Digimarc Corp (DMRC) 2002 Q2 法說會逐字稿

Good afternoon. My name is and I will be your conference facilitator today.

At this time I would like to welcome everyone to the Digimarc Corporation quarter 2, 2002 earnings release conference call.

All lines have been placed on mute to prevent any noise. After the speakers' remarks there will be a question and answer period. If you would like to ask a question during this time, simply press star, then the number one on your telephone keypad. If you would like to withdraw your question, push star, then the number two on your telephone keypad.

Thank you. Mr. Davis, you may begin your conference.

Good afternoon, ladies and gentlemen. Welcome to our conference call.

With me today is , our CFO, and Paul Gifford, our President and Chief Operating Officer.

We have released second quarter financial results today that exceeded Q2 guidance for revenues. EPS, excluding one-time restructuring charges, was inline with Street consensus.

The purpose of this conference call is to provide you with a summary of our financial results, and an update on significant business developments during the quarter.

We will respond to your questions at the end of the call, however, first I'd like E.K. to review the financial information contained in our press release. E.K.?

Thank you, Bruce.

Before we start our discussion on the results, I would like to go over a couple of items. First, I would like to point out that during the course of this conference call, we will be making forward-looking statements, which are subject to risks and uncertainties. These forward-looking statements, including our comments about our expectations about future results, growth areas, revenues and losses per share, are based on information currently available to us. They are subject to change, and the actual results may differ materially from our expectations.

For further information about these risks and uncertainties, I would like to refer you to the risk factors contained in our SEC filings, including our Form 10-K, filed on April 1, 2002, and our Form 10-Q for the first quarter, filed on May 14, 2002.

A replay of this conference call will be available for one week through web casts located on our Investor Relations web site at www.digimarc.com, or www.streetevents.com.

Now, turning our discussion to the second quarter 2002 financial results. First, for a review of the income statement: I am pleased to report revenues for the second quarter of 2002 were a record 20.8 million, up 16.6 million, or 395 percent, compared with the second quarter of 2001, and up 2.4 million, or 13 percent sequentially from the previous quarter.

The dramatic increase in revenues from last year is due to the acquisition of the ID Systems business, while the sequential growth resulted from strong performance in ID Systems and government programs.

Within ID Systems, revenues from domestic programs grew six percent sequentially, while the international revenues grew at an impressive 68 percent from quarter-to-quarter.

Our federal government and central bank activities reported solid performances. Commercial solutions continued to lag. Second quarter total revenues of 20.8 million significantly exceeded the range of guidance for at our last earnings release call of 19 million to 20 million.

Gross margins for the quarter are 42 percent. While substantially in line with the 43 percent reported last quarter, and as expected, was below the 50 percent margin reported in the first quarter of last year due to a change in the product mix, where a higher percentage of our current revenues come from, and government sectors, which tend to have lower gross margins than in licensing and commercial solutions.

Operating expenses for the second quarter of 2002 were 12.4 million, up 153,000, or one percent from last quarter. Operating expenses include amortization of intangibles and certain expenses related to the transition of that e-systems business.

Also, during the second quarter, we continue to consolidate and streamline operations. We made a decision during the quarter to close our Tulsa facility, and consolidate continuing operations based in Tulsa facility to Ft. Wayne, Indiana. You will recall the Ft. Wayne operation was acquired in December of last year as a result of our acquisition of the ID Systems from Polaroid. The consolidation resulted in four employees of Tulsa being relocated to Ft. Wayne, and 16 employees being terminated.

In other efforts to improve operating efficiency, we reduced our workforce in other locations by 14, for our total reduction in workforce of 30, or approximately six percent of our workforce. This includes contract workers. These changes led to a gross, non-recurring restructuring charge of 575,000 in the second quarter.

During the quarter, we also recorded non-cash expenses in the amount of approximately half a million dollars, related to deferred employee stock option compensation charges, which is in line with the charges taken in previous quarters.

Other income net of approximately 320,000 was in line with our expectations, but substantially down from the prior year due to lower interest rates on lower cash balances.

The activities discussed resulted in a net loss of 3.4 million in the second quarter of 2002, 770,000 better than the 4.2 million loss reported last quarter. Net loss per share for the quarter was 20 cents, including gross restructuring charges of $575,000, based on 17.29 million weighted average shares. Net loss per share, excluding the restructuring charges would have been 16 cents, in line with the first call consensus and within our guidance 15 cents to 17 cents lost given on our last quarter conference call.

to the balance sheet, our cash, cash equivalent, and short-term investment balances were 52.1 million, down approximately 5.4 million from last quarter, due to cash used for working capital in our Digital Watermarking business, increase in capital expenditure related to ID Systems infrastructure build out, and cash used for payment of professional fees in connection with our acquisition of ID Systems business from Polaroid.

On a standalone basis, ID Systems generated positive cash flow from operations in the second quarter.

Accounts receivable increased 800,000 from 20 million in the last quarter to 20.8 million in the second quarter on increased revenues. The second quarter days sales outstanding, or DSO, was approximately 87 days.

During the quarter, we made significant progress obtaining reassignment of drivers' license contracts to Digimarc from Polaroid. As of this reporting date, we have successfully transferred all major state government contracts. The process of obtaining reassignment of contracts to Digimarc is a one-time acquisition-related activity. With the completion of reassignment of major state government contracts, we expect our third quarter DSO to improve to about 70 days.

Inventory net results were at 6.1 million, essentially unchanged from the 6.2 million recorded last quarter. This inventory represents materials to be used in manufacturing ID cards and consumable supplies sold to our customers.

Long-term assets increased from 47.7 million in the last quarter to 49.3 million, primarily as a result of program asset additions and IT infrastructure build-out in ID Systems. This was offset by depreciation of assets already in use.

In summary, in the second quarter we generated record revenues and we continued to focus on our financial goals by improving operating efficiencies, and responsibly managing expenses through streamlining and consolidation of operations.

Without the restructuring charges, our spending was substantially in line with our expectations, and the first call estimates of 16 cents loss for the quarter. Our balance sheet continues to be -- continues to remain strong with 52.1 million in cash, cash equivalents and short-term investments.

Now, I will turn the discussion back over to Bruce.

Thanks, E.K.

Digimarc ID Systems continued to perform well in the second quarter. Demand for ID System Solutions is strong. We are engaged in a very high level of bid activity that -- assuming we execute well -- should bode well for the long-term growth and profitability of this line of the business.

We entered into a number of new contracts during the quarter, including contracts for driver's license systems in Nebraska and Maine, of certain components for the Hong Kong Smart Identity Card Project, and provision of Costa Rica's new Digital ID Card Program for Minors.

Yesterday, we announced that the state of Florida has given notice of its intent to award its digital driver's license contract to Digimarc ID Systems. Under the terms of the bid and intent to award, the term of the contract would run approximately five years from the date of implementation, with an option to extend another five years.

It's important to appreciate that this is a notice of intent to award only. The final award and contract are subject to a number of contingencies including, among others, the availability of protest allowed under state law to challenge the intent to award - which we understand the incumbent supplier intends to take advantage of - resolution of such protest in our favor, and the negotiation and execution of the details and final contract.

There are other issues that could affect the successful closing and implementation of the contract, including approval of funding by the Florida Legislature, posting of an appropriate bond, satisfactory performance, and similar contingencies.

With all this said, we are very excited about this preliminary indication of a major competitive win. Florida is the fourth largest state in annual driver's license issuance volume, issuing more than four million drivers' licenses each year. The state has estimated 70 million licenses will be issued over the proposed ten-year term of the contract.

In government programs, work continued on our long-term project with the central banks. While business in the defense and intelligence sectors grew, times of broader interest in our technology offerings among prospective customers in these areas.

In the licensing area, we considered our first audio watermarking agreement, and established a non-exclusive patent license with Activated Content, who is providing forensic tracking solutions for pre-release music.

We also spent considerable time on government and industry standards matters, as digital watermarking has become a hot policy topic among policymakers in Washington and overseas.

Recognition is spreading regarding the unique role that watermarking can play in protecting entertainment video from piracy via what's become known as the analog hole.

Those who are interested can find more detail concerning the policy debate in the presentation entitled, "Facts On Digital Watermarking For Video Copy Protection In The Analog Hole" posted on our web site.

The DVDCCA announced in May that it again was delaying its decision on consensus watermark. The new target date is August 1. at the time of the announcement, that it is not expected that the board will move the date again. That date is fast approaching.

Our intellectual property assets increased significantly during the quarter -- 11 new patents issued bringing our total to 65. We also had our first European patent issued. Innovations in these patents included basic technology improvements in a variety of watermarking-based applications.

We filed more than 40 applications during the quarter, bringing our total pending patents to over 320. We also acquired video watermarking technology from Telstra, a diversified Australian communication services and multimedia products company, including pending U.S. and Australian patent applications.

In May, I was elected Chairman, succeeding who served in the post for the past six years. Digimarc is very fortunate to have benefited from Phillip's strong investor support, guidance and loyalty. He has been and continues to be a huge supporter of our business, and we are looking forward to his continuing contributions as a Director and member of several key committees of the Board. I am honored to follow in his footsteps as Chairman, and I am committed to leading Digimarc on to continuing growth and prosperity.

With 13 percent sequential growth in the second quarter, and an improving bottom line -- despite difficulties in the global economy -- we continue to make progress toward our previously announced goal of profitability by the end of this year.

Our growth is fueled by continuing demand for personal identity systems and solutions for enhanced protection of copyrights, and by expansion of our services to the U.S. and other national government customers. This continuing growth coupled with rigorous financial and operational discipline should permit us to accomplish our financial objectives.

Our business model is working. The substantial majority of our revenues are from customers and applications that are not directly correlated with economic cycles -- primarily commissions to drivers' licenses and other identity systems pursuant to existing contracts, and from our continuing work with central banks and the anti-counterfeiting system.

We believe the company will continue to experience growth in other security market opportunities, such as national defense, where despite the difficult economy, because of about national security and terrorism.

When the economy improves, the engines of growth will continue the pace, while it should become easier to gain trial on adoption of our enterprise solutions.

will now provide you with details of our guidance for Q3 and the full year of 2002. ?

Based on the activities Bruce discussed in our ID Systems business, and opportunities with federal government and central banks, we estimate that revenues for the third quarter will be in the range of 22 million to 23 million, with a loss per share of four cents to six cents.

We anticipate 2002 revenues to be in the range of 82 million to 85 million, and expect the net loss per share to be in the range of 43 cents to 48 cents. We continue to expect to achieve modest profitability in the fourth quarter.

Before we conclude, I would like to give you an update on our coming investor relations activities in the third quarter of 2002. On August 12th, we'll be presenting at Pacific Crest Technology Forum in Vail Colorado at the Sonnenalp Resort at 10am. On September fourth, we'll be presenting at Wells Fargo van Kasper, the Class of 2002 Conference in San Francisco at the Fairmont Hotel at 11am. On September 14th, we'll be presenting at the Northwest Investor Conference in Portland, Oregon at the Convention Center.

As part of our Investor Relations Program during the week of August 5th, we'll be in Boston, New York City, and Connecticut meeting with existing and prospective institutional investors.

This concludes our presentation. We now welcome your questions.

At this time, I would like to remind everyone if you would like to ask a question, please press star, then the number one on your telephone keypad.

We'll pause for just a moment to compile the Q&A roster.

Your first question comes from Jennifer Jordan, Wells Fargo Securities.

Good afternoon, gentlemen. Good job, here, on meeting expectations this time.

Just a couple of quick questions. First, if you could give us a sense of what other contracts are coming up to bid in the ID Systems business, and where we should be looking for that. And second, if there's been any -- as you approach the August 1st deadline for the DVDCCA -- if there's been any acceleration in activity or discussion that might be worth looking at.

With respect to the first question, Jennifer, there are five state driver's license contracts open for bid at this point: Oregon, Vermont, Florida, Georgia, and Oklahoma. We expect there'll somewhere between two and five more that will open up during the remainder of the year.

Um hmm.

All of those are subject to the vagaries of state decision making. So, there are five now, and maybe another -- as many as five more by yearend.

Is that just a typical cycle of these coming up for renewal at the end of their five-year terms, or are people reviewing their driver's license because of the current security concerns? And, also -- a follow-on -- which of these states are you the incumbent in?

The answer to the first question is that I think there's a heightened pace of activity here by the states because of increased concern about security -- and also, increased concerned about efficiency. There's some pressure on budgets across all the government entities.

With respect to incumbents, I believe that all but Florida are our states.

OK.

I'm standing up -- the problem I had -- I'm cross checking that, so, if I'm wrong, we'll get back to you.

OK.

With respect to the DVDCCA, you know, those guys are a little hard to handicap. They said -- as I noted in the prepared remarks -- that they were not going to extend again. I don't know how to interpret it other than the plain meaning of the terms.

OK.

But their track record's not very good, so ...

No.

We're standing by to see what they do by month end. I suspect they'll probably wait till the last minute if they're gonna do something.

OK. Great. Thank you.

Your next question comes from Steve Lidberg from PacificCrest.

Good afternoon.

The first question regards the restructuring activity. When was that wrapped up during the quarter, and what type of run-rate are we looking right now from an operating expense level?

Steve, the activities were wrapped up in June. We have not fully, for example, is like Tulsa transition to Ft. Wayne. That's not completely done yet. So, that will actually be happening in Q3.

In terms of savings from such activities, we'll see savings going forward in the couple of million dollars range on an annualized basis.

So, we could potentially see a quarterly run-rate closer to 11.5 or $11 million from an operating expense standpoint?

Yeah. We don't, you know, give guidance at that precise -- on that kind of line-item basis. But, that seems about reasonable.

in highlight of the up-tick and, I guess, pipeline activity -- for the lack of a better phrase -- with the ID Systems business -- government business. I was wondering if you could provide any more color there. Is the activity spread geographically from an international domestic business? What do some of the timelines that looking at there?

It's across the board. In the U.S. driver's license area -- if we end up with 10 states out to bid, that's a pretty heavy load for a year. Virtually all of the customers are interested in talking about upgrades for security. And, as we've previously announced, we'll be looking for an opportunity to introduce digital watermarking into this area as soon as we're ready to deliver it.

And so, domestically, it's very vigorous. Internationally, there is always a lot of opportunity. There seems to be a very substantial amount of credible opportunity now, where it requires substantial resources to pursue, and if we win, we'll provide substantial long-term value for the shareholders. So, it's looking good across the board, is the short answer.

As far as detail goes -- we're dealing with detail on the domestic side. On the international side we tend not to provide a lot of detail because the environment there can be quite complicated, and we feel it's more appropriate for us to talk to you about business that we obtain, rather than business that we're pursuing.

And last question on the watermarking side of things: the sequential up-tick in revenue -- was that largely defense and intelligence related? And, what does the pipeline look there, from the commercial activity? Is there any hope at starting to produce some more -- some greater sequential increases as we move throughout the year?

With respect to the sequential growth, it's coming from government programs, and we're restricted in the level of detail we can provide in that area. But, in general, business is quite good there.

With respect to what we referred to as commercial solutions -- which is ImageBridge and MediaBridge today -- it's a real tough environment out there for marketing spending. I see -- as I look at other companies involved in trying to be suppliers in that environment, they're all struggling. So, everyone's still in budget-cut mode. At some point -- maybe a couple of 500-point days on the Dow, and people will get to spending. But, as of the end of last quarter, they're still cocooning, and it's difficult to get them to try new things, never mind buy old things.

So, that's the problem that we're having. We're not able to generate any significant business in those areas in the current environment.

Now, with respect to the licensing area, if the DVDCCA makes a positive judgment in the selection of the Consensus Watermark, I believe that could be a watershed event for licensing, where people who have been somewhat skeptical about watermarking will now get more serious. And, it could have a nice halo effect on other parts of the business, including the commercial solutions area. So, I'm keeping my fingers crossed.

Great. Thank you.

You next question comes from Murray Arenson with Morgan Keegan.

Thanks. Good afternoon.

Couple of questions first on the expense side, which might be related. One: I wondered if there's further consolidation or restructuring that you see ahead, or if we're done with that. And secondly, I noticed in your revisions to guidance, you up-ticked on the revenue line and down-ticked on the bottom line. I wondered if you could provide some color on that.

Murray, as far as the restructuring charges, we don't anticipate any further restructuring charges. We considered all that in the Q2 at the time we made the decision to relocate.

In the margins going forward, they are subject to the product mix, so we'd like to be on the conservative side, so we are anticipating gross margins close to around -- you know, we've been running in the low 40s. Our model right now is around 40 percent or so. It may be high 30s to 40 percent type of number. So, that then will have an impact on the EPS. So, we are being conservative until we know what kind of add-on revenues, and international sales -- you know, those margins tend to fluctuate, so we tend to be on the conservative side.

OK. First, you mentioned in your remarks some of the activity in Washington regarding the analog hole, and I just wondered if you could give us some insight into how you work your end of things, since things in Washington often seem so disjointed and slow to move.

We've been very active in educating policymakers about digital watermarking and its role in the general protection of entertainment copyrights. That educational process has included educating the senators and representatives themselves, their staffs, and the senior staffs of the relevant agencies.

So, we've been actually very active in Washington. I was in Washington several times during the quarter. And, just anecdotally, I was speaking on a panel at a digital rights get-together earlier this week, and spontaneously, everybody on the panel started talking about digital watermarking and protection of entertainment content, and dealing with the analog hole. And we also noted in our presentation on the web that the CEOs of major entertainment and technology companies are all talking about digital watermarking.

So, they're getting -- the policymakers are getting an earful from lots of different people, and that's why it's been important for us to go in and provide our insights on the technology and its role directly to the policymakers.

Whether the policymakers have the direct influence or not in the form of some kind of legislation or regulation, is perhaps less important than the way in which they exercise their influence with the relevant industries to encourage adoption. So, you could view it, at a minimum, as a marketing activity and perhaps as a precursor to direct policy involvement by the government.

Gotcha. Lastly, I wondered if you could give me a little more detail. I noticed this quarter you reclassified the line-items on the revenue side, basically to watermarking and ID Systems, and we've kind of gone back and forth over recent quarters between license subscription and service, and those sort of items. Maybe you could just delineate further what got moved into where, and how I should be looking at that.

The way we are reported in this quarter is consistent with how we have reported in the last quarter, or since the acquisition of ID Systems business. We don't break out the digital watermarking revenues into further classifications at this point, and we don't plan to do that going forward as well.

In fact, Murray, you make -- you should anticipate that as we begin to introduce watermarking into ID Systems, and as we begin to license ID Systems' non-watermarking technologies, the distinction that we're making here may no longer be appropriate at some point in the future.

Gotcha. OK. Great. Thank you.

At this time there are no further questions.

OK. Well, thank you very much, everyone, for joining our conference on a busy day. If you have any further questions, please let us know.

Thanks a lot. Bye bye.

Thank you for participating in today's conference call. You may now disconnect.