UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(MARK ONE)

þ		QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2008

o		TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from                      to                     

Commission file number 000-27969

IMMERSION CORPORATION

 

(Exact name of registrant as specified in its charter)

Delaware		94-3180138
(State or other jurisdiction of		(I.R.S. Employer Identification No.)
incorporation or organization)

801 Fox Lane, San Jose, California 95131

(408) 467-1900

     Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes þ No o

     Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

Large accelerated filer o		Accelerated filer þ		Non-accelerated filer   o (Do not check if a smaller reporting company)		Smaller Reporting Company o

    Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

Yes o No þ

    Number of shares of common stock outstanding at October 31, 2008: 27,895,336

 

 

IMMERSION CORPORATION

INDEX

		Page
PART I
FINANCIAL INFORMATION
Item 1. Financial Statements
Condensed Consolidated Balance Sheets (Unaudited) as of September 30, 2008 and December 31, 2007			3
Condensed Consolidated Statements of Operations (Unaudited) for the Three Months and Nine Months Ended September 30, 2008 and 2007 (Restated)			4
Condensed Consolidated Statements of Cash Flows (Unaudited) for the Nine Months Ended September 30, 2008 and 2007 (Restated)			5
Notes to Condensed Consolidated Financial Statements (Unaudited)			6
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations			26
Item 3. Quantitative and Qualitative Disclosures About Market Risk			44
Item 4. Controls and Procedures			45
PART II
OTHER INFORMATION			46
Item 1. Legal Proceedings			46
Item 1A. Risk Factors			48
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds			63
Item 6. Exhibits			63
SIGNATURES			64
EX-10.44
EX-10.45
EX-31.1
EX-31.2
EX-32.1
EX-32.2

PART I
FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

CONDENSED CONSOLIDATED BALANCE SHEETS

(In thousands, except share and per share amounts)
(Unaudited)

		September 30,				December 31,
		2008				2007
ASSETS
Current assets:
Cash and cash equivalents		$	102,083			$	86,493
Short-term investments			16,976				51,619
Accounts receivable (net of allowances for doubtful accounts of: September 30, 2008 — $353 and December 31, 2007 — $85)			5,276				5,494
Inventories, net			4,892				3,674
Deferred income taxes			211				3,351
Prepaid expenses and other current assets			4,830				3,036
Total current assets			134,268				153,667
Property and equipment, net			3,202				2,112
Deferred income tax assets, net			—				4,031
Intangibles, net and other assets			10,062				8,558
Total assets		$	147,532			$	168,368
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Accounts payable		$	2,213			$	1,657
Accrued compensation			3,041				1,828
Other current liabilities			25,184				2,629
Deferred revenue and customer advances (Note 6)			4,653				4,478
Total current liabilities			35,091				10,592
Long-term deferred revenue, less current portion			16,546				14,269
Deferred income tax liabilities			211				—
Other long-term liabilities			651				1,720
Total liabilities			52,499				26,581
Contingencies (Note 14)
Stockholders’ equity:
Common stock and additional paid-in capital — $0.001 par value; 100,000,000 shares authorized; shares issued: September 30, 2008 — 30,641,899 and December 31, 2007 — 30,389,850; shares outstanding: September 30, 2008 — 28,815,336 and December 31, 2007 — 30,389,850			164,720				160,147
Warrants			1,731				1,731
Accumulated other comprehensive income			135				137
Accumulated deficit			(58,202	)			(20,228	)
Treasury stock at cost: September 30, 2008 — 1,826,563 shares and December 31, 2007 — 0 shares			(13,351	)			—
Total stockholders’ equity			95,033				141,787
Total liabilities and stockholders’ equity		$	147,532			$	168,368

See accompanying Notes to Condensed Consolidated Financial Statements.

IMMERSION CORPORATION

		Three Months Ended								Nine Months Ended
		September 30,								September 30,
		2008				2007				2008				2007
														(As restated,
														see Note 15)
Revenues:
Royalty and license		$	4,761			$	2,904			$	11,393			$	7,862
Product sales			4,755				5,420				13,992				14,299
Development contracts and other			565				1,479				2,164				2,651
Total revenues			10,081				9,803				27,549				24,812
Costs and expenses:
Cost of product sales (exclusive of amortization of intangibles shown separately below)			2,951				2,563				7,607				6,533
Sales and marketing			4,296				2,825				11,996				8,558
Research and development			3,155				2,482				9,239				7,538
General and administrative			4,774				2,781				14,121				9,162
Amortization of intangibles			179				243				584				739
Litigation settlement, conclusions, and patent license			20,750				—				20,750				(134,900	)
Total costs and expenses			36,105				10,894				64,297				(102,370	)
Operating income (loss)			(26,024	)			(1,091	)			(36,748	)			127,182
Interest and other income			988				1,856				3,404				4,037
Interest expense			—				(211	)			—				(1,024	)
Income (loss) before provision for income taxes			(25,036	)			554				(33,344	)			130,195
Provision for income taxes			(7,262	)			(61	)			(4,630	)			(13,688	)
Net income (loss)		$	(32,298	)		$	493			$	(37,974	)		$	116,507
Basic net income (loss) per share		$	(1.10	)		$	0.02			$	(1.26	)		$	4.35
Shares used in calculating basic net income (loss) per share			29,448				28,630				30,092				26,768
Diluted net income (loss) per share		$	(1.10	)		$	0.02			$	(1.26	)		$	3.73
Shares used in calculating diluted net income (loss) per share			29,448				31,399				30,092				31,315

See accompanying Notes to Condensed Consolidated Financial Statements.

IMMERSION CORPORATION

		Nine Months Ended
		September 30,
		2008				2007
						(As restated,
						see Note 15)
Cash flows from operating activities:
Net income (loss)		$	(37,974	)		$	116,507
Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities:
Depreciation and amortization			844				661
Amortization of intangibles			584				739
Stock-based compensation			2,968				1,942
Excess tax benefits from stock-based compensation			(194	)			(10,579	)
Realized gain on short-term investments			(81	)			—
Allowance for doubtful accounts			269				(53	)
Interest expense — accretion on 5% Convertible Debenture			—				535
Fair value adjustment of Put Option and Registration Rights			—				(15	)
Loss on disposal of equipment			—				28
Changes in operating assets and liabilities:
Accounts receivable			(61	)			(51	)
Inventories			(1,136	)			(412	)
Deferred income taxes			7,382				(5,610	)
Prepaid expenses and other current assets			(1,795	)			397
Other assets			12				—
Accounts payable			609				(2,255	)
Accrued compensation and other current liabilities			23,207				699
Income taxes payable			(170	)			12,498
Deferred revenue and customer advances			2,453				(29,624	)
Other long-term liabilities			(1,069	)			657
Net cash provided by (used in) operating activities			(4,152	)			86,064
Cash flows provided by (used in) investing activities:
Purchases of short-term investments			(44,221	)			(31,777	)
Maturities of short-term investments			78,978				—
Intangibles and other assets			(2,219	)			(1,444	)
Purchases of property and equipment			(1,821	)			(1,169	)
Net cash provided by (used in) investing activities			30,717				(34,390	)
Cash flows provided by (used in) financing activities:
Issuance of common stock under employee stock purchase plan			330				317
Exercise of stock options and warrants			1,168				10,817
Excess tax benefits from stock-based compensation			194				10,579
Payments on long-term debt			—				(1,400	)
Purchases of treasury stock			(12,643	)			—
Net cash provided by (used in) financing activities			(10,951	)			20,313
Effect of exchange rates on cash and cash equivalents			(24	)			1,460
Net increase in cash and cash equivalents			15,590				73,447
Cash and cash equivalents:
Beginning of the period			86,493				32,012
End of the period		$	102,083			$	105,459
Supplemental disclosure of cash flow information:
Cash paid (received) for taxes		$	(731	)		$	6,032
Cash paid for interest		$	—			$	572
Non-cash investing and financing activities:
Amounts accrued for property and equipment, and intangibles		$	848			$	—
Amounts accrued for purchase of treasury stock		$	709			$	—

See accompanying Notes to Condensed Consolidated Financial Statements.

IMMERSION CORPORATION

1. SIGNIFICANT ACCOUNTING POLICIES

     Description of Business

     Immersion Corporation (the “Company”) was incorporated in 1993 in California and reincorporated in Delaware in 1999 and develops, manufactures, licenses, and supports a wide range of hardware and software technologies and products that enhance digital devices with touch interaction.

     Principles of Consolidation and Basis of Presentation

     The condensed consolidated financial statements include the accounts of Immersion Corporation and its majority-owned subsidiaries. All intercompany accounts, transactions, and balances have been eliminated in consolidation.

     The accompanying condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) for interim financial information and with the instructions for Form 10-Q and Article 10 of Regulation S-X and, therefore, do not include all information and footnotes necessary for a complete presentation of the financial position, results of operations, and cash flows, in conformity with accounting principles generally accepted in the United States of America. These condensed consolidated financial statements should be read in conjunction with the Company’s audited consolidated financial statements included in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2007. In the opinion of management, all adjustments consisting of only normal and recurring items necessary for the fair presentation of the financial position and results of operations for the interim period have been included.

     The results of operations for the interim periods ended September 30, 2008 are not necessarily indicative of the results to be expected for the full year.

     Short-term Investments

     The Company’s short-term investments consist primarily of highly liquid commercial paper and government agency securities purchased with an original or remaining maturity of greater than 90 days on the date of purchase. The Company classifies all debt securities with readily determinable market values as “available-for-sale” in accordance with Statement of Financial Accounting Standards (“SFAS”) No. 115, “Accounting for Certain Investments in Debt and Equity Securities” (“SFAS No. 115”). Even though the stated maturity dates of these debt securities may be one year or more beyond the balance sheet date, the Company has classified all debt securities as short-term investments in accordance with Accounting Research Bulletin No. 43, Chapter 3A, “Working Capital—Current Assets and Current Liabilities,” as they are reasonably expected to be realized in cash or sold during the normal operating cycle of the Company. These investments are carried at fair market value with unrealized gains and losses considered to be temporary in nature reported as a separate component of other comprehensive income (loss) within stockholders’ equity.

     The Company follows the guidance provided by Financial Accounting Standards Board (“FASB”) Staff Position (“FSP”) 115-1/124-1 and Emerging Issues Task Force (“EITF”) No. 03-01, “The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments” (“EITF No. 03-01”), to assess whether the Company’s investments with unrealized loss positions are other than temporarily impaired. Realized gains and losses and declines in value judged to be other than temporary are determined based on the specific identification method and are reported in the condensed consolidated statement of operations. Factors considered in determining whether a loss is temporary include the length of time and extent to which fair value has been less than the

cost basis, the financial condition and near-term prospects of the investee , and the Company’s intent and ability to hold the investment for a period of time sufficient to allow for any anticipated recovery in market value.

     Effective January 1, 2008, the Company adopted the provisions of SFAS No. 157 “Fair Value Measurements” (“SFAS No. 157”), which defines fair value, establishes a framework for measuring fair value, and expands disclosures about fair value measurements required under other accounting pronouncements. SFAS No. 157 clarifies that fair value is an exit price, representing the amount that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants. SFAS No. 157 also requires that a fair value measurement reflect the assumptions market participants would use in pricing an asset or liability based on the best information available. Assumptions include the risks inherent in a particular valuation technique (such as a pricing model) and/or the risks inherent in the inputs to the model.

     SFAS No. 157 establishes a fair value hierarchy that prioritizes the inputs to valuation techniques used to measure fair value. The hierarchy gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (level 1 measurements) and the lowest priority to unobservable inputs (level 3 measurements). The three levels of the fair value hierarchy under SFAS No. 157 are described below:

     Level 1: Unadjusted quoted prices in active markets that are accessible at the measurement date for identical, unrestricted assets or liabilities;

     Level 2: Quoted prices in markets that are not active or financial instruments for which all significant inputs are observable, either directly or indirectly;

     Level 3: Prices or valuations that require inputs that are both significant to the fair value measurement and unobservable.

     A financial instrument’s level within the fair value hierarchy is based on the lowest level of any input that is significant to the fair value measurement.

     In February 2008, the FASB issued FSP No. 157-2 that delays the effective date of SFAS No. 157 for nonfinancial assets and nonfinancial liabilities, except for items that are recognized or disclosed at fair value in the financial statements on a recurring basis (at least annually) until fiscal years beginning after November 15, 2008. The delay is intended to allow the FASB and constituents additional time to consider the effect of various implementation issues that have arisen, or that may arise, from the application of SFAS No. 157. The Company continues to assess the impact that FSP 157-2 may have on its consolidated financial position and results of operations.

     Further information about the application of SFAS No. 157 may be found in Note 2 below.

     Revenue Recognition

     The Company recognizes revenues in accordance with applicable accounting standards, including Securities and Exchange Commission (“SEC”) Staff Accounting Bulletin (“SAB”) No. 104, “Revenue Recognition” (“SAB No. 104”), EITF No. 00-21, “Accounting for Revenue Arrangements with Multiple Deliverables” (“EITF No. 00-21”), Statement of Position (“SOP”) 81-1 “Accounting for Performance for Construction-Type and Certain Production-Type contracts” (“SOP 81-1”), and SOP 97-2, “Software Revenue Recognition” (“SOP 97-2”), as amended. Revenue is recognized when persuasive evidence of an arrangement exists, delivery has occurred or service has been rendered, the fee is fixed and determinable, and collectability is probable. The Company derives its revenues from three principal sources: royalty and license fees, product sales, and development contracts.

          Royalty and license revenue — The Company recognizes royalty and license revenue based on royalty reports or related information received from the licensee as well as time-based licenses of its intellectual property portfolio. Up-front payments under license agreements are deferred and recognized as revenue either based on the royalty reports received or amortized over the license period depending on the

nature of the agreement. Advance payments under license agreements that also require the Company to provide future services to the licensee are deferred and recognized over the service period when vendor-specific objective evidence (“VSOE”) related to the value of the services does not exist.

     The Company generally recognizes revenue from its licensees under one or a combination of the following models:

License revenue model		Revenue recognition
Perpetual license of intellectual property portfolio based on per unit royalties, no services contracted.		Based on royalty reports received from licensees. No further obligations to licensee exist.
Time-based license of intellectual property portfolio with up-front payments and/or annual minimum royalty requirements, no services contracted. Licensees have certain rights to updates to the intellectual property portfolio during the contract period.		Based on straight-line amortization of annual minimum/up-front payment recognized over contract period or annual minimum period.
Perpetual license of intellectual property portfolio or technology license along with contract for development work.		Based on cost-to-cost percentage-of-completion accounting method over the service period or completed contract method. Obligation to licensee exists until development work is complete.
License of software or technology, no modification necessary, no services contracted.		Up-front revenue recognition based on SOP 97-2 criteria or EITF No. 00-21, as applicable.

     Individual contracts may have characteristics that do not fall within a specific license model or may have characteristics of a combination of license models. Under those circumstances, the Company recognizes revenue in accordance with SAB No. 104, EITF No. 00-21, SOP 81-1, and SOP 97-2, as amended, to guide the accounting treatment for each individual contract. See also the discussion regarding “Multiple element arrangements” below. If the information received from the Company’s licensees regarding royalties is incorrect or inaccurate, the Company’s revenues in future periods may be adversely affected. To date, none of the information the Company has received from its licensees has caused any material adjustment to period revenues.

          Product sales — The Company recognizes revenues from product sales when the product is shipped, provided the other revenue recognition criteria are met, including that collection is determined to be probable and no significant obligation remains. The Company sells the majority of its products with warranties ranging from three to sixty months. The Company records the estimated warranty costs during the quarter the revenue is recognized. Historically, warranty-related costs and related accruals have not been significant. The Company offers a general right of return on the MicroScribe^® product line for 14 days after purchase. The Company recognizes revenue at the time of shipment of a MicroScribe digitizer and provides an accrual for potential returns based on historical experience. The Company offers no other general right of return on its products.

          Development contracts and other revenue — Development contracts and other revenue is comprised of professional services (consulting services and/or development contracts), customer support, and extended warranty contracts. Development contract revenues are recognized under the cost-to-cost percentage-of-completion accounting method based on physical completion of the work to be performed or completed contract method. Losses on contracts are recognized when determined. Revisions in estimates are reflected in the period in which the conditions become known. Customer support and extended warranty contract revenue is recognized ratably over the contractual period.

          Multiple element arrangements — The Company enters into revenue arrangements in which the customer purchases a combination of patent, technology, and/or software licenses, products, professional services, support, and extended warranties (multiple element arrangements). When VSOE of fair value exists for all elements, the Company allocates revenue to each element based on the relative fair value of each of the elements. The price charged when the element is sold separately generally determines the fair value or VSOE.

     The Company’s revenue recognition policies are significant because the Company’s revenues are a key component of its results of operations. In addition, the Company’s revenue recognition policies determine the timing of certain expenses, such as commissions and royalties.

     Recent Accounting Pronouncements

     In February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities” (“SFAS No. 159”). The new Statement allows entities to choose, at specified election dates, to measure eligible financial assets and liabilities at fair value in situations in which they are not otherwise required to be measured at fair value. If a company elects the fair value option for an eligible item, changes in that item’s fair value in subsequent reporting periods must be recognized in current earnings. SFAS No. 159 also establishes presentation and disclosure requirements designed to draw comparison between entities that elect different measurement attributes for similar assets and liabilities. SFAS No. 159 was effective on January 1, 2008. The Company did not elect the fair value option for any of its financial instruments, therefore the adoption of SFAS No. 159 did not impact the condensed consolidated financial statements.

     In April 2008, the FASB issued FSP No. FAS 142-3, “Determination of the Useful Life of Intangible Assets” (“FSP No. FAS 142-3”). FSP No. FAS 142-3 amends the factors that should be considered in developing renewal or extension assumptions used to determine the useful life of a recognized intangible asset under Statement of SFAS No. 142, “Goodwill and Other Intangible Assets.” FSP No. FAS 142-3 is effective for fiscal years beginning after December 15, 2008. The Company is currently assessing the impact that FSP No. FAS 142-3 will have on its results of operations, financial position, or cash flows.

2. FAIR VALUE DISCLOSURES

     Short-term Investments

September 30, 2008

Gross

Gross

Unrealized

Unrealized

Amortized

Holding

Holding

Fair

Cost

Gains

Losses

Value

(In thousands)

U.S. government agency securities

$

16,934

$

42

$

—

$

16,976

		December 31, 2007
						Gross				Gross
						Unrealized				Unrealized
		Amortized				Holding				Holding				Fair
		Cost				Gains				Losses				Value
		(In thousands)
Corporate commercial paper		$	41,740			$	—			$	(34	)		$	41,706
U.S. government agency securities			9,871				42				—				9,913
Total		$	51,611			$	42			$	(34	)		$	51,619

     The contractual maturities of the Company’s available-for-sale securities on September 30, 2008 and December 31, 2007 were all due in one year or less.

     Cash Equivalents and Short-term Investments

     The financial assets of the Company measured at fair value on a recurring basis are cash equivalents and short-term investments. The Company’s cash equivalents and short-term investments are generally classified within Level 1 or Level 2 of the fair value hierarchy because they are valued using quoted market prices, broker or dealer quotations, or alternative pricing sources with reasonable levels of price transparency.

     The types of instruments valued based on quoted market prices in active markets include most U.S. government agency securities and most money market securities. Such instruments are generally classified within Level 1 of the fair value hierarchy.

     The types of instruments valued based on quoted prices in markets that are less active, broker or dealer quotations, or alternative pricing sources with reasonable levels of price transparency include most investment-grade corporate commercial paper. Such instruments are generally classified within Level 2 of the fair value hierarchy.

     The following table sets forth the Company’s cash equivalents and short-term investments which are measured at fair value on a recurring basis by level within the fair value hierarchy as of September 30, 2008. As required by SFAS No. 157, these are classified based on the lowest level of input that is significant to the fair value measurement.

		Fair value measurement using												Assets at
		Level 1				Level 2				Level 3				fair value
		(In thousands)
Corporate commercial paper		$	—			$	19,961			$	—			$	19,961
U.S. Government agency securities			28,869				—				—				28,869
Money market accounts			67,146				—				—				67,146
Total		$	96,015			$	19,961			$	—			$	115,976

     The above table excludes $3.1 million of cash.

3. INVENTORIES

		September 30,				December 31,
		2008				2007
		(In thousands)
Raw materials and subassemblies		$	3,768			$	2,843
Work in process			364				179
Finished goods			760				652
Inventories, net		$	4,892			$	3,674

4. PROPERTY AND EQUIPMENT

		September 30,				December 31,
		2008				2007
		(In thousands)
Computer equipment and purchased software		$	4,262			$	3,195
Machinery and equipment			2,982				2,532
Furniture and fixtures			1,229				1,212
Leasehold improvements			1,248				1,267
Total			9,721				8,206
Less accumulated depreciation			(6,519	)			(6,094	)
Property and equipment, net		$	3,202			$	2,112

5. INTANGIBLES AND OTHER ASSETS

		September 30,				December 31,
		2008				2007
		(In thousands)
Patents and technology		$	16,955			$	15,105
Accumulated amortization of patents and technology			(7,298	)			(6,714	)
Intangibles, net			9,657				8,391
Other assets			405				167
Intangibles and other assets, net		$	10,062			$	8,558

     The estimated annual amortization expense for intangible assets as of September 30, 2008 is $724,000 in 2008, $709,000 in 2009, $1.1 million in 2010, $1.1 million in 2011, $1.0 million in 2012, and $5.6 million in total for all years thereafter.

6. COMPONENTS OF OTHER CURRENT LIABILITIES AND DEFERRED REVENUE AND CUSTOMER ADVANCES

		September 30,				December 31,
		2008				2007
		(In thousands)
Accrued legal		$	367			$	417
Income taxes payable			255				534
Other current liabilities			3,812				1,678
Amount due to Microsoft Corporation (Note 9)			20,750				—
Total other current liabilities		$	25,184			$	2,629
Deferred revenue, current portion		$	4,574			$	4,352
Customer advances			79				126
Total current deferred revenue, and customer advances		$	4,653			$	4,478

7. LONG-TERM DEFERRED REVENUE

     On September 30, 2008, long-term deferred revenue was $16.5 million and included approximately $14.5 million of deferred revenue from Sony Computer Entertainment. On December 31, 2007, long-term deferred revenue was $14.3 million and included approximately $11.7 million from Sony Computer Entertainment. See Note 9 for further discussion.

8. STOCK-BASED COMPENSATION

     Stock Options and Awards

     The Company’s equity incentive program is a long-term retention program that is intended to attract, retain, and provide incentives for talented employees, consultants, officers, and directors, and to align

stockholder and employee interests. Essentially all of the Company’s employees participate in the equity incentive program. The Company may grant options, stock appreciation rights, restricted stock, restricted stock units (“RSU’s”), performance shares, performance units, and other stock-based or cash-based awards to employees, directors, and consultants. Since inception, the Company has approved programs to purchase up to 19,377,974 shares of its common stock. Under these programs, stock options may be granted at prices not less than the fair market value on the date of grant for incentive stock options and not less than 85% of fair market value on the date of grant for nonstatutory stock options. These options generally vest over 4 years. RSU’s generally vest over 3 years and expire 10 years from the date of grant. On September 30, 2008, 2,386,648 shares of common stock were available for grant, and there were 7,251,470 options to purchase shares of common stock outstanding, as well as 20,500 RSU’s outstanding.

     On June 6, 2007, the Company’s stockholders approved the Immersion Corporation 2007 Equity Incentive Plan (the “2007 Plan”). The 2007 Plan replaced the Company’s 1997 Stock Option Plan (the “1997 Plan”). Effective June 6, 2007, the 1997 Plan was terminated. Under the 2007 Plan, the Company may grant stock options, stock appreciation rights, restricted stock, RSU’s, performance shares, performance units, and other stock-based or cash-based awards to employees and consultants. The 2007 Plan also authorizes the grant of awards of stock options, stock appreciation rights, restricted stock, and restricted stock units to non-employee members of the Company’s Board of Directors and deferred compensation awards to officers, directors, and certain management or highly compensated employees. The 2007 Plan authorizes the issuance of 2,303,232 shares of the Company’s common stock, and up to an additional 1,000,000 shares subject to awards that remain outstanding under the 1997 Plan as of June 6, 2007 and which subsequently terminate without having been exercised or which are forfeited to the Company.

     On April 30, 2008, the Company’s Board of Directors approved the issuance of equity awards under the Immersion Corporation 2008 Employment Inducement Award Plan (the “2008 Plan”). Under the 2008 Plan, the Company may issue awards in the form of stock options, stock appreciation rights, restricted stock purchase rights, restricted stock bonuses, restricted stock units (“RSU’s”), performance shares, performance units, deferred compensation awards, and other cash and stock awards. Such awards may be granted to new employees who had not previously been a director, and former employees or directors whose period of service was followed by a bona-fide period of non-employment.

     Employee Stock Purchase Plan

     The Company has an Employee Stock Purchase Plan (“ESPP”). Under the ESPP, eligible employees may purchase common stock through payroll deductions at a purchase price of 85% of the lower of the fair market value of the Company’s stock at the beginning of the offering period or the purchase date. Participants may not purchase more than 2,000 shares in a six-month offering period or purchase stock having a value greater than $25,000 in any calendar year as measured at the beginning of the offering period. A total of 500,000 shares of common stock are reserved for the issuance under the ESPP plus an automatic annual increase on January 1, 2001 and on each January 1 thereafter through January 1, 2010 by an amount equal to the lesser of 500,000 shares per year or a number of shares determined by the Board of Directors. As of September 30, 2008, 397,813 shares had been purchased since the inception of the ESPP. Under SFAS No. 123R, “Share-Based Payment,” (“SFAS No. 123R”), the ESPP is considered a compensatory plan and the Company is required to recognize compensation cost related to the fair value of common stock purchased under the ESPP.

     The Company did not modify its ESPP in the nine months ended September 30, 2008.

     General Stock Option Information

     The following table sets forth the summary of option activity under the Company’s stock option plans:

										Weighted
										Average
						Weighted				Remaining				Aggregate
		Number				Average				Contractual				Intrinsic
		of Shares				Exercise Price				Term				Value
										(In years)
Outstanding at December 31, 2007 (3,774,245 exercisable at a weighted average price of $9.11 per share)			6,014,370			$	9.11
Granted (weighted average fair value of $5.02 per share)			2,179,925				8.76
Exercised			(204,891	)			5.71
Forfeited and Cancelled			(737,934	)			8.84
Outstanding at September 30, 2008			7,251,470			$	9.13				5.68			$1.87 million
Exercisable at September 30, 2008			4,265,859			$	9.14				3.51			$1.85 million

     The expected to vest share balance as of September 30, 2008 is 6,112,543.

     The aggregate intrinsic value is calculated as the difference between the exercise price of the underlying awards and the quoted price of the Company’s common stock for the options that were in-the-money at September 30, 2008. The aggregate intrinsic value of options exercised under the Company’s stock option plans, determined as of the date of option exercise, was approximately $700,000 for the nine months ended September 30, 2008.

     Additional information regarding options outstanding as of September 30, 2008 is as follows:

								Options Outstanding												Options Exercisable
												Weighted
												Average				Weighted								Weighted
Range of												Remaining				Average								Average
Exercise								Number				Contractual				Exercise				Number				Exercise
Prices								Outstanding				Life (Years)				Price				Exercisable				Price
$	1.20	-	$ 6.02						728,823				5.03			$	3.26				642,198			$	2.95
	6.03	-	6.79						730,204				4.56				6.35				591,711				6.34
	6.81	-	6.98						748,524				5.77				6.96				541,680				6.96
	7.00	-	7.53						725,096				6.42				7.16				500,329				7.06
	7.60	-	8.61						953,766				7.28				8.47				185,045				8.11
	8.67	-	9.01						788,778				3.22				8.99				570,155				8.98
	9.04	-	9.24						821,794				5.81				9.09				455,241				9.13
	9.47	-	10.00						881,790				7.94				9.84				167,790				10.00
	10.13	-	31.88						835,009				4.63				19.12				574,024				21.05
	33.50	-	43.25						37,686				1.54				39.95				37,686				39.95
$	1.20	-	$43.25						7,251,470				5.68			$	9.13				4,265,859			$	9.14

     Restricted Stock Units

     Restricted stock unit activity for the nine months ended September 30, 2008 is as follows:

						Weighted				Weighted
						Average				Average				Aggregate
		Number				Grant Date				Remaining				Intrinsic
		of Shares				Fair Value				Contractual Life				Value
Outstanding at December 31, 2007
Granted			20,500			$	5.58
Vested			—
Forfeited			—
Outstanding at September 30, 2008			20,500			$	5.58				1.91			$	119,310
Expected to Vest			15,726			$	5.58				1.91			$	92,523

     The aggregate intrinsic value is calculated as the difference between the exercise price of the underlying awards, and the quoted price of the Company’s stock for the restricted stock units that were in-the-money as of September 30, 2008.

     Stock-based Compensation

          Valuation and amortization method — The Company uses the Black-Scholes-Merton option pricing model (“Black-Scholes model”), single-option approach to determine the fair value of stock options and ESPP shares. All share-based payment awards are amortized on a straight-line basis over the requisite service periods of the awards, which are generally the vesting periods. The determination of the fair value of stock-based payment awards on the date of grant using an option-pricing model is affected by the Company’s stock price as well as assumptions regarding a number of complex and subjective variables. These variables include actual and projected employee stock option exercise behaviors, the Company’s expected stock price volatility over the term of the awards, risk-free interest rate, and expected dividends.

          Expected term — The Company estimates the expected term of options granted by calculating the average term from the Company’s historical stock option exercise experience. The expected term of ESPP shares is the length of the offering period. The Company used the simplified method as prescribed by SAB No. 107 for options granted prior to December 31, 2007.

          Expected volatility — The Company estimates the volatility of its common stock taking into consideration its historical stock price movement, the volatility of stock prices of companies of similar size with similar businesses, if any, and its expected future stock price trends based on known or anticipated events.

          Risk-free interest rate — The Company bases the risk-free interest rate that it uses in the option pricing model on U.S. Treasury zero-coupon issues with remaining terms similar to the expected term on the options.

          Expected dividend — The Company does not anticipate paying any cash dividends in the foreseeable future and therefore uses an expected dividend yield of zero in the option-pricing model.

          Forfeitures — The Company is required to estimate future forfeitures at the time of grant and revise those estimates in subsequent periods if actual forfeitures differ from those estimates. The Company uses historical data to estimate pre-vesting option forfeitures and records stock-based compensation expense only for those awards that are expected to vest.

     The assumptions used to value option grants and shares under the ESPP are as follows:

		Three Months Ended								Nine Months Ended
		September 30,								September 30,
Options		2008				2007				2008				2007
Expected term (in years)			5.5				6.25				5.5				6.25
Volatility			64	%			60	%			62	%			60	%
Interest rate			3.1	%			4.4	%			2.9	%			4.6	%
Dividend yield			—				—				—				—

		Three Months Ended								Nine Months Ended
		September 30,								September 30,
Employee Stock Purchase Plan		2008				2007				2008				2007
Expected term (in years)			0.5				0.5				0.5				0.5
Volatility			83	%			58	%			80	%			50	%
Interest rate			1.9	%			5.0	%			2.0	%			5.1	%
Dividend yield			—				—				—				—

     Total stock-based compensation recognized in the consolidated statements of operations is as follows:

		Three Months Ended								Nine Months Ended
		September 30,								September 30,
		2008				2007				2008				2007
Income Statement Classifications		(In thousands)								(In thousands)
Cost of product sales		$	42			$	32			$	114			$	78
Sales and marketing			286				297				864				674
Research and development			211				152				680				467
General and administrative			501				218				1,310				723
Total		$	1,040			$	699			$	2,968			$	1,942

     SFAS No. 123R requires the benefits of tax deductions in excess of recognized compensation expense to be reported as a financing cash flow, rather than as an operating cash flow. For the three months and nine months ended September 30, 2008, the Company recorded $18,000 and $194,000, respectively, of excess tax benefits from stock-based compensation. For the three months and nine months ended September 30, 2007, the Company recorded $1.3 million and $10.6 million, respectively, of excess tax benefits from stock-based compensation.

     The Company has calculated an additional paid-in capital (“APIC”) pool pursuant to the provisions of SFAS No. 123R. The APIC pool represents the excess tax benefits related to stock-based compensation that

are available to absorb future tax deficiencies. The Company includes only those excess tax benefits that have been realized in accordance with SFAS No. 109, “Accounting for Income Taxes.” If the amount of future tax deficiencies is greater than the available APIC pool, the Company will record the excess as income tax expense in its condensed consolidated statements of operations.

     As of September 30, 2008, there was $11.0 million of unrecognized compensation cost, adjusted for estimated forfeitures, related to non-vested stock options and RSUs granted to the Company’s employees and directors. This cost will be recognized over an estimated weighted-average period of approximately 2.98 years for options and 2.91 years for RSUs. Total unrecognized compensation cost will be adjusted for future changes in estimated forfeitures.

     Warrants

     On December 23, 2004, in conjunction with 5% Convertible Debentures, the Company issued an aggregate of 426,951 warrants to purchase shares of its common stock at an exercise price of $7.0265. The warrants may be exercised at any time prior to 5:00 p.m. Eastern time, on December 23, 2009. Any warrants not exercised prior to such time will expire.

     Stock Repurchase Program

     On November 1, 2007, the Company announced its Board of Directors’ authorized the repurchase of up to $50 million of the Company’s common stock. The Company may repurchase its stock for cash in the open market in accordance with applicable securities laws. The timing of and amount of any stock repurchase will depend on share price, corporate and regulatory requirements, economic and market conditions, and other factors. The stock repurchase authorization has no expiration date, does not require the Company to repurchase a specific number of shares, and may be modified, suspended, or discontinued at any time.

     During the three months ended September 30, 2008, the Company repurchased 1.1 million shares for $7.2 million at an average cost of $6.50 through open market repurchases. During the nine months ended September 30, 2008, the Company repurchased 1.8 million shares for $13.4 million at an average cost of $7.31 through open market repurchases. This amount is classified as treasury stock on the Company’s condensed consolidated balance sheet.

9. LITIGATION CONCLUSIONS AND PATENT LICENSE

     In 2003, the Company executed a series of agreements with Microsoft that provided for settlement of its lawsuit against Microsoft as well as various licensing, sublicensing, and equity and financing arrangements. Under the terms of these agreements, in the event that the Company elected to settle the action in the United States District Court for the Northern District of California entitled Immersion Corporation v. Sony Computer Entertainment of America, Inc., Sony Computer Entertainment Inc. and Microsoft Corporation, Case No. C02-00710 CW (WDB), as such action pertains to Sony Computer Entertainment, and grant certain rights, the Company would be obligated to pay Microsoft a minimum of $15.0 million for amounts up to $100.0 million received from Sony Computer Entertainment, plus 25% of amounts over $100.0 million up to $150.0 million, and 17.5% of amounts over $150.0 million. The Company determined that the conclusion of its litigation with Sony Computer Entertainment did not trigger any payment obligations under its Microsoft agreements. Accordingly, the liability of $15.0 million that was in the financial statements at December 31, 2006 was extinguished, and the Company accounted for this sum during 2007 as litigation conclusions and patent license income. However, on June 18, 2007, Microsoft filed a complaint against the Company in the U.S. District Court for the Western District of Washington alleging one claim for breach of a contract. Microsoft alleged that the Company breached a “Sublicense Agreement” executed in connection with the parties’ settlement in 2003 of the Company’s claims of patent infringement against Microsoft. The complaint alleged that Microsoft was entitled to payments that Microsoft contends are due under the Sublicense Agreement as a result of Sony Computer

Entertainment’s satisfaction of the judgment in the Company’s lawsuit against Sony Computer Entertainment and payment of other sums to the Company. In a letter sent to the Company dated May 1, 2007, Microsoft stated that it believed the Company owed Microsoft at least $27.5 million, an amount that was subsequently increased to $35.6 million. Although the company disputed Microsoft’s allegations, on August 25, 2008 the parties agreed to settle all claims. The Company had made no offers to settle prior to August 25, 2008. Under the terms of the settlement, the Company paid Microsoft $20.8 million in October 2008.

     In March 2007, the Company’s patent infringement litigation with Sony Computer Entertainment concluded. Sony Computer Entertainment satisfied the judgment against it from the United States District Court for the Northern District of California, which included damages, pre-judgment interest, costs and interest totaling $97.3 million, along with compulsory license fees already paid to the Company of $30.6 million and interest earned on these fees of $1.8 million. As of March 19, 2007, the Company and Sony Computer Entertainment entered into an agreement whereby the Company granted Sony Computer Entertainment and certain of its affiliates a worldwide, non-transferable, non-exclusive license under the Company’s patents that have issued, may issue, or claim a priority date before March 2017 for the going forward use, development, manufacture, sale, lease, importation, and distribution of Sony Computer Entertainment’s current and past PlayStation and related products. The license does not cover adult, foundry, medical, automotive, industrial, mobility, or gambling products. Subject to the terms of the agreement, the Company also granted Sony Computer Entertainment and certain of its affiliates certain other licenses (relating to PlayStation games, backward compatibility of future consoles, and the use of their licensed products with certain third party products), an option to obtain licenses in the future with respect to future gaming products and certain releases and covenants not to sue. Sony Computer Entertainment granted the Company certain covenants not to sue and agreed to pay the Company twelve quarterly installments of $1.875 million (for a total of $22.5 million) beginning on March 31, 2007 and ending on December 31, 2009, and may pay the Company certain other fees and royalty amounts. In total, the Company will receive a minimum of $152.2 million through the conclusion of the litigation and the business agreement. In accordance with the guidance from EITF No. 00-21, the Company has allocated the present value of the total payments, equal to $149.9 million, between each element based on their relative fair values. Under this allocation, the Company recorded $119.9 million as litigation conclusions and patent license income, and the remaining $30.0 million is allocated to deferred license revenue to the extent payment is received in advance of revenue recognition. Such deferred revenue was $17.5 million at September 30, 2008. The Company recorded $749,000 and $2.2 million as revenue for the three-month and nine-month periods ended September 30, 2008, respectively. The Company recorded $749,000 and $1.6 million as revenue for the three-month and nine-month periods ended September 30, 2007, respectively. On September 30, 2008, the Company had recorded $4.6 million of the $30.0 million as revenue and will record the remaining $25.4 million as revenue, on a straight-line basis, over the remaining capture period of the patents licensed, ending March 19, 2017. The Company has accounted for future payments in accordance with Accounting Principles Board Opinion No. 21 (“ABP No. 21”). Under APB No. 21, the Company determined the present value of the $22.5 million future payments to equal $20.2 million. The Company is accounting for the difference of $2.3 million as interest income as each $1.875 million quarterly payment installment becomes due. This amount is accrued at September 30, 2008 in Other current liabilities.

     On October 20, 2004, Internet Services LLC (“ISLLC”) filed claims against the Company in its lawsuit against Sony Computer Entertainment in the U.S. District Court for the Northern District of California, alleging that the Company breached a contract with ISLLC by suing Sony Computer Entertainment for patent infringement relating to haptically-enabled software whose topics or images are allegedly age-restricted, for judicial apportionment of damages between ISLLC and the Company of the damages awarded by the jury, and for a judicial declaration with respect to ISLLC’s rights and duties under agreements with the Company. On December 29, 2004, the District Court issued an order dismissing ISLLC’s claims against Sony Computer Entertainment with prejudice and dismissing ISLLC’s claims against the Company without prejudice to ISLLC. On January 12, 2005, ISLLC filed Amended Cross-Claims and Counterclaims against the Company that contained similar claims. On March 24, 2005, the District Court again dismissed certain of these claims with prejudice and dismissed the other claims without prejudice.

     On February 8, 2006, ISLLC filed a lawsuit against the Company in the Superior Court of Santa Clara County. ISLLC’s complaint sought a share of the damages awarded to the Company in the Sony litigation and of the Microsoft settlement proceeds, and generally restated the claims already adjudicated by the District Court. On March 16, 2006, the Company answered the complaint, cross claimed for declaratory relief, breach of contract by ISLLC, and for rescission of the contract, and removed the lawsuit to federal court. The case was assigned to Judge Wilken in the U.S. District Court for the Northern District of California as a case related to the previous proceedings involving Sony Computer Entertainment and ISLLC. On May 10, 2007, ISLLC filed a motion in the District Court to remand its latest action to the Superior Court, or in the alternative, for leave to file an amended complaint. The Company opposed ISLLC’s motion, and cross-moved for judgment on the pleadings. On June 26, 2007, the District Court ruled on the motions, denying ISLLC’s motion to remand or for leave to file an amended complaint, and granting in part the Company’s motion for judgment on the pleadings. The District Court also dismissed one of ISLLC’s claims. However, on May 16, 2008, the District Court entered an order granting the Company’s motion for summary judgment on all of ISLLC’s claims, as well as the Company’s counterclaim for declaratory relief. As a result, the only claims remaining in the action were the Company’s counterclaims against ISLLC. On August 22, 2008, the Company settled its counterclaims against ISLLC and amended the terms of its existing business agreement with ISLLC. For the three months and nine months ended September 30, 2008, the Company recognized $1.1 million in royalty and license revenue as of result of this settlement with ISLLC.

10. INCOME TAXES

     For the three months and nine months ended September 30, 2008, the Company recorded income tax provisions of $7.3 million and $4.6 million on income (loss) before taxes of $(25.0) million and $(33.3) million, yielding effective tax rates of (29.0)% and (13.9)%, respectively. For the three months and nine months ended September 30, 2007, the Company recorded income tax provisions for income taxes of $(61,000) and $(13.7) million, on income (loss) before taxes of $554,000 and $130.2 million, yielding effective tax rates of 11.0% and 10.5%. The income tax provision for the three and nine months ended September 30, 2008 arises because the Company recorded a full valuation allowance on deferred tax assets of $7.3 million. Accordingly, the charge differs from the expected benefit derived by applying the applicable United States federal statutory rate before taxes. The income tax provision for the three and nine months ended September 30, 2007, are as a result of applying the estimated annual effective tax rate to cumulative income (loss) before taxes, adjusted for certain discrete items which are fully recognized in the period they occur.

     The Company adopted FIN 48, regarding accounting for uncertain tax benefits, on January 1, 2007. As of September 30, 2008, the Company has unrecognized tax benefits of approximately $651,000, including interest of $24,000 which, if recognized, would result in a reduction of the Company’s effective tax rate. Future changes in the unrecognized tax benefit will have an impact on the effective tax rate. There were no material changes in the amount of unrecognized tax benefits during the quarter ended September 30, 2008. The Company does not expect any material changes to its liability for unrecognized tax benefits during the next twelve months. The Company’s policy is to account for interest and penalties related to uncertain tax positions as a component of the income tax provision.

     The Company is subject to taxation in the United States and various states and foreign jurisdictions. The tax years 1993-2007 remain open to examination by the federal and most state tax authorities due to net operating loss and credit carryforwards. The Company’s foreign operations in Canada are open to audit under statute of limitation for the years ending December 31, 1998 through 2007. During June 2008, the Internal Revenue Service concluded the examination of calendar year 2004 with no changes.

     In the quarter ended September 30, 2008, the Company had recorded a valuation allowance for the entire deferred tax asset as a result of uncertainties regarding the realization of the asset balance due to losses in fiscal 2008, the variability of operating results, and near term projected results. In the event that the Company determines the

realizability of the deferred tax asset, an adjustment to the valuation allowance may increase income in the period such determination is made. The valuation allowance does not impact the Company’s ability to utilize the underlying net operating loss carryforwards, which expire from 2018 to 2028.

     The Company’s income taxes payable for federal and state purposes have been reduced by the tax benefits from employee stock options. The net tax benefits from employee stock option transactions were approximately $0 and $108,000 during the three and nine months ended September 30, 2008, respectively, and are reflected as increases to additional paid-in capital. The net tax benefits from employee stock option transactions were approximately $1.4 million and $13.2 million during the three months and nine months ended September 30, 2007, respectively. The Company includes only the direct tax effects of employee stock incentive plans in calculating these increases to additional paid-in capital.

     The “Emergency Economic Stabilization Act of 2008,” which contains the “Tax Extenders and Alternative Minimum Tax Relief Act of 2008”, was enacted on October 3, 2008 by the U.S. government. Under the Act, the research credit was retroactively extended for amounts paid or incurred after December 31, 2007 and before January 1, 2010. The effects of the change in the tax law will be recognized in the Company’s fourth quarter, which is the quarter in which the law was enacted. The Company is currently in the process of analyzing the impact of the new law.

11. NET INCOME (LOSS) PER SHARE

     The following is a reconciliation of the numerators and denominators used in computing basic and diluted net income (loss) per share (in thousands, except per share amounts):

		Three Months Ended								Nine Months Ended
		September 30,								September 30,
		2008				2007				2008				2007
														(Restated)
Numerator:
Net income (loss) used in computing basic net income (loss) per share		$	(32,298	)		$	493			$	(37,974	)		$	116,507
Interest on 5% Convertible Debentures			—				—				—				348
Net income (loss) used in computing diluted net income (loss) per share		$	(32,298	)		$	493			$	(37,974	)		$	116,855
Denominator:
Shares used in computation of basic net income (loss) per share
(weighted average common shares outstanding)			29,448				28,630				30,092				26,768
Dilutive potential common shares:
Stock options			—				2,523				—				1,937
Warrants			—				246				—				322
5% Convertible Debentures			—				—				—				2,288
Shares used in computation of diluted net income (loss) per share			29,448				31,399				30,092				31,315
Basic net income (loss) per share		$	(1.10	)		$	0.02			$	(1.26	)		$	4.35
Diluted net income (loss) per share		$	(1.10	)		$	0.02			$	(1.26	)		$	3.73

     As of the three and nine months ended September 30, 2008, the Company had securities outstanding that could potentially dilute basic earnings per share in the future, but these were excluded from the computation of diluted net loss per share in the periods presented since their effect would have been anti-dilutive. These outstanding securities consisted of the following:

Outstanding stock options			7,251,470
Restricted Stock Units			20,500
Warrants			436,772

     For the three months and nine months ended September 30, 2007, options and warrants to purchase approximately 383,034 and 1.3 million shares of common stock, respectively, with exercise prices greater than the average fair market value of the Company’s stock of $15.57 and $11.54 respectively were not included in the calculation because the effect would have been anti-dilutive. Additionally for the three months ended September 30, 2007, securities representing the conversion of the 5% Convertible Debentures of 1,189,751 were excluded from the calculation because the effect would have been anti-dilutive.

12. COMPREHENSIVE INCOME (LOSS)

     The following table sets forth the components of comprehensive income (loss):

		Three Months Ended								Nine Months Ended
		September 30,								September 30,
		2008				2007				2008				2007
		(In thousands)								(In thousands)
														(Restated)
Net income (loss)		$	(32,298	)		$	493			$	(37,974	)		$	116,507
Change in unrealized losses on short-term investments			42				—				13				(25	)
Foreign currency translation adjustment			5				46				(15	)			79
Total comprehensive income (loss)		$	(32,251	)		$	539			$	(37,976	)		$	116,561

13. SEGMENT REPORTING, GEOGRAPHIC INFORMATION, AND SIGNIFICANT CUSTOMERS

     The Company develops, manufactures, licenses, and supports a wide range of hardware and software technologies that more fully engage users’ sense of touch when operating digital devices. The Company focuses on the following target application areas: automotive, consumer electronics, entertainment, gaming, and commercial and industrial controls; medical simulation; mobile communications; and three-dimensional design and interaction. The Company manages these application areas under two operating and reportable segments: 1) Immersion Computing, Entertainment, and Industrial, and 2) Immersion Medical. The Company determines its reportable segments in accordance with criteria outlined in SFAS No. 131, “Disclosures about Segments of an Enterprise and Related Information.”

     The Company’s chief operating decision maker (“CODM”) is the Chief Executive Officer. The CODM allocates resources to and assesses the performance of each operating segment using information about its

revenue and net income (loss). A description of the types of products and services provided by each operating segment is as follows:

     Immersion Computing, Entertainment, and Industrial develops and markets touch feedback technologies that enable software and hardware developers to enhance realism and usability in their computing, entertainment, and industrial applications. Immersion Medical develops, manufactures, and markets medical training simulators that recreate realistic healthcare environments.

     The following tables display information about the Company’s reportable segments:

		Three Months Ended								Nine Months Ended
		September 30,								September 30,
		2008				2007				2008				2007
		(In thousands)								(In thousands)
														(restated)
Revenues:
Immersion Computing, Entertainment, and Industrial		$	6,909			$	4,578			$	17,109			$	12,810
Immersion Medical			3,221				5,240				10,530				12,044
Intersegment eliminations			(49	)			(15	)			(90	)			(42	)
Total		$	10,081			$	9,803			$	27,549			$	24,812
Net Income (Loss):
Immersion Computing, Entertainment, and Industrial		$	(29,977	)		$	(810	)		$	(34,032	)		$	116,037
Immersion Medical			(2,282	)			1,305				(3,897	)			466
Intersegment eliminations			(39	)			(2	)			(45	)			4
Total		$	(32,298	)		$	493			$	(37,974	)		$	116,507

		September 30,				December 31,
		2008				2007
		(In thousands)
Total Assets:
Immersion Computing, Entertainment, and Industrial		$	162,378			$	181,860
Immersion Medical			7,913				6,552
Intersegment eliminations			(22,759	)			(20,044	)
Total		$	147,532			$	168,368

     Intersegment eliminations represent eliminations for intercompany sales and cost of sales and intercompany receivables and payables between Immersion Computing, Entertainment, and Industrial and Immersion Medical segments.

     The Company operates primarily in the United States and in Canada where it operates through its wholly owned subsidiary, Immersion Canada, Inc. Segment assets and expenses relating to the Company’s corporate operations are not allocated but are included in Immersion Computing, Entertainment, and

Industrial as that is how they are considered for management evaluation purposes. As a result, the segment information may not be indicative of the financial position or results of operations that would have been achieved had these segments operated as unaffiliated entities. Management measures the performance of each segment based on several metrics, including net income (loss). These results are used, in part, to evaluate the performance of, and allocate resources to, each of the segments.

     Revenue by Product Lines — Information regarding revenue from external customers by product lines is as follows:

		Three Months Ended								Nine Months Ended
		September 30,								September 30,
		2008				2007				2008				2007
		(In thousands)								(In thousands)
Revenues:
Consumer, Computing, and Entertainment		$	4,684			$	2,567			$	10,648			$	6,057
3D			1,204				1,035				3,522				3,123
Touch Interface Products			972				961				2,849				3,588
Subtotal Immersion Computing, Entertainment, and Industrial			6,860				4,563				17,019				12,768
Immersion Medical			3,221				5,240				10,530				12,044
Total		$	10,081			$	9,803			$	27,549			$	24,812

     Revenue by Region — The following is a summary of revenues by geographic areas. Revenues are broken out geographically by the ship-to location of the customer. Geographic revenue as a percentage of total revenue was as follows:

		Three Months Ended								Nine Months Ended
		September 30,								September 30,
		2008				2007				2008				2007
North America			56	%			73	%			58	%			67	%
Europe			18	%			19	%			20	%			18	%
Far East			26	%			7	%			19	%			12	%
Rest of the world			0	%			1	%			3	%			3	%
Total			100	%			100	%			100	%			100	%

     The Company derived approximately 56% and 73% of its total revenues from the United States of America for the three months ended September 30, 2008 and 2007, respectively. The Company derived 12% of its total revenues from Korea for the three months ended September 30, 2008. The Company derived 55% and 66% of its total revenues from the United States of America for the nine months ended September 30, 2008 and 2007, respectively. Revenues from other countries represented less than 10% individually for the periods presented.

     The majority of the Company’s long-lived assets are located in the United States of America. Long-lived assets include net property and equipment and long-term investments and other assets. Long-lived assets that were outside the United States of America constituted less than 10% of the total on September 30, 2008 and December 31, 2007.

     Significant Customers — Customers comprising 10% or greater of the Company’s net revenues are summarized as follows:

		Three Months Ended								Nine Months Ended
		September 30,								September 30,
		2008				2007				2008				2007
Customer A			10	%			*	%			*	%			*	%
Customer B			10	%			*	%			*	%			*	%
Customer C			*	%			12	%			*	%			12	%
Customer D			*	%			14	%			*	%			11	%
Customer E			*	%			*	%			*	%			*	%
Total			20	%			26	%			0	%			23	%

Customer B, C, and E accounted for 10%, 11%, and 18%, respectively, of the Company’s accounts receivable on September 30, 2008. Customer D accounted for 24% of the Company’s accounts receivable on December 31, 2007. No other customer accounted for more than 10% of the Company’s accounts receivable on September 30, 2008 or on December 31, 2007.

14. CONTINGENCIES

     In re Immersion Corporation

     The Company is involved in legal proceedings relating to a class action lawsuit filed on November 9, 2001 in the U. S. District Court for the Southern District of New York, In re Immersion Corporation Initial Public Offering Securities Litigation, No. Civ. 01-9975 (S.D.N.Y.), related to In re Initial Public Offering Securities Litigation, No. 21 MC 92 (S.D.N.Y.). The named defendants are the Company and three of its current or former officers or directors (the “Immersion Defendants”), and certain underwriters of its November 12, 1999 initial public offering (“IPO”). Subsequently, two of the individual defendants stipulated to a dismissal without prejudice.

     The operative amended complaint is brought on purported behalf of all persons who purchased the Company’s common stock from the date of the Company’s IPO through December 6, 2000. It alleges liability under Sections 11 and 15 of the Securities Act of 1933 and Sections 10(b) and 20(a) of the Securities Exchange Act of 1934, on the grounds that the registration statement for the IPO did not disclose that: (1) the underwriters agreed to allow certain customers to purchase shares in the IPO in exchange for excess commissions to be paid to the underwriters; and (2) the underwriters arranged for certain customers to purchase additional shares in the aftermarket at predetermined prices. The complaint also appears to allege that false or misleading analyst reports were issued. The complaint does not claim any specific amount of damages.

     Similar allegations were made in other lawsuits challenging over 300 other initial public offerings and follow-on offerings conducted in 1999 and 2000. The cases were consolidated for pretrial purposes. On February 19, 2003, the District Court ruled on all defendants’ motions to dismiss. The motion was denied as to claims under the Securities Act of 1933 in the case involving Immersion as well as in all other cases (except for 10 cases). The motion was denied as to the claim under Section 10(b) as to the Company, on the basis that the complaint alleged that the Company had made acquisition(s) following the IPO. The motion

was granted as to the claim under Section 10(b), but denied as to the claim under Section 20(a), as to the remaining individual defendant.

     The Company and most of the issuer defendants had settled with the plaintiffs. In this settlement, plaintiffs would have dismissed and released all claims against the Immersion Defendants in exchange for a contingent payment by the insurance companies collectively responsible for insuring the issuers in all of the IPO cases, and for the assignment or surrender of certain claims the Company may have against the underwriters. The Immersion Defendants would not have been required to make any cash payments in the settlement, unless the pro rata amount paid by the insurers in the settlement exceeded the amount of the insurance coverage, a circumstance that the Company believed was remote. In September 2005, the District Court granted preliminary approval of the settlement. The District Court held a hearing to consider final approval of the settlement on April 24, 2006, and took the matter under submission. Subsequently, the U.S. Court of Appeals for the Second Circuit vacated the class certification of plaintiffs’ claims against the underwriters in six cases designated as focus or test cases. Miles v. Merrill Lynch & Co. (In re Initial Public Offering Securities Litigation), 471 F.3d 24 (2d Cir. 2006). Thereafter, the District Court ordered a stay of all proceedings in all of the lawsuits pending the outcome of plaintiffs’ petition to the Second Circuit for rehearing en banc and resolution of the class certification issue. On April 6, 2007, the Second Circuit denied plaintiffs’ petition for rehearing, but clarified that the plaintiffs may seek to certify a more limited class in the District Court. Accordingly, the parties withdrew the prior settlement, and plaintiffs filed an amended complaint in attempt to comply with the Second Circuit’s ruling. On March 26, 2008, the District Court denied in part and granted in part the motions to dismiss the focus cases on substantially the same grounds as set forth in its prior opinion.

     During the three months ended September 30, 2008, the terms of a settlement have been reached between all of the parties to all of the lawsuits, under which the Company will not be required to pay any cash. The settlement is subject to completion of documentation and court approval, neither of which can be assured. The Company has not accrued for any loss on this matter, and believes the possibility of loss to be remote.

     Other Contingencies

     From time to time, the Company receives claims from third parties asserting that the Company’s technologies, or those of its licensees, infringe on the other parties’ intellectual property rights. Management believes that these claims are without merit. Additionally, periodically, the Company is involved in routine legal matters and contractual disputes incidental to its normal operations. In management’s opinion, the resolution of such matters will not have a material adverse effect on the Company’s consolidated financial condition, results of operations, or liquidity.

     In the normal course of business, the Company provides indemnifications of varying scope to customers against claims of intellectual property infringement made by third parties arising from the use of the Company’s intellectual property, technology, or products. Historically, costs related to these guarantees have not been significant, and the Company is unable to estimate the maximum potential impact of these guarantees on its future results of operations.

     As permitted under Delaware law, the Company has agreements whereby it indemnifies its officers and directors for certain events or occurrences while the officer or director is, or was, serving at its request in such capacity. The term of the indemnification period is for the officer’s or director’s lifetime. The maximum potential amount of future payments the Company could be required to make under these indemnification agreements is unlimited; however, the Company currently has director and officer insurance coverage that limits its exposure and enables it to recover a portion of any future amounts paid. Management believes the estimated fair value of these indemnification agreements in excess of applicable insurance coverage is indeterminable.

15.

RESTATEMENT OF PREVIOUSLY ISSUED QUARTERLY RESULTS OF OPERATIONS (UNAUDITED)

     Subsequent to the filing of Form 10-Q for the nine months ended September 30, 2007, the Company determined that there were errors in its accounting for income taxes for the release of deferred income tax valuation allowance related to stock option deductions for prior years and the utilization of an incorrect effective state tax rate. The Company restated its previously reported provision for income taxes of $7.1 million to $13.7 million and previously reported net income of $123.1 million to $116.5 million. The impact on the condensed consolidated statements of operations and condensed consolidated cash flows is presented below:

		Nine Months Ended
		September 30, 2007
		As Previously								As
		Reported				Adjustments				Restated
		(In thousands
		except per share amounts)
Total revenues		$	24,812			$	—			$	24,812
Income before provision for income taxes		$	130,195			$	—			$	130,195
Provision for income taxes			(7,093	)			(6,595	)			(13,688	)
Net income		$	123,102			$	(6,595	)		$	116,507
Basic net income per share		$	4.60			$	(0.25	)		$	4.35
Shares used in calculating basic net income per share			26,768				—				26,768
Diluted net income per share		$	3.93			$	(0.20	)		$	3.73
Shares used in calculating diluted net income per share			31,408				(93	)			31,315
Changes to cash flows from operating activities:
Net income		$	123,102			$	(6,595	)		$	116,507
Excess tax benefits from stock-based compensation			(3,215	)			(7,364	)			(10,579	)
Deferred income taxes			(5,351	)			(259	)			(5,610	)
Income taxes payable			6,271				6,227				12,498
Other long-term liabilities			30				627				657
Net cash provided by operating activities			93,428				(7,364	)			86,064
Changes to cash flows from financing activities:
Excess tax benefits from stock-based compensation		$	3,215			$	7,364			$	10,579
Net cash provided by financing activities			12,949				7,364				20,313

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, and Section 21E of the Securities Exchange Act of 1934, as amended. The forward-looking statements involve risks and uncertainties. Forward-looking statements are identified by words such as “anticipates,” “believes,” “expects,” “intends,” “may,” “will,” and other similar expressions. However, these words are not the only way we identify forward-looking

statements. In addition, any statements, which refer to expectations, projections, or other characterizations of future events, or circumstances, are forward-looking statements. Actual results could differ materially from those projected in the forward-looking statements as a result of a number of factors, including those set forth below in Management’s Discussion and Analysis of Financial Condition and Results of Operations and Risk Factors, those described elsewhere in this report, and those described in our other reports filed with the SEC. We caution you not to place undue reliance on these forward-looking statements, which speak only as of the date of this report, and we undertake no obligation 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.

OVERVIEW

     We are a leading provider of haptic technologies that allow people to use their sense of touch more fully when operating a wide variety of digital devices. To achieve this heightened interactivity, we develop and manufacture or license a wide range of hardware and software technologies and products. While we believe that our technologies are broadly applicable, we are currently focusing our marketing and business development activities on the following target application areas: automotive, consumer electronics, entertainment, gaming, and commercial and industrial controls; medical simulation; mobile communications; and three-dimensional design and interaction. We manage these application areas under two operating and reportable segments: 1) Immersion Computing, Entertainment, and Industrial and 2) Immersion Medical.

     In some markets, such as video console gaming, mobile phones, and automotive controls, we license our technologies to manufacturers who use them in products sold under their own brand names. In other markets, such as medical simulation and 3D design and interaction, we sell products manufactured under our own brand name through direct sales to end users, distributors, OEMs, or value-added resellers. From time to time, we also engage in development projects for third parties.

     Our objective is to drive adoption of our touch technologies across markets and applications to improve the user experience with digital devices and systems. We and our wholly owned subsidiaries hold more than 700 issued or pending patents in the U.S. and other countries, covering various aspects of hardware and software technologies.

CRITICAL ACCOUNTING POLICIES AND 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 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, stock-based compensation, bad debts, inventory reserves, short-term investments, warranty obligations, patents and intangible assets, contingencies, and litigation. 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.

     We believe the following are our most critical accounting policies as they require our significant judgments and estimates in the preparation of our condensed consolidated financial statements:

     Revenue Recognition

     We recognize revenues in accordance with applicable accounting standards, including SAB No. 104, “Revenue Recognition,” EITF No. 
00-21, “Accounting for Revenue Arrangements with Multiple Deliverables,” AICPA SOP 81-1 “Accounting for Performance for Construction-Type and Certain Production-Type contracts,” and AICPA SOP 97-2, “Software Revenue Recognition,” as amended. Revenue is recognized when persuasive evidence of an arrangement exists, delivery has occurred or service

has been rendered, the fee is fixed and determinable, and collectability is probable. We derive our revenues from three principal sources: royalty and license fees, product sales, and development contracts.

     Royalty and license revenue — We recognize royalty and license revenue based on royalty reports or related information received from the licensee as well as time-based licenses of our intellectual property portfolio. Up-front payments under license agreements are deferred and recognized as revenue either based on the royalty reports received or amortized over the license period depending on the nature of the agreement. Advance payments under license agreements that also require us to provide future services to the licensee are deferred and recognized over the service period when VSOE related to the value of the services does not exist.

     We generally recognize revenue from our licensees under one or a combination of the following license models:

License revenue model		Revenue recognition
Perpetual license of intellectual property portfolio based on per unit royalties, no services contracted.		Based on royalty reports received from licensees. No further obligations to licensee exist.
Time-based license of intellectual property portfolio with up-front payments and/or annual minimum royalty requirements, no services contracted. Licensees have certain rights to updates to the intellectual property portfolio during the contract period.		Based on straight-line amortization of annual minimum/up-front payment recognized over contract period or annual minimum period.
Perpetual license of intellectual property portfolio or technology license along with contract for development work.		Based on cost-to-cost percentage-of-completion accounting method over the service period or completed contract method. Obligation to licensee exists until development work is complete.
License of software or technology, no modification necessary, no services contracted.		Up-front revenue recognition based on SOP 97-2 criteria or EITF No. 00-21, as applicable.

     Individual contracts may have characteristics that do not fall within a specific license model or may have characteristics of a combination of license models. Under those circumstances, we recognize revenue in accordance with SAB No. 104, EITF No. 00-21, SOP 81-1, and SOP 97-2, as amended, to guide the accounting treatment for each individual contract. See also the discussions regarding “Multiple element arrangements” below. If the information received from our licensees regarding royalties is incorrect or inaccurate, our revenues in future periods may be adversely affected. To date, none of the information we have received from our licensees has caused any material reduction in future period revenues.

          Product sales — We recognize revenues from product sales when the product is shipped, provided the other revenue recognition criteria are met, including that collection is determined to be probable and no significant obligation remains. We sell our products with warranties ranging from three to sixty months. We record the estimated warranty costs during the quarter the revenue is recognized. Historically, warranty-related costs and related accruals have not been significant. We offer a general right of return on the MicroScribe product line for 14 days after purchase. We recognize revenue at the time of shipment of a

MicroScribe digitizer and provide an accrual for potential returns based on historical experience. We offer no other general right of return on our products.

          Development contracts and other revenue — Development contracts and other revenue is comprised of professional services (consulting services and/or development contracts), customer support, and extended warranty contracts. Development contract revenues are recognized under the cost-to-cost percentage-of-completion accounting method based on physical completion of the work to be performed or completed contract method. Losses on contracts are recognized when determined. Revisions in estimates are reflected in the period in which the conditions become known. Customer support and extended warranty contract revenue is recognized ratably over the contractual period.

          Multiple element arrangements — We enter into revenue arrangements in which the customer purchases a combination of patent, technology, and/or software licenses, products, professional services, support, and extended warranties (multiple element arrangements). When VSOE of fair value exists for all elements, we allocate revenue to each element based on the relative fair value of each of the elements. If vendor specific objective evidence does not exist, the revenue is generally recorded over the term of the contract.

     Our revenue recognition policies are significant because our revenues are a key component of our results of operations. In addition, our revenue recognition determines the timing of certain expenses, such as commissions and royalties. Revenue results are difficult to predict, and any shortfall in revenue or delay in recognizing revenue could cause our operating results to vary significantly from quarter to quarter and could result in greater or future operating losses.

     Stock-based Compensation

     We account for stock-based compensation in accordance with SFAS No. 123R. We elected the modified-prospective method, under which prior periods are not revised for comparative purposes. Under the fair value recognition provisions of this statement, stock-based compensation cost is measured at the grant date based on the fair value of the award and is recognized as expense on a straight-line basis over the requisite service period, which is the vesting period.

          Valuation and amortization method — We use the Black-Scholes model, single-option approach to determine the fair value of stock options, and ESPP shares. All share-based payment awards are amortized on a straight-line basis over the requisite service periods of the awards, which are generally the vesting periods. The determination of the fair value of stock-based payment awards on the date of grant using an option-pricing model is affected by our stock price as well as assumptions regarding a number of complex and subjective variables. These variables include actual and projected employee stock option exercise behaviors, our expected stock price volatility over the term of the awards, risk-free interest rate, and expected dividends.

          Expected term — We estimate the expected term of options granted by calculating the average term from our historical stock option exercise experience. We used the simplified method as prescribed by SAB No. 107 for options granted prior to December 31, 2007.

          Expected volatility — We estimate the volatility of our common stock taking into consideration our historical stock price movement, the volatility of stock prices of companies of similar size with similar businesses, if any, and our expected future stock price trends based on known or anticipated events.

          Risk-free interest rate — We base the risk-free interest rate that we use in the option pricing model on U.S. Treasury zero-coupon issues with remaining terms similar to the expected term on the options.

          Expected dividend — We do not anticipate paying any cash dividends in the foreseeable future and therefore use an expected dividend yield of zero in the option pricing model.

          Forfeitures — We are required to estimate future forfeitures at the time of grant and revise those estimates in subsequent periods if actual forfeitures differ from those estimates. We use historical data to estimate pre-vesting option forfeitures and record stock-based compensation expense only for those awards that are expected to vest. Changes in estimated forfeitures will be recognized through a cumulative catch-

up adjustment in the period of change and will also impact the amount of compensation expense to be recognized in future periods.

     If factors change and we employ different assumptions for estimating stock-based compensation expense in future periods, or if we decide to use a different valuation model, the future periods may differ significantly from what we have recorded in the current period and could materially affect our operating results.

     The Black-Scholes model was developed for use in estimating the fair value of traded options that have no vesting restrictions and are fully transferable, characteristics not present in our option grants and ESPP shares. Existing valuation models, including the Black-Scholes and lattice binomial models, may not provide reliable measures of the fair values of our stock-based compensation. Consequently, there is a risk that our estimates of the fair values of our stock-based compensation awards on the grant dates may bear little resemblance to the actual values realized upon the exercise, expiration, early termination, or forfeiture of those stock-based payments in the future. Certain stock-based payments, such as employee stock options, may expire and be worthless or otherwise result in zero intrinsic value as compared to the fair values originally estimated on the grant date and reported in our financial statements. Alternatively, value may be realized from these instruments that are significantly higher than the fair values originally estimated on the grant date and reported in our financial statements. There currently is no market-based mechanism or other practical application to verify the reliability and accuracy of the estimates stemming from these valuation models, nor is there a means to compare and adjust the estimates to actual values.

     See Note 8 to the condensed consolidated financial statements for further information regarding the SFAS No. 123R disclosures.

     Accounting for Income Taxes

     We use the asset and liability method of accounting for income taxes. Under this method, income tax expense is recognized for the amount of taxes payable or refundable for the current year. In addition, deferred tax assets and liabilities are recognized for the expected future tax consequences of temporary differences between the financial reporting and tax bases of assets and liabilities, and for operating losses and tax credit carryforwards. Management must make assumptions, judgments, and estimates to determine our current provision for income taxes and also our deferred tax assets and liabilities and any valuation allowance to be recorded against a deferred tax asset.

     Our judgments, assumptions, and estimates relative to the current provision for income tax take into account current tax laws, our interpretation of current tax laws, and possible outcomes of current and future audits conducted by foreign and domestic tax authorities. We have established reserves for income taxes to address potential exposures involving tax positions that could be challenged by tax authorities. Although we believe our judgments, assumptions, and estimates are reasonable, changes in tax laws or our interpretation of tax laws and any future tax audits could significantly impact the amounts provided for income taxes in our consolidated financial statements.

     Our assumptions, judgments, and estimates relative to the value of a deferred tax asset take into account predictions of the amount and category of future taxable income, such as income from operations or capital gains income. Actual operating results and the underlying amount and category of income in future years could render inaccurate our current assumptions, judgments, and estimates of recoverable net deferred taxes. Any of the assumptions, judgments, and estimates mentioned above could cause our actual income tax obligations to differ from our estimates, thus materially impacting our financial position and results of operations.

     Litigation Conclusions and Patent License

     In March 2007, we announced the conclusion of our patent infringement litigation against Sony Computer Entertainment at the U.S. Court of Appeals for the Federal Circuit. Sony Computer Entertainment satisfied the U.S. District Court for the Northern District of California judgment against it. As of March 19, 2007, we entered into a new business agreement with Sony Computer Entertainment. We determined that the conclusion of our litigation with Sony Computer Entertainment did not trigger any payment obligations under our Microsoft agreements. However, on June 18, 2007, Microsoft filed a complaint against us in the United States District Court for the Western District of Washington alleging

breach of our “Sublicense Agreement” dated July 25, 2003 and seeks damages, specific performance, declaratory judgment, and attorneys’ fees and costs. At a court ordered mediation meeting on December 11, 2007, Microsoft indicated they believe the amount owed to be $35.6 million. On August 25, 2008, the parties agreed to settle Microsoft’s breach of contract claim as well as our counterclaim. The settlement arrangement provided that we pay Microsoft $20.8 million, which we paid in October 2008, and the case was dismissed.

     Short-term Investments

     Our short-term investments consist primarily of highly liquid commercial paper and government agency securities purchased with an original or remaining maturity of greater than 90 days on the date of purchase. We classify all debt securities with readily determinable market values as “available-for-sale” in accordance with SFAS No. 115. Even though the stated maturity dates of these debt securities may be one year or more beyond the balance sheet date, we have classified all debt securities as short-term investments in accordance with Accounting Research Bulletin No. 43, Chapter 3A, “Working Capital—Current Assets and Current Liabilities,” as they are reasonably expected to be realized in cash or sold during our normal operating cycle. These investments are carried at fair market value with unrealized gains and losses considered to be temporary in nature reported as a separate component of other comprehensive income (loss) within stockholders’ equity.

     We follow the guidance provided by FSP 115-1/124-1 and EITF No. 03-01 to assess whether our investments with unrealized loss positions are other than temporarily impaired. Realized gains and losses and declines in value judged to be other than temporary are determined based on the specific identification method and are reported in the condensed consolidated statement of operations. Factors considered in determining whether a loss is temporary include the length of time and extent to which fair value has been less than the cost basis, the financial condition and near-term prospects of the investee, and our intent and ability to hold the investment for a period of time sufficient to allow for any anticipated recovery in market value.

     Effective January 1, 2008, we adopted the provisions of SFAS No. 157, which defines fair value, establishes a framework for measuring fair value, and expands disclosures about fair value measurements required under other accounting pronouncements. SFAS No. 157 clarifies that fair value is an exit price, representing the amount that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants. SFAS No. 157 also requires that a fair value measurement reflect the assumptions market participants would use in pricing an asset or liability based on the best information available. Assumptions include the risks inherent in a particular valuation technique (such as a pricing model) and/or the risks inherent in the inputs to the model.

     SFAS No. 157 establishes a fair value hierarchy that prioritizes the inputs to valuation techniques used to measure fair value. The hierarchy gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (level 1 measurements) and the lowest priority to unobservable inputs (level 3 measurements). The three levels of the fair value hierarchy under SFAS No. 157 are described below:

     Level 1: Unadjusted quoted prices in active markets that are accessible at the measurement date for identical, unrestricted assets or liabilities;

     Level 2: Quoted prices in markets that are not active or financial instruments for which all significant inputs are observable, either directly or indirectly;

     Level 3: Prices or valuations that require inputs that are both significant to the fair value measurement and unobservable.

     A financial instrument’s level within the fair value hierarchy is based on the lowest level of any input that is significant to the fair value measurement.

     In February 2008, the Financial FASB issued FSP No. 157-2 that delays the effective date of SFAS No. 157 for nonfinancial assets and nonfinancial liabilities, except for items that are recognized or

disclosed at fair value in the financial statements on a recurring basis (at least annually) until fiscal years beginning after November 15, 2008. The delay is intended to allow the FASB and constituents additional time to consider the effect of various implementation issues that have arisen, or that may arise, from the application of SFAS No. 157. The Company continues to assess the impact that FSP 157-2 may have on our consolidated financial position and results of operations.

     Further information about the application of SFAS No. 157 may be found in Note 2 to the condensed consolidated financial statements.

     Recovery of Accounts Receivable

     We maintain allowances for doubtful accounts for estimated losses resulting from our review and assessment of our customers’ ability to make required payments. If the financial condition of one or more of our customers were to deteriorate, resulting in an impairment of their ability to make payments, additional allowances might be required. To date such estimated losses have been within our expectations.

     Inventory Reserves

     We reduce our inventory value for estimated obsolete and slow moving inventory in an amount equal to the difference between the cost of inventory and the net realizable value based upon assumptions about future demand and market conditions. If actual future demand and market conditions are less favorable than those projected by management, additional inventory write-downs may be required.

     Product Return and Warranty Reserves

     We provide for estimated costs of future anticipated product returns and warranty obligations based on historical experience when related revenues are recognized, and we defer warranty-related revenue over the related warranty term.

     Intangible Assets

     We have acquired patents and other intangible assets. In addition, we capitalize the external legal and filing fees associated with patents and trademarks. We assess the recoverability of our intangible assets, and we must make assumptions regarding estimated future cash flows and other factors to determine the fair value of the respective assets that affect our condensed consolidated financial statements. If these estimates or related assumptions change in the future, we may be required to record impairment charges for these assets. We amortize our intangible assets related to patents and trademarks, once they issue, over their estimated useful lives, generally 10 years. Future changes in the estimated useful life could affect the amount of future period amortization expense that we will incur. During the three months and nine months ended September 30, 2008, we capitalized costs associated with patents and trademarks of $674,000 and $1.9 million, respectively. Our total amortization expense for the same periods for all intangible assets was $179,000, and $584,000, respectively.

     The above listing is not intended to be a comprehensive list of all of our accounting policies. In many cases, the accounting treatment of a particular transaction is specifically dictated by GAAP, with no need for management’s judgment in their application. There are also areas in which management’s judgment in selecting any available alternative would not produce a materially different result.

RESULTS OF OPERATIONS FOR THE THREE MONTHS AND NINE MONTHS ENDED SEPTEMBER 30, 2008 AND 2007

     The following Management’s Discussion and Analysis gives effect to the restatement discussed in Note 15 to the condensed consolidated financial statements.

Overview

     We achieved a 3% increase in revenues during the three months ended September 30, 2008 as compared to the three months ended September 30, 2007. The third quarter revenue growth was primarily due to a 64% increase in royalty and license revenues mainly from increased gaming and mobility royalty and license fees. The revenue increase was partially offset by a 12% decrease in product sales and a 62%

decrease in development contract revenues. We achieved an 11% increase in revenues during the nine months ended September 30, 2008 as compared to the nine months ended September 30, 2007. The first nine months revenue growth was primarily due to a 45% increase in royalty and license revenues mainly from increased gaming and mobility royalty and license fees, partially offset by a 2% decrease in product sales and an 18% decrease in development contract revenues. Our net loss was $32.3 million for the three months ended September 30, 2008 compared to net income of $493,000 for the three months ended September 30, 2007. Our net loss was $38.0 million for the nine months ended September 30, 2008 compared to net income of $116.5 million for the nine months ended September 30, 2007. In the third quarter of 2008 and throughout the first nine months of 2008, we continued to invest in research, development, sales, and marketing across all our key business segments. In August 2008, we settled our litigation with Microsoft and we agreed to make a one time payment to Microsoft in the amount of $20.8 million which was recorded in the third quarter of 2008 and paid in October 2008. In March 2007, we concluded our patent infringement litigation against Sony Computer Entertainment and recognized a gain of $119.9 million of litigation conclusions and patent license in the first nine months of 2007. During the three months ended September 30, 2008, the Company assessed the realizability of the deferred tax asset and determined the amount was no longer realizable and recorded a $7.3 million charge to income tax expense.

     For the remainder of 2008, we expect to continue to focus on the execution of sales and marketing plans in our established businesses to increase revenue and make selected investments in product and technology development and sales and marketing for longer-term growth areas. Our success could be limited by several factors, including the timely release of our new products or our licensees’ products, continued market acceptance of our products and technology, the introduction of new products by existing or new competitors, and the cost of ongoing litigation. For a further discussion of these and other risk factors, see Part II, Item 1A — “Risk Factors.”

		September 30,
REVENUES		2008				2007				Change
		($ In thousands)
Three months ended:
Royalty and license		$	4,761			$	2,904				64	%
Product sales			4,755				5,420				(12	)%
Development contracts and other			565				1,479				(62	)%
Total Revenue		$	10,081			$	9,803				3	%
Nine months ended:
Royalty and license		$	11,393			$	7,862				45	%
Product sales			13,992				14,299				(2	)%
Development contracts and other			2,164				2,651				(18	)%
Total Revenue		$	27,549			$	24,812				11	%