Immersion Corp (IMMR) 2003 Q4 法說會逐字稿

Good afternoon, my name is April and I will be your conference facilitator today. At this time I would like to welcome everyone to the Immersion fourth quarter earnings conference call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer period. If you would like to ask a question during this time, simply press star then the number one on your telephone keypad. If you would like to withdraw your question, press the pound key. Thank you. Mr. Viegas, you may begin your conference.

Thank you, April. Good afternoon, ladies and gentlemen. I am pleased to welcome you to this discussion of our results for the fourth quarter and full year of 2003. Joining me on today's call is Immersion's vice president and corporate controller Mary Beth Faust, who will take you through our financials.

By now you should have received a copy of our fourth quarter earnings news release that was distributed following the close of market today and is also available on our website at www.immersion.com. A replay of today's call may be accessed until February 13th, 2004, in the U.S. by dialing (800) 642-1687 and entering reservation number 4572152. A replay of this call will also be archived and available at our website for one year.

During the course of our comments today, we will be making forward-looking statements. Our actual results could differ materially from these current expectations. Factors that could cause actual results or developments to differ include risk factors listed in today's news release, the company's SEC filings, our annual report to shareholders, as well as those factors mentioned during our discussions today.

We are pleased with this quarter's performance. And I'd like to begin by providing you with some of this quarter's highlights and some of the key opportunities we see in 2004.

Our total revenue of $8 .3 million was the highest quarterly revenue in the company's history. Our revenue was higher across virtually all categories, especially royalties and license revenue, and higher across most businesses led by medical. Our gross margin increased to 81% and our operating loss decreased by 70% over last year's fourth quarter.

As previously announced, this quarter we achieved the second of three milestones associated with the Medtronic licensing and developments contract signed last February. As a result, Immersion was able to recognize $2 .9 million, the majority of which was previously deferred revenue. In fact, as previously forecast, our medical business was profitable for the full year of 2003. In addition, Immersion received a $1 million cash payment in early January that was not reflected in our year-end cash balance.

The majority of the Medtronic revenues recognized during the fourth quarter had been deferred during the previous three quarters. Going forward, we expect to recognize in excess of $500,000 in revenues for each of the next seven quarters associated with the Medtronic agreement. Mary Beth will be covering the financial details of our performance during her upcoming comments, so I'd like to briefly discuss new activities which we believe will generate revenue growth in 2004.

We have partnered with Samsung as our first cell phone licensee, demonstrating continued progress with leading cell phone handset manufacturers. This multi-year worldwide license agreement grants Samsung, the innovative product leader in the cellular market, rights to Immersion's patented TouchSense technologies to deliver a new generation of cellular phones for Samsung's global markets and customers. Most cell phones today vibrate with single force and speed, like pagers. TouchSense high fidelity Haptics brings a wide range of frequencies, dynamics and crispness never before possible.

We have named our TouchSense Technology implementation for the mobility market the Vibe Tones System. With the Vibe Tone System, phones are easier to use, more fun and more personal. And, they become even better communication devices. Immersion's unique development and offering tools could also enable Samsung's developer community to create and enhance applications for a new class of products, such as touch-ringers, touch-enabled messaging and new touch-enabled data driven applications. Samsung is in the process of identifying suitable products and territories for what we hope will be a product launch later this year.

This licensing agreement with the innovation leader in the cellular product market demonstrates Immersion's success at improving force effects, miniaturizing and optimizing our technology so that it can fit into a cell phone, and creating a streamline development environment for application designers. As a reminder, our strategy in this area goes beyond providing new Haptic features to drive demand for replacement phones for hardware manufacturers such as Samsung. On one hand, we are also engaged with content providers to provide better applications such as synchronized vibe tones for today's popular ring tones, enhanced instant messaging, and games with more features. And on the other hand, we are engaged with service providers and carriers to provide personalization capable of stimulating increased phone usage. We are pleased with the response that we have received thus far and view the cell phone/PDA market as one of the next growth catalysts for Immersion.

In addition to the cell phone business opportunities, we will also be introducing new medical products in 2004 that stem from work that we have done during 2003. One of these results from our broad and extensive relationship with Medtronic, the importance of which cannot be overstated. Before describing the new products, I'd like to review the different ways our relationship with Medtronic helps build our company.

First, we perform development work for Medtronic. Under these agreements, we develop various medical simulation tools for their use in various sales and training programs. Second, we produce and sell simulation products to assist in their sales, education, and training efforts. And, third, we license certain portions of our intellectual property and technology for internal use by Medtronic.

As a result of the development work we have been doing recently with Medtronic, we have created a generic product, an endovascular simulator, that has already been demonstrated and will be formally introduced to the market this spring. This simulator duplicates the look and feel of performing difficult medical procedures with realistic fluoroscopic images and tactile feedback, including such procedures as inserting a wire lead into a heart, coronary angiography and angioplasty. It is one of the exciting ways that demonstrates what we do in one area can be leveraged to create benefits for Immersion in other related areas.

A second medical product that was announced during the fourth quarter, and that will be introduced to the market in the second quarter of 2004, is Immersion Medical's first hysteroscopy training simulator. This will be one of the first commercial training simulators that can specifically increase doctors' competence levels using a hysteroscope to conduct diagnostic and operative gynecological procedures that are safe and more comfortable for the patient. With it, physicians will not only get a visual idea of what they'll face in the operating room, they will also get a sense of how it will feel.

This simulator is the culmination of work initiated in 1998. and during 2003 Immersion Medical worked together with Gynecare, Immersion developing the hardware while Gynecare provided clinical expertise for the software development. We are excited about these new opportunities in medical and are also working on several other initiatives that we hope to be telling you about more as the year progresses.

Rounding out the highlights for the fourth quarter are the following: In order to capitalize on our leading technology and strategic partnerships, we have expanded our sales team with the hiring of Barry Bergman in medical sales and Tim Tight in our industrial products group. Barry will manage the Immersion Medical sales team and comes to us with more than 20 years' experience at hardware and software companies, including Cisco and Sun. Tim will focus on touch feedback for industrial controls. He has held numerous senior-level marketing and sales positions for companies such as Diablo Research and Raychem. Combined with the recent hiring of Mike Zuckerman and Mark Belinsky, the Immersion executive team is well positioned to execute on our 2004 market development and sales strategy.

Our patent infringement litigation with Sony continues to progress and we remain confident in the merits of our case. To briefly recap, on October 2nd, Judge Wilkin issued her ruling associated with the Markman hearing that took place in late April. Since that time, summary judgment motions have been filed with an expected court hearing on February 27th of this year. The date of the jury trial is still scheduled for April 12th of this year. We will continue to provide you with updates as warranted.

Before turning the call over to Mary Beth, who will review our financial performance for the quarter, I'd like to mention that we now own more than 210 patents in our worldwide intellectual property portfolio with over 240 pending applications. Mary Beth?

Thanks, Vic. Let me begin by briefly reviewing each of our four businesses. As Vic pointed out and as we had anticipated, our medical business was profitable for the full year driven largely by the recognition of $1.9 million in royalty and license revenue and $1 million in development, contract and other revenue associated with the Medtronic licensing and development agreements. The fourth quarter of 2003 represented the highest medical revenue quarter in Immersion's history. Revenues from medical were more than double from the year-ago quarter and more than triple the immediately preceding quarter.

Revenues from our 3D and professional group increased 22% on a quarter-over-quarter sequential basis and were relatively flat on a year-over-year comparison. Increased development contract revenues offset slightly lower product sales. Revenues from our consumer computing and entertainment area improved sequentially on a quarter-over-quarter basis by 95% and year-over-year by 11%, primarily as a result of higher royalties, product sales and development contracts during this seasonally strong period and an increase in new product offerings previously announced by some of our licensees. Our automotive business revenues during the fourth quarter were 126% higher than the corresponding quarter a year ago and 4% higher than the prior quarter, primarily due to higher royalties.

Turning now to the income statement. As stated in today's earnings release, revenues for the fourth quarter of 2003 were $8.3 million, compared to $5.5 million in the fourth quarter of 2002. Royalties from patent and technology licensing in the fourth quarter represented 43% of total revenue at $3.5 million compared to $1.5 million in the corresponding quarter last year. This improvement is primarily attributable to the recognition of previously deferred revenue from the Medtronic contract.

Product sales accounted for 33% of total revenue, at $2.8 million compared to $2.9 million in the fourth quarter a year ago. The decrease is related to a somewhat lower sales in 3D products. Development contract revenues for the quarter represented 24% of total revenue, or $2 million, compared to $1.1 million in the fourth quarter of 2002. Development contract revenues were higher across all businesses, especially medical.

On a GAAP basis, net loss was $3.7 million or 18 cents per share compared to a net loss of $6.4 million or 32 cents per share for the fourth quarter of 2002. This quarter's net loss includes approximately $2.1 million or 10 cents per share in non-cash charges related to amortization for stock-based compensation and intangible assets, the write-off of an investment in a privately held company, and accretion on our Series A redeemable convertible preferred stock. This compares to non-cash charges of approximately $4.5 million or 22 cents per share, attributable to amortization of stock-based compensation and intangible assets and impairment of goodwill for the same quarter last year.

Fourth quarter 2003 operating expenses were $8.1 million compared to $5.9 million in the fourth quarter of 2002. The higher operating expenses are primarily due to legal expenses associated with the patent infringement litigation. During the quarter, litigation expenses were $2.3 million, compared to $741,000 in the fourth quarter of 2002. And for the full year of 2003 litigation expense was $7 million compared to $1.9 million for the full year of 2002. Going forward, we expect this current level of operating expenses to rise due to increased litigation expenses as we approach the scheduled April 2004 jury trial associated with our patent infringement litigation. And increased sales in marketing expenses related to the expansion of our sales and marketing team and new marketing programs related to our medical business and cell phone initiatives.

Gross margins were 81% in the fourth quarter of 2003 compared to 73% for the fourth quarter of 2002 due to the higher contribution from royalties in the revenue mix. Specifically from the recognition of revenues previously deferred on the Medtronic agreements. Interest and other expense was $1.6 million higher in the fourth quarter of 2003 relating primarily to the write-off of an equity investment and privately held company, a non-cash charge of $1 million. In the fourth quarter last year, there was a $3.8 million charge -- non-cash charge taken as impairment of goodwill.

Additionally, this quarter we recorded accretion and dividend expense on our Series A redeemable convertible preferred stock in the amount of $632,000. Payments which may be due to Microsoft as a result of the settlement with Sony computer entertainment will accrete on a straight-line basis from $26 million to $30 million over the expected life of the litigation, which we have estimated to be 24 months. During the quarter ended December 31, 2003, we recorded $528,000 related to accretion.

Holders of Series A redeemable convertible preferred stock are entitled to cumulative dividends at a rate of 7% per annum. Dividends are payable in cash or stock semi-annually in arrears on July 25th and January 25th of each year. During the fourth quarter of 2003, we accrued $104,000 for dividends payable on Series A redeemable convertible preferred stock. Finally, during the fourth quarter, we recorded an income tax provision of $154,000 related to Federal alternative minimum tax due on 2003 taxable income primarily as a result of the Microsoft patent license payments.

On the balance sheet, our year-end 2003 cash and cash equivalents balance stood at $21.7 million. Subsequent to the close of the fiscal year, Immersion received a $1 million cash payment from Medtronic as a result of achieving the milestone in December relating to the agreements that Vic spoke about earlier. As a result of the agreements entered into with Microsoft in late July, the $20 million license fee paid by Microsoft as well as $7.1 million in Series A redeemable convertible preferred stock was recorded as a long-term customer advance from Microsoft. We believe that the future events and contingencies will require deferral of this licensee until certain future events or contingencies occur. The future events and contingencies which cause this deferral include the redemption provisions of the Series A redeemable convertible preferred stock as well as certain payment obligations under the sublicense agreement.

This concludes the review of our financial results, and I will now turn the call back over to Vic, who will make some closing comments before opening the call for questions. Vic?

Thanks, Mary Beth. In closing, I would like to briefly mention some other 2003 milestones and a couple of events coming up in the first quarter of 2004.

Our agreements with Microsoft provided $26 million in cash payments for license rights, equity, and settlement of a patent infringement lawsuit. As a result, Immersion's cash position was substantially increased, and we have the ability to raise an additional $9 million by requiring Microsoft to buy Immersion debentures, if we choose. Several of our licensing partners, including Logitech, have incorporated our touch technology into the first gaming peripherals with the force feedback for the new Macintosh platform that Immersion has been supporting since January 2003.

We continue to build upon the momentum with automotive manufacturers like BMW, Volkswagen and Rolls Royce and with OEM providers like Siemens, ENVIDEO Automotive, as well as Alpine Electronics. We launched a new module for our endoscopy simulator that uses a flexible fiberoptic scope with a light inserted through the mouth to visually examine the lining of the esophagus, stomach and upper duodenum. This minimally invasive procedure screens for cancers and ulcers and takes biopsies of any suspicious pathology while helping training hospitals maintain and measure a clinician's skills.

Our 3D business was awarded a grant to research ways to train U.S. seamen and Marines for expedition warfare duties, such as safely following an enemy through a darkened room and dodging obstacles at night. By adding a sense of touch to virtual simulations of hostile conditions, Immersion is assisting the Office of Naval Research in the development of safe virtual combat conditions. Perhaps most importantly, this research further expands Immersion's reach into the military sector, long recognized as a principal user of simulation tools for training.

With the strengthened balance sheet, the endorsement of the world's leader in software services and Internet technologies, established traction in the large cellular phone market, continued success in the medical simulation and training area, and a new sales and marketing team in place, Immersion is poised to penetrate the best long-term opportunities for our pioneering Haptic technology. Our focus will remain on those markets promising the greatest financial returns.

In recognition of Immersion's success at bringing forth new technologies that will change people's lives, we have been invited to present at the March 23rd National Press Foundation's "The Future 2004" in Washington, D.C. We will be demonstrating the iDrive automotive controller and various medical simulation and training products. This is another opportunity for immersion to evangelize the benefits of Haptics and an example of how attractive we are as a leading-edge technology company that is finding market acceptance.

Before discussing any questions you may have, let me mention that we remain interested in meeting with current and potential institutional investors wanting to know more about Immersion. We will be presenting at the 16th annual Roth Capital Partners Growth Stock Conference in Dana Point, California on February 17th. If you are interested in scheduling a follow-up call or would be interested in meeting with us, please notify Pierre Hersh at Clark, Rosen & Company by calling 415-397-2686. I will now turn the call back to April for your questions. April?

Thank you. At this time, I would like to remained everyone in order to ask a question, please press star then the number one on your telephone keypad. We'll pause for just a moment to compile the Q & A roster. The first question comes from the line of Michael Ching from Palmeras Capital.

Good afternoon, gentlemen, and Mary Beth, I guess. Great performance, I came on a little bit late. Can you give us a little more color on the Samsung project and whether you expect material revenues and when you do.

Um, sure, that's -- that gets a little difficult because we're not in control of our partner's strategy in terms of the products and the rollout and the timing, but I can tell you that we -- we have taken our technology, which we have progressed well beyond the demonstration phase, and we're currently engaged in productization efforts. This is completing the source code for the various different elements, the firmware, the hardware design, and so on. So we're very comfortable that we have a very robust solution and one that's ready for products. When -- when Samsung chooses to introduce that technology and in what products or territories or markets is really going to depend on their internal programs. I can say that up till now we have not recorded any revenue under the contract. There will be, I predict, certain development revenues, very minor in 2004, and with a little luck, our hope is that there will be phones shipping in the world generating royalty income. In terms of the -- the magnitude and the dollars, I think 2004 is not going to be a significant revenue generator. It is more a period of proving the technology, getting product into the market, and developing the necessary relationships with the carriers, the content developers and the operating system providers.

Right. And will it be on a per-unit basis?

Yes. The license that we entered into will generate per unit royalties. We believe not only for the hardware, but over time will also generate revenue from the software and application side as well, which is typically our strategy.

Right. And so is it possible to make some sort of guesstimate as to -- would you make, you know, more or less than a dollar per unit.

I wouldn't want to speculate, but I -- I would say that it would be cents per phone in terms of the hardware side and on the content side we would be looking at cents per download or cents per unit sale.

Got it. And then one last question on that. Is there any exclusivity? In other words, might you be able to go to anybody besides Samsung with a similar type of solution, might this yield a larger type of program, or does Samsung have any exclusivity in this particular market.

There is no exclusivity in the current agreement. Our intent is to make them as successful as possible.

Got it. Great. Well, it sounds like a great program, thank you.

Thank you.

Again, I would like to remind everyone, in order to ask a question, please press star then the number one on your telephone keypad. Again, we'll pause for just a moment to compile the Q & A roster. The next question comes from the line of Alex Woodward of Masomea Capital.

Hi, great quarter, guys.

Thanks, Alex.

I was wondering if maybe you could talk about just in generic terms your core markets and basically how much you think you may have increased the addressable market, your total TAM in 2003, and what it looks like for 2004 and going forward.

Well, we -- we've organized around business segments and clearly at this point our medical segment is the largest segment within our company. In addition to the medical market, we also address the consumer space with business opportunities in the gaming and now the mobility markets. And we also have business segments in the industrial area, namely our automotive controller solution as well as our 3D product line. So those are the business segments that we're currently addressing and how we're formulated as a company.

In terms of the addressable market, it's a tough question. I'll try to answer it by saying that -- by offering two additional product platforms, the hysteroscopy simulator and the endovascular simulator, in the medical space, we believe that we've dramatically increased our addressable market, not only additional facilities where these types of procedures are being trained or provide training, but also in -- in terms of additional sales to existing customer base. Plus, additional software content modules that we can sell into the installed base. So I haven't given you really a very specific increase, but just in sure numbers alone, the number of simulator platforms had grow dramatically in 2004.

In the gaming sector, we've noticed a significant shift in effort by our licensees. We've assisted them in many cases to provide the technology solution to the console platform. So while we were historically addressing the PC market, we are now -- our licensees are aggressively going after the after-market console space.

The mobility market obviously is a brand-new market for us. I believe over 400 million phones sold last year. The ring tone downloads I believe were in excess of $3 billion spent to download personalized ring tones, so we are obviously just going to scratch the surface, but we think the opportunity is very large. In the automotive space, we continue to expand the supplier base and continue to work on new development programs. Of those programs have not been announced by our licensees so there's not much I can speak to there.

Well, you've certainly done a great job being an industry pioneer and laying the groundwork for the Haptics industry that will follow based upon your hard work. Any feel for what the growth rate for Immersion is a year for 2004 will be or any guidance for -- for Q1.

I would prefer not to provide guidance at this time. The revenue base is still a bit unpredictable. I would definitely look at revenue growth during 2004. That revenue growth should -- should support the increased investment in our sales and marketing programs. We are continuing to spend on the litigation front. So from a profitability standpoint, it will continue to impede profitability. But at this point, I'd rather not give revenue projections for Q1 or for the full year other than to say the opportunities are just outlined, I believe should grow revenue in 2004.

Thank you.

Thank you, Alex.

Your next question comes from the line of Robert Littlehill of Bear Stearns.

Vic, how are you.

Fine, thanks Robert.

Quick question. February 27th in the litigation front, what happens -- can you just explain that date again, what happens on the 27th of February.

That's the current date that the court has scheduled the summary judgment motion hearing. Sony has filed for summary judgment on a few areas; Immersion likewise has filed summary motions on a few areas. And what we're asking the Court is to consider these motions, which we believe will frame the litigation trial. So February 27th the judge will meet with both parties and have a discussion, clarification on the judgment -- on the summary judgment motions that were already filed, and then ask some clarification questions. And it would be -- I would expect some time after that hearing that she would make a ruling on those motions and then, um, provide jury instructions and get ready for jury trial in April.

Great. Thank you very much.

You're welcome.

Your next question comes from the line of Kurt Meyer of Lehman Brothers.

Hi, Vic. A couple different areas. Relative to the Medtronic contract, is my recollection correct here that that was originally done back in February of '03.

That's correct.

And we had a first milestone that I believe was near the end of August that clearly we went through but I don't recall that that generated any revenue or income hitting the balance sheet or the income statement. And obviously we got through milestone number 2 which was a very positive one. Am I correct in that there's a third milestone.

That's correct. Let me clarify. We did enter into a series of agreements in February of 2003. Those agreements cover licensing rights to use the technology and a series of development initiatives to enhance and improve some of the technology that we've made available to Medtronic. We -- the development effort is roughly a 30-month project, and during those 30 months, we have a number of initiatives in a number of scheduled program development efforts.

We've tracked three milestones, one in August, as you mentioned, where we made a delivery of some enhancements to the base technology, and Medtronic is using that in their training programs as we speak. The second milestone was further development and enhancements to that base technology, and that's a milestone that we met in December. And then there's a third, which will be the completion of the project, which will not occur until -- I believe it's the middle of 2005.

And so those are the three milestones. However, between milestone two and milestone three, there will be continual development and transfer of new and improved technology to Medtronic. The importance of the second milestone was the features that were to be developed through the second milestone were significant enough to Medtronic that they retained a refund right if the technology hadn't reached a certain level of maturity. So, again, giving you a flavor for this ongoing development effort, we identified what was a substantive milestone to delivery. When we met that milestone, essentially the refund right lapsed and, as a result, we were able to book all of the revenue related to the efforts beginning in February throughout the whole year. As we go forward, there will -- there are no refund rights and so we will book that revenue based on the development progress.

Is there -- what's the -- what happens at the third milestone? Is there an additional payment, or what happens if we don't meet that milestone?

Well, yes, the answer is there is additional monies that will be paid, actually, monthly, as we move forward. There are additional monies that would be paid at -- upon achieving the third milestone. The third milestone, again, is a culmination of a number of features and improvements to the base technology. So to answer the second part of your question, if we were to not be successful in meeting that third milestone, I believe the agreements provide for an extension of the development time to complete the -- those products.

Okay. To the phone side of the equation, we're talking about the ability to potentially download vibe tones. Can you give us a sense of how many vibe tones may be able to be held on a given cell phone? Is that five, is that 50?

I believe a way to look at this would be once we enable a phone, that phone becomes almost a play-back machine. If you can think of it as a video cassette recorder in play-back mode. And so as you download a vibe tone or any other application, a game or instant messaging capability or any one of the other things that might be available, what you're doing is sending code through the content that will simply tell the phone how to respond. So once we've built that capability into the phone, it's just simply a matter of instructing that phone to do -- to generate a certain tactile response. So our part of the technology is not going to encumber the phone or its memory. It will have more to do with the -- the application being downloaded, whether it's the game. The question really is how many games can you load on to a phone or how many instant messaging types of commands can you download.

Okay. And in your discussion with carriers at this point in time, the Verizons and the AT&T Wirelesses of the world. As you talk about data content vibe tones, etc., and the potential sharing of that revenue stream which I think you mentioned was a $3 billion business worldwide on ring tones, how have the discussions gone? What's been the push back from them? Are they looking at this as green field opportunities that they're very enthusiastic about it, or can you give us a sense of -- of what the response has been?

Well, I would say initially there is support and effort related to the Samsung initiative. So to the extent that Samsung brings a phone into the market, their carriers are interested in that -- taking advantage of that capability. Secondly, the -- the ability to have high fidelity force feedback in a phone is one that the carriers believe will enhance the user interface and will allow people better experience, personalize their phones, and consume minutes on the phone, which, in the end, is -- is how the carriers make money. So discussions with carriers lead us to believe that -- that there's a significant opportunity as we get phones deployed into the marketplace.

Okay. And last but not least, there's another company that is doing some things in the Haptic world which I believe I've known about for a number of years, but I'm not sure exactly what their scope of business is outside of perhaps academia and that is Sensible. Do you run across these fellows in any of your discussions in any of the markets that you work?

Up till now, I'd say no. They have -- it's my understanding they have remained in the higher-end CAD space. They have a very high quality, fine product called the Phantom. There have been, over time, research studies performed in various areas using the Phantom, but we have not run across them in any of the major markets that we're going after.

Great. Thanks for your time.

Thanks, Kurt.

At this time, there are no further questions.

Okay. Well, thank you very much for your participation on today's call. We appreciate your continued interest in Immersion and hope that we will be speaking with you again soon. Thank you very much.

This concludes today's conference call. You may now disconnect