IMMERSION CORP 10-Q

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations This Management’s Discussion and Analysis of Financial Condition and Results of Operations includes forward-looking statements within the meaning of Section 27A of the Securities Act, 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 frequently 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 trends related thereto, trends related thereto; and the recognition and components thereof; our costs and expenses, including capital expenditures; our investment of surplus funds and sales of marketable debt securities ; 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; including with respect to taxes; our plans and estimates related to and the impact of current and future litigation and arbitration; our leases, sublease and the timing and income related thereto; and our stock repurchase and equity distribution programs. 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 risk factors contained below under Part II, Item 1A, Risk 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, unless required to do so by applicable law. 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. OVERVIEW We are a premier licensing company focused on the invention, acceleration, and scaling, through 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, and wearables, as well as residential, commercial, and industrial Internet of Things. In recent years, we have seen a trend towards broad market adoption of haptic technology. 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 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 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 1,200 issued or pending patents worldwide as of September 30, 2022. 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. Our portfolio includes numerous patents and patent applications that we believe may become essential to emerging standards in 28 development by Standards Development Organizations (“SDOs”) including media standards in development by ISO/IEC Moving Picture Expert Group (MPEG) and software and system standards in development at IEEE-SA. We were incorporated in 1993 in California and reincorporated in Delaware in 1999. Results of Operations Overview Total revenues for the three months ended September 30, 2022 was $14.0 million, an increase of $6.8 million, or 95%, compared to the same period in 2021. Total revenues for the nine months ended September 30, 2022 was $29.3 million, an increase of $4.0 million, or 16%, compared to the same period in 2021. Total cost and operating expenses were $3.1 million in the three months ended September 30, 2022, a decrease of $0.4 million, or 12% compared to the same period in 2021. Total cost and operating expenses were $10.7 million in the nine months ended September 30, 2022, a decrease of $2.7 million, or 20% compared to the same period in 2021. In the three months ended September 30, 2022, we had net income of $7.7 million compared to a net income of $3.8 million in the three months ended September 30, 2021. In the nine months ended September 30, 2022 and 2021 we had net income of $11.0 million and $11.1 million, respectively. The following table sets forth our Condensed Consolidated Statements of Income and Comprehensive Income data as a percentage of total revenues: Three Months Ended September 30, Nine Months Ended September 30, 2022 2021 2022 2021 Revenues: Fixed fee license revenue 55 % 18 % 36 % 17 % Per-unit royalty revenue 45 81 63 82 Total royalty and license revenue 100 99 99 99 Development, services, and other — 1 1 1 Total revenues 100 100 100 100 Costs and expenses: Cost of revenues — — — — Sales and marketing 2 6 3 11 Research and development 2 11 4 14 General and administrative 18 32 29 28 Total costs and expenses 22 49 36 53 Operating income 78 51 64 47 Interest and other income (loss), net (17) 7 (22) 1 Income before provision for income taxes 61 58 42 48 Provision for income taxes (6) (5) (4) (4) Net income 55 % 53 % 38 % 44 % 29 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. Three Months Ended September 30, 2022 Compared to Three Months Ended September 30, 2021 A revenue summary for the three months ended September 30, 2022 and 2021 are as follows (in thousands, except for percentages): Three Months Ended September 30, 2022 2021 $ Change % Change Fixed fee license revenue $ 7,662 $ 1,247 $ 6,415 514% Per-unit royalty revenue 6,269 5,821 448 8% Total royalty and license revenue 13,931 7,068 6,863 97% Development, services, and other revenue 75 105 (30) (29)% Total revenues $ 14,006 $ 7,173 $ 6,833 95% Royalty and license revenue Fixed fee license revenue increased $6.4 million, or 514% in in the third quarter of 2022 compared to the same period in 2021 due to a $6.4 million increase in mobility license revenue. Per-unit royalty revenue increased by $0.4 million, or 8%, in the third quarter of 2022 compared to the same period in 2021, primarily due to a $0.9 million increase in other royalties revenue partially offset by a $0.2 million decrease in royalties from mobility licensees and a $0.2 million decrease in royalties from gaming licensees. 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. We also anticipate that our royalty revenue will fluctuate relative to our customers’ unit shipments. Geographically, revenues generated in Asia, North America and Europe for the three months ended September 30, 2022 represented 43%, 54%, and 3%, respectively, of our total revenue as compared to 80%, 15%, and 5%, respectively, for the three months ended September 30, 2021. 30 Nine Months Ended September 30, 2022 Compared to Nine Months Ended September 30, 2021 A revenue summary for the three months ended September 30, 2022 and 2021 are as follows (in thousands, except for percentages): Nine Months Ended September 30, 2022 2021 $ Change % Change Revenues: Fixed fee license revenue $ 10,653 $ 4,346 $ 6,307 145% Per-unit royalty revenue 18,426 20,671 (2,245) (11)% Total royalty and license revenue 29,079 25,017 4,062 16% Development, services, and other revenue 218 325 (107) (33)% Total revenues $ 29,297 $ 25,342 $ 3,955 16% Royalty and license revenue Fixed fee license revenue increased $6.3 million, or 145% in the first nine months of 2022 compared to the same period in 2021 primarily attributable to a $6.4 million increase in mobility revenue and a $0.1 million increase in other license revenue. Per-unit royalty revenue decreased by $2.2 million, or 11%, in the first nine month of 2022 compared to the same period in 2021, primarily caused by a $2.4 million decrease in royalties from mobility licensees, a $1.0 million decrease in royalties from automotive licensees and a $0.3 million decrease in royalties from gaming licensees. These decreases were partially offset by a $1.4 million increase in royalties from other licensees. Geographically, revenues generated in Asia, North America and Europe for the nine months ended September 30, 2022 represented 61%, 33%, and 6%, respectively, of our total revenue as compared to 80%, 13%, and 7%, respectively, for the nine months ended September 30, 2021. Operating Expenses A summary of operating expenses for the three and nine months ended September 30, 2022 and 2021 are as follows (in thousands, except for percentages): Three Months Ended September 30, 2022 2021 $ Change % Change Sales and marketing $ 282 443 $ (161) (36) % Research and development 254 803 (549) (68) % General and administrative 2,540 2,246 294 13 % Nine Months Ended September 30, 2022 2021 $ Change % Change Sales and marketing $ 986 2,743 $ (1,757) (64) % Research and development 1,118 3,442 (2,324) (68) % General and administrative 8,550 7,106 1,444 20 % Sales and Marketing - Our sales and marketing expenses primarily consisted of employee compensation and benefits, including stock-based compensation; sales commissions; advertising; collateral marketing materials; market development funds; travel; and allocated facilities costs. 31 Sales and marketing expenses decreased $0.2 million, or 36% and $1.8 million, or 64%, in the three and nine months ended September 30, 2022, respectively, compared to the same periods in 2021. The decreases in Sales and Marketing expenses were primarily attributable to decreases in compensation, benefits and other personnel related costs primarily due to lower headcount, decreases in variable compensation and stock-based compensation expense. Research and Development - Our research and development expenses primarily consisted of employee compensation and benefits, including stock-based compensation; outside services and consulting fees; tooling and supplies; and allocated facilities costs. Research and development expenses decreased $0.5 million, or 68% and $2.3 million, or 68%, in the three and nine months ended September 30, 2022, respectively, compared to the same periods in 2021. The decreases in Research and Development costs were primarily attributable to decreases in compensation, benefits and other personnel related costs due to lower headcount and decreases in stock-based compensation expense and severance costs. General and Administrative - Our general and administrative expenses primarily consisted of employee compensation and benefits including stock-based compensation; legal other professional fees; external legal costs for patents; office expense; travel; and allocated facilities costs. General and administrative expenses increased $0.3 million, or 13%, in the third quarter of 2022 as compared to the same period in 2021 primarily due to a $0.8 million increase in compensation, benefits and other personnel related costs partially offset by a $0.3 million decrease in consulting and professional services and a $0.3 million decrease in legal costs. General and administrative expenses increased $1.4 million, or 20%, in the first nine months of 2022 as compared to the same period in 2021 primarily due to a $2.1 million increase in compensation, benefits and other personnel related costs and a $0.3 million increase in Annual Stockholders' Meeting and other public company related costs. These increases were partially offset by a $0.6 million decrease in legal costs and a $0.4 million decrease in consulting and professional services. The increases in compensation, benefits and other personnel related costs were driven by increases in stock-based compensation expense and higher variable compensation during the three and nine months ended September 30, 2022 compared to the same periods in 2021. The decrease in legal expense in the three and nine months ended September 30, 2022 compared to the same period in 2021was primarily attributable to reduced activities, as well as a decrease in patent maintenance and prosecution costs. We may be required to engage in litigation to protect our IP, in which case our general and administrative expenses could substantially increase reflecting such litigation costs. Interest and Other Income (Loss) Interest and Other Income (loss) - Interest and other income consists primarily of interest and dividend income from cash and cash equivalents and marketable debt and equity securities, short-term investments realized and unrealized gains (losses) on our marketable equity securities and derivative instruments and realized gains (losses) on our marketable debt securities. Interest and other income (loss) decreased $2.8 million during the three months ended September 30, 2022 compared to the same period in 2021 primarily driven by a $4.0 million net loss on marketable securities partially offset by a $1.0 million increase in interest and dividend income. The net loss on marketable securities for the three months ended September 30, 2022 primarily consisted of a $10.1 million increase in net losses on marketable equity securities partially offset by a $6.1 million net gains on derivative instruments. Interest and other income (loss) decreased $6.6 million during the nine months ended September 30, 2022 compared to the same period in 2021 primarily driven by a $10.4 million increase in net loss on marketable securities partially offset by a $3.7 million increase in interest and dividend income. The increase in net loss on marketable securities for the nine months ended September 30, 2022 largely consisted of a $13.8 million increase in net loss on marketable securities partially offset by a $3.4 million increase in net gains derivative instruments. 32 The increase in interest and dividend income in the three and nine months ended September 30, 2022 compared to the same periods in 2021 was largely attributable to higher interest and dividend income from investments as well as interest income from a Korean tax litigation settlement. Income Taxes A summary of provision for income taxes and effective tax rates for the three and nine months ended September 30, 2022 and 2021 are as follows (in thousands): Three Months Ended September 30, 2022 2021 $ Change % Change Income before provision for income taxes $ 8,582 $ 4,111 Provision for income taxes (877) (340) (537) 158 % Effective tax rate (10.2) % (8.3) % Nine Months Ended September 30, 2022 2021 $ Change % Change Income before provision for income taxes $ 12,226 $ 12,135 Provision for income taxes (1,264) (987) (277) 28 % Effective tax rate (10.3) % (8.1) % Provision for income taxes for the three and nine months ended September 30, 2022 and 2021 resulted primarily from estimated domestic and foreign taxes included in the calculation of the effective tax rate. We continue to maintain a full valuation allowance against all of our federal and state deferred tax assets in the United States as well as federal tax assets in Canada. As a result, no benefit for losses generated from our U.S. territory was included in the calculation of the 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. We continue to maintain a valuation allowance of against certain of our deferred tax assets, including all federal, state and certain foreign deferred tax assets in the United States and Canada 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 the underlying net operating loss carryforwards. We also maintain liabilities for uncertain tax positions. As of September 30, 2022, we had unrecognized tax benefits under ASC 740 Income Taxes of approximately $6.4 million and applicable interest of $0.1 million. The total amount of unrecognized tax benefits that would affect our effective tax rate, if recognized, is $1.3 million. We account for interest and penalties related to uncertain tax positions as a component of income tax provision. We do not expect to have any significant changes to unrecognized tax benefits during the next twelve months. Liquidity and Capital Resources Our cash equivalents, investments - current and investments - noncurrent consist primarily of money-market funds, investment in equity and debt marketable securities (including mutual funds) and certificates of deposit. All marketable securities are stated at market value. Realized gains and losses on marketable equity securities and marketable debt securities are recorded in Other income (expense), net on the Condensed Consolidated Statements of Income and Comprehensive Income. Unrealized gains and losses on marketable equity securities (including mutual funds) are reported as Other income (expense), net on our Condensed Consolidated Statement of Income and Comprehensive Income. Unrealized gains and losses on marketable debt securities reported as a component of Accumulated other comprehensive income on our Condensed Consolidated Balance Sheets . Certificates of deposit are report as Investment - current or Investment -noncurrent based on their 33 remaining maturity days. Interest income from certificates of deposit are reported as Interest and other income (loss), net on the Condensed Consolidated Statement of Income and Comprehensive Income. Cash, cash equivalents and investments-current - As of September 30, 2022, our cash, cash equivalents, and investments- current totaled $133.5 million, a decrease of $4.4 million from $137.9 million on December 31, 2021. A summary of select cash flow information for the nine months ended September 30, 2022 and 2021 (in thousands): Nine Months Ended September 30, 2022 2021 Net cash provided by operating activities $ 32,080 $ 10,722 Net cash used in investing activities $ (35,578) $ (32,775) Net cash provided by (used in) financing activities $ (11,225) $ 53,132 Cash provided by operating activities - Our operating activities primarily consists of net income adjusted for certain non-cash items including depreciation and amortization; stock-based compensation expense, deferred income taxes and the effect of changes in operating assets and liabilities. Net cash provided by operating activities was $32.1 million in the nine months ended September 30, 2022, a $21.4 million increase compared to the same period in 2021. This cash increase was primarily attributable to a $11.1 million increase from changes in net operating assets and a $10.5 million increase from changes in non-cash items partially offset by a $0.2 million decrease in net income. Cash provided by (used in) investing activities - Our investing activities primarily consist of purchases of marketable securities and other investments and proceeds from disposal of marketable securities and other investments; proceeds from issuance of derivative instruments; payments made to settle derivative instruments and purchases of computer equipment, furniture and leasehold improvements. Net cash used in investing activities during the nine months ended September 30, 2022 was $35.6 million primarily consisting of $141.9 million in cash used to purchase marketable securities and in the settlement of derivative instrument partially offset by $106.4 million in proceeds from selling marketable securities and derivatives. Net cash used in investing activities during the nine months ended September 30, 2021 was $32.8 million primarily consisting of $34.4 million of purchases marketable securities partially offset by $1.8 million of proceeds from sale of derivative instruments. Net cash used by financing activities during the nine months ended September 30, 2022 was $11.2 million primarily consisting of cash paid for stock repurchases. Net cash provided by financing activities during the nine months ended September 30, 2021 was $53.1 million primarily consisting of $50.1 million of net proceeds from common stock issuances and $3.0 million cash proceeds from stock option exercises and stock purchases under our employee stock purchase plan. Total cash, cash equivalents, and short-term investments were $133.5 million as of September 30, 2022 of which approximately 22%, or $30.0 million, was held by our foreign subsidiaries and subject to repatriation tax effects. Our intent is to permanently reinvest a majority of our earnings from foreign operations, and current plans do not anticipate that we will need funds generated from foreign operations to fund our domestic operations. On November 14, 2022, our Board of Directors declared a quarterly dividend. The first dividend, in the amount of $0.03 per share, will be payable, subject to any revocation, on January 30, 2023, to stockholders of record on January 15, 2023. Future dividends will be subject to further review and approval by the Board in accordance with applicable law. The Board reserves the right to adjust or withdraw the quarterly dividend in future periods as it reviews the capital allocation strategy from time-to-time. We may continue to invest in, protect, and defend our extensive IP portfolio, which can result in the use of cash in the event of litigation. 34 On February 23, 2022, our Board of Directors approved a stock repurchase program of up to $30 million of our common stock for a period of up to twelve months. Any stock repurchases may be made through open market and privately negotiated transactions, at such times and in such amounts as management deems appropriate, including pursuant to one or more Rule 10b5-1 trading plans adopted in accordance with Rule 10b5-1 of the Securities Exchange Act of 1934. Additionally, the Board authorized the use of any derivative or similar instrument to effect stock repurchase transactions, including without limitation, accelerated share repurchase contracts, equity forward transactions, equity option transactions, equity swap transactions, cap transactions, collar transactions, naked put options, floor transactions or other similar transactions or any combination of the foregoing transactions. The stock repurchase program was implemented as a method to return value to our stockholders. The timing, pricing and sizes of any repurchases will depend on a number of factors, including the market price of our common stock and general market and economic conditions. The stock repurchase program does not obligate us to repurchase any dollar amount or number of shares, and the program may be suspended or discontinued at any time. In the nine months ended September 30, 2022, we repurchased 1,270,294 shares of our common stock for $7.0 million at an average purchase price of 5.50 per share. As of September 30, 2022, we have $23.0 million available for future repurchase under the stock repurchase program. At September 30, 2022, we had a liability for unrecognized tax benefits totaling $0.2 million, none of which could be payable in cash. We did not have any other significant non-cancellable purchase commitments as of September 30, 2022. We anticipate that capital expenditures for property and equipment for the remainder of 2022 will be less than $1.0 million. While the unprecedented public health and governmental efforts to contain the spread of COVID-19 have created significant uncertainty as to general economic and capital market conditions in 2022 and beyond, as of November 14, 2022, the date of this Quarterly Report on Form 10-Q, we believe we have sufficient capital resources to meet our working capital needs for the next twelve months and beyond. Critical Accounting Estimates Our discussion and analysis of our financial condition and results of operations are based upon our condensed consolidated financial statements, which have been prepared in accordance with U.S. GAAP. The preparation of these condensed consolidated financial statements requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues, expenses, and related disclosure of contingent assets and liabilities. On an ongoing basis, we evaluate our estimates and assumptions, including those related to revenue recognition, marketable securities and derivative instruments, income taxes and contingencies. We base our estimates and assumptions on historical experience and on various other factors that we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates and assumptions. 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 November 14, 2022 the date of issuance of this Quarterly Report on Form 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, 2021 filed with the SEC on February 25, 2022, for a complete discussion of our critical accounting policies and estimates. The preparation of financial statements and related disclosures in conformity with U.S. generally accepted accounting principles (“GAAP”) and our discussion and analysis of our financial condition and operating results require the management to make judgments, assumptions and estimates that affect the amounts reported. See Note 1. Significant Accounting Policies of the Notes to Condensed Consolidated Financial Statements in Part I, Item 1 herein, which describes the significant accounting policies and methods used in the preparation of our condensed consolidated financial statements. Management bases its estimates on historical experience and on various other assumptions it believes to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities. 35 Recent Accounting Pronouncements See Note 1 Significant Accounting Policies of the Notes to Condensed Consolidated Financial Statements for information regarding the effect of new accounting pronouncements on our financial statements. Item 4. Control and Procedures Based on their evaluation as of September 30, 2022, our management, with the participation of our Chief Executive Officer and Chief Financial Officer, has concluded that our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act) were effective to ensure that the information required to be disclosed by us in this Quarterly Report on Form 10-Q was (i) recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and regulations and (ii) accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, to allow timely decisions regarding required disclosure. There were no changes to internal controls over financial reporting that occurred during the quarter ended September 30, 2022 that have materially affected or are reasonably likely to materially affect our internal controls over financial reporting. Our management, including our Chief Executive Officer and Chief Financial Officer, does not expect that our disclosure controls and procedures or our internal controls over financial reporting will prevent all error and all fraud. A control system, no matter how well conceived and operated, can provide only reasonable, not absolute assurance that the objectives of the control system are met. Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within Immersion, have been detected. 36 PART II