

2,247

 

 

Furniture and fixtures

 

13

 

 

13

 

 

Computer equipment and software

 

1,579

 

 

356

 

 

Construction in process

 

907

 

 

767

 

 

Total

 

  $

132,368

 

 

  $

85,806

 

 

Less accumulated depreciation

 

(20,785

)

 

(17,104

)

 

Property and equipment, cinema systems and digital projectors, net

 

  $

111,583

 

 

  $

68,702

 

 

 

 

Depreciation expense amounted to $4.4 million and $2.0 million for the three months ended December 24, 2010 and December 25, 2009, respectively. Depreciation expense amounted to $10.4 million and $5.2 million for each of the  nine months ended December 24, 2010 and December 25, 2009, respectively.

 

We receive virtual print fees (VPFs) from third-party motion picture studios. VPFs represent amounts from third-party motion picture studios that are paid to us when a motion picture is played on one of our digital projectors. VPFs are deferred and deducted from the selling price of the digital projector. VPFs are recorded as a liability on the accompanying condensed consolidated balance sheets and totaled $1.5 million and $6.8 million as of December 24, 2010 and March 26, 2010, respectively.

 

During the three months ended December 24, 2010, we received $0.3 million in cash from motion picture exhibitor customers for the sale of digital projectors, the resulting gain was not significant. During the nine months ended December 24, 2010, we received $15.6 million in cash from motion picture exhibitor customers for the sale of digital projectors, resulting in a gain of $6.7 million in other income (loss). With the proceeds, we repaid an aggregate of $5.3 million of notes payable to the equipment providers.

 

4. Borrowings

 

Revolving credit facility agreement and term loan

Prior to July 21, 2010, the date of our initial public offering, we had a $35.0 million credit facility agreement with City National Bank that provided for a maximum amount of borrowing under a revolving credit facility of $25.0 million and a term loan of $10.0 million.

 

Borrowings outstanding under the term loan totaled $10.0 million as of March 26, 2010 at an interest rate of 8.625%. Borrowings outstanding under the revolving credit facility totaled $10.2 million as of March 26, 2010. The interest rates related to our borrowings outstanding under the revolving credit facility ranged from 4.6% to 6.0%.

 

All amounts outstanding under the credit facility agreement became due and were repaid upon the closing of our initial public offering on July 21, 2010.

 

Credit and security agreement

We have entered into a new credit and security agreement with City National Bank, dated as of June 24, 2010, which provides for a revolving credit facility of up to $15.0 million and which will mature on June 30, 2012. This agreement and the revolving credit facility provided thereunder became effective on July 21, 2010. Our obligations under the new credit and security agreement are secured by a first priority security interest in substantially all of our tangible and intangible assets in favor of City National Bank and are guaranteed by our subsidiaries, ColorLink, Inc. (“ColorLink”) and Stereographics Corporation (“Stereographics”).

 

Under the new credit and security agreement, our business will be subject to certain limitations, including limitations on our ability to incur additional debt, make certain investments or acquisitions, enter into certain merger and consolidation transactions, and sell our assets other than in the ordinary course of business. We will also be required to maintain compliance with certain financial covenants, including a minimum fixed charge coverage ratio and a maximum leverage ratio. As of December 24, 2010, we were in compliance with all financial covenants in our credit facility agreement. If we fail to comply with any of the covenants or if any other event of default, as defined in the agreement, should occur, the bank could elect to prevent us from borrowing and declare the indebtedness to be immediately due and payable.

 

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As of December 24, 2010, there were no borrowings outstanding under the credit and security agreement. As of December 24, 2010, there was $15.0 million available to borrow under the credit and security agreement.

 

Interest expense related to our borrowings under our credit and security agreement was not significant for the three months ended December 24, 2010. Interest expense related to our borrowings under our credit facility agreement and credit and security agreement was $0.6 million for the nine months ended December 24, 2010. Interest expense related to our borrowings under our credit facility agreement was $0.4 million and $0.5 million for the three and nine months ended December 25, 2009, respectively.

 

Notes payable

From time to time, we enter into equipment purchase agreements with certain of our vendors for the purchase of digital projectors, digital servers, lenses and accessories. We pay a portion of the cost of the equipment upon delivery and finance a portion of the purchase price by issuing notes payable. The equipment is included in digital projectors in the accompanying condensed consolidated balance sheets. Certain of these notes payable are non-interest bearing. In those cases, we record the net present value of the notes payable assuming an implied annual interest rate which is approximately 8.0%. The notes are secured by the underlying equipment.

 

Notes payable totaled $2.9 million and $11.3 million as of December 24, 2010 and March 26, 2010, respectively. Interest expense is based on annual interest rates ranging from 7.0% to 8.4%. Interest expense related to notes payable was $0.1 million and $0.2 million for the three months ended December 24, 2010 and December 25, 2009, respectively. Interest expense related to notes payable was $0.3 million and $0.6 million for the nine months ended December 24, 2010 and December 25, 2009, respectively.

 

5. Commitments and contingencies

 

Indemnities and commitments

During the ordinary course of business, we make certain indemnities and commitments under which we may be required to make payments in relation to certain transactions. These indemnities include indemnities of certain customers and licensees of our technologies, and indemnities to our directors and officers to the maximum extent permitted under the laws of the State of Delaware. The duration of these indemnities and commitments varies, and in certain cases, is indefinite. The majority of these indemnities and commitments do not provide for any limitation of the maximum potential future payments we could be obligated to make. We have not recorded any liability for these indemnities and commitments in the accompanying condensed consolidated balance sheets. We do, however, accrue for losses for any known contingent liability, including those that may arise from indemnification provisions, when future payment is probable and estimable.

 

We have entered into contracts with certain of our vendors. Future obligations under such contracts totaled $5.2 million at December 24, 2010 and include revolving 90-day supply commitments. Many of the contracts contain cancellation penalty provisions requiring payment of up to 20.0% of the unused contract.

 

6. Mandatorily redeemable convertible preferred stock and equity (deficit)

 

Initial public offering

On July 21, 2010, we completed the initial public offering of our common stock in which we sold and issued 6 million shares of common stock at an issue price of $16.00 per share. A total of approximately $96 million in gross proceeds were raised from the initial public offering, or $81.9 million in net proceeds after deducting underwriting discounts and commissions of approximately $6.7 million and other offering costs of approximately $7.4 million.

 

Convertible preferred stock

Our previously outstanding Series A, B and D convertible preferred stock was classified as part of permanent equity within the condensed consolidated balance sheets based on their rights and preferences set forth under the certificate of incorporation, California and Delaware law and the accounting standards pertaining to classification within the condensed consolidated balance sheet. We therefore recorded the Series A, B and D preferred stock at their original issuance price net of applicable issuance costs. On July 21, 2010, in conjunction with our initial public offering, all of our previously outstanding Series A, B and D convertible preferred stock in the amount of 6,084,311 shares converted at a ratio of 1:1.5 into 9,126,466 shares of common stock.

 

Mandatorily redeemable convertible preferred stock

Our Series C mandatorily redeemable convertible preferred stock was classified in temporary equity under the SEC’s guidance provided in Accounting Series Release No. 268, Presentation in Financial Statements of “Redeemable Preferred Stocks,” (ASR 268) because the holders of our Series C mandatorily redeemable convertible preferred stock had the right to cause us to redeem the instrument for cash for a specified period. On July 21, 2010, in conjunction with our initial public offering, all of our previously outstanding Series C mandatorily redeemable convertible preferred stock in the amount of 5,139,500 shares converted at a ratio of 1:1.5 into 7,709,250 shares of common stock.

 

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We accreted the carrying value of the Series C mandatorily redeemable convertible preferred stock up to liquidation value through July 21, 2010. Accretion is provided using the effective interest-rate method. For the three months ended December 25, 2009, we recorded accretion of $3.1 million. For the nine months ended December 24, 2010 and December 25, 2009, we recorded accretion of $4.9 million and $9.3 million, respectively.

 

Motion picture exhibitor stock options

In connection with motion picture exhibitor licensing agreements, we issued to motion picture exhibitors a 10-year option to purchase 3,668,340 shares of our common stock at $0.00667 per share. These stock options to our motion picture exhibitor licensees vest upon the achievement of screen installation targets and are valued at the underlying stock price at each reporting period until the targets are met.

 

Amounts recorded as a revenue reduction from motion picture exhibitor stock options totaled $22.0 million and $11.8 million for the three months ended December 24, 2010 and December 25, 2009, respectively. Amounts recorded as a revenue reduction from motion picture exhibitor stock options totaled $34.0 million and $18.0 million for the nine months ended December 24, 2010 and December 25, 2009, respectively. The reduction to revenue resulting from motion picture exhibitor stock options for the three and nine months ended December 24, 2010 reflects the price of our common stock of $28.42 per share and 3,749 deployed RealD Cinema Systems out of 4,500 RealD Cinema Systems set forth in the performance vesting targets. As of December 24, 2010, unrecognized motion picture exhibitor stock options reductions in revenue totaled $6.7 million based upon an estimated fair value of our common stock of $28.42 per share and 100% achievement of screen installation targets. Reductions to revenue resulting from motion picture exhibitor stock options may increase as compared to a previous period as the stock price of our common stock and number of screen installations increase.

 

As of December 24, 2010, 2,445,559 of the motion picture exhibitor stock options had vested. Additionally, 1,630,373 exhibitor stock options were exercised by certain of our motion picture exhibitors during the nine months ended December 24, 2010.

 

Warrants

As of December 24, 2010, there were warrants outstanding to purchase 653,400 shares of common stock. For the nine months ended December 24, 2010, 435,600 warrants were exercised. The outstanding warrants’ weighted-average exercise price is $0.83 per share. As of December 24, 2010, the weighted-average remaining term of the warrants was 5.2 years.

 

7. Share-based compensation

 

We account for stock options granted to employees and directors by recording compensation expense based on estimated fair values. We estimate the fair value of share-based payment awards on the date of grant. The value of the portion of the award that is ultimately expected to vest is recognized as expense over the requisite service periods in our consolidated statements of operations. Share-based awards are attributed to expense using the straight-line method over the vesting period. We determine the value of each option award that contains a market condition using a lattice-based option valuation model, while all other option awards are valued using the Black-Scholes valuation model as permitted under ASC 718 Compensation — Stock Compensation. The assumptions used in calculating the fair value of share-based payment awards represent our best estimates. Our estimates may be impacted by certain variables including stock price volatility, employee stock option exercise behaviors, additional stock option grants, estimates of forfeitures, and the related income tax impact.

 

In April 2010, our board of directors unanimously adopted the RealD Inc. 2010 Stock Incentive Plan (the “2010 Stock Plan”), and in June 2010, our stockholders approved the 2010 Stock Plan. The board of directors intends for the 2010 Stock Plan to replace our 2004 Amended and Restated Stock Incentive Plan, (the “2004 Plan”), such that, effective with our initial public offering, we will no longer make any new grants under the 2004 Plan. Instead, the board of directors or our compensation committee will issue equity compensation awards under the 2010 Stock Plan. The stock plan provides for the granting of nonstatutory stock options, incentive stock options, stock appreciation rights, restricted stock awards and stock units to employees, officers, directors, non-employee directors and consultants.

 

Stock options

Stock options granted generally vest over a four-year period, with 25% of the shares vesting after one year and monthly vesting thereafter.  The options generally expire ten years from the date of grant. For the nine months ended December 24, 2010, we granted 2,714,700 stock options at a weighted average grant date fair value of $8.82 per share.  For the three and nine months ended December 24, 2010, share-based compensation expense related to stock options was $2.2 million and $4.7 million, respectively.

 

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Performance stock options

Certain of our management-level employees receive performance stock options, which gives the recipient the right to receive common stock that is contingent upon achievement of specified pre-established performance goals over the performance period, which is generally three years. The performance goals for the performance stock options are based on the measurement of our total shareholder return, on a percentile basis, compared to a comparator group of companies. Depending on the outcome of the performance goals, the recipient may ultimately earn performance stock options equal to or less than the number of performance stock options granted. For the nine months ended December 24, 2010, we granted 641,250 performance stock options at a weighted average grant date fair value of $9.45 per share. For the three and nine months ended December 24, 2010, share-based compensation expense related to performance stock options was $0.5 million and $0.9 million, respectively.

 

Restricted stock units

For the nine months ended December 24, 2010, we granted our board of directors 54,372 restricted stock units at a weighted average grant date fair value of $19.84 per share. The restricted stock units vest on a monthly basis over one to two years. For the three and nine months ended December 24, 2010, share-based compensation expense related to restricted stock units was $0.2 million and $0.4 million, respectively.

 

Share-based compensation expense for all share-based arrangements for the three and nine months ended December 24, 2010 and December 25, 2009 was as follows:

 

 

 

Three months ended

 

Nine months ended

 

 

 

December 24,

 

December 25,

 

December 24,

 

December 25,

 

(in thousands)

 

2010

 

2009

 

2010

 

2009

 

Cost of revenue

 

  $

50

 

 

  $

20

 

 

  $

93

 

 

  $

60

 

 

Research and development

 

434

 

 

211

 

 

1,016

 

 

754

 

 

Selling and marketing

 

898

 

 

431

 

 

2,053

 

 

1,188

 

 

General and administrative

 

1,598

 

 

101

 

 

2,826

 

 

228

 

 

Total

 

  $

2,980

 

 

  $

763

 

 

  $

5,988

 

 

  $

2,230

 

 

 

8. Income taxes

 

Our income tax expense for the three and nine months ended December 24, 2010 was $1.6 million and $3.3 million, respectively, primarily due to an increase in our foreign tax expense. We have net operating losses that may potentially be offset against future earnings. 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.

 

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9. Equity (deficit)

 

A summary of the changes in total equity (deficit) for the nine months ended December 24, 2010 was as follows:

 

 

 

RealD Inc.

 

 

 

 

 

 

 

 

stockholders’

 

Noncontrolling

 

 

Total

 

(in thousands)

 

deficit

 

interest

 

 

equity (deficit)

 

 

 

 

 

 

 

 

 

 

Balance, March 26, 2010

 

  $

(44,020)

 

  $

2,134

 

 

  $

(41,886)

 

Accretion of Series C preferred stock

 

(4,934)

 

-

 

 

(4,934)

 

Share-based compensation

 

5,988

 

-

 

 

5,988

 

Exercise of stock options

 

951

 

-

 

 

951

 

Exercise of motion picture exhibitor options

 

11

 

-

 

 

11

 

Exercise of warrants

 

363

 

-

 

 

363

 

Motion picture exhibitor option reduction in revenue

 

34,008

 

-

 

 

34,008

 

Noncontrolling interest distribution

 

-

 

(888)

 

 

(888)

 

Conversion of preferred stock

 

67,765

 

-

 

 

67,765

 

Issuance of common stock in connection with initial public offering, net of issuance costs

 

81,940

 

-

 

 

81,940

 

Comprehensive income (loss):

 

 

 

 

 

 

 

 

Net income (loss)

 

(11,822)

 

692

 

 

(11,130)

 

Total comprehensive loss

 

 

 

 

 

 

(11,130)

 

Balance, December 24, 2010

 

  $

130,250  

 

  $

1,938  

 

 

  $

132,188  

 

 

10. Subsequent Events

 

On January 26, 2011, the Company entered into the First Amendment to the Real D System License Agreement (U.S. 2008), by and between the Company and Regal Cinemas, Inc. (“Regal”), to provide for revised terms in respect of payment, royalties and duration. Pursuant to the First Amendment, the Company agreed with Regal to expand the number of RealD-enabled screens across the Regal theater circuit from 1,500 to 3,000 screens.

 

On January 28, 2011, the compensation committee of the Company’s board of directors approved an increase in the Company’s 2010 Stock Plan to enable the issuance of up to 1,950,400 additional shares of our common stock under the 2010 Stock Plan.

 

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

 

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 “may,” “will,” “should,” “expects,” “plans,” “anticipates,” “believes,” “estimates,” “predicts,” “potential,” “continue” or the negative of these terms or other comparable terminology. 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 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 2011; our ability to supply our solutions to our customers on a timely basis; growth opportunities and trends in the markets in which we operate; our plans, strategies and expected opportunities; the deployment of and demand for our products and products incorporating our technologies; and future competition. Actual results may differ materially from those discussed in 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.

 

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Overview

 

We are a leading global licensor of 3D technologies. Our extensive intellectual property portfolio enables 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 Format, active and passive eyewear, and display and gaming technologies to consumer electronics manufacturers and content providers and distributors to enable the delivery and viewing of 3D content on high definition televisions, laptops and other displays. Our cutting-edge 3D technologies have been used for applications such as piloting the Mars Rover, heads-up displays for military jets and robotic medical procedures.

 

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:

 

·                  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.

·                  Number of 3D motion pictures. Total 3D motion pictures are the number of 3D motion pictures that are exhibited for more than three showings per day and for a period in excess of one week and for which we receive a license fee from the motion picture exhibitor during the relevant period.

·                  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, depreciation and amortization, share-based compensation expense and exhibitor option 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 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):

 

 

 

Nine Months Ended

 

 

 

 

December 24,
2010

 

 

December 25,
2009

 

 

 

 

 

 

 

 

 

 

Number of RealD enabled screens (at period end)

 

 

 

 

 

 

 

Total domestic RealD enabled screens

 

6,900

 

 

2,800

 

 

Total international RealD enabled screens

 

4,400

 

 

1,500

 

 

Total RealD enabled screens

 

11,300

 

 

4,300

 

 

Number of locations with RealD enabled screens (at period end)

 

 

 

 

 

 

 

Total domestic locations with RealD enabled screens

 

2,300

 

 

1,700

 

 

Total international locations with RealD enabled screens

 

1,900

 

 

900

 

 

Total locations with RealD enabled screens

 

4,200

 

 

2,600

 

 

Number of 3D motion pictures (released during period) 

 

20

 

 

11

 

 

 

 

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.”  If we are successful in expanding our business with consumer electronics manufacturers and content producers and distributors to incorporate our RealD Format and display and gaming technologies into their products and platforms, our key business metrics in future periods may include the number of units of 3D-enabled plasma and LCD televisions, interactive gaming consoles and laptop computers shipped in that period.

 

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. 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 and other geographic regions, enhance and expand our technology and product offerings and pursue strategic acquisitions.

 

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 December 24, 2010, there were approximately 11,300 RealD-enabled screens worldwide as compared to approximately 4,300 RealD-enabled screens worldwide as of December 25, 2009, an increase of 7,000 RealD-enabled screens or 163%.  In March 2010, Digital Cinema Implementation Partners (“DCIP”), completed its financing that is providing funding for the digital conversion of approximately 14,000 additional domestic theater screens operated by our licensees American Multi-Cinema, Inc., or AMC, Cinemark USA, Inc., or Cinemark, and Regal Cinemas, Inc., or Regal. We believe the increasing number of theater screens being financed by DCIP provides us with significant opportunities to deploy additional RealD Cinema Systems and furthers our penetration of the domestic market. Based on the slate announcements by motion picture studios, we anticipate that approximately 35 3D motion pictures will be released worldwide in 2011, including sequels to successful major motion picture franchises, such as Harry Potter, Transformers, Pirates of the Caribbean, Kung Fu Panda and Cars, and that as the number of RealD-enabled screens and 3D motion pictures released increases, we expect that our revenue and capital needs will continue to grow.

 

Consumer electronics

We have recently made available our RealD Format, active and passive eyewear, and display and gaming technologies to consumer electronics manufacturers and content distributors to enable 3D in high definition televisions, laptops and other displays in the home and elsewhere. We believe that the recent success of major 3D motion pictures, including Avatar, Alice in Wonderland, Shrek Forever After, Toy Story 3 and Despicable Me, is leading to the creation and distribution of 3D content for the consumer electronics market. The development of this market represents a significant opportunity for new revenue.

 

Motion picture exhibitor stock options

We expect to incur variability in our license revenue and operating results in connection with stock options issued to some of our motion picture exhibitor licensees that vest upon the achievement of screen installation targets. For further discussion regarding exhibitor stock options, see “Key components of our results of operations—Revenue—Motion picture exhibitor stock options” and “Critical accounting policies and estimates.”

 

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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

 

 

Nine months ended

 

 

 

December 24,

 

December 25,

 

 

December 24,

 

December 25,

 

(in thousands)

 

2010

 

2009

 

 

2010

 

2009

 

Consolidated statements of operations data:

 

 

 

 

 

 

 

 

 

 

Gross revenue

 

$

79,740 

 

$

41,989 

 

 

$

221,630 

 

$

112,408 

 

Motion picture exhibitor options

 

(21,960)

 

(11,794)

 

 

(34,008)

 

(17,966)

 

Net revenue

 

57,780

 

30,195

 

 

187,622

 

94,442

 

Cost of revenue

 

51,642

 

31,627

 

 

149,759

 

84,685

 

Gross margin

 

6,138

 

(1,432)

 

 

37,863

 

9,757

 

Operating expenses:

 

 

 

 

 

 

 

 

 

 

Research and development

 

4,347

 

2,322

 

 

10,751

 

7,327

 

Selling and marketing

 

5,813

 

3,342

 

 

15,251

 

11,123

 

General and administrative

 

10,596

 

3,920

 

 

25,195

 

9,870

 

Total operating expenses

 

20,756

 

9,584

 

 

51,197

 

28,320

 

Operating loss

 

(14,618)

 

(11,016)

 

 

(13,334)

 

(18,563)

 

Interest expense

 

(71)

 

(575)

 

 

(873)

 

(1,149)

 

Other income (loss)

 

(431)

 

(210)

 

 

6,376

 

(670)

 

Loss before income taxes

 

(15,120)

 

(11,801)

 

 

(7,831)

 

(20,382)

 

Income tax expense

 

1,648

 

478

 

 

3,299

 

1,431

 

Net loss

 

(16,768)

 

(12,279)

 

 

(11,130)

 

(21,813)

 

Net (income) loss attributable to noncontrolling interest

 

181

 

261

 

 

(692)

 

726

 

Accretion of preferred stock

 

-

 

(3,093)

 

 

(4,934)

 

(9,278)

 

Net loss attributable to RealD Inc. common stockholders

 

$

(16,587)

 

$

(15,111)

 

 

$

(16,756)

 

$

(30,365)

 

 

 

 

 

 

 

 

 

 

 

 

Other data:

 

 

 

 

 

 

 

 

 

 

Adjusted EBITDA (1)

 

$

16,908

 

$

5,397

 

 

$

44,361

 

$

11,508

 

 

 

(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.”

 

In the period to period comparative discussion below, we describe our net revenue, license revenue (composed principally of revenue from our RealD Cinema Systems), and product and other revenue (principally composed of our RealD eyewear and, to a much lesser extent, professional product revenue).

 

Three months ended December 24, 2010 compared to three months ended December 25, 2009

 

Revenue

 

 

 

Three months ended

 

 

 

 

 

 

 

December 24,

 

 

December 25,

 

 

Amount

 

 

Percentage

 

(in thousands)

 

2010

 

 

2009

 

 

Change

 

 

Change

 

Revenue:

 

 

 

 

 

 

 

 

 

 

 

 

Gross license

 

$

40,798

 

 

$

16,063

 

 

$

24,735

 

 

154.0%

 

Motion picture exhibitor options

 

(21,960

)

 

(11,794

)

 

(10,166

)

 

86.2%

 

Net license

 

18,838

 

 

4,269

 

 

14,569

 

 

341.3%

 

Product and other

 

38,942

 

 

25,926

 

 

13,016

 

 

50.2%

 

Total net revenue

 

$

57,780

 

 

$

30,195

 

 

$

27,585

 

 

91.4%

 

 

The significant increase in net revenue recorded during the three months ended December 24, 2010 compared to the three months ended December 25, 2009 was primarily due to an increase in the number of RealD-enabled screens, an increase in the number of 3D motion pictures released and the resulting increase in the box office of 3D motion pictures on RealD-enabled screens. Our international markets comprised approximately 58% of gross revenue for the three months ended December 24, 2010.

 

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For the three months ended December 24, 2010, there were 12 motion pictures that contributed greater than $1.0 million of admission-based fees to net license revenue. The top ten motion pictures that contributed greater than $1.0 million of admission-based fees to net license revenue for the three months ended December 24, 2010 included the following: Jackass 3D ($3.7 million), Megamind ($3.2 million), Tangled ($3.0 million), Despicable Me ($2.8 million), Toy Story 3 ($2.2 million), Saw VII ($2.1 million), Resident Evil: Afterlife ($1.9 million), The Chronicles of Narnia ($1.9 million), Legends of the Guardians ($1.6 million), and Tron: Legacy ($1.4 million). For the three months ended December 25, 2009, there were five motion pictures which contributed greater than $1.0 million of admission-based fees to net license revenue. Net license revenue for the three months ended December 25, 2009 included admission-based fees related to the following motion pictures:  Avatar ($4.4 million), A Christmas Carol ($3.6 million), Cloudy with a Chance of Meatballs ($1.8 million), Up ($1.7 million), and Toy Story 1 & 2 ($1.2 million). Both domestically and internationally, our net license revenue increased during the period as a result of the increased number of RealD-enabled screens and the number of 3D motion picture releases increasing. The reduction to revenue resulting from motion picture exhibitor stock options increased $10.2 million based upon the change in the price of our common stock and the number of RealD-enabled screens of the related exhibitor. The reduction to revenue resulting from motion picture exhibitor stock options in the three months ended December 24, 2010 reflects the price of our common stock of $28.42 per share and 3,749 deployed RealD Cinema Systems out of 4,500 RealD Cinema Systems set forth in the performance vesting targets. As of December 24, 2010, unrecognized motion picture exhibitor stock options reductions to revenue totaled $6.7 million based upon the price of our common stock of $28.42 per share and 100% achievement of screen installation targets. Reductions to revenue resulting from motion picture exhibitor stock options may increase as compared to a previous period as the stock price of our common stock and number of screen installations increase.

 

Net license revenues comprised 33% and 14% of total revenues for each of the three months ended December 24, 2010 and December 25, 2009, respectively. International license revenues comprised 58% of gross license revenues in the three months ended December 24, 2010.

 

The increase in our net product and other revenue in the three months ended December 24, 2010 as compared to the three months ended December 25, 2009, was primarily a result of an increase in the number of consumers attending 3D motion pictures using our RealD eyewear. International product revenues comprised 57% of total product revenues in the three months ended December 24, 2010.

 

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. As the volume of RealD eyewear usage increases as a result of an expanding 3D motion picture slate and box office, we may experience additional price pressure from our customers. As a result, our net revenues may increase at a slower rate in future periods.

 

Cost of Revenue

 

 

Three months ended

 

 

 

 

 

 

 

December 24,

 

 

December 25,

 

 

Amount

 

 

Percentage

 

(in thousands)

 

2010

 

 

2009

 

 

Change

 

 

Change

 

Revenue

 

$

57,780

 

 

$

30,195

 

 

$

27,585

 

 

91.4%

 

Cost of Revenue:

 

 

 

 

 

 

 

 

 

 

 

 

License

 

5,301

 

 

2,587

 

 

2,714

 

 

104.9%

 

Product and other

 

46,341

 

 

29,040

 

 

17,301

 

 

59.6%

 

Total cost of revenue

 

$

51,642

 

 

$

31,627

 

 

$

20,015

 

 

63.3%

 

Gross profit

 

$

6,138

 

 

$

(1,432

)

 

$

7,570

 

 

528.6%

 

Gross margin

 

 10.6%

 

 

 -4.7%

 

 

 

 

 

 

 

 

For the three months ended December 24, 2010, our cost of revenue increased primarily due to increased RealD eyewear sales. Cost of revenue decreased, as a percentage of revenue, to 89% for the three months ended December 24, 2010, as compared to 105% for the three months ended December 25, 2009. The increase in gross margin was primarily due to an increase in license revenues which partially offset the increased use of RealD eyewear, which generates lower gross margin. For the three months ended December 24, 2010, the $10.2 million increase in the reduction to revenue resulting from motion picture exhibitor stock options directly contributed to a $10.2 million decrease in gross profit.

 

Excluding the impact of motion picture exhibitor stock options of $22.0 million, gross profit would have been $28.1 million for the three months ended December 24, 2010, and gross margin would have been 35%. Excluding the impact of motion picture stock options of $11.8 million, gross profit would have been $10.4 million for the three months ended December 25, 2009, and gross margin would have been 25%.

 

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License gross margin improved to 72% for the three months ended December 24, 2010 from 39% for the three months ended December 25, 2009. Excluding the impact of motion picture exhibitor stock options of $22.0 million, gross profit for license revenue would have been $35.5 million for the three months ended December 24, 2010, and gross margin would have been 87% primarily due to economies of scale and the increase in the number of 3D motion pictures released and the resulting increase in the box office of 3D motion pictures on RealD-enabled screens. Excluding the impact of motion picture exhibitor stock options of $11.8 million, gross profit for license revenue would have been $13.5 million for the three months ended December 25, 2009, and gross margin would have been 84%.

 

We had a negative product and other gross profit of $7.4 million for the three months ended December 24, 2010, primarily due to RealD eyewear. The increase in our cost of product and other revenue is a result of the increase in the volume of RealD eyewear. Product and other gross margin decreased to negative 19% for the three months ended December 24, 2010 as compared to negative 12% for the three months ended December 25, 2009. Freight related expense increased by an aggregate of $1.1 million as a result of the increased use of RealD eyewear and our international expansion, partially offset by a reduction in expedited freight costs.

 

Our cost of revenue as a percentage of net revenue will be affected in the future by the relative mix of net license and net product revenue, the mix of domestic and international product revenues and the impact of motion picture exhibitor options. 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

 

 

 

 

 

 

 

December 24,

 

 

December 25,

 

 

Amount

 

 

Percentage

 

(in thousands)

 

2010

 

 

2009

 

 

Change

 

 

Change

 

Research and development

 

$

4,347

 

 

$

2,322

 

 

$

2,025

 

 

87.2%

 

Selling and marketing

 

5,813

 

 

3,342

 

 

2,471

 

 

73.9%

 

General and administrative

 

10,596

 

 

3,920

 

 

6,676

 

 

170.3%

 

Total operating expenses

 

$

20,756

 

 

$

9,584

 

 

$

11,172

 

 

116.6%

 

 

Research and development.  Our research and development expenses increased primarily due to a $0.9 million increase in spending on prototypes, a $0.5 million increase in personnel costs, which include an increase in the number of research and development personnel to 33 at December 24, 2010 from 28 at December 25, 2009 to increase our product development and engineering capabilities, professional fees, and $0.2 million spent on consultants. We expect 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 a $1.3 million increase in personnel costs.  The change in personnel costs includes an increase in the number of selling and marketing personnel to 23 at December 24, 2010 from 14 at December 25, 2009, a $0.5 million increase in share-based compensation expense and a $0.2 million increase in contractual and discretionary bonuses. Costs also increased from the incurrence of additional advertising and marketing initiatives of $0.8 million.  Personnel costs and advertising and marketing spending are expected to continue to increase in order to drive revenue growth. We expect to incur additional selling and marketing expenses in fiscal year 2011 as we increase our international marketing efforts, particularly in Asia, and build our consumer electronics business worldwide.

 

General and administrative.  Our general and administrative expenses increased primarily due to a $2.5 million increase in personnel costs. The increase in personnel costs includes an increase in salaries and benefits of $0.7 million as we increased the number of general and administrative employees to 24 at December 24, 2010 from 14 at December 25, 2009 to support our overall growth, including the requirements of being a public company. Also included in personnel costs is a $1.5 million increase in share-based compensation expense and a $0.3 million increase in contractual and discretionary bonuses. Legal expenses and professional fees increased $1.5 million to support the growth in our operations.  Public company related expenses of $0.8 million include listing, registration and issuance costs, as well as investor relations and compliance fees. Bad debt expense of $1.2 million also contributed to the change in expenses.  We expect to incur additional general and administrative expenses for sales and use taxes as our revenue in the United States grows, as well as to comply with SEC reporting requirements, stock exchange listing standards and provisions of the Sarbanes-Oxley Act of 2002.

 

Other

Interest expense.  Interest expense for the three months ended December 24, 2010 and December 25, 2009 was $0.1 million and $0.6 million, respectively, primarily due to the reduction of borrowings outstanding under our credit facility agreement and notes payable.

 

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Income tax.  Our income tax expense for the three months ended December 24, 2010 was $1.6 million, primarily due to an increase in our foreign tax expense. We have net operating losses that may potentially be offset against future earnings. 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.

 

Noncontrolling interest.  Noncontrolling interest represents a 44.4% interest in our subsidiary, Digital Link II, LLC, or Digital Link II. Digital Link II was formed for purposes of funding the deployment of digital projector systems and servers to our motion picture exhibitor licensees. The increase in the net loss attributable to noncontrolling interest was primarily due to the depreciation and property taxes on additional digital projectors leased by Digital Link II.

 

Nine months ended December 24, 2010 compared to nine months ended December 25, 2009

 

Revenue

 

 

Nine months ended

 

 

 

 

 

 

 

December 24,

 

 

December 25,

 

 

Amount

 

 

Percentage

 

(in thousands)

 

2010

 

 

2009

 

 

Change

 

 

Change

 

Revenue:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Gross license

 

$

102,398

 

 

$

43,959

 

 

$

58,439

 

 

132.9%

 

Motion picture exhibitor options

 

(34,008

)

 

(17,966

)

 

(16,042

)

 

89.3%

 

Net license

 

68,390

 

 

25,993

 

 

42,397

 

 

163.1%

 

Product and other

 

119,232

 

 

68,449

 

 

50,783

 

 

74.2%

 

Total net revenue

 

$

187,622

 

 

$

94,442

 

 

$

93,180

 

 

98.7%

 

 

The significant increase in net revenue recorded during the nine months ended December 24, 2010 compared to the nine months ended December 25, 2009 was primarily due to an increase in the number of RealD-enabled screens, an increase in the number of 3D motion pictures released and the resulting increase in the box office of 3D motion pictures on RealD-enabled screens. Our international markets comprised approximately 55% of gross revenue for the nine months ended December 24, 2010.

 

For the nine months ended December 24, 2010, there were 19 motion pictures which contributed greater than $1.0 million of admission-based fees to net license revenue. The top ten motion pictures that contributed greater than $1.0 million of admission-based fees to net license revenue for the nine months ended December 24, 2010 included the following: Toy Story 3 ($14.3 million), Shrek Forever After ($9.0 million), Despicable Me ($6.5 million), How to Train Your Dragon ($6.1 million), Alice in Wonderland ($5.4 million), Clash of the Titans ($4.7 million), The Last Airbender ($3.8 million), Avatar ($3.7 million), Jackass 3D ($3.7 million) and Resident Evil: Afterlife ($3.3 million). For the nine months ended December 25, 2009, there were nine motion pictures which contributed greater than $1.0 million of admission-based fees to net license revenue. Net license revenue for the nine months ended December 25, 2009 included admission-based fees related to the following motion pictures: Up ($8.0 million), Ice Age 3 ($6.0 million), Monsters vs. Aliens ($4.9 million), Avatar ($4.4 million), GForce ($3.4 million), A Christmas Carol ($3.6 million), Final Destination ($2.5 million), Cloudy with a Chance of Meatballs ($2.4 million) and Toy Story 1 & 2 ($1.2 million). Both domestically and internationally, our net license revenue increased during the period as a result of the increased number of RealD-enabled screens and the number of 3D motion pictures increasing the box office. The reduction to revenue resulting from motion picture exhibitor stock options increased $16.0 million based upon the change in the price of our common stock and the number of RealD-enabled screens of the related exhibitor. The reduction to revenue resulting from motion picture exhibitor stock options in the nine months ended December 24, 2010 reflects the price of our common stock of $28.42 per share and 3,749 deployed RealD Cinema Systems out of 4,500 RealD Cinema Systems set forth in the performance vesting targets. As of December 24, 2010, unrecognized motion picture exhibitor stock options reductions to revenue totaled $6.7 million based upon the price of our common stock of $28.42 per share and 100% achievement of screen installation targets.  Reductions to revenue resulting from motion picture exhibitor stock options may increase as compared to a previous period as the stock price of our common stock and number of screen installations increase.

 

Net license revenues comprised 36% and 28% of total revenues for each of the nine months ended December 24, 2010 and December 25, 2009, respectively. International license revenues comprised 50% of gross license revenues in the nine months ended December 24, 2010.

 

The increase in our net product and other revenue in the nine months ended December 24, 2010, as compared to the nine months ended December 25, 2009, was primarily a result of an increase in the number of consumers attending 3D motion pictures using our RealD eyewear. International product revenues comprised 58% of total product revenues in the nine months ended December 24, 2010, due to increased usage of RealD eyewear internationally at higher unit selling prices than domestic RealD eyewear.

 

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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. As the volume of RealD eyewear usage increases as a result of an expanding 3D motion picture slate and box office, we may experience additional price pressure from our customers. As a result, our net revenues may increase at a slower rate in future periods.

 

Cost of Revenue

 

 

Nine months ended

 

 

 

 

 

 

 

December 24,

 

 

December 25,

 

 

Amount

 

 

Percentage

 

(in thousands)

 

2010

 

 

2009

 

 

Change

 

 

Change

 

Revenue

 

$

187,622

 

 

$

94,442

 

 

$

93,180

 

 

98.7%

 

Cost of Revenue:

 

 

 

 

 

 

 

 

 

 

 

 

License

 

11,660

 

 

7,099

 

 

4,561

 

 

64.2%

 

Product and other

 

138,099

 

 

77,586

 

 

60,513

 

 

78.0%

 

Total cost of revenue

 

$

149,759

 

 

$

84,685

 

 

$

65,074

 

 

76.8%

 

Gross profit

 

$

37,863

 

 

$

9,757

 

 

$

28,106

 

 

288.1%

 

Gross margin

 

20.2%

 

10.3%

 

 

 

 

 

 

 

For the nine months ended December 24, 2010, our cost of revenue increased primarily due to increased RealD eyewear sales. Cost of revenue decreased, as a percentage of revenue, to 80% for the nine months ended December 24, 2010, as compared to 90% for the nine months ended December 25, 2009. The increase in gross margin was primarily due to an increase in license revenues which partially offset the increased use of RealD eyewear which generates lower gross margin. For the nine months ended December 24, 2010, the $16.0 million increase in reduction to revenue resulting from motion picture exhibitor stock options directly contributed to a $16.0 million decrease in gross profit.

 

Excluding the impact of motion picture exhibitor stock options of $34.0 million, gross profit would have been $71.9 million for the nine months ended December 24, 2010, and gross margin would have been 32%. Excluding the impact of motion picture stock options of $18.0 million, gross profit would have been $27.7 million for the nine months ended December 25, 2009, and gross margin would have been 25%.

 

License gross margin improved to 83% for the nine months ended December 24, 2010 from 73% for the nine months ended December 25, 2009.  Excluding the impact of motion picture exhibitor stock options of $34.0 million, gross profit for license revenue would have been $90.7 million for the nine months ended December 24, 2010, and gross margin would have been 89% primarily due to economies of scale and the increase in the number of 3D motion pictures released and the resulting increase in the box office of 3D motion pictures on RealD-enabled screens. Excluding the impact of motion picture exhibitor stock options of $18.0 million, gross profit for license revenue would have been $36.9 million for the nine months ended December 25, 2009, and gross margin would have been 84%.

 

We had a negative product and other gross profit of $18.9 million for the nine months ended December 24, 2010, primarily due to RealD eyewear. The increase in our cost of product and other revenue and negative gross profit is a result of the increase in the volume of RealD eyewear. Product and other gross margin was negative 16% for the nine months ended December 24, 2010 as compared to negative 13% for the nine months ended December 25, 2009. Freight related expense increased by an aggregate of $6.6 million as a result of the increased use of RealD eyewear and international expansion.  Of this increase, $2.4 million is related to expedited shipping expenses we incurred in the nine months ended December 24, 2010 to satisfy a significant increase in demand. Excluding expedited shipping expenses, gross margin for the nine months ended December 24, 2010 would have improved further.

 

Costs associated with the recycling program have been expensed in the period incurred, which further reduced gross profit. Recycling costs increased $2.0 million to $6.0 million for the nine months ended December 24, 2010 from $4.0 million for the nine months December 25, 2009, and included the cost to transport RealD eyewear between theaters and the recycling production facility and costs to process the RealD eyewear for reuse.

 

Our cost of revenue as a percentage of net revenue will be affected in the future by the relative mix of net license and net product revenue, the mix of domestic and international product revenues and the impact of motion picture exhibitor options. 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.

 

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Operating expenses

 

 

 

 

 

 

 

 

 

 

 

Nine months ended

 

 

 

 

 

 

 

December 24,

 

December 25,

 

Amount

 

Percentage

 

(in thousands)

 

2010

 

2009

 

Change

 

Change

 

Research and development

 

$

10,751  

 

$

7,327  

 

$

3,424  

 

46.7% 

 

Selling and marketing

 

15,251  

 

11,123  

 

4,128  

 

37.1% 

 

General and administrative

 

25,195  

 

9,870  

 

15,325  

 

155.3% 

 

Total operating expenses

 

$

51,197  

 

$

28,320  

 

$

22,877  

 

80.8% 

 

 

Research and development.  Our research and development expenses increased primarily due to a $1.4 million increase in personnel costs, which include an increase in the number of research and development personnel to 33 at December 24, 2010 from 28 at December 25, 2009 to increase our product development and engineering capabilities and increased spending on prototypes of $1.1 million. We expect 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 a $2.5 million increase in personnel costs.  The change in personnel costs includes $1.3 million related to the increase in the number of selling and marketing personnel to 23 at December 24, 2010 from 14 at December 25, 2009, a $0.9 million increase in share-based compensation expense and a $0.4 million increase in contractual and discretionary bonuses.  Costs also increased from the incurrence of additional advertising and marketing initiatives of $0.9 million.  Personnel costs and advertising and marketing spending are expected to continue to increase in order to drive revenue growth. We expect to incur additional selling and marketing expenses in fiscal year 2011 as we increase our international marketing efforts, particularly in Asia, and build our consumer electronics business worldwide.

 

General and administrative.  Our general and administrative expenses increased primarily due to a $2.1 million increase in sales and use taxes and a $4.8 million increase in personnel costs.  Sales and use taxes increased due to the increase in domestic revenues. We absorb the majority of all sales and use taxes in the United States and do not pass such costs on to our customers. The increase in personnel costs includes an increase in salaries and benefits of $1.5 million as we increased the number of general and administrative employees to 24 at December 24, 2010 from 14 at December 25, 2009 to support our overall growth, including the requirements of being a public company. Also included in personnel costs is an increase of $2.6 million related to share-based compensation expense and an increase of $0.6 million related to discretionary and contractual bonuses. Legal expenses and professional fees increased $3.6 million to support the growth in our operations.  Public company related expenses of $1.3 million include listing, registration and issuance costs, as well as investor relations and compliance fees. Bad debt expense of $1.7 million also contributed to the change in expenses.  We expect to incur additional general and administrative expenses for sales and use taxes as our revenue in the United States grows, as well as to comply with SEC reporting requirements, stock exchange listing standards and provisions of the Sarbanes-Oxley Act of 2002.

 

Other

Interest expense.  Interest expense for the nine months ended December 24, 2010 and December 25, 2009 was $0.9 million and $1.1 million, respectively.  Our interest expense decreased primarily due to reductions in borrowings as we repaid $25.1 million under our previous revolving credit facility on July 21, 2010. As of December 24, 2010, there were no borrowings outstanding under the credit and security agreement.

 

Other income (loss).  Other income for the nine months ended December 24, 2010 increased primarily due to a $6.7 million gain from the sale of digital projectors.

 

Income tax.  Our income tax expense for the nine months ended December 24, 2010 was $3.3 million, primarily due to an increase in our foreign tax expense. We have net operating losses that may potentially be offset against future earnings. 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.

 

Noncontrolling interest.  Noncontrolling interest represents a 44.4% interest in our subsidiary, Digital Link II. Digital Link II was formed for purposes of funding the deployment of digital projector systems and servers to our motion picture exhibitor licensees. The increase in the net income attributable to noncontrolling interest was primarily due to the gain from the sale of digital projectors for the nine months ended December 24, 2010.

 

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Table of Contents

 

Seasonality

 

Although not apparent in our results of operations due to our rapid growth rate, our operations are generally subject to the number of 3D motion pictures released and the box office of those 3D motion pictures. We expect to experience seasonal fluctuations in results of operations as a result of changes in the number of 3D motion pictures released and the box office of those 3D motion pictures. Our quarterly financial results have fluctuated in the past and may continue to fluctuate in the future based on a number of factors, 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 1.A below under the caption “Risk factors.”

 

Liquidity and capital resources

 

Since our inception and through July 21, 2010, we have financed our operations through the sale of redeemable convertible preferred stock, borrowings under our credit facility agreement with City National Bank and through the issuance of notes payable to stockholders and vendors, and net cash provided by operating activities. Our cash flow from operating activities has historically been significantly impacted by the contractual payment terms and patterns related to the license of our RealD Cinema Systems and use and sale of our RealD eyewear, as well as significant investments in research, development, selling and marketing activities and corporate infrastructure. Prior to fiscal 2010, many of our licensing and product sale contracts included terms that required upfront payments. Since a majority of our revenue recognized under our motion picture exhibitor licenses results in admission and usage fees being paid to us subsequent to such consumer attendance, our deferred revenue balances may continue to decline over the next several years.

 

Cash provided by operating activities is expected to be a primary recurring source of funds in future periods and will be driven by increased revenue generated from the growing number of 3D motion pictures exhibited on our RealD Cinema Systems and an increase in the number of RealD-enabled screens, partially offset by increased working capital requirements associated with installing new RealD Cinema Systems as well as for building inventory, logistics and recycling costs for our RealD eyewear.  Depending on our operating performance in any given period and the installation rate of additional RealD Cinema Systems, we expect to supplement our liquidity needs primarily with proceeds from our IPO and borrowings under our new revolving credit facility with City National Bank.

 

As of December 24, 2010, our primary sources of liquidity were our cash and cash equivalents of $35.5 million and our credit security agreement with City National Bank providing for a revolving credit facility of up to $15.0 million, $15.0 million of which was available for borrowing.

 

Our cash equivalents primarily consist of money market funds and other marketable securities that mature within three months from the date of purchase. The carrying amount of cash equivalents reasonably approximates fair value due to the short maturities of these instruments. The primary objective of our investment activities is preservation of capital, fulfillment of liquidity needs and fiduciary control of cash and investments. We also seek to maximize income from our investments without assuming significant risk. We do not enter into investments for trading or speculative purposes.

 

On July 21, 2010, we completed the initial public offering of our common stock in which we sold and issued 6 million shares of common stock at an issue price of $16.00 per share. A total of approximately $96 million in gross proceeds were raised from the initial public offering, or $81.9 million in net proceeds after deducting underwriting discounts and commissions of approximately $6.7 million and other offering costs of approximately $7.4 million.

 

On July 21, 2010, we repaid $25.1 million under our previous revolving credit facility.

 

On July 23, 2010, 407,593 shares were issued pursuant to the exercise of motion picture exhibitor stock options.

 

On December 17, 2010, 1,222,780 shares were issued pursuant to the exercise of motion picture exhibitor stock options.

 

We believe that our cash, cash equivalents, potential cash flows from operations, and our availability under our credit security agreement with City National Bank will be sufficient to satisfy our currently anticipated cash requirements through at least the next 12 months.

 

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The following table sets forth our major sources and (uses) of cash for each period as set forth below.

 

 

 

Nine months ended

 

 

 

December 24,

 

December 25,

 

(in thousands)

 

2010

 

2009

 

Operating activities

 

$

21,612  

 

$

(6,915)

 

Investing activities

 

(52,412) 

 

(19,794)

 

Financing activities

 

$

53,138  

 

$

13,927 

 

 

Cash flow from operating activities

Net cash inflows from operating activities during the nine months ended December 24, 2010 primarily resulted from improved operating performance as RealD Cinema System installations and admissions increased. Net cash inflows from operating activities also benefited from increases in accounts payable and accrued expenses, partially offset by an increase in glasses inventories. Increases in accounts payable and accrued expenses were due to increased business activities at quarter end, resulting in significant amounts due to vendors and employees. Glasses inventories grew in order to support an increase in RealD Cinema System installations and admissions and due to the cancellation of the motion picture release of Harry Potter and the Deathly Hallows Part 1 in 3D.

 

Net cash outflows from operating activities during the nine months ended December 25, 2009 primarily resulted from a net loss, an increase in accounts receivable and inventories partially offset by increases in accounts payable and accrued expenses. Accounts receivable increased as a result of an increase in revenue. Inventories grew in order to support an increase in RealD Cinema System installations and admissions. Increases in accounts payable and accrued expenses were due to increased business activities at quarter end, resulting in significant amounts due to vendors and employees.

 

Cash flow from investing activities and capital resources

For both the nine months ended December 24, 2010 and December 25, 2009, cash outflow for investing activities was primarily related to the establishment of our initial infrastructure and for the purchase of component parts for our RealD Cinema Systems, digital projectors, and other property, equipment and leasehold improvements. In the nine months ended December 24, 2010, we received proceeds of $15.6 million as a result of the sale of digital projectors to certain of our motion picture exhibitors. Capital expenditures were $68.0 million for the nine months ended December 24, 2010 and $19.8 million for the nine months ended December 25, 2009. We expect our capital expenditures of cinema systems and related components to be approximately $70.0 million to $75.0 million for the fiscal year ending March 25, 2011. In the future, we will continue to invest in our business to grow sales and develop new products and support the related increasing employee headcount. We expect capital expenditures to represent a decreasing percentage of net revenue in the future.

 

Cash flow from financing activities

Net cash inflows from financing activities for the nine months ended December 24, 2010 primarily resulted from the proceeds from the completion of the initial public offering of our common stock in which we sold and issued 6 million shares of common stock at an issue price of $16.00 per share. A total of approximately $96.0 million in gross proceeds were raised from the initial public offering, or $81.9 million in net proceeds after deducting underwriting discounts and commissions of approximately $6.7 million and other offering costs of approximately $7.4 million. We used the net proceeds from the initial public offering to repay $25.1 million of amounts outstanding under the credit facility agreement.  In the nine months ended December 24, 2010, repayments of long-term debt of $9.1 million and a noncontrolling interest distribution of $0.9 million offset proceeds from our revolving credit facility of $5.0 million.

 

Net cash inflows from financing activities for the nine months ended December 25, 2009 primarily resulted from proceeds from our term loan of $10.0 million and proceeds from our revolving credit facility of $5.0 million partially offset by repayments of long-term debt of $1.1 million.

 

From time to time, we enter into equipment purchase agreements with certain of our vendors for the purchase of digital projectors, digital servers, lenses and accessories. We pay a portion of the cost of the equipment upon delivery and finance a portion of the purchase price by issuing notes payable. Certain of these notes payable are non-interest bearing. In those cases, we record the net present value of the notes payable assuming an implied annual interest rate which is approximately 8.0%. Interest expense is based on annual interest rates ranging from 7.0% to 8.4%. The notes are secured by the underlying equipment. Notes payable totaled $2.9 million at December 24, 2010 and $11.3 million at March 26, 2010.

 

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Table of Contents

 

Prior to July 21, 2010, the date of our initial public offering, we had $25.1 million of credit facilities pursuant to a credit facility agreement with City National Bank that provides for a maximum amount of borrowing under a revolving credit facility of $25 million and a term loan of $10 million. All amounts outstanding under the credit facility agreement became due and were repaid upon the closing of our initial public offering on July 21, 2010.

 

We have entered into a new credit and security agreement with City National Bank, dated as of June 24, 2010, which provides for a revolving credit facility of up to $15.0 million and which will mature on June 30, 2012. This agreement and the revolving credit facility provided thereunder became effective on July 21, 2010. Our obligations under the new credit and security agreement are secured by a first priority security interest in substantially all of our tangible and intangible assets in favor of City National Bank and are guaranteed by our subsidiaries, ColorLink and Stereographics.

 

Under the new credit and security agreement, our business will be subject to certain limitations, including limitations on our ability to incur additional debt, make certain investments or acquisitions, enter into certain merger and consolidation transactions, and sell our assets other than in the ordinary course of business. We will also be required to maintain compliance with certain financial covenants, including a minimum fixed charge coverage ratio and a maximum leverage ratio. As of December 24, 2010, we were in compliance with all financial covenants in our credit facility agreement. If we fail to comply with any of the covenants or if any other event of default, as defined in the agreement, should occur, the bank could elect to prevent us from borrowing and declare the indebtedness to be immediately due and payable.

 

As of December 24, 2010, there were no borrowings outstanding under the credit and security agreement and there was $15.0 million available to borrow under the credit and security agreement. In the future, we may continue to utilize commercial financing, lines of credit and term loans for general corporate purposes, including investing in technology.

 

For the nine months ended December 24, 2010, proceeds from employee stock option exercises was $1.0 million.  For the nine months ended December 24, 2010 proceeds from the exercise of warrants in our common stock was $0.4 million. From time to time, we expect to receive cash from the exercise of employee stock options and warrants in our common stock. Proceeds from the exercise of employee stock options and warrants outstanding will vary from period to period based upon, among other factors, fluctuations in the market value of our common stock relative to the exercise price of such stock options and warrants.

 

On July 23, 2010, 407,593 shares were issued pursuant to the exercise of motion picture exhibitor stock options.

 

On December 17, 2010, 1,222,780 shares were issued pursuant to the exercise of motion picture exhibitor stock options.

 

 

Off-balance sheet arrangements

 

We do not have any relationships with unconsolidated entities or financial partnerships, such as entities often referred to as structured finance or special purpose entities that would have been established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes. As such, we are not exposed to any financing, liquidity, market or credit risk that could arise if we had engaged in those types of relationships. We enter into guarantees in the ordinary course of business related to the guarantee of our own performance and the performance of our subsidiaries.

 

Non-U.S. GAAP discussion

 

In addition to our U.S. GAAP results, we present Adjusted EBITDA as a supplemental measure of our performance. However, Adjusted EBITDA is not a recognized measurement under U.S. GAAP. We define Adjusted EBITDA as net income (loss), plus net interest expense, income taxes, depreciation and amortization, share-based compensation expense and exhibitor option expense, as further adjusted to eliminate the impact of certain items that we do not consider indicative of our core operating performance. Management considers 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 that period. Non-U.S. GAAP adjustments to our results prepared in accordance with U.S. GAAP are itemized below. You are encouraged to evaluate these adjustments and the reasons we consider them appropriate for supplemental analysis. In evaluating Adjusted EBITDA, you should be aware that in the future we may incur expenses that are the same as or similar to some of the adjustments in this presentation. Our presentation of Adjusted EBITDA should not be construed as an inference that our future results will be unaffected by unusual or non-recurring items.

 

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Set forth below is a reconciliation of Adjusted EBITDA to net loss for the three and nine months ended December 24, 2010 and December 25, 2009:

 

 

 

Three months ended

 

Nine months ended

 

 

 

December 24,

 

December 25,

 

December 24,

 

December 25,

 

(in thousands)

 

2010

 

2009

 

2010

 

2009

 

 

 

 

 

 

 

 

 

 

 

Net loss

 

$

(16,768)

 

$

(12,279)

 

  $

(11,130)

 

$

(21,813)

 

Add (deduct):

 

 

 

 

 

 

 

 

 

Interest expense

 

71

 

575

 

873

 

1,149

 

Income tax expense

 

1,648

 

478

 

3,299

 

1,431

 

Depreciation and amortization

 

4,384

 

2,010

 

10,428

 

5,387

 

Other (income) loss (1)

 

431

 

210

 

(6,376)

 

670

 

Share-based compensation expense (2)

 

2,980

 

763

 

5,988

 

2,230

 

Exhibitor option expense (3)

 

21,960

 

11,794

 

34,008

 

17,966

 

Impairment of assets and intangibles (4)

 

519

 

115

 

814

 

408

 

Sales and use tax (5)

 

1,291

 

1,470

 

5,443

 

3,323

 

Property tax (6)

 

392

 

174

 

839

 

494

 

Management fee (7)

 

-

 

87

 

175

 

263

 

Adjusted EBITDA

 

$

16,908

 

$

5,397

 

  $

44,361

 

$

11,508

 

 

(1)   Includes amortization of debt issue costs, unrealized foreign currency exchange gains and losses and gain of $6.7 million from the sale of digital projectors in the nine month period ended December 24, 2010.

(2)   Represents share-based compensation expense of nonstatutory and incentive stock options and restricted stock units to employees, officers, directors and consultants.

(3)<