IMMR - NASDAQ

Good day, and welcome to the Immersion Corporation Third Quarter 2018 Earnings Conference Call. Today's conference is being recorded. And at this time, I'd like to turn today's conference over to Ms. Jennifer Jarman of The Blueshirt Group. Please go ahead, ma'am.

Thank you, Carrie. Good afternoon, and thank you for joining us today on Immersion's Third 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 Tom Lacey, interim CEO; and Nancy Erba, CFO. During this call, we may make forward-looking statements, which may include projected financial results or operating metrics, business strategies, litigation, 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-Q 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, our 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 will now turn the call over to Tom.

Thanks, Jennifer, and thanks, everyone, for joining us on the call. Or for those listening later on the website replay, thanks for joining us. We're very pleased to report our results for Q3 2018. As you will hear from Nancy and I, things are progressing well within the company. Before getting into the details of our business, given this is my initial conference call, I want to take the opportunity to share my observations on the company, specifically the people, organization, technology, patent assets and legal matters. To summarize, I like what I see so far. After I share my observations, Nancy will provide an update on our financials, followed by me providing an update on operational business, including legal matters, before turning the call over to the operator for questions. First of all, I'm very pleased to be on the board of Immersion. I'm equally pleased to be the Interim CEO, helping to get the company properly engaged and focused on the many substantive and exciting opportunities ahead. My timing of joining is good as we started and are making excellent progress on our multiyear strategic plan that we will review with the board in December. As many of you know, prior to Immersion, my most recent CEO job at Tessera, now called Xperi, included both technology and IP monetization. Thus, I am quite familiar with the markets and space where Immersion operates. I am pleased and pleasantly surprised with the internal state of the Immersion operations. The senior management team has done a very solid job keeping things moving forward, and I have a high degree of confidence in the internal management team. Similarly, the Immersion employees are very talented and long tenure is commonplace throughout the company. This is especially true in a technology organization, where we have a great deal of world-class haptics expertise. A recent completed internal survey indicated that literally 100% of employees truly care about Immersion. There's a sincere internal passion for the company, which continues to be extremely valuable as it has helped the employees stay focused on our business during the ongoing CEO search. Let me touch briefly on the technology of the company. We are unequivocally the leaders in haptics technology. Our experts have done and continue to do a fabulous job of looking far into the future to identify, develop and patent future haptics needs and opportunities, which has resulted in a very broad set of haptics inventions and intellectual property. In order to help our customers ramp world-class haptics into their products, our talented team expertly applies our system architecture and haptics know-how in the form of software development kits, reference platforms and demos. Let me now provide my observations on the legal front. Legal matters ultimately depend greatly on the overall strength of the company's patent assets. Recognized externally and validated internally, our haptic patent assets are simply rock solid. As one example of the strength of our portfolio, in my short tenure, I've been pleasantly surprised how many companies have proactively reached out to us for engagement in licensing conversations. As another example of the strength of the more than 3,200 issued and pending patents in our portfolio, we ranked second in the 2017 IEEE patent pipeline power in the computer peripheral category and 15th overall. Impressive rankings for any company, let alone one of our size. Our patents are frequently cited in other patent filings, demonstrating further proof that our patents are foundational. In layman's terms, Immersion's years of innovation and development of haptics technology have created a broad and deep world-class patent portfolio that is virtually impossible to replicate. With that, let me turn it over to Nancy, who will give us an update on the financials

Thanks, Tom. Let me begin by referring you to this afternoon's press release for information regarding our Q3 financial performance, including tables that illustrate the comparison of our revenue for the third quarter to the same period a year ago, highlighting the impact of our adoption of ASC 606. Our revenue of $8.6 million for Q3 2018 was down 28% from revenue of $11.9 million in the year-ago period. As we have discussed in previous calls, we adopted ASC 606 on a modified retrospective basis, so a comparison to the same quarter a year ago may not be particularly meaningful. If you refer to the table, which depicts revenue on a comparable basis under ASC 605, you will see revenue from per unit royalty arrangements was down $600,000 or 13% compared with the prior year quarter, reflecting declines in reported royalty bearing shipments by medical, gaming and mobile licensees, offset in part by an increase in royalty bearing shipments reported by automotive licensees. Revenues from fixed licensee arrangements were down 45% on a comparable basis, primarily due to a nonrecurring fixed license fee from a mobility licensee recognized during the third quarter of 2017, offset in part by license fees from new customers, including Fitbit, recognized in the third quarter of 2018. For the 9 months ended September 30, 2018, total revenue of $100.1 million increased $72 million or 256%, compared to the 9 months ended September 30, 2017. This increase was primarily attributable to a $70.8 million increase in fixed license fee revenue. As we discussed in our previous calls, the treatment of fixed fee arrangements under ASC 606 is expected to drive lumpiness in our results and contribute to the lack of comparability with prior year results. I am pleased to see positive trends in our pipeline, with new customers and even new markets being added by our sales team onto our list of future revenue opportunities each quarter. This expanding pipeline demonstrates the value of our IP as well as the expanding adoption of haptics. Turning to operating expenses. We continue to see the impact of the restructuring activity we undertook in December 2017. This, coupled with the reduction in litigation expenses due to the settlements with Apple and Fitbit, results in operating expenses for the third quarter being down 21% from the year-ago quarter. For the 9 months ended September 30, 2018, operating expenses were down 29%. We are pleased that our focus on operational excellence has enabled us to effectively manage the business and that we continue making progress on key initiatives, while tightly managing discretionary spend. Moving on to income taxes and the effects of the Tax Reform Act. We have made a reasonable estimate of the effects of the act for the third quarter and the 9 months ended September 30, 2018. But as discussed on our call last quarter, the impact of the act is not significant due to the full valuation allowance we carry against substantially all of our deferred tax assets. We 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 net operating loss carryforwards. GAAP net loss for the quarter was $4.6 million or $0.15 per share. GAAP net income for the 9 months ended September 30, 2018, was $57.5 million or 1 point -- $1.83 per diluted share. Non-GAAP net loss for the third quarter of 2018 was $2.2 million or $0.07 per share. Non-GAAP net income for the 9 months ended September 30, 2018, was $63.9 million or $2.04 a share. Looking to the balance sheet. We continue to place tremendous emphasis on maintaining the strength of our balance sheet. Our cash portfolio, including cash and short-term investments, was $130.5 million as of September 30, 2018, up from $46.5 million at the end of 2017, primarily due to cash generated from operations. We remain vigilant in our focus on cash management and continue to closely monitor discretionary spend to ensure utilization of cash is aligned with key strategic initiatives. This could include buyback of stock or any potential asset acquisition. As always, we would take into consideration the ROI on any such cash usage. In light of current and recently completed contract negotiations, we have refined our 2018 outlook to take into consideration the expected structure of these contracts. We now anticipate lower amounts of fixed fee minimums than initially forecasted, which we expect will result in a higher proportion of revenue recognized over time as the licensee's sales occurs. More per unit revenue recognition should enable better predictability and higher per unit rates. Given this, as we enter the final 2 months of the fourth fiscal quarter, we have better visibility to our anticipated financial results and are narrowing our annual revenue guidance to $108 million to $111 million. This range reflects our expectations regarding the timing and structure of new customer agreements and the related revenue treatment under ASC 606. I would, however, like to add that we have multiple opportunities under discussion, which could enable us to exceed the high end of this narrowed range. Regarding our expense outlook for 2018, we now expect GAAP operating expenses, excluding litigation, to be between $47 million and $49 million. Litigation expenses of $9 million to $10 million and stock-based compensation expense of $8 million to $9 million for the year. Due to the full valuation allowance, we are forecasting cash tax expense for the year to be approximately $300,000. As a reminder, we define non-GAAP net income as GAAP income adjusted to reflect cash tax less stock-based compensation and restructuring expenses. We now expect 2018 non-GAAP net income to be between $59 million and $64 million for 2018. Finally, we would like to emphasize that our outlook is independent of any additional possible litigation outcomes currently ongoing in our largest mobility line of business. We continue to believe post-litigation settlements, our current business model positions us well for operations that generate sustained positive cash flow in the future. I'll now turn the call back to Tom for further comments on our operations.

Thanks, Nancy, very well done. Now I'll provide an update on operational events during the quarter. Early in the quarter, we announced an agreement with Fitbit that was important to us as we have now set a baseline in the wearables market. We're in discussions to license others in the wearables market, comprised of smaller and more numerous potential customers. In automotive, as we announced earlier this week, we're extremely pleased to have signed a new agreement with Preh, a leading supplier of human-machine interface solution for automobiles, and a preferred partner for renowned OEMs in the field of haptics feedback, including Audi and others. With the addition of Preh, making our sixth automotive license signed this year, we are confident this is a fantastic market opportunity for us. Our current customers are comprised of important Tier 1 providers, driving haptics capability into premium cars. We've earned this significant customer penetration because of our know-how and because of our strong recognized position in the haptics market with foundational intellectual property. With accelerating momentum -- you like the car analogy there? With accelerating momentum, we plan to continue to focus our efforts in licensing all suppliers into the burgeoning automotive market, where features that start in premium vehicles ultimately waterfall into the mid-range and entry-level segments, thereby, dramatically increasing volumes and corresponding revenues. We're very excited and confident about our growth prospects in automotive in the coming quarters and years ahead. As a new initiative, during the quarter, we've explored and begun discussions with several driver IC manufacturers as potential channel for our technology in China and other places around the world. Although early in the process, there's substantial interest from this channel in part because of the breadth of our know-how related to haptics implementation, and in part due to the market acknowledgment of our broad patent portfolio as haptics capabilities are increasingly important to their end customers. If successful in this initiative, which we fully expect, this will likely prove to be a very efficient and important distribution channel for our technology and inventions into the mobile, wearables, IoT, computing, gaming and other markets. Lastly, I'll provide an update on our legal matters with Samsung and Motorola. It was a good quarter for us on a legal front. We've made significant progress in our litigation against Samsung and Motorola, with favorable claim construction decisions. As I noted earlier, I have great deal of familiarity with IP monetization business. Filing a lawsuit is always a last resort for me personally, and the Immersion board and management share this view. However, if we can't reach agreement with our customer on fair value, we'll ultimately let the courts decide. As you're probably aware on any IP legal matter, it is critically important to understand the underlying patent strength and to assess the overall strength of the case. Since assuming the Interim CEO role, I've been able to do a deep dive into the merits and patents involved in our cases against Samsung and Motorola. I remain confident in our position in both cases. As always, I'm hopeful fair settlements can be reached, but if necessary, we're fully prepared to continue down the legal path. Mediation with Samsung is scheduled for later this month, and a trial is scheduled for May 2019 in the United States. For Motorola, we recently had a settlement conference, and trial is scheduled for September 2019. For additional details on case timelines and recent events, I'll refer you to the legal proceedings section of our 10-Q, which will be filed tomorrow. In summary, I hope you can sense my optimism about the company. Our leadership in haptics and the strength and breadth of our portfolio is recognized worldwide across numerous and important markets, which will help fuel the company's growth. With that, now let me turn the call back over to Carrie so that Nancy and I can take any questions. Carrie, over to you.

[Operator Instructions] And our first question will be from Charlie Anderson with Dougherty & Co.

So I wanted to start with the sort of -- the change in the guidance, just the mechanics around the structure of the new deals, was that an Immersion-driven endeavor? Was that a customer-driven endeavor? Kind of what end markets are we talking about there? And as we look at that Q4 amount, does that sort of become a baseline to those new deals? Are they incorporated on there, sort of run-rate basis in the Q4? And then I've got a follow-up or 2.

Sure. So these were primarily auto deals, where we had anticipated originally, earlier when we were setting our guidance, that we would be coming to a higher level of minimums upfront. As part of the discussions with the customer, I can't say it's ours or theirs. I think it was mutually reached, the agreement, and some that are currently in conversation where it looks like there'll be more per unit, which means likely higher rates and more predictable over the license term. So I would say we're happy about it. It just -- sometimes, as you're in these discussions, they evolve and took a turn that was a little bit different than we originally expected. So as far as run rate, Q4 we'll see some, but I think you'll see that even growing as there are other customers that are still in discussion with this type of framework that would lead to those likely taking place either in Q4 or likely into Q1 of next year.

Great. And then, Tom, a question for you, in terms of licensee in the mobility market. From your perspective, how much of that is dependent on the outcome in Samsung versus not? How crucial is that? Maybe just your view on kind of the lay of the land, mobility generally and kind of where you stand with Samsung. And I've got one more follow-up.

Yes. So as you know, we reached an agreement with a very large cellphone provider earlier this year. And a lot of people were watching that. I think is the way I think about it, I thought about it from the outside and I think about that from the inside too. So does that help in additional conversations? Absolutely, definitely helps. And as I mentioned specifically with respect to Samsung, I really like -- I think we have a strong case there. I said it multiple different ways, that's what I said. Again, if we have to go to trial in May, we will. We're prepared to. If not, we can reach a settlement, that would be great, too.

And then lastly for me, just on the buyback...

With respect -- let me -- one other thing, Charlie, I'm sorry you didn't finish the question. With respect to mobility, the rest of the market, I think the simplest way to think about it is China, and I think there's multiple ways to pursue that, whether it's direct to some of it -- direct licensing discussions and technology engagement discussions with some of the -- primarily 2 big guys there, and/or through this driver IC channel that I talked about as an initial engagement here this quarter. So pretty excited about kind of multiple -- way I think about it is multiple prongs into trying to get the Chinese mobility market licensed. Nancy, do you have anything?

No.

Okay.

Yes, and then just in respect to potential buyback activity, it sounded like something you're open to in terms of what you do with the strong balance sheet. I wonder is there anything standing in your way. The common question we get from investors in terms of why you guys haven't repurchased shares, just any additional color on buyback generally would be helpful.

Yes, I mean, we are always open and looking to the best use of the cap. As you can imagine, earlier in this year and with litigation expenses, we were holding on to cash pretty tightly. We're still going to manage it very, very frugally, I'll say. But we are absolutely watching what's happening with the stock, and we'll evaluate any buybacks based on that, and also coupled with what else we have going as a company, right, and what the best uses of that cash is. We're always evaluating the market both from a stock perspective and also, as we mentioned, looking at potentially acquiring different assets that may be available. And if something comes up with a good ROI, we're also open to that.

[Operator Instructions] And our next question will be from Josh Nichols with B. Riley FBR.

Yes. I was going to ask, I mean things are progressing on the Samsung front, but I haven't heard much. Any update you could provide? I know you're also pursuing litigation in China. Any additional details that you can talk about on that front?

Yes, on Samsung overall, I think -- the way I think about these things in general, when -- without getting specific, we have nondisclosure agreements in place, obviously, and confidentiality that you have to respect and honor. But if I step back and if you think about any kinds of matters of this magnitude, you would expect that there would be dialogue between companies. You just -- that would be something you would normally expect. With respect to the China matter, it was originally scheduled for trial later this year in this calendar year, and our desire is to wait for what they call results of what they call invalidity matters. And so we decided to push that a bit.

Okay, so that's going to be more like a '19 situation, I guess. But is there a date on the books or no?

No. Yes, and no. Yes, you're right, like early '19, and no, there's not a date.

Got it. And then with a little bit more of a shift back to variable payment structures as opposed to fixed, how should we think -- how material would the seasonality impact potentially be? I know historically, like Q4 or Q1 has been a bit more seasonal than other quarters, just trying to think how to work through it as far as the model goes?

Yes, and I should -- so this isn't a matter of fixed versus variable, the contracts that we were discussing, if you recall, some of our auto deals have minimum structured into them. So you recognize that minimum amount in the quarter in which the agreement is signed. So this would be more that they would be more per unit in -- at the higher rates going over time. So it's not a shift from fixed to per unit. They were always per unit. It was a matter of how much would be negotiated as a minimum upfront. That said, that's the auto business, and so we'll follow auto cyclicality. Certainly, gaming more cyclical in the December quarter. We will now be estimating the unit shipments in the quarter in which they occur versus 1 quarter in arrears. So it's a little bit easier, I would say, to make the distinction between when a unit is shipped and the revenue is recognized. So Q4 for gaming will tend to be a little bit heavier. I think auto is more midyear, mid-fall and then Q4 as well.

And then, a last question for me. Like I saw the update guide that included $9 million to $10 million of litigation for the year. How much of that litigation is expected for 4Q?

We don't give the quarterly look, but I mean between $9 million and $10 million, it's going to be a small amount that will end up in Q4 at this point, probably.

The reason I just asked was because I know the company has talked about really one of the big longer-term priorities is getting to a point of sustainable profitability, where you could break even or generate even a little bit of cash even without one of these -- some of these large license wins. And I was wondering, do you think that that's something that ultimately would be achievable at these type of revenue levels with some OpEx cuts? Or what needs to happen to get the company where it's going to be able to achieve profitability on a consistent basis without some of these large deals?

I think really it's going to depend upon the waterfall in automotive, as Tom mentioned in his comments, how quickly do haptics waterfall out of just premium cars and into more midrange and entry-level automobiles. We will grow with that naturally because of our Tier 1 arrangements. And then our success in China, right? I mean, how quickly can we get sustainable ongoing revenue in China? It's certainly a market that is right for haptics and right for Immersion, which is great. If we're able to do that successfully in the first year versus longer term, that will obviously impact our financial results. And then it's adoption of new -- of haptics into new markets. We've talked a little bit about IoT. We're getting more interest there; if that begins to take off, that market can as well help to bring us to more sustained profitability. Certainly, these larger agreements are very important to us for many reasons, right, because they also impact the discussions. But there are paths for good revenue growth for us even without them. And it's just a matter of our ability to execute upon them.

I'm showing no further questions in the queue at this time. I'd like to turn the call back over to management.

Carrie, thank you. Again, I hope you can sense my optimism on the opportunities ahead for the company, and thanks for joining us on the call today, whether it's live or via webcast. As a side note, we look forward to meeting those of you in New York, joining us at the Dougherty NDR next week, or at the Needham conference in January. With that, Tom and Nancy are signing off. Thank you.