This was an interesting call, to say the least.  The top line numbers – which matched my expectations – belie the progress that I think has occurred over the past several months, clearly reflected in Clent’s narrative and which continues today.  The second half of the year should produce very pleasant results for Immersion shareholders.  I’ll explain, but let’s first dispose of the Q1 numbers……

Q1 2009

Revenues: totaled $7Mm {they tried to get away with $7.5Mm by calling the extra $.5Mm “non-GAAP” – whatever!}, with gross earnings of around $5.8Mm.  All very much in line with the recent forecast I offered…..  but the details didn’t match at all!!

Medical:  Ugh!  $2.5Mm; I had thought $3.5Mm was a minimal estimate under the circumstances of the SJ move, and the bleak economy.  Man, was I wrong there!  It would seem the various disruptions are really disruptive!!  More later.

Touch:  Hooray!  $4.5Mm; much better than expected.  Clent & Co. are no longer separately reporting mobility, touch i/f and console/gaming so we have to make inferences to break it out.  I’m not very good at this – but I’ll do my best.  My belief is that very little growth is occurring in either touch i/f or console/gaming for reasons explained in a letter awhile back.  Nothing’s changed.  On the other hand, handset deliveries with embedded Immersion haptics are expanding rapidly – Clent reports that 15.3Mm such handsets were shipped in Q1.  I think that line must be responsible for the improved performance – the arithmetic suggests mobility revenues totaled around $2.4Mm for the quarter; I had modeled $1.4Mm.  Not too shabby! 

But there are some complexities involved…….   Immersion had postponed recognizing $700K in royalty payments from 4^th quarter 2008 to this quarter and there was no comment whether this is a permanent thing, with a similar shift occurring in this quarter {and for each successive quarter}, or not.  If not then we have a false signal, and the related revenue growth is not indicative.  If otherwise, then we have a very encouraging signal.  I simply don’t know……….  Wish I had asked the question….  Opportunity lost….  I also don’t know to which business line this royalty applies, and am assuming mobility.

Gross margins:  84% gross margins; much better than the 72% I had modeled.  There are two reasons for this improvement.  First, on a %age basis, the disposed 3D business appeared to penalize gross margins and is now gone – so no more contribution from that; second, this quarter’s revenue mix favored the much higher margin touch businesses than has historically been the case.

Gross earnings:  Altogether reported gross earnings were about 10% higher than expected, largely due to the favorable margin mix explained above.

Cash expenses:  About $12.5Mm, in line with expectations

Quarterly cash consumption and Balance Sheet cash: $5Mm and $80Mm, respectively, pretty close to the model……  maybe $1Mm better.

The Call

Clent was on his “A” game this time.  The call was efficient and I think provided a clear indication of the state of the business, and its various components.  And the analysts’ questions were handled competently.  A nice turnaround……  some highlights:

1. Without providing guidance, Immersion provided “guidance”.  Several times during the call we were told to expect cash breakeven performance for the second half of 2009, with cash expenses in the vicinity of $10Mm per quarter.  There are a couple of important implications:  (1) second half gross earnings can be expected to total at least $20Mm and (2) after another $5Mm in cash consumed during 2^nd Q, the cash hoard is unlikely to dip much below $75Mm.

2. Company headcount has been reduced from 183 heads {end of Q4 2008} to 174 heads currently.  Another 20 FTE reduction is in the works, leaving 154.  The financial benefit of the reductions, plus the move, won’t be realized until 3^rd quarter.

3. Medical:
   1. Suffering from a very weak domestic healthcare industry and normal seasonal softness, with international activity slightly off.  
   2. The move is apparently complete – or nearly so – and headcount is reduced from 80 to 54 persons.
   3. Encouraged by Japanese and Chinese plans to incorporate simulation training as a component of national healthcare {Immersion has 3^rd party indigenous representation in both countries}.
   4. Hopeful that HR 588 will become part of the US healthcare system improvement initiative.  A brief summary of HR 588 is attached beneath this letter.
   5. Significant new sim product efforts currently producing initial incremental sales.  Earlier commented that the stalled revenue growth during the past several quarters is partially due to a lack of new product.  Huh?  Again, more later.
   6. A new deal with Mako {haven’t really checked them out} gets Immersion into the “live” surgical business – meaning the technology is being used for haptic feedback during real-deal surgeries.  Not just for simulation any longer.

4. Touch:
   1. Q1 cell phones shipments containing Immersion haptics totaled 15.3 Mm, which is a 25% increase from the 12.1Mm shipped during 4^th qtr 2008.
   2. In addition, the penetration of Immersion haptics in touchscreen phones has grown dramatically – in 2007, 2008 and expected EOY 2009 Immersion model penetration totals 3%, 15%, and {anticipated} 25%, respectively.
   3. Nokia’s specs for the Series 60 and Series 40 model lines both include Immersion haptics.  This is a big deal, especially WRT the high volume targeted Series 40. {But probably no unit royalties.}
   4. Touch-based phones continue to be a fast growing segment of the otherwise modestly declining cell phone market.  Immersion’s haptics assist manufacturers with the need to differentiate.
   5. Apparently more chip manufacturer discussions are underway.  {Discussed this concept in a previous letter.}
   6. Clent referred to the opportunity for Immersion-based haptic “ubiquity” a number of times, mentioning on-going {but unable to provide any detail} discussions with multiple white goods, consumer goods, and other manufacturers.  Same ‘ol story here since God made rocks – “we’re talkin’ to everybody in the world and we’re really excited, but ‘sorry’ we can’t say anything more.”

5. Other:
   1. Revenues from other than US sources represented 55% of the total for the quarter.
   2. While recurring cash expenses are currently running in the vicinity of $12.5Mm per quarter, the business rationalization {ie, head reductions} will shave that to $10-$11Mm per quarter during the second half of the year.
   3. Days’ receivable has extended due to the larger international revenue component
   4. Sayonara to Sony – the company is nearing the end of the SNE litigation payment stream, with three more quarterly payments to be made. 
   5. Clent announced {as I recall} two planned company shutdowns as an expense saving measure.  Not sure how long each is – probably a week …..

Some Random Comments:

1. In recent letters, I had expressed concern {at the time, perhaps hope??} that the company was ripe for a takeover principally due to the very low stock price and the fat cash balance.  As long as the stock trades near cash value, this remains a possibility.  It is, however, partially mitigated by the Matazama and ValueAct ownership positions which – as long as the company’s growth prospects appear good – serve as barriers to a cheap deal.

2. I was very much encouraged by this report, and have made an attempt to adjust my 2009 model accordingly.  I’ll send it along separately – this is already too long!

3. Clent’s changed emphasis from the 4^th qtr CC to this CC is interesting.  My takeaway from the 4^th qtr was the substantial emphasis on medical to the near exclusion of touch.  I had interpreted that to mean touch had been placed on the back burner.  Not so.  This CC provided equal emphasis to each.

4. I am a bit confused by part of the explanation for the decline in medical.  I understand the disruption from the move; I understand the effect of the weak economy; I do not understand new product offerings as a reason.  Market penetration for any of the med sim products is certainly quite low; if that’s not the case, then this market is very, very small.  And it isn’t {I hope!}  If penetration is low, then it wouldn’t seem to me that more product would be any part of a solution for this problem.  So, I don’t get it.  In any case, the business is likely to continue to be challenged by the domestic US market for a considerable period.  The recovery from the move should be underway.  I have no problem with plans to expand the medical product portfolio – but to use this as a solution for slow sales in a barely penetrated market……?????

5. As mentioned, Clent & Co. flatly stated the expectation for b/e ops cash flow during the 2^nd half of 2009.  For this to occur, I think both medical and touch will have to be experiencing robust growth – given current revenue levels.  This is a major commitment from them and expresses their confidence with their plans and the execution of those plans.  I am both pleased and surprised.  Frankly, I can’t wait!!

6. But I’ve been fooled before by my optimism……..

7. Separately – and without announcement – Vic left his role as board chairman.  Still has a very large equity position.  Given all the hiring announcements, I wonder why this change was left to the proxy statement.  Curious.  In any case, his departure provides further evidence that the board is pleased with Clent.  In addition, we learn that Clent’s sole incentives are now financial.  Hallelujah!  About time!

8. Over the past several quarters I have expressed enthusiasm for Clent’s hiring with reservations noted about his executive history solely in large, well funded enterprises and in growth environments.  Wondering about his ability to adjust to less staff; less resource – less of everything, except {of course} problems.  Seemed a little slow to recognize the slowdown.  However, I think this CC pretty much resolves these questions.  I suppose the jury is still out for many, but the evidence is becoming clear that he doesn’t hesitate to make decisive moves and seems to operate appropriately under substantial adversity.  And, I think, he has both a vision for where this company can go and how to get there…..kudos….

Summary:

I think the 2^nd quarter will be similar to the first quarter, perhaps a little stronger in both revenues and gross earnings as medical begins a slow recovery, and as mobility’s growth maintains.  Cash consumption is likely to also be similar.  But that should be the end of the poor quarters during the turnaround “investment”.

I am looking forward to the 3^rd and 4^th quarters with great anticipation, as I am taking Clent’s comments as good guidance for what to expect……..   Without details {later}, I think we could see in the vicinity of $25Mm in 2^nd half revenues and perhaps $20Mm in gross earnings.  That would bring total year revenues to about $42Mm…..  with a 16% increase in gross earnings over 2008.

All this in spite of the crummy economic conditions we currently face.

The Stock:

Well, here we are around $4/sh with $2.91 in cash.  Heading toward maybe $2.70 in cash when we learn of the 2^nd qtr 2009 results.  It’s very likely that we won’t know of the turn in medical or a sustained rapid growth in mobility until nearly year’s end – 3^rd quarter CC at the earliest.  If the anticipated revenue production occurs, then I think we will see the stock trading solidly in the very high single digits {not quite $10/sh} by year’s end. 

And it’s impossible to say how it might get there – too many moving parts to hazard a guess.  We could go back to a small premium/discount to cash as folks wait on tangible results.  Or not, if a couple of larger players take positions. 

I’d venture a guess to say at current levels this is a buy – caveat emptor….. 

What a change in my outlook.  Very welcomed!  Pass the hash……