This Apple Inc. Supplier Faces Significant Difficulties

On Feb. 8, Imagination Technologies (NASDAQOTH: IGNMF), the semiconductor intellectual property vendor that supplies Apple (AAPL 0.35%) with graphics processor designs for integration into the latter's A-series processors, made a number of significant announcements.

The first is that the company's longtime CEO Sir Hossein Yassaie, who has been with the company since 1992, has stepped down as CEO "with immediate effect." Andrew Heath, a non-executive director from the company's board, will now serve as interim chief executive as the company searches for a full-time replacement.

In addition to this major executive change, Imagination reports that royalty revenues from key customers have "fallen short of previous expectations for the last calendar quarter of 2015." Forecasts for the company's first fiscal quarter of 2016, per the company, have also come down.

All told, management is looking at what it describes as a "material reduction in expected [fiscal year 2016] revenues and resulting profitability."

Indeed, the company is now forecasting a loss on an EBIT (earnings before interest and tax) basis for the current fiscal year.

Time for some restructuring
As a result of the company's deteriorating financial performance, the company announced that it is initiating some rather significant restructuring actions.

The company plans to divest itself of Pure, which produces digital radios and wireless speakers.

"The Group believes there are potentially more appropriate owners for Pure, given the economics of scale in the consumer electronics market, who will be able to leverage its leading technologies and brand," said the company in a press release.

As far as the financials go, the company said that it plans to bring down total operating expenses for what it describes as its "on-going businesses" by 15 million pounds (roughly $21.62 million), with 2 million pounds of these savings "re-invested" in the company's PowerVR graphics/multimedia intellectual property business.

All told, Imagination says that it will "initiate a full operational review, including all [research and development] expenditure" that it expects to "last several months" and ultimately "ensure investment is focused on core activities which are set to deliver attractive returns."

The situation here is not pretty
Although it would appear that Imagination will do its best to continue investing at appropriate levels in order to try to maintain graphics processor IP leadership, its financial condition leaves me concerned with the company's long-term viability.

In particular, Imagination sees substantial royalty revenue from sales of iOS-powered devices, each of which includes royalty-bearing processors.

As is well known at this point, Apple is hard at work developing its own graphics processing units. Although Imagination has years of experience with developing graphics processors that Apple doesn't, Apple's very strong financial condition affords it the luxury to invest as much as needed to develop competitive graphics processor designs, potentially ones that do not bear royalties to Imagination.

In addition to the risk around Apple, Imagination's key rival in the semiconductor intellectual property licensing business, ARM Holdings, also enjoys a much more robust financial condition.

Although Imagination's designs are still regarded as industry-leading, at this point I could see ARM very well investing to the point where its graphics designs catch up with, and potentially push past, Imagination's over a multiyear horizon.

At this point, the situation simply doesn't look pretty, though I plan to closely monitor it for any signs of improvement.