Shum Mukherjee - Chief Financial Officer
Immersion Corporation (IMMR) Immersion at Security Research Associates Inc Fall Growth Stock Conference Call Transcript November 15, 2011 1:30 PM ET
Good morning everyone. Delighted to be here presenting at this conference. There is going to be a breakout session after this, and one of the things I would encourage all of you to do if possible is to attend the breakout session because we have got some demos, and there is nothing like demos to show you the value of Haptics. So if you at all have the time please come to the breakout session, and we will be happy to give you some demos.
Let me get started with the formal presentation, these are forward-looking statements and non-GAAP measures that we use. I like to give a quick summary of the company. It is a small agile company. We have a world-class customer base, very strong IP, and we happen to be in very large and rapidly growing markets. So the combination of the fact that we are in the right market in the right time, we have got a very strong portfolio and we have a sorted balance sheet now with $63 million of cash, no debt, and positive operating cash flow.
Now the company was founded in 1993, and over the last 15, 17 years it has gone through a lot of changes, and it is important to understand how the company evolved in order to understand and get a good perspective on where the company is today. So in terms of the company evolution, it was founded in 1993, and it did its IPO in 1997. The current CEO of the company is Victor Viegas, and he was the CFO who took the company public in 1997.
One of the first projects the company did after getting public is to buy 4 other Haptics companies, and you know, unlike many other technologies Haptics is not really a very popular technology. In fact, advanced Haptics courses are only available in two or three universities around the world. So what the company did is it bought 4 other Haptics companies, and with these companies came people, processes, and most importantly patents. So very early on the company accumulated a lot of Haptics patents and throughout the history of the company, it has continued innovating and continued developing patents, and innovation and patent development is very, very much a culture in the company.
In the initial years, the company focused on a number of segments, it won a lot of contracts from gaming companies like Logitech. It was successful in entering into the automotive market with BMW, and then in the middle of 2002 the company found that a number of other gaming companies like Microsoft and Sony were infringing on its patents, and as a result of this the company sued these companies, and over time settled and won those litigations.
So fast forward now to 2007, the company has won the litigation. In 2008, Vic retired as CEO, but continued to stay on the board, and a new CEO was appointed, who decided to focus the company’s efforts on the medical business. Now the timing was unfortunate because if you recall that was also the time when the recession started, and a lot of hospitals and medical companies weren’t really interested in spending a lot of investment dollars for medical products.
And so over 2008 and 2009, the company went through significant losses, a lot of the cash that it had obtained from Sony, from the $150 million it got down to the $80 million level during this time. But another very interesting thing happened during this time, which is in 2006, 2007 the iPhone was introduced, and with that smart phones really took off. And that was an area where the company had a lot of strength, because as we have seen there are a lot of advantages to the touch technology. The only disadvantage that people don’t like is the fact that it doesn’t give feedback, and Haptics provides that feedback.
So the combination of touch technology with Haptics is very, very compelling. So that is level setting the place, Vic came back to the company in late 2009, and decided to redirect the strategy of the company. Up until now, the company has been selling both products and licenses, and products accounted for about 50% of total revenues, licenses accounting for the other.
So Vic’s new strategy was basically to transfer the product to other companies, and he transferred three of the four main medical product lines to a company called CAE, retained the licensing rights, but then reconvert the company from one, which was half products, half licensing to one which was almost completely licensing. So today as a company about 90% of our revenues come from licensing. We have one product line left, which is in the medical simulation business, but our focus is actually on licensing. And as we go through the model, you will see why this is very important, and why this has proven to be very successful for us.
Now moving on what is Haptics. So, Haptics is a science of touch just like acoustics is the science of sound, and Haptics is the science of sight, Haptics is a science of touch, and what Haptics does it essentially brings life to objects like touch screens, it brings them to life. Without Haptics, you know, touch screens are very limited, small controls, visual impediments, small devices, but your fingers are very large. So it doesn’t give you the feel and you never know when you press the touch screen whether your touch is being registered or not, and it is a very, very uncomfortable feeling.
And what happens particularly in situations where if you are driving and there is a centre console and if you are touching it, and you don’t know whether the touch is registered, you tend to look back at the screen, and you take your eyes off the road, and that is a safety hazard. So what Haptics does is bring that reinforcement back to life, and that makes for a tremendous user experience.
So Haptics feedback allows you to feel the keys on a virtual keyboard, silent button press confirmation, in games it is now virtually unthinkable to be able to play a game without some type of feedback to get to your hands. So that is where Haptics comes in and is very, very useful. And then similarly when scrolling or swiping, or when you do surgery, again Haptics has become very useful. So the whole concept of Haptics is that it works extremely well with touch screens, and provides the feedback, which the user gets what he needs.
How does this do it, the mechanics of this technology is relatively simple, within the phone there is a motor, when you press let us say the number 5, it sends a signal to the touch screen controller, that in turn goes to a host or an embedded application, which then goes to the touch sense, here which is Immersion technology, and it sends a signal back to the motor asking it to play in a certain way, in a certain frequency, and as the motor vibrates the user feels the vibration.
So the technology is relatively straightforward and simple. Now in addition to the technology, there are other elements in the Haptics ecosystem. You have actuators on motors on the one hand, and then you have our embedded controller software, and these two are sufficient to deploy Haptics technology. But in addition to that, there are two other elements that are also very important in deploying Haptics across a variety of applications, and encouraging the use of Haptics.
And the first of these is what we call operating system integration using our MOTIV platform, and as we see in a while, what MOTIV does is enable the implementation of Haptics across a wide variety of application in the mobile phone in a very, very quick and efficient manner. Similarly to popularize the impact of Haptics, you know, there are third-party application programs and we’re very, very involved in encouraging developers to write more and more applications for Haptics that will continue to provide the users with very superior experiences.
Just to summarize the four elements of the Haptics ecosystem, you have got the motors, you have got the Immersion software and technology and know-how, you have got MOTIV that provides operating system integration, and you have got third-party applications. What this means for instance is in MOTIV, if you did not have MOTIV you would have to support Haptics separately for each and every application. Now think about a mobile phone, there are hundreds and hundreds of applications that you have today in a mobile phone. You can dial a number, you can read and you can play games and there are hundreds of applications and what used to happen before MOTIV is that for each application you have to support the Haptics separately.
And many OEMs who used Haptics wouldn’t want to do it because as you might know in the mobile space it is always a rush to get your next phone launched, and people lack the time to be able to do all of this. With MOTIV what happens is within the android platform, you can deploy the Haptics effect to a wide variety of applications across the board, in a very, very limited amount of time. So that has been a big advantage and many people are actively looking to deploy MOTIV as a piece of software to enhance the experience, and improve the experience in implementing Haptics in different forms.
The MOTIV platform comprises two things; one is the integrator for OEMs, where it allows you to seamlessly integrate Haptics across a wide variety of applications. It also provides an [inaudible] for application developers. And again, one of the things we mentioned is that in this ecosystem it is not just important to have Haptics, sell Haptics to the OEMs, we feel it is also important to encourage a lot of developers so that a lot of applications come to Haptics and that really makes the user experience a lot more compelling.
So it is a combination of new applications and the technology that makes for the user experience. We have as I mentioned a very, very active developer program, and we encourage, and we started this about six months ago, and it is extremely successful. So there are a number of people who are now engaged in the development of Haptics. We participate in a lot of training events, [inaudible] and all this creates a sense of community for the Haptics community, and encourages them to develop more and more applications using Haptics, and in turn this again creates a great user experience.
The technology trends that we have seen today are very favorable. You know the technology is moving from keyboards to touch screens and from buttons to touch surfaces. So why is that? It is because touch screen offers a tremendous amount of flexibility, and previously four or five years ago, they were very expensive. But now with touch screens costs having come down, it competes with conventional type of technologies, and provides a tremendous amount of flexibility because you know with the touch screen, you can write or you can portray a variety of different information at the touch of a button.
The only problem with touch screen is that it doesn’t give that feedback that people are very used to and when you touch the screen, sometimes you are not sure whether your touch has registered. So touch screens with Haptics is a very powerful combination, and that is a very favorable technology trend that is assisting companies that have Haptics.
What this means is that the application of Haptics is now not only a new market for mobile phones, but also in some of the existing and conventional markets, are segments of those markets are now benefiting from the use of Haptics technology. The biggest market for Haptics clearly is the mobile phone market. Now today, about 1.6 billion phones are sold, and the total number of mobile phones in the world today is the order of 5 billion.
The mobile phone market is now slowed down; the growth has slowed down to about 8% to 10% a year. But the touch phone segment of the market and the smart phone segment of the market continues to grow very rapidly. So touch phones today up to 1.6 [ph] about 30% more higher touch phones. And these touch phones as we said offer tremendous amount of flexibility, but the only thing lacking in them is the feedback, and that is what Haptics provides.
This market is dominated by about 10 players, and three of those 10 players happen to be Immersion’s customers. When you go to the next market, automobiles, about 82 million vehicles are sold every year, and as you know that market goes up and down, typically with GDP. The growth of the entire market is very modest, maybe 3% to 5% a year. But what is happening is there is more and more applications for what is known as the infotainment segment of the automobiles. And what happens is there is a centre console, and in that console, you get all types of information, some of which you are able to control, some of which you can visually see. You also get, for instance, things like rotary knobs, which allow you to scroll down lists in a very effective way.
Now that segment of the market that you have on centre consoles, that in fact today a third or 25% of the cars have that centre console. But that segment of the market with center consoles that is growing very rapidly. And so cars with centre consoles, whereas the total market is growing about 3% to 5% a year, that particular segment is growing about 20% to 25% a year. So you see examples of the touch screen technology, which is both in real products like mobile phones, but also in conventional products like automobiles, and these conventional products now are using more and more touch technology, and as a result of that the use of Haptics becomes more and more important.
If you look at Immersion’s revenue segmentation today, about 45% is mobile, 30% is gaming, 15% is medical, and the balance 10%, half of it is automobiles, and half of it is chips and others. So the automobile sector is a very promising sector for growth, but as you know the design cycles in automobiles are very long, and it takes anywhere from 3 to 5 years from the time we first start talking to an automobile manufacturer or to an ODM, who sells to the end automobile manufacturer, it could take 3 to 5 years for that to get into the design, and get into the product, finally be sold in the market from which we can generate revenue.
So that leads us to what our value proposition is because we have a very compelling value proposition. And the value proposition has two aspects to it, it has got both the emotional value, and as we spoke about particularly in things like games it excites the senses, and today it is unthinkable of playing some sort of a console games without some sort of vibration.
So it provides a lot of emotional appeal, at the same time it also has a lot of functional value. So in the example of the automobile, if you have a touch screen without Haptics, when you touch the screen you don’t know whether your touch has registered, and you tend to look back to the screen and take your eyes of the road, which is a safety hazard. So Haptics provides you that instant feedback, your eyes keeps staying on the road and that leads to a more safer driving experience.
Similarly when you are texting or typing, the use of Haptics gives you instantaneous feedback, and that in turn allows you to increase the accuracy, and reduce the error rate very, very significantly. So that is a compelling value proposition. It creates a truly differentiated user experience, and the incremental cost of providing that experience is very low. So with an incremental cost of somewhere like between $1 to $2, on a telephone whose worth [ph] could be about $200, on that type of incremental cost, you provide a very, very compelling experience.
Now moving on, we have world-class customers and partners, and we are able to leverage the best in class ecosystems. So we work with a lot of chip manufacturers, and we also work with a lot of solution providers. This is the touch screen market, we are running out of time, so I won’t go through it. But as I have described this market is growing very rapidly, 25% to 35% a year. It is -- Immersion was in about 25% of the touch screens last year, and that percentage continues to increase.
We have got a variety of different solutions, we call it good, better, best [ph] to cater to a variety of different customers, and be able to premium price with some of our products. In terms of competition, the competition in Haptics, a lot of people are providing some very basic Haptics experience. We provide what we call programmable Haptics, which is a very rich user experience. You can have very different types of Haptics effects, which makes the experience extremely compelling.
We support this with a very broad and deep patent portfolio. As I said we acquired a lot of patents in the companies, again, but we have continuously innovated, generated patents, and today we have got a very, very strong patent position, 1200 patent, half of which are granted and half of which are pending. Moving on now to the financials, our long-term model has now moved to a licensing model, and licensing accounts for about 90% of our total revenues.
Under this model, our gross margins are going to be north of 95%. In terms of Haptics, we are spending $6 million to $6.5 million of cash Opex every quarter, and we think that would be sufficient for us in the foreseeable future. Our adjusted EBITDA accordingly will be about 30% to 35%, and we will generate net income of between 5% to 20%. Now we said this was a long term model, but in fact we achieved this model in Q1 of this year, where we had revenues of $9.7 million, and because of the strength and scalability of the licensing model that in and of itself generated about $1.3 million of net income.
Moving on to our revenues in Q3, in terms of our seasonality, Q1 and Q4 tend to be our stronger quarters, Q2 and Q3 are not so strong quarters. So in terms of Q3, we have generated revenues of $6.5 million. Royalties and licenses accounted for 91% of total revenues. When I move to a full income statement, Q3 again on $6.5 million, we made a loss of $1.4 million. If you look at the entire time, we had revenues of $16.5 million and net income was a breakeven 78,000.
When you look at EBITDA for Q3 and year-to-date, our EBITDA year-to-date was $4.1 million, which was 50% above the EBITDA we generated in 2010. Moving on to our balance sheet, we have a relatively straight forward balance sheet, about $63 million in cash and cash equivalents. We are operating cash flow positive. Year-to-date September this year we have generated operating cash flow of $2.2 million, compared to an operating cash loss of $1.2 million in the same period last year.
So relatively straightforward balance sheet, no fancy instruments, $63 million in cash, positive operating cash flow and in our last conference call we just announced revival of our stock repurchase plan. So that essentially is the Immersion story, we are a small agile company, about 100 employees. We have a world-class customer base, and also we leverage partners like Cyprus and [inaudible] and work with them, and use their sales force to increase and generate more sales for us.
We are in large and rapidly growing markets. Some of these markets are new markets, some of these markets are conventional markets, and segments of the markets are being converted to touch, and that has been our greatest strength because everyone loves touch, accepting the fact that it doesn’t have feedback, and that is where we come in and provide that very important feedback.
We have a very strong IP position and a solid balance sheet, $63 million of cash with operating cash flow. So thank you very much for attending this presentation. I think we might have some time for Q&A. But there is a breakout session, [inaudible] and I would encourage you to come there, because we will able to show you some demos. So thank you very much.
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