RealD Revenues Up 69 Percent on Screen Expansion, 3D Releases, But Glasses Tug on Profits

As of September 24, the number of RealD 3D movie screens worldwide was 9,300, with 5,600 in the U.S. and Canada and 3,700 in international markets, the company said. That compares with 2,300 domestic and 1,000 international RealD 3D screens that had been installed by the prior year. According to Real D’s 10-Q, released Wednesday, the number of 3D movies available for the six-month period ended Sept. 24 was 11, compared with 7 for the period in the prior year. In total, the company expects 32 3D titles to release in 2011.

As revenues from more screens and movies go up, costs go up, the company said in its 10-Q. According to the document, RealD had a “negative product and other gross profit” of $11.5 million for the six months ended Sept. 24, primarily due to RealD eyewear. The boost in cost of product revenue and negative gross profit resulted from increasing volume of eyewear to support higher attendance. As a result, product and other gross margin was negative 14.3 percent for the six months ended Sept. 24, compared with negative 14.2 percent for the six months ended Sept. 25, the company said. Shipping expenses increased by an aggregate $5.7 million, the company said, resulting from higher eyewear demand from international expansion.

Costs associated with the 3D glasses recycling program further cut gross profit, according to the 10-Q. Recycling costs increased $2 million year-over-year to $4.3 million for the six months ended Sept. 24. Costs included transporting glasses from theaters to recycling facilities and processing glasses for reuse.

In the future, cost of revenue as a percentage of net revenue will be impacted by the relative mix of net license and net product revenue, the mix of domestic and international product revenue and the impact of motion picture exhibitor stock options, the company said. As the number of RealD-enabled screens goes up in proportion to 3D movies and attendance, “our total cost of revenue may continue to increase,” the company said.

In the earnings webcast, RealD CEO Michael Lewis noted that five years ago there was one 3D film and 100 3D screens in the domestic market. “Today 60 films have been committed for RealD,” he said, and the installed base “is approaching 10,000 screens.” Although he expressed excitement about upcoming 3D releases for the six Star Wars movies, Titanic and the Avatar sequels, he was “disappointed” by the decision of Warner Bros. to cancel the 3D release of the seventh Harry Potter movie because of the resulting “negative impact” on RealD’s upcoming Q3 financial results. Seeking to minimize the impact of that loss, he said, it’s important to recognize that RealD is a “portfolio business” with all major 3D motion pictures “playing across our platform” making RealD “not reliant on any one film, studio or exhibitor.” He did, however, support Warner’s long-term view not to release a movie that “doesn’t meet the highest standards of 3D quality."

During the fiscal Q2 period, Lewis said domestic box office revenue totaled $420 million, with RealD 3D capturing 83 percent of sales. He said 3D versions of Resident Evil, Jackass 3D and Saw 3D accounted for 82, 90, and 91 percent of the total box office sales for those movies. “Clearly consumers are willing to pay a premium for RealD,” he said, adding that the top two and six of the top 10 movies for the year have been released in 3D. Lewis also cited the growing proportion of international business and said Asia ended the quarter with 500 RealD screens, including 120 in China and 165 in South Korea. Longer term he sees the revenue split will “mirror the international-domestic box office split” of 2:1.

For the home market, RealD continues to “work with the key members of the 3D consumer electronics ecosystem” through partnerships with content producers, distributors, chip makers and consumer electronics companies, Lewis said, “with the goal of enabling a RealD 3D experience on any visual display device.” He cautioned that 3D is “still in the very early days” of adoption in the home. CFO Drew Skarupa said licensing revenue of RealD 3D active eyewear based on sales of 3D TVs is “still relatively immaterial."

According to the 10-Q, the company recently made available its RealD active and passive eyewear and display and gaming technologies to CE manufacturers and content distributors to enable 3D in HDTVs, laptops and “other displays in the home and elsewhere.” It said the development of the CE market “represents a significant opportunity for new revenue.” Although cinema 3D eyewear continues to offset RealD revenue, Skarupa told analysts that it would be profitable with 3D glasses “within two years.” The company incurred $3 million in “expedited shipping costs” for last quarter due to supply issues as it tried to keep up with demand. In fiscal Q2, RealD brought on multiple eyewear suppliers, which helped “create competitiveness on the cost side,” he said. In addition to becoming “more efficient,” he said, the company is also seeing “improvement in the recovery rate” of glasses. “Glasses lost as a percentage of glasses revenue” has declined for the last three quarters, he said.