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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

For the Quarterly Period Ended June 25, 2010

OR

For the transition period from ______ to ______.

Commission File Number: 001-34818

RealD Inc.

(Exact name of registrant as specified in its charter)

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  o    No x

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.

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 July 29, 2010, the registrant had 48,109,320 shares of common stock, par value $0.0001 per share, outstanding. 

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RealD Inc.

QUARTERLY REPORT ON FORM 10-Q
FOR THE QUARTER ENDED
JUNE 25, 2010

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PART I – FINANCIAL INFORMATION

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PART I — FINANCIAL INFORMATION

ITEM 1. – FINANCIAL STATEMENTS

RealD Inc.

Condensed consolidated balance sheets

(in thousands, except share and per share data)

See accompanying notes to condensed consolidated financial statements

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RealD Inc.

Condensed consolidated statements of operations (unaudited)

(in thousands, except share and per share data)

See accompanying notes to condensed consolidated financial statements

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RealD Inc.

Condensed consolidated statements of cash flows (unaudited)

(in thousands)

See accompanying notes to condensed consolidated financial statements

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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 filed pursuant to Rule 424(b) under the Securities and Exchange Act, as amended (the “Securities Act”) with the SEC on July 16, 2010 (the “Prospectus”). 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, 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.

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.

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

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from those estimates.

Net income (loss) per share of common stock

Basic income (loss) per share of common stock is computed by dividing the net income (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 are entitled to participate in dividends and earnings of our company, we apply the two-class method in calculating our earnings per share for periods when we generate 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 have net losses. Diluted income (loss) per share of common stock adjusts the basic weighted average number of shares of common stock outstanding for the potential dilution that could occur if stock options, warrants and convertible preferred stock were exercised or converted into common stock. Diluted income (loss) per share of common stock is the same as basic income (loss) per share of common stock for the three months ended June 26, 2009 because the effects of potentially dilutive items were anti-dilutive given our net loss.

The calculation of the basic and diluted income (loss) per share of common stock for the three months ended June 25, 2010 and June 26, 2009 was as follows:

The weighted-average number of anti-dilutive shares excluded from the calculation of diluted income (loss) per common share for the three months ended June 25, 2010 and June 26, 2009 was as follows:

The above anti-dilution table excludes 2,445,561 motion picture exhibitor options that vest upon the achievement of screen installation targets because the targets were not met as of June 25, 2010.

Fair value measurements

As of June 25, 2010 and March 26, 2010, the fair values of our financial assets and liabilities that were carried at fair value on a recurring basis were not significant.

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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 June 25, 2010, we had outstanding forward contracts based in British pound sterling, Canadian dollar and the Euro with notional amounts totaling $4.8 million. As of June 25, 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 is determined based on observable inputs that are corroborated by market data. For the three months ended June 25, 2010 and June 26, 2009, the net gains and losses related to the change in fair value of our foreign currency forward contracts were not significant.

Accounts receivable

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 $1.0 million and $1.2 million as of June 25, 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 month ended June 25, 2010 and June 26, 2009, we recorded inventory impairments of $0.9 million $1.0 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 $5.4 million of deferred offering costs incurred through June 25, 2010 and recorded as other assets on our condensed consolidated balance sheets. On July 21, 2010, amounts incurred 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 June 25, 2010 and June 26, 2009, impairment charges for impaired RealD Cinema Systems charged to cost of revenue were not significant.

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.

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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.

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 totaled $0.5 million and $5.1 million for the three months ended June 25, 2010 and June 26, 2009, respectively.

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 $5.1 million and $1.4 million for the three months ended June 25, 2010 and June 26, 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.

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

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

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Depreciation expense amounted to $2.6 million and $1.6 million for the three months ended June 25, 2010 and June 26, 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 June 25, 2010 and March 26, 2010, respectively.

During the three months ended June 25, 2010, we received $15.4 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 and term loan

As of June 25, 2010, 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. We have used amounts drawn under our credit facility agreement for working capital, capital expenditures and to finance operations. The revolving credit facility provides for, at our option, Revolving LIBOR loans, which bear interest at the London Interbank Offered Rate (LIBOR) plus a margin of 4.25% and Revolving Prime loans which bear interest at the fluctuating Prime Rate plus a margin of 2.75%. The borrowings under the term loan bear interest at the LIBOR plus a margin of seven and one-half percent (7.50%). The credit facility agreement is collateralized by a first priority perfected security interest in certain assets, including substantially all of our tangible and intangible property.

Under the credit facility agreement, we were subject to limitations, including limitations on our ability to incur additional debt, make certain investments or acquisitions and enter into certain merger and consolidation transactions. The credit facility agreement also contained a material adverse change clause, and we were required to maintain compliance with certain covenants, including a minimum Adjusted EBITDA target, a minimum fixed charge coverage ratio and a minimum number of screens installed. As of June 25, 2010, we were in compliance with all financial covenants in our credit facility agreement. All amounts outstanding under the credit facility agreement become due upon the closing of our initial public offering on July 21, 2010.  If we had failed to comply with any of the covenants or experience a material adverse change, the lenders could have elected to prevent us from borrowing and declare the indebtedness to be immediately due and payable.

Borrowings outstanding under the term loan totaled $10.0 million as of June 25, 2010 and March 26, 2010 at an interest rate of 8.625%. Borrowings under the revolving loan credit facility totaled $15.1 million as of June 25, 2010 and $10.2 million as of March 26, 2010. The interest rates at June 25, 2010 related to our borrowings under the revolving loan credit facility ranged from 4.6% to 6.0%. Interest expense related to our borrowings under the credit facility agreement was $0.3 million and $0.1 for the three months ended June 25, 2010 and June 26, 2009, respectively. As of June 25, 2010, there was $9.9 million available to borrow under the credit facility 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.

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 $4.4 million and $11.3 million as of June 25, 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 $0.2 million and $0.2 million for the three months ended June 25, 2010 and June 26, 2009, respectively.

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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 California. 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 $9.8 million at June 25, 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)

Convertible preferred stock

Our outstanding Series A, B and D convertible preferred stock and common 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.

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 ASR 268 because the holders of our Series C mandatorily redeemable convertible preferred stock have the right to cause us to redeem the instrument for cash for a specified period.

We accreted the carrying value of the Series C mandatorily redeemable convertible preferred stock up to liquidation value through December 2011. Accretion is provided using the effective interest-rate method. During the three months ended June 25, 2010 and June 26, 2009, we recorded accretion of $3.8 million and $3.1 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 totaled $0.5 million and $5.1 million for the three months ended June 25, 2010 and June 26, 2009, respectively. As of June 25, 2010, unrecognized motion picture exhibitor stock options reductions in revenue totaled $17.0 million based upon an estimated fair value of our common stock of $15.00 per share and 100% achievement of screen installation targets. As of June 25, 2010, 1,222,779 of the motion picture exhibitor stock options had vested. Reductions of revenue resulting from motion picture exhibitor stock options may increase as compared to a previous period as the estimated fair value of our common stock and number of screen installations increase.

Warrants

As of June 25, 2010, there were warrants outstanding to purchase 1,089,000 shares of common stock. The warrants’ weighted-average exercise price is $0.83 per share. As of June 25, 2010, the weighted-average remaining term of the warrants was 5.7 years.

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7. Share-based compensation

Share-based compensation expense for the three months ended June 25, 2010 and June 26, 2009 was as follows:

8. Equity (deficit)

A summary of the changes in total equity (deficit) for the three months ended June 25, 2010 was as follows:

9. Subsequent Events

On July 21, 2010, we completed an initial public offering (“IPO”) 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. In addition, we issued 111,706 shares of common stock upon the exercise of outstanding options. A total of approximately $96 million in gross proceeds were raised from the IPO or $82.6 million in net proceeds after deducting underwriting discounts and commissions of approximately $6.7 million and other offering costs of approximately $6.7 million. On July 21, 2010, all shares of our then-outstanding convertible preferred stock automatically converted into 16,835,714 shares of common stock.

We used the net proceeds from the IPO to repay $25.1 million of amounts outstanding under the credit facility agreement.

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On July 21, 2010, our amended and restated certificate of incorporation became effective.

Our new credit and security agreement became effective on July 21, 2010, which provides for a revolving credit facility of up to $15 million and is scheduled to mature on June 30, 2012. 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. 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.

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

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; growth opportunities and trends in the market 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.

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.

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.

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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 loss, plus interest expense, net, income taxes and depreciation and amortization, as further adjusted to eliminate the impact of certain 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 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.’’

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

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,

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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 June 25, 2010, there were approximately 7,500 RealD-enabled screens worldwide as compared to approximately 2,600 RealD-enabled screens worldwide as of June 26, 2009, an increase of 4,900 RealD-enabled screens or 188%.  Digital Cinema Implementation Partners (“DCIP”), recently completed its financing and is expected to fund the digital conversion of approximately 14,000 additional domestic theater screens operated by our licensees AMC, Cinemark and Regal. We believe the increasing number of theater screens to be financed by DCIP provides us with significant opportunity 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 23 3D motion pictures will be released worldwide during 2010, including sequels to successful major motion picture franchises such as Harry Potter, Tron and Chronicles of Narnia and 33 3D motion pictures will be released worldwide in 2011. 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 and Toy Story 3 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 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 “Critical accounting policies and estimates.”

RealD eyewear shipping expenses

We anticipate incurring approximately $0.5 million to $2.0 million of expedited shipping expenses in the three months ended September 24, 2010 to satisfy anticipated demand and build sufficient inventory to mitigate the risk of future inventory shortages.

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Results of operations

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

(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 June 26, 2009 compared to three-months ended June 25, 2010

Revenue

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The significant increase in net revenue recorded during the three months ended June 25, 2010 compared to the three months ended June 26, 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 50% of gross revenue for the three months ended June 25, 2010.

Net license revenue for the three months ended June 25, 2010 includes admission-based fees related to the following motion pictures: Shrek Forever After ($4.2 million), How to Train Your Dragon ($5.2 million), Clash of the Titans ($4.1 million),  Toy Story 3 ($2.7 million) and  Alice in Wonderland ($4.2 million). Net license revenue for the three months ended June 26, 2009 includes admission-based fees related to the following motion pictures: Monsters vs. Aliens ($4.9 million) and Up ($4.2 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. Reduction to revenue resulting from motion picture exhibitor stock options decreased $4.6 million based upon the change in the estimated fair value 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 June 25, 2010 reflects an estimated fair value of our common stock of $15.00 per share and 1,932 deployed RealD Cinema Systems out of 4,500 RealD Cinema Systems set forth in the performance vesting targets. As of June 25, 2010, unrecognized motion picture exhibitor stock options reductions to revenue totaled $17.0 million based upon an estimated fair value of our common stock of $15.00 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 to the extent that the value of our common stock and number of RealD-enabled screen installations increase.

Net license revenues comprised 40% and 23% of total revenues for the three months ended June 25, 2010 and June 26, 2009, respectively.

The increase in our net product revenue in the three months, as compared to the three ended June 26, 2009, was primarily a result of an increase in the number of consumers attending 3D motion pictures using our RealD eyewear.

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, we expect our net revenues will increase at a slower rate in future periods.

Cost of revenue

Our cost of revenue increased primarily due to increased RealD eyewear sales. Cost of revenue decreased, as a percentage of revenue, to 72.3% for the three months ended June 25, 2010, as compared to 88.8% for the three months ended June 26, 2009. The increase in gross margin was primarily due to an increase in license revenues and a decrease in the reduction to revenue resulting from motion picture exhibitor stock options, which partially offset the increased use of RealD eyewear which generates lower gross margin. The $4.6 million decrease in reduction to revenue resulting from motion picture exhibitor stock options directly contributed to a $4.6 million increase in gross profit.

Excluding the impact of motion picture exhibitor stock options, gross profit would have increased $0.5 million from $17.9 million for the three months ended June 25, 2010 to $18.4 million and gross margin would have been 28.5%. Excluding the impact of motion picture stock options, gross profit would have increased $5.1 million from $2.9 million for the three months ended June 26, 2009 to $7.9 million and gross margin would have been 30.9%. The increased use of RealD eyewear was driven by increased attendance.

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License cost of revenue increased primarily as a result of a $1.0 million increase in depreciation expense partially offset by a decrease in overhead expenses.

We had a negative product and other gross profit of $4.8 million for the three months ended June 25, 2010, primarily due to RealD eyewear. The increase in our cost of product revenue and negative gross margins are a result of the increase in the volume of RealD eyewear. Inbound and outbound freight expense increased by an aggregate of $4.4 million as a result of the increased use of RealD eyewear. Of this increase, $3.0 million is related to expedited shipping expenses we incurred in the three months ended June 25, 2010 to satisfy a significant increase in demand.

Significant costs associated with the establishment and expansion of the recycling program have been expensed in the period incurred, which further reduced gross margin. Recycling costs increased $1.4 million to $2.2 million for the three months ended June 25, 2010 from $0.8 million for the three months ended June 26, 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 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, we expect our total cost of revenue will continue to increase.

Operating expenses

Research and development.  Our research and development expenses increased primarily due to a $0.4 million increase in personnel costs, as we increased the number of research and development personnel to 32 at June 25, 2010 from 27 at June 26, 2009 to increase our product development and engineering capabilities. 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 our expansion internationally, primarily into Europe.   Costs were primarily from increases in personnel, as well as, advertising and marketing initiatives. Personnel costs, 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 $1.5 million increase in sales and use taxes as a result of increased revenue. We absorb the majority of all sales and use taxes in the United States and do not pass such costs on to our customers. Personnel costs increased $0.8 million, including an increase in executive and other discretionary bonuses of $0.4 million, as we increased the number of general and administrative employees to 18 at June 25, 2010 from 12 at June 26, 2009 to support our overall growth. Legal expenses and professional fees increased $0.7 million to support the growth in our operations. 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 increased $0.2 million primarily due to increases in borrowings under our credit facility agreement. Our borrowings under the credit facility agreement increased to $25.1 million as of June 25, 2010 from $20.2 million as of March 26, 2010.

Other income (loss).  Other income increased primarily due to a $6.7 million gain from the sale of digital projectors partially offset by a foreign exchange loss in the three months ended June 25, 2010.

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Income tax.  Our income tax expense was $0.8 million for the three months ended June 25, 2010 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, 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 income attributable to noncontrolling interest was primarily due to the gain from the sale of digital projectors in the three months ended June 25, 2010.

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.”

Our gross revenue was approximately $65 million in the three months ended June 25, 2010, a decrease of approximately 15.3% compared to gross revenue of $76.7 million in the three months ended March 26, 2010. Our gross revenue decreased as a result of the period-to-period decline in the 3D motion picture box office. The period-to-period variance was primarily attributable to the seasonal release patterns of 3D motion pictures and the performance of Avatar (the highest grossing motion picture of all time) during the three months ended March 26, 2010, which was not replicated during the three months ended June 25, 2010. Our net revenue for the three months ended June 25, 2010 was $64.5 million (after adjustment to revenue of $0.5 million relating to motion picture exhibitor options), increasing by approximately 16.4% compared to net revenue of $55.4 million (after adjustment to revenue of $21.3 million relating to motion picture exhibitor options) for the three months ended March 26, 2010. Our net revenue increased primarily as a result of a significant decrease in our adjustment to revenue relating to motion picture exhibitor options in the three months ended June 25, 2010, attributable to a decrease in the estimated stock price and an increase in screen installation targets. See “Critical accounting policies and estimates.

Our net income was $9.9 million in the three months ended June 25, 2010, improving from the net loss of $17.9 million reported for the three months ended March 26, 2010. The improvement is primarily attributable to the increase in net revenue discussed above, as well as an increase in other income, primarily attributable to the sale of digital projectors to motion picture exhibitors.

Liquidity and capital resources

Since our inception and through June 25, 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.

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 the IPO and borrowings under our new revolving credit facility with City National Bank.

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At June 25, 2010, our primary sources of liquidity were our cash and cash equivalents of $19.5 million and our credit facility agreement with City National Bank providing for a revolving credit facility of $25 million, $9.9 million of which was available for borrowing. Our cash equivalents primarily consist of money market funds. 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.

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

On July 21, 2010, we completed the IPO 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 IPO, or $82.6 million in net proceeds after deducting underwriting discounts and commissions of approximately $6.7 million and other offering costs of approximately $6.7 million. On July 21, 2010, all shares of our then-outstanding convertible preferred stock automatically converted into 16,835,714 shares of common stock.  We used the net proceeds from the IPO to repay $25.1 million of amounts outstanding under the credit facility agreement.

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

We believe that our cash, cash equivalents, and potential cash flows from operations will be sufficient to satisfy our currently anticipated cash requirements through at least the next 12 months.

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

Cash flow from operating activities

Net cash inflows from operating activities during the three months ended June 25, 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 deferred revenue from international eyewear sales, accrued expenses, partially offset by an increase in glasses inventories and deferred offering costs. Increases in 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.

Net cash outflows from operating activities during the three ended June 26, 2009 primarily resulted from a net loss, an increase in accounts receivable and inventories partially offset by increases in deferred costs-eyewear, deferred revenue 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.

Cash flow from investing activities and capital resources

For the three months ended June 25, 2010 and June 26, 2009, cash outflow for investing activities is 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 three months ended June 25, 2010, we received proceeds of $15.4 million as a result of the sale of digital projectors to certain of our motion picture exhibitors. Capital expenditures were $15.8 million for the three months ended June 25, 2010 and $3.4 million in for the three months ended June 26, 2009. We expect our capital expenditures to be approximately $45.0 million to $55.0 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