Digimarc Corp (DMRC) 2003 Q1 法說會逐字稿

Ladies and gentlemen, welcome to your Digimarc Corporation first quarter 2003 earnings release conference call. My name is Andrea, and I will be your coordinator today.

At this time, your lines are in listen-only mode, with a question and answer session to follow. Should you require assistance while on this call please key star, zero on your touch-tone phone and an operator will be happy to assist you. As a reminder, this call is being recorded for replay purposes.

And now, over to the host of today’s conference call, Bruce Davis. Please proceed.

I’d like to welcome everyone to today’s conference call. With me is EK Ranjit, our CFO, and Paul Gifford, our President and Chief Operating Officer.

We released first quarter financial results today. The purpose of the conference call is to provide you with a summary of the financial results, an update on significant business developments during the quarter, and our financial guidance for Q2 ’03 and the full year 2003.

We’ll respond to your questions at the end of the call. EK will begin by reviewing and commenting on the financial information contained in our press release. EK.

Thank you, Bruce.

Before we start our discussion on the financial 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 for future results, growth areas, revenues, and EPS are based on information currently available to us. They are subject to change and 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 March 31, 2003.

A replay of this conference call will be available for two weeks through a webcast located on our Investor Relations web site at www.digimarc.com or www.streetevents.com. Thereafter the webcast will be available at the Investor Section of our web site under the subcategory ‘archives.’

Now turning our discussion to the first quarter 2003 financial results I am pleased to report that Q1 was our first profitable quarter as a public company. Revenues and EPS were within the range of guidance we gave on our last conference call. EPS was one cent better than FirstCall consensus, gross margins improved primarily as a result of prudent cost management, and DSOs continued to improve.

As to the details of the income statement revenues for the first quarter of 2003 was 21.7m, up 3.2m or 18 percent compared with the first quarter of 2002, and up $900,000 or four percent from the previous quarter. The increase of revenues from last year is due to strong performance in ID Systems, the growth in domestic program revenues which accounted for 15.1m of the 19.3m in ID Systems’ revenues were driven by [literally] high card volume issuance, issuance volumes compared to previous quarter volume levels, and revenues from new programs. Add on revenues were limited by tight State budgets. International sales continued to be strong, and accounted for the remaining 4.2m of ID Systems’ revenues in the first quarter.

In other areas of our business licensing performed as expected. Likewise, in watermarking solutions Federal Government and banking activities performed per our forecast, which was slightly lower than the fourth quarter due to seasonality of the work being performed. Commercial solutions revenues continue to lag except for major [bridge] sales where we have been showing steady growth.

First quarter total revenues of 21.7m were within the range of guidance provided at our last earnings release call of 21.5m to 22.5m.

Gross margin for the quarter improved to 45 percent as anticipated. Up from 43 percent reported in the prior quarter due to a favorable revenue mix and our continued focus on reducing costs.

Operating expenses for the first quarter of 2003 were 9.8m, up 500,000 or six percent from the prior quarter, but down 2.5m or 20 percent from the same period of 2002. The sequential increase in operating expenses was expected. The 20 percent reduction from the first quarter 2002 was a result of our continuing effort to responsibly manage costs by consolidating and streamlining operations to maximize our efficiencies.

During the quarter we reported non-cash expenses of approximately 450,000 related to deferred employee stock options, compensation charges which is in line with the charges taken in the previous quarters. This P&L charge will be fully amortized by the end of this year as [local] quarterly amounts as we progress through the year.

Other income net of approximately 116,000 was in line with our expectations, and substantially down from the prior year due to lower interest rates on lower cash balances.

Provision for income taxes of 50,000 relates to taxes we estimate we will pay for profitable operations in foreign countries. No provision has been made for U.S. taxes due to loss carry forwards.

The activities discussed above resulted in net income of 29,000 for the first quarter of 2003, which is 254,000 better than the 225,000 loss reported last quarter. Diluted EPS for the quarter was breakeven based on 18.35m weighted average shares, which is at the mid point of the average we gave at our last conference call and a penny better than FirstCall consensus.

With regard to the balance sheet we had positive cash flow from operations of approximately $1m. Our cash, cash equivalent, and short-term investment balances were 50.3m, down 2.9m from 53.2m reported last quarter. The 2.9m reduction in cash was a result of 3.2m of capital spending associated with new ID Systems’ programs in the first quarter and the payment of 700,000 of annual insurance premiums made during the quarter offset by the positive cash flow from operations.

Accounts receivable increased by 61,000 to 15.2m. First quarter DSOs were approximately 62 days, an improvement over the 68 days for the fourth quarter of 2002.

Inventory net of reserves was 5.7m, up $600,000 from the 5.1m reported last quarter. During the quarter we increased our inventory balances to meet anticipated rollout schedules for new programs coming into production and to meet international demands for consumables orders. Inventory includes materials to be used in manufacturing ID cards and consumable supplies that we sell to our customers.

Long-term assets increased from 56m in the last quarter to 57.3m, primarily as a result of program asset additions and IT infrastructure build-out in ID Systems net of depreciation of assets already in use.

Deferred revenue was 3.4m, down 300,000 from the 3.7m reported last quarter. This decrease came from the regular amortization of the balance into revenue, offset by additions related to projects that we performed for our customers for which revenue was deferred.

In summary, we generated a profit for the first time as a public company, both revenues and EPS within the range of guidance we gave on our last conference call, EPS was one cent better than FirstCall consensus, gross margins improved primarily as a result of prudent cost management, and DSO continued to improve.

Now I will turn the discussion back over to Bruce.

Thank you, EK.

I’ll briefly review Q1 operations and provide an update on our plans and expectations for the remainder of the year. EK will then provide detailed financial guidance for Q2 and an update for the full year.

We were very pleased to have achieved our first profitable quarter as a public company, culminating five consecutive quarters of improved financial performance. ID Systems led the way with improved financial performance and continuing progress in cost effectiveness and general competitiveness.

The State of New Jersey announced yesterday that it has awarded a three-year $4.5m contract for a major overhaul of its drivers license issuance system to Digimarc, and that it will be the first State to employ digital watermarking to enhance the security of its driver licenses.

With the adoption of digital watermarking by New Jersey for a state-of-the-art license program we are beginning deployment in a key strategic initiative to propagate digital watermarking benefits first in our driver license customer base, and later through licensing in a wide range of secure personal identification documents.

Digital watermarking provides a secure covert machine readable means to deter counterfeiting and forgery that is compatible with existing card designs. It enables cross-jurisdictional objective authentication without changing existing driver license card design, giving issuing authorities control of access to data, and a means for authentication and forensic analysis.

We had some good news in biometrics, too. The facial recognition technology that we use for driver license applications in North America was a top performer in the recent facial recognition vendor test in 2002 sponsored by [Missed] [ph]. Basic technology developed by [Identics Incorporated] [ph], the world’s leading multi-biometrics security technology company, ranked among the top three products in all three applications tested by Missed. The agency evaluated 14 facial recognition products and an analysis of 121,000 images of 37,000 people in three large-scale, real world application areas: verification, identification, and watch list recognition performance.

And in watermarking solutions work continued to pay us with the Central Bank, and we continued market development initiatives in security for ID documents and packaging. Our intellectual property assets continued to increase. We now have 95 issued patents containing more than 2,000 claims, with more than 350 applications pending. Starting the infringement lawsuit that we filed against Spectrum Corporation during the fourth quarter of 2002, [inaudible] that certain uses of the watermarking for document security infringe our patents. The litigation is in its early stages, and we are engaged in negotiations with the defendant company.

The DVD CCA process for selecting a watermark solution [inaudible] play control are continuing. The DVD CCA has requested another extension until August. We are supporting the DVD CCA process, as well as working on alternative paths to adoption, including private company negotiations and policy initiatives.

We further strengthened our Board of Directors during the quarter with the election of Jim Richardson. Jim is a 25-year veteran of the high tech sector, and has served as Chief Financial and Administrative Officer for five global technology companies, ranging in size from 20m to 300m in revenues. His most recent executive post was at [Web Trends] [ph], now a Division of [Net IQ] [ph]. Jim is a seasoned financial executive with an impressive track record of helping several public technology companies successfully navigate the financial, regulatory, and capital formation requirements attendant to the kind of high growth we are experiencing.

In electing Jim to the Digimarc Board we are being responsive to the heightened interest of regulators in the investment community and assuring that the Board has the requisite expertise to oversee the financial affairs of our company on behalf of our shareholders. Jim will serve as the Chair of the Audit Committee. We are also looking forward to the benefits of Jim’s perspectives in rounding out the excellent group of advisors already serving on the Board.

We continue to anticipate a profitable year on higher revenues, with the best prospects for growth in ID Systems and in watermarking solutions for financial institutions. As I mentioned last quarter, our 2003 plan is conservative. We intend to capitalize on investments and secure personal identification, our Central Bank relationships, [new] investments and developing the market for defense intelligence solutions, product development investments and its [Galiber] [ph] security class watermarking for authentication and tracking, and increasing licensing revenues from our global leadership in digital watermarking technology.

We expect that growth in ID Systems’ revenues will be driven by [increased] volumes and continuing demand for improvements to security and interoperability of systems for issuing drivers licenses. The ability to fund such improvements may be limited by the budgetary concerns of many States. We intend to compete effectively and gain share through quality of service, innovation, and improving cost effectiveness. Our digital watermarking and biometrics offerings will enhance our competitive differentiation and provide improved important new security benefits to our customers.

Our focus on watermarking solutions is on extending our successful efforts with Central Bank and counterfeit deterrents to employer markets, and the authentication of tracking solutions for use in travel and other secure personal identification documents.

In defense and intelligence we will work to increase the size and duration of contracts, build relationships with established suppliers, and otherwise lay the foundation for what we hope will become multi-year licensing and service agreements akin to our successful long-term relationship with the Central Bank.

In commercial solutions the recent growth in image bridge revenues is expected to continue. Use of digital watermarking for tracking and monitoring entertainment and news that began in 2002 is growing. However, migration to other applications is being slowed by a lack of consensus among leading companies in the motion picture, music, consumer electronics, and computer industries. And associated debates among policy makers in Washington about how to best manage copyrights for entertainment content in the increasingly digital processing distribution and consumption environments.

Although we remain optimistic that our technology is integral to the management of such content implementation may not occur for some time given the lack of consensus about basic policies and architectures. We will continue to press the agenda for use of digital watermarking, and other audio and video applications, including copy prevention and play control. However, we are mindful that Digimarc is a rather small voice in a debate among global industry and political leaders.

Our strategic blend of products, services, and licensing, the government and enterprise customers, and careful expense management will foster growth in revenues and earnings despite the difficult economic environment.

We remain committed to increasing shareholder value through diligent entrepreneurial efforts coupled with rigorous financial and operational discipline.

EK will now provide you with details of our guidance for Q2 and for the full year of 2003.

The following statements concerning projections of future financial performance are based on current expectations. These statements are forward-looking subject to risks and uncertainties, and actual results may differ materially. These statements do not include the potential impact of an investment outside the ordinary course of business, or mergers and acquisitions. Continuing uncertainty in global economic conditions make it particularly difficult to predict product demand and other related matters.

We estimate that the second quarter 2003 revenues will be in the range of $21.2m to $22m. Revenues are highly dependent on a number of factors including but not limited to general economic conditions, our ability to predict card issuance volumes from existing State driver license programs, our ability to secure new contracts, the political and competitive environment in countries in which we seek business, changes in customer order or usage patterns, and changes in the demand for our products and services.

We expect gross margins to be in the range of 45 to 47 percent in the second quarter, gross profit margin may be higher or lower than expected due to a number of factors, including but not limited to competitive pricing actions, changes in estimated product costs, changes in our estimated product mix, and changes in revenue levels.

We expect combined operating expenses for R&D and SG&A of approximately 9.1m to 9.7m in the second quarter of 2003. Operating expenses particularly certain marketing and compensation related expenses vary depending on the level of revenue and profit.

We expect non-cash charges related to the amortization of deferred stock compensation to be approximately 450,000 in the second quarter. These charges relate to options granted to employees in 1999 prior to the company’s initial public offering. The last of these charges will be recorded by the company in the fourth quarter of 2003.

We expect to record a provision for income taxes of $50,000 that relates to taxes payable in foreign locations. Income taxes for domestic operations are expected to be zero due to net operating loss carry forward from prior periods.

We expect interest income of approximately $105,000 in the second quarter of 2003, assuming no material change in average cash balances or interest rates from the prior quarter. Based on the above assumptions we estimate fully diluted EPS to be in the range of breakeven to a profit of two cents for the second quarter of 2003. For the full year 2003 we remain comfortable with the FirstCall consensus of 21 cents diluted EPS.

Before we conclude, I would like to give you an update on upcoming Investor Relations’ activities in the second quarter of 2003. On Tuesday, May 6th, we will be presenting at the JP Morgan Technology and Telecom Conference at the Westin St. Francis in San Francisco at 10:00 a.m. On Thursday, May 22nd, we will be hosting our Annual Shareholders Meeting at the Meridian Hotel in Boston, starting at 11:30 a.m. During the month of May we will be meeting with current and prospective investors in San Francisco, Seattle, and Denver.

This concludes our presentation. We now welcome your questions.

Ladies and gentlemen, this is your question and answer session. If you would like to ask a question please key star, one on your touch-tone phone, and star, two if you need to withdraw your question. Please hold for the first question.

Bill Frerichs, please proceed. Excuse me, sir. Can you please proceed with your question?

Okay. Congratulations, Bruce and EK, on a profitable quarter. And very nice publicity in ‘The New York Times’ this morning. I was curious as to whether the New Jersey license had better unit pricing given the enhanced security features?

Bill, the way in which we are delivering watermarking benefits to the drivers license segment is to include it in the portfolio of security features that we provide, and to have it be a unique benefit from Digimarc. And so neither watermarking nor any of the other security features are separately priced. They’re included in the response to the bid, and then States vary somewhat in how they like to see the response to the bid. Most usual is price per card.

Okay, but it’s a reason to go with you versus a competitor, correct?

That’s right. It provides competitive differentiation. And as the number of drivers licenses that are watermarked increases we believe that there will be a general demand for a variety of applications from various sectors for use of the watermarking technology, including retail, airport security, law enforcement, and so forth.

Okay, and is there, given the fact that it has the watermark is there a reader technology somewhere in the information chain on the end, the authorities in New Jersey?

Yes, we’ll be delivering readers to the authorities there. The readers, as you know, are basically standard imaging tools, cameras, that have our proprietary software in them.

Okay, great. Thanks very much.

Okay.

Your next question comes from [Damon Marty] [ph].

Yes, good afternoon. Just a quick question regarding the installation time in Florida. Are you at risk of [us] getting some extension to make-up that time difference, the installation? You know, how long it’s going to take you to get installed there?

The timetable for Florida has been pretty steady for quite some time now. And things seem to be going fine. Until the contract is finalized and the implementation begins all of the risks that we have previously identified exist, but we don’t have any indications of any problems.

So at what point in time do you estimate that the installation will be complete?

Well, we believe that we should be able to get the contract finalized within the next couple of months and begin installation in the Fall. And that has been the scheduled since late last year.

Okay, thank you.

Your next question comes from Steve Lidberg.

Yeah, EK, with regards to the capital expenditures of $3.2m how much of that amount was due to system build-outs at your State customers? And then, with regards to the adoption of watermarking within the – for drivers licenses what are the prospects for additional States [owning] certain things? Thanks.

Okay. In regard to the capital expenditures in Q1 they are all related to State programs. There are about four different new programs coming on-board, and so the capital expenditure relates to those.

Regarding the adoption of watermarking in other State drivers license programs we are working with a number of States right now. So, you know, stay-tuned. We will have more announcements as we are ready to do that.

(Caller Instructions.)

Your next question comes from [Andrew Weiner] [ph].

Hi, good afternoon, guys.

Hi, Andrew.

Hi. I wanted to either see if you guys are, you know, confirming or not. I believe on the last, on the year-end quarterly call when you gave your guidance for fiscal ’03 that you were anticipating watermarking revenues of somewhere in the $13m to $15m level this year. And I believe you said basically that the watermarking revenues were to plan this first quarter. So does that mean you’re still comfortable with $13m to $15m for the year?

Andrew, we’ve reiterated our comfort with the profit target that FirstCall has. And on the revenue side of things it’s a little hard to tell this early in the year whether any changes are necessary. At this point in time we’re sticking with our guidance.

Okay. And on this call you gave as the two sort of drivers of growth, ID Systems and watermarking for financial institutions are the best opportunities. Can you elaborate a little bit on, I mean is that to imply an extension beyond the government contracts resulting in revenues?

Yes, if you’re talking about watermarking solutions as the last part of that question?

Yes, I am sorry, I was talking specifically about the watermarking.

Yeah, as we mentioned at the start of the year we think in 2003 we’re going to get some significant evidence of the strategic benefits of the Central Bank relationship, and so that’s what we’re alluding to there. We believe that we’ll be able to grow the business outside of the project that we have had with them for deterring the counterfeiting of bank notes using personal computers. And so, that’s a scenario where we feel quite confident that we’re going to generate new business.

We’re potentially slowed down a bit on watermarking adoption in the entertainment field by the big debates that are going on among all the vested interests. There seems to be a substantial sentiment that watermarking is needed, but there are so many, I guess you might call them substantial interests implicated that they’ve been chasing their tail for a year or more now. And we’re getting challenged I think to try to figure out exactly when and how it will get wrapped up. I’ve always been humbled by the process, but it continues to baffle me. They seem to have to resolve larger issues for watermarking to be carried along with.

And primarily I believe that the consumer electronics and computer industries need to develop some kind of plan for the digital distribution of entertainment product which has an economic model. You know, the only existing digital distribution does not have an economic model. It’s piracy. And that certainly is not sustainable.

And so watermarking I think is a key technology to the development of the distribution channel for digital content that has an economic model supporting it. And so we believe we’re going to get a big boost when it happens. The trouble is it keeps getting pushed out.

Getting back to your comment about seeing significant evidence of a strategic relationship with Central Bank with other financial institutions, I guess, are expanding beyond the Central Bank. I realize what you’re doing is confidential, and so it’s hard to say. But can you elaborate in any sense as to by that do we mean we’re going to have licensed partners who are then going to develop applications? Or will this literally be royalty, you know, per unit bearing relationships where there’ll be deployment this year, where we’ve helped them develop, you know, applications already and it’s just, you know, top secret at this point?

It’s a little hard to say for the reasons that you’ve described, but also because we’re early in the process. We are having conversations with potential partners about certain solutions. And so it may look a little different than the historical model with the Central Bank where we’re the supplier of the basic technology and the primary support for the system. We obviously have lots of partners in the Central Bank relationship in the computer industry we don’t identify.

But in the expansion of that business we’re looking for the leverage of existing suppliers in order to give us opportunities for licensing and high margin revenue. The Central Bank relationship has been a very good and profitable relationship, but it involves a substantial commitment of resources from our company. So if we can find existing suppliers who would like to license our technology to provide new solutions or enhance their existing solutions that would be excellent. And so that’s part of our effort right now is to see how much we’ll do ourselves and how much partners may do.

And I guess the last question I had was, you know, I was hoping you could comment on it sounded similar to what we do – there was an article in ‘The New York Times’ I guess a couple of weeks back on a group called Cryptography Research. And you know, ‘The Times’ article gave them a big plug on how they were distributing their so-called self-protecting digital content.

Right.

You know, it describes it as embedding a digital mark which, you know, strikes me as very similar.

Yes.

To what we do. Can you sort of comment on whether this is competitive, complementary, whether they potentially are infringing on our patents in some way?

I understand the firm that was quoted there is a consulting firm. And so they were describing an architecture that they thought would work better than the one that has been contemplated by the [CPTWG] [ph]. We were very pleased to see their paper and the publicity that it got because our patents cover that kind of implementation, as well.

And so we would be delighted if someone came-up with a creative way to get a stalemate unstuck in the entertainment industry. So if that approach is easier to implement than the one that has been worked on for the past five years then we think that would be terrific. But we don’t view them as competitive at all, we view them hopefully as a facilitator of some moving forward.

Okay, I must have confused proposal or consulting versus actual?

Yeah, the fact that anyone would propose a system architecture that they can provide some resources to help implement it doesn’t mean they own everything they propose. I mean these guys are consultants, and they probably have some value to offer to the various constituents involved in the process. But it doesn’t mean that they own watermarking technology per se. I don’t think they do.

Thank you for clearing that up.

Yes.

The next question comes from Bill Frerichs.

Bruce and EK, given the breakeven or black zeroes, I guess, profit that you had this quarter, and the guidance of zero to two cents for Q2, and the comfort level with the full year EPS you’re clearly expecting a strong finish. And I was wondering how you might see that finish distributed between Q3 and Q4? And if you could point to any specific events that are going to provide an impulse of revenue to create that strong finish?

We intend to deliver the profit goals that have been stated through revenue growth and cost management. Bill, I don’t think it would be appropriate to provide further detail on the forecast at this point in time, because as you might imagine there are lots of pluses and minuses that sum-up to our expectations.

We just believe based on our assessment on the circumstances as we see them that we should be able to meet our goals.

There’s not some big deal that you’re seeing that is just bound to get switched on?

Well, there are a lot of big deals that may happen.

Okay.

And yet I am not going to describe any of them specifically in advance because we don’t know that they will happen.

Bill, if I may just add to that. If you – our customer concentration is we don’t have any customer over 10 percent, and that’s been the case for the last five quarters. And so there isn’t any one program that’s going to drive the growth, you know, going forward. It’s going to be a number of different things. We’ve got new programs coming on-board from ID Systems. We’ve got a number of things on the watermarking side that we previously referred to. And so those are the things that will drive the growth.

Okay. And one last housekeeping question on modeling. How much of the ID Systems’ revenue recognized in this quarter rolled up from deferred revenue last quarter?

Well, I don’t have a break-out specifically for ID Systems. Our net reduction in deferred revenue was about $300,000 for the quarter, quarter-to-quarter. ID Systems, the bulk of those revenues in deferred revenues is licensing, watermarking related revenues. ID Systems is a much smaller piece.

Well, you had a sequential decline in deferred. How much went into deferred?

We don’t break that out, Bill.

Okay, thanks.

(Caller Instructions.)

Your next question comes from Andrew Weiner.

Hi, guys. I just, I guess, I wanted to follow-up. You know, I think on the year-end call you cited New Jersey as one of the sort of key contracts that was up for renewal or for bid. Can you sort of give us an update on what other States or jurisdictions, if they’re international, are currently up for bid or expected to be up for bid in the next sort of six months? And maybe what the timeline looks like for some of these?

Yeah, well, we can, Andrew, only discuss those that the information is in the public domain. And there are two State contracts that we are in the process of bidding right now. One is Indiana, and the other one is Alabama. Well, obviously, we have more than those two contracts that we have bids that we are working on, but those are the only ones I can specifically, you know, talk about.

Okay. And, I guess, another question on the ID side. Is there any opportunity at all, the focus has primarily been on, you know, drivers license or some sort of government identification card. Is there any opportunity in the corporate sector at all? Or are you still trying to really get your hands around sort of the public sector opportunity before you intend to address some of the other opportunities?

Our strength, Andrew, is in the multi-million user systems, and so we believe that there are adjacent market opportunities available to us but not really in corporate because the opportunities are too small. More in the government sector, and in broadening the reach of our systems technology to encompass related entities like law enforcement. The corporate market today is a highly fragmented market. Lots of small players, no standard offering, and so forth. It looks like a market that is in need of consolidation. And if and when it does then we may be able to provide some products into the market.

Thank you.

You’re welcome.

(Caller Instructions.)

At this time, there appears to be no further questions in the queue.

Okay. Thanks very much, everyone. We’ll say good-bye.

Ladies and gentlemen, thank you for your participation. You may now disconnect.