RealD's (RLD) CEO Michael Lewis on Q1 2015 Results - Earnings Call Transcript

Aug. 5.14 | About: RealD Inc. (RLD)


Q1 2015 Earnings Call

August 05, 2014 4:30 pm ET


Christine McLaughlin -

Michael V. Lewis - Co-Founder, Chairman, Chief Executive Officer

Andrew A. Skarupa - Chief Financial Officer and Chief Business Development Officer - Cinema


Stan Meyers - Piper Jaffray Companies, Research Division

Benjamin E. Mogil - Stifel, Nicolaus & Company, Incorporated, Research Division

Steven B. Frankel - Dougherty & Company LLC, Research Division

Eric C. Wold - B. Riley Caris, Research Division


Good afternoon. My name is Jay, and I will be your conference operator today. At this time, I would like to welcome everyone to the RealD First Quarter Fiscal 2015 Earnings Conference Call. [Operator Instructions] Thank you.

I would now like to turn the conference over to Ms. Christine McLaughlin of RealD. You may begin.

Christine McLaughlin

Thank you, and welcome to RealD's conference call to discuss our financial results for the first fiscal quarter of 2015 ended June 30, 2014. By now, everyone should have access to the earnings press release, which was distributed today at approximately 4:00 p.m. Eastern Time. It is available on the Investor Relations portion of RealD's website at Also available on the website is the financial highlights presentation that provides a detailed review of our results for the first fiscal quarter. This call is being webcast and will be available for replay.

In our remarks today, we will include statements that are considered forward looking within the meaning of United States' securities laws. In addition, management may make additional forward-looking statements in response to your questions.

Forward-looking statements are based on management's current knowledge and expectations as of today, August 5, 2014, and are subject to certain risks and uncertainties that may cause actual results to differ materially from the forward-looking statements.

A detailed discussion of these risks and uncertainties is contained in our annual report on Form 10-K and quarterly reports on Form 10-Q. The company undertakes no obligation to update any forward-looking statements.

On this call, we will refer to non-GAAP measures, such as adjusted EBITDA that, when used in combination with GAAP results, provide us with additional analytical tools to understand our operations. In our earnings press release and in our SEC filings, we have provided reconciliations of these non-GAAP measures to their most comparable GAAP measures.

With that said, I'll hand the call over to Michael Lewis.

Michael V. Lewis

Thanks, Christine. Good afternoon, and thanks for joining us on today's call.

Since we just spoke 2 months ago, we'll keep our remarks brief. The year is off to a strong start, with RealD delivering meaningful improvements in our key profitability metrics. Adjusted EBITDA grew 43% year-over-year, and we generated net income in excess of $5 million. The strong improvement in profitability reflects the realization of our cost reduction efforts put into place last year.

Drew will outline our OpEx reductions in more detail, but as you can see, ongoing operating expenses were down approximately 20% year-over-year.

At the same time, we continue to maximize the performance of our platform worldwide. Despite the anticipated domestic box office weakness across the board, year-to-date our domestic 3D percentages have remained constant with the prior year period.

Our theater optimization program continues to deliver benefits as we partner with studios and exhibitors to support RealD's premium 3D offering.

Internationally, our performance continues to be driven by our growth markets of China, Russia and Latin America. Demand for 3D content in these markets remains very strong, and we are also encouraged by the increase in local 3D content production in China and Russia.

In the first quarter, the majority of our 400 screen installs fell within these targeted territories. With respect to China, demand for 3D content continues to increase. In fact, it is estimated that China will overtake the U.S. as the largest 3D market worldwide by the end of 2014. 6 of the top 10 films in the region were shown in 3D.

In addition, of the top 10 films, 3D comprised nearly 70% of the box office, which is up from 53% in the prior year period. Transformers: Age of Extinction, released in late June, broke prior records to become China's highest grossing 3D film ever, surpassing Avatar, and bringing in approximately $350 million to date in total 3D box office.

Local 3D content continues to be a prevailing trend, with 15 locally produced 3D films set to be released over the course of fiscal 2015 alone.

With respect to RealD, licensing revenues in China grew 83% over the prior year period to exceed $5 million for the third consecutive quarter. As our market share is only 13%, we believe that there is still ample room for growth in this strategically important market.

Turning to Russia, which now ranks as the third largest 3D market worldwide. 9 of the top 10 films in the region were shown in 3D, up from 4 in the prior year period. Of the top 10 films, 3D represented over 60% of the box office, up from 27% in the prior year period.

And with respect to RealD, licensing revenues for the quarter increased 220% over the prior year period.

Similar to China, the opportunity is significant with our market share currently at 11%. Just a few weeks ago, we opened our third LUXE auditorium in Crocus City, located just outside of Moscow. We are very proud of this flagship location that represents our vision for the future of cinema.

Over the next 18 months, we expect to roll out the remaining 20 auditoriums under contract. We also intend to replicate this model in additional international territories.

And finally, we spent quite a bit of time on our last quarterly call discussing our product pipeline and respective time lines associated with them.

Our R&D initiatives include RealD TrueImage, new screen technologies, laser projection and consumer-focused applications. We're confident in the time frames provided in our last call. For more detail, we will be including our intelligent backlight technology presentation from SID 2014 on our website, and would also refer you to the recent article published by Insight Media on our TrueImage technology.

Moving forward, we will continue to take a prudent and disciplined approach to our R&D initiatives, investing in complementary technologies that leverage our visual expertise, strengthen our competitive position and that have the strongest potential to contribute to our financial results.

In summary, the year is off to a strong start, and as we continue to advance our strategic plan, we look forward to keeping you up-to-date on our progress.

With that, I'll hand the call over to Drew.

Andrew A. Skarupa

Thank you, Michael. I'll begin with a brief review of our key financial highlights for the quarter and will conclude by discussing our outlook.

Most notably, we are pleased to deliver net income of over $5 million. Second, we saw continued momentum in Chinese license revenue as demonstrated by 83% growth over the prior year period, driven by continued strong demand for 3D content and growth of an installed base in China. As a percent of total installs, China represented 31%, up from 13% in the prior year quarter. And as a percent of total license revenue, China license revenues nearly doubled over the prior year period to comprise 14% of our overall license revenues in the quarter.

And third, adjusted EBITDA improved 43% in the quarter over the prior year period, benefiting from our proactive effort to reduce operating expenses.

Now turning to our first fiscal quarter results in more detail. Revenues were $55.4 million, which included license revenues of $36 million and product and other revenues of $19.4 million. License revenues decreased 4% from the prior year quarter, which was partially offset by a 10% increase in international license revenues, primarily driven by growth in China.

International license revenues grew to 63% of total license revenues from 55% in the prior year quarter, which is on par with the industry overall box office average of 67%.

Product and other revenues decreased 11% from the prior year quarter and represented approximately 35% of total revenues. Domestic product revenues represented 66% of total product revenues, and international product revenues represented 34% of total product revenues.

Licensing gross profit was $25.1 million or 70% gross margin, which was relatively flat with the prior year quarter. Noncash depreciation expense, included in license cost of revenue, was $8.2 million, representing 23% of license revenue, up from $7.7 million or 21% of license revenue in the prior year quarter.

Excluding noncash depreciation and amortization expense, our pro forma license margin was 93% as compared to 92% in the prior year quarter.

Field support and related costs, including impairment expense of $1 million, included in license cost of revenue were $1.3 million, a decrease from $1.8 million in the prior year quarter, primarily as a result of our cost reduction plan.

Including impairment expense, total cost of license revenue increased to $10.9 million from $10.8 million in the prior year quarter. Product and other gross profit was $4.9 million or 25% gross margin compared to $1.7 million or 8% gross margin in the prior year quarter. The improvement was primarily due to glasses' cost reductions, as well as an increase in the recycled eyewear mix to 41% of domestic shipments for the quarter from 31% in the year-ago quarter.

Research and development expenses of $3.8 million decreased 32% from $5.5 million in the prior year quarter, primarily due to lower personnel costs as a result of our cost reduction plan and a reduction in the number of R&D projects.

Selling and marketing expenses of $5.8 million decreased 21% from $7.3 million in the prior year quarter, primarily due to reduced marketing expenses and personnel costs as a result of our cost reduction plan.

Included in selling and marketing expenses during the quarter were share-based compensation expense of $927,000, a decline of 30% from the prior year quarter; selling expenses of $1.8 million, an increase of 4%, primarily as a result of expansion into Russia, China and Brazil; consumer selling and marketing expenses of $177,000, a decline of 77%; and marketing expenses of $2.8 million, a decline of 17%.

General and administrative expenses of $12.3 million decreased 14% from $14.4 million in the prior year quarter as a result of lower personnel costs stemming from our cost reduction plan, as well as reduced outside service fees in sales and property taxes.

Total operating expenses were $21.9 million, a decrease of 20% from $27.3 million in the prior year quarter, reflecting the aforementioned benefits of our cost reduction plan. Share-based compensation expense included in operating expenses was $3.8 million, down from $4.3 million in the prior year quarter.

Total operating expenses. On a fully allocated basis, we estimate our investment in consumer visual technologies, which include both 2D and 3D products and applications, was approximately $3.7 million for the quarter, down from $7 million in the prior year quarter. Further, of the $3.8 million in total company-wide R&D expenses for the quarter, we estimate approximately $1.8 million was direct R&D spend on consumer visual technologies. This is down from the prior year quarter in which total company-wide R&D expenses were $5.5 million. And of that, we estimate approximately $3.9 million was direct R&D spend on consumer visual technologies.

GAAP operating income was $8.1 million versus $877,000 in the prior year quarter. Net income attributable to common stockholders was $5.5 million or $0.10 per share for the first fiscal quarter of 2015 versus a net loss attributable to common stockholders of $1.5 million or a loss of $0.03 per share in the prior year quarter.

Adjusted EBITDA was $22.9 million, up 43% from $16 million in the prior year quarter, primarily due to decreased overall operating expenses, as well as higher product and other gross margin.

Cash flow from operating activities for the quarter was $4.1 million, and total capital expenditures were $5.4 million, resulting in negative free cash flow of $1.3 million.

Turning to our balance sheet. As of June 30, 2014, cash and cash equivalents were $27.8 million, a decrease of $959,000 from last quarter. Total borrowings on our credit facility were $35.4 million, a decrease of $900,000 from $36.3 million in the prior quarter. As a result, net debt was approximately $7.6 million at the end of the quarter.

On June 26, we amended our existing credit facility with various lenders led by City National Bank. The amended agreement includes a revolving credit facility of $50 million, as well as a delayed-draw term loan facility of $50 million, of which $35.4 million has been drawn.

Now let's talk about box office metrics. In the first fiscal quarter, our license revenue of $36 million represented 4.6% of the $787 million in estimated worldwide RealD box office. The slight variation from our previously guided 4.5% is primarily related to the higher proportion of Chinese license revenue during the quarter, which is not accounted for in our box office results.

For modeling purposes, we still continue to believe 4.5% is an appropriate approximation of RealD's worldwide license revenue as a percentage of estimated worldwide RealD box office on an annual basis.

Taking into account all these aforementioned factors, we are reiterating and expanding on our annual guidance as follows. We continue to expect total operating expenses for the full fiscal year of 2015 to be in the range of $85 million to $88 million, which reflects an 11% anticipated year-over-year decline at the midpoint of our guidance range, and highlights the impact from our previously discussed cost reduction plan.

To expand on the components of our guidance for operating expenses for fiscal 2015, we anticipate the following. We continue to expect share-based compensation expense within total operating expenses of approximately $17 million, and depreciation and amortization expense between $9 million and $11 million. We expect share-based compensation expense and research and development expenses to be approximately $3 million. We expect selling and marketing expenses to be in the range of $20 million to $22 million.

Within selling and marketing expenses, we expect share-based compensation to be approximately $5 million, cinema selling expenses to be approximately $6 million and cinema marketing expense to be in the range of $7.5 million to $9.5 million.

We expect general and administrative expenses to be in the range of $45 million to $46 million. Within G&A expenses, we expect share-based compensation to be approximately $9 million, sales and use taxes and other miscellaneous taxes to be $6.5 million and depreciation and amortization expense within G&A expenses to be approximately $4.5 million.

In addition, we'd also like to highlight that on a pro forma basis, operating expenses, less sales and property and other miscellaneous taxes, as well as noncash expenses, such as depreciation and amortization and stock compensation within operating expenses, would be in the range of $51.5 million to $54.5 million, which reflects a 24% decline at the midpoint of our guidance.

And with that, we will open up the call for questions.

Question-and-Answer Session


[Operator Instructions] And our first question comes from James Marsh with Piper Jaffray.

Stan Meyers - Piper Jaffray Companies, Research Division

This is Stan in for James. I guess, a bigger picture question here first on China and Russia. Can you guys talk about the pace of expansion there that you guys expect over the next 12 months? I noticed you had added a couple hundred screens in China. Sort of what do you guys expect the pace to be over the next few years?

Andrew A. Skarupa

Yes. As you know, we signed a deal with Wanda -- and for which we doubled the footprint with Wanda, and we've been rolling out quite a few screens every quarter with Wanda, as well as others. We're doing somewhere around 125 to 150 screens per quarter in China, and we would expect that pace to continue. As well as -- as Michael pointed out, we've experienced tremendous growth in our license revenue, and that's primarily a result of the 125 to 150 screens per quarter in China, as well as the continued robust demand for 3D content. So we would continue to see that level of install pace.

Stan Meyers - Piper Jaffray Companies, Research Division

And then you mentioned R&D sort of declining, I think, 32% as a result of some cuts due to certain projects. Can you elaborate on what those projects are? And any of those that's discussed previously in the last call?

Andrew A. Skarupa

Stan, those cuts are the same cuts we talked about when we announced the cost reduction plan and reiterated our guidance last quarter. We're just expanding on our guidance to more granular detail to provide more transparency to our shareholders. Essentially, we just reduced the number of projects in the last fiscal year when we announced our cost reduction plan, and now we're realizing the full benefits of the cost reduction plans on a year-over-year comparable.


The next question comes from Ben Mogil with Stifel.

Benjamin E. Mogil - Stifel, Nicolaus & Company, Incorporated, Research Division

On the glasses front, so once again, we're seeing some margin there. Part of it, I think, is what you attributed to, is on the lower -- the higher recycling rate. Are you seeing any conversation with the studios around sort of them trying to get some of that back? And then secondly, I guess, sort of more in the first quarter -- first calendar quarter, I'm sorry, should be around the level you were talking about some of the incentives that you've been working on with exhibitors to sort of get 3D rates up. Can you talk anecdotally, statistically, however you want to look at it, about some of the wins and some of the challenges in that area?

Andrew A. Skarupa

Sure, Ben. So we reiterate that we'll continue to guide at breakeven on glasses, and we've really learned that the top program is in ecosystem approach. We're working with both the studios and the exhibitors on the marketing and promotion of a film, and we continue to offer financial incentives to the entire ecosystems. And part of it is through glasses, and we're seeing strong benefits there. If you want to use an anecdotal film, if we look at Godzilla, what we saw on Godzilla, we saw 45% 3D, which is a strong uplift from other comparable films, and 54% in the international markets. And again, that's a combination of really getting behind the film with the studios and exhibitors and the marketing and promotion of the films. And part of that is the financial incentives both on the glasses side and to the exhibitors. So that's one of the strong reasons why we continue to believe we should break even on glasses as well, as we did have successful recycle rates at 41% during the quarter on glasses.


The next question comes from Steven Frankel with Dougherty.

Steven B. Frankel - Dougherty & Company LLC, Research Division

Drew, could you start with what specifically were the take rates in the quarter domestically, internationally and in total?

Andrew A. Skarupa

Sure. We'll work backwards. In total, for the quarter, the 3D percentage was 41%. That's the worldwide total. The international average was 45%, and the domestic, 35%.

Steven B. Frankel - Dougherty & Company LLC, Research Division

Okay. And you used to talk about international rates that were significantly higher than that. What's changed in the last 12 months? Is it economic? Is it a maturity of the market?

Andrew A. Skarupa

Well, it's really hard to categorize international as an international market. It's just so different. First of all, we're approaching an industry standard of 67%. Now nearly 65% of our business is now international, and every country is so different. So we really have to talk about it separately. When you look at Russia, China, Brazil, Germany, no decline whatsoever. They continue to be robust. Plus, especially when you talk about Brazil, China and Russia, they're growth markets, and China will one day surpass the U.S. So we have to keep looking at it differently. In some of the southern European countries, we're definitely seeing economic hard times continue, which make it difficult on ticket pricing. We see challenges in Korea that we would like to work on in terms of ticket price premium relative to the consumer there, relatively high. So it's a different answer depending on each country. We also have the World Cup going on. So a lot of folks actually just didn't go to the movies. And then we also, as we all know, in the industry, had an overall challenging box office for this quarter year-over-year. So there's quite a different answers to that country by country.

Steven B. Frankel - Dougherty & Company LLC, Research Division

And what were those equivalent numbers last year?

Andrew A. Skarupa

So domestic went from 37% to 35%, and we're seeing that stabilization. Again, international on a broad basis 51% to 45%, and then so grand total, 44% to 41%.

Steven B. Frankel - Dougherty & Company LLC, Research Division

Okay. And what do you expect to get out of this LUXE initiative? Do you expect to see higher take rates kind of sort of stick in markets where you have LUXE theaters?

Andrew A. Skarupa

The answer is yes. RealD's mission is to perfect the visual image, and as we've talked about in research and development activities, to meet that mission, in terms of perfecting the visual image, both in 2D and 3D applications, and we just want to bring a better value proposition to the exhibitor and consumer. And the overall intent is to really move that consumer public to that premium space, and we're seeing that the consumers really demand that premium experience and are willing to pay for it. So the goal for RealD is to continue to expand that business line. And we -- as Michael talked about it in his comments, we see opportunities in markets beyond Russia to expand the business, which generates a higher return to RealD at the end of the day in terms of return on investments. So our plan is to expand beyond Russia over time.


[Operator Instructions] Our next question comes from Eric Wold with B. Riley.

Eric C. Wold - B. Riley Caris, Research Division

Two questions. I guess, one, kind of thinking about your capital allocation, we're seeing the allocated spend towards these new initiatives decline from last year. Your expectation is that, in order to be commercially available next year, start generating revenue against that spend. And the core business is stable and producing some solid cash flow. At what point does it become more likely that you'd want to use some of your cash and cash flow towards a buyback, when you feel more comfortable kind of bumping that up?

Andrew A. Skarupa

Well, Eric, that's a good question. And we've recently renewed our credit facility, which allows us to do a buyback, and we'll continue to explore that. We're constantly looking at our capital allocation, our expense levels and really determining what's the right allocation on both the income statement and the balance sheet. We made no announcements, as of today, on any type of buyback, but we continue to evaluate all our options.

Eric C. Wold - B. Riley Caris, Research Division

Okay. And then second question. Thinking about China and the opportunities there, as the data becomes more available and -- using either RenTrak or others, do you feel more comfortable with what is coming out of that market in terms of box office in a real-time basis and can accept the data coming out? Does it make sense or can you switch towards kind of the same kind of $0.50 per ticket model as you have in other parts of the world? Would that be more advantageous? Do you feel that -- are you -- have you done the math in terms of are you leaving money on the table for the model you have now had you switch to that other model?

Andrew A. Skarupa

The answer is yes, we have actually switched to that model. We don't disclose any specifics of any deal with any of our customers worldwide, but we have moved to that model with exhibitors. We have gotten comfortable from terms of box office reporting and other corroborative evidence to support our royalty reporting. So the answer is yes, and we've developed kind of win-win economic propositions with the exhibitors throughout. So that's the other reason why we experienced tremendous growth. In China, as a result of local indigenous content, we're benefiting from our royalty model there as well.

Eric C. Wold - B. Riley Caris, Research Division

And last question. At what point would the reported box office begin to include China?

Andrew A. Skarupa

We're getting closer. We worked with third-party reporting services. I think one of my answers to Steve Frankel's question -- actually, just to bring that back, those numbers do not include China 3D percentages. So the overall percentages are actually higher if we would have included China, Steve. But Eric, to your question, it's soon. We're not the third-party reporting entity who gathers that data and reports it, but they are getting extremely close. And at some point in our monthly box office reporting, we will include China, and we will then relook at that 4.5% guidance when we get there. So stay tuned. Can't make any promises on dates because we rely on other parties, but we are seeing a closer trend there.


There are no additional questions at this time. I would like to thank everyone for their time and participation today. This concludes today's conference call, and you may now disconnect.

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