(EDGAR Online via COMTEX) -- ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
This Quarterly Report on Form 10-Q includes forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended (the "Securities Act"), and Section 21E of the Securities Exchange Act of 1934, as amended (the "Exchange Act"). The forward-looking statements involve risks and uncertainties. Forward-looking statements are identified by words such as "anticipates," "believes," "expects," "intends," "may," "can," "will," "places," "estimates," and other similar expressions. However, these words are not the only way we identify forward-looking statements. Examples of forward-looking statements include any expectations, projections, or other characterizations of future events, or circumstances, and include statements regarding: the impact of COVID-19 on our business, including as to revenue, and potential cost reduction measures, and the impact of COVID-19 on our customers, suppliers, and on the economy in general; our strategy and our ability to execute our business plan; our competition and the market in which we operate; our customers and suppliers; our revenue and the components thereof; our costs and expenses; seasonality and demand; our investment in research and technology development; changes to general and administrative expenses; our foreign operations and the reinvestment of our earnings related thereto; our investment in and protection of our IP; our employees; capital expenditures and the sufficiency of our capital resources; unrecognized tax benefit and tax liabilities; the impact of changes in interest rates and foreign exchange rates, as well as our plans with respect to foreign currency hedging in general; changes in laws and regulations; our plans related to and the impact of current and future litigation or activism; our sublease and the timing and income related thereto; and our stock repurchase program.
Because forward-looking statements relate to the future, they are subject to inherent uncertainties, risks and changes in circumstances that are difficult to predict and many of which are outside of our control. Actual results could differ materially from those projected in the forward-looking statements, therefore we caution you not to place undue reliance on these forward-looking statements. Important factors that could cause our actual results and financial condition to differ materially from those indicated in the forward-looking statements include, among others, the following: the effects of the COVID-19 global pandemic on us and our business, and on the business of our suppliers and customers; unanticipated changes in the markets in which we operate; the effects of the current macroeconomic climate (especially in light of the ongoing adverse effects of the COVID-19 global pandemic); delay in or failure to achieve adoption of or commercial demand for our products or third party products incorporating our technologies; the inability of Immersion to renew existing licensing arrangements, or enter into new licensing arrangements for our patents and other technologies on favorable terms; the loss of a major customer; the ability of Immersion to protect and enforce our intellectual property rights; unanticipated difficulties and challenges in developing or acquiring successful innovations and our ability to patent those innovations; stockholder activism; changes in patent law; confusion as to our licensing model or agreement terms; the ability of Immersion to return to consistent profitability in the future; the inability of Immersion to retain or recruit necessary personnel; the commencement, by others or by us, of legal or administrative action; risks related to our international operations and other factors.
Any forward-looking statements made by us in this report speak only as of the date of this report, and we do not intend to update these forward-looking statements after the filing of this report. You are urged to review carefully and consider our various disclosures in this report and in our other reports publicly disclosed or filed with the SEC that attempt to advise you of the risks and factors that may affect our business.
We are a premier licensing company focused on the creation, design, development, and licensing of innovative haptic technologies that allow people to use their sense of touch to engage with products and experience the digital world around them. We are one of the leading experts in haptics, and our focus on innovation allows us to deliver world-class intellectual property ("IP") and technology that enables the creation of products that delight end users. Our technologies are designed to facilitate the creation of high-quality haptic experiences, enable their widespread distribution, and ensure that their playback is optimized. Our primary business is currently in the mobility, gaming, and automotive markets, but we believe our technology is broadly applicable and see opportunities in evolving new markets, including entertainment, social content, virtual and augmented reality, sexual wellness and wearables, as well as residential, commercial, and industrial Internet of Things ("IoT"). In recent years, we have seen a trend towards broad market adoption of haptic technology, and estimate our technology is now in more than 3 billion devices worldwide. As other companies follow our leadership in recognizing how important tactile feedback can be in people's digital lives, we expect the opportunity to license our IP and technologies will continue to expand.
We have adopted a business model under which we provide advanced tactile software, related tools and technical assistance designed to integrate our patented technology into our customers' products or enhance the functionality of our patented technology, and offer licenses to our patented technology to our customers. Our licenses enable our customers to
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deploy haptically-enabled devices, content and other offerings, which they typically sell under their own brand names. We and our wholly-owned subsidiaries hold more than 2,500 issued or pending patents worldwide as of March 31, 2020. Our patents cover a wide range of digital technologies and ways in which touch-related technology can be incorporated into and between hardware products and components, systems software, application software, and digital content. We believe that our IP is relevant to many of the most important and cutting-edge ways in which haptic technology is and can be deployed, including in connection with mobile interfaces and user interactions, in association with pressure and other sensing technologies, as part of video and interactive content offerings, as related to virtual and augmented reality experiences, and in connection with advanced actuation technologies and techniques.
We were incorporated in 1993 in California and reincorporated in Delaware in 1999.
Impact of COVID-19
In March 2020, the World Health Organization declared COVID-19 to be a global pandemic and the President of the United States declared the COVID-19 outbreak a national emergency. The outbreak has resulted in governments around the world implementing increasingly stringent measures to help control the spread of the virus, which has resulted in a significant deterioration of economic conditions in many of the countries in which we operate. The spread of the COVID-19 virus has also caused us to modify our business practices (including implementing work-from-home policies and restricting travel by our employees) in ways that may be detrimental to our business. These practices may have impacted our ability to deploy our workforce effectively. These same developments may affect the operations of our suppliers and customers, as their own workforces and operations are disrupted by efforts to curtail the spread of this virus. While expected to be temporary, these disruptions may negatively impact our revenue, results of operations, financial condition, and liquidity in 2020.
Although such disruptions did not have a material adverse impact on our financial results for the first quarter of fiscal 2020, the COVID-19 pandemic and our resulting economic effects could have significant adverse effects on our customers' ability to manufacture, distribute and sell products incorporating our touch-enabling technologies, which may result in a reduction in the royalties we receive and could cause adverse effects on our business, results of operations, financial condition and cash flows.
As part of our response to the impact of the COVID-19 pandemic on our business, we are taking the following cost reduction measures: a 10% reduction of the base salaries of certain company executives and a 25% reduction of cash compensation of each directors' cash compensation for service on the Board and each of our committees; reduced and renegotiated professional services fees from third party services providers and relocation of certain positions to lower-cost regions. We also suspended our 401(k) match until further notice. We will continue to analyze our cost structure and may implement additional cost reduction measures as may be necessary due to the on-going economic challenges resulting from the COVID-19 pandemic.
While we are unable to accurately predict the full impact that COVID-19 will have on our results from operations, financial condition, liquidity and cash flows due to numerous uncertainties, including the duration and severity of the pandemic and containment measures, our compliance with these measures has impacted our day-to-day operations and could disrupt our business and operations, as well as that of our key customers, suppliers and other counterparties, for an indefinite period of time. We will continue to evaluate the nature and extent of the impact of COVID-19 to our business.
CRITICAL ACCOUNTING POLICES AND ESTIMATES
Due to the COVID-19 pandemic, there has been uncertainty and disruption in the global economy and financial markets. We are not aware of any specific event or circumstance that would require updates to our estimates or judgments or require us to revise the carrying value of our assets or liabilities as of May 8, 2020, the date of issuance of this Quarterly Report on Form
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10-Q. These estimates may change as new events occur and additional information is obtained. Actual results could differ materially from these estimates under different assumptions or conditions.
Please refer to Management's Discussion and Analysis of Financial Condition and Results of Operations contained in Part II, Item 7 of our Annual Report on Form 10-K for the year ended December 31, 2019 filed with the SEC on March 6, 2020, for a complete discussion of our other critical accounting policies and estimates.
RESULTS OF OPERATIONS
Total revenue for the three months ended March 31, 2020 was $6.3 million, an increase of $1.1 million, or 22%, compared to $5.1 million for the three months ended March 31, 2019 primarily driven by a $1.6 million, or 48%, increase in per-unit royalty revenue partially offset by a $0.5 million or 26.0%, decrease in fixed fee license revenue.
Net loss for the three months ended March 31, 2020 was $4.8 million, a decrease of $6.2 million, or 56%, as compared to a net loss of $11.0 million for the three months ended March 31, 2019. This decrease in net loss was mainly attributable to a $1.1 million increase in total revenue and a $5.8 million decrease in total cost and operating expenses partially offset by an $0.8 million decrease in interest and other income (expense). The decrease in cost and expenses was primarily due to lower legal and settlement costs attributable to reduced activities following litigation settlements, and decreased compensation costs largely due to lower stock-based compensation expense, partially offset by increased depreciation expense resulting from the shortening in estimated useful life of our San Jose California Facility ("SJ Facility") to March 31, 2020 following our decision to exit this facility.
The following table sets forth our condensed consolidated statements of income data as a percentage of total revenue:
Three Months Ended March 31, 2020 2019 Revenues: Fixed fee license revenue 21 % 34 % Per-unit royalty revenue 78 65 Total royalty and license revenue 99 99 Development, services, and other revenue 1 1 Total revenues 100 100 Costs and expenses: Cost of revenues 1 - Sales and marketing 27 32 Research and development 27 45 General and administrative 118 248 Total costs and expenses 173 325 Operating income (loss) (73 ) (225 ) Interest and other income (loss) (4 ) 12 Income (loss) before provision for income taxes (76 ) (213 ) Provision for income taxes (1 ) (2 )
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REVENUES Our revenue is primarily derived from fixed fee license agreements and per-unit royalty agreements, along with less significant revenue earned from development, services and other revenue. Royalty and license revenue is composed of per unit royalties earned based on usage or net sales by licensees and fixed payment license fees charged for our IP and software. A revenue summary for the three months ended March 31, 2020 and 2019 are as follows (in thousands, except for percentages): Three Months Ended March 31, 2020 2019 $ Change % Change Revenues: Fixed fee license revenue $ 1,287 $ 1,740 $ (453 ) (26 )% Per-unit royalty revenue 4,895 3,307 1,588 48 % Total royalty and license revenue 6,182 5,047 1,135 22 % Development, services, and other revenue 75 75 - -% Total revenues $ 6,257 $ 5,122 $ 1,135 22 %
Three Months Ended March 31, 2020 Compared to Three Months Ended March 31, 2019
Royalty and license revenue - Total royalty and license revenue for three months ended March 31, 2020 increased $1.1 million, or 22%, from $5.0 million for the three months ended March 31, 2019 to $6.2 million for the three months ended March 31, 2020.
Per-unit royalty revenue increased by $1.6 million, or 48%, from $3.3 million for the three months ended March 31, 2019 to $4.9 million for the three months ended March 31, 2020, primarily caused by a $2.7 million increase in royalties from our mobility licenses partially offset by a $0.5 million decrease in royalties obtained from our gaming licenses ("gaming royalties") and a $0.5 million decrease in royalties obtained from our automotive licenses ("automotive royalties)"). The $2.7 million increase in mobility royalties was due mainly to per-unit royalty agreements entered into during the three months ended June 30, 2019 and partially offset by the impact of lower shipments estimated for other mobility licensees. The $0.5 million decrease in gaming royalties was caused by lower shipment volumes estimated for our gaming licensees. The $0.5 million decrease in automotive royalties was caused by lower shipment volumes estimated for our automotive licensees.
Fixed fee license revenue decreased $0.5 million, or 26%, from $1.7 million for the three months ended March 31, 2019 to $1.3 million for the three months ended March 31, 2020, primarily due to a $0.5 million decrease in automotive license revenue.
We expect royalty and license revenue to continue to be a major component of our future revenue as our technology is included in products and we succeed in our efforts to monetize our IP. Our fixed fee license revenue could fluctuate depending upon the timing of execution of new fixed license fee arrangements under ASC 606.
Development, services and other revenue - Development, services, and other revenue was $75,000 for each of the three months ended March 31, 2020 and 2019.
Geographically, revenues generated in Asia, North America, and Europe for the three months ended March 31, 2020 represented 79%, 17%, and 4%, respectively, of our total revenue as compared to 48%, 38%, and 14%, respectively, for the three months ended March 31, 2019. The increase in revenue attributable to Asia as a percentage of total revenue was primarily driven by increased revenues from mobility partially offset by decreased revenues from automotive customers in Asia. The decrease in revenue attributable to North America as a percentage of total revenue was primarily driven by lower revenues from automotive and mobility customers in the region. The decrease in revenue attributable to Europe as a percentage of total revenue was primarily caused by lower revenues from gaming, automotive and medical customers in the region.
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OPERATING EXPENSES The following tables set forth a summary of our operating expenses for the three months ended March 31, 2020 and 2019 (in thousands): Three Months Ended March 31, 2020 2019 Change % Change Sales and marketing $ 1,716 $ 1,609 $ 107 7 % % of total revenue 27 % 32 % Research and development $ 1,689 $ 2,302 $ (613 ) (27 )% % of total revenue 27 % 45 % General and administrative $ 7,356 $ 12,695 $ (5,339 ) (42 )% % of total revenue 118 % 248 %
Sales and Marketing - Our sales and marketing expenses are primarily comprised of employee compensation and benefits, sales commissions, advertising, trade shows, collateral marketing materials, market development funds, travel, and allocation of facilities costs. Sales and marketing expenses increased $0.1 million for the three months ended March 31, 2020 compared to the three months ended March 31, 2019. This increase was primarily due to a $0.3 million increase in depreciation expense primarily resulting from the shortening in estimated useful life of the leasehold improvements of the SJ Facility to March 31, 2020 following our decision to exit this facility, partially offset by a $0.3 million decrease in compensation, benefits and other personnel related costs due to lower stock-based compensation.
Research and Development - Our research and development expenses are comprised of employee compensation and benefits, outside services and consulting fees, tooling and supplies, and an allocation of facilities costs. Research and development expenses decreased $0.6 million, or 27%, for the three months ended March 31, 2020 compared to three months ended March 31, 2019. This decrease was primarily due to a $0.6 million decrease in compensation, benefits and other personnel related costs largely attributable to lower stock-based compensation, partially offset by a $0.1 million increase in depreciation expense resulting from the shortening in estimated useful life of leasehold improvements of the SJ Facility to March 31, 2020 following our decision to exit this facility.
We believe that continued investment in research and development is critical to our future success, and we expect to continue making targeted investments in areas of research and technology development to support future growth in key markets.
General and Administrative - Our general and administrative expenses consist of employee compensation and benefits, legal and professional fees, external legal costs for patents; office supplies; travel; and allocation of facilities costs. General and administrative expenses decreased $5.3 million, or 42%, for three months ended March 31, 2020 compared to the three months ended March 31, 2019 due to a $5.9 million decrease in legal expenses partially offset by a $0.4 million increase in depreciation expense resulting from the shortening in estimated useful life of leasehold improvements of the SJ Facility to March 31, 2020 following our decision to exit this facility. The decrease in legal expense was primarily attributable to reduced activities following litigation settlements.
We expect our general and administrative expenses to decrease in the future as we achieve targeted reductions in consulting and professional services.
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INTEREST AND OTHER INCOME (LOSS)
Interest and Other Income (Loss) - Interest and other income (loss) consists of interest income from cash equivalents and short-term investments, interest on notes receivable, translation exchange rate gains and other income. Interest and other income (loss) decreased $0.8 million during the three months ended March 31, 2020 compared to the same period in 2019 primarily driven by a $0.4 million increase in foreign currency translation loss and a $0.3 million decrease in investment earnings on cash equivalents and short-term investments. Foreign exchange translation loss was $0.4 million for the three months ended March 31, 2020 compared to a foreign exchange gain of $19,000 for the same period in 2019. The significant fluctuation in foreign exchange translation gain (loss) was a result of the depreciation of the South Korean Won and the Canadian dollar against the U.S. dollar partially resulting from the increased market volatility driven by the global COVID-19 pandemic. The decrease in investment earnings was primarily due to a lower effective interest rate and a decrease in total cash, cash equivalents and short-term investments during the three months ended March 31, 2020 as compared to the same period in 2019.
PROVISION FOR INCOME TAXES The following table sets forth a summary of our provision for income taxes for the three months ended March 31, 2020 and 2019 (in thousands except for percentages): Three Months Ended March 31, 2020 2019 Change % Change Loss before provision for income taxes $ (4,776 ) $ (10,901 ) Provision for income taxes (52 ) (115 ) $ 63 (55 )% Effective tax rate (1.1 )% (1.1 )%
Provision for income tax for the three months ended March 31, 2020 and 2019, respectively, resulted primarily from estimated foreign taxes included in the calculation of the effective tax rate. We continue to carry a full valuation allowance on our federal deferred tax assets. As a result, no benefit for losses generated from our U.S. territory was included in the calculation of the year-to-date effective tax rate, which was the main reason for the difference between the statutory tax rate and actual effective tax rate. The year-over-year change in provision for income taxes resulted primarily from the change in income from continuing operations across various tax jurisdictions.
On December 22, 2017, the Tax Cuts and Jobs Act ("Tax Act") was passed into law. Among other changes, the Tax Act reduced the US federal corporate income tax rate from 35% to 21%, required companies to pay a one-time transition tax on earnings of certain foreign subsidiaries that were previously tax deferred and created new taxes on certain foreign sourced earnings. In addition, the Act introduced the Base Erosion and Anti-Abuse Tax (the "BEAT"), which creates a new tax on certain related-party payments. We concluded that we have not met the threshold requirements of the BEAT. Although the measurement period has closed, further technical guidance related to the Tax Act, including final regulations on a broad range of topics, is expected to be issued. In accordance with ASC 740, we will recognize any effects of the guidance in the period that such guidance is issued.
On March 27, 2020, the Coronavirus Aid, Relief, and Economic Security Act ("CARES Act") was passed into law. The CARES Act includes several significant business tax provisions including modification to the taxable income limitation for utilization of net operating losses ("NOLs") incurred in 2018, 2019 and 2020 and the ability to carry back NOLs from those years for a period of up to five years, an increase to the limitation on deductibility of certain business interest expense, bonus depreciation for purchases of qualified improvement property and special deductions on certain corporate charitable contributions. We analyzed the provisions of the CARES Act and determined there was no effect on our provision for the current period.
We continue to maintain a valuation allowance of $27.9 million against certain of our deferred tax assets, including all federal, state, and certain foreign deferred tax assets as a result of uncertainties regarding the realization of the asset balance due to historical losses, the variability of operating results, and uncertainty regarding near term projected results. In the event that we determine the deferred tax assets are realizable based on an assessment of relevant factors, an adjustment to the valuation allowance may increase income in the period such determination is made. The valuation allowance does not impact our ability to utilize any underlying net operating loss carryforwards.
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We also maintain liabilities for uncertain tax positions. As of March 31, 2020, we had unrecognized tax benefits under ASC 740 of approximately $4.8 million and applicable interest of $27,000. The total amount of unrecognized tax benefits . . .
May 08, 2020
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