Table of Contents

 

 

**UNITEDSTATES**

**SECURITIESAND EXCHANGE COMMISSION**

**Washington,D.C. 20549**

 

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**FORM 10-Q**

 

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

 

**For the Quarterly Period Ended September 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.**

**(Exactname of registrant as specified in its charter)**

 

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| **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’stelephone number, including area code)**

 

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

 

Indicate by check mark whether the registrant hassubmitted electronically and posted on its corporate Website, if any, everyInteractive Data File required to be submitted and posted pursuant to Rule 405of Regulation S-T (Section 232.405 of this chapter) during the preceding12 months (or for such shorter period that the registrant was required tosubmit and post such files).Yes  o    No  o

 

Indicate by check mark whether the registrant is alarge accelerated filer, an accelerated filer, a non-accelerated filer, or asmaller reporting company. See  thedefinitions of “large accelerated filer,” “accelerated filer” and “smaller  reporting company” in Rule 12b-2 of theExchange 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 ashell company (as defined in  Rule 12b-2of the Exchange Act).Yes  o    No  x

 

On October 29, 2010, the registrant had 48,514,227shares of common stock, par value $0.0001 per share, outstanding.

 

 

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Table ofContents

 

**RealD Inc.**

**QUARTERLY REPORT ON FORM 10-QFOR THE QUARTER ENDEDSeptember 24, 2010**

 

 

**TABLE OF CONTENTS**

 

**PART I – FINANCIAL INFORMATION**

 

 

 

 
| ** **                                 | ** **                                                                                                                                           | **Page  Number** |
|--------------------------------------------|------------------------------------------------------------------------------------------------------------------------------------------------------|------------------|
| Part I.  Financial Information        |
|                                       |                                                                                                                                                 |             |
| ITEM 1.                               | Financial statements                                                                                                                                 | 3                |
|                                       |                                                                                                                                                 |             |
|                                       | Condensed  consolidated balance sheets as of September 24, 2010 (unaudited) and  March 26, 2010                                            | 3                |
|                                       |                                                                                                                                                 |             |
|                                       | Condensed consolidated  statements of operations (unaudited) for the three and six months ended  September 24, 2010 and September 25, 2009 | 4                |
|                                       |                                                                                                                                                 |             |
|                                       | Condensed consolidated statements of cash flows  (unaudited) for the six months ended September 24, 2010 and  September 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                                                          | 17               |
|                                       |                                                                                                                                                 |             |
| ITEM 3.                                    | Quantitative and qualitative  disclosures about market risk                                                                                          | 34               |
|                                       |                                                                                                                                                 |             |
| ITEM 4.                                    | Controls and procedures                                                                                                                              | 35               |
|                                       |                                                                                                                                                 |             |
|                                       |                                                                                                                                                 |             |
| **PART II –  OTHER INFORMATION** |
|                                       |                                                                                                                                                 |             |
|                                       |                                                                                                                                                 |             |
|                                       |                                                                                                                                                 |             |
| ITEM 1.                                    | Legal proceedings                                                                                                                                    | 36               |
|                                       |                                                                                                                                                 |             |
| ITEM 1A.                                   | Risk factors                                                                                                                                         | 36               |
|                                       |                                                                                                                                                 |             |
| ITEM 2.                                    | Unregistered sales of equity  securities and use of proceeds                                                                                         | 46               |
|                                       |                                                                                                                                                 |             |
| ITEM 5.                                    | Other information                                                                                                                                    | 46               |
|                                       |                                                                                                                                                 |             |
| ITEM 6.                                    | Exhibits                                                                                                                                             | 46               |

 

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Table of Contents

 

**PART I – FINANCIAL INFORMATION**

 

**ITEM 1.– FINANCIAL STATEMENTS**

 

**RealDInc.**

**Condensedconsolidated balance sheets**

**(in thousands, except per share data)**

 
| ** **                                                                                                                                                                                                                                                                       | ** ** | **September 24,** | ** ** | **March 26,** | ** **    |
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------|------------|--------------------|---------------|
| ** **                                                                                                                                                                                                                                                                       | ** ** | **2010**               | ** ** | **2010**           | ** **    |
| ** **                                                                                                                                                                                                                                                                       | ** ** | **(unaudited)**        | ** ** | ** **         | ** **    |
| **Assets**                                                                                                                                                                                                                                                                       | ** ** | ** **             | ** ** | ** **         | ** **    |
| Current assets:                                                                                                                                                                                                                                                                  |       |                   |       |               |          |
| Cash and cash equivalents                                                                                                                                                                                                                                                        |       |   $          | 47,402     |               |   $ | 13,134 |   |
| Marketable securities                                                                                                                                                                                                                                                            |       | 6,849                  |       | –             |          |
| Accounts receivable, net                                                                                                                                                                                                                                                         |       | 57,822                 |       | 51,184             |          |
| Inventories                                                                                                                                                                                                                                                                      |       | 26,196                 |       | 6,539              |          |
| Deferred costs – eyewear                                                                                                                                                                                                                                                    |       | 1,619                  |       | 1,842              |          |
| Deferred income taxes                                                                                                                                                                                                                                                            |       | 4,349                  |       | 4,349              |          |
| Prepaid expenses and other current assets                                                                                                                                                                                                                                        |       | 4,312                  |       | 1,128              |          |
| Total current assets                                                                                                                                                                                                                                                             |       | 148,549                |       | 78,176             |          |
| Property and equipment, net                                                                                                                                                                                                                                                      |       | 4,126                  |       | 2,558              |          |
| Cinema systems, net                                                                                                                                                                                                                                                              |       | 71,917                 |       | 40,623             |          |
| Digital projectors, net-held for sale                                                                                                                                                                                                                                            |       | 11,262                 |       | 25,521             |          |
| Goodwill                                                                                                                                                                                                                                                                         |       | 10,657                 |       | 10,657             |          |
| Other intangibles, net                                                                                                                                                                                                                                                           |       | 1,964                  |       | 2,024              |          |
| Other assets                                                                                                                                                                                                                                                                     |       | 131                    |       | 2,587              |          |
| Total assets                                                                                                                                                                                                                                                                     |       |   $          | 248,606    |               |   $ | 162,146 |   |
| **Liabilities, redeemable convertible  preferred stock and equity (deficit)**                                                                                                                                                                                                    | ** ** | ** **             | ** ** | ** **         | ** **    |
| Current liabilities:                                                                                                                                                                                                                                                             |       |                   |       |               |          |
| Accounts payable                                                                                                                                                                                                                                                                 |       |   $          | 40,910     |               |   $ | 37,625 |   |
| Accrued expenses and other liabilities                                                                                                                                                                                                                                           |       | 29,204                 |       | 24,608             |          |
| Deferred revenue                                                                                                                                                                                                                                                                 |       | 25,130                 |       | 19,430             |          |
| Credit facility agreement                                                                                                                                                                                                                                                        |       | –                 |       | 20,066             |          |
| Income taxes payable                                                                                                                                                                                                                                                             |       | 1,540                  |       | 1,254              |          |
| Current portion of long-term debt                                                                                                                                                                                                                                                |       | 2,846                  |       | 9,299              |          |
| Total current liabilities                                                                                                                                                                                                                                                        |       | 99,630                 |       | 112,282            |          |
| Deferred revenue, net of current portion                                                                                                                                                                                                                                         |       | 15,479                 |       | 14,144             |          |
| Virtual  print fee liability and customer deposits                                                                                                                                                                                                                               |       | 4,642                  |       | 8,331              |          |
| Long-term  debt, net of current portion                                                                                                                                                                                                                                          |       | 1,029                  |       | 2,031              |          |
| Deferred tax liability                                                                                                                                                                                                                                                           |       | 4,413                  |       | 4,413              |          |
| **Commitments and contingencies**                                                                                                                                                                                                                                                |       |                   |       |               |          |
| Series C  mandatorily redeemable convertible preferred stock, no par value, zero and 5,140  shares authorized; zero and 5,140 shares issued and outstanding; zero and  $17.025 redemption value per share at September 24, 2010 and March 26,  2010, respectively |       | –                 |       | 62,831             |          |
| **Equity (deficit)**                                                                                                                                                                                                                                                             |       |                   |       |               |          |
| Series A  redeemable convertible preferred stock, no par value, zero and 3,000 shares  authorized; zero and 2,000 shares issued and outstanding at  September 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  September 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  September 24, 2010 and March 26, 2010, respectively                                                           |       | –                 |       | 19,952             |          |
| Common  stock, $0.0001 par value, 200,000 and 52,700 shares authorized; 48,514 and  24,691 shares issued and outstanding at September 24, 2010 and  March 26, 2010, respectively                                                                                       |       | 258,754                |       | 68,371             |          |
| Accumulated deficit                                                                                                                                                                                                                                                              |       | (137,460               | )          | (137,291           | )             |
| Total  RealD Inc. stockholders’ deficit                                                                                                                                                                                                                                     |       | 121,294                |       | (44,020            | )             |
| Noncontrolling  interest                                                                                                                                                                                                                                                         |       | 2,119                  |       | 2,134              |          |
| Total  equity (deficit)                                                                                                                                                                                                                                                          |       | 123,413                |       | (41,886            | )             |
| Total  liabilities, mandatorily redeemable convertible preferred stock and equity  (deficit)                                                                                                                                                                                     |       |   $          | 248,606    |               |   $ | 162,146 |   |
|                                                                                                                                                                                                                                                                             |       |                   |       |               |          |

 

*Seeaccompanying notes to condensed consolidated financial statements*

 

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**RealDInc.**

**Condensed consolidated statements of operations (unaudited)**

**(in thousands, except per share data)**

 
| ** **                                                 | ** ** | **Three months ended** | ** ** | **Six months ended** |
|------------------------------------------------------------|------------|----------------------------------|------------|--------------------------------|
| ** **                                                 | ** ** | **September 24,**           | ** ** | **September 25,**         | ** ** | **September 24,** | ** ** | **September 25,** |
| ** **                                                 | ** ** | **2010**                         | ** ** | **2009**                       | ** ** | **2010** | ** ** | **2009** |
|                                                       |       |                             |       |                           |   |   |   |   |   |   |   |   |
| Revenue:                                                   |       |                             |       |                           |   |   |   |   |   |   |   |   |
| License                                                    |       |  $                          | 23,762     |                           |   |  $ | 15,770 |   |   |  $ | 49,552 |   |   |  $ | 21,724 |   |
| Product and other                                          |       | 41,560                           |       |                           | 22,913 |   |   | 80,290 |   |   | 42,523 |   |
| Total revenue                                              |       | 65,322                           |       |                           | 38,683 |   |   | 129,842 |   |   | 64,247 |   |
| Cost of revenue:                                           |       |                             |       |                           |   |   |   |   |   |   |   |   |
| License                                                    |       | 3,364                            |       |                           | 2,226 |   |   | 6,359 |   |   | 4,512 |   |
| Product and other                                          |       | 48,135                           |       |                           | 28,131 |   |   | 91,758 |   |   | 48,546 |   |
| Total cost of revenue                                      |       | 51,499                           |       |                           | 30,357 |   |   | 98,117 |   |   | 53,058 |   |
| Gross margin                                               |       | 13,823                           |       |                           | 8,326 |   |   | 31,725 |   |   | 11,189 |   |
| Operating expenses:                                        |       |                             |       |                           |   |   |   |   |   |   |   |   |
| Research and development                                   |       | 3,425                            |       |                           | 2,605 |   |   | 6,404 |   |   | 5,005 |   |
| Selling and marketing                                      |       | 5,333                            |       |                           | 3,879 |   |   | 9,438 |   |   | 7,781 |   |
| General and administrative                                 |       | 8,369                            |       |                           | 3,219 |   |   | 14,599 |   |   | 5,950 |   |
| Total operating expenses                                   |       | 17,127                           |       |                           | 9,703 |   |   | 30,441 |   |   | 18,736 |   |
| Operating income (loss)                                    |       | (3,304                           | )          |                           | (1,377 | ) |   | 1,284 |   |   | (7,547 | ) |
| Interest expense                                           |       | (283                             | )          |                           | (292 | ) |   | (802 | ) |   | (574 | ) |
| Other income (loss)                                        |       | 197                              |       |                           | (450 | ) |   | 6,807 |   |   | (460 | ) |
| Income (loss) before income taxes                          |       | (3,390                           | )          |                           | (2,119 | ) |   | 7,289 |   |   | (8,581 | ) |
| Income tax expense                                         |       | 824                              |       |                           | 426 |   |   | 1,651 |   |   | 953 |   |
| Net income (loss)                                          |       | (4,214                           | )          |                           | (2,545 | ) |   | 5,638 |   |   | (9,534 | ) |
| Net (income) loss attributable to noncontrolling  interest |       | 187                              |       |                           | 228 |   |   | (873 | ) |   | 465 |   |
| Accretion of preferred stock                               |       | (1,096                           | )          |                           | (3,093 | ) |   | (4,934 | ) |   | (6,185 | ) |
| Net loss attributable to RealD Inc. common  stockholders   |       |  $                          | (5,123     | )                              |   |  $ | (5,410 | ) |   |  $ | (169 | ) |   |  $ | (15,254 | ) |
|                                                       |       |                             |       |                           |   |   |   |   |   |   |   |   |
| Loss per common share:                                     |       |                             |       |                           |   |   |   |   |   |   |   |   |
| Basic and diluted                                          |       |  $                          | (0.12      | )                              |   |  $ | (0.22 | ) |   |  $ | (0.01 | ) |   |  $ | (0.63 | ) |
|                                                       |       |                             |       |                           |   |   |   |   |   |   |   |   |
| Shares used in computing earnings per common  share:       |       |                             |       |                           |   |   |   |   |   |   |   |   |
| Basic and diluted                                          |       | 42,856                           |       |                           | 24,554 |   |   | 33,774 |   |   | 24,378 |   |
|                                                       |       |                             |       |                           |   |   |   |   |   |   |   |   |

 

*Seeaccompanying notes to condensed consolidated financial statements*

 

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**RealDInc.**

**Condensed consolidated statements of cash flows (unaudited)**

**(in thousands)**

 
| ** **                                                                                          | ** ** | **Six months ended**         | ** ** |
|-----------------------------------------------------------------------------------------------------|------------|------------------------------|------------|
| ** **                                                                                          | ** ** | **September 24, ** | ** ** | **September 25,** | ** ** |
| ** **                                                                                          | ** ** | **2010 **               | ** ** | **2009** | ** ** |
| **Cash flows from operating activities**                                                            | ** ** | ** **                   | ** ** | ** ** | ** ** | ** ** |
| Net income (loss)                                                                                   |       |  $                      | 5,638      |   |   |  $ | (9,534 | ) |
| Adjustments to reconcile net income (loss) to net  cash provided by (used in) operating activities: |       |                         |       |   |   |   |
| Depreciation and amortization                                                                       |       | 6,044                        |       |   | 3,377 |   |
| Non-cash interest expense                                                                           |       | 480                          |       |   | 353 |   |
| Non-cash stock compensation                                                                         |       | 3,008                        |       |   | 1,467 |   |
| Motion picture exhibitor option reduction in  revenue                                               |       | 12,048                       |       |   | 6,172 |   |
| Gain on sale of digital projectors                                                                  |       | (6,676                       | )          |   | – |   |
| Impairment of long-lived assets                                                                     |       | 295                          |       |   | 293 |   |
| Changes in operating assets and liabilities:                                                        |       |                         |       |   |   |   |
| Accounts receivable                                                                                 |       | (6,638                       | )          |   | (11,075 | ) |
| Inventories                                                                                         |       | (19,657                      | )          |   | (1,213 | ) |
| Prepaid expenses and other current assets                                                           |       | (3,184                       | )          |   | (4,645 | ) |
| Deferred costs - eyewear                                                                            |       | 223                          |       |   | 2,551 |   |
| Other assets                                                                                        |       | 2,462                        |       |   | (13 | ) |
| Accounts payable                                                                                    |       | 3,465                        |       |   | 5,820 |   |
| Accrued expenses and other liabilities                                                              |       | 4,175                        |       |   | 4,417 |   |
| Virtual print fee liability and customer deposits                                                   |       | 1,692                        |       |   | 548 |   |
| Income taxes payable                                                                                |       | 286                          |       |   | 333 |   |
| Deferred revenue                                                                                    |       | 7,035                        |       |   | (5,497 | ) |
| Net cash provided by (used in) operating  activities                                                |       | 10,696                       |       |   | (6,646 | ) |
|                                                                                                |       |                         |       |   |   |   |
| **Cash flows from investing  activities**                                                           |       |                         |       |   |   |   |
| Purchases of marketable securities                                                                  |       | (6,849                       | )          |   | – |   |
| Purchases of property and equipment                                                                 |       | (1,938                       | )          |   | (694 | ) |
| Purchases of cinema systems and related components                                                  |       | (36,375                      | )          |   | (9,580 | ) |
| Purchases of digital projectors                                                                     |       | (114                         | )          |   | (295 | ) |
| Proceeds from sale of digital projectors                                                            |       | 15,354                       |       |   | – |   |
| Net cash used in investing activities                                                               |       | (29,922                      | )          |   | (10,569 | ) |
|                                                                                                |       |                         |       |   |   |   |
| **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                                                                        |       | (8,128                       | )          |   | (1,294 | ) |
| Proceeds from credit facility agreement -  revolving credit facility                                |       | 5,000                        |       |   | – |   |
| Repayments on credit facility agreement -  revolving credit facility                                |       | (15,150                      | )          |   | – |   |
| Proceeds from exercise of stock options                                                             |       | 445                          |       |   | 29 |   |
| Proceeds from exercise of warrants                                                                  |       | 272                          |       |   | – |   |
| Proceeds from exercise of motion picture exhibitor  options                                         |       | 3                            |       |   | – |   |
| Net cash provided by financing activities                                                           |       | 53,494                       |       |   | 8,735 |   |
| Net increase (decrease) in cash and cash  equivalents                                               |       | 34,268                       |       |   | (8,480 | ) |
| Cash and cash equivalents, beginning of year                                                        |       | 13,134                       |       |   | 15,704 |   |
| Cash and cash equivalents, end of year                                                              |       |  $                      | 47,402     |   |   |  $ | 7,224 |   |
|                                                                                                |       |                         |       |   |   |   |
| **Supplemental disclosures of cash  flow information**                                              |       |                         |       |   |   |   |
| Accretion of Series C preferred stock                                                          |       |  $                      | 4,934      |   |   |  $ | 6,185 |   |
| Digital projectors purchased in exchange for notes                                                  |       | 423                          |       |   | 1,277 |   |

 

*See accompanying notes to condensed consolidated financialstatements*

 

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**RealDInc.**

**Notesto condensed consolidated financial statements (unaudited)**

 

**1. Businessand basis of presentation**

 

RealD Inc., including itssubsidiaries (RealD), is a global licensor of stereoscopic 3D technologies.

 

The accompanying condensedconsolidated financial statements are unaudited. These unaudited interimcondensed consolidated financial statements have been prepared in accordancewith accounting principles generally accepted in the United States (“GAAP”) andapplicable 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 financialstatements. Interim results are not necessarily indicative of results for anysubsequent quarter, the full fiscal year or any future periods. Certain informationand note disclosures normally included in the financial statements prepared inaccordance with GAAP have been condensed or omitted pursuant to such rules andregulations. Accordingly these interim condensed consolidated financialstatements should be read in conjunction with the consolidated financialstatements and notes thereto contained in the Company’s Prospectus filedpursuant to Rule 424(b) under the Securities and Exchange Act, asamended (the “Securities Act”) with the SEC on July 16, 2010 (the “Prospectus”).The consolidated balance sheet as of March 26, 2010, included herein wasderived from the audited financial statements as of that date, and thecondensed notes to the condensed consolidated financial statements do notinclude all disclosures including notes required by GAAP.

 

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

 

On April 8, 2010, wereincorporated 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 IIwas formed to fund the deployment of digital projector systems and servers tothird-party exhibitors.

 

All significant intercompanybalances and transactions have been eliminated in consolidation.

 

On June 28, 2010, weamended our certificate of incorporation, which increased our total authorizedcapital stock to 200 million shares, and effected a split of our commonstock, which resulted in each share of our common stock splitting into one andone-half shares (or a 1-for-1.5 forward split). The accompanying condensedconsolidated financial statements and notes to the condensed consolidatedfinancial statements have been retroactively restated to reflect the stocksplit for all periods presented.

 

On July 21, 2010, wecompleted the initial public offering of our common stock in which we sold andissued 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 theinitial public offering, or $81.9 million in net proceeds after deductingunderwriting discounts and commissions of approximately $6.7 million and otheroffering costs of approximately $7.4 million.

 

We have evaluated the impactof subsequent events up to the filing date of these interim condensedconsolidated financial statements.

 

**2. Summaryof significant accounting policies**

 

***Accountingperiod***

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

 

***Use of estimates***

The preparation of financialstatements in conformity with GAAP requires management to make estimates andassumptions 

 

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that affect the reportedamounts of assets and liabilities and disclosures of contingent assets andliabilities at the date of the financial statements and the reported amounts ofrevenue and expense during the reporting period. Actual results could differfrom those estimates.

 

***Net loss pershare of common stock***

Basic loss per share ofcommon stock is computed by dividing the net loss attributable to RealD Inc.common stockholders for the period by the weighted average number of shares ofcommon stock outstanding during the period. Because the holders of ourconvertible preferred stock are entitled to participate in dividends andearnings of our company, we apply the two-class method in calculating ourearnings per share for periods when we generate net income. The two-classmethod requires net income to be allocated between the common and preferredstockholders based on their respective rights to receive dividends, whether ornot declared. No such dividends were paid. Because the convertible preferredstock was not contractually obligated to share in our losses, no suchallocation was made for periods when we have net losses. Diluted loss per shareof common stock is the same as basic loss per share of common stock for allperiods presented because the effects of potentially dilutive items wereanti-dilutive given our net losses.

 

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

 
| ** **                                                          | ** ** | ** ** | ** ** | **Three months ended** | ** ** | ** ** | ** ** | **Six months ended** | ** ** |
|---------------------------------------------------------------------|------------|------------|------------|----------------------------------|------------|------------|------------|--------------------------------|------------|
| ** **                                                          | ** ** | ** ** | ** ** | **September 24,**           | ** ** | ** ** | ** ** | **September 25,**         | ** ** | ** ** | ** ** | **September 24,** | ** ** | ** ** | ** ** | **September 25,** | ** ** |
| **(in thousands, except per share data):** | ** ** | ** ** | ** ** | **2010**                         | ** ** | ** ** | ** ** | **2009**                       | ** ** | ** ** | ** ** | **2010** | ** ** | ** ** | ** ** | **2009** | ** ** |
| Numerator:                                                          |       |       |       |                             |       |       |       |                           |       |   |   |   |   |   |   |   |   |
| Net income (loss)                                                   |       |       |       | $                                | (4,214     | )          |       |                           | $          | (2,545 | ) |   |   | $ | 5,638 |   |   |   | $ | (9,534 | ) |
| Net (income) loss attributable to noncontrolling  interest          |       |       |       | 187                              |       |       |       | 228                            |       |   |   | (873 | ) |   |   | 465 |   |
| Accretion of preferred stock                                        |       |       |       | (1,096                           | )          |       |       | (3,093                         | )          |   |   | (4,934 | ) |   |   | (6,185 | ) |
| Net loss attributable to RealD Inc. common  stockholders            |       |       |       | $                                | (5,123     | )          |       |                           | $          | (5,410 | ) |   |   | $ | (169 | ) |   |   | $ | (15,254 | ) |
|                                                                |       |       |       |                             |       |       |       |                           |       |   |   |   |   |   |   |   |   |
| Denominator:                                                        |       |       |       |                             |       |       |       |                           |       |   |   |   |   |   |   |   |   |
| Weighted-average common shares outstanding                          |       |       |       | 42,856                           |       |       |       | 24,554                         |       |   |   | 33,774 |   |   |   | 24,378 |   |
|                                                                |       |       |       |                             |       |       |       |                           |       |   |   |   |   |   |   |   |   |
| Loss per common share:                                              |       |       |       |                             |       |       |       |                           |       |   |   |   |   |   |   |   |   |
| Basic and diluted                                                   |       |       |       | $                                | (0.12      | )          |       |                           | $          | (0.22 | ) |   |   | $ | (0.01 | ) |   |   | $ | (0.63 | ) |

 

The weighted-average numberof anti-dilutive shares excluded from the calculation of diluted loss percommon share for the three and six months ended September 24, 2010 and September 25,2009 was as follows: 

 
| ** **                                    | ** ** | ** ** | ** ** | ** **                       | ** ** | ** ** | ** ** | ** **                     | ** ** |
|-----------------------------------------------|------------|------------|------------|----------------------------------|------------|------------|------------|--------------------------------|------------|
| ** **                                    | ** ** | ** ** | ** ** | **Three months ended** | ** ** | ** ** | ** ** | **Six months ended** | ** ** |
| ** **                                    | ** ** | ** ** | ** ** | **September 24,**           | ** ** | ** ** | ** ** | **September 25,**         | ** ** | ** ** | ** ** | **September 24,** | ** ** | ** ** | ** ** | **September 25,** | ** ** |
| **(in thousands)**                       | ** ** | ** ** | ** ** | **2010**                         | ** ** | ** ** | ** ** | **2009**                       | ** ** | ** ** | ** ** | **2010** | ** ** | ** ** | ** ** | **2009** | ** ** |
| Options and warrants to purchase common stock |       |       |       | 10,458                           |       |       |       | 6,661                          |       |   |   | 9,139 |   |   |   | 6,561 |   |
| Conversion of convertible preferred stock     |       |       |       | 3,885                            |       |       |       | 16,836                         |       |   |   | 10,360 |   |   |   | 16,836 |   |
| Total                                         |       |       |       | 14,343                           |       |       |       | 23,497                         |       |   |   | 19,499 |   |   |   | 23,397 |   |

 

The above anti-dilutiontable excludes 1,630,375 motion picture exhibitor options that vest upon theachievement of screen installation targets because the targets were not met asof September 24, 2010.

 

***Marketable securities***

The carrying cost,unrealized gains and losses and fair value of marketable securities by majorsecurity as of September 24, 2010 were as follows:

 

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| ** **                | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** **     | ** ** | ** ** | ** ** | **September 24, 2010** | ** ** |
|---------------------------|------------|------------|------------|------------|------------|------------|------------|----------------|------------|------------|------------|----------------------------------|------------|
| ** **                | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | **Unrealized** | ** ** | ** ** | ** ** | **Unrealized**                   | ** ** | ** ** | ** ** | **Estimated** | ** ** |
| **(in thousands)**   | ** ** | ** ** | ** ** | **Cost**   | ** ** | ** ** | ** ** | **gain**       | ** ** | ** ** | ** ** | **loss**                         | ** ** | ** ** | ** ** | **fair value** | ** ** |
| Available-for-sale:       |       |       |       |       |       |       |       |           |       |       |       |                             |       |   |   |   |   |
| Corporate obligations     |       |       |       | $          | 5,823      |       |       |           | $          | —     |       |                             |       | $ | — |   |   |   | $ | 5,823 |   |
| Municipal debt securities |       |       |       | 2,526      |       |       |       | —         |       |       |       | —                           |       |   |   | 2,526 |   |
| U.S. agency securities    |       |       |       | 1,651      |       |       |       | —         |       |       |       | —                           |       |   |   | 1,651 |   |
| Total                     |       |       |       | $          | 10,000     |       |       |           | $          | —     |       |                             |       | $ | — |   |   |   | $ | 10,000 |   |

 

 
| **Classification in the condensed consolidated balance sheets** | ** ** | ** ** | ** ** | ** **             | ** ** |
|-----------------------------------------------------------------------------------------------|------------|------------|------------|------------------------|------------|
| ** **                                                                                    | ** ** | ** ** | ** ** | **September 24,** | ** ** |
| **(in thousands)**                                                                       | ** ** | ** ** | ** ** | **2010**               | ** ** |
| Cash and cash equivalents                                                                     |       |       |       | $                      | 3,151      |   |
| Marketable securities                                                                         |       |       |       | 6,849                  |       |
| Total                                                                                         |       |       |       | $                      | 10,000     |   |

 

All contractual maturities ofdebt securities classified as available-for-sale at September 24, 2010were due within one year.

 

We classify unrealized gainsand losses reported as a component of accumulated other comprehensive income.As of September 24, 2010, the carrying value of our marketable securitiesapproximated fair value primarily attributable to the short holding andmaturity periods of the instruments. For the three and six months ended September 24,2010, the unrealized gains and losses from the available-for-sale securitieswere not significant.

 

The objectives of RealDinvestment policy are to preserve capital, provide sufficient liquidity tosatisfy operating and investment purposes, and capture a market rate of returnbased on the company’s investment policy parameters and market conditions.  Our investment policy limits investments tocertain types of debt and money market instruments issued by institutions withinvestment grade credit ratings and places restrictions on maturities andconcentration by type and issuer.

 

***Derivativeinstruments***

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

 

We purchase foreign currencyforward contracts, generally with maturities of six months or less, to reducethe volatility of cash flows primarily related to forecasted payments andexpenses denominated in certain foreign currencies. As of September 24,2010, we had outstanding forward contracts based in British pound sterling,Canadian dollar and the Euro with notional amounts totaling $2.4 million. As ofSeptember 24, 2010 and March 26, 2010, the carrying amount of ourforeign currency forward contracts was not significant and was classified asLevel 2 fair value instruments, which was determined based on observable inputsthat are corroborated by market data. For the three and six months ended September 24,2010, the net loss  related to the changein fair value of our foreign currency forward contracts was $0.1 million. Forthe three and six months ended September 25, 2009, the net gain (loss)related to the change in fair value of our foreign currency forward contractswas not significant.

 

***Fair value measurements***

As of September 24,2010, the fair values of our financial assets and liabilities carried at fairvalue on a recurring basis were as follows:

 

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| **(in thousands)**            | ** ** | ** ** | ** ** | **Quoted prices in  acive markets   (Level 1)** | ** ** | ** ** | ** ** | **Signficant other  observable inputs  (Level 2)** | ** ** | ** ** | ** ** | **Significant  unobservable  inputs (Level 3)** | ** ** | ** ** | ** ** | **Total** | ** ** |
|------------------------------------|------------|------------|------------|--------------------------------------------------------------------------|------------|------------|------------|-------------------------------------------------------------------|------------|------------|------------|-----------------------------------------------------------|------------|------------|------------|-----------|------------|
| **Assets:**                        |       |       |       |                                                                     |       |       |       |                                                              |       |       |       |                                                      |       |       |       |      |       |
| Corporate obligations              |       |       |       | $                                                                        | 5,823      |       |       |                                                              | $          | —     |       |                                                      |       | $          | —     |      |       |   | $ | 5,823 |   |
| Municipal debt securities          |       |       |       | 2,526                                                                    |       |       |       | —                                                            |       |       |       | —                                                    |       |       |       | 2,526     |       |
| U.S. agency securities             |       |       |       | 1,651                                                                    |       |       |       | —                                                            |       |       |       | —                                                    |       |       |       | 1,651     |       |
| Total assets                       |       |       |       | $                                                                        | 10,000     |       |       |                                                              | $          | —     |       |                                                      |       | $          | —     |      |       |   | $ | 10,000 |   |
|                               |       |       |       |                                                                     |       |       |       |                                                              |       |       |       |                                                      |       |       |       |      |       |
| **Liabilities:**                   |       |       |       |                                                                     |       |       |       |                                                              |       |       |       |                                                      |       |       |       |      |       |
| Foreign currency forward contracts |       |       |       | $                                                                        | —     |       |       |                                                              | $          | 137        |       |                                                      |       | $          | —     |      |       |   | $ | 137 |   |
| Total liabilities                  |       |       |       | $                                                                        | —     |       |       |                                                              | $          | 137        |       |                                                      |       | $          | —     |      |       |   | $ | 137 |   |

 

We base the fair value ofour Level 1 financial instruments on active quoted market prices for identicalinstruments. Our Level 1 financial instruments include corporate obligations,municipal debt securities and U.S. government bonds. We obtain the fair valueof our Level 2 financial instruments from broker/dealer quotes of the same orsimilar securities, based on historical data and other observable inputs,rather than direct observations of quoted prices in active markets. Our Level 2financial instruments include foreign currency forward contracts.

 

As of September 24,2010, we had no assets or liabilities measured and recorded at fair value on arecurring basis that are categorized as Level 3, or that were transferred in orout of the Level 3 category.

 

***Accountsreceivable***

Accounts receivable consistof trade receivables, VAT receivable, employee and other receivables. We extendcredit to our customers, who are primarily in the movie production andexhibition businesses. We provide for the estimated accounts receivable thatwill not be collected. These estimates are based on an analysis of historicalbad debts, customer concentrations, customer creditworthiness, current economictrends and changes in the customers’ payment terms and their economiccondition. Collection of accounts receivable may be affected by changes ineconomic or other industry conditions and may, accordingly, impact our overallcredit risk. The allowance for doubtful accounts and customer credits totaled$2.1 million and $1.2 million as of September 24, 2010 and March 26,2010, respectively.

** **

***Inventories anddeferred costs-eyewear***

Inventories and deferredcosts 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, weevaluate ending inventories and deferred costs-eyewear for net realizablevalue. 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 stateinventories at lower of cost or market, we maintain reserves against suchinventories. If our analyses indicate that market is lower than cost, awrite-down of inventories is recorded in cost of revenue in the period the lossis identified.

 

For the three months ended September 24,2010 and September 25, 2009, we recorded inventory impairments of $1.5million and $2.0 million, respectively, as a result of our net realizable valueanalyses.  For each of the six monthsended September 24, 2010 and September 25, 2009, we recordedinventory impairments of $2.4 million and $3.0 million, respectively, as aresult of our net realizable value analyses.

 

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

 

The number of domesticRealD-enabled screens and related usage of RealD eyewear is expected to grow.Accordingly, for RealD eyewear located at a motion picture exhibitor, webelieve that it is not operationally practical to perform physical counts orrequest the motion picture exhibitor to perform physical counts and confirmquantities held to ensure that losses due to damage, destruction, and shrinkageare specifically recognized in the period incurred. We believe that the cost tomonitor shrinkage or usage significantly outweighs the financial reportingbenefits of using a specific identification methodology of expensing. Webelieve that utilizing a composite method of expensing RealD eyewear inventorycosts provides a rational and reasonable approach to ensuring that shrinkage isprovided for in the period incurred and that inventory costs are expensed inthe periods that reasonably reflect the periods in which the related revenue isrecognized. In 

 

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doing so, we believe thefollowing methodology reasonably and generally reflects periodic income or lossunder these facts and circumstances:

 

·                  For anestimated period of time following shipment to domestic motion pictureexhibitors, no expense is recognized between the time of shipment and until thedelivery is made as the inventory unit is in transit and unused.

·                  The inventoryunit cost is expensed on a straight-line basis over an estimated usage periodbeginning when we believe usage of the inventory unit has started. Inestimating the expensing start date and related expense period, we considervarious factors including, but not limited to, those relating to a 3D motionpicture’s opening release date, a 3D motion picture’s expected release period,the number of currently playing 3D motion pictures, the motion pictureexhibitor’s buying and stocking patterns and practices and the quantitiesshipped per inventory unit.

 

We believe that theexpensing methodology described above rationally and reasonably approximatesthe period the related usage occurs resulting in our RealD eyewear productrevenue. The expensing start date following the date of shipment is meant toapproximate the date at which usage begins. Additionally, as the expense recognitionperiod has been and is expected to continue to be short, we believe itadequately recognizes inventory impairments due to loss and damage on a timelybasis. We further believe that exposures due to loss or damage, if any, areconsidered normal shrinkage and a necessary and expected cost to generate therevenue per 3D motion picture earned through RealD eyewear usage. We continueto monitor the reasonableness of this methodology to ensure that itapproximates the period over which the related RealD eyewear product revenue isearned and realizable. RealD eyewear inventory costs that have not yet beenexpensed are reported as deferred costs-eyewear.

 

***Deferredoffering costs***

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

 

***Impairment of long-livedassets***

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

 

For the three months ended September 24,2010 and September 25, 2009, impairment charges for impaired RealD CinemaSystems charged to cost of revenue totaled $0.2 million. For each of the sixmonths ended September 24, 2010 and September 25, 2009, impairmentcharges for impaired RealD Cinema Systems charged to cost of revenue totaled$0.3 million.

 

***Revenue recognition and revenue reductions***

We derive substantially allof our revenue from the license of our RealD Cinema Systems and the productsale of our RealD eyewear. We evaluate revenue recognition for transactionsusing the criteria set forth by the SEC in Staff Accounting BulletinNo. 104, *Revenue Recognition* (SAB 104)and Accounting Standards Codification Topic 605, *RevenueRecognition* ASC 605. The revenue recognition guidance statesthat revenue is recognized when all of the following criteria are met:persuasive evidence of an arrangement exists, delivery has occurred or serviceshave been rendered, the seller’s price to the buyer is fixed or determinableand collectability is reasonably assured.

 

*Licenserevenue*

License revenue is accountedfor 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 andrecognized over the lease term using the straight-line method. Additional leasepayments that are contingent upon future events outside our control, includingthose related to admission and usage, are recognized as revenues when thecontingency is resolved and we have no more obligations to our customersspecific to the contingent payment received. Certain of our license revenuefrom leasing our RealD Cinema Systems is earned upon admission by the motionpicture exhibitor’s consumers. Our licensees, however, do not report and payfor such license revenue until after the admission has occurred, which may bereceived subsequent to our fiscal period end. We estimate and record licensingrevenue related to motion picture exhibitor consumer admissions in the quarterin which the admission occurs, but only when reasonable estimates of suchamounts can be made. We determine that there is persuasive evidence of anarrangement upon the 

 

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execution of a licenseagreement or upon the receipt of a licensee’s admissions report. Revenue isdeemed fixed or determinable upon verification of a licensee’s admissionsreport in accordance with the terms of the underlying executed agreement or, incertain circumstances, receipt of a licensee’s admissions report. We determinecollectability based on an evaluation of the licensee’s recent payment history.

 

*Productrevenue*

We recognize productrevenue, net of allowances, when title and risk of loss have passed and whenthere is persuasive evidence of an arrangement, the payment is fixed ordeterminable, and collectability of payment is reasonably assured. In theUnited States and Canada, certain of our product revenue from the sale of ourRealD eyewear is earned upon admission and usage by the motion pictureexhibitor’s consumers. Our customers, however, do not report admission or usageinformation until after the admission and usage has occurred, and suchinformation may be received subsequent to our fiscal period end. We estimateand record such product revenue in the quarter in which the admission and usageoccurs, but only when reasonable estimates of such amounts can be made.

 

*Revenuereductions*

We record revenue net ofmotion picture exhibitor stock options and estimated revenue allowances. Inconnection with certain exhibitor licensing agreements, we issued the motionpicture exhibitors a 10-year option to purchase shares of our common stock atapproximately $0.00667 per share. The stock options vest upon the achievementof screen installation targets. Motion picture exhibitor stock options arevalued at the underlying stock price at each reporting period until the targetsare met. Amounts recognized are based on the number of RealD-enabled screens asa percentage of total screen installation targets. The stock options do nothave net cash settlement features. Amounts recorded as a revenue reductiontotaled $11.6 million and $1.1 million for the three months ended September 24,2010 and September 25, 2009, respectively. Amounts recorded as a revenuereduction totaled $12.0 million and $6.2 million for each of the six monthsended September 24, 2010 and September 25, 2009, respectively. Thereduction to revenue resulting from motion picture exhibitor stock options forthe three and six months ended September 24, 2010 reflects the price ofour common stock of $16.35 per share and 2,792 deployed RealD Cinema Systemsout of 4,500 RealD Cinema Systems set forth in the performance vesting targets.Once AMC, Regal and Cinemark achieve the 4,500 screen vesting performancetarget and the options are fully vested, the motion picture exhibitor stockoption expense will end.

 

***Shipping andhandling costs***

Amounts billed to customersfor shipping and handling costs are included in revenue. Shipping and handlingcosts that we incur consist primarily of packaging and transportation chargesand are recorded in cost of revenue. Shipping and handling costs recognized incost of revenue were $1.5 million and $2.1 million for the three months ended September 24,2010 and September 25, 2009, respectively. Shipping and handling costsrecognized in cost of revenue were $6.6 million and $3.5 million for each ofthe six months ended September 24, 2010 and September 25, 2009,respectively.

 

***Recentaccounting pronouncements***

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

 

Accounting Standards Update No. 2009-13,*Revenue Recognition (Topic605)—Multiple-Deliverable Revenue Arrangements—a consensus of the EmergingIssues Task Force*(ASU**2009-13)amends Accounting Standards Codification Subtopic 605-25, *Revenue Recognition— Multiple-Element Arrangements*(ASC605-25). The amendments in ASU 2009-13 enable vendors**to account for products or services separately rather thanas a combined unit upon meeting**certaincriteria and establish a hierarchy for determining the selling price of adeliverable. In**addition, avendor can determine a best estimate of selling price, in a manner that isconsistent**with that used todetermine the price to sell the deliverable on a standalone basis, if a vendor**does not have vendor-specific objectiveevidence or third-party evidence of selling price. ASC**605-25 is also amended to eliminate theuse of the residual method and requires a vendor to**allocate revenue using the relative selling price method.The amendments in ASU 2009-13 will**beeffective prospectively, with an option for retrospective restatement of thefinancial**statements, for revenuearrangements entered into or materially modified in fiscal years**beginning on or after June 15, 2010with early adoption permitted at the beginning of an**entity’s fiscal year. We expect to prospectively adopt theamendments in ASU 2009-13**beginningin the first quarter of fiscal year 2012. We are currently evaluating theimpact 

 

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the**adoption of new guidance will have onconsolidated financial statements.

 

**3. Propertyand equipment, RealD Cinema Systems and digital projectors**

 

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

 
| ** **                                                           | ** ** | ** ** | ** ** | **September 24,** | ** ** | ** ** | ** ** | **March 26,** | ** ** |
|----------------------------------------------------------------------|------------|------------|------------|------------------------|------------|------------|------------|--------------------|------------|
| **(in thousands)**                                              | ** ** | ** ** | ** ** | **2010**               | ** ** | ** ** | ** ** | **2010**           | ** ** |
| RealD  Cinema Systems                                                |       |       |       | $                      | 84,490     |       |       |               | $          | 48,508 |   |
| Digital  projectors                                                  |       |       |       | 13,739                 |       |       |       | 33,196             |       |
| Leasehold  improvements                                              |       |       |       | 698                    |       |       |       | 719                |       |
| Machinery  and equipment                                             |       |       |       | 3,516                  |       |       |       | 2,247              |       |
| Furniture  and fixtures                                              |       |       |       | 13                     |       |       |       | 13                 |       |
| Computer  equipment and software                                     |       |       |       | 595                    |       |       |       | 356                |       |
| Construction  in process                                             |       |       |       | 1,216                  |       |       |       | 767                |       |
| Total                                                                |       |       |       | $                      | 104,267    |       |       |               | $          | 85,806 |   |
| Less  accumulated depreciation                                       |       |       |       | (16,962                | )          |       |       | (17,104            | )          |
| Property  and equipment, RealD Cinema Systems and digital projectors |       |       |       | $                      | 87,305     |       |       |               | $          | 68,702 |   |

 

Depreciation expenseamounted to $3.3 million and $1.7 million for the three months ended September 24,2010 and September 25, 2009, respectively. Depreciation expense amountedto $5.9 million and $3.3 million for each of the six months ended September 24,2010 and September 25, 2009, respectively.

 

We receive virtual printfees (VPFs) from third-party motion picture studios. VPFs represent amountsfrom third-party motion picture studios that are paid to us when a motionpicture is played on one of our digital projectors. VPFs are deferred anddeducted from the selling price of the digital projector. VPFs are recorded asa liability on the accompanying condensed consolidated balance sheets andtotaled $1.7 million and $6.8 million as of September 24, 2010 and March 26,2010, respectively.

 

During the six months ended September 24,2010, we received $15.4 million in cash from motion picture exhibitor customersfor the sale of digital projectors, resulting in a gain of $6.7 million inother income (loss). With the proceeds, we repaid an aggregate of $5.3 millionof notes payable to the equipment providers.

 

**4.Borrowings**

 

***Revolving creditfacility agreement and term loan***

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

 

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

 

Allamounts outstanding under the credit facility agreement became due and wererepaid upon the closing of our initial public offering on July 21, 2010.

 

***Credit and security agreement***

Wehave entered into a new credit and security agreement with City National Bank,dated as of June 24, 2010, which provides for a revolving credit facilityof up to $15.0 million and which will mature on June 30, 2012. Thisagreement and the revolving credit facility provided thereunder becameeffective on July 21, 2010. Our obligations under the new credit andsecurity agreement are secured by a first priority security interest insubstantially all of our tangible and intangible assets in favor of CityNational Bank and are guaranteed by our subsidiaries, ColorLink andStereographics.

 

Under the new credit andsecurity agreement, our business will be subject to certain limitations,including limitations on our ability to incur additional debt, make certaininvestments or acquisitions, enter into certain merger and consolidation

 

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transactions, and sell ourassets other than in the ordinary course of business. We will also be requiredto maintain compliance with certain financial covenants, including a minimumfixed charge coverage ratio and a maximum leverage ratio. As of September 24,2010, we were in compliance with all financial covenants in our credit facilityagreement. If we fail to comply with any of the covenants or if any other eventof default, as defined in the agreement, should occur, the bank could elect toprevent us from borrowing and declare the indebtedness to be immediately dueand payable.

 

As of September 24,2010, there were no borrowings outstanding under the credit and securityagreement. As of September 24, 2010, there was $15.0 million available toborrow under the credit and security agreement.

 

Interest expense related toour borrowings under our credit facility agreement and credit and securityagreement was $0.2 million and $0.6 million for the three and six months endedSeptember 24, 2010, respectively. Interest expense related to ourborrowings under our credit facility agreement was $0.1 million and $0.2million for the three and six months ended September 25, 2009,respectively.

 

***Notes payable***

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

 

Notes payable totaled $3.9million and $11.3 million as of September 24, 2010 and March 26,2010, respectively. Interest expense is based on annual interest rates rangingfrom 7.0% to 8.4%. Interest expense related to notes payable was $0.1 millionand $0.2 million for the three months ended September 24, 2010 and September 25,2009, respectively. Interest expense related to notes payable was $0.2 millionand $0.4 million for each of the six months ended September 24, 2010 and September 25,2009, respectively.

 

**5.Commitments and contingencies**

 

***Indemnities andcommitments***

During the ordinary courseof business, we make certain indemnities and commitments under which we may berequired to make payments in relation to certain transactions. Theseindemnities include indemnities of certain customers and licensees of ourtechnologies, and indemnities to our directors and officers to the maximumextent permitted under the laws of the State of California. The duration ofthese indemnities and commitments varies, and in certain cases, is indefinite.The majority of these indemnities and commitments do not provide for anylimitation of the maximum potential future payments we could be obligated tomake. We have not recorded any liability for these indemnities and commitmentsin the accompanying condensed consolidated balance sheets. We do, however,accrue for losses for any known contingent liability, including those that mayarise from indemnification provisions, when future payment is probable andestimable.

 

We have entered intocontracts with certain of our vendors. Future obligations under such contractstotaled $4.3 million at September 24, 2010 and include revolving 90-daysupply commitments.******Many of the contractscontain cancellation penalty provisions requiring payment of up to 20.0% of theunused contract.

 

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

 

***Initial publicoffering***

On July 21, 2010, wecompleted the initial public offering of our common stock in which we sold andissued 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 theinitial public offering, or $81.9 million in net proceeds after deductingunderwriting discounts and commissions of approximately $6.7 million and otheroffering costs of approximately $7.4 million.

 

***Convertiblepreferred stock***

Our outstanding Series A,B and D convertible preferred stock was classified as part of permanent equitywithin the condensed consolidated balance sheets based on their rights andpreferences set forth under the certificate of incorporation, California andDelaware law and the accounting standards pertaining to classification withinthe condensed consolidated balance sheet. We therefore recorded the Series A,B and D preferred stock at their original issuance price net of applicableissuance costs. On July 21, 2010, in conjunction with our initial publicoffering, our total outstanding Series A, B and D 

 

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convertible preferred stockin the amount of 6,084,311 shares converted at a ratio of 1:1.5 into 9,126,466shares of common stock.

 

***Mandatorilyredeemable convertible preferred stock***

Our Series Cmandatorily redeemable convertible preferred stock was classified in temporaryequity under the SEC’s guidance provided in ASR 268 because the holders of our Series Cmandatorily redeemable convertible preferred stock have the right to cause usto redeem the instrument for cash for a specified period. On July 21,2010, in conjunction with our initial public offering, our total outstanding Series Cmandatorily redeemable convertible preferred stock in the amount of 5,139,500shares converted at a ratio of 1:1.5 into 7,709,250 shares of common stock.

 

We accreted the carryingvalue of the Series C mandatorily redeemable convertible preferred stockup to liquidation value through July 21, 2010. Accretion is provided usingthe effective interest-rate method. For the three months ended September 24,2010 and September 25, 2009, we recorded accretion of $1.1 million and$3.1 million, respectively. For each of the six months ended September 24,2010 and September 25, 2009, we recorded accretion of $4.9 million and$6.2 million, respectively.

 

***Motion pictureexhibitor stock options***

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

 

Amounts recorded as arevenue reduction totaled $11.6 million and $1.1 million for the three monthsended September 24, 2010 and September 25, 2009, respectively.Amounts recorded as a revenue reduction totaled $12.0 million and $6.2 millionfor each of the six months ended September 24, 2010 and September 25,2009, respectively. The reduction to revenue resulting from motion pictureexhibitor stock options for the three and six months ended September 24,2010 reflects the price of our common stock of $16.35 per share and 2,792deployed RealD Cinema Systems out of 4,500 RealD Cinema Systems set forth inthe performance vesting targets. As of September 24, 2010, unrecognizedmotion picture exhibitor stock options reductions in revenue totaled $9.5million based upon an estimated fair value of our common stock of $16.35 pershare and 100% achievement of screen installation targets. Once AMC, Regal andCinemark achieve the 4,500 screen vesting performance target and the optionsare fully vested, the motion picture exhibitor stock option expense will end.

 

As of September 24,2010, 2,037,965 of the motion picture exhibitor stock options had vested.Additionally, 407,593 exhibitor stock options were exercised by certain of ourmotion picture exhibitors during the six months ended September 24, 2010.Reductions of revenue resulting from motion picture exhibitor stock options mayincrease as compared to a previous period as the estimated fair value of ourcommon stock and number of screen installations increase.

 

***Warrants***

As of September 24,2010, there were warrants outstanding to purchase 762,300 shares of commonstock. For the six months ended September 24, 2010, 326,700 warrants wereexercised. The outstanding warrants’ weighted-average exercise price is $0.83per share. As of September 24, 2010, the weighted-average remaining termof the warrants was 5.5 years.

 

**7.Share-based compensation**

 

We account for stock optionsgranted to employees and directors by recording compensation expense based onestimated fair values. We estimate the fair value of share-based payment awardson the date of grant. The value of the portion of the award that is ultimatelyexpected to vest is recognized as expense over the requisite service periods inour consolidated statements of operations. Share-based awards are attributed toexpense using the straight-line method over the vesting period. We determinethe value of each option award that contains a market condition using alattice-based option valuation model, while all other option awards are valuedusing the Black-Scholes valuation model as permitted under ASC 718 *Compensation — Stock Compensation*. The assumptions used incalculating the fair value of share-based payment awards represent our bestestimates. Our estimates may be impacted by certain variables including stockprice volatility, employee stock option exercise behaviors, additional stockoption grants, estimates of forfeitures, and the related income tax impact.

 

In April 2010, ourboard of directors unanimously adopted the RealD Inc. 2010 Stock IncentivePlan, or the 2010 Stock Plan, and in June 2010, our stockholders approvedthe 2010 Stock Plan. The board of directors intends for the 2010 Stock Plan toreplace our 2004 Amended and Restated Stock Incentive Plan, or the 2004 Plan,such that, effective with our initial public offering, we will no longer makeany new grants under the 2004 Plan. Instead, the board of directors or ourcompensation 

 

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committee will issue equitycompensation awards under the 2010 Stock Plan. The stock plan provides for thegranting of nonstatutory stock options, incentive stock options, stockappreciation rights, restricted stock awards and stock units to employees,officers, directors, non-employee directors and consultants.

 

***Stock options***

Stock options grantedgenerally vest over a four-year period, with 25% of the shares vesting afterone year and monthly vesting thereafter. The options generally expire ten years from the date of grant. In July 2010,we granted 2,455,500 stock options at a weighted average grant date fair valueof $8.75 per share. For the six months ended September 24, 2010,share-based compensation expense related to stock options was $2.5 million.

 

***Performance stock options***

Certain of ourmanagement-level employees receive performance stock options, which gives therecipient the right to receive common stock that is contingent upon achievementof specified pre-established performance goals over the performance period,which is generally three years. The performance goals for the performance stockoptions are based on the measurement of our total shareholder return, on apercentile basis, compared to a comparator group of companies. Depending on theoutcome of the performance goals, the recipient may ultimately earn performancestock options equal to or less than the number of performance stock optionsgranted. In July 2010, we granted 641,250 performance stock options at aweighted average grant date fair value of $9.45 per share. For the six monthsended September 24, 2010, share-based compensation expense related toperformance stock options was $0.4 million.

 

***Restricted stock units***

In August 2010, wegranted our board of directors 54,372 restricted stock units at a weightedaverage grant date fair value of $19.84 per share. The restricted stock unitsvest on a monthly basis over one to two years. For the six months ended September 24,2010, share-based compensation expense related to restricted stock units was$0.1 million.

 

Share-based compensationexpense for all share-based arrangements for the three and six months ended September 24,2010 and September 25, 2009 was as follows:

 
| ** **                 | ** ** | **Three months ended** | ** ** | **Six months ended** | ** ** |
|----------------------------|------------|----------------------------------|------------|--------------------------------|------------|
| ** **                 | ** ** | **September 24,**           | ** ** | **September 25,**         | ** ** | **September 24,** | ** ** | **September 25,** | ** ** |
| **(in thousands)**    | ** ** | **2010**                         | ** ** | **2009**                       | ** ** | **2010** | ** ** | **2009** | ** ** |
| Cost of revenue            |       | $                                | 30         |                           | $          | 20 |   | $ | 43 |   | $ | 40 |   |
| Research and development   |       | 381                              |       | 216                            |       | 582 |   | 543 |   |
| Selling and marketing      |       | 774                              |       | 408                            |       | 1,156 |   | 757 |   |
| General and administrative |       | 1,167                            |       | 59                             |       | 1,227 |   | 127 |   |
| Total                      |       | $                                | 2,352      |                           | $          | 703 |   | $ | 3,008 |   | $ | 1,467 |   |

 

**8. Income taxes**

 

Our income tax expense for the three and six monthsended September 24, 2010 was $0.8 million and $1.7 million, respectively,primarily due to an increase in our foreign tax expense. We have net operatinglosses that may potentially be offset against future earnings. We file federalincome tax returns and income tax returns in various state and foreignjurisdictions. Due to the net operating loss carryforwards, our United States federaland state returns are open to examination by the Internal Revenue Service andstate jurisdictions for all years since inception.

 

**9. Equity (deficit)**

 

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

 

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| ** **                                                                                  | ** ** | **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                                                                    |       |                   | 3,008          |               |       | -                     |   |   | 3,008 |
| Exercise of stock options                                                                   |       |                   | 447            |               |       | -                     |   |   | 447 |
| Exercise of motion picture exhibitor options                                                |       |                   | 3              |               |       | -                     |   |   | 3 |
| Exercise of warrants                                                                        |       |                   | 272            |               |       | -                     |   |   | 272 |
| Motion picture exhibitor option reduction in revenue                                        |       |                   | 12,048         |               |       | -                     |   |   | 12,048 |
| 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:                                                                       |       |                   |           |               |       |                  |   |   |   |
| Net income                                                                                  |       |                   | 4,765          |               |       | 873                   |   |   | 5,638 |
| Total comprehensive income                                                                  |       |                   |           |               |       |                  |   |   | 5,638 |
| Balance, September 24, 2010                                                            |       | $                      |  121,294  |               | $          |  2,119           |   | $ |  123,413 |

 

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

 

***Forward-looking statements***

 

*The following discussion andanalysis should be read in conjunction with our interim condensed consolidatedfinancial statements and the related notes that appear elsewhere in this Form 10-Q.These discussions contain forward-looking statements reflecting our currentexpectations that involve risks and uncertainties. In some cases, you canidentify 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: statementsregarding the extent and timing of future licensing, products and servicesrevenue levels and mix, expenses, margins, net income per diluted share, incometaxes, tax benefits, acquisition costs and related amortization, and othermeasures of results of operations; our expectations regarding demand andacceptance for our technologies; 3D motion picture releases and conversionsscheduled for 2010 and 2011; our ability to supply our solutions to ourcustomers on a timely basis; growth opportunities and trends in the market inwhich we operate; our plans, strategies and expected opportunities; thedeployment of and demand for our products and products incorporating ourtechnologies; and future competition. Actual results may differ materially fromthose 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, Item1A of this Quarterly Report on Form 10-Q and elsewhere in this filing.Although we believe that the expectations reflected in the forward-lookingstatements are reasonable, we cannot guarantee future results, levels ofactivity, performance or achievements. Moreover, neither we nor any otherperson assumes responsibility for the accuracy and completeness of theseforward-looking statements. We are under no duty to update any of theforward-looking statements after the date of this Quarterly Report on Form 10-Qto conform our prior statements to actual results.*

 

**Overview**

 

We are a leading globallicensor of 3D technologies. Our extensive intellectual property portfolioenables a premium 3D viewing experience in the theater, the home and elsewhere.We license our RealD Cinema Systems to motion picture exhibitors that show 3Dmotion pictures and alternative 3D content. We also provide our RealD Format,active and passive eyewear, and display and gaming technologies to consumerelectronics manufacturers and content providers and distributors to enable thedelivery and viewing of 3D content on high definition televisions, laptops andother displays. Our cutting-edge 3D technologies have been used forapplications such as piloting the Mars Rover, heads-up displays for militaryjets and robotic medical procedures.

 

For financial reportingpurposes, we currently have one reportable segment. We have three operatingsegments: cinema, consumer electronics and professional within which we marketour various applications. Operating segments are defined as components of anenterprise about which separate financial information is available that isevaluated regularly by the chief operating decision maker, or decision-makinggroup, in deciding how to allocate resources and in assessing performance. Ourchief operating decision maker is our Chief Executive Officer. We aggregate ourthree operating segments into one reportable segment based on qualitativefactors, including similar economic characteristics and the nature of theproducts and services. Our product portfolio is used in applications thatenable a premium 3D viewing experience across these segments. We currentlygenerate substantially all of our revenue from the license of our RealD CinemaSystems and the use and sale of our eyewear.

 

**Key business metrics**

 

Our management regularlyreviews a number of business metrics, including the following key metrics toevaluate our business, monitor the performance of our business model, identifytrends affecting our business, determine the allocation of resources, makedecisions regarding corporate strategies and evaluate forward-lookingprojections. The measures that we believe are the primary indicators of ourquarterly and annual performance are as follows:

 

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

·                  **Number of locations.**Domestic locations aremotion picture exhibition complexes in the United States or Canada with one ormore screens enabled with our RealD Cinema Systems. International locations aremotion picture 

 

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exhibitioncomplexes outside the United States and Canada with one or more screens enabledwith our RealD Cinema Systems.

·                  **Number of 3D motion pictures.**Total 3D motion pictures arethe number of 3D motion pictures that are exhibited for more than threeshowings per day and for a period in excess of one week and for which wereceive a license fee from the motion picture exhibitor during the relevantperiod.

·                  **AdjustedEBITDA.** We use Adjusted EBITDA as a supplemental measure of our performance.We define Adjusted EBITDA as net loss, plus interest expense, net, income taxesand depreciation and amortization, as further adjusted to eliminate the impactof certain items that we do not consider indicative of our core operatingperformance. We consider our core operating performance to be that which can beaffected by our managers in any particular period through their management ofthe resources that affect our underlying revenue and profit generatingoperations for that period. However, Adjusted EBITDA is not a recognizedmeasurement under U.S. GAAP and should not be considered in isolation or as asubstitute for performance measures calculated in accordance with U.S. GAAP.For further discussion regarding Adjusted EBITDA, see ‘‘—Non-U.S. GAAPdiscussion.’’

 

The following table setsforth additional performance highlights of key business metrics for the periodspresented (approximate numbers):

 
| ** **                                                      | ** ** | **Six months ended**     | ** ** |
|-----------------------------------------------------------------|------------|------------------------------------|------------|
| ** **                                                      | ** ** | **September 24,   2010** | ** ** | **September 25,  2009** | ** ** |
| Number  of RealD enabled screens (at period end)                |       |                               |       |   |   |
| Total  domestic RealD enabled screens                           |       | 5,600                              |       | 2,300 |   |
| Total  international RealD enabled screens                      |       | 3,700                              |       | 1,000 |   |
| Total  RealD enabled screens                                    |       | 9,300                              |       | 3,300 |   |
| Number  of locations with RealD enabled screens (at period end) |       |                               |       |   |   |
| Total  domestic locations with RealD enabled screens            |       | 2,100                              |       | 1,400 |   |
| Total  international locations with RealD enabled screens       |       | 1,700                              |       | 700 |   |
| Total  locations with RealD enabled screens                     |       | 3,800                              |       | 2,100 |   |
| Number  of 3D motion pictures (released during period)          |       | 11                                 |       | 7 |   |

 

Ifwe are successful in expanding our business with consumer electronicsmanufacturers and content producers and distributors to incorporate our RealDFormat and display and gaming technologies into their products and platforms,our key business metrics in future periods may include the number of units of3D-enabled plasma and LCD televisions, interactive gaming consoles and laptopcomputers shipped in that period.

 

 

**Opportunities, trends and factors affecting comparability**

 

We have rapidly evolved andexpanded our business since we acquired ColorLink in March 2007. Thisexpansion has included hiring most of our senior management team, acquiring andgrowing our research and development facilities in Boulder, Colorado, andbuilding infrastructure to support our business. These investments in andchanges to our business have allowed us to significantly increase our revenueand key business metrics. We expect to continue to invest for the foreseeablefuture in expanding our business as we increase our direct sales and marketingpresence in the United States, Europe, Asia and other geographic regions,enhance and expand our technology and product offerings and pursue strategicacquisitions.

 

***Cinema***

The shift in the motionpicture industry from analog to digital over the past decade has created anopportunity for new and transformative 3D technologies. As of September 24,2010, there were approximately 9,300 RealD-enabled screens worldwide ascompared to approximately 3,300 RealD-enabled screens worldwide as of September 25,2009, an increase of 6,000 RealD-enabled screens or 182%.****** Digital Cinema Implementation Partners (“DCIP”),recently completed its financing and is expected to fund the digital conversionof approximately 14,000 additional domestic theater screens operated by ourlicensees AMC, Cinemark and Regal. We believe the increasing number of theaterscreens to be financed by DCIP provides us with significant opportunity todeploy additional RealD Cinema Systems and furthers our penetration of thedomestic market. Based on the slate announcements by motion picture studios, weanticipate that 22 3D motion pictures will be released worldwide during 2010, includingsequels to successful major motion picture franchises such as *Chronicles of*

 

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*Narnia* and *Tron,* and that approximately 32******3Dmotion pictures will be released worldwide in 2011. As the number ofRealD-enabled screens and 3D motion pictures released increases, we expect thatour revenue and capital needs will continue to grow.

 

***Consumer electronics***

We have recently madeavailable our RealD Format, active and passive eyewear, and display and gamingtechnologies to consumer electronics manufacturers and content distributors toenable 3D in high definition televisions, laptops and other displays in thehome and elsewhere. We believe that the recent success of major 3D motionpictures, including *Avatar,**Alice in Wonderland,**Shrek Forever After* and *Toy Story 3* is leading to thecreation and distribution of 3D content for the consumer electronics market.The development of this market represents a significant opportunity for newrevenue.

 

***Motion picture exhibitor stock options***

We expect to incurvariability in our license revenue and operating results in connection withstock options issued to some of our motion picture exhibitor licensees thatvest upon the achievement of screen installation targets. For furtherdiscussion regarding exhibitor stock options, see “Critical accounting policiesand estimates.”

 

**Results of operations**

 

The following table setsforth our condensed consolidated statements of operations for each of theperiods indicated:

 
| ** **                                                                                                                             | ** ** | **Three  months ended** | ** ** | **Six months ended**   | ** ** |
|----------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------------|------------|------------------------|------------|
| ** **                                                                                                                             | ** ** | **September 24,**  | ** ** | **September 25,** | ** ** | **September 24,** | ** ** | **September 25,** | ** ** |
| **(in thousands)**                                                                                                                     | ** ** | **2010**                | ** ** | **2009**               | ** ** | **2010** | ** ** | **2009** | ** ** |
| **Consolidated statements of operations  data:**                                                                                       |       |                    |       |                   |       |   |   |   |   |   |   |   |   |
| Gross revenue                                                                                                                          |       |    $               | 76,878     |                   |    $  | 39,777 |   |    $ | 141,890 |   |    $ | 70,419 |   |
| Motion picture exhibitor options                                                                                                       |       |                    | (11,556)   |                   |       | (1,094) |   |   | (12,048) |   |   | (6,172) |   |
| Net revenue                                                                                                                            |       |                    | 65,322     |                   |       | 38,683 |   |   | 129,842 |   |   | 64,247 |   |
| Cost of revenue                                                                                                                        |       |                    | 51,499     |                   |       | 30,357 |   |   | 98,117 |   |   | 53,058 |   |
| Gross margin                                                                                                                           |       |                    | 13,823     |                   |       | 8,326 |   |   | 31,725 |   |   | 11,189 |   |
| Operating expenses:                                                                                                                    |       |                    |       |                   |       |   |   |   |   |   |   |   |   |
| Research and development                                                                                                               |       |                    | 3,425      |                   |       | 2,605 |   |   | 6,404 |   |   | 5,005 |   |
| Selling and marketing                                                                                                                  |       |                    | 5,333      |                   |       | 3,879 |   |   | 9,438 |   |   | 7,781 |   |
| General and administrative                                                                                                             |       |                    | 8,369      |                   |       | 3,219 |   |   | 14,599 |   |   | 5,950 |   |
| Total operating expenses                                                                                                               |       |                    | 17,127     |                   |       | 9,703 |   |   | 30,441 |   |   | 18,736 |   |
| Operating income (loss)                                                                                                                |       |                    | (3,304)    |                   |       | (1,377) |   |   | 1,284 |   |   | (7,547) |   |
| Interest expense                                                                                                                       |       |                    | (283)      |                   |       | (292) |   |   | (802) |   |   | (574) |   |
| Other income (loss)                                                                                                                    |       |                    | 197        |                   |       | (450) |   |   | 6,807 |   |   | (460) |   |
| Income (loss) before income taxes                                                                                                      |       |                    | (3,390)    |                   |       | (2,119) |   |   | 7,289 |   |   | (8,581) |   |
| Income tax expense                                                                                                                     |       |                    | 824        |                   |       | 426 |   |   | 1,651 |   |   | 953 |   |
| Net income (loss)                                                                                                                      |       |                    | (4,214)    |                   |       | (2,545) |   |   | 5,638 |   |   | (9,534) |   |
| Net (income) loss attributable to noncontrolling  interest                                                                             |       |                    | 187        |                   |       | 228 |   |   | (873) |   |   | 465 |   |
| Accretion of preferred stock                                                                                                           |       |                    | (1,096)    |                   |       | (3,093) |   |   | (4,934) |   |   | (6,185) |   |
| Net loss attributable to RealD Inc. common  stockholders              |       |    $               | (5,123)    |                   |    $  | (5,410) |   |    $ | (169) |   |    $ | (15,254) |   |
|                                                                                                                                   |       |                    |       |                   |       |   |   |   |   |   |   |   |   |

 
| **Other data:**     |   |                |   |   |                |   |   |                |   |   |                |   |   |
|---------------------|--------|---------------------|--------|--------|---------------------|--------|--------|---------------------|--------|--------|---------------------|--------|--------|
| Adjusted EBITDA (1) |   |    $ | 16,479 |   |    $ | 3,859  |   |    $ | 27,453 |   |    $ | 6,111  |   |

(1)         Adjusted EBITDAis not a recognized measurement under U.S. GAAP.  For a definition of Adjusted EBITDA andreconciliation to net income (loss), the comparable U.S. GAAP item, see “—Non-U.S. GAAPdiscussion.”

 

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

 

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**Three months ended September 24,2010 compared to three months ended September 25, 2009**

 

***Revenue***
|                             | ** ** | **Three  months ended** | ** ** | ** **             | ** ** | ** ** | ** ** | ** **     |
|----------------------------------|------------|-------------------------|------------|------------------------|------------|------------|------------|----------------|
|                             | ** ** | **September 24,**  | ** ** | **September 25,** | ** ** | **Amount** | ** ** | **Percentage** | ** ** |
| **(in thousands)**               | ** ** | **2010**                | ** ** | **2009**               | ** ** | **change** | ** ** | **change**     | ** ** |
| **Revenue:**                     | ** ** | ** **              | ** ** | ** **             | ** ** | ** ** | ** ** | ** **     | ** ** | ** ** | ** ** | ** ** |
| Gross license                    |       | $                       | 35,318     |                   |       | $          | 16,864     |           |   | $ | 18,454 |   |   | 109.4% |   |
| Motion picture exhibitor options |       | (11,556                 | )          |                   | (1,094     | )          |       | (10,462        | ) |   | 956.3% |   |
| Net license                      |       | 23,762                  |       |                   | 15,770     |       |       | 7,992          |   |   | 50.7% |   |
| Product and other                |       | 41,560                  |       |                   | 22,913     |       |       | 18,647         |   |   | 81.4% |   |
| Total net revenue                |       | $                       | 65,322     |                   |       | $          | 38,683     |           |   | $ | 26,639 |   |   | 68.9% |   |

 

The significant increase innet revenue recorded during the three months ended September 24, 2010compared to the three months ended September 25, 2009 was primarily due toan increase in the number of RealD-enabled screens, an increase in the numberof 3D motion pictures released and the resulting increase in the box office of3D motion pictures on RealD-enabled screens. Our international marketscomprised approximately 56% of gross revenue for the three months ended September 24,2010.

 

For the three months ended September 24,2010, there were eight motion pictures that contributed greater than $1.0million of admission-based fees to net license revenue. Net license revenue forthe three months ended September 24, 2010 includes admission-based feesrelated to the following motion pictures: *Toy Story 3*($9.4 million), *Shrek Forever After*($3.7 million)*, Despicable Me* ($3.7 million), *The Last Airbender* ($3.0 million), *Step Up*($1.8 million)**and*Resident Evil*($1.4 million).  For the three months ended September 25,2009, there were four motion pictures which contributed greater than $1.0million of admission-based fees to net license revenue. Net license revenue forthe three months ended September 25, 2009 includes admission-based feesrelated to the following motion pictures: *Ice Age 3* ($5.9 million),  *Up*($2.1 million), *GForce* ($3.0million) and *Final Destination* ($2.3 million).Both domestically and internationally, our net license revenue increased duringthe period as a result of the increased number of RealD-enabled screens and thenumber of 3D motion picture releases increasing. The reduction to revenueresulting from motion picture exhibitor stock options increased $10.5 millionbased upon the change in the price of our common stock and the number ofRealD-enabled screens of the related exhibitor. The reduction to revenueresulting from motion picture exhibitor stock options in the three months endedSeptember 24, 2010 reflects the price of our common stock of $16.35 pershare and 2,792 deployed RealD Cinema Systems out of 4,500 RealD Cinema Systemsset forth in the performance vesting targets. As of September 24, 2010,unrecognized motion picture exhibitor stock options reductions to revenuetotaled $9.5 million based upon the price of our common stock of $16.35 pershare and 100% achievement of screen installation targets. Reductions torevenue resulting from motion picture exhibitor stock options may increase ascompared to a previous period to the extent that the value of our common stockand number of RealD-enabled screen installations increase.

 

Net license revenuescomprised 36% and 41% of total revenues for each of the three months ended September 24,2010 and September 25, 2009, respectively. International license revenuescomprised 52% of gross license revenues in the three months ended September 24,2010.

 

The increase in our netproduct and other revenue in the three months ended September 24, 2010 ascompared to the three months ended September 25, 2009, was primarily aresult of an increase in the number of consumers attending 3D motion picturesusing our RealD eyewear. International product revenues comprised 59% of totalproduct revenues in the three months ended September 24, 2010, primarilydue to increased usage of RealD eyewear internationally at higher unit sellingprices than domestic RealD eyewear.

 

We expect our futurerevenue, particularly in our license business, will be driven by the number ofRealD-enabled screens and motion pictures released in 3D. As the volume ofRealD eyewear usage increases as a result of an expanding 3D motion pictureslate and box office, we may experience additional price pressure from ourcustomers. As a result, our net revenues may increase at a slower rate infuture periods.

 

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***Cost of Revenue***
|                  | ** ** | **Three  months ended** | ** ** | ** **             | ** ** | ** ** | ** ** |
|-----------------------|------------|-------------------------|------------|------------------------|------------|------------|------------|
|                  | ** ** | **September 24,**  | ** ** | **September 25,** | ** ** | **Amount** | ** ** | **Percentage** | ** ** |
| **(in thousands)**    | ** ** | **2010**                | ** ** | **2009**               | ** ** | **change** | ** ** | **change** | ** ** |
| **Revenue**           |       | $                       | 65,322     |                   | $          | 38,683     |       | $ | 26,639 |   | 68.9% |   |
| **Cost of Revenue:**  | ** ** | ** **              | ** ** | ** **             | ** ** | ** ** | ** ** | ** ** | ** ** |
| License               |       | 3,364                   |       | 2,226                  |       | 1,138      |       | 51.1% |   |
| Product and other     |       | 48,135                  |       | 28,131                 |       | 20,004     |       | 71.1% |   |
| Total cost of revenue |       | $                       | 51,499     |                   | $          | 30,357     |       | $ | 21,142 |   | 69.6% |   |
| Gross profit          |       | $                       | 13,823     |                   | $          | 8,326      |       | $ | 5,497 |   | 66.0% |   |
| Gross margin          |       | 21.2%                   |       | 21.5%                  |       |       |       |   |   |

 

For the three months ended September 24,2010, our cost of revenue increased primarily due to increased RealD eyewearsales. Cost of revenue decreased, as a percentage of revenue, to 78.8% for thethree months ended September 24, 2010, as compared to 78.5% for the threemonths ended September 25, 2009. The minimal change in gross margin wasprimarily due to improved margins on a larger percentage of RealD eyewearrevenue. For the three months ended September 24, 2010, the $10.5 millionincrease in the reduction to revenue resulting from motion picture exhibitorstock options directly contributed to a $10.5 million decrease in gross profit.

 

Excluding the impact ofmotion picture exhibitor stock options of $11.6 million, gross profit wouldhave been $25.4 million for the three months ended September 24, 2010, andgross margin would have been 33.0%. Excluding the impact of motion picturestock options of $1.1 million, gross profit would have been $9.4 million forthe three months ended September 25, 2009, and gross margin would havebeen 23.7%.

 

Excluding the impact ofmotion picture exhibitor stock options of $11.6 million, gross profit forlicense revenue would have been $32.0 million for the three months ended September 24,2010, and gross margin would have been 90.5%. Excluding the impact of motion picture exhibitor stock options of $1.1million, gross profit for license revenue would have been $14.6 million for thethree months ended September 25, 2009, and gross margin would have been86.8%.

 

We had a negative productand other gross profit of $6.6 million for the three months ended September 24,2010, primarily due to RealD eyewear. The increase in our cost of productrevenue is a result of the increase in the volume of RealD eyewear. Product andother gross margin increased to negative 15.8% for the three months ended September 24,2010 as compared to 22.8% for the three months ended September 25, 2009.Product and other gross margin improved as a result of our recycling effortsand an increase in the percentage of higher margin international product sales.Freight related expense increased by an aggregate of $1.2 million as a resultof the increased use of RealD eyewear and our international expansion.Expedited freight charges were insignificant in the three months ended September 24,2010.

 

Costs associated with ourrecycling program have been expensed in the period incurred, which furtherreduced gross profit. Recycling costs increased $0.7 million to $2.2 millionfor the three months ended September 24, 2010 from $1.5 million for thethree months September 25, 2009, and included the cost to transport RealDeyewear between theaters and the recycling production facility and costs toprocess the RealD eyewear for reuse.

 

Our cost of revenue as apercentage of net revenue will be affected in the future by the relative mix ofnet license and net product revenue, the mix of domestic and internationalproduct revenues and the impact of motion picture exhibitor options. As thenumber of RealD-enabled screens and the number of 3D motion pictures andattendance increase, our total cost of revenue may continue to increase.

 

***Operating expenses***
|                       | ** ** | **Three  months ended** | ** ** | ** **             | ** ** | ** ** | ** ** |
|----------------------------|------------|-------------------------|------------|------------------------|------------|------------|------------|
|                       | ** ** | **September 24,**  | ** ** | **September 25,** | ** ** | **Amount** | ** ** | **Percentage** | ** ** |
| **(in thousands)**         | ** ** | **2010**                | ** ** | **2009**               | ** ** | **change** | ** ** | **change** | ** ** |
| Research and development   |       | $                       | 3,425      |                   | $          | 2,605      |       | $ | 820 |   | 31.5% |   |
| Selling and marketing      |       | 5,333                   |       | 3,879                  |       | 1,454      |       | 37.5% |   |
| General and administrative |       | 8,369                   |       | 3,219                  |       | 5,150      |       | 160.0% |   |
| Total operating expenses   |       | $                       | 17,127     |                   | $          | 9,703      |       | $ | 7,424 |   | 76.5% |   |

 

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*Research and development.*  Our research and development expensesincreased primarily due to a $0.5 million increase in personnel costs, whichinclude an increase in the number of research and development personnel to 31at September 24, 2010 from 27 at September 25, 2009 to increase ourproduct development and engineering capabilities. We expect to increase ourresearch and development expenses to support our anticipated growth in consumerelectronics projects and initiatives, primarily for additional personnel,consultants and prototype and materials costs, as well as for continuedinvestment in our cinema business.

 

*Sellingand marketing.*  Our sellingand marketing expenses increased primarily due a $1.2 million increase inpersonnel costs.  The change in personnelcosts includes an increase in the number of selling and marketing personnel to16 at September 24, 2010 from 13 at September 25, 2009, a $0.4million increase in share based compensation expense and a $0.6 millionincrease in contractual and discretionary bonuses. Costs also increased fromthe incurrence of additional advertising and marketing initiatives.  Personnel costs, advertising and marketingspending are expected to continue to increase in order to drive revenue growth.We expect to incur additional selling and marketing expenses in fiscal year2011 as we increase our international marketing efforts, particularly in Asia,and build our consumer electronics business worldwide.

 

*Generaland administrative.*  Our generaland administrative expenses increased primarily due to a $0.9 million increasein sales and use taxes and a $1.5 million increase in personnel costs.  Sales and use taxes increased due to theincrease in domestic revenues. We absorb the majority of all sales and usetaxes in the United States and do not pass such costs on to our customers. Theincrease in personnel costs includes an increase in salaries and benefits of$0.4 million as we increased the number of general and administrative employeesto 20 at September 24, 2010 from 12 at September 25, 2009 to supportour overall growth, including the requirements of being a public company. Alsoincluded in personnel costs is an increase of $1.1 million related to sharebased compensation expense.  Legalexpenses and professional fees increased $1.3 million to support the growth inour operations.  Public company relatedexpenses of $0.5 million and $0.4 million for bad debt expense also contributedto the change in expenses.  We expect toincur additional general and administrative expenses for sales and use taxes asour revenue in the United States grows, as well as to comply with SEC reportingrequirements, stock exchange listing standards and provisions of theSarbanes-Oxley Act of 2002.

 

***Other***

*Interestexpense.*  Interestexpense for the three months ended September 24, 2010 and September 25,2009 was $0.3 million, primarily due to borrowings under our credit facilityagreement and notes payable.

 

*Incometax.*  Our income tax expense for thethree months ended September 24, 2010 was $0.8 million, primarily due toan increase in our foreign tax expense. We have net operating losses that maypotentially be offset against future earnings. We expect to incur an increasingamount of income tax expenses that relate primarily to federal and state incometax and international operations. We file federal income tax returns and incometax returns in various state and foreign jurisdictions. Due to the netoperating loss carryforwards, our United States federal and state returns areopen to examination by the Internal Revenue Service and state jurisdictions forall years since inception.

 

*Noncontrollinginterest.* Noncontrolling interest represents a 44.4% interest in our subsidiary,Digital Link II, LLC, or Digital Link II. Digital Link IIwas formed for purposes of funding the deployment of digital projector systemsand servers to our motion picture exhibitor licensees. The increase in the netloss attributable to noncontrolling interest was primarily due to thedepreciation and property taxes on additional digital projectors leased byDigital Link II.

 

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**Six months ended September 24,2010 compared to six months ended September 25, 2009**

** **

***Revenue***
|                             | ** ** | **Six  months ended**  | ** ** | ** **             | ** ** | ** ** | ** ** | ** **     |
|----------------------------------|------------|------------------------|------------|------------------------|------------|------------|------------|----------------|
|                             | ** ** | **September 24,** | ** ** | **September 25,** | ** ** | **Amount** | ** ** | **Percentage** | ** ** |
| **(in thousands)**               | ** ** | **2010**               | ** ** | **2009**               | ** ** | **change** | ** ** | **change**     | ** ** |
| **Revenue:**                     | ** ** | ** **             | ** ** | ** **             | ** ** | ** ** | ** ** | ** **     | ** ** | ** ** | ** ** | ** ** |
| Gross license                    |       | $                      | 61,600     |                   |       | $          | 27,896     |           |   | $ | 33,704 |   |   | 120.8% |   |
| Motion picture exhibitor options |       | (12,048                | )          |                   | (6,172     | )          |       | (5,876         | ) |   | 95.2% |   |
| Net license                      |       | 49,552                 |       |                   | 21,724     |       |       | 27,828         |   |   | 128.1% |   |
| Product and other                |       | 80,290                 |       |                   | 42,523     |       |       | 37,767         |   |   | 88.8% |   |
| Total net revenue                |       | $                      | 129,842    |                   |       | $          | 64,247     |           |   | $ | 65,595 |   |   | 102.1% |   |

 

The significant increase innet revenue recorded during the six months ended September 24, 2010compared to the six months ended September 25, 2009 was primarily due toan increase in the number of RealD-enabled screens, an increase in the numberof 3D motion pictures released and the resulting increase in the box office of3D motion pictures on RealD-enabled screens. Our international marketscomprised approximately 53% of gross revenue for the six months ended September 24,2010.

 

For the six months ended September 24,2010, there were 11 motion pictures which contributed greater than $1.0 millionof admission-based fees to net license revenue. Net license revenue for the sixmonths ended September 24, 2010 includes admission-based fees related tothe following motion pictures: *Toy Story 3*($12.1 million), *Shrek Forever After*($7.9 million)*, How to Train Your Dragon* ($5.7 million), *  Alice inWonderland* ($4.8 million), *Clash of theTitans* ($4.3 million), *Despicable Me*($3.7 million) and *The Last Airbender*($3.0 million). For the six months ended September 25, 2009, there werefive motion pictures which contributed greater than $1.0 million ofadmission-based fees to net license revenue. Net license revenue for the sixmonths ended September 25, 2009 includes admission-based fees related tothe following motion pictures: *Up* ($6.3million), *Monsters vs. Aliens*($4.9 million), *Ice Age**3*($5.9 million), *GForce* ($3.0 million) and *FinalDestination* ($2.3 million). Both domestically and internationally,our net license revenue increased during the period as a result of theincreased number of RealD-enabled screens and the number of 3D motion picturesincreasing the box office. The reduction to revenue resulting from motionpicture exhibitor stock options increased $5.9 million based upon the change inthe price of our common stock and the number of RealD-enabled screens of therelated exhibitor. The reduction to revenue resulting from motion pictureexhibitor stock options in the six months ended September 24, 2010reflects the price of our common stock of $16.35 per share and 2,792 deployedRealD Cinema Systems out of 4,500 RealD Cinema Systems set forth in theperformance vesting targets. As of September 24, 2010, unrecognized motionpicture exhibitor stock options reductions to revenue totaled $9.5 millionbased upon the price of our common stock of $16.35 per share and 100%achievement of screen installation targets. Reductions to revenue resultingfrom motion picture exhibitor stock options may increase as compared to aprevious period to the extent that the value of our common stock and number ofRealD-enabled screen installations increase.

 

Net license revenuescomprised 38% and 34% of total revenues for each of the six months ended September 24,2010 and September 25, 2009, respectively. International license revenuescomprised 45% of gross license revenues in the six months ended September 24,2010.

 

The increase in our netproduct and other revenue in the six months ended September 24, 2010, ascompared to the six months ended September 25, 2009, was primarily aresult of an increase in the number of consumers attending 3D motion picturesusing our RealD eyewear. International product revenues comprised 59% of totalproduct revenues in the six months ended September 24, 2010, due toincreased usage of RealD eyewear internationally at higher unit selling pricesthan domestic RealD eyewear.

 

We expect our futurerevenue, particularly in our license business, will be driven by the number ofRealD-enabled screens and motion pictures released in 3D. As the volume ofRealD eyewear usage increases as a result of an expanding 3D motion pictureslate and box office, we may experience additional price pressure from ourcustomers. As a result, our net revenues may increase at a slower rate infuture periods.

 

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***Cost of Revenue***
|                  | ** ** | **Six  months ended**  | ** ** | ** **             | ** ** | ** ** | ** ** |
|-----------------------|------------|------------------------|------------|------------------------|------------|------------|------------|
|                  | ** ** | **September 24,** | ** ** | **September 25,** | ** ** | **Amount** | ** ** | **Percentage** | ** ** |
| **(in thousands)**    | ** ** | **2010**               | ** ** | **2009**               | ** ** | **change** | ** ** | **change** | ** ** |
| **Revenue**           |       | $                      | 129,842    |                   | $          | 64,247     |       | $ | 65,595 |   | 102.1% |   |
| **Cost of Revenue:**  | ** ** | ** **             | ** ** | ** **             | ** ** | ** ** | ** ** | ** ** | ** ** |
| License               |       | 6,359                  |       | 4,512                  |       | 1,847      |       | 40.9% |   |
| Product and other     |       | 91,758                 |       | 48,546                 |       | 43,212     |       | 89.0% |   |
| Total cost of revenue |       | $                      | 98,117     |                   | $          | 53,058     |       | $ | 45,059 |   | 84.9% |   |
| Gross profit          |       | $                      | 31,725     |                   | $          | 11,189     |       | $ | 20,536 |   | 183.5% |   |
| Gross margin          |       | 24.4%                  |       | 17.4%                  |       |       |       |   |   |

 

For the six months ended September 24,2010, our cost of revenue increased primarily due to increased RealD eyewearsales. Cost of revenue decreased, as a percentage of revenue, to 75.6% for thesix months ended September 24, 2010, as compared to 82.6% for the sixmonths ended September 25, 2009. The increase in gross margin wasprimarily due to an increase in license revenues which partially offset theincreased use of RealD eyewear which generates lower gross margin. For the sixmonths ended September 24, 2010, the $5.9 million increase in reduction torevenue resulting from motion picture exhibitor stock options directlycontributed to a $5.9 million decrease in gross profit.

 

Excluding the impact ofmotion picture exhibitor stock options of $12.0 million, gross profit wouldhave been $43.8 million for the six months ended September 24, 2010, andgross margin would have been 30.8%. Excluding the impact of motion picturestock options of $6.2 million, gross profit would have been $17.4 million forthe six months ended September 25, 2009, and gross margin would have been24.6%.

 

License gross marginimproved to 87.2% for the six months ended September 24, 2010 from 79.2%for the six months ended September 25, 2009 due primarily to productionefficiencies.  Excluding the impact ofmotion picture exhibitor stock options of $12.0 million, gross profit forlicense revenue would have been $55.2 million for the six months ended September 24,2010, and gross margin would have been 89.7%. Excluding the impact of motion picture exhibitor stock options of $6.2million, gross profit for license revenue would have been $23.4 million for thesix months ended September 25, 2009, and gross margin would have been83.8%.

 

We had a negative productand other gross profit of $11.5 million for the six months ended September 24,2010, primarily due to RealD eyewear. The increase in our cost of productrevenue and negative gross profit is a result of the increase in the volume ofRealD eyewear. Product and other gross margin was negative 14.3% for the sixmonths ended September 24, 2010 as compared to negative 14.2% for the sixmonths ended September 25, 2009. Freight related expense increased by anaggregate of $5.7 million as a result of the increased use of RealD eyewear andinternational expansion.  Of thisincrease, $3.0 million is related to expedited shipping expenses we incurred inthe six months ended September 24, 2010 to satisfy a significant increasein demand. Excluding expedited shipping expenses, gross margin for the sixmonths ended September 24, 2010 would have improved further.

 

Costs associated with therecycling program have been expensed in the period incurred, which furtherreduced gross profit. Recycling costs increased $2.0 million to $4.3 millionfor the six months ended September 24, 2010 from $2.3 million for the sixmonths September 25, 2009, and included the cost to transport RealDeyewear between theaters and the recycling production facility and costs toprocess the RealD eyewear for reuse.

 

Our cost of revenue as apercentage of net revenue will be affected in the future by the relative mix ofnet license and net product revenue, the mix of domestic and internationalproduct revenues and the impact of motion picture exhibitor options. As thenumber of RealD-enabled screens and the number of 3D motion pictures andattendance increase, our total cost of revenue may continue to increase.

 

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***Operating expenses***
|                       | ** ** | **Six  months ended**  | ** ** | ** **             | ** ** | ** ** | ** ** |
|----------------------------|------------|------------------------|------------|------------------------|------------|------------|------------|
|                       | ** ** | **September 24,** | ** ** | **September 25,** | ** ** | **Amount** | ** ** | **Percentage** | ** ** |
| **(in thousands)**         | ** ** | **2010**               | ** ** | **2009**               | ** ** | **change** | ** ** | **change** | ** ** |
| Research and development   |       | $                      | 6,404      |                   | $          | 5,005      |       | $ | 1,399 |   | 28.0% |   |
| Selling and marketing      |       | 9,438                  |       | $                      | 7,781      |       | 1,657      |   | 21.3% |   |
| General and administrative |       | 14,599                 |       | 5,950                  |       | 8,649      |       | 145.4% |   |
| Total operating expenses   |       | $                      | 30,441     |                   | $          | 18,736     |       | $ | 11,705 |   | 62.5% |   |

 

*Researchand development.*  Our researchand development expenses increased primarily due to a $0.9 million increase inpersonnel costs, which include an increase in the number of research and developmentpersonnel to 31 at September 24, 2010 from 27 at September 25, 2009to increase our product development and engineering capabilities. We expect toincrease our research and development expenses to support our anticipatedgrowth in consumer electronics projects and initiatives, primarily foradditional personnel, consultants and prototype and materials costs, as well asfor continued investment in our cinema business.

 

*Sellingand marketing.*  Our sellingand marketing expenses increased primarily due to a $1.1 million increase inpersonnel costs.  The change in personnelcosts includes $0.4 million related to the increase in the number of sellingand marketing personnel to 16 at September 24, 2010 from 13 at September 25,2009, and a $0.5 million increase in share based compensation expense.  Costs also increased from the incurrence ofadditional advertising and marketing initiatives.  Personnel costs, advertising and marketingspending are expected to continue to increase in order to drive revenue growth.We expect to incur additional selling and marketing expenses in fiscal year2011 as we increase our international marketing efforts, particularly in Asia,and build our consumer electronics business worldwide.

 

*Generaland administrative.*  Our generaland administrative expenses increased primarily due to a $2.3 million increasein sales and use taxes and a $2.3 million increase in personnel costs.  Sales and use taxes increased due to theincrease in domestic revenues. We absorb the majority of all sales and usetaxes in the United States and do not pass such costs on to our customers. Theincrease in personnel costs includes an increase in salaries and benefits of$0.8 million as we increased the number of general and administrative employeesto 20 at September 24, 2010 from 12 at September 25, 2009 to supportour overall growth, including the requirements of being a public company. Alsoincluded in personnel costs is an increase of $1.1 million related to sharebased compensation expense and an increase of $0.3 million related todiscretionary and contractual bonuses. Legal expenses and professional feesincreased $2.0 million to support the growth in our operations.  Public company related expenses of $0.5 millionand $0.5 million for bad debt expense also contributed to the change inexpenses.  We expect to incur additionalgeneral and administrative expenses for sales and use taxes as our revenue inthe United States grows, as well as to comply with SEC reporting requirements,stock exchange listing standards and provisions of the Sarbanes-Oxley Act of2002.

 

***Other***

*Interest expense.*  Interest expense for each of the six monthsended September 24, 2010 and September 25, 2009 was $0.8 million and$0.6 million, respectively.  Interestexpense increased $0.2 million primarily due to increases in borrowings underour credit facility agreement. On July 21, 2010, we repaid $25.1 millionunder our previous revolving credit facility. As of September 24, 2010,there were no borrowings outstanding under the credit and security agreement.

 

*Otherincome (loss).*  Other income for the six months ended September 24,2010 increased primarily due to a $6.7 million gain from the sale of digitalprojectors.

 

*Incometax.*  Our income tax expense for thesix months ended September 24, 2010 was $1.7 million, primarily due to anincrease in our foreign tax expense. We have net operating losses that maypotentially be offset against future earnings. We expect to incur an increasingamount of income tax expenses that relate primarily to federal and state incometax and international operations. We file federal income tax returns and incometax returns in various state and foreign jurisdictions. Due to the netoperating loss carryforwards, our United States federal and state returns areopen to examination by the Internal Revenue Service and state jurisdictions forall years since inception.

 

*Noncontrollinginterest.* Noncontrolling interest represents a 44.4% interest in our subsidiary,Digital Link II, LLC, or Digital Link II. Digital Link IIwas formed for purposes of funding the deployment of digital projector systemsand servers to our motion picture exhibitor licensees. The increase in the netincome attributable to noncontrolling interest was primarily due to the gainfrom the sale of digital projectors for the six months ended September 24,2010.

 

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***Seasonality***

 

Although not apparent in ourresults of operations due to our rapid growth rate, our operations aregenerally subject to the number of 3D motion pictures released and the boxoffice of those 3D motion pictures. We expect to experience seasonalfluctuations in results of operations as a result of changes in the number of3D motion pictures released and the box office of those 3D motion pictures. Ourquarterly financial results have fluctuated in the past and may continue tofluctuate in the future based on a number of factors, many of which are beyondour control. Factors that may cause our operating results to vary or fluctuateinclude those discussed in Part II, Item 1.A below under the caption “Riskfactors.”

 

**Liquidity and capital resources**

 

Since our inception andthrough July 21, 2010, we have financed our operations through the sale ofredeemable convertible preferred stock, borrowings under our credit facilityagreement with City National Bank and through the issuance of notes payable tostockholders and vendors, and net cash provided by operating activities. Ourcash flow from operating activities has historically been significantlyimpacted by the contractual payment terms and patterns related to the licenseof our RealD Cinema Systems and use and sale of our RealD eyewear, as well assignificant investments in research, development, selling and marketingactivities and corporate infrastructure. Prior to fiscal 2010, many of ourlicensing and product sale contracts included terms that required upfrontpayments. Since a majority of our revenue recognized under our motion pictureexhibitor licenses results in admission and usage fees being paid to ussubsequent to such consumer attendance, we expect our deferred revenue balancesto continue to decline over the next several years.

 

Cash provided by operatingactivities is expected to be a primary recurring source of funds in futureperiods and will be driven by increased revenue generated from the growingnumber of 3D motion pictures exhibited on our RealD Cinema Systems and anincrease in the number of RealD-enabled screens, partially offset by increasedworking capital requirements associated with installing new RealD CinemaSystems as well as for building inventory, logistics and recycling costs forour RealD eyewear.

 

As of September 24,2010, our primary sources of liquidity were our cash and cash equivalents of$47.4 million, marketable securities of $6.8 million and our creditsecurity agreement with City National Bank providing for a revolving creditfacility of up to $15.0 million, $15.0 million of which was available forborrowing.

 

Our cash equivalentsprimarily consist of money market funds and other marketable securities thatmature within three months from the date of purchase. The carrying amount ofcash equivalents reasonably approximates fair value due to the short maturitiesof these instruments. The primary objective of our investment activities ispreservation of capital, fulfillment of liquidity needs and fiduciary controlof cash and investments. We also seek to maximize income from our investmentswithout assuming significant risk. We do not enter into investments for tradingor speculative purposes.

 

On July 21, 2010, wecompleted the initial public offering of our common stock in which we sold andissued 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 theinitial public offering, or $81.9 million in net proceeds after deductingunderwriting discounts and commissions of approximately $6.7 million and otheroffering costs of approximately $7.4 million.

 

On July 21, 2010, werepaid $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 exhibitorstock options.

 

We believe that our cash,cash equivalents, potential cash flows from operations, and our availabilityunder our credit security agreement with City National Bank will be sufficientto satisfy our currently anticipated cash requirements through at least thenext 12 months.

 

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

 
| ** **              | ** ** | **Six months ended** | ** ** |
|-------------------------|------------|--------------------------------|------------|
| **(in thousands)** | ** ** | **September 24,  2010**   | ** ** | **September 25,  2009** | ** ** |
| Operating activities    |       | $                              | 10,696     |   | $ | (6,646) |   |
| Investing activities    |       | (29,922)                       |       | (10,569) |   |
| Financing activities    |       | $                              | 53,494     |   | $ | 8,735 |   |

 

***Cash flow from operating activities***

Net cash inflows fromoperating activities during the six months ended September 24, 2010primarily resulted from improved operating performance as RealD Cinema Systeminstallations and admissions increased. Net cash inflows from operatingactivities also benefited from increases in deferred revenue from internationaleyewear sales, accounts payable and accrued expenses, partially offset by anincrease in glasses inventories and accounts receivable. Increases in accountspayable and accrued expenses were due to increased business activities atquarter end, resulting in significant amounts due to vendors and employees.Glasses inventories and accounts receivable grew in order to support anincrease in RealD Cinema System installations and admissions.

 

Net cash outflows fromoperating activities during the six months ended September 25, 2009primarily resulted from a net loss, an increase in accounts receivable andinventories partially offset by increases in deferred costs-eyewear, deferredrevenue and accounts payable and accrued expenses. Accounts receivableincreased as a result of an increase in revenue. Inventories grew in order tosupport an increase in RealD Cinema System installations and admissions.Increases in accounts payable and accrued expenses were due to increasedbusiness activities at quarter end, resulting in significant amounts due tovendors and employees.

 

***Cash flow from investing activities andcapital resources***

For both the six monthsended September 24, 2010 and September 25, 2009, cash outflow forinvesting activities was primarily related to the establishment of our initialinfrastructure and for the purchase of component parts for our RealD CinemaSystems, digital projectors, and other property, equipment and leaseholdimprovements. In the six months ended September 24, 2010, we purchasedavailable-for-sale securities of $6.8 million. In the six months ended September 24,2010, we received proceeds of $15.4 million as a result of the sale of digitalprojectors to certain of our motion picture exhibitors. Capital expenditureswere $38.4 million for the six months ended September 24, 2010 and $10.6million in for the six months ended September 25, 2009. We expect ourcapital expenditures of cinema systems and related components to beapproximately $70.0 million to $75.0 million for the fiscal year endingMarch 25, 2011. In the future, we will continue to invest in our businessto grow sales and develop new products and support the related increasingemployee headcount. We expect capital expenditures to represent a decreasingpercentage of net revenue in the future.

 

***Cash flow from financing activities***

Net cash inflows fromfinancing activities for the six months ended September 24, 2010 primarilyresulted from the proceeds from the completion of the initial public offeringof our common stock in which we sold and issued 6 million shares of commonstock at an issue price of $16.00 per share. A total of approximately $96million in gross proceeds were raised from the initial public offering, or$81.9 million in net proceeds after deducting underwriting discounts andcommissions of approximately $6.7 million and other offering costs ofapproximately $7.4 million. We used the net proceeds from the initial publicoffering to repay $25.1 million of amounts outstanding under the creditfacility agreement.  In the six monthsended September 24, 2010, repayments of long-term debt of $8.1 million anda noncontrolling interest distribution of $0.9 million offset proceeds from ourrevolving credit facility of $5.0 million.

 

Net cash inflows fromfinancing activities for the six months ended September 25, 2009 primarilyresulted from proceeds from our term loan of $10 million partially offset byrepayments of long-term debt of $1.3 million.

 

From time to time, we enterinto equipment purchase agreements with certain of our vendors for the purchaseof digital projectors, digital servers, lenses and accessories. We pay aportion of the cost of the equipment upon delivery and finance a portion of thepurchase price by issuing notes payable. Certain of these notes payable are non-interestbearing. In those cases, we record the net present value of the notes payableassuming an implied annual interest rate which is approximately 8%. Interestexpense is based on annual interest rates ranging from 7.0% to 8.4%. The notesare secured by the underlying equipment. Notes payable totaled$3.9 million at September 24, 2010 and $11.3 million atMarch 26, 2010.

 

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Priorto July 21, 2010, the date of our initial public offering, we had $25.1million of credit facilities pursuant to a credit facility agreement with CityNational Bank that provides for a maximum amount of borrowing under a revolvingcredit facility of $25 million and a term loan of $10 million. All amountsoutstanding under the credit facility agreement became due and were repaid uponthe closing of our initial public offering on July 21, 2010.

 

Wehave entered into a new credit and security agreement with City National Bank,dated as of June 24, 2010, which provides for a revolving credit facilityof up to $15.0 million and which will mature on June 30, 2012. Thisagreement and the revolving credit facility provided thereunder becameeffective on July 21, 2010. Our obligations under the new credit andsecurity agreement are secured by a first priority security interest insubstantially all of our tangible and intangible assets in favor of CityNational Bank and are guaranteed by our subsidiaries, ColorLink andStereographics.

 

Under the new credit andsecurity agreement, our business will be subject to certain limitations,including limitations on our ability to incur additional debt, make certaininvestments or acquisitions, enter into certain merger and consolidationtransactions, and sell our assets other than in the ordinary course ofbusiness. We will also be required to maintain compliance with certainfinancial covenants, including a minimum fixed charge coverage ratio and a maximumleverage ratio. As of September 24, 2010, we were in compliance with allfinancial covenants in our credit facility agreement. If we fail to comply withany of the covenants or if any other event of default, as defined in theagreement, should occur, the bank could elect to prevent us from borrowing anddeclare the indebtedness to be immediately due and payable.

 

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

 

For the six months ended September 24,2010, proceeds from employee stock option exercises was $0.4 million.  For the six months ended September 24,2010 proceeds from the exercise of warrants in our common stock was $0.3million. From time to time, we expect to receive cash from the exercise of employeestock options and warrants in our common stock. Proceeds from the exercise ofemployee stock options and warrants outstanding will vary from period to periodbased upon, among other factors, fluctuations in the market value of our commonstock 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 exhibitorstock options.

 

**Off-balance sheet arrangements**

 

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

 

**Non-U.S. GAAP discussion**

 

In addition to our U.S. GAAPresults, we present Adjusted EBITDA as a supplemental measure of ourperformance. However, Adjusted EBITDA is not a recognized measurement underU.S. GAAP. We define Adjusted EBITDA as net income (loss), plus interestexpense, net, income taxes, depreciation and amortization, share-basedcompensation expense and exhibitor option expense, as further adjusted toeliminate the impact of certain items that we do not consider indicative of ourcore operating performance. Management considers our core operating performanceto be that which can be affected by our managers in any particular periodthrough their management of the resources that affect our underlying revenueand profit generating operations that period. Non-U.S. GAAP adjustments to ourresults prepared in accordance with U.S. GAAP are itemized below. You areencouraged to evaluate these adjustments and the reasons we consider themappropriate for supplemental analysis. In evaluating Adjusted EBITDA, youshould be aware that in the future we may incur expenses that are the same asor similar to some of the adjustments in this presentation. Our presentation ofAdjusted EBITDA should not be construed as an inference that our future resultswill be unaffected by unusual or non-recurring items.

 

Set forth below is areconciliation of Adjusted EBITDA to net income (loss) for the three and sixmonths ended September 24, 2010 and September 25, 2009:

 

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| ** **                               | ** ** | **Three months ended** | ** ** | **Six months ended** | ** ** |
|------------------------------------------|------------|----------------------------------|------------|--------------------------------|------------|
| ** **                               | ** ** | **September 24,**           | ** ** | **September 25,**         | ** ** | **September 24,** | ** ** | **September 25,** | ** ** |
| **(in thousands)**                  | ** ** | **2010**                         | ** ** | **2009**                       | ** ** | **2010** | ** ** | **2009** | ** ** |
|                                     |       |                             |       |                           |       |   |   |   |   |
| Net income (loss)                        |       | $                                | (4,214)    |                           | $          | (2,545) |   | $ | 5,638 |   | $ | (9,534) |   |
| Add (deduct):                            |       |                             |       |                           |       |   |   |   |   |
| Interest expense                         |       | 283                              |       | 292                            |       | 802 |   | 574 |   |
| Income tax expense                       |       | 824                              |       | 426                            |       | 1,651 |   | 953 |   |
| Depreciation and amortization            |       | 3,376                            |       | 1,765                          |       | 6,044 |   | 3,377 |   |
| Other (income) loss (1)                  |       | (197)                            |       | 450                            |       | (6,807) |   | 460 |   |
| Share-based compensation expense (2)     |       | 2,352                            |       | 703                            |       | 3,008 |   | 1,467 |   |
| Exhibitor option expense (3)             |       | 11,556                           |       | 1,094                          |       | 12,048 |   | 6,172 |   |
| Impairment of assets and intangibles (4) |       | 164                              |       | 245                            |       | 295 |   | 293 |   |
| Sales and use tax (5)                    |       | 2,007                            |       | 1,133                          |       | 4,152 |   | 1,853 |   |
| Property tax (6)                         |       | 241                              |       | 208                            |       | 447 |   | 320 |   |
| Management fee (7)                       |       | 87                               |       | 88                             |       | 175 |   | 176 |   |
| Adjusted EBITDA                          |       | $                                | 16,479     |                           | $          | 3,859 |   | $ | 27,453 |   | $ | 6,111 |   |

 

(1)          Includesamortization of debt issue costs, unrealized foreign currency exchange gainsand losses and gain of $6.7 million from the sale of digital projectors in thethree month period ended June 25, 2010.

(2)          Representsshare-based compensation expense of nonstatutory and incentive stock options toemployees, officers, directors and consultants.

(3)          Representsstock options granted to some of our motion picture exhibitor licensees. Theamounts are recorded as contra revenue in the condensed consolidated financialstatements.

(4)          Representsimpairment of long-lived assets, such as fixed assets, theatrical equipment andidentifiable intangibles.

(5)          Representstaxes incurred by us for cinema license and product revenue.

(6)          Representsproperty taxes on RealD Cinema Systems and digital projectors.

(7)          Representspayment of management fees to our Series C mandatorily redeemableconvertible preferred stockholder (included in general and administrativeexpense, which was terminated upon the completion of our initial publicoffering).

 

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We present Adjusted EBITDA because we believe itassists investors and analysts in comparing our performance across reportingperiods on a consistent basis by excluding items that we do not believe areindicative of our core operating performance. In addition, we use AdjustedEBITDA in developing our internal budgets, forecasts and strategic plan; inanalyzing the effectiveness of our business strategies; to evaluate potentialacquisitions; in making compensation decisions; in communications with ourboard of directors concerning our financial performance and because our creditfacility agreement uses Adjusted EBITDA to measure our compliance with certaincovenants. Adjusted EBITDA has limitations as an analytical tool. Some of theselimitations are:

 

·                  AdjustedEBITDA does not reflect our cash expenditures, or future requirements, forcapital expenditures or contractual commitments;

·                  AdjustedEBITDA does not reflect changes in, or cash requirements for, our workingcapital needs;

·                  AdjustedEBITDA does not reflect the significant interest expense, or the cashrequirements necessary to service interest or principal payments, on our debts;

·                  althoughdepreciation and amortization are non-cash charges, the assets beingdepreciated and amortized will often have to be replaced in the future, andAdjusted EBITDA does not reflect any cash requirements for such replacements;

·                  non-cashcompensation is and will remain a key element of our overall long-termincentive compensation package, although we exclude it as an expense whenevaluating our ongoing operating performance for a particular period;

·                  AdjustedEBITDA does not reflect the impact of certain cash charges resulting frommatters we consider not to be indicative of our ongoing operations; and

·                  othercompanies in our industry may calculate Adjusted EBITDA differently than we do,limiting its usefulness as a comparative measure.

 

Because of these limitations, Adjusted EBITDA shouldnot be considered in isolation or as a substitute for performance measures calculatedin accordance with U.S. GAAP. We compensate for these limitations by relyingprimarily on our U.S. GAAP results and using Adjusted EBITDA only as asupplement. Our condensed consolidated financial statements and the notes tothose statements included elsewhere are prepared in accordance with U.S. GAAP.

 

**Critical accounting policies and estimates**

 

This discussion is basedupon our condensed consolidated financial statements, which have been preparedin accordance with U.S. GAAP. The preparation of our financial statementsrequires us to make estimates and judgments that affect the reported amounts ofassets, liabilities, revenues, and expenses, and related disclosure ofcontingent assets and liabilities. On an on-going basis, estimates and judgmentsare evaluated, including those related to revenue recognition, revenuedeductions, product returns, fair value of our common stock, share-basedcompensation, inventories, definite lived asset impairments, goodwillimpairment and income taxes. These estimates and judgments are based onhistorical experience and on various other assumptions that we believe to bereasonable under the circumstances, which form the basis for our judgmentsabout the carrying values of assets and liabilities not readily apparent fromother sources. By their nature, estimates are subject to an inherent degree ofuncertainty. Actual results may differ from these estimates.

 

We believe the followingcritical accounting policies, among others, affect our more significantjudgments and estimates used in the preparation of our condensed consolidatedfinancial statements.

 

***Revenue recognition and revenue reductions***

We derive substantially allof our revenue from the license of our RealD Cinema Systems and the productsale of our RealD eyewear. We evaluate revenue recognition for transactionsusing the criteria set forth by the SEC in Staff Accounting BulletinNo. 104, *Revenue Recognition*(SAB 104) and Accounting Standards Codification Topic 605, *Revenue Recognition* ASC 605. The revenue recognitionguidance states that revenue is recognized when all of the following criteriaare met: persuasive evidence of an arrangement exists, delivery has occurred orservices have been rendered, the seller’s price to the buyer is fixed ordeterminable and collectability is reasonably assured.

 

*Licenserevenue.*  Licenserevenue is accounted for as an operating lease. License revenue is primarilyderived under per-admission, periodic fixed fee, or per-motion picture basiswith motion picture exhibitors. Amounts received up front, less estimatedallowances, are deferred and recognized over the lease term using thestraight-line method. Additional lease payments that are contingent upon futureevents outside our control, including those related to admission and usage, arerecognized as revenues when the contingency is resolved and we have no moreobligations to our customers specific to the contingent payment received.Certain of our license revenue from leasing our RealD Cinema Systems is earnedupon admission by the motion picture exhibitor’s consumers. Our licensees,however, do not report and pay for such license 

 

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revenue until after theadmission has occurred, which may be received subsequent to our fiscal periodend. We estimate and record licensing revenue related to motion pictureexhibitor consumer admissions in the quarter in which the admission occurs, butonly when reasonable estimates of such amounts can be made. We determine thatthere is persuasive evidence of an arrangement upon the execution of a licenseagreement or upon the receipt of a licensee’s admissions report. Revenue isdeemed fixed or determinable upon verification of a licensee’s admissionsreport in accordance with the terms of the underlying executed agreement or, incertain circumstances, receipt of a licensee’s admissions report. We determinecollectability based on an evaluation of the licensee’s recent payment history.

 

*Productrevenue.*  We recognizeproduct revenue, net of allowances, when title and risk of loss have passed andwhen there is persuasive evidence of an arrangement, the payment is fixed ordeterminable, and collectability of payment is reasonably assured. In theUnited States and Canada, certain of our product revenue from the sale of ourRealD eyewear is earned upon admission and usage by the motion pictureexhibitor’s consumers. Our customers, however, do not report admission or usageinformation until after the admission and usage has occurred, and suchinformation may be received subsequent to our fiscal period end. We estimateand record such product revenue in the quarter in which the admission and usageoccurs, but only when reasonable estimates of such amounts can be made.

 

*Revenuereductions.*  We recordrevenue net of motion picture exhibitor stock options and estimated revenueallowances. In connection with certain exhibitor licensing agreements, weissued the motion picture exhibitors a 10-year option to purchase shares of ourcommon stock at approximately $0.00667 per share. The stock options vest uponthe achievement of screen installation targets. Motion picture exhibitor stockoptions are valued at the underlying stock price at each reporting period untilthe targets are met. Amounts recognized are based on the number ofRealD-enabled screens as a percentage of total screen installation targets. Thestock options do not have net cash settlement features. Amounts recorded as arevenue reduction totaled $11.6 million and $1.1 million for the three monthsended September 24, 2010 and September 25, 2009, respectively.Amounts recorded as a revenue reduction totaled $12.0 million and $6.2 millionfor each of the six months ended September 24, 2010 and September 25,2009, respectively. The reduction to revenue resulting from motion pictureexhibitor stock options for the three and six months ended September 24,2010 reflects the price of our common stock of $16.35 per share and 2,792deployed RealD Cinema Systems out of 4,500 RealD Cinema Systems set forth inthe performance vesting targets. Once AMC, Regal and Cinemark achieve the 4,500screen vesting performance target and the options are fully vested, the motionpicture exhibitor stock option expense will end.

 

***Share-based compensation***

 

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

 

*Stock options*

Stock options grantedgenerally vest over a four-year period, with 25% of the shares vesting afterone year and monthly vesting thereafter. The options generally expire ten years from the date of grant. In July 2010,we granted 2,455,500 stock options at a weighted average grant date fair valueof $8.75 per share. For the six months ended September 24, 2010, share-basedcompensation expense related to stock options was $2.5 million.

 

*Performance stock options*

Certain of ourmanagement-level employees receive performance stock options, which gives therecipient the right to receive common stock that is contingent upon achievementof specified pre-established performance goals over the performance period,which is generally three years. The performance goals for the performance stockoptions are based on the measurement of our total shareholder return, on a percentilebasis, compared to a comparator group of companies. Depending on the outcome ofthe performance goals, the recipient may ultimately earn performance stockoptions equal to or less than the number of performance stock options granted.In July 2010, we granted 641,250 performance stock options at a weightedaverage grant date fair value of $9.45 per share. For the six months ended September 24,2010, share-based compensation expense related to performance stock options was$0.4 million.

 

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*Restricted stock units*

In August 2010, wegranted our board of directors 54,372 restricted stock units at a weightedaverage grant date fair value of $19.84 per share. The restricted stock unitsvest on a monthly basis over one to two years. For the six months ended September 24,2010, share-based compensation expense related to restricted stock units was$0.1 million.

 

Share-based compensationexpense for the three and six months ended September 24, 2010 and September 25,2009 was as follows:

 
| ** **                 | ** ** | **Three months ended** | ** ** | **Six months ended** | ** ** |
|----------------------------|------------|----------------------------------|------------|--------------------------------|------------|
| ** **                 | ** ** | **September 24,**           | ** ** | **September 25,**         | ** ** | **September 24,** | ** ** | **September 25,** | ** ** |
| **(in thousands)**    | ** ** | **2010**                         | ** ** | **2009**                       | ** ** | **2010** | ** ** | **2009** | ** ** |
| Cost of revenue            |       | $                                | 30         |                           | $          | 20 |   | $ | 43 |   | $ | 40 |   |
| Research and development   |       | 381                              |       | 216                            |       | 582 |   | 543 |   |
| Selling and marketing      |       | 774                              |       | 408                            |       | 1,156 |   | 757 |   |
| General and administrative |       | 1,167                            |       | 59                             |       | 1,227 |   | 127 |   |
| Total                      |       | $                                | 2,352      |                           | $          | 703 |   | $ | 3,008 |   | $ | 1,467 |   |

 

***Inventories***

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

 

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

 

·                  For anestimated period of time following shipment to domestic motion pictureexhibitors, no expense is recognized between the time of shipment and until thedelivery is made as the inventory unit is in transit and unused.

·                  The inventoryunit cost is expensed on a straight-line basis over an estimated usage periodbeginning when we believe usage of the inventory unit has started. Inestimating the expensing start date and related expense period, we considervarious factors including, but not limited to, those relating to a 3D motionpicture’s opening release date, a 3D motion picture’s expected release period,the number of currently playing 3D motion pictures, the motion pictureexhibitor’s buying and stocking patterns and practices and the quantities shippedper inventory unit.

 

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

 

***Impairment of long-livedassets***

We review long-lived assets,such as property and equipment, cinema systems, digital projectors andintangibles, for impairment whenever events or changes in circumstancesindicate that the carrying amount of an asset may not be recoverable. Factorsor circumstances that could indicate the occurrence of such events includecurrent period operating or cash flow losses combined with a history ofoperating or cash flow losses, a projection or forecast that demonstratescontinuing operating or cash flow losses, or incurring costs in excess ofamounts originally expected to acquire or construct an asset. If the asset isnot recoverable, an impairment loss is recognized as the amount by which thecarrying amount of the 

 

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asset exceeds its fairvalue.

 

For the three months ended September 24,2010 and September 25, 2009, impairment charges for impaired RealD CinemaSystems charged to cost of revenue totaled $0.2 million. For each of the sixmonths ended September 24, 2010 and September 25, 2009, impairmentcharges for impaired RealD Cinema Systems charged to cost of revenue totaled$0.3 million.

 

***Deferred tax asset valuation and taxexposures***

As of September 24,2010, we have determined based on the weight of the available evidence, bothpositive and negative, to provide for a valuation allowance againstsubstantially all of the net deferred tax assets. The current deferred taxassets not reserved for by the valuation allowance are those in foreignjurisdictions or amounts that may be carried back in future years. If there isa change in circumstances that causes a change in judgment about the realizabilityof the deferred tax assets, we will adjust all or a portion of the applicablevaluation allowance in the period when such change occurs.

 

We are subject to ongoingtax exposures, examinations and assessments in various jurisdictions.Accordingly, we may incur additional tax expense based upon the outcomes ofsuch matters. In addition, when applicable, we adjust tax expense to reflectour ongoing assessments of such matters which require judgment and canmaterially increase or decrease its effective rate as well as impact operatingresults.

 

Significant judgment isrequired in determining the provision for income taxes, deferred tax assets andliabilities, the valuation allowance against our deferred tax assets anduncertainty in income tax positions. Our financial position and results ofoperations may be materially impacted if actual results significantly differfrom these estimates or the estimates are adjusted in future periods.

 

***Contingencies and assessments***

We are subject to variousloss contingencies and assessments arising in the course of our business, someof which relate to litigation, claims, property taxes and sales and use orgoods and services tax assessments. We consider the likelihood of the loss orthe incurrence of a liability, as well as our ability to reasonably estimatethe amount of loss in determining loss, contingencies and assessments. Anestimated loss contingency or assessment is accrued when it is probable that aliability has been incurred and the amount of loss can be reasonably estimated.We regularly evaluate current information available to us to determine whethersuch accruals should be adjusted. Based on the information presently available,including discussion with counsel and other consultants, management believes thatresolution of these matters will not have a material adverse effect on ourbusiness, consolidated results of operations, financial condition or cashflows.

 

***Recentaccounting pronouncements***

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

 

Accounting Standards Update No. 2009-13,*Revenue Recognition (Topic605)—Multiple-Deliverable Revenue Arrangements—a consensus of the EmergingIssues Task Force*(ASU**2009-13)amends Accounting Standards Codification Subtopic 605-25, *Revenue Recognition— Multiple-Element Arrangements*(ASC605-25). The amendments in ASU 2009-13 enable vendors**to account for products or services separately rather thanas a combined unit upon meeting**certaincriteria and establish a hierarchy for determining the selling price of adeliverable. In**addition, avendor can determine a best estimate of selling price, in a manner that isconsistent**with that used todetermine the price to sell the deliverable on a standalone basis, if a vendor**does not have vendor-specific objectiveevidence or third-party evidence of selling price. ASC**605-25 is also amended to eliminate theuse of the residual method and requires a vendor to**allocate revenue using the relative selling price method.The amendments in ASU 2009-13 will**beeffective prospectively, with an option for retrospective restatement of thefinancial**statements, for revenuearrangements entered into or materially modified in fiscal years**beginning on or after June 15, 2010with early adoption permitted at the beginning of an**entity’s fiscal year. We expect to prospectively adopt theamendments in ASU 2009-13**beginningin the first quarter of fiscal 2012. We are currently evaluating the impact the**adoption of new guidance will have onconsolidated financial statements.

 

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**ITEM 3. QUANTITATIVE ANDQUALITATIVE DISCLOSURES ABOUT MARKET RISK**

 

We have operations outsidethe United States. We are exposed to market risks in the ordinary course of ourbusiness. These risks primarily include interest rate, foreign exchange andinflation risks as well as changes in the general economic conditions in thecountries where we conduct business. To reduce certain of these risks, wemonitor the financial condition of our large customers and limit creditexposure by collecting in advance and setting credit limits, as we deemappropriate. In addition, our investment strategy currently has been to investin financial instruments that are highly liquid, readily convertible into cashand which mature within three months from the date of purchase. We also enterinto foreign exchange derivative hedging transactions as part of our riskmanagement program. For accounting purposes, we do not designate any of ourderivative instruments as hedges and we do not use derivatives for speculatingtrading purposes and are not a party to leveraged derivatives.

 

***Interest rate risk***

We are exposed to marketrisk related to changes in interest rates.

 

Our investments areconsidered cash equivalents and primarily consist of money market funds andother marketable securities that mature within three months from the date ofpurchase. At September 24, 2010, we had cash, cash equivalents and marketablesecurities of $54.3 million. The carrying amount of cash equivalents reasonablyapproximates fair value due to the short maturities of these instruments. Theprimary 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 assumingsignificant risk. We do not enter into investments for trading or speculativepurposes. Our investments are exposed to market risk due to a fluctuation ininterest rates, which may affect our interest income and the fair market valueof our investments. Due to the short-term nature of our investment portfolio,however, we do not believe an immediate 10% increase or decrease in interestrates would have a material effect on the fair market value of our portfolio,and therefore we do not expect our operating results or cash flows to be materiallyaffected by a sudden change in market interest rates.

 

We do not believe our cashequivalents have significant risk of default or illiquidity. While we believeour cash equivalents do not contain excessive risk, we cannot provide absoluteassurance that in the future our investments will not be subject to adversechanges in market value. In addition, we maintain significant amounts of cashand cash equivalents at one or more financial institutions that are in excessof federally insured limits. We cannot be assured that we will not experiencelosses on these deposits.

 

At September 24, 2010,we had no borrowings outstanding under the credit and security agreement. Therevolving credit facility provides for, at our option, Revolving LondonInterbank Offered Rate (LIBOR) loans, which bear interest at the greater ofthree and one half percent (3.50%) or the LIBOR plus two and one-half percent(2.50%) or Revolving Prime loans which bear interest at the greater of threeand one half percent (3.50%) or the fluctuating Prime Rate per annum. Changesin interest rates do not affect operating results or cash flows on our fixedrate borrowings but would impact our variable rate borrowings.

 

***Foreign currency risk***

We have foreign currencyrisks related to our revenue and operating expenses denominated in currenciesother than the United States dollar. Our historical revenue has generally beendenominated in United States dollars, and a significant portion of our currentrevenue continues to be denominated in United States dollars; however, weexpect an increasing portion of our future revenue to be denominated incurrencies other than the United States dollar, primarily the Euro, Britishpound sterling, Canadian dollar and Japanese yen. Our operating expenses are generallydenominated in the currencies of the countries in which our operations arelocated, primarily the United States and United Kingdom. Increases anddecreases in our international revenue from movements in foreign exchange ratesare partially offset by the corresponding increases or decreases in ourinternational operating expenses. To further reduce our net exposure to foreignexchange rate fluctuations on our results of operations, we have entered intoforeign currency forward contracts.

 

As of September 24,2010, we had outstanding forward contracts based in British pound sterling,Canadian dollar and the Euro with notional amounts totaling $2.4 million. We donot designate any of our forward contracts as hedges for accounting purposes.For the three and six months ended September 24, 2010, the net loss  related to the change in fair value of ourforeign currency forward contracts was $0.1 million. For the three and sixmonths ended September 25, 2009, the net gain (loss) related to the changein fair value of our foreign currency forward contracts was not significant.With regard to these contracts, a hypothetical 10.0% adverse movement inforeign exchange rates compared with the U.S. dollar relative to exchange rateson September 24, 2010 would result in a reduction in fair value of theseforward contracts and a 

 

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corresponding foreigncurrency loss of approximately $0.2 million. This analysis does not considerthe impact that hypothetical changes in foreign currency exchange rates wouldhave on anticipated transactions and assets and liabilities that these foreigncurrency sensitive instruments were designed to offset.

 

As our internationaloperations grow, our risks associated with fluctuation in currency rates willbecome greater, and we will continue to reassess our approach to managing thisrisk. In addition, currency fluctuations or a weakening United States dollarcan increase the costs of our international expansion.

 

 

**ITEM 4.  CONTROLS ANDPROCEDURES**

 

**Evaluation of Disclosure Controls and Procedures**

 

Wemaintain “disclosure controls and procedures,” as such term is defined in Rules 13a-15(e) and15d-15(e) under the Securities Exchange Act of 1934 (the “Exchange Act”),that are designed to ensure that information required to be disclosed by us inreports that we file or submit under the Exchange Act is recorded, processed,summarized, and reported within the time periods specified in Securities andExchange Commission rules and forms, and that such information isaccumulated and communicated to our management, including our Chief ExecutiveOfficer and Chief Financial Officer, as appropriate, to allow for timelydecisions regarding required disclosure. In designing and evaluating ourdisclosure controls and procedures, management recognized that disclosurecontrols and procedures, no matter how well conceived and operated, can provideonly reasonable, not absolute, assurance that the objectives of the disclosurecontrols and procedures are met. Additionally, in designing disclosure controlsand procedures, our management necessarily was required to apply its judgmentin evaluating the cost-benefit relationship of possible disclosure controls andprocedures. The design of any disclosure controls and procedures also is basedin part upon certain assumptions about the likelihood of future events, andthere can be no assurance that any design will succeed in achieving its statedgoals under all potential future conditions.

 

Subjectto the limitations noted above, our management, with the participation of ourChief Executive Officer and Chief Financial Officer, has evaluated the effectivenessof the design and operation of our disclosure controls and procedures as of theend of the fiscal period covered by this Quarterly Report on Form 10-Q.Based on that evaluation, the Chief Executive Officer and Chief FinancialOfficer have concluded that, as of such date, our disclosure controls andprocedures were effective to meet the objective for which they were designedand operate at the reasonable assurance level.

 

**Changes in Internal Control over Financial Reporting**

Therewere no changes in our internal control over financial reporting during thefiscal quarter ended September 24, 2010, that have materially affected, orare reasonably likely to materially affect, our internal control over financialreporting.

 

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**PART II.**

**OTHER INFORMATION**

 

**ITEM 1. LEGAL PROCEEDINGS**

 

We are involved in variouslegal proceedings from time to time arising from the normal course of businessactivities, including claims of alleged infringement of intellectual propertyrights, commercial, employment and other matters. In our opinion, resolution ofthese proceedings is not expected to have a material adverse effect on ouroperating results or financial condition. However, it is possible that anunfavorable resolution of one or more such proceedings could materially affectour future operating results or financial condition in a particular period.

 

**ITEM 1A. RISKFACTORS**

 

*The following risk factors andother information included in this Quarterly Report on Form 10-Q should becarefully considered. The risks and uncertainties described below are not theonly ones we face. Additional risks and uncertainties not presently known to usor that we presently deem less significant may also impair our businessoperations. If any of the following risks actually occur, our business,operating results and financial condition could be materially adverselyaffected.*

 

**Risks relating to our business**

 

***If motion pictures that can be viewed withRealD Cinema Systems are not made or are not commercially successful, ourrevenue could decline.***

 

Almost all of our revenue iscurrently dependent upon both the number of 3D motion pictures released and thecommercial success of those 3D motion pictures. We have not developed any ofour own 3D content and rely on motion picture studios producing and releasing3D motion pictures compatible with our RealD Cinema Systems. There is noguarantee an increasing number of 3D motion pictures will be released or thatmotion picture studios will continue to produce 3D motion pictures at all.Motion picture studios may refrain from producing and releasing 3D motionpictures for any number of reasons, including their lack of commercial success.The commercial success of a 3D motion picture depends on a number of factorsthat are outside of our control, including whether it achieves criticalacclaim, timing of the release, marketing efforts and promotional support forthe release. In the past, consumer interest in 3D motion pictures was episodicand motion picture studios tended to use 3D motion pictures as a gimmick ratherthan as an artistic tool to enhance the experience. If consumers’ recentrenewed interest in the 3D viewing experience fails to grow or it declines forany reason, box office performance may suffer and motion picture studios mayreduce the number of 3D motion pictures they produce. Poor box officeperformance of 3D motion pictures, disruption or reduction in 3D motion pictureproduction or conversion of two-dimensional motion pictures into 3D motionpictures, changes in release schedules, a reduction in marketing efforts for 3Dmotion pictures by motion picture studios or a lack of consumer demand for 3Dmotion pictures could result in lower 3D motion picture attendance, which couldsubstantially reduce our revenue.  Forexample, the announcement by Warner Brothers that the conversion of *Harry Potter and the Deathly Hallows* from 2D into 3D couldnot be completed on time for a 2010 release in 3D may negatively impact 3Dmotion picture attendance and box office in the calendar fourth quarter of2010.

 

***If motion picture exhibitors do notcontinue to use our RealD Cinema Systems or experience financial difficulties,our growth and results of operations could be adversely affected.***

 

Our primary licensees in themotion picture industry are motion picture exhibitors. Our license agreementswith motion picture exhibitors do not obligate these licensees to deploy aspecific number of our RealD Cinema Systems. We cannot predict whether any ofour existing motion picture exhibitor licensees will continue to perform undertheir license agreements with us, whether they will renew their licenseagreements with us at the end of their term or whether we may now or in thefuture be in breach of those agreements. If motion picture exhibitors reduce oreliminate the number of 3D motion pictures that are exhibited in theaters, thenmotion picture studios may not produce and release 3D motion pictures and ourrevenue could be adversely affected.

 

In addition, net licenserevenue from AMC, Cinemark and Regal together comprised approximately 13% ofour net consolidated revenue in the year ended March 31, 2008, 16% in theyear ended March 27, 2009 and 18% in the year ended March 26, 2010.Any inability or failure by AMC, Cinemark or Regal to pay us amounts due in atimely fashion or at all could substantially reduce our cash flow and couldmaterially and adversely impact our financial condition and results of 

 

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operations.

 

***A deterioration in our relationships withthe major motion picture studios could adversely affect our business.***

 

The six major motion picturestudios accounted for approximately 83% of domestic box office revenue and 9 ofthe top 10 grossing 3D motion pictures in 2009. License fees generated frommotion pictures released by these studios represented nearly 100% of our motionpicture exhibitor license revenue. Total revenue generated for motion picturesreleased by these motion picture studios represented nearly 100% of our totalrevenue in the year ended March 26, 2010. In addition, for our domestic operations and in certain internationalmarkets, these major motion picture studios pay us a per use fee for our RealDeyewear. To the extent that our relationship with any of these major motionpicture studios deteriorates or any of these studios stop making motionpictures that can be viewed at RealD-enabled theater screens, refuse toco-brand with us or stop using our RealD eyewear, our costs could increase andour revenue could decline, which could adversely affect our business andresults of operations.

 

***If motion picture exhibitors do notcontinue converting analog theaters to digital or the pace of conversionsslows, our future prospects could be limited and our business could beadversely affected.***

 

Our RealD Cinema Systemsonly work in theaters equipped with digital cinema projection systems, whichenable 3D motion pictures to be delivered, stored and projected electronically,and our systems are not compatible with analog motion picture projectors.Motion picture exhibitors have been converting projectors to digital cinemaover the last several years, giving us the opportunity to deploy our RealDCinema Systems. After motion picture exhibitors convert their projectors todigital cinema, they must install a silver screen and our RealD Cinema System.The conversion by motion picture exhibitors of their projectors and screensfrom analog to digital cinema requires significant expense. In 2009, motionpicture exhibitors installed approximately 7,500 digital cinema projectors, anapproximately 86% growth rate from 2008, and in 2008, motion picture exhibitorsinstalled approximately 2,300 digital cinema projectors, an approximately 36%growth rate from 2007. Although DCIP recently completed its financing that isproviding funding for the digital conversion of approximately 14,000 additionaldomestic theater screens operated by our licensees AMC, Cinemark and Regal, wecannot predict the pace or success of this conversion, or that we will haveadequate supply of the components comprising our RealD Cinema Systems in anygiven period to satisfy motion picture exhibitor demand. As ofDecember 31, 2009, approximately 18% of domestic theater screens hadconverted to digital and a much smaller percentage of international theaterscreens had been converted. If the market for digital cinema develops moreslowly than expected, the motion picture exhibitors we have agreements with,including AMC, Cinemark and Regal, delay or abandon the conversion of theirtheaters, our ability to grow our revenue and our business could be adverselyaffected.

 

***If the deployment of our RealD CinemaSystems is delayed or not realized, our future prospects could be limited andour business could be adversely affected.***

 

We have license agreementswith motion picture exhibitors that give us the right, subject to certainexceptions, to deploy our RealD Cinema Systems if a location under contract isalready equipped with our systems and they choose to install additional 3Ddigital projector systems. As of September 24, 2010, we were working withour motion picture exhibitor licensees to deploy our RealD Cinema Systems on upto approximately 4,000 additional screens under our existing agreements withthem.  However, our license agreements donot obligate our licensees to deploy a specific number of our RealD CinemaSystems. Numerous factors beyond our control could influence when and whetherour RealD Cinema Systems will be deployed, including motion picture exhibitors’ability to fund capital expenditures, their decision to delay or abandon theconversion of their theaters to digital projection or reduce the number of 3Dmotions pictures exhibited in their theaters, and our ability to secureadequate supplies of components comprising our RealD Cinema System in any givenperiod. If motion picture exhibitors delay, postpone or decide not to deployRealD Cinema Systems at the number of screens they have announced, or we areunable to deploy our RealD Cinema Systems in a timely manner, our futureprospects could be limited and our business could be adversely affected.

 

***We have a history of net losses and maycontinue to suffer losses in the future.***

 

We have incurred net lossesin each of our last five fiscal years, and incurred a net loss of approximately$39.7 million for the year ended March 26, 2010. If we cannot becomeprofitable, our financial condition will deteriorate, and we may be unable toachieve our business objectives.

 

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***Any inability to protect our intellectualproperty rights could reduce the value of our 3D technologies and brand, whichcould adversely affect our financial condition, results of operations andbusiness.***

 

Our business is dependentupon our patents, trademarks, trade secrets, copyrights and other intellectualproperty rights. Effective intellectual property rights protection, however,may not be available under the laws of every country in which we and ourlicensees operate, such as China. The efforts we have taken to protect ourproprietary rights may not be sufficient or effective. Any significantimpairment of our intellectual property rights could harm our business or ourability to compete. In addition, protecting our intellectual property rights iscostly and time consuming. It may not be practicable or cost effective for usto fully protect our intellectual property rights in some countries orjurisdictions. If we are unable to successfully identify and stop unauthorizeduse of our intellectual property, we could lose potential revenue andexperience increased operational and enforcement costs, which could adverselyaffect our financial condition, results of operations and business.

 

It is possible that some ofour 3D technologies may not be protectable by patents. In addition, given thecosts of obtaining patent protection, we may choose not to protect particularinnovations that later turn out to be important. Even where we do have patentprotection, the scope of such protection may be insufficient to prevent thirdparties from designing around our particular patent claims or otherwiseavoiding infringement. Furthermore, there is always the possibility that anissued patent may later be found to be invalid or unenforceable, or acompetitor may attempt to engineer around our issued patent. Additionally,patents only offer a limited term of protection. Moreover, the intellectualproperty we maintain as trade secrets could be compromised by third parties, orintentionally or accidentally by our employees, which would cause us to losethe competitive advantage resulting from them.

 

***Our RealD Cinema Systems and othertechnologies are generally designed for use with third-party technologies andhardware, and if we are unable to maintain the ability of our RealD CinemaSystems and other technologies to work with these third-party technologies andhardware, our business and operating results could be adversely affected.***

 

Our RealD Cinema Systems andother technologies are generally designed for use with third-party technologiesand hardware, such as Christie projectors, Doremi servers, Harkness Hallscreens and Sony Electronics 4K SXRD® digitalcinema projectors. Third-party technologies and hardware may be modified,re-engineered or removed altogether from the marketplace. In addition,third-party technologies used to interact with our RealD Cinema Systems, RealDFormat and other 3D technologies can change without prior notice to us, whichcould result in increased costs or our inability to provide our 3D technologiesto our licensees. If we are unable to maintain the ability of our RealD CinemaSystems, RealD Format and other 3D technologies to work with these third-partytechnologies and hardware, our business and operating results could beadversely affected.

 

***We may in the future be subject tointellectual property rights claims that are costly to defend, could require usto pay damages and could limit our ability to use particular 3D technologies inthe future.***

 

We may be exposed to, orthreatened with, future litigation by other parties alleging that our 3Dtechnologies infringe their intellectual property rights. Any intellectualproperty claims, regardless of their merit, could be time consuming, expensiveto litigate or settle and could divert management resources and attention. Anadverse determination in any intellectual property claim could require us topay damages and/or stop using our 3D technologies, trademarks, copyrightedworks and other material found to be in violation of another party’s rights andcould prevent us from licensing our 3D technologies to others. In order toavoid these restrictions, we may have to seek a license. This license may notbe available on reasonable terms, could require us to pay significant licensefees and may significantly increase our operating expenses. A license also maynot be available to us at all. As a result, we may be required to use and/ordevelop non-infringing alternatives, which could require significant effort andexpense. If we cannot obtain a license or develop alternatives for anyinfringing aspects of our business, we may be forced to limit our 3Dtechnologies and may be unable to compete effectively. In certain instances, wehave contractually agreed to provide indemnification to licensees relating toour intellectual property. This may require us to defend or hold harmlessmotion picture exhibitors, consumer electronics manufacturers or otherlicensees. We have from time to time corresponded with one or more thirdparties regarding patent enforcement issues and in-bound and out-bound patentlicensing opportunities. In addition, from time to time we may be engaged indisputes regarding the licensing of our intellectual property rights, includingmatters related to our license fee rates and other terms of our licensingarrangements. These types of disputes can be asserted by our licensees orprospective licensees or by other third parties as part of negotiations with usor in private actions seeking monetary damages or injunctive relief or inregulatory actions. Requests for monetary and injunctive remedies asserted inclaims like these could be material and could have a significant impact on ourbusiness. Any disputes with our licensees, potential licensees or other thirdparties could adversely affect our business, results of operations andprospects.

 

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***If we are unable to maintain our brand andreputation for providing high quality 3D technologies, our business andprospects could be materially harmed.***

 

Our business and prospectsdepend, in part, on maintaining and strengthening our brand and reputation forproviding high quality 3D technologies in the markets we serve. If problemswith our 3D technologies cause motion picture exhibitors, consumer electronicsmanufacturers or other licensees to experience operational disruption orfailure or delays in the delivery of their products and services to theircustomers, our brand and reputation could be diminished. Maintaining andstrengthening our brand and reputation may be particularly challenging as weenter markets in which we have limited experience, such as the 3D consumerelectronics market. If we fail to promote and maintain our brand and reputationsuccessfully, our business and prospects could be materially harmed.

 

***Competition from other providers of 3Dtechnologies to the motion picture industry could adversely affect ourbusiness.***

 

The motion picture industryis highly competitive, particularly among providers of 3D technologies. Ourprimary competitors include Dolby, Laboratories, Inc., or Dolby, IMAXCorporation, or IMAX, MasterImage 3D, LLC, or MasterImage, and X6DLimited, or Xpand. In addition, other companies, including motion pictureexhibitors and studios, may develop their own 3D technologies in the future.Consumers may also perceive the quality of 3D technologies delivered by some ofour competitors to be equivalent or superior to our 3D technologies. Inaddition, some of our current or future competitors may have significantlygreater financial, technical, marketing and other resources than we do or mayhave more experience or advantages in the markets in which we compete that willallow them to offer lower prices or higher quality technologies, products orservices. If we do not successfully compete with these providers, we could losemarket share and our business could be adversely affected.

 

***We face potential competition fromcompanies with greater brand recognition and resources in the consumerelectronics industry.***

 

The 3D consumer electronicsmarket is new and rapidly developing, and we must compete with companies thatenjoy competitive advantages, including:

 

·                  more developed distribution channels anddeeper relationships with consumer electronics manufacturers;

 

·                  a moreextensive customer base;

 

·                  technologiesthat may be better suited for 3D consumer electronics products;

 

·                  broadertechnology, product and service offerings; and

 

·                  greaterresources for competitive activities, such as research and development, strategicacquisitions, alliances, joint ventures, sales and marketing, and lobbyingindustry and government standards.

 

As a result, these currentand potential competitors may be able to respond more quickly and effectivelythan we can to new or changing opportunities, products, technologies orstandards in the 3D consumer electronics market.

 

We also face competitionwhere existing licensees relying on our RealD Cinema Systems in the motionpicture industry may become current or potential competitors in the 3D consumerelectronics market, or vice versa. For example, Sony Pictures Entertainment, Inc.,or Sony Pictures, is a major motion picture studio, but certain of itsaffiliates also design, manufacture and market consumer electronics productsand components and are entering the 3D consumer electronics market. In 2009, wesigned an agreement with Sony Electronics making available to it some of our 3Dtechnologies for potential use with their consumer electronics products. To theextent that Sony Electronics or our other licensees choose to utilize competing3D technologies that they have developed or in which they have an interest,rather than use our 3D technologies, our growth prospects could be adverselyaffected.

 

***The introduction of new 3D technologies andchanges in the way that our competitors operate could harm our business. If wefail to keep up with rapidly changing 3D technologies or the growth of new andexisting markets, our 3D technologies could become less competitive orobsolete.***

 

The motion picture andconsumer electronics industries in general are undergoing significant changes.Due to technological 

 

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advances and changingconsumer tastes, numerous companies have developed, and are expected tocontinue to develop, new 3D technologies that may compete directly with our 3Dtechnologies. Competitors may develop alternative 3D technologies that are moreattractive to consumers, content producers and distributors, motion pictureexhibitors, consumer electronics manufacturers and others, or more costeffective than our technologies, and which make our 3D technologies lesscompetitive. As a result of this competition, we could lose market share, whichcould harm our business and operating results. We expect to expend considerableresources on research and development in response to changes in the motionpicture and consumer electronics industries. However, we may not be able todevelop and effectively market new 3D technologies that adequately orcompetitively address the needs of these changing industries, which could havean adverse effect on our business and prospects.

 

***If our 3D technologies fail to be widelyadopted by or are not compatible with the needs of our licensees, our businessprospects could be limited and our operating results could be adverselyaffected.***

 

Our motion picture andconsumer electronics licensees depend upon our 3D technologies being compatiblewith a wide variety of motion picture and consumer electronics systems,products and infrastructure. We make significant efforts to design our 3Dtechnologies to address capability, quality and cost considerations so thatthey either meet or, where possible, exceed the needs of our licensees in themotion picture and consumer electronics industries. To have our 3D technologieswidely adopted in the motion picture and consumer electronics industries, wemust convince a broad spectrum of professional organizations worldwide, as wellas motion picture studios and exhibitors and consumer electronics manufacturerswho are members of such organizations, to adopt them and to ensure that our 3Dtechnologies are compatible with their systems, products and infrastructure.

 

If our 3D technologies arenot widely adopted or retained or if we fail to conform our 3D technologies tothe expectations of, or standards set by, industry participants, they may notbe compatible with other products and our business, operating results andprospects could be adversely affected. We expect that meeting and maintainingthe needs of our licensees for compatibility with them will be significant toour business in the future. In addition, the market for broadcast technologieshas traditionally been heavily regulated by governments or other regulatorybodies, and we expect this to continue to be the case in the future. If our 3Dtechnologies are not compatible with the broadcasting infrastructure inparticular geographic areas, our ability to compete in these markets could beadversely affected.

 

***Other forms of entertainment may be moreattractive to consumers than those using our 3D technologies, which could harmour growth and operating results.***

 

We face competition for consumerattention from other forms of entertainment that may drive down motion picturebox office and license revenue from motion picture exhibitors. We compete witha number of alternative motion picture distribution channels, such as cable,satellite, broadcast, packaged media and the Internet. There are also otherforms of entertainment competing for consumers’ leisure time and disposableincome such as concerts, amusement parks and sporting events. A significantincrease in the popularity of these alternative motion picture channels andcompeting forms of entertainment could reduce the demand for theatricalexhibition of 3D motion pictures, including those viewed with our RealD CinemaSystems, and have an adverse effect on our business and operating results.

 

***Motion picture exhibitor stock options, ourshare price and the pace of theater conversions to RealD-enabled screens couldcreate volatility in our reported revenue and earnings.***

 

In connection with some ofour motion picture exhibitor licensing agreements, we issued to the motionpicture exhibitors a 10-year option to purchase shares of our common stock atapproximately $0.00667 per share. The stock options vest upon the achievementof screen installation targets. Motion picture exhibitor stock options arevalued at the underlying stock price at each reporting period until the targetsare met. Amounts recognized are based on the number of screens installed as apercentage of total screen installation targets. We record revenue net ofmotion picture exhibitor stock options, the amount of which is determined bychanges in our share price and the number of RealD-enabled screens relative tocertain targets. If our share price were to increase or decrease significantlyduring a reporting period, it could impact our reported revenue and earningsincluding potentially leading us to report negative revenue under certaincircumstances.

 

***Our limited operating history in the 3Dconsumer electronics market presents risk to our ability to achieve success inthis area.***

 

Our 3D technologies haveonly recently been made available to consumer electronics manufacturers,including JVC, 

 

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Panasonic, Samsung, SonyElectronics and Toshiba, to enable 3D viewing on high definition televisions,laptops and other displays. To date, we have not generated revenue of anymaterial significance from our arrangements with these and other consumerelectronics manufacturers. The 3D consumer electronics market is rapidlydeveloping, as manufacturers are working to set standards and content producersand distributors are working on increasing the availability of new 3D content.However, the demand for our 3D technologies and the income potential from the3D consumer electronics market are unproven. In addition, because the 3Dconsumer electronics market is new and quickly evolving, we have limitedinsight into trends that may emerge and affect our business. We may make errorsin predicting and reacting to relevant business trends. We also may not be ableto successfully address these risks on a timely basis or at all.

 

***If consumer electronics manufacturers limittheir use of our 3D technologies in high definition televisions, laptops andother displays or such products are not accepted by consumers, our potentialgrowth in this market will be significantly reduced.***

 

We are dependent on consumerelectronics manufacturers to use our RealD Format, active and passive eyewear,and display and gaming technologies with their high definition televisions,laptops and other displays, and for content distributors to deliver 3D contentvia cable, satellite, broadcast, packaged media and the Internet. While we haveentered into agreements with some consumer electronics manufacturers regardingthe use of our 3D technologies in various consumer electronics products, theseagreements are not exclusive, and we can give no assurances that these consumerelectronics manufacturers will utilize our 3D technologies or that there willbe sufficient consumer demand for 3D electronics products. In addition, sincethe 3D consumer electronics market is emerging, it is unclear if consumers willaccept viewing 3D content in the home and elsewhere. The lack of consumerinterest in 3D technologies may cause consumer electronics manufacturers tolimit their use of our 3D technologies. As a result, our future prospects couldbe adversely affected if consumer electronics manufacturers choose not to useour 3D technologies.

 

***Acquisition activities could result inoperating difficulties, dilution to our stockholders and other harmfulconsequences.***

 

We have built our business,in part, through acquisitions of intellectual property and other assets. We mayselectively pursue strategic acquisitions in the future. Future acquisitionscould divert management’s time and focus from operating our business. Inaddition, integrating an acquired company, business or technology is risky andmay result in unforeseen operating difficulties and expenditures. Foreignacquisitions also involve unique risks related to integration of operationsacross different cultures and languages, currency risks and the particulareconomic, political and regulatory risks associated with specific countries.

 

We may not accurately assessthe value or prospects of acquisition candidates, and the anticipated benefitsfrom our future acquisitions may not materialize. In addition, futureacquisitions or dispositions could result in potentially dilutive issuances ofour equity securities, including our common stock, the incurrence of debt,contingent liabilities or amortization expenses, or write-offs of goodwill, anyof which could harm our financial condition.

 

***Our growth may place a strain on ourresources, which could harm our operations or increase our costs.***

 

We have experiencedsignificant growth since we acquired ColorLink in 2007. The growth that we haveexperienced in the past, as well as any further growth that we experience, mayplace a significant strain on our resources and increase demands on ourmanagement, our information and reporting systems and our internal controlsover financial reporting. We will incur additional general and administrativeexpenses to comply with the U.S. Securities and Exchange Commission, orSEC, reporting requirements, the listing standards of the New York StockExchange, or NYSE, and provisions of the Sarbanes-Oxley Act of 2002, and willcontinue to incur additional research and development expenses. If we areunable to manage our growth effectively while maintaining appropriate internalcontrols, we may experience operating inefficiencies that could increase ourcosts.

 

***We face risks from doing businessinternationally that could harm our business, financial condition and resultsof operations.***

 

We are dependent oninternational business for a portion of our total revenue. International grossrevenue accounted for approximately 27% of our total gross revenue in fiscal2008, 27% in fiscal 2009 and 46% in fiscal 2010. We expect that ourinternational business will continue to represent a significant portion of ourrevenue for the foreseeable future. This future revenue will depend to a largeextent on the continued use and expansion of our 3D technologies in the motionpicture and consumer electronics industries worldwide. As a result, ourbusiness is subject to certain risks inherent in international 

 

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business, many of which arebeyond our control. These risks include:

 

·                  fluctuatingforeign exchange rates;

 

·                  laws andpolicies affecting trade, investment and taxes, including laws and policiesrelating to customs, duties, the repatriation of funds and withholding taxesand changes in these laws and our compliance with the foregoing;

 

·                  changes inlocal regulatory requirements, including restrictions on content;

 

·                  differingcultural tastes and attitudes;

 

·                  differingdegrees of protection for intellectual property;

 

·                  the need toadapt our business model to local requirements;

 

·                  the instabilityof foreign economies and governments; and

 

·                  politicalinstability, natural disaster, war or acts of terrorism.

 

Events or developmentsrelated to these and other risks associated with international business couldadversely affect our revenue from those sources, which could have a materialadverse effect on our business, financial condition and results of operations.

 

***Our operating results may fluctuatesubstantially from quarter to quarter, which may be different from analysts’expectations and adversely affect our stock price.***

 

Our operating results mayfluctuate from quarter to quarter. Factors that have affected our operatingresults in the past, and are likely to affect our operating results in thefuture, include, among other things:

 

·                  the timing ofwhen a 3D motion picture is released. These motion pictures tend to be releasedbased on specific consumer entertainment dynamics, which results in seasonalpatterns, with the largest number of motion pictures being released in summerand early winter;

 

·                  the rate ofinstallation of new RealD Cinema Systems. In connection with some of our motionpicture exhibitor license agreements, we issued to three motion pictureexhibitors 10-year options to purchase an aggregate of 3,668,340 shares of ourcommon stock at an exercise price of approximately $0.00667 per share, whichvests upon the achievement of screen installation targets. Reductions torevenue resulting from motion picture exhibitor stock options may increase asthe estimated fair value of our common stock and number of RealD-enabled screeninstallations increase.

 

·                  the timing ofexpenses. Our expenses, including depreciation expense of our RealD CinemaSystems deployed at a motion picture exhibitor’s premises, digital projectordepreciation expenses, RealD eyewear costs (including shipping, handling andrecycling costs) and occupancy costs, have in the past, and may in the future,increase significantly, including in quarters when we do not experience asimilar growth in revenue; and

 

·                  the timing andaccuracy of license fee reports. It is not uncommon for license fee reports toinclude positive or negative corrective or retroactive license fees that coverextended periods of time.

 

In addition, variances inour operating results from analysts’ expectations could adversely affect ourstock price. See also “Management’s discussion and analysis of financialcondition and results of operations—Six months ended September 24, 2010compared to six months ended September 25, 2009—Seasonality.”

 

***Our RealD eyewear may, in the future, beregulated by the Food and Drug Administration, or FDA, or by state or foreignagencies, which could increase our costs and adversely impact ourprofitability.***

 

Currently, polarizedeyewear, including our RealD eyewear, is not regulated by the FDA, or by stateor foreign agencies. However, certain eyewear, such as non-prescription readingglasses and sunglasses, are considered to be medical devices by the FDA and aresubject to regulations imposed by the FDA and various state and foreignagencies. With the rising 

 

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popularity of polarized 3Deyewear, there has been an increasing level of public scrutiny examining itspotential health risks. Polarized 3D eyewear, including our RealD eyewear, mayat some point be subject to federal, state or foreign regulations that couldpotentially restrict how our RealD eyewear is produced, used or marketed, andthe cost of complying with those regulations may adversely affect ourprofitability.

 

***If 3D viewing with active or passiveeyewear is found to cause health risks or consumers believe that it does,demand for the 3D viewing experience may decrease or we may become subject toliability, which could adversely affect our results of operations, financialcondition, business and prospects.***

 

Research conducted byinstitutions unrelated to us has suggested that 3D viewing with active orpassive eyewear may cause vision fatigue, eye strain, discomfort, headaches,motion sickness, dizziness, nausea, epileptic seizures, strokes,disorientation, perceptual after-effects, decreased postural stability or otherhealth risks in some consumers. If these potential health risks aresubstantiated or consumers believe in their validity, demand for the 3D viewingexperience in the theater, the home and elsewhere may decline. As a result,major motion picture studios and other content producers and distributors mayrefrain from developing 3D content, motion picture exhibitors may reduce thenumber of 3D-enabled screens (including RealD-enabled screens) they currentlydeploy or plan to deploy, or they may reduce the number of 3D motion picturesexhibited in their theaters, which would adversely affect our results ofoperations, financial condition and prospects. A decline in consumer demand mayalso lead consumer electronics manufacturers and content distributors to reduceor abandon the production of 3D products, which could adversely affect ourprospects.

 

In addition, if health risksassociated with our RealD eyewear materialize, we may become subject togovernmental regulation or product liability claims, including claims forpersonal injury. Successful assertion against us of one or a series of largeclaims could materially harm our business. Also, if our RealD eyewear is foundto be defective, we may be required to recall it, which may result insubstantial expense and adverse publicity that could adversely impact oursales, operating results and reputation. Potential product liability claims mayexceed the amount of our insurance coverage or may be excluded under the termsof the policy, which could adversely affect our financial condition. Inaddition, we may also be required to pay higher premiums and accept higherdeductibles in order to secure adequate insurance coverage in the future, whichcould adversely affect our results of operations, financial condition andbusiness.

 

***Our agreements with motion picture studiosdomestically and motion picture exhibitors internationally require us to managethe supply chain of our RealD eyewear, and any interruption to the supply chainfor our RealD eyewear components could adversely affect our results ofoperations, financial condition, business and prospects.***

 

Our RealD eyewear is anintegral part of our RealD Cinema Systems. We have entered into non-exclusiveagreements with several manufacturers to produce RealD eyewear. We managemanufacturing, distribution and recycling of RealD eyewear for motion picturestudios and exhibitors worldwide. Domestically, we provide our RealD eyewearfree of charge to motion picture exhibitors and then receive a fee from themotion picture studios for the usage of that RealD eyewear by the motionpicture exhibitors’ consumers. Most international motion picture exhibitorspurchase RealD eyewear directly from us and sell them to consumers as part oftheir admission or as a concession item. Any interruption in the supply ofRealD eyewear from manufacturers, increase in shipping cost, logistics orrecycling interruption or other disruption to our global supply chain couldadversely affect our results of operations, financial condition, business andprospects. For example, in connection with recent major 3D motion picturereleases and increased consumer demand, we exhausted our inventory of RealDeyewear and have incurred increased shipping costs to accelerate delivery.

 

***Economic conditions beyond our controlcould reduce consumer demand for motion pictures and consumer electronics usingour 3D technologies and, as a result, adversely affect our business, revenueand growth prospects.***

 

The global economicenvironment in late 2008 and 2009 was volatile and continues to pose risks. Theeconomy could remain significantly challenged for an indeterminate period oftime. Present economic conditions could lead to a decrease in discretionaryconsumer spending, resulting in lower motion picture box office. In the eventof declining box office revenue, motion picture studios may be less willing torelease 3D motion pictures and motion picture exhibitors may be less willing tolicense our RealD Cinema Systems. Further, a decrease in discretionary consumerspending may adversely affect future demand for 3D consumer electronicsproducts that may use our 3D technologies, which could cause our business,revenue and growth prospects to suffer.

 

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***The loss of members of our management orresearch and development teams could substantially disrupt our businessoperations.***

 

Our success depends to asignificant degree upon the continued individual and collective contributionsof our management and research and development teams. A limited number ofindividuals have primary responsibility for managing our business, includingour relationships with motion picture studios and exhibitors and consumerelectronics manufacturers and the research and development of our 3Dtechnologies. The loss of any of these individuals, including Michael V. Lewis,our Chairman and Chief Executive Officer, or Joshua Greer, our President, orour failure to attract and retain other qualified and experienced personnel onacceptable terms, could impair our ability to sustain and grow our business. Inaddition, because we operate in a highly competitive industry, our hiring ofqualified executives, scientists, engineers or other personnel may cause us orthose persons to be subject to lawsuits alleging misappropriation of tradesecrets, improper solicitation of employees or other claims.

 

***Our ability to use our net operating losscarryforwards could be subject to additional limitation if our ownership haschanged or will change by more than 50%, which could potentially result inincreased future tax liability.***

 

While currently subject to afull valuation allowance for purposes of preparing our consolidated financialstatements (see the discussion above under the heading “Management’s discussionand analysis of financial condition and results of operations—Criticalaccounting policies and estimates—Deferred tax asset valuation and taxexposures”), we intend to use our U.S. net operating loss carryforwards toreduce any future U.S. corporate income tax liability associated with ouroperations. Section 382 of the U.S. Internal Revenue Code of 1986, asamended, generally imposes an annual limitation on the amount of net operatingloss carryforwards that may be used to offset taxable income when a corporationhas undergone significant changes in stock ownership. We have not determinedwhether such ownership change has previously occurred. It is possible that ourinitial public offering, either on a standalone basis or when combined withpast or future transactions (including, but not limited to, significantincreases during the applicable testing period in the percentage of our stockowned directly or constructively by (i) any stockholder who owns 5% ormore of our stock or (ii) some or all of the group of stockholders whoindividually own less than 5% of our stock), will cause us to undergo one ormore ownership changes. In that event, our ability to use our net operatingloss carryforwards could be adversely affected. To the extent our use of netoperating loss carryforwards is significantly limited under the rules ofSection 382 (as a result of the initial public offering or otherwise), ourincome could be subject to U.S. corporate income tax earlier than it would ifwe were able to use net operating loss carryforwards, which could result in lowerprofits.

 

**Risks related to our common stock**

 

***The price of our common stock may fluctuatesignificantly, and you could lose all or part of your investment.***

 

Volatility in the marketprice of our common stock may prevent you from being able to sell your sharesat or above the price you paid for your shares. The market price of our commonstock could fluctuate significantly for various reasons, which include:

 

·                  our quarterlyor annual earnings or those of our competitors;

 

·                  the public’sreaction to our press releases, our other public announcements and our filingswith the SEC;

 

·                  changes inearnings estimates or recommendations by research analysts who track our commonstock or the stocks of our competitors;

 

·                  new laws orregulations or new interpretations of laws or regulations applicable to ourbusiness;

 

·                  changes inaccounting standards, policies, guidance, interpretations or principles;

 

·                  changes in generalconditions in the domestic and global economies or financial markets, includingthose resulting from war, incidents of terrorism or responses to such events;

 

·                  litigationinvolving our company or investigations or audits by regulators into the operationsof our company or our competitors; and

 

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·                  sales of commonstock by our directors, executive officers and significant stockholders.

 

In addition, the stockmarket in general, and the market for technology and media companies inparticular, has experienced extreme price and volume fluctuations that haveoften been unrelated or disproportionate to the operating performance of thosecompanies. Broad market and industry factors may seriously affect the marketprice of our common stock, regardless of actual operating performance. Inaddition, in the past, following periods of volatility in the overall marketand the market price of a particular company’s securities, securities classaction litigation has often been instituted against these companies. Iflitigation is instituted against us, it could result in substantial costs and adiversion of our management’s attention and resources.

 

***Your percentage ownership in us may bediluted by future issuances of capital stock, which could reduce your influenceover matters on which stockholders vote.***

 

Our board of directors hasthe authority, without action or vote of our stockholders, to issue all or anypart of our authorized but unissued shares of common stock, including sharesissuable upon the exercise of options, shares that may be issued to satisfy ourobligations under our equity incentive plans or shares of our authorized butunissued preferred stock. Issuances of common stock or preferred voting stockcould reduce your influence over matters on which our stockholders vote and, inthe case of issuances of preferred stock, likely could result in your interestin us being subject to the prior rights of holders of that preferred stock.

 

***We currently do not intend to pay dividendson our common stock and, consequently, your only opportunity to achieve areturn on your investment is if the price of our common stock appreciates.***

 

We do not expect to paydividends on shares of our common stock in the foreseeable future, and weintend to use cash to grow our business. Consequently, your only opportunity toachieve a positive return on your investment in us will be if the market priceof our common stock appreciates.

 

***Provisions in our certificate ofincorporation and bylaws and Delaware law may discourage, delay or prevent achange of control of our company or changes in our management and, therefore,may depress the trading price of our stock.***

 

Our certificate ofincorporation and bylaws will contain provisions that could depress the tradingprice of our stock by acting to discourage, delay or prevent a change ofcontrol of our company or changes in our management that the stockholders ofour company may deem advantageous. These provisions:

 

·                  authorize theissuance of “blank check” preferred stock that our board of directors couldissue to increase the number of outstanding shares to discourage a takeoverattempt;

 

·                  provide for aclassified board of directors (three classes);

 

·                  provide thatstockholders may only remove directors for cause;

 

·                  provide thatstockholders may only remove directors prior to the expiration of their termupon a supermajority vote of at least 80% of our outstanding common stock;

 

·                  provide thatany vacancy on our board of directors, including a vacancy resulting from anincrease in the size of the board, may only be filled by the affirmative voteof a majority of our directors then in office, even if less than a quorum;

 

·                  provide that aspecial meeting of stockholders may only be called by our board of directors orby our chief executive officer;

 

·                  provide thataction by written consent of the stockholders may be taken only if the board ofdirectors first approves such action; provided that, notwithstanding theforegoing, we will hold an annual meeting of stockholders in accordance withNYSE rules, for so long as our shares are listed on NYSE, and as otherwiserequired by the bylaws;

 

·                  provide that theboard of directors is expressly authorized to make, alter or repeal our bylaws;and

 

·                  establishadvance notice requirements for nominations for elections to our board ofdirectors or for proposing matters 

 

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thatcan be acted upon by stockholders at stockholder meetings.

 

Additionally, we will besubject to Section 203 of the Delaware General Corporation Law, whichgenerally prohibits a Delaware corporation from engaging in any of a broadrange of business combinations with any “interested” stockholder for a periodof three years following the date on which the stockholder became an “interested”stockholder.

 

**ITEM 2. UNREGISTEREDSALES OF EQUITY SECURITIES AND USE OF PROCEEDS**

 

None.

 

**ITEM 3. DEFAULTS UPON SENIOR SECURITIES**

 

None.

 

**ITEM 5. OTHER INFORMATION**

 

None.

 

**ITEM 6. EXHIBITS**

 

Thefollowing exhibits are attached hereto and filed herewith:

 

**EXHIBIT INDEX**

 
| **ExhibitNumber** | **Description**                                                                                                                                                                                                                                      |
|-------------------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 3.1(1)            | Amended and Restated  Certificate of Incorporation.                                                                                                                                                                                                  |
|              |                                                                                                                                                                                                                                                 |
| 3.2(2)            | Amended and Restated  Bylaws.                                                                                                                                                                                                                        |
|              |                                                                                                                                                                                                                                                 |
| 4.1(3)            | Form of specimen  common stock certificate.                                                                                                                                                                                                     |
|              |                                                                                                                                                                                                                                                 |
| 31.1‡        | Certification of Principal  Executive Officer required by Rule 13a-14(a) or Rule 15d-14(a) of  the Securities Exchange Act of 1934, as adopted pursuant to Section 302  of the Sarbanes-Oxley Act of 2002 (filed herewith). |
|              |                                                                                                                                                                                                                                                 |
| 31.2‡        | Certification of Principal  Financial Officer required by Rule 13a-14(a) or Rule 15d-14(a) of  the Securities Exchange Act of 1934, as adopted pursuant to Section 302  of the Sarbanes-Oxley Act of 2002 (filed herewith). |
|              |                                                                                                                                                                                                                                                 |
| 32.1‡        | Certification of Chief  Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted  pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (filed  herewith).                                                                     |
|              |                                                                                                                                                                                                                                                 |
| 32.2‡        | Certification of Chief  Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted  pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (filed  herewith).                                                                     |

 

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| (1)    | Incorporated by reference  to Exhibit 3.2 filed with the Registrant’s Registration Statement on  Form S-1 (No. 333-165988) on April 9, 2010.        |
|--------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| (2)    | Incorporated by reference  to Exhibit 3.4 filed with the Registrant’s Registration Statement on  Form S-1 (No. 333-165988) on April 9, 2010.        |
| (3)    | Incorporated by reference  to exhibit of same number filed with the Registrant’s Registration Statement  on Form S-1/A (No. 333-165988) on May 26, 2010. |
| ‡ | Filed herewith                                                                                                                                                               |

 

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**SIGNATURE**

 

Pursuantto the requirements of the Securities Exchange Act of 1934, the registrant hasduly caused this report to be signed on its behalf by the undersigned thereuntoduly authorized.

 
|   | RealD  Inc. |
|--------|-------------|
|   |        |   |
|   | By:         | /s/ Andrew A. Skarupa |
|   |        | **Andrew  A. Skarupa**

**Chief  Financial Officer and Chief Operating Officer** |

 

Date:November 2, 2010

 

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