Immersion Corp (IMMR) 2006 Q3 法說會逐字稿

Good afternoon. My name is Audrey and I will be your conference operator today. At this time, I would like to welcome everyone to the Immersion Third Quarter Financial Conference Call. (Operator Instructions.) I would now like to turn the call over to Ms. Gayle Schaeffer, Vice President, Corporate Marketing. Please go ahead.

Thank you, Audrey. Good afternoon, and thank you for joining us today. I am pleased to welcome you to this discussion of Immersion's results for the third quarter of 2006 by Vic Viegas, CEO and President, and Stephen Ambler, CFO and Vice President, 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. Instructions on how to replay this call are available in our earnings press release.

During the course of our comments today, we will be making forward-looking statements. These forward-looking statements include Management's current analysis of certain aspects of Immersion'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 the risk factors mentioned in today's news release, in Immersion's SEC filings, and in our annual report to shareholders, as well as any factors mentioned during our discussions today.

Vic will provide a brief summary of Immersion's third quarter results, and give an update on our medical, gaming, touch interface products, and mobility businesses, followed by Stephen, who will supply details on our financial performance. Vic?

Thank you for joining us today. I am happy to report that revenues in the third quarter grew 22% over the same quarter last year. We had growth of 35% in non-gaming revenue, primarily in our medical and touch interface products groups, which offset the expected decline in our gaming revenue. Our overall growth shows increasing demand for our haptics technology, which is being used in a growing number of applications across many different markets.

Let's begin with our medical business, where revenue grew 64% over the third quarter last year fueled by growth in our business with Medtronic and Laerdal. We continue our long-term relationship with Medtronic, developing and supplying them with endovascular simulators, used to help train physicians on procedures that use Medtronic devices, such as pacemaker leads.

During the last conference call, we discussed our new relationship with Laerdal, a global company with a large worldwide sales force. After just one quarter, our revenue from this arrangement has grown substantially. Our focus for the rest of 2006 and 2007 in medical is to continue leveraging industry alliances such as these, expand international sales, and launch new products that allow physicians to learn in a no-risk environment.

In the gaming market, our revenue remains soft with a 28% decline in the third quarter, compared to the same period last year. As we've stated in previous conference calls, we believe the transition to the next generation console systems has dampened consumer demand for current Xbox, PS2 and GameCube systems and peripherals. Despite new products coming to market and acquiring new licensees, our gaming royalty revenue will likely continue to decline unless console makers license third parties to make additional next generation peripherals.

Given this climate, we are taking several steps. The first is to capture available market revenue for third-party Xbox, PS2, and GameCube peripherals with vibration feedback. Since the last conference call, we signed two new licensees who are entering the gaming peripheral market. Existing licensees continue to produce new products for the market. For example, our licensee announced in May, eDimensional, began shipping emotion sensing and vibration feedback gamepad controller for the PS2 in September.

The second step is to introduce next generation technology that would bring the gaming experience to a new level, making it far more engaging, immersive, and realistic. We spent a fair bit of time in our last conference call describing this technology and the very favorable reviews it has received in the press, so I won't repeat that information here. We will continue our marketing activities to promote our next generation technology to game developers and game console suppliers.

And the third step is to make the entire industry, including consumers, aware of the importance of our technology and what it supplies to the gaming experience. In September, we announced the results of an independent study by Ipsos Insight. The purpose of the study was to measure consumer reaction to existing vibration feedback technology and to make the results available to key market players - game developers, console manufacturers, and third-party peripheral suppliers. The study collected consumer opinions on vibration feedback technology, measured expectations for the technology in next generation systems, and assessed whether the feature, or lack of it, would influence purchasing behavior.

I encourage you to read the full report on the study in the Gaming section of our website. Here are just a few key results. By almost a three--by an almost three-to-one margin, those surveyed like and want vibration feedback in video games. A third of survey respondents feel it is "essential to the fun, realism, and overall experience," especially for the most popular game genres.

The second key point is more than eight of every 10 gamers surveyed feel that it is important for a new version of a game console to offer backward compatibility for video games. That is, that a new console model be able to play games that were designed for the previous console model. Almost seven of every 10 gamers consider vibration feedback part of that definition of backward compatible.

And the third key result--and of key interest is the study revealed that only 18% of gamers surveyed knew that Sony had announced removing vibration feedback from PS3 controllers. Gamers were disappointed with that news. Of those who had indicated that they would purchase a PS3, 5% then said they would definitely not buy the PS3 without the vibration feature. 32% were somewhat less likely to purchase, and 14% were unsure how it might affect their purchase decision. Fewer than half reported that they would definitely still buy or even be more likely to buy a PS3 with the knowledge that it would not have the vibration feature.

Supported by this research, we are in the midst of a program to fully educate the press, and by doing so, the public. We believe it's important for consumers to know about the lack of support for vibration feedback in PS3 controllers, and that Sony has not announced support for including vibration feedback through third-party game pad controllers. Our research indicates that the gaming community strongly supports advanced haptic technology, and that the feature will figure prominently into their purchase decision.

Further, we hope to make them aware that a next generation technology does exist and that it is a dramatic improvement over current vibration systems without any measurable impact on cost or power consumption.

Moving on, our touch interface products business continues to be a potential source for significant future growth. Revenue in the third quarter for this business grew 15% over the same quarter last year. We have many opportunities for growth of our tactile touch screen products across high volume market segments, including casino gaming, kiosk, industrial controls, automotive, and medical equipment.

Each of these markets, and many others, has adopted the touch screen because of its many benefits, including intuitive user input, software flexibility, and space and cost savings. What the touch screen does not supply, however, is tactile confirmation. The loss of that simple quality can be detrimental to user engagement and understanding, completion of commercial transactions, safety, and other factors.

Our technology can help solve these problems. To meet anticipated market demand, we established a relationship with a contract manufacturer in China and preparations for high volume production of tactile touch screen components are well underway.

We continue to make progress with 3M touch systems and their OEM customers on the design and integration of our components in the casino gaming and bartop amusement products. We believe that there will be two or more OEMs showing gaming machines with Immersion touch sense technology at two prestigious industry events - the Global Gaming Expo in Las Vegas, which is November 14th through the 16th, and the combined Amusement Trades Exhibition International and International Casino Exhibition to be held in London, January 24 through 26, 2007.

The kiosk market is another important source of potential growth where we are focusing sales and marketing resources. Summit Research Associates estimates the number--the worldwide production of touch screen-based kiosks in 2006 to be 170,000 units. At the Self Service and Kiosk Show in San Antonio in September, we demonstrated the value of touch sense technology to representatives from airline, major retail, photo kiosk, quick serve restaurant, government, and other sectors. Almost to a person, the reaction was, and I quote, "This make the touch screen work the way it ought to." And they would often then bring their colleagues to try it.

In the third quarter, we also built relationships that gave our touch screen technology access to established market channels. We announced that the largest supplier of kiosks in North America, Kiosk Information Systems, has decided to offer our touch screen technology to its customers. In addition, ELO Touch Systems, a major supplier of touch monitors to the kiosk industry, exhibited the touch monitor with our technology at the Self Service and Kiosk Show.

We are making progress with tactile touch screens in other industries as well, achieving a recent design win from a manufacturer of medical equipment for hospitals. Interest in the automotive industry is also substantial where we are directly, and also through our licensee, SMK, experiencing more activity. I am optimistic about our technology being included in many more designs in 2007, which we expect will lead to follow-on product shipments.

In our mobility business, we continue to build momentum with handset makers and operators. We are especially encouraged by the very positive response from handset makers to our new tactile touch screen technology for mobile devices. Even though we just announced the technology in June, we anticipate that our licensees will launch several mobile phones with VibeTonz-enabled touch screens in the fourth quarter of this year, or in early first quarter of next year.

According to a Gartner data quest 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. The analysts and handset makers we've engaged have been very excited by the prospect of an inexpensive tactile touch screen that can solve the problem of a lack of confirming feedback, especially when trying to activate small graphical buttons for operating these devices in direct sunlight.

You may have seen the recent Verizon Wireless and Samsung advertising campaigns featuring two VibeTonz-enabled phones. The higher end, Samsung SCH-a930 Music Phone, and the value priced A870. With these latest high volume phones, VibeTonz technology is now being deployed across a wide spectrum of mobile products. We anticipate having a cumulative total in excess of 4 million VibeTonz-enabled phones in the market by the end of the fourth quarter.

We continue to actively engage other leading handset makers in technology and business discussions with the near term goal of signing additional licensees to significantly increase the number of VibeTonz handsets.

Korea is a trend-setting advanced mobile phone market, often implementing new phone--new mobile phone technologies, such as 3G services and ringback tones, that later become successful in the larger market of Europe and America. Our VibeTonz technology now enjoys broad support within the mobile industry in Korea, and we believe it is on the same path for broader adoption outside Korea. We now have licenses with the top three handset makers in Korea and the top two operators or their content aggregators.

Recently, we established an important new operator relationship with KTF, the number two operator in Korea, with 13 million subscribers. Our new relationship with KTF is through an Immersion agreement with their content aggregator, GeoTel, who supplies KTF subscribers with games, music, video on demand, messaging, and other content and services. Immersion already has a well-established relationship with SK Telecom, the number one operator with 20 million subscribers, who earlier in the third quarter launched the first content category exclusively for VibeTonz-enabled ringtones with premium pricing.

These companies, along with leading content providers, are using our VibeTonz technology and tools to create compelling content that can generate a new source of revenue for their business.

Now, a very brief legal update. Please refer to our most recent 10-Q and 10-K for more detail. Over the past four years, Immersion has been defending its intellectual property through litigation against Sony Computer Entertainment. On October 3, 2006, a three-judge panel for the Federal Circuit Court of Appeals held an hour-long oral hearing on Sony's appeal. While we cannot predict when the Federal Circuit will issue its decision, we believe that a decision is likely in the first quarter of 2007. We remain confident that our victory in the district court will be upheld in the appeals process.

I'd now like to turn the call over to Stephen to give detail on our financial performance for the quarter and upcoming investor relations events. Stephen?

Thanks, Vic. I am pleased to report improved third quarter results, demonstrating continued execution of our sales and marketing plans and growing customer demand for our haptic technology.

Revenues for the third quarter of 2006 were $6.6 million compared to $5.4 million in the third quarter of 2005, an increase of 22%. Our net loss under GAAP for the third quarter of 2006 was $3.2 million, equivalent to $0.13 a share, compared to $4.2 million, or $0.17 a share, in the third quarter of 2005. This is an improvement of 24% on last year. However, as was the case in Q1 and Q2, these numbers are not directly comparable, because in 2006 we are accounting for non-cash stock-based compensation under FAS 123(R), whereas in 2005 we were not.

The stock compensation charge in the 2006 third quarter was $724,000. Our loss, excluding the non-cash stock charge, was $2.4 million for the quarter, equal to $0.10 a share. This is a $1.7 million, or 41% improvement over the prior year period. 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 medical and touch interface product lines. This growth was partly offset by decreases in revenue from our gaming and 3D product lines.

Looking at each of these businesses in detail, starting with gaming. As we have stated in each of our last three conference calls, product demand for our licensees' current generation gaming peripheral product is being adversely affected by the transition to next generation console systems. We expect this decrease in license royalties to continue through the fourth quarter of 2006 and into 2007.

Our gaming business revenues were $817,000 for the quarter, down 28% from a year ago, when they were at $1.1 million for the quarter. Gaming revenues accounted for 12% of total revenues for the quarter. On a year-to-date basis, our gaming revenues totaled $3.2 million, and are down 33% compared to last year.

On a [indiscernible] note, products and licensing from our touch interface products provided double-digit growth. Touch screen components, rotary modules, and commercial gaming products accounted for revenues of $900,000 for the quarter, or 14% of total revenue. This performance compares to $786,000 in the year ago quarter, an improvement of 15%.

For the nine months ended September 30, 2006, our touch interface product revenues totaled $2.7 million, compared to $2.3 million in the comparative period, an increase of 18%.

Our medical business exhibited very strong performance. Revenues were $3.8 million in the quarter, up 64% from $2.3 million in the year-ago quarter. Our medical business comprised 57% of total Company revenues for the quarter. Medical revenues grew on increased product sales and completion of development contract work. For the nine-months ended September 30, 2006, medical revenues totaled $9.8 million, compared to $7 million in the nine months ended September 30, 2005, a very strong increase of 41%.

3D Products. Revenues from our 3D products were again steady, and totaled $1 million for the quarter, down 11% from $1.2 million in the comparable period a year ago, due primarily to reduced government contract revenue. 3D revenues comprised 16% of our total revenues for the quarter. Year-to-date, 3D revenues totaled $3.4 million, compared to $3.3 million in the comparative period, an increase of 3%.

Analyzing our third quarter revenue by category, total product sales accounted for 65% of revenues of $4.3 million, compared to 63% of total revenue, or $3.4 million, in the third quarter a year ago. Medical product sales grew 38% over the third quarter of 2005 and totaled $3 million for the quarter. We also saw growth in 3D and touch interface product sales compared to the third quarter of 2005.

Royalties from patent and technology licensing represented 20% of total revenue, or $1.3 million, as compared to 27% of total revenue or $1.5 million for the comparable period a year ago. The decrease in royalty revenue was primarily attributed to the softness in third-party gaming peripheral sales.

Development contract and other revenues for the quarter represented 15% of total revenue, or $962,000, compared to 10% of total revenue, or $538,000, in the third quarter of 2005. The majority of this growth came from our medical business.

For the quarter, our gross margin was $4.6 million, or 17%, compared to $3.6 million, or 67%, in the third quarter of 2005. Despite reduced royalty income, we were able to maintain our margins, primarily as a result of increased development contract revenue. The margin of 17% is lower than in recent quarters, and this was primarily due to the mix of sales in the period. Year-to-date margin is 73%, and we anticipate our margin in the fourth quarter will be above this level.

Third quarter 2006 operating expenses, prior to the offset of litigation settlements that, after taking account $707,000 worth of non-cash stock-based compensation charges, were $7.7 million. Excluding non-cash stock-based compensation charges, operating expenses were $6.9 million, compared to $7.5 million in the year ago period - a decrease of 8%.

Litigation costs included within operating expenses were $364,000 in the quarter, compared to $1.5 million in the comparative period.

In summary, we believe these results demonstrate the continued progress the Company has made in executing its sales and marketing plans, in investing in product and technology development, controlling operating expenses, and protecting and defending its intellectual property.

Moving to the balance sheet, on September 30, 2006, we had cash and cash equivalents totaling $29 million, down from $30.9 million on June 30, 2006. There was no change in the period related to our long-term convertible debt, which is due December 2009. In mid-August 2006, we received $1.3 million from Sony under the terms of their compulsory license for the period April 1, 2006 through June 30, 2006. As with previous payments, this sum is accounted for as long-term deferred revenue.

As of September 30, 2006, we had 24.6 million shares of common stock outstanding, and we also had 137 employees. We recently attended and presented at the Valley Ridge Small Cap Financial Expo in Las Vegas. We will be attending and presenting next week at the AEA Classic Financial Conference in Monterey on November 7 and 8, 2006. And we will be presenting at the Thomas Weisel Technology Conference in San Francisco on February 6, 2007. If you are planning to attend either of these events, we look forward to seeing you there.

Vic?

Thanks, Stephen. In closing, I continue to be excited about the momentum and strong growth in several of our key businesses - medical, mobility, and touch interface products. In spite of a tough situation in the gaming market, we are growing overall revenue, which is key to achieving profitability, and in response to the gaming situation, we've taken as strong a stance as possible, documenting that gamers want vibration technology, promoting our next generation solution that's been called "10 times better" than what's available today, and reaching out to educate all market participants and consumers.

Across our businesses, we have successfully demonstrated the value of our technology for solving problems and for improving the user experience for many applications. Our endovascular simulators help physicians learn in an environment with no risk to patients. Our tactile touch screen components provide reassuring confirmation when using a touch screen. Immersion's next generation rumble feedback technology takes the console gaming experience to a whole new level. And our momentum in Korea's wireless market shows the promise of widespread adoption of our VibeTonz technology.

We've also made important new alliances with large worldwide companies, such as Medtronic, Laerdal, 3M Touch Systems, Samsung, and LG Electronics, to name a few. These relationships are fueling growth for Immersion and we are working hard to expand these relationships and others in medical, mobility, gaming, automotive, kiosk, and other markets. I believe we have the right focus and are making the right investments to continue the growth that will lead Immersion to profitability.

Audrey, please open the call for questions. Hello, Audrey?

Yes, sir. (Operator Instructions.) The first question comes from the line of [Mark McMahon] with Wachovia.

Hi, Steve and Vic. How are you guys doing?

Doing fine, thanks, Mark.

Yes, fine, thanks.

Two questions, really. One, if you could expand on what exactly you meant by exploring contract manufacturing in China, and what that is in relation to in terms of new business, a partnership that you've already signed here in the United States, or anticipation of any future agreements?

And then, secondly, in terms of your long-term deferred revenue that you're receiving from Sony. If in the event that you guys are successful in the final litigation outcome, how is it going to be booked? Is it going to be like a one-time lump sum, or are you going to go back and restate earnings for the previous quarters to account for that revenue? And what's the total amount that you have to date now sitting in escrow, I take it?

Good questions, Mark. Thank you. To answer your first question, we--in the tactile touch screen business, we provide a component--several components to be accurate. And those components are what allow you to create these very rich and robust effects on a tactile touch screen. Primarily, these are small low cost actuators that we would make available to our design partners, people like 3M for the casino market, and as I mentioned before, the ELO Touch Systems, and other integrators and other companies that would want to implement this technology into their products.

So, the component itself is something that we are now working with a contract manufacturer in China. And I'm kind of happy to say that the first production run came off the line with I think about 90% plus yield and passing our specifications. So, we've really accomplished a lot in productizing our tactile technology. But this is in anticipation of the orders for creating tactile touch screens and the need to have high volume production in China.

I'll let Stephen answer the second question.

Just to follow-up on that real quick. So, for example, your 3M partnership in terms of the casino touch screen slot machines. This would be in anticipation that you guys think that perhaps for these shows, they're customers, that there's going to be strong demand and then you guys would then have to be in the position to be able to provide 3M with the components they need to quickly put together the devices.

Absolutely. That would be one key application, the casino gaming. But as I mentioned before, we have lots of market opportunities that we're going after and these include point of sale kiosks, office equipment, medical controls, industrial controls. So, there are a lot of places that will benefit from the use of the Immersion tactile touch screen technology. So, we're excited with our relationship with 3M in the casino space. And in addition to that, there are a number of other applications that we're gearing up and preparing our products for.

Thank you.

Okay. On the second part of the call--the question, sorry. We've received so far in payments or interest $25.3 million from Sony. If all the contingencies go away, we would be able to take that sum to income and we would take it in one period. We would not go back and restate prior periods.

Okay. And you would anticipate that to take place in whatever quarter a final decision would transpire, right?

When all the contingencies go away, which hopefully would be in the same period. Yes.

Okay. Thank you very much. Congratulations on a good quarter, guys.

Thank you, Mark.

Your next question comes from the line of [Chris Little], a private investor.

Hi, Chris.

Hi.

Hi, Vic. Hi, Steve. I wanted to congratulate you guys on a very solid quarter. I just have a couple of questions for you. So, Vic, you mentioned that there would be two upcoming shows that would--for the casino gaming market that would show real products for--that include touch sense. So, would you know whether those products would be sellable or when we would actually see revenue hit the top line for Immersion? Like, would that be in the first quarter--Q7, or do you anticipate that being a little further out, like Q2?

Sure. Chris, the--to answer the second part of your question, the revenue side. We're currently generating revenue now, primarily development revenue and some product sales of control boards and other low volume types of early design wins in other markets. But I think really when we should start to expect some meaningful revenue from our tactile touch screen opportunity, I think we are probably looking at Q2 for the beginning of that ramp up. So, Q2 of 2007 would be when I would expect to see some meaningful revenue.

In terms of what will be demonstrated at the various shows, we're aware of--I think we said two. There could be more that will be demonstrating our technology integrated in products that will be demonstrated to the industry. These are probably beyond the prototype phase. These are coming close to being shippable products. They will then at that show solicit interest from their customers, presumably begin starting to take orders, and place orders. And then, the revenue machine kind of starts.

So, some of those demonstrations we expect to be in public. Others we expect to be in let's say VIP booths or in closed sessions. But I think you'll be pleased with the visibility of the technology in the 3M booth and in other booths as well.

Okay, great. Just a couple more questions. This is a patent-related question. Now, I know that there are some console controller manufacturers outside of the United States I believe, like, for example, there's a company called KiRo in Japan. Are the patents that you guys have--are they exclusive only to the United States, or do they carry over to a sort of worldwide forum where you might be able to sue companies that might infringe on some of your patents?

Well, Chris, we've got over 300 patents currently and over 300 in application form, so--or pending applications. So, we're looking at a patent pool in excess of 600 patents. Those patents cover our technology around the world. Some are in the United States and some are in international markets. So, it's difficult to say where we have patents or where we don't have patents. You'd have to look at this long list. But we do have pretty broad coverage in the areas of our interest.

In terms of specific companies, I can't speak to the details. We do have many licensees worldwide in all parts of the world, including China, Japan, the U.S., and throughout Europe. So, we do conduct business all over the world. We have IP all over the world. Specific companies, I'm not at liberty to really discuss.

Okay, fair enough. And my final question. I understand that there are several companies out there developing morphable touch screens or--such as Apple. Has there been any interest or have you done any demonstrations with Apple, and perhaps--in terms of integrating touch sense into any of their products or--?

--Well, I think we--specifically with Apple, I can't really respond to the tactile touch screen. We've historically had a very good relationship with them. We've worked with integrating our technology into their operating systems, so that gaming controllers can play on their systems. And we've had some real success there. In terms of other things, we have shown them other technologies, including the touch screen. Whether we move forward with those, whether those get to the marketplace, is obviously still something that is to be seen.

In terms of other companies launching other products, I guess I would maybe remind you that we've--for probably a year and a half now or more, we've proliferated our prototypes and even our designs and put those into the hands of many other companies. So, a lot of what you're seeing--I'm not going to say all, but many of the demonstrations that you might see in various different markets will most likely be prototypes from Immersion or development kits that we've made available to various different companies. Aside from that, I'm not really aware of a significant presence in tactile touch screens by other companies other than using Immersion's technology.

Great. Thanks a lot.

Thank you.

Your next question comes from the line of [Curt Mayer] with Lehman Brothers.

Hi, Vic. A couple of different questions. You mentioned ELO showed a touch monitor in San Antonio. Are they a licensee at this point in time?

The answer to that question is, no, Curt. They are not a licensee. They are someone who we've worked with and continue to work with [inaudible] the value of adding tactile capability to touch screens. And they believe in the technology enough to show it publicly and solicit interest from their customers.

Okay. Regarding the joint venture with 3M and the component supply situation over in China, trying to get my better understanding of this. Are you looking at getting the components made in China, and then, selling them to the joint venture at a profit? And then, you then profit from the joint venture level as well? Or are you supplying these components to the joint venture at cost?

Curt, there is no joint venture.

Okay.

There's a very close relationship. And it's more of a purchase relationship where we are providing components, in this particular case, actuators. We've also provided technology, including development tools and APIs, firmware, and other kinds of technologies, including control board technologies. And we've ported our technology onto 3M control boards.

So, there's a tight relationship. But we would be selling this kit of actuators. We would typically sell those to 3M who would then integrate that into a tactile touch screen, and that would then either be sold as a kit to their customers, or it would be integrated into a product and provided to their customers.

Okay. Thanks. I appreciate you clearing that up. You also mentioned that we should be looking potentially either in Q4 or Q1--I think you said several phones that would be utilizing touch screen technologies. "Several" is one of those subjective words. Are we looking at the potential of two, of five, of 10? And I know you're not in control of the release of these things, but can you give us perhaps more--a better understanding of how many phones we're actually looking at?

This is somewhat confidential information, so I'm not going to be able to give you specific numbers. I can only tell you that the lineup of models that we expect to launch over the next few quarters, and the models that are currently in design, I would say we have more models in some level of completion than we've ever had. So, the number of models that are being--are candidates for inclusion, if VibeTonz technology continues to grow, the models that are in the marketplace continue to have success.

And I think what I was primarily pointing out is that there are a fairly large number of models that will hit the market soon and that these models will be using VibeTonz to create tactile sensations on touch screens--.

--Okay--.

--Which I think is a--we've recently announced the availability of tactile technology onto small touch screens. And this is one where we will have VibeTonz driving that touch screen. Even though we're creating tactile effects on the screen, these--we've now been talking about two different types of technology - one which we call lateral actuator technology, using actuators to vibrate the screen. And in other applications we are using onboard low-cost actuators in cell phones or PDAs that can also create the vibration to create the tactile queues on the touch screen.

Okay. Are you getting in your agreements now with the phones that are going to be rolling out over the next three to six months--the royalty that you get now or in the next six months, is it going to be consistent, higher or lower than what you got from Samsung a year or two years ago when you initially licensed them?

So, we have one agreement with Samsung and it covers VibeTonz technology. I think the way to look at this is we've just added one new very important application. So, in addition to using VibeTonz to drive vibration enhanced ring tones or games or messaging, or user interface advantages, now we're using VibeTonz to create tactile touch screens in a mobile device. So, it's consistent with the business model and the pricing schemes that we have in--already under contract with Samsung and the other two licensees, Pantech and LG.

Okay. And I'm going to go down a very dark alleyway, which I know nobody really wants to think about right now. But being rational, we've got to look at the downside of things. If the court decision out of D.C. goes the wrong way and it completely gets overturned, Stephen mentioned a $25.3 million aggregate amount that we've essentially taken in. But obviously, it shows up as deferred revenue.

We're sitting with 29 million in cash. If this thing goes the wrong way and we, therefore, unless I'm looking at this wrong, we have to pay them back that money, am I correct in thinking we're sitting with $4 million, give or take, in the bank?

Well, I'm not going to go through let's say the legal aspects of that question or the actions that Immersion could or would take. But just simply, we have won in front of a jury and a judgment was entered by the judge. I believe virtually every legal aspect of the case has turned in Immersion's favor. So now, we have--are working through the appeals process.

And if the appeals court, based on what was presented, decided to overturn all aspects of the case--so we're talking about multiple patents, we're talking about multiple claims of multiple patents. And if that were all overturned, that's an extreme hypothetical, and maybe I'll just leave it at that.

I agree with you that it's a very extreme case, but I thought, obviously, I should ask the question anyway. I appreciate it. Thank you.

Thank you, Curt.

Your next question comes from the line of Ben Montgomery, a private investor.

I have a couple of quick questions. I missed the early part of the call. But I was just wondering if you have any kind of estimation as to when the Company actually will turn cash flow positive and profitable?

Well, we do have a fairly good internal set of forecasts that are starting to show us turning the corner. I can't say which period. We're not going to provide that kind of guidance right now.

Okay.

In terms of cash flow positive, I think depending on how you calculate that, we've been cash flow positive at various quarters, if you include the fact that we have operating losses that are significantly influenced by non-cash transactions. On top of that, you have the cash flow of the compulsory license.

Sure.

If you add that, we do have periods where we're contributing to the cash balance, and we would continue to expect that in the future. If you're talking about purely a GAAP basis profitable period, again, I can't forecast that for you here. But we are starting to see, with the continued growth in revenue, we do expect to have a very strong fourth quarter. We're getting closer to that point.

One other quick question. Did you attend the oral arguments for the appeal? And if so, what was your feeling about the Sony attorney in that presentation?

Yes, I was there. The whole event lasted about an hour. I thought all sides were well prepared. Everybody argued their points I think as well as they could. Obviously, I feel our case, our points, and our legal team did the best job. I feel very confident about what was accomplished back in Washington, and I still feel confident that the lower district court ruling will be upheld. And I think it would not be appropriate for me to give you my personal thoughts on the Sony attorney or any of their other activities or behavior.

Okay. Thank you very much.

Your next question comes from the line of Alec Berman with AMPAC Research.

Hey. How are you doing?

Hi.

I just wanted to understand--so, on the legal thing. If it does get resolved in the first quarter, is that the end or are there still other appeals they can do, or where are we at sort of on the whole situation with that at this time--right now?

Well, I--it would be difficult for me to try to predict all of their actions and what they might do. I think we're hoping for the appeals court to rule in the first quarter of 2007. Assuming that things went in our favor, my guess is there could still be a challenge to that ruling, and there could be an escalation to the Supreme Court. And so, there are probably other activities that they could try.

I also want to highlight that the current appeal that is pending is regarding the main lawsuit and issue. There is separately a motion that was brought by Sony that was dismissed at the lower court ruling. This is the 60B hearing that took place. And that is a separate action that will also be heard in appeals through the appeals court. So, it's awfully difficult for me to predict what their actions might be or how they might drag this out further. But we have to assume the worst, and assume that things will continue to proceed slowly.

Got you. So, I guess what I was trying to ask is when eventually--I mean, eventually at some point they--you can't drag it out forever. Eventually, wouldn't it be important that this end eventually? Eventually, you've got to--you keep losing. Assuming, eventually you can't--there's nothing else you can do, right? [Inaudible.]

Again, I can't predict what their actions would be. But if the appeals court turns in our favor, again, there's probably things that they could do to delay the decision and the actual transfer of funds for anywhere from three to six months. If things don't go completely in our favor and it needs to be remanded back to the lower court, again, that could take more time and it's just too difficult to predict how fast that could go.

There will be an end. I assure you that. There will be an end. Immersion will continue to [proceed] this to its logical conclusion. As I mentioned before, our goal would be to try to settle this. But if that isn't a possibility under fair and reasonable terms, then we will see this through the court system as far as it needs to go.

Okay. Thanks a lot.

All right, Alec.

Okay.

(Operator Instructions.) We have a follow-up question from the line of Alec Berman with AMPAC Research.

Oh. It's me, again. Okay. The--basically--just maybe remind me of the business model. So, on the actuators that will come out of China I guess, their--the margin sort of target or model on those. Remind me how that works, again.

Well, we would sell those actuators to customers. And we would sell those with a markup that would include the use of our technology and the cost of those components. It really will depend on the relationship and the volume. The questions that you'd have to answer before you could hypothetically give a price quote. Would our control board be used, or would our control technology be integrated into the customer's control board? How many actuators are needed to actuate the screen? How large is the screen? What's the volume of purchases?

So, these are all kinds of issues that get to the heart of how we would price the product. But the sale price of the product would incorporate the component cost plus profit margin, including our technology.

Got you. The standard sort of product markup type of thing, which would be a function of the--okay--customer volume and so forth. One other quick thing. You said sort of you were thinking about a good strong Q4 or whatever. What's the primary driver of that? Is there a [indiscernible] phone in here as the pinnacle thing to grow? What do you see as far as the main driver of Q4?

Well, we--historically, we typically have a seasonal benefit in the fourth quarter because of the consumer products that are sold around the holiday season. So, if you were to go through each of the businesses, I think we continue to see growth in the medical business. And I believe we have visibility into the fourth quarter, so we would expect the medical group to grow. The mobility business, with increasing sales of cell phones, we have some confidence that the revenue in the fourth quarter will be better. The gaming business, typically it's a strong--the stronger supporter will be the fourth quarter.

We even expect our TIP group - our touch interface products - and our 3D group to continue to grow and have very good quarters. So, the combination of every one of our businesses expecting to grow leads me to believe that fourth quarter should be pretty strong.

(Operator Instructions.) We have another follow-up question from the line of Alec Berman.

Okay, great. We've got a private conference call here. The medical, is that--I think that's really sort of going well, kind of accelerating or just beginning to grow. Pretty--is that the kind of business where it's pretty smooth or could it kind of be bumpy quarter-to-quarter in terms of bouncing around as it grows? Or is it sort of kind of--is there a natural diversity of customers and things that it could be a fairly smooth thing in theory?

I would say that historically the medical group has probably shown some tendencies of being lumpy. And that's primarily from the timing of completion of development work. If we're working on a large contract for either a corporate customer or a government agency, depending on the effort and the deliverables, there could be significant revenue recorded in a particular quarter.

I would say though, as we sit here today and over the last few quarters, the combination of continued growth in our sales to universities and hospitals, which is the lifeblood of the Company, the backlog of development work, and the new relationship we have with Laerdal, who has over 500 salespeople in over 22 countries selling the virtual IV products around the world--the combination of those actions should reduce or possibly eliminate that lumpiness.

The business has become much more predictable. We have a very strong queue of orders that we believe we can close and deliver against, so I would expect the business to be a little better--a little more predictable.

Can you--I mean, define it as much to say that--I know you don't--it's hard to look too far ahead. But just, know reasonably that it won't be kind of--is it capable of seeing a constant more type of growth next year or is it just growing nicely each quarter it seems year-over-year? Is the pipeline visible enough for you to say something like that, or you don't want to say that at this point or--?

--Yes. I don't think I want to try to predict revenue in any particular quarter or even year-to-year. I'm just addressing the issue. I think that there have been a few quarters where we had lumpy revenue, a very substantial revenue. I believe the fourth quarter a few years ago was tied to the--some development work. Those types of actions are now smaller because the revenue is larger and we have revenue coming in from multiple sources.

So, I would guess that the business would be a little more predictable. The management team there is more seasoned, so they have a better sense of what to expect in their business. But in terms of predicting what impact that has on fourth quarter revenue or next year, to try to quantitatively capture that is just something I don't want to try to do here.

Yes. Now, I guess it would be nice I guess in terms of the--it sort of looks like a market where the addressable market is still fairly large versus what you're addressing so far, meaning just in a general sense it looks like a pretty good--a lot of opportunity here going forward I guess?

I would say in the medical business that's true. But in all of our other markets, we're only scratching the surface in the total available market, and the potential for each of these businesses is significant. We're very much at the early end of using our--the full capabilities of our technology and we're making it available. More people are aware of the benefits and we have more relationships. But I think we're just at the very early stages of deployment.

On the handset front, so just to be clear, so basically these products are going to be coming out in the next few quarters you're hoping. This is the first generation of not just VibeTonz for vibrations sake, but actual true touch screens where you hit a--let's say you dial a phone number or whatever you want to do and you actually feel something. So, that's what you're talking about here. That's sort of--that's what we're seeing coming out in the next few quarters. Is that what you were trying to say?

Yes, that's right. So, the VibeTonz that has been used to synchronize with game play and ringtones and user input, I think that the OEMs, our licensing partners, are now starting to use touch screens and they're taking advantage of VibeTonz to tactically enable these touch screens. So, those are--some of the models that we see being launched here will have that capability. And we're pleased to see such quick response and such quick design success in an area that's relatively new for Immersion.

Yes. I thought that was sort of surprising. I said, that's a good trend. I guess you also said this--to be clear. So, it doesn't--the business model is the same, I mean, once you get--you directly get paid for phone--what you might make on it would be the same, but what it does is gives--it gives someone that much more reason to put it in because it gives more features than essentially your technology would give the product.

Yes, that's right. Alec, I'm going to turn it back over to Audrey to see if there are any more questions, if that's okay.

Of course.

Thank you.

Your next question comes from the line of [Mark Whistler] with Agora.

Hi, Mark.

Hi, how are you? Thanks so much for taking my call. And congratulations on a great quarter. Hopefully, you haven't already given guidance to this. But I'm just curious if you could add a little bit of information about what you expect from Apple and the touch screen iPod. Just a slight bit of detail would be great. Thank you.

Yes. I'm not sure why there's a focus on Apple. What I said I think is we've worked with them in the past on integrating our technology into their operating system. We're happy to take their calls. We definitely try to show them new technologies, but in terms of working together, products, and what might come to the market, I'm happy to tell you--not happy to tell you, but I'm happy to disclose, we're not working on anything that we see coming to the market in the near future.

So, we would love to be--to work with them, but right now, it's not something that we're anticipating, and it's not something that we're actively working on.

Okay. Thank you very much.

At this time, there are no further questions. Are there any closing remarks?

Sure. Thank you, Audrey. Well, thanks very much for your participation on today's call. We appreciate your continued interest in and support of Immersion. Thank you and good afternoon.

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