Immersion Corp (IMMR) 2006 Q2 法說會逐字稿

Good afternoon. My name is Brandy, and I will be your conference operator today. At this time, I would like to welcome everyone to Immersion's second-quarter investors conference call. (Operator Instructions). Thank you. Mr. Viegas, you may begin your conference.

Good afternoon, ladies and gentlemen. I'm pleased to welcome you to this discussion of Immersion's results for the second quarter of 2006. With me today is Stephen Ambler, Immersion's CFO and Vice President of Finance.

By now, you may have seen this quarter's earnings release that was distributed following the close of market today. If you have not, it is available on our website at www.immersion.com. A replay of this call will be available through August 10, 2006 by dialing 800-642-1687 and entering confirmation number 2398093. The replay will also be archived and available on our website for one year.

During the course of our comments today, we will be making forward-looking statements. These forward-looking statements reflect management's current forecasts of certain aspects of the Company's future business. Forward-looking statements are based on current information that is by its nature dynamic and subject to rapid and even abrupt changes. Our forward-looking statements are subject to risks and uncertainties that may cause actual results to differ materially from those projected or implied in our statements. Factors that could cause actual results or developments to differ include risk factors mentioned in today's news release in the Company's SEC filings and in our Annual Report to shareholders as well as any factors mentioned during our discussions today.

As I have discussed in previous conference calls, our main focus is to achieve revenue growth that leads Immersion to an operating profit. This requires a careful balance of four areas -- one, the execution of sales and marketing plans to increase revenue; two, selected investment in product and technology development; three, control over operating expenses and four, protection and defense of our intellectual property portfolio across all of our businesses.

During today's call, I will be discussing these focus areas and overall business results for the second quarter of 2006 as well as providing an update on our litigation in the Sony case. Overall, Immersion revenue for the second quarter of 2006 grew 7% over the same quarter last year to a total of $6.7 million. The 7% growth results from a 28% growth in our non-gaming businesses and a 46% decrease in our gaming revenue due to the downturn of third-party controller sales in the video game industry. Excluding the stock-based compensation charge, our net loss for the second quarter of 2006 was $1.7 million or over $1.1 million less when compared to $2.8 million the same quarter a year ago when we had no non-cash stock charges. We finished the quarter with 30.9 million in cash, essentially the same balance we had on March 31, 2006.

I would now like to update you on our medical, gaming, touch interface products and mobility businesses. Our medical revenue grew 39% compared to the second quarter last year. We continue to pursue a product growth strategy for our medical business with three growth initiatives -- one, expanding international sales; two, developing new products and three, establishing alliances in the industry. We recently announced an agreement with Laerdal Medical A/S that involves all three of these initiatives. The collaboration agreement allows both companies to leverage their combined technology to market and sell a vascular access medical simulation product, a virtual IV system.

Immersion Medical is developing and manufacturing the system and selling in the United States. Laerdal is marketing and selling the system worldwide. The companies have a combined sales force of over 500 people operating in 22 countries, providing an expanded domestic and international sales opportunity for the Immersion Medical product.

Second-quarter gaming revenue decreased 46% compared to the second quarter last year, consistent with the decline of third-party controller sales in the video gaming industry. As we stated in conference calls for the previous two quarters, we believe the transition to the next-generation systems has dampened consumer demand for current Xbox, PS2, and Game Cube systems and peripherals. In addition, console makers appear to be restricting and in some cases denying third-party licenses for the manufacturer of peripherals for new gaming platforms, causing our revenue from our third-party licensees to decline.

These industry conditions are beyond our control, and we expect they will continue to negatively affect Immersion's gaming revenue. We expect the Electro Source ongoing royalty payments to affect our revenue positively during the remainder of 2006. We also signed one new license agreement for game peripherals in the second quarter with eDimensional.

In parallel with Sony's public demonstration of the new PS3 video gaming console at the industry's premier gaming show, E3, Sony Computer Entertainment, Inc. issued a press release on May 8 stating and I quote, "Pursuant to the introduction of this new six axis sensing system, the vibration feature that is currently available on DualShock and DualShock 2 controllers for PlayStation and PlayStation 2 will be removed from the new PS3 controller, as vibration itself interferes with information detected by the sensor."

Since that time, Sony has made conflicting statements to the press regarding its possible support for force feedback in its software development kit or PS3 console for third-party peripherals, such as steering wheels. To our knowledge, Sony has not licensed any third parties to make vibration-enabled peripherals, including controllers, steering wheels or joysticks for the PS3 console system.

Since early May, we have actively promoted our full range of vibration feedback technology to consumers, the press and developers through public relations activities, ad campaigns, user tests and surveys. I did a number of press interviews stating that I am confident that both our current and next-generation vibration technology can coexist with motion or tilt sensing in a gaming controller. While I will not be covering the results of our promotional campaigns in detail in this call, I want to emphasize that user tests and surveys show strong evidence that vibration feedback technology improves the gaming experience and that there is a strong desire for the feature to be included in the PS3 platform by gamers and developers.

We demonstrated our next-generation vibration feedback technology at a press event on June 15 and formally announced it on June 19. This new TouchSense technology matches the realism expected of the next-generation gaming experience with high-definition graphics and high-fidelity sound, vibration feedback that provides a far more engaging realistic and immersive tactile experience. Reaction from gaming industry journalists who have tried the technology has been very positive. One described it as and I quote, "Ten times better than the rumbling on a PS2 or Xbox 360." And another said and I quote again, "The realism and impressiveness created by Immersion's new TouchSense technology is unlike anything you'll ever feel. In fact, you have probably never even imagined how precise and advanced rumble can be."

Our next-generation technology is backwards compatible with existing dual motor systems, allowing an implementation path at any stage of product lifecycle even after a console has launched. The new technology can be implemented in most systems without cost, power, consumption, weight or space increases and is compatible with motion or tilt sensing. Should Sony and Immersion resolve their legal differences, we would be happy to work with Sony to implement next-generation vibration technology in the PS3 console system.

It may be of interest to note that the vibration feature has been added mid life to a console system before. The PS1 console launched in 1995 without vibration feedback for its controller. Then, in 1997, Sony introduced the DualShock controller for the PS1 in Japan and in the United States the following year. We will continue to actively promote our next-generation technology to gain console suppliers and game content developers in an effort to make available to the gaming community an advanced and engaging playing environment to complement advanced graphics and sound.

Moving on, our touch interface products business consists of our commercial gaming products as well as touch screen and rotary products for multiple industries, including automotive, industrial automation, retail, financial and point-of-sale. Revenue in the second quarter for this business group grew 7% compared to the same quarter last year.

In the tactile touchscreen business, we recently announced the completion of designs for high-volume production of actuators and control boards. We have sold integration kits to customers in the kiosk, automotive, industrial controls and medical equipment markets. These customers are actively engaging with us in a typical OEM design process to produce prototypes, complete engineering designs, transfer to manufacturing, tests, and ultimately introduce a finished product. This past quarter, we continued to work closely with 3M touch systems and their OEM customers on the integration of our components into casino, gaming and bar-top amusement products.

We believe there will be one or more OEMs showing gaming machines with Immersion TouchSense technology at the Global Gaming Expo in Las Vegas from November 14 through the 16 of this year. In addition, we believe additional OEMs will show gaming products with our technology at the combined Amusement Trades Exhibition International and International Casino Exhibition in London, January 24 through the 26, 2007.

We broadened our marketing efforts to focus on design engineers in numerous markets by exhibiting at the Society for Information Display Show in early June and conducting a press outreach program to engineering component publications. The OEM design cycle varies by product and industry, so I cannot accurately predict when products containing our technology will be launched. However, I'm optimistic about the revenue growth potential of our touch interface products.

In our mobility business, we recently announced the addition of LG Electronics as a licensee of our VibeTonz System. According to an IDC report, LG is the world's top manufacturer of CDMA mobile handsets and forth in the total number of handsets sold worldwide in the first quarter of 2006. We now have two of the top five handset OEMs as licensees, Samsung and LG Electronics, along with Pantec Company, who is the number seven handset producer worldwide. With additional handset licensees, VibeTonz technology can be more widely deployed by various operators serving different geographies and market segments. We also continue to aggressively pursue license agreements with other handset manufacturers.

Korea is one of the most advanced wireless markets in the world. SK Telecom, its number one operator with approximately 20 million subscribers and an Immersion licensee, continues to embrace VibeTonz System technology and use it to create innovative new services. SK Telecom introduced VibeTonz-enabled games through its GXG service in October 2005 and now over 20 games from a number of publishers are available for download.

In July, SK Telecom launched a multimedia phone personalization service based on Immersion's VibeTonz System called the VibeBell Service. VibeBell Service allows users to select and download from a large catalog of VibeTonz-enabled MPEG-4 media files, including over 1,000 clips from hit songs. SK Telecom's first handset with support for VibeBell touch-enabled media, including VibeTonz-enhanced games is the Samsung SCH-B450, which was also released in July. This handset accepts satellite direct multimedia broadcasts and has a number of 3D gaming features, such as 1 million polygon 3D processor for detailed and realistic graphics, user-friendly game pad and 3D motion recognition as well as a TV out connection to play games on a TV screen.

In the United States in June, Samsung and Verizon Wireless released the Samsung SCH-A930 mobile phone that contains Immersion's VibeTonz capability. We announced new content developer agreements with Punch Entertainment, SkyZone Entertainment, and Sonic Branding Solutions for VibeTonz-enabled games for the phone. We have since signed another content agreement with Super Happy Fun Fun, Inc., who is launching a VibeTonz-enhanced puzzle game with motion tilt control, 3D Tilt-A-World. Various games produced by these companies are now being sold on Verizon's Get It Now service and additional games have been submitted for posting.

In June, we announced a new capability of our VibeTonz System to enable touchscreens in mobile devices, such as PDAs and smart phones to have tactile feedback. The VibeTonz System provides an inexpensive and robust way of improving the usability of mobile device touchscreens by providing an unmistakable tactile confirmation to the user that their finger or stylus press was accepted as input. According to a Gartner Dataquest forecast, smart phones are the fastest-growing segment of the mobile handset market with sales expected to double year-over-year in 2006, reaching 200 million in 2008. Analysts and OEMs alike are excited by the prospect of a tactile touchscreen that can improve the user interface in these devices.

In summary, we are encouraged by the progress our mobility business continues to make. Over the past three months, we expanded the number of high-volume handset licensees, achieved more support from operators for VibeTonz-enabled mobile phones and content, saw more mobile phones with VibeTonz technology to market and introduced new applications of the VibeTonz System to areas like tactile touchscreens and MPEG-4 of multimedia authoring and playback.

Now, I would like to provide an update on our litigation against Sony. As previously announced on March 24, 2005, the court entered judgment in Immersion's favor and awarded Immersion a total of $90.7 million in damages and interest. The court issued and subsequently stayed pending appeal a permanent injunction against the manufacture, use, sale or import into the United States of the infringing Sony PlayStation system consisting of the PlayStation consoles, DualShock controllers and the 47 games found by the jury to infringe Immersion's patents. The court further ordered Sony to pay a compulsory license fee for the duration of the stay of the permanent injunction, pursuant to which Sony has made quarterly payments to Immersion.

Since the entry of judgment over a year ago, Sony has aggressively pursued several paths in its efforts to undo the judgment against it. These paths include appeals to the Federal Circuit Court, a motion seeking relief from the judgment under federal rule of Civil Procedural Rule 60B, requests for inter partes reexamination of the litigated patents to the United States Patent and Trademark Office, and a lawsuit against the Patent and Trademark Office for its decision to suspend reexamination of the litigated claims of the patents. The various courts and the PTO have ruled in favor of Immersion on each of these matters, except the appeals which have not yet been concluded.

Here is a summary of recent events related to each of these procedures. Sony appealed the $90.7 million award, the injunction and the compulsory license orders to the United States Court of Appeals for the Federal Circuit. Briefing for the appeal is complete, and we anticipate a hearing being set sometime in the fall of 2006. In the event the Federal Circuit hears the appeal in the fall, a decision on the appeal is likely in the first quarter of '07.

With regard to Sony's motion and the District Court before Judge Wilken, seeking relief from the final judgment under Rule 60B of the federal rules of civil procedure, on March 8, 2006, the District Court issued its order denying Sony's motion in its entirety. Sony has appealed the judge's order to the Federal Circuit, and briefing should be complete by October 2006. The appeal of the order under Rule 60B currently remains on a separate later schedule than Sony's appeal of the judgment.

The United States Patent and Trademark Office has ruled in Immersion's favor, halting Sony's attempts to derail the judgment through PTO proceedings. In May 2005, Sony filed a request for inter partes reexamination of the 333 and 213 patents. On Immersion's second petition to the PTO, the PTO granted Immersion's petition and suspended the inter partes reexaminations, pending the resolution of Sony's appeal of the judgment in the litigation. Thereafter, the PTO dismissed Sony's third petition requesting permission to file additional inter partes reexamination of the claims of the 333 and 213 patents for which reexamination was not requested by Sony previously.

Sony also filed ex parte reexamination requests of some of the claims in the two patents. The PTO granted the ex parte reexaminations only as to those claims that were not part of the inter partes reexamine. Recently, Sony filed a fourth petition to the PTO requesting merger of the ex parte proceeding and the currently-suspended inter partes proceeding. And the PTO denied this latest petition on July 3, 2006.

In sum, only reexamination of certain unlitigated claims of the 213 and 333 patents is proceeding before the PTO at this time. Lastly, on December 13, 2005, Sony Computer Entertainment filed a lawsuit against the PTO and the US District Court for the Eastern District of Virginia, claiming that the PTO made a mistake in suspended the inter partes reexamination. The court granted our motion to intervene and participate in this lawsuit. After an expedited schedule on May 22, 2006, the Virginia District Court granted summary judgment in Immersion's and the PTO's favor on all grounds. Sony has stated that it will not appeal this judgment.

In summary, over the past year, Sony has launched a barrage of legal maneuvers designed to delay, nullify or reverse the District Court's judgment in several different forums, of which only the appeals to the Federal Circuit remain pending. Immersion continues to steadfastly defend the judgment and is confident of further victory in the appeals process.

I would now like to turn the call over to Stephen to cover a number of topics including a review of our financial performance for the quarter. Stephen?

Revenues for the second quarter of 2006 was $6.7 million compared to $6.2 million in the second quarter of 2005, an increase of 7%. Our net loss under GAAP for the second quarter of 2006 was $2.4 million, equivalent to $0.10 a share compared to $2.8 million or $0.12 a share in the second quarter of 2005. This is an improvement of 16%. As was the case last quarter, these numbers are not directly comparable. Because in 2006, we are accounting for non-cash stock compensation under FAS 123R. Whereas in 2005, we were not. The stock compensation charge in the 2006 second quarter was $694,000. Without this charge, our loss would have been $1.7 million for the quarter, which is a $1.1 million or 40% improvement over the prior year period. And it's also a $500,000 improvement over Q1 2006.

Our loss for the quarter excluding non-cash stock compensation is the lowest quarterly loss the Company has made since going public in 1999. This improvement reflects the continued efforts of management to achieve profitability in the foreseeable future. Compared to the year ago quarter, we saw growth in revenues from our 3D, medical, and touch interface product lines. This growth was partly offset by a decrease in our gaming revenue.

Looking at each of these businesses in detail, in gaming, we mentioned on the last two conference calls the product demand for current generation gaming console and peripheral products was being affected by the transition to next-generation console systems and that we expected this to continue through 2006. Our gaming business revenues were $981,000 for the quarter, down 46% from a year ago when they were $1.8 million for the quarter. Gaming revenues accounted for 15% of total revenues.

Touch interface products. Product and licensing revenues in this business, which comes from touchscreens, touch panels, rotary modules and commercial gaming products were $978,000 for the quarter, equal to 15% of total revenue, compared to $913,000 in the year ago quarter and that's an increase of 7%.

Medical. Our medical revenues were $3.5 million in the quarter, up 39% from revenues of $2.5 million in the quarter a year ago. Medical revenues comprised 52% of total Company revenues for the quarter.

3D. Revenues from our 3D products were again steady and totaled $1.2 million in the quarter, up 19% from $1 million in the comparable period a year ago. 3D revenues comprised 18% of our total revenues for the quarter.

Analyzing our second-quarter revenues by category -- product sales accounted for 59% of total revenues of $3.9 million compared to 52% of total revenues or $3.3 million in the second quarter a year ago. Product sales grew in the medical and 3D areas of our business. Royalties from patents and technology licensing represented 26% of total revenues or $1.7 million as compared to 37% of total revenues or $2.3 million for the comparable period a year ago. The decrease in royalty revenue was primarily attributable to the softness in the gaming peripheral market. Development contract and other revenues for the quarter represented 15% of total revenue or $1 million compared to 11% of total revenue or $660,000 in the second quarter of 2005.

For the quarter, our gross margin was $4.9 million or 73% compared to $4.6 million, also 73% in the second quarter of 2005. Despite reduced royalty income, we were able to maintain our margins primarily as a result of increased development contract revenues. Second-quarter 2006 operating expenses prior to the offset of litigation settlement but after taking in account of $676,000 worth of non-cash stock-based compensation charges was $7.3 million. Excluding non-cash stock-based compensation charges, operating expenses were $6.7 million in the quarter compared to $7.2 million in the year ago quarter, a decrease of 7%.

Litigation costs included within operating expenses were $332,000 in the quarter compared to $619,000 in the comparative period. Despite litigation being a lower expense this quarter than in recent quarters, it remains a significant expense. And we anticipate that this will continue until such time as the Sony and other related litigation is concluded. In addition, the level of Sony litigation quarterly expense will remain lumpy for the foreseeable future with a level of expense each quarter determined by the level of litigation activity during the quarter. Litigation settlement is comprised of a $400,000 payment received in the quarter pursuant to the licensing and settlement agreements we signed in February.

Moving to the balance sheet, on June 30, 2006, we maintained our cash and cash equivalent balance at $30.9 million, the same balance we had at March 31, 2006. There was no change in the period related to our long-term convertible debt due December 2009. In mid-May 2006, we received $1.3 million from Sony under the terms of their compulsory license for the period January 1, 2006 through March 31, 2006. As with previous payments, this sum has been accounted for as a long-term deferred revenue.

As of June 30, 2006, we have 24.6 million shares of common stock outstanding, and we also had 134 employees. We recently had a second analyst, Mark Argento of Craig-Hallum Capital, pick up financial coverage of the Company. And we attended and presented at the Craig-Hallum Financial Conference in Minneapolis on June 8. In addition, we also attended and presented at the Cowen-sponsored investor conference at the Society for Information Display International Symposium in San Francisco on June 6. We will be attending and presenting at the AeA Classic Financial Conference in Monterrey on November 7 and 8, 2006 and at the VALUERICH Small-cap Financial Expo in Las Vegas on October 25 and 26, 2006. So if you are planning to attend either, we look forward to meeting you there.

We held our annual shareholder meeting on June 7 in Santa Clara, California. This was our best-attended shareholder meeting ever. We would like to thank those shareholders who attended for their support of the Company and hope they enjoyed sampling the leading applications of our technology that were on display. If you would like to be kept automatically informed of Immersion's news releases, SEC filings, financial calendar, and stock quotes, you can subscribe to the email alert service within the Investor Relations section of our website. Our Web address is www.immersion.com. Vic?

In closing, I want to reiterate that my goal is to generate the revenue growth that will lead Immersion to profitability. We're carefully investing in our growth opportunities and are making significant progress in executing our business strategies. We're continuing our efforts to prevail in the Sony litigation and remain confident in our position in the appeal process. Brandy, please open the call for questions.

(Operator Instructions). Kevin Hunt, Weisel Partners.

(technical difficulty) from the medical revenue. Can you give us a little more details? It seemed like that was really strong in the quarter compared to kind of what you have been doing recently. And so can you give us anymore details on why that was?

I think the first part of your question we didn't hear. But I'm assuming you're talking about our medical business and the strong 39% growth and you would like to hear about the details?

Exactly.

As you pointed out, the medical group had a wonderful quarter. It continues to benefit from our focus on increasing our international presence, not only with our own sales efforts, but during the quarter we brought onboard a number of new salespeople, focused in international and OEM-type opportunities. The relationship that we announced with Laerdal kicked in during the quarter. So with their sales force already in place, addressing the emergency market and the first responder market, they have had some real success with the virtual IV product. So I would say it was a combination of those to things as well as just a growing awareness of the value that our medical simulators bring into the marketplace.

If you remember not that long ago, Frost & Sullivan conducted a return on investment study. The results of this study were quite staggering. The payback for many of our simulators are less than even three or four months. And so, I think the industry has accepted the benefits. They see the value, and they are responding by purchasing our systems.

Then on the gaming side, can you give us any update on Microsoft's third-party licenses? Is there any activity there going on? And then should we think with this [UltraSource] now going sort of in the mix, so we should be maybe thinking then that the gaming revenues have sort of bottomed out here or what can you tell us about that?

Sure. We are really not privy to what Microsoft's licensing patterns or their practices are. We are -- have access to industry data much like I'm sure you and others have -- NPD. So you are able to track and monitor third-party activities and various sales for different platforms, and it continues to be rather weak from the third party. So we're not sure that there's been any change in their licensing practices, and we're really not aware of what their future plans are. It has affected our revenues -- is obvious in the quarter -- 46% below the quarter a year ago.

From Electro Source, they are a licensee of ours. They are paying us for ongoing sales of their vibro-tactile-enabled products, and we will continue to add those revenues to our overall gaming revenue. That revenue alone will not counterbalance anytime soon the weakness that we are experiencing from all of our third-party licensees. So, we would continue to expect at least through the fourth quarter of this year continued weakness when compared to our 2005 quarterly performance for the gaming business. But as we mentioned, we are seeing substantial growth in our non-gaming business, which is very important and very valuable for the future.

One last question, just a balance sheet question. Your PP&E number kind of jumped pretty high compared to any other quarter I can remember recently. Is there any -- can you tell us why that was?

Good observation. Yes. We have made a conscious effort to increase our demonstration pool -- our demo pool. And with an increased sales force promoting an increased number of different products and with better coverage around the world, we've added to that pool so we can do a better job of demonstrating and selling our technology and our products into the marketplace. So it's a good indicator of our sales activities.

Now, how does that affect the income statement I guess? Does that go into like a depreciation CapEx-type of situation?

We have an increase in the demo pool. It's the primary increase in the fixed assets, and that demo pool will be depreciated over a period of time. The benefit from my perspective is we have more salespeople in more territories demonstrating more products, and the chances for their success I think increases substantially. So, we are making an investment in the sales force to improve our revenue in the near-term.

[Kevin Slattery], Symmetry Peak Management.

Quick question. Just in terms of your operating margin targets, could you describe that to us as well as just a little bit more background on the 3D business that you do and also new verticals that you hope to enter over the next few years and your total addressable market opportunity?

That's a lot of stuff there. From an operating performance, during the quarter I believe we had very similar gross margins of --

Of 73%

73%. And that is in the face of a substantially lowered royalty revenue from the gaming sector. And I think that is indicative of our efforts to improve and increase our margins in all of our product areas. Namely, our medical products are seeing increased margins as well as our touch interface products and our 3D products as well. So the gross margin really will be determined by the revenue mix, whether we can grow our royalty revenue faster. Obviously, we will have a substantial improvement in the gross margins. We've done a fairly good job of keeping our expenses in check. We had a reduction in the litigation expenses, so you are seeing operating profit margins should continue to increase as our sales increase. And we do expect our sales to increase.

The 3D area is an area that has been relatively flat in revenue this quarter compared to the second quarter of last year -- I think was up about 19%. The group there is stable. We have a sales force that have been onboard for some time. They continue to expand the distribution network and improve and increase their training materials and their effectiveness and selling into the distribution channels. We continue to invest in new products in this area as well to see if we can't continue to increase the revenue. So it is still a very viable and a very important part of what we do.

In terms of new verticals, if you look at our technology, it really is so fundamental that whether you are talking about vibration technology used in the cell phone or the gaming space all the way up to full force feedback in the medical space, if you look at the fundamental capabilities of this technology, there really are almost no limitations to the verticals we can go after. And so while we market to industry leaders, many of these industry leaders sell across lots of different verticals. We also work with integrators that sell into different verticals. So I don't think I would highlight any new vertical that will be new and different for us. But I think you will see that we will continue to expand into new territories, new markets as our technology becomes embraced, whether it is the TouchSense technology or VibeTonz technology or tactile touchscreen technology.

Just a stab at kind of quarterly guidance for next quarter.

Oh, I really don't want to try to provide any guidance. I haven't had a lot of success in the past. I can say that all of our businesses appear to be healthy. We see quite a few opportunities on the horizon, new partners that we've signed during the quarter that should benefit Q3 and then Q4. I would expect to see continued good results, and I would continue to expect that Q3 will be better than Q3 of 2005. But anymore guidance than that really is too difficult for me to give right now.

[Benjamin Beady], Private Investor.

I just had a couple of quick questions. Earlier in the year during one of the conference calls, you stated that there might be a possibility of squeaking out a slightly profitable quarter during calendar year '06. I'm just wondering if you have any further thoughts on that. And also, I was wondering with respect to the TouchSense technology, you stated at the shareholders meeting that you had a couple of vendors that were literally sprinting to get the technology out into the marketplace and was wondering if you could give us any further color on those kinds of relationships.

Sure. In terms of profitability, this year, as you're aware, the FAS 123 impact is a non-cash charge that we are taking each quarter. The most recent quarter was something slightly less than 700,000. We would expect something similar to that to affect our Q3 and Q4 quarters, which will make profitability difficult. But as we continue to grow our revenue, if you were to look at our operations without considering these non-cash charges for 123, we think we are getting very close to profitability.

Whether we reach that point in the fourth quarter of this year, I am virtually certain we will not reach it in Q3. It is a possibility in Q4, but I would not want to predict that we will reach that in '06.

In terms of the TouchSense, the technology does require -- as I mentioned before, it is a design process where you are working with OEMs. In many cases, they are doing user studies, producing and building some demonstration units and they're testing the market reaction. Those activities are going on. We continue to refine and complete our own internal designs for product, and those efforts are virtually complete. Our efforts with these other OEMs and the design features and the design aspects that we work through, they are going quite well. But in terms of seeing a product launched in the market, I think our best shot at seeing a meaningful opportunity would be at the G2E Show later this year, where we would expect a few OEMs to begin demonstrating products with the TouchSense technology.

Has there been any interest in the PDA handset technology that you demonstrated at the shareholder meeting? Anybody interested in that particular product?

Yes. The additional benefits that you can drive from our VibeTonz technology, mainly using VibeTonz to provide a tactile queue with a touchscreen, there appears to be lots of interest from not only our current cell phone OEMs but also in other companies that are moving into these smart phone PDA-type devices. So we still see a lot of interest. But again, looking at the design cycle and the time it takes for them to make that commitment and to launch product, that will be a decision they will make. But it will require continued effort to finish the integration of the technology into their products.

Just one final question. I was wondering if you had had any discussions with any of the contract manufacturers about promoting the technology.

We have in the past had discussions with the contract manufacturers and various integrators. Many times, they are in a position where it's probably a thin-margin business. They really are taking the direction from their customer. So we are finding that the efforts with the customer to develop the feature set, test the feature set and make the sales effort at the OEM level is having more success than trying to come in through the contract manufacturing side.

Alec Berman, AMPAC Research.

Good call so far. A question for you. [Elotell] asked about the demo pool growing. You had explained that there are -- or sales force basically giving more of them to more salesmen to show. Is it specific to a specific area where you are doing most of this? Is it mostly medical or is it kind of broad-based across all your products or where are you seeing this?

I would say it's focused primarily in the medical space, not exclusively but primarily in the medical space.

Another question is -- do you think the kind of fact that you are rolling out this sort of -- the tactile ability on the touchscreens -- do you think maybe this offers another lever point to maybe loosen up the discussions with Sony? Because you obviously made a lot of products that have touchscreens or may in the future have touchscreens. Do you think maybe there's some way to say -- hey, look, we can work out with you on this area as well as a means to sort of get this whole thing resolved on the gaming front?

Clearly, we would love to work with Sony in a number of different product areas. Our squabble has been in the gaming space up until now. But if you look at the products that they have in the markets they serve, we think that our tactile touchscreen technology, our mobile device technology and other areas that they currently operate in that we could add some value. And we would be very happy to do that. We want to make them a successful company once we resolve our differences.

Mark Argento, Craig-Hallum.

Just hopped on the call, so I apologize if I ask a question that has already been answered or asked. But the first thing I wanted to do is touch a little bit on this Laerdal -- I think I am pronouncing it correctly -- the medical deal that you guys announced I think it was earlier this week. Can you talk a little bit about kind of what the relationship looks like? Is this a prototype model that you could roll out with some other products in terms of leveraging the different competencies of your organization and some of your customers?

Clearly, the opportunity in the medical space is substantial. We are just scratching the surface. And we are working hard to continue to grow market share and increase the market. But what we are really after is transforming the industry, showing that medical simulation is the proper way to train physicians and first responders. A company like Laerdal has had already a lot of success in these efforts. They have a very close relationship with the American Heart Association, where they have developed products for CPR purposes. And they found a lot of interest in advancing the training and the tools used for training purposes within the industry. So partnering with a company like this is terrific for Immersion.

When I met with the current CEO and I believe the son of the founder, I met with Tore Laerdal; we really hit it off well. We both see a lot of synergies in having the two companies work together. They are focused primarily on emergency care and resuscitation -- kind of the first responder market. That's not a market that we typically have served extensively. We focus more on the teaching facilities -- the universities and hospitals. And so there isn't a tremendous amount of overlap between our products or our sales force. So this is an effort that we are really excited. We think it will add a lot of value into the nursing community for sure and the market in general. And it's a very valuable relationship.

This is a substantial company, founded in 1960. And they are located in Stavanger, Norway. So we think that an alliance like this is important to help if you will cast a bigger shadow in the industry. And there are other companies that we think could also help bring about the same types of benefits. So we will continue to pursue those kinds of opportunities to see if we can't demonstrate to the industry the real value in surgical training with simulation systems.

But from a P&L perspective, are you guys going to -- are you going to end up running most of the sales of the product through your P&L? Or what can we expect to see in terms of how this will impact the numbers going forward?

We are responsible for the development and continued improvement of the product. We produce the product and then we sell our product on our own through our own sales force in the US. We sell that product to Laerdal who then sells those products throughout the world. So you will see sales from not only our direct sales force but also into Laerdal flowing through Immersion's P&L.

So you essentially have what like a wholesale-type relationship with them on the Laerdal component of sales or what their sales force is selling? (multiple speakers) You're basically going to manufacture and then wholesale it to them, so you can book that as revenues through your P&L?

Yes, that's right.

Then in terms of -- let's switch gears to the mobile side. Kind of one of the gating factors in the mobile market clearly is getting enough content and the right content to be enabled with the VibeTonz technology. Could you talk how active are you guys in talking to the content providers, the game makers out there, the Electronic Arts of the world and some of the other mobile game manufacturers out there and developers and trying to really get them to step up behind the technology?

Sure. It's a major area of focus. In fact, a lot of our sales efforts are targeted at the content side as well as the carrier side. Those are the two parties that see the greatest value in the improved personalization, the improved user interface and the value they derive from increased sales. So we are working hard to increase the number of content partners and the quality of the content partners. Electronic Arts, as you mentioned, they purchased Jamdat recently. And they are a substantial player on the content side.

So we continue to market and try to promote our technology into EA as well as all other content developers. The issues really that we are facing are the lack of a sufficient number of phones in the market currently. So there's this trade-off between having enough phones in the market to attract all the content players and vice versa creating and generating enough content to promote more models and more phones on the market. I think I mentioned before, the number of phones in the market is growing dramatically quarter by quarter, and so we are seeing a tremendous interest by the carriers and the content developers because they are seeing that customers are buying the content. They like it and the volumes are increasing and they went to be on board early. So we are working hard to make that happen. But the struggle for us really is to find the right balance of content and phones in the marketplace.

Last question for you. I know you have a partnership with 3M on the touchscreen side predominantly with focus on larger screens. I know more and more auto manufacturers are rolling out electronic systems or in-dash nav systems and also stereo systems, satellite radio, what have you -- all integrated kind of behind a touch panel. What is the opportunity to really get after that market because it seems like it's a real valuable market or would be a really applicable market for you guys to get after? What kind of key players are in that space that you would need to partner with? What kind of -- what companies specifically?

Sure, you are exactly right. The automotive market is one of the largest opportunities that presents itself to us. We announced sometime ago a very important relationship with a company by the name of SMK located in Japan. They I believe are the largest supplier of touchscreens in the automotive industry. They are a licensee of ours, and they are actively promoting our capability to their customers. So, I think we are working with the industry leader there.

There's also an aftermarket -- or let's say a consumer device category. And this would be a category that an aftermarket purchase, you could buy this at your local electronics store and add it to your vehicle or carry it with you, have it with you for trips and so on. That's a slightly different industry. You know the kind of companies in that space -- companies called TomTom, Navman, and a few others -- we're actively showing them the values and benefits of what we have to offer. And it appears that there is quite a bit of interest. So you are right. That's a great application, a good market for us. We are working with what we believe to be the industry leaders there, and we're working hard to get design wins and product into the marketplace.

Chris Little, Private Investor.

Congratulations on a very dynamic quarter. It looks like you guys had a lot going on. I have a bunch of questions. My first question is the advanced haptics. I know that you demoded it this quarter. What is the likelihood that we're going to be seeing advanced haptics in say other gaming consoles, like the Xbox 360?

Well, we introduced this technology to the press as you mentioned and the feedback was terrific. The user studies that we've done and the demonstrations we've given always generate a lot of enthusiasm, a lot of excitement. So we're very optimistic that this is a capability that the industry wants. We're still at the very early phase of introducing this to the development community, showing them the tools and the capabilities, also trying to meet with the right parties at Microsoft and other companies and show them the benefits and the value. So, we are actively promoting it.

What's the chances? It's something we're going to continue to pursue but we need to make sure that they are interested, they are willing to pay us and that we can put a fair deal together. So, we are still working that.

I understand that they have availability of your technology. But you actually mentioned that there would be some paying that would be involved. Would that be they would pay you for the cost of the actual parts to actually implement advanced haptics or am I just off?

So let me clarify a little bit. Our license with Microsoft grants them rights to our patent portfolio. So they can invent, develop, they can purchase, they can invest in this field of technology called haptics. They have the right to do that. But in terms of the technology that we've developed, the actual algorithms or the software code or the actuator designs or any of the other important features that create this very precise set of effect, the way that we do that is not something that we've made available under the current license agreement to Microsoft. So they could on their own try to develop the tools and the capability. It would take them some time and cost them some money. But they have the rights to do that under the current license. But in terms of having access to our technology, that is not something that they have access to and that would require a new license and further payment.

That's good to hear that you guys can actually realize some income from that relationship. Also too, you mentioned that LG is a new licensee of VibeTonz. I understand that LG also manufacturers a lot of light goods. Would you be able to comment on whether or not you have demoed or whether or not they might be interested in expanding that license to include some of the TouchSense for their light goods?

Well, actually, LG Samsung and others also have as you know diverse and broad set of opportunities that they pursue every day. The relationship with LG is focused primarily on the cell phone handheld device space. So interest in our other technologies for other markets, I believe that we have discussed that capability. And it's something that we could pursue at some later date, but it's not currently part of the current license agreement.

One final question. So assuming that the judgment comes in first quarter of '07 and let's also say that the PlayStation 3 does not have any haptic capabilities, how quickly or if at all would you actually try to get compensation from some of the other games that use force feedback? Because I understand that only 47 games have been included in the lawsuit. But it's my understanding there's hundreds if not maybe even thousands of games that actually do have this haptic capability and I do believe that you would be able to also get some type of compensation from those games. So when would we as investors see that or is that in the -- have you guys even thought about that?

I can assure you we thought a lot about it. So I think to be clear, the judgment has been entered so that has been done. But what is still pending is their appeal, and that's what we would hope to see decided in Immersion's favor in the first quarter of '07. So assuming and this is a hypothetical -- I don't want to go too far down this road. But assuming that the appeal were to be in Immersion's favor, then we would move quickly to address some of the issues that you alluded to, namely an injunction which is currently stayed pending the appeal. So we would work towards that as well as capturing other infringing products. Whether they are additional games or other type of products, we would begin pursuing that. So we are well aware of it. It's part of a strategy, but I'm really not at liberty to go into anymore detail than that.

[Mark Cabash], Private Investor.

Congratulations. I've been following you for a while, and I'm thrilled to see the steady progress. I would love to put you back on that soap box that I left you on last quarter regarding a couple of different issues. One of them -- the D-pad, the new controller in which you have licensed as it obviously is superior because it incorporates the rumble effects and also motion. Currently, can anyone utilize that with any existing installed console base?

You threw me for a loop there on the D-pad. I'm assuming that's eDimensional; that's their product.

That is correct. Yes, sir.

Right. Let's see here. I am not sure if that product is limited to any particular platform. I apologize; I can't give you a lot of details about their product right now. But we're confident that vibration technology, whether it is the current implementation or our future implementation on next generation, we're confident that can be used in combination with motion sensing or tilt control in the existing platforms. And obviously, we believe in the future platforms that are about to be launched. So we believe there's a way to solve that problem.

I'm confident in your capabilities in that regard. Next question -- pertaining to the point of sales that you had mentioned, I assume that means like the cash registers at the grocery stores or kiosks at airports.

Those are a few. There are a number of other applications. For example, makeup and other kinds of opportunities to choose products on the retail level, there is also interest from that space as well.

Pertaining to the VibeTonz handset manufacturers, I currently ran out and bought that new Samsung phone here in the States. Does US have a competitive installation base versus the Asian communities for the phones? Or are we still lopsided regarding our revenue that's generated from that country versus US?

Well, the Korean market is clearly an advanced market in terms of the applications. I think if you look at the phones per headcount, they are quite substantial. I don't know that there are any disadvantages or weaknesses. The phone you mentioned, I went out and bought myself. We're seeing great interest in that. We're seeing great interest over in Europe, and the phones sold in China and Taiwan are doing well. So I think we're having -- we're seeing some success in all the markets. And all markets are being addressed by the leading carriers in those territories.

Fantastic! Congratulations to the entire team over there at Immersion Medical. I think their product line has set an incredible pace in which the rest of the Company has got a tough time to compete with. But the way I look at it -- and correct me if I'm wrong, Vic -- every one of those patents and areas, you are trying to disseminate our technologies in seems to be sitting on a powder keg. Any one of them in any given quarter could reap a tremendous amount of reward based off of those patents in which you have. Which do you think might be the second-fastest grower next calendar year?

I appreciate the positive outlook, and I also appreciate your own personal support. Our technology is finding a lot of you know interest and getting a lot of excitement in a number of different industries. The three that seem to be having the most success at least in the near term are the medical, the mobility and the tactile touchscreen. Those are three that as you said, almost any one of them could have a substantial increase in a given quarter in terms of opportunity. So those three I think have the biggest opportunity at least in the near term.

I would agree with that. And lastly, Vic, I would like to -- it's hard to project on a quarterly basis your revenues and/or when you might be earning money. But do you have a suggested number regarding your revenues that you would be at a breakeven point?

It will depend on the revenue mix. Obviously, if we had substantially increased royalties, we would get there faster. I'm guessing my pro forma looks at a number something in the neighborhood of 8 -- somewhere between 8 million and 9 million that would allow us to be profitable.

On a quarterly basis?

On a quarterly basis, yes.

Fantastic! I can see it happening soon.

At this time, there are no further questions.

Thank you very much for your participation in today's call. We appreciate your continued interest in Immersion. Thank you and good afternoon.

This concludes today's Immersion second-quarter investors conference call. You may now disconnect.