IMMR - NASDAQ

Jennifer Jarman - Director, The Blueshirt Group Carl Schlachte - Chairman & Interim CEO Nancy Erba - CFO & Principal Accounting Officer

Charles Anderson - Dougherty & Company Anthony Stoss - Craig-Hallum Capital Group Michael Nichols - B. Riley FBR, Inc. Robert Katz - Senvest

Good day, and welcome to the Immersion Corporation First Quarter 2018 Earnings Call. Today's conference is being recorded. At this time, I'd like to turn the conference over to Jennifer Jarman. Please go ahead, ma'am.

Thank you, Celestina. Good afternoon, and thank you for joining us today on Immersion's First Quarter 2018 Conference Call. This call is also being broadcast live over the web, and can be accessed from the Investor Relations section of the company's website at www.immersion.com. With me on today's call are Carl Schlachte, Interim CEO and Chairman of the Board; and Nancy Erba, CFO. During this call, we may make forward-looking statements, which may include projected financial results or operating metrics, business strategies, litigations, anticipated future products, anticipated market demand or opportunities and other forward-looking topics. These statements are subject to risks, uncertainties and assumptions. Accordingly, actual results could differ materially. For a listing of the risks that could cause this, please see our most recent Form 10-K filed with the SEC as well as the factors identified in the press release we issued today after market close. Additionally, please note that during this call, we may discuss non-GAAP financial measures. For each non-GAAP financial measure discussed, a presentation of the most directly comparable GAAP financial measure and a reconciliation of the differences between the non-GAAP financial measure discussed and the most directly comparable GAAP financial measure is available in today's press release. With that said, I'll go ahead and turn the call over to Carl.

Thanks, Jennifer, and thanks, everyone, for joining us this afternoon. I'm very pleased to be speaking with you this afternoon. As we are about to recognize the 25th anniversary of Immersion this month, it seems fitting that today, we announce record revenue of $85.4 million for our first quarter of 2018. At the heart of Immersion is our passion for innovation. This core tenet touches every employee of the company and permeates our work each day. Today, we are pleased to count among our customers some of the most influential and innovative leaders in the mobile, gaming and automotive markets, yet we are just beginning to see the breadth of haptics implementations that are possible across these varied markets. As a reminder, in December, we announced the restructuring of the company, and we have refocused our strategy and investments on our core competencies in the mobile, wearables, gaming and automotive markets. Within the mobile market, we remain steadfast in our commitment to reach all major mobile OEMs with our cutting-edge haptic technology. As Apple is now our customer, the largest opportunities remain with global head -- customers headquartered in Asia. We're in discussions with several of the leading Chinese OEMs and are optimistic about our ability to work with them to provide their customers with an excellent haptic experience. This optimism stems from important trends we see in the haptic ecosystem today. According to IDTechEx, market adoption of high-definition-capable actuators will almost double this year, and that trend is not expected to slow down. The semiconductor technology driving those actuators is increasing in performance and capability. And most importantly, haptics use cases enabled by emerging technology have become more sophisticated and are being adopted by leading mobile OEMs. In the wearables market, recent industry news has highlighted the importance and value of having haptics as an integral component of smartwatches and fitness health bands. Although this market has tended to be very disparate with many players, we are confident in the value of our technology and look forward to opportunities for partnerships with new customers in 2018. Turning to the automotive market. We continue to be very pleased with the growth we are seeing, both in terms of existing customer traction and the signing of new licensees. Today, we have the leading Tier 1 suppliers to the automotive market as our customers, including ALPS, Continental, Marquardt, and most recently, Bosch and Panasonic. Haptic implementation in cars is compelling today, both in terms of cost reductions for the automotive manufacturers but also as a means to reduce driver distraction. The gaming market has historically been an earlier adopter of Immersion's haptic technology. We have demonstrated the value of haptics with platform customers like Nintendo; and controller customers like Logitech, BDA, Guillemot and PDP. Today, this market is moving to the next generation of haptics in VR, and we are having meaningful discussions with innovative leaders in virtual reality, both at the platform and controller lever, which we know will benefit from our technology in bringing VR games to life. In front of us also lies augmented reality. Immersion's history is built upon the ability to innovate ahead of the market, and this continues to be one of our core competencies. The work our team is doing today is positioning us for future haptic implementations that live in our imaginations, whether they be industrial, technological or gaming use cases. As you can tell, across all of our core markets, we continue to see meaningful opportunity to expand our roster of customers, build upon our revenue base and add shareholder value. I'll now turn the call over to Nancy to discuss the financials, recent accounting changes and an update to our outlook for 2018.

Thanks, Carl. First, I invite you to refer to this afternoon's press release for information I have historically shared verbally, with tables including revenue by market as well as noncash charges included in operating expenses. As Carl said, my focus today will be on the adoption of ASC 606, a brief update on the impact of the tax reform act and an update to our outlook for 2018. Our record revenue of $85.4 million for Q1 reflects strong performance in our mobile line of business as well as growth in automotive, stemming primarily from new customer agreements executed during the quarter. The adoption of ASC 606, had a significant impact on the way revenue was recognized for these contracts. We adopted ASC 606 on a modified retrospective basis as of January 1, 2018, so a comparison of our current quarter results to the same quarter a year ago is not particularly meaningful. I refer you to the income statement comparison table included in today's press release, which shows the impact of our adoption of ASC 606. As we discussed on our year-end call, we anticipated the adoption of ASC 606 would have a significant impact on revenue recognition for our fixed license fee arrangements. Prior to adoption, we typically recognize these fees ratably over the term of the arrangement. Under the new revenue standard, we must determine whether a fixed license fee is related to technology or patents delivered upon execution of the arrangement and/or whether the fee also relates to technology or patents to be delivered over the term of the arrangement. In most cases, our fixed license fee arrangements will have an element of both, and we will have to allocate the fixed fee to each obligation on a fair value basis. The fee allocated to technology or patents delivered upfront will be recognized as revenue in the period the agreement is executed. The fee allocated to the ongoing obligation will be recognized ratably over the term of the agreement. As a result of this change in revenue recognition, we expect our fixed license fee revenue could fluctuate dramatically depending upon the timing of execution of new fixed license fee arrangements, as we saw in Q1. Despite our expectation that we may continue to see lumpiness in our reported revenue, we do not plan to let accounting treatment drive our business decisions. Our approach will continue to be made -- our approach will continue to be to make the right decisions for the business and structure new agreements in a way that makes the best commercial sense on a case-by-case basis. Turning to operating expenses. We are seeing the impact of the restructuring activity we undertook in December as our operating expenses decreased 31% compared to the same quarter last year. We have sharpened our focus on key markets and initiatives, which combined with the reduction in litigation expense now that the agreement with Apple has been reached, enable us to operate effectively at this reduced level of operating expense. Moving on to the tax reform act. We continue to assess the impacts of various components of the act, including impacts related to the global intangible low tax income, or GILTI; and foreign-derived intangible income, or FDII, provisions. We have made a reasonable estimate of the effects of the act for Q1. However, these estimates did not have a significant impact on our current quarter provision expenses due to the fact that we have a full valuation allowance against substantially all of our deferred tax assets. We will provide updates throughout the year as our evaluation of the act's impacts continues. In parallel, we will continue to assess factors related to the realizability of our deferred tax assets to determine if or when an adjustment to our valuation allowance is appropriate. As a reminder, the valuation allowance does not impact our ability to utilize our deferred tax assets, including in net income loss carryforwards. GAAP net income for the quarter was $69.9 million or $2.29 per diluted share. Now to address our balance sheet. We are very pleased with the strength of our balance sheet. Our cash portfolio, including cash and short-term investments, was $139 million as of March 31, 2018. We are confident in our liquidity position and plan to closely manage operating expenses in order to preserve a healthy cash balance. As we look forward to the remainder of 2018, we will continue to be pragmatic and carefully monitor our cash balance and stock price as well as market conditions and strategic factors as we consider any nonoperational uses of cash, including future buybacks of our stock. I'd now like to provide an update to our guidance for 2018. As I mentioned earlier, with the treatment of certain of our fixed fee agreements, revenue in Q1 under ASC 606, the success in licensing new customers in the automotive market and the strength of our pipeline as we see it today, we have upwardly revised our expected 2018 revenue range to be between $108 million and $118 million. As a reminder, this outlook is independent of any possible litigation outcome. For expenses, we continue to estimate litigation expense between $8 million and $10 million for 2018; GAAP operating expenses of $47 million to $49 million, excluding litigation; and stock-based compensation of between $7 million and $8 million for the year. Due to the full valuation allowance, we are forecasting cash tax expense going forward to be approximately $300,000 for the year. As a reminder, we define non-GAAP net income as GAAP net income adjusted to reflect cash tax, less stock-based compensation. We now expect non-GAAP net income to be between $59 million and $67 million for 2018. I'd like to share some additional color around our ongoing business model. We anticipate the back half of the year, excluding any resolution to current litigation, to fluctuate depending upon the time and structure of new contract agreements. That said, we believe our business model is one that allows for long-term cash generation, and we would expect post-litigation resolutions to be in a position to demonstrate sustained positive cash flow. I will now turn the call back over to Carl.

Thanks, Nancy. In closing, we are very pleased with the progress Immersion has made these past 6 months. By nearly any metric, our business is healthier this year than it was last year. While we still have work to do, our restructuring and renewed focus on our underlying fundamentals is showing strong early returns. We remain confident in Immersion's continued ability to monetize our technology across the span of the macroeconomic trends that we see happening right now in the haptics ecosystem. The intellectual property we are licensing now is a result of Immersion's innovation dating back many years. Our Q1 results can be seen as a beginning of the wave of compelling haptics use cases we foresaw with our first patent filed 25 years ago in 1993. We are on the verge of a wider-scale market adoption of haptics, and our ability to demonstrate the value of our technology -- the value our technology brings to our customers, our shareholders and to the technology landscape. We'll now open up the call to your questions. Operator?

I may want to start with -- wondered if there were any 10% customers in the quarter. And if you had any, what the percentages were by some of the 10% customers?

Sure. We have not broken out the 10% customers for the quarter. But I think it's pretty clear that there are a number of customers who made up a significant portion of the revenue, and we'll be highlighting a little bit more of that in the Q. But you can suffice it to say that a couple of customers were representative of the majority of that revenue.

Okay, got it. And then just understanding the term of some of the deals you guys are signing, I mean you've highlighted several that you signed here and as you looked out more over the course of the year. I wonder if you can just walk us through sort of your philosophy there, measures of what you've done and when you intend to do in terms of how long you want to sign people up for?

Well, I think traditionally, we have negotiated agreements that were shorter in term. We have been pretty vocal over the last year in saying that we would like to see people reach agreements and negotiate agreements that are longer term in nature. Some markets, like automotive, that has been something that has been pretty easily -- easy to achieve because both sides want to have that ongoing relationship for an extended period of time. Our objective is, of course, to be able to provide a view that can demonstrate sustained profitability over the coming years, and having longer-term agreements certainly helps us in that. So that's something we'll look to continue to achieve.

Charlie, it's Carl. Yes, I was just going to reemphasize that. The longer-term agreements are, we believe, better for us especially with the way that our business works, and the way we see it working in the future. So we're moving as many of our contracts or discussions into that realm as we possibly can.

Great. And then last one from me, just the upside in the guidance relative to a few months ago. I wonder if you can maybe just walk us through what changed roughly.

Sure. At the time we gave our guidance for the year, recall, we had pretty recently signed the agreement with Apple. And over the past several months, we've gotten a lot more clarity in terms of how that revenue would be recognized, what portion would be impacting Q1, what portion for the full year, and then what is recognized over time. In addition to that, we had several agreements that were executed in Q1 that I think came in a little bit earlier than we had originally thought. And as we look at our pipeline of customers in front of us for the rest of the year, we feel very good about being able to increase the range to the $108 million, $118 million level.

Got it. If you don't mind just to put a final point in it. In terms of what you were thinking you were going to do in Q1 versus the rest of the year, did that change relative to a few months ago?

Yes. Operator We'll take our next question from Anthony Stoss from Craig-Hallum.

Nice to see the auto business really growing. I'm curious, Carl, if you can comment about how far you think you're penetrated into that market. What other use cases there might be for Apple? And then not too long ago, you were talking about you got high hopes on landing one or more China smartphone vendors by the end of this calendar year. Curious, your thoughts or any updates on that.

Okay. So yes, so in automotive, I think we've done a good job in penetrating a good number of the Tier 1s. That doesn't mean our job there is done though. I think the use cases there end up to be -- end up being very compelling. As we mentioned in the script, there's a whole thing around reducing distraction for the driver and getting confirmation when you're keeping your eyes on the road. That ends up being very important. Additionally, this whole activity around removing buttons and physical things from the car, yet wanting to replace that activity with something that gives feedback, is something a lot of the Tier 1s, a lot of the automotive guys are working on right now. So we see not only additional opportunities within the customer base in terms of just the number of licensees that we can bring on, but also additional activities within each of the developments that we're doing with the automotive guys, if that makes any sense.

Then on the China smartphone side.

On the China smartphone side, we continue to see -- I can't get too specific there but I can tell you that we're seeing very good activity with the Chinese OEMs that we're talking to. I think bringing in big players, such as Apple, has certainly renewed a lot of folks' interest in the way that their technology is perceived in that space. So all I'm going to tell you is kind of watch how we do through the balance of the year.

And we'll take our next question from Josh Nichols from B. Riley FBR.

I wanted to ask, looking at the remaining 3 quarters for 2018, how should we be thinking about the percentage split between fixed and variable revenue given the guidance range?

Good question, I think. I think you should see -- again, it was going to depend on what gets signed this year. So if we have additional fixed fee agreements that come in, in the remainder of the year, obviously, those will be additive, too. But I would expect the balance to be sitting in ratable in terms of the per-unit royalty. And depending upon how contracts are agreed to in the coming months, that's probably where you're going to see the majority of the revenue.

Okay, and then any, I guess, expected -- since most of the payments are going to be ratable, that we have variable license fees, any seasonality to take into consideration with the adoption of ASC 606 looking in the next two -- couple of quarters?

Yes. Traditionally, because we have the recognition of revenue 1 quarter and arrears with gaming in particular and to some extent, mobile, we saw Q1, Q2 a little bit heavier. I would expect to see that pulled into the Q4 time frame just that -- given that we'll be estimating shipments in the quarter in which they occur for the -- for that portion of our revenue. So I would look to Q4 to be a little bit heavier.

And then you mentioned this, I think, on the -- this call and in the last call. The company has a pretty impressive war chest at this point, and you mentioned that you're monitoring the stock price. I mean, how are you thinking about executing potential buyback? And what are the board's thoughts as far as levels that, that might be executed at?

Yes. I don't really want to get into specifics around levels or things like that. But I would say that we just completed the first quarter, we just completed a whole series of activities around restructuring, and we're looking at how the business operates under that basis. We're also getting used to how the new accounting standard is flowing into our thinking about our revenue going forward. So when we look at all that, we think it's appropriate to be a little bit cautious as we go into the forthcoming couple of quarters. That being said, we understand that there's a question around the uses of cash. I guess, my point would be as a board and as a management team, we're trying to be as pragmatic and cautious as possible as we look at the use of that cash during the course of the year.

And then last question for me, and then I'll hop back in the queue. So with the adoption of ASC 606, obviously, outsized cash generation in the first quarter. But how should we think about the relationship between earnings and cash flow for the remaining quarters, assuming there's no large fixed contracts that are signed?

I think you would consider it as we have historically. We don't have large CapEx, so cash flow does tend to mirror pretty closely our EBITDA. So I think that's a fair analysis to do, similar to how the company has been restructured in the past. Operator [Operator Instructions]. And we'll take Eric Sterling from Senvest.

This is Robert Katz. I have a question about the CEO -- status of the CEO search. And where is that today? And I have a follow-up question.

Okay. So this is Carl. Robert, the search -- I think we mentioned this on the last call that we have a nomination and governance committee that's undertaking a process to look at CEO candidates. We've been looking at them. We've interviewed them, and that process is ongoing as we speak.

Okay, great. I look forward to further updates on that. A question about the IP that you have. Have you licensed any of Immersion's IPs that's directly focused on AR or VR to any of your customers yet?

No. I mean, we have not yet announced. We are in discussions, certainly, with some of the leading innovators in VR and AR. But we have not yet announced any new agreements in that space.

How would you size that opportunity for the company?

I'll give mine, and then Carl can comment. I think VR, right now, if you do just kind of the search around the different analysts, whether they be Gartner or others, seems to be primarily focused on entertainment. So think about that along the gaming front. And as that -- as there are new transitions in gaming, certainly, VR will grow there. But I would say that it would be a traditional market for us and traditional market size. I think AR probably has a much larger opportunity just because it crosses so many different industries, whether that be industrial or manufacturing, retail, et cetera. So that's all in front of us. And I think that market is probably a little bit further out. But as Carl mentioned, that's why it's so important. The innovation that we're doing today focused in that area will serve us well into the future.

Yes, I agree with everything Nancy said. The caveat, I was going to put around your question, Robert, was I think when we size the market, we really size it based on where we -- the timing of it. Is it going to be -- is this something that we see is going to be very active for us this year? Yes, probably from the standpoint of our internal development activities and the types of discussions that we're engaged in with third parties. Probably no from a revenue standpoint for us this year. That being said, the stacking for us kind of looks more like -- if you think of VR as more analogous to the kinds of things we saw in gaming, that we might see that first and then AR a little bit behind it.

And do any of these plans supply to the mobile market as well?

Without getting into too many deep specifics here, I think there's a trend in the mobile market to use the handset as, I'll say, a way of interacting in an AR sense. So in other words, you're looking at the screen, and you're using -- you're looking at your mobile handset screen, and you're using that as an augmented reality device. So from that standpoint, we've been careful about the way that we've developed intellectual property in that space. And I think that's all I want to say about that on that front. Operator [Operator Instructions]. And there are no further questions. I'd like to turn it over to management.