It’s All in the Touch…
The word haptic refers to the sensation of touch. When we touch something we receive feedback telling us what the thing feels like. For example, if you are drilling a hole, you feel the vibration from the drill in your hands. That feeling or sense of touch is the foundation of haptic technology.
The feedback we receive from simple things — like using a stick shift in a car or sawing a piece of wood — makes us react in certain ways. The primary sensory cortex in the brain is responsible for reacting to tactile sensations. All the feedback from touch sensations is received and processed by this central sensory receptor. Immersion Technologies (IMMR:NASDAQ) has developed, patented and licensed haptic technolo- gy for digital applications. This means they have figured out how to translate visual or aural sensations from, say, a computer monitor or speakers into sensations that you can feel.
Founded in 1993, Immersion Corporation is a recognized leader in developing, licensing and marketing haptic technology and products.The applications are endless, and so is the potential for profit. One aspect of their technology is used in a multibillion-dollar industry and the company is just beginning to get paid for it. A Modern-Day David and Goliath Story Video gaming is a US$12 billion dollar industry. The biggest players in the industry are Sony, with its wildly successful Playstation series, Microsoft with its Xbox, Sega and Nintendo. Sony and Microsoft are no doubt the most recognizable names in the video gaming field. Sales of their products continue to climb.
But what few people know about is the battle that s been brewing between these two giants in the industry and Immersion Technologies. It was tough enough for the Biblical character David to defeat Goliath. As you may recall, the story is about David, a diminutive boy who slew the giant warrior Goliath with a stone from his sling. For millennia this story has been used as the archetype of an underdog winning against all odds.
This is the story of Immersion Technologies and its struggles to defeat not just one Goliath, but two! Immersion has long maintained that its haptic technology is both unique and patented. The problem is that Immersion is a tiny company with a market capitalization of less than US$150 million and very little cash to defend its position. Going to court against a giant like Microsoft or Sony is an expensive proposition. Many companies just give up and go out of business long before a judge ever sees the evidence. But Immersion Technologies wasn t going to give up that easily. After all, they had created this technology and were not about to let Microsoft or Sony use it without paying for it.
So Immersion filed a lawsuit against both companies. First it sued Microsoft, the biggest and richest software company in the world. The claim: that Microsoft illegally used Immersions s haptic technology to provide the touch sensations in its Xbox gaming system. These sensations allow the game player to feel things through the game controllers. For example, if you hit a wall in a car race video game, you would have felt nothing in the past. You would just have seen the car hit and a graphic explosion on screen, and heard some noise. But with Immersion s haptic technology, you feel a shudder or strong vibration in the controller immediate sensory feedback that is so unmistakable that Microsoft decided it would add substantially to the realism of its games. But Microsoft decided to ignore Immersion s patents and use their technology without paying for it.
With its meager cash hoard, Immersion took on Microsoft in court. Remember, Microsoft has a market capitalization of US$250 billion and cash on hand of more than US$40 billion. It is the biggest gorilla in the world.For more than a year, Immersion kept pressing Microsoft with the lawsuit. Microsoft basically ignored Immersion, swatting it away as you would an annoying fly. Goliath Falls Then, in mid 2003, just as the case was about to go in front of a judge, Microsoft raised a white flag and settled the dispute with Immersion. As part of the settlement, Microsoft agreed to license Immersion s technology, pay the company more than US$20 million in cash and take a 10% stake in the company. Not bad for a small fry with nothing more than a few patented technologies and very little cash. Here s a little
briefing from Immersion about their settlement with Microsoft: During the quarter ended September 30, 2003, we entered into agreements with Microsoft providing
for certain license rights under our patents, the settling of our lawsuit against Microsoft and providing for
certain investments by Microsoft in our new Series A Redeemable Convertible Preferred Stock; as a
result, our cash position increased by $26.0 million. Pursuant to the license agreement, we granted
Microsoft a worldwide royalty-free, irrevocable license in exchange for $20.0 million. Under the terms of
the Series A Redeemable Convertible Preferred Stock purchase agreement, Microsoft purchased
2,185,792 shares of Preferred Stock for $2.745, an aggregate purchase price of $6.0 million. The
Preferred Stock accrues cumulative dividends at a rate of 7% per year, payable in cash or additional
shares of Preferred Stock and can be redeemed at the request of Microsoft for twice the original purchase
price plus any dividends in the form of additional shares that remain unpaid and any accrued but unpaid
cash dividends per share on or after July 25, 2006. In addition, and at our discretion, we may require
Microsoft to buy up to $9.0 million of our 7% Senior Redeemable Convertible Debentures, $3.0 million
in the first year plus $2.0 million per annum for the next three years. No debentures have been purchased
to date. (Immersion September 2003, 10Q)
This news was enough to spike the company s shares more than 100% overnight, to US$4 per share, about US$3.70 below its current price. Even at the current US$7.70 price, the shares are more than 80% below their all-time high and in our opinion very cheap. Microsoft Settles With the Microsoft settlement, Immersion has proved that its tech-
nology is real, effective and worth money. But there s another giant out there that is still illegally using
Immersions technology: Sony Corporation. This is a brief snippet from a lawsuit filed by Immersion Technologies: Immersion Corporation vs. Microsoft Corporation, Sony Computer Entertainment, Inc. and Sony Computer Entertainment of America, Inc. On February 11, 2002, we filed a complaint against Microsoft Corporation, Sony Computer Entertainment, Inc., and Sony Computer Entertainment of America, Inc. in the U.S. District Court for the Northern District Court of California
alleging infringement of U.S. Patent Nos. 5,889,672 and 6,275,213. The case was assigned to United States
District Judge Claudia Wilken. On April 4, 2002, Sony Computer Entertainment and Microsoft answered the complaint by denying the material allegations and alleging counterclaims seeking a judicial declaration that the asserted patents were invalid, unenforceable, or not infringed. Under the counter-claims, the defendants are also seeking damages for attorneys fees. The process of discovery and exchanging information and documents on infringement, invalidity, and damages, is ongoing. On October 8, 2002, we filed an amended complaint, withdrawing the claim under the 672 patent and adding claims
under a new patent, U.S. Patent No. 6,424,333.
On October 10, 2002, the Court entered an Amended Case Management Order that set, among other dates in the case, April 25, 2003 for a hearing to construe the claims of the asserted patents and April 5, 2004 for the start of trial. On October 28, 2002, Sony Computer Entertainment and Microsoft answered the amended complaint and alleged similar counterclaims for declaratory relief that the asserted patents are invalid, unenforceable, or not infringed.
On March 21, 2003, Sony Computer Entertainment filed a
motion for summary judgment of non-infringement. At Immersion s request, the Court ordered this motion stricken, without prejudice to its being re-filed at a later date after the Court rules on claim construction. On April 25, 2003, the Court held the scheduled claim construction hearing. On July 9, 2003, the Court issued an Order Modifying Case Management Order that reset certain scheduled dates in the case, including setting April 12, 2004 as the start of trial. On October 2, 2003, the Court issued its Claim Construction Order construing certain terms of the patents asserted in the lawsuit.
In April 2004, Immersion s fortunes could change forever. That s when the company goes to court against Sony. Sony is the manufacturer of Playstation, the world s bestselling video game console. Just like Microsoft, Sony is a very large and wealthy company. Just like Microsoft, Immersion is claiming that Sony is using its patented haptic technology without payment.
Sony has been ignoring Immersion, just like Microsoft did for many months. After all, if Immersion failed muster the financial muscle to hold on until the case finally gets to court, then Sony would get off free and clear. And, of course, even if it did get to court Immersion might lose anyway. As far as Sony was concerned, this looked like the right plan that is, until the Microsoft settlement. One Down… One to Go What Sony did not count on was that Microsoft would settle the case. Keep in mind that Microsoft set- tled for about US$30 million in cash and investments. Microsoft attorneys, the best money can buy, obviously saw that they stood a good chance of losing in court, at which point they might have faced punitive
damages much higher than US$30 million.
Microsoft would not have settled unless they knew that that were using Immersion s technology witout proper compensation, and that it could be proved. Sony is in a worse situation than Microsoft. Here s why.
Sony has sold tens of millions of Playstations worldwide. They have outsold the Xbox by at least a factor of ten. That s because Xbox was released long after the Playstation line. Sony now has to face a company that has two things it did not have prior to the Microsoft settlement:
1. Immersion now has cash to fight Sony and it has Microsoft in its corner. But it also has something a lot scarier
2. It has precedent. If Microsoft saw that settlement was a win because it would have lost in court, then it is obvious that Sony s legal team is sweating bullets. If Microsoft settled for an amount that it most likely based on usage, then Sony s liability could be up to 10 times the Microsoft settlement. Of course, if Sony goes to court and wins it could be nothing at all — that is the risk Immersion takes.
We think that Sony will settle out of court before April 2004 or it risks a massive punitive judgment. If it does settle, or lose the court battle, and if the settlement or judgment is commensurate with the one Immersion reached with Microsoft, Immersion s shares could double or triple overnight. Consider that the company is currently trading at US$7.70 with US$20 million in sales projected for 2004. If the company wins a settlement in excess of the one with Microsoft, which is entirely possible, then it could be sitting on a huge pile of cash by the end of 2004. Of course, Sony could just buy Immersion and get it over with. But we think Microsoft would have a problem with that!
A Real Company with a Real Business
It is easy to get caught up in the Microsoft/Sony situation. But there is a lot more to Immersion than
that. The company is beginning to make waves in all sorts of places. For example, the new BMW 7 series has a driver control system called iDrive that allows drivers to control several car accessories by touch.
Immersion s haptic technology is used to provide the driver with touch feedback. This allows the driver to concentrate on the road while the accessory provides him with tactile as opposed to visual or audio feedback. The company s medical division, Immersion Medical, just introduced its AccuTouch Hysteroscopy Simulator, which allows physicians to perform virtual training operations with feedback. According to the company, the high-fidelity hardware and software enable a physician to sense changes in texture, resistance and density life-like cues that improve control, performance and results.
In October 2003, the company received two US Army and NIH research contracts to develop other training simulators to provide physicians with touch feedback. The company signed on a new gaming licensee from China in August. ShenZhen Futime is currently shipping its first Immersion-licensed product, a multi-platform force feedback wheel for Playstation2,GameCube, and Xbox. And Padix Co. Ltd is making a family of force feedback game pads, joysticks and racing wheels for PC gaming. And on January 7, 2004, Immersion announced a multi-year, worldwide license agreement with Samsung Electronics Co., a global leader in telecommunications, semiconductor, flat-panel display and digital convergence technology. This news alone caused Immersion s shares to jump more than 25%. The agreement grants Samsung rights to Immersion s TouchSense technology and haptic authoring tools to develop applications for mobile phones. Under the license, Samsung will use Immersion s patented TouchSense technology in its mobile phones to deliver a variety of new capabilities for messaging, games and alerts that create a more compelling product.
Immersions unique development and authoring tools could enable Samsung to create and enhance applications for a new class of products. Here s a line from their press release Immersion is delighted to have Samsung as our first cell phone licensee. Most cell phones vibrate today with single force and speed — like pagers. High fidelity haptics brings a wide range of frequencies, dynamics and crispness never before possible. Users can experience a new channel of information flow with touch, making the phones easier to use, more fun, and more personal through applications like alerts, caller ID, messaging and gaming. This deal is very positive for Immersion s fight against Sony, because the increased value associated with the company s technology puts even more pressure on Sony to settle.
Plus, you have another major company recognizing that haptic technology belongs to Immersion Technologies. Time Is Running Out… Its not the manufacturers and licensees that are going to be the future drivers of Immersion s sales and profits, it is the consumer. As technology becomes more widespread and exciting, consumers will demand more realistic features.
The next frontier for technology is touch feedback. It is just making its way onto the radar screen for many users and investors. With the win against Microsoft and the new licensing agreements, Immersion has proven that its technology and patents are at the forefront of this new frontier. In the spring of 2004 we ll get an idea of just how valuable this intellectual and real property is.
Thats when the lawsuit against Sony is supposed to go to court. We are betting that Sony will approach Immersion with a settlement before trial. Considering that Sony s use of the technology dwarfs anyone else s, the outlook for a major settlement is excellent. If the Sony settles or loses at trial, Immersion s shares should soar. A double or triple is not out of the question, depending on the terms of the win or settlement.
Remember, there are only 20 million shares outstanding and institutions and insiders own half of that.
Immersion trades on the NASDAQ Stock Exchange under the symbol IMMR. The company s website is Immersion.com. For more information visit their site or contact Bridget McQeen at Immersion,Inc. Her email address and phone number are bmcqueen@immersion.com, 408-350-8778.
