Digimarc Corp (DMRC) 2003 Q3 法說會逐字稿

My name is Derrick and I will be your conference facilitator. At this time, I would like to welcome everyone to Digimarc earnings economy conference call. All lines have been placed on mute to prevent any background noise. After the speakers remarks there will be a question and answer period. If you would like to ask a question at this time, simply press star and then the number one on your telephone keypad. If you would like to withdraw your questions, press star and the number two on the telephone keypad. I would like to turn the call over to Bruce Davis. Thank you, sir, you may begin.

Welcome to our Q3 conference call. With me today is E.K. Ranjit, our CFO and Paul Gifford our President and Chief Operating Officer.. We released the third quarter financial results today, the purpose of this conference call is to provide you with a summary of financial reports, anupdate significant business developments during the quarter, and our financial guidance for Q4 '03. We'll respond to your questions after the call. E.K. will begin by reviewing and commenting on the financial information contained in the press release.

E.K.?

Thank you, Bruce. Before we start our discussions on the financial result, I would like to go over a couple of items.

First, I would like to point out, during the course of this conference call we'll be making forward-looking statements, which are subject to risk and uncertainties. Such forward-looking statements include, but are not limited to, statements relating to financial guidance for Digimarc fourth fiscal quarter and fiscal year 2003 and other statements containing swords such as, "beliefs, expects, estimates, or anticipates" and words of similar management opinion. These statements are based on management current expectations and subject to certain assumptions, risks, uncertainties and changes in circumstances. Actual results may vary materially from those expressed or implied from the statements here in or from historical results, due to any of a number of unforeseen influences.

More detailed information about such risk factors are in filings by Digimarc with the SEC, including, without limitation, Digimarc's most recent quarterly report on form 10-Q under item II management discussion and analysis of financial condition and results of operation. Any guidance we offer is a point in time estimate. We expressly disclaim any obligation to revise or update any forward-looking statements, including guidance, in order to reflect events or state of circumstances that may arise after the date of this conference call. Whether they arise as a result of new information, future events or otherwise.

A replay of this conference call will be available for two weeks through the web cast located on the investor relations page at www.digimarc.com, or under the sub-category, events, at www.streetevents.com. Thereafter, the web cast will be available on the investor relations page of our web site under the category, "events," sub-category "Web cast archives." Now turning our discussion to the third quarter 2003 financial results.

I'm pleased to report that Q3 marked the third consecutive quarter of profitability. While our estimates were slightly below, revenue estimates were slightly below expectations we reported strong gross margins and net income. Earnings per share of .07 was a high end of the guidance and in line with the first call conferences. The ESO and other financial performance indicators continue to improve and we generated significant positive cash flow from the operations.

During the quarter we also completed a very successful transactions which was approximately $27.7 million to the cash balances and brought on board an impressive portfolio of new investors, including Goldman Sachs, Highbridge Capital, Baystar Capital, UBS and Crestview Capital. As to the details of the income statement, revenues for the third quarter 2003 were 23.3 million, down 246,000 or 1% compared with the previous quarter and down 4.2 million or 16% from the third quarter 2002.

For year-over-year comparisons, please note that third quarter of 2002, including revenues of 5.1 million from a large water identification system sales that was delivered entirely within that quarter. Domestic program revenues which accounted for 17.4 million of the 19.8 million in ID systems revenues for the quarter increased from the prior quarter due to higher card issuance volumes and higher report card revenues from new programs. Add on the domestic revenues also improved from five quarters.

International revenues of 2.4 million were below our expectations due to delay in a large international border identification system sale that we had anticipated booking and beginning to shape in the third quarter, which slipped to the fourth quarter. We know anticipate shipments from this program to begin in the fourth quarter and continue in 2004. Apart from the Q3 delay international booking opportunities continue to look strong.

In other areas of our business, watermarking solutions and licensing showed modest sequential revenue growth from the continuing work with Center Banks. Use of watermarking for monitoring and forensic tracking of audio and video context. And increased demand for Image Bridge which facilitates copyright protection and on line licensing of commercial photography.

Third quarter totalled revenues of 22.3 million or 700,000 or 3% below the low end of our guidance range. For the nine months ended September 30, 2003. Revenues were 66.6 million, up 700,000, compared to the 65.8 million reported in the comparable period of 2002.

Gross margins improved 12.7% compared to third quarter of 2002, and two% from the previous quarter. This marked the fourth consecutive quarter of margin improvement driving by our continued focus on cost management and productivity. Gross margins for nine months ended September 30, 2003 was 46% compared to 39.2% for the comparable period 2002. An improvement of 6.8% year-over-year.

Operating expenses third quarter of 2003 were 9.4 million down $1 million or 10% from the third quarter of 2002 and down 700,000 from the previous quarter. For the nine month ended September 30, 2003, operating expenses were 29. 3 million, down 5.9 million or 17% compared to the comparable period 2002. The reductions are as a result of our continuing effort to responsibly manage cost by consolidating and streamlining operations to maximize productivity.

During the quarter we recorded non-cash expenses of approximately 320,000 relating to the full employee stock option compensation charges which less than the charges taken in the prior quarters. This P&L charge will be fully amortization in the fourth quarter. Other income net of approximately 146,000 was in line with the expectations and substantially down from the prior year due to lower interest rates on the lower average cash balance.

The [ INDISCERNIBLE ] For income taxes of approximately 51,000 relates to estimated taxes we expect to pay in foreign countries from profitable operations. No provisions have been made for U.S. taxes due to loss carried-forwards. The activities discussed about resulted in net income of 1.3 million for the third quarter of 2003 and diluted earnings per share of .07 on 19.73 million [ INDISCERNIBLE ] Average shares. This compares to a net loss of 928,000 or a basic and diluted earnings per share loss of .05 on 17.46 million average shares in the third quarter 2002. And net income of 287,000 or a deluded earnings per share of .02 on 18.54 million weighted average shares reported in the previous quarter.

Third quarter basic and diluted earnings per share of .07 is the high end of the range of guidance to .05 to .07 we gave at the last conference call and is in line with the first call consensus.

For the nine months ended September 30, 2003, we generated net income of 1.6 million or .08 per diluted shares compared to a loss of 8.5 million or .49 per share in the comparable period of 2002. An improvement of 10.1 million in net income or .57 year-over-year. With regard to the balance, our cash, cash equivalent, restricted cash, and short term investment balances was 7.78 million up 26.3 million from the prior quarter. The increase in cash was as a result of adding 23.7 million from the [ INDISCERNIBLE ] Transaction completed in August 2003, and 2.6 million of net cash generated from operations.

In addition, during the quarter, the restricted cash balance was reduced by 11.3 million adding to the improvement in overall liquidity. The [ INDISCERNIBLE ] Was reduced by 2.3 million from the prior quarter to 13.1 million at September 30, 2003, as a result of improved cash collections. DSO improved to 58 days from 61 days reported in the second quarter of 2003. Inventory net results was 5.1 million down 753,000 from the 5.8 million reported last quarter. Inventory includes materials to be used in producing ID cards and consumable supplies that we sell to our customers.

Long-term assets increased from 58.8 million in the second quarter to 59.9 million in the third quarter as a result of programs and additions and net of depreciation of assets already in use. Before the revenue decreased 1.4 million to 3.1 million as a result of regular amortization of the full revenue balances, offset by addition related to payments we'll receive from the customers.

In summary, we generated increasing profits for the third consecutive quarter and met the first consensus EPS and significantly improved the gross margin for the fourth consecutive quarter. We generated positive cash flow from operations and added 23.7 million to our cash balance from a very successful liquidity transaction and our DSO continue to improve.

Now, I'll turn the discussion back over to Bruce.

Thank you, E.K. Q3 marked the third consecutive quarter of profitable operations and our seventh consecutive quarter of improved financial performance. The improved earnings resulted from higher than anticipated growth margins and effective expense management..

Key areas of operational focus include continuous improvement of supplies on a chain and project management, a relentless focus on customer satisfaction, ongoing assessments of the impact of changes in our markets on our investment rates and priorities, and better aligning of resources to these successful factors. We were recognized during the quarter by Delote and Tusche as number 48 on the 2003 Delote technology theft 500, a ranking of the 500 fastest growing technology companies in North American. Based on average percentage growth over five years, 1998 to 2002. Digimarc revenues grew over 8700% during this period. Our financial performance reflects the interplay of earlier adoption of breakthrough technology of watermarking and steady progress of our ID systems business has made since we acquired from enabling access from Polaroid Corporation in 2001.

Our company ranked number two on the Oregon Technology Fast 50, a ranking of the fastest growing technology firms in Oregon. We are dedicated to continuing a high rate of growth with prudent risk management perimeter. To facilitate certain growth plans we completed the successful equity financing during the quarter netting $23.7 million. The primary motivation for the financing was to strengthen the balance sheet and increase our flexibility, as we contemplate various opportunities to accelerate growth while continuing to improve profitability.

In the two years since acquiring the enabling access from Polaroid. Digimarc systems has developed into a healthy, profitable market leading provider of secure personal identification solutions. And as poised to effectively compete for growth opportunities both domestically and internationally. Business consistently delivering on financial objectives, brings enhancements to drivers license issuance systems and licenses and improving customer satisfaction.

There were a number of positive develop actions at ID systems during the quarter. For instance, the five year contract with the state of Florida to provide the state of art drivers license system was approved and preparation for deployment have begun. We expect the contract to begin generating revenues in the second half of 2004 and significantly contribute to growth in 2005. In Georgia, where we challenge the award of the drivers license contract to the competitor the Georgia superior court made significant findings that the Digimarc made a compelling case that irregularity has occurred during the percurment process and demonstrated a substantial likelihood of success on the merits with a full trial. The court unjoined any further activities by the state in continuing to work with the alternative supplier until trial.

Discovery has begun, no trial date has been set. While awaiting trial or other resolution of this dispute, installation of the competitor's system is in joint and we continue to supply drivers license to the citizens of Georgia via the extensions of the existing contract with the state. We also had good news from Kansas where the customer extended the contract in conjunction with a major system upgrade as part the Kansas Department of Revenue became the fifth customer to adopt [INDISCERNIBLE]. Our second customer to adopt the identity verification solution using facial biometrics and our first customers implement background search processes involving authentication of source documents to enhance identity verification prior to issuance.

In the additional watermarking area we produced solid results. Work with the central bank is proceeding the pace and we are making excellent progress thus long term goals. Revenues were strong and will more than double over 2002 for the full year, if the trend thus far of 2003 continues through year- end. Our watermarking based applications for secure identification documents is gaining momentum in the drivers license phase and will lay a foundation for the revenue growth for direct and third party development.

The growing adoption of watermarking for drivers licenses is encouraging as it adds momentum to the portfolio of early stages options to counterfeit and protection solutions across the full range of media types. The most mature and substantial deployments of watermarking solutions today are in counterfeit deterrents for central banks and enhance online licensing as appliance monitoring for commercial photographers. The use of watermarking in the entertainment industry is increasing, although the BWM watermarking based solution for preventing piracy of movies through copy prevention and play control, which was proposed to the DVD, CCA, and multi industry standard has not been adopted. Uses of watermarking protects the copyrights via other means, principally variant on the theme of friends tracking are proliferating. We will continue to support the DVD, CCA process as it seems to us that a fully articulated copy right protection architecture should contain some degree of device control. We remain confident that Digimarc watermarking is essential ingredient of effective management of entertainment content and viable economic models for emerging digital distribution strategies.

General entertainments market development bowed well for digital watermarking. Adventures offering license digital distribution entertainment content, mainly music, thus far, are proliferating. There are no signs of a abatement of threats to the entertainment industries copyrights. It looks like things are worse. Witness the motion picture association announcement of the TROCONIAN step to eliminate academy award screeners due to piracy concerns.

There are now several ventures suppling forensic tracking of pre-released music and broadcast monitoring of news programming, advertisements, and promotional videos. We are seeing several new opportunities starting to emerge in forensic tracking of pre-released video and computer games, copy right protection for digital cinema, and transactional watermarks that facilitate digital music downloads. Universal pictures demonstrated leadership in recognizing the relevance of digital watermarking to its business with a bold announcement shortly after the quarter of the adoption of digital watermarking for all of its contents across all channels of distribution, mapping for the first time, from a customer perspective, the broad range of applications of digital watermarking for entertainment content. Universal announced it was adopting audio watermarking based solutions from one of our licensee for copy prevention, broadcast and internet monitoring and forensic tracking of the movies and television programs.

In support of the new the solutions adopted by universal, the supplier, [INDISCERNIBLE ] negotiated an extension of the field of use in its license with us to include the use of audio watermarking and audio visual copy right protection solutions. They provide media and entertainment companies, consumer electronic companies and computer software/hardware companies with effective and affordable solutions to protect against the unauthorized use of film and video content. The products will protect motion pictures throughout the entire release cycle, from theatrical release to pay-per-view and video on demand and rental and retail on package and electronic media and analog and digital broadcast. Meanwhile, they continue to develop a market for the media service which tracks and reports broadcast air play on all major affiliate and independent television and radio stations in the 100 top U.S. media markets.

During the quarter they announced that premier radio networks, a subsiderary of clear channel have started to using contra media on a variety of premiere programs and networks. Premiere syndicates more than 70 radio programs and services to more than 5,000 radio affiliates and reaches over 180 million listeners weekly. Telatrack, who uses phillips watercast system by Digimarc to supply broadcast verification services is now deployed in 100 major U.S. markets and coverage of major broadcasters around the world with a network coverage now spanning 44 countries.

Teletrack is being used by REUTERS throughout Europe Asia and Latin America. And NBC news channel using it to monitor the news and sponsorship content in key markets in the United States and Europe. It was recently expanded for provide advertising proof of performance and copy right management. Outside of the entertainment field we're working on a reprice of Digimarc media based on favorable technology trends and mobile communications. We're modestly investing in contra with intell and others to develop a wireless applications to turn printed materials into wireless launching points to compelling consumer and business content, including entertainment and mobil commerce delivered in the mix of streaming audio and video directly to the users smart camara phone or personal digital assistant. We showcased this wireless media bridge system at the Intel developer form in San Jose during September. It was selected as best new application at the forum by a panel of industry experts.

We'll update you from time to time on this project, it's too early to provide details on the likelihood of commercial success or business models and marketing plans. Our property assets continue to grow. 12 patents issued during the quarter, we now have 124 issued U.S. patents containing more than 2600 claims with more than 350 patent applications pending.

In conclusion, we are delivering on our promise of improved financial performance. We expect the strategic blend of product, services, and licenses to government and enterprise customers combined with carefull expense management will foster continuing growth in revenues and earnings. The underlying theme of our business is the provision of cost-effective security solutions for valuable media content. The macro level trends in all the markets are looking good and I'm optimistic about continuing progress and look forward to continuing profitable growth for the Company. E.K. will now provide you with details of the guidance for Q4.

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

We estimate that forth quarter 2003 total revenues will be in the range of 24 million to 25 million. Revenues are highly dependent on a number of factors, including, but are not limited to general economic conditions, the company's ability to predict [ INDISCERNIBLE ] From existing state drivers license programs, the company's ability to secure new contractings, the political and competitive environment in countries in which the company seeks business.

Changes in customer order and/or usage patterns and changes in the demand for the company's products and services. We expect gross margins in the fourth quarter of 2003 to be in the range of 44 to 46%. Gross margin may be higher or lower, because of factors, but are not limited to competitive pricing actions, changes in estimated product costs, and changes in the company's estimated revenue mix. We expect combined operating expenses for research and development, engineering and selling and G&A of approximately 9.5 million to 10.5 million in the fourth quarter of 2003.

Operating expenses particularly certain marketing and compensation related expenses depending on the level of revenues and profits and we expect non cash charges related to the amortization of the full stock compensation to be approximately 115,000 in the fourth quarter. These charges relate to options granted to employees in '99. Prior to the company's initial public offering. These charges are included in the operating expenses of 9.5 million to 10.5 million stated above. The company will record the last of these charges in the fourth quarter of 2003.

We expect to record a provision for income taxes of, approximately, 50,000 during the month of -- during the fourth quarter of 2003, that relates to taxes payable in foreign location.

Income taxes for the domestic operations are expected to be 0. During the same period, due to net operating loss carried forward benefits the company as from prior periods. We expect our income consisting mainly of interest income to be approximately 170,000 in the fourth quarter of 2003, assuming no material change in average cash balance or interest rates from the third quarter ending cash balance. Based on the above assumption we estimate diluted earnings per share to be in the change of 7 cents to 10 cents for the fourth quarter 2003. The fourth quarter diluted earnings per share cancellation includes approximately 1.8 million shares from the company's private placement transaction completed in August 2003. For the full year, 2003, we expect diluted earnings per share to be in the range of 15 to 18 cents.

Before we conclude I want to give you an update on upcoming investor relations activities. On November 4 and 5 we're scheduled to present at the American electronics association classic conference in San Diego. During the month of October, we plan to meet with [ INDISCERNIBLE ] And prospective investors in Toronto, Canada and early January we're scheduled to present at the NEDHAM annual growth conference in New York.

This concludes our presentation we'll now welcome your questions.

At this time I would like to remind everyone, in order to ask a question, press star, then, the number one on your telephone keypad. We'll pause for a moment to compile the Q&A roster.

Your first question from Bill Frerichs with D.A. Davidson and Company.

Good afternoon Bruce and E.K. My question is this, do you -- could you tell me, in the digital watermarking line on the income statement, how much of the $2.472 million might represent BARENTS?

Bill, as you know, as part of our agreement with BARENTS we don't disclose account amount, it's amortized every quarter and a certain amount goes into that line, but it is not disclosed.

Is it substantial portion of that line?

It's mostly license fees and there's minimum license fees and if the volume goes up significantly, then, you know, the license will grow as well.

Okay. Now, could you talk us through the economics of their deal with Columbia -- excuse me, with Universal so we get an idea of how big the opportunity might be for Digimarc?

One thing I want to point out is this license arrangement with the universal, that's that is an incremental revenue, it's not part of the whole licensing arrangement we have. This is an incremental revenue stream.

And when does this begin?

What?

When does this begin when will we receive revenue from it?

We'll see revenue immediately.

So you would expect the digital watermarking line to be sequentially higher in Q3? I mean, Q4 than Q3?

Yes, the quarter we expect the watermarking revenues to go up.

Could you give us any idea of what proportion of the total revenue watermarking will be? Versus license? Or do you want us to back in to it through the gross margin?

Bill, we -- you -- you know, our business pretty well. We have couple substantial relations included in that line that are confidential so it wouldn't be appropriate for us to break that line down further. Due to the concerns with the central bank and with variance and other contributors of the revenue there is.

How much the line is the result of litigation settlements and how much of it is actual economic commerce, if you will?

Same answer.

Okay.

Okay.

Thanks.

Okay.

Your next question from Jeff Putnam with U.B. O'connor.

Research & Development was down significantly this quarter. It actually helped the quarter it looks like. Is that something you're going to see or does that go up going forward, do you have any guidance with that's going?

The level of investment in Research & Development relates to the maturity of the technology. So as the technology matures, we -- the expenses tend to shift more from Research & Development line to marketing lines so if you look at the P&L on a quarter to quarter basis that's the trend you'll see. So we'll continue to invest on R&D and marketing based on the opportunities and level of activities we have going.

Jeff, I can add a footnote there. With respect to the watermarking research and development, we've invested a very substantial amount of capital over the past six years building a solid technology foundation and a world-class patent portfolio to protect it. Much of that work, now, has been completed. And, so, the Research & Development at this stage, and moving forward, is focussed more on product development, than on basic technology, although we continue to develop our basic technology resources, and, so, the overall amount of Research & Development necessary to support growth is the smaller because of our partnership model in which we openly license our core technology to other companies to produce watermarking solutions, such as the variance announcement this quarter.

Final you've got a fair amount of cash there, any interest-thing that hits you in the face right now.

We're interested in expanding the business through external means, where it makes sense. And we're actively engaged in the exploration and the possibilities of external growth. We don't have any particular announcements to make at this point in time.

Great. Thanks a lot, guys.

Yep. .

Your next question from Chris Kincade with SG Cowen Securities.

Hi guys. I was just wondering if you could give more color on gross margin and sort of where you saw the strength by segment, up 200 basis points, quarter on quarter and which segment was stronger or can you give any sort of sense of the strengths?

Sure, Chris. We actually saw improvement in gross margin in all of -- in both of our markets -- markets. In the watermarking area, with the continues improvement in licensing and less service-related type of revenue streams, that margin got healthier in this quarter. On the ID system side of the business, we did not have any low margin international business in this quarter. That's kind of good and bad. The bad thing is that we missed the top line, slightly, because of that. But, the margins got healthier because a revenue mix was much stronger. So the combination of all of these factors, along with the continue effort to contain costs, gave us, you know, the growth and margin this quarter.

Great. That makes sense. And, then, could you give an update on watermarking deployments for drivers licenses, sort of characterize where you are on the deployments and, are you generating revenues, right now, from watermarked ID's?

I think we kept everyone up-to-date on the adoption of watermarking by various customers and all of the customers, thus far are existing customers of ours, that is where we are the system provider. And, then, in those circumstances, we generally don't tease apart the price for watermarking, per se. It's usually bundled in with other things, either in a price per card or lump sum price. And, so, we have created a price list. We have made it known to states that are not customers of ours. We have had some discussions with the system suppliers of those states and we hope that sometime in the not too distance future we'll get validation of external pricing that we could share with you. When we get the first such deals we won't be in a position, yet, to share it with you, because we need to be able to aggregate some number of deals to protect of confidential amount of customer information. But, that's when I think we'll be able to give you something that I can stand behind in terms of the market perception of value, which I think is what you're looking for. So, we're not quite ready to do that, yet.

But, is it fair to say that the five states that you have right now, how many of those are issuing watermarked ID's right now?

One state is in production.

Okay. Thank you.

Yep.

Your next question from Jennifer Jordan with Wells Fargo.

Good afternoon, gentlemen. Just a couple of questions. E.K. you mentioned the one deal that slipped, can you give us any sense of the magnitude of that deal in terms of what it would have added, had it made the quarter?

I can give you a sense for what the impact would be, happened in this quarter. |

Uh hun.

It would be in the range of about $2-3 million.

Okay. And, when you look at -- you talked, when you did your private placement deal about opportunities that you see for aggregation of the ID systems business, could you give us an update of where you are in terms of the efforts that you are pursuing there internationally and domestically and a timeframe for when you might have some kind of announcement?

Jennifer, it's Bruce. We're working on it. We'll have an announcement as soon as someone says yes. As I said before, we are interested in a number of opportunities, we've identified some specific targets and we've engaged in discussions and we don't have any deals and I can't give you specific timing because it takes two to put a transaction together. So, at this point in time, we're still engaged in the strategy that I've described. And I believe that we're making progress.

So we should be looking for something on the international side, first. Is that a safe assumption?

No, it's not.

No? Okay.

There are interesting opportunities, domestically and internationally. Our -- with three related objectives, improving the breath and depth of the product portfolio, increasing our distribution and improving our access to capital. So, those are the primary criteria for evaluating targets and we could end up with one of them located in the U.S. or overseas. It's really, whether here or there, is not fundamental to the analysis.

And, E.K., it looks like for the fourth quarter the revenue number, obviously, the guidance is slightly lower than what we had in our models and I'm wondering the EPS is a couple of cents lower than we're looking for before, which I believe was around .20 is most of that the dilution the additional shares or how would you break that up.

On the revenue line. If I look at most guidance, out there, we are kind of in the -- you know, to around 25 million is what I see, as kind of average revenue numbers out there. And, that's on the high end of our guidance right now. So, you know, it's not outside of our guidance.

Uh-huh.

And, relating to the EPS, there's some dilution, infact, in Q4, about a penny.

Okay.

From the, you know, increased number of shares.

So the rest of it would be the addition charge for taxes, maybe 15,000 higher than we had in our model amount for the stock compensation, and, then the slightly lower revenue?

Yeah. The earnings per share guidance that I have right now is .07 to .10, and .10 was the guidance previously out there which did not factor in the dilution impact, okay? So the dilution impact, the .10 previously out there is more like .09.

Okay.

But, our guidance ranges, we're right there.

Okay. Thanks, E.K.

You're very welcome.

Once again, I would like to remind everyone, in order to ask a question, please press star and then the number one on your telephone keypad. Your next question from Steve Lidberg with Pacific Crest Securities.

Good afternoon, guys. First question, is with regard to guidance for fourth quarter. Traditionally we've seen a seasonal slow down in fourth quarter, and obviously your guidance is to seasonally up Q4, some of that I imagine, or a lot of that being said to the international opportunity that you see out there. Given the volatility of the international business, what kind of visibility at this point do you have around the deals and what kind of confidence do you see them actually closing? Thanks.

Steve, on the domestic seasonality is on the domestic side.

Right.

Usually around Q4, timeframe. In Q4, the international opportunities we see are pretty strong. So our comfort level is pretty high. With the with the international piece of the business that we're seeing right now.

Okay. And, Bruce, on the watermarking of drivers licenses, I believe you stated, as kind of a goal, that you would like somewhere between 30 to 50% of total drivers licenses to be in the contract for watermarking, towards the end of this year, early next year. Where are you in making progress on that goal and how achievable is that goal? And, then, also, where did the head count end up at the end of the quarter and give me last quarter head count? Thanks.

Let me take the last one, the head count was about 447, I believe. We hired about 20 -- about 21 people during the quarter. Primarily to support some of the new programs that we are working at.

With respect to watermarking adoption for drivers licenses, I think we're at about 10% issuance volume now. So, after a couple of quarters we're at 10 and looking for acceleration of the adoption, but, the key to getting to the numbers I was talking about are small number of large states, and I can't tell for sure whether they're going to be signed up or not, before year-round. So that will be the swing. And as you know, we have the largest states for the most part, as our customers. And, so, we're engaged in conversations with them and their favorable disposed, but I'm not sure they'll sign that's my only uncertainty with respect to my prior hypothesis about how much adoption we would get.

Great. Thank you.

Your next question from Daniel Lewis with Jim Asset Management.

Good afternoon, guys. Could you comment on what's happening with the VWM group, firstly?

Sure. The DVD, CCA's didn't reach a consensus on the watermark and there was no adoption. They, rather than say, okay, we surrender, they formed another committee, which is known as the ARDG, the analog retransmition discussion group, and the purpose of that -- the stated purpose of that group is to determine whether watermarking is, in fact, an essential ingredient of the system, in -- as a signalling means of analog content and primarily technology being discussed is called CGMA is a vertical blanking interval of communication, which means it's been around for a long time. And so, I think that that committee is reflective of two contradicting ambitions.

One, the entertainment companies wanting to get protection, and the other, the IT industry trying to find means to delay implementation and I actually think that that committee's purpose is to engage the entertainment industry in a seemingly protective exercise and try to put out watermarking until larger issues are resolved. As you know, my theory about the adoption of watermarking for copy prevention play control is primarily an economic issue not a technical issue. And so, at any point in time in a way unforeseeable to me that economic issue will get resolved. That's where that is. It's kind of hung up in in conflict between the consumer electronics and the entertainment industry on one side and the IT or PC industry on the other side.

And has there been movement, towards resolving the economic issue in anyway, shape or form?

It's hard for me to tell. That's are very high-level big companies be, and we're too small to participate. I think that there is progress in the entertainment industry in adopting watermarking. And I don't know what that means specifically for VWM offerings, I presume that improves the odds to get adopted and that's the point I made in my prepared remarks. Alternative means to use watermarking for copy right and protection and content management are emerging that are getting less resistance. And so, as they proliferate and the industry adopts watermarking as the normal part of the work flow, it would make it possible, then to, do device control using watermarking, which is what the VWM solution is. So, it will be easier to implement but I don't know what that means. It's kind of [INAUDIO] to the issue does the entertainment want to pay the IT industry to play because the I think the IT industry deals with things. I don't know, it's really hard to tell.

The next question to E.K. You know, previous guidance for revenues has been in the order of 25 million, and, early -- in the earlier part of the call you mentioned that the short form Q-3 would be made up during Q4, that it was just a delay. So, is it -- did we think of the original 25 million of guidance as really 24 plus the million that was a short fall for Q3?

The -- the new business that's coming in, that's going to be fulfilled in Q4, and in 2004, going in to 2004. So, the 25 million guidance includes that. You know, so if you look at our mix in the revenue guidance for the year, that's about the same amount of revenues that shifted from Q3 to Q4. So, one quarter to that in 2003, now, is moved in to 2004. So, overall, you know, our guidance, earlier guidance for the year was 94 million, and we're looking at about 92-type of number right now and the difference is that $2 million.

And the lower sequential gross margin would be related to higher international revenues?

Right.

As a proportion?

Right.

Okay. All right. Thanks.

Thanks.

Once again, I would like to remind everyone, in order to ask a question, press star and then the number one on your telephone keypad. Your next question is from an drew Andrew Weiner with Burnham Management.

High, good afternoon.

Hi, Andrew.

I was wondering if you could provide a little color. You mentioned earlier in the call that you saw some additional add-on revenue in the ID business and specifically I think you eluded to domestic revenues being up sequentially based on higher issuance volume and some higher ASP, I guess, card issuance. I was wondering, maybe, if you have any quantitive measures to put some color on that?

I do not have a - we don't break out revenues by contract or by state. So, that's kind of difficult to do. The strength in the add-on revenues that we saw this quarter is in the range of about $300,000 to $400,000 quarter to quarter improvement. There's three components driving the domestic revenues one is the add-on revenues, the other one is some of the newer programs that we have beginning to generate revenues from and they have a higher price per card. So that's how Q3 as well. And the last item is the high issuance volume and that's -- as Steve mentioned earlier, the seasonality in issuance and Q3 typically a strong quarter for issuance. And that's what we saw.

Okay. I guess the partly my question is, not necessarily by state, but rather, maybe talk to trends and start to think about '04 versus '03 on the best you could figure it on apples to apples basis on what you could figure the ASP might look like. Taking, for example, that doing about 60 million cards with about $1.30 averaging ASP, if you assume $80 million or in that neighborhood of IB Business revenue and look at a contract like Florida that's $1.62 without watermarking or facial recognition or any of those type of things, maybe, could you talk a little bit about the longer term trends and what you think the ASB's will grow at?

Andrew, I think what you're trying to back in to here, perhaps is '04 guidance we're not prepared to give yet. But, it -- if we keep it at a higher level for a moment, we -- we think that the economic situation in the country is getting better, likely to get worse, the states will get a little less pressure. They've had severe pressure for the past couple of years. That may have caused them to think a little differently about the purchase but I don't think it's will be revolutionary. I think it's a bit better.

There is continuing substantial interest in the states in improving their systems. And, that goes for existing systems as well as replacement systems and, so, I think we're in the early stages of a powerful upgrade cycle, and I guess, the add-ons versus new systems, you know, it all sort of blends in together when you look at a price per card. We also want to increase our share of that business. And, so, yeah, a lot, we have a lot of different forces from some of which contradictory and some complimentary that goes into the pricing mix and, thus, I think you'll probably have to wait a bit until we give the '04 guidance to get something meaningful on what you're looking for. Other than the long-term trends.

And I think the long-term trends are very positive, and that's because, take what I just said and add to that, and interest kind of capability that is emerging for state drivers license systems to be more secure and more inter related with other data bases and more important to citizens as the primary means of identification out of state. So, think, you know, on the high level, it looks very promising. And our businesses hitting on all cylinders and running very well now and, so, with an efficient business with strong demand and with our technology leadership, I'm very optimistic about what we can deliver from the domestic market. And, then, aus know, I see great promise in the global market. So, time to estimate short-term trends in revenue per card, maybe something that we can't help much on because it implies too much about what we think about our business plan for '04 which the board hasn't approved yet, and we'll get board approval for the end of the quarter and some guidance early in the year to allow you to do the calculations that you want to do.

Can you talk, E.K., you said you feel pretty good about the backlog of opportunities, I guess, in the international market, and I was wondering if those are all voter ID-type contracts, which are sort of one off in nature, versus any potential, either, drivers license or something similar, that might be more recurring in nature?

The international business, Andrew, has really, two components. One side of that business looks just like the U.S. drivers license-type of business. You know? It's predictable, month after month-type of business. The other one is the opportunities that where you see the spikes in certain quarters for the revenues goes up, or things like the water registration cards and national ID programs and so on. And we are seeing opportunities for both type of businesses.

The broad range of opportunities, not just one or the other, and in any particular quarter there are opportunities in a wide variety of [INDISCERNIBLE] systems. So there will be a little bit of volatility, hopefully [ INDISCERNIBLE ] The upside to do things right.

And my last question:bruce, I was hoping maybe you could provide a little more color on ImageBridge, you know, sounds like probably off a small base but revenues were picking up there, maybe you could talk, specifically, without disclosing the customers, the types of applications and, you know, what the outlook is for the next, sort of, going forward, as far as our continued growth in that area?

Yeah. It's turning out to be a nice contributor to the business it had been pretty nominal at first, and without much in your tourance and saturation of the marketplace and increasing concerns about the copy rights and facilitating licensing and managing assets, more and more people are subscribing to the product and they're using it for a wide variety of purposes. Including, copy right protection, asset management, facilitate of licensing and even market research and as a result we're seeing very significant growth in revenues, and it's beginning to become a significant contributor to the business and we don't see any slackening of demand. So we've now dedicated some more resources to it and we're looking for ways to facilitate the growth and meet the customer demands and elaborate the product and build it into a solid part of on going business, so, we've been pleasantly surprised. It's been growing in the recent quarters it's been growing a lot.

Thank you.

Your next question comes Steven Lidberg with Pacific Crest Securities.

Two follow-up questions. First of all, whether is Florida going to start contributing to revenue, Bruce? And, secondly, is your contract with the central banks up for renewal the end of this year, again, or what is the timing of that? Thanks.

First with respect to Florida. We'll be online as soon as we can and how quickly we do that is a function of the collaborative efforts of our sales and the state authorities. Speaking with us, we're moving with all due speed to implement sometimes states have better success than other times and it's hard to predict on their side how they'll do. I know they are highly motivated and a great group of people in Florida on the customer side and we're hoping to begin to generate licenses in the second half of '04. And, the fully online at maximum volume in '05. That's why I noted in my remarks it will be a very substantial contributor to the '05 plan and hope to make a significant contribution in '04 but it's subject to some uncertainties as to the specific start date.

With regard to the Central Bank. We have an understanding with them, regarding next year. So, we're comfortable that we and they know what we're going to be doing. We don't have a signed contract for the year, which will be very uncommon in our relationship and we're also anticipating that moving forward will have a longer term perspective of the relationship, which will transcend individual annual contracts.

Great. Thank you.

Your next question comes from Bill Frerichs with D. A. Davidson.

E.K., could you tell me, please, looking again at the break down of revenue, if any of the digital watermarking line is in allocation from your own ID systems business?

Oh, first the the break out of Q4 revenues, idea on that, is that what he's looking for?

Yeah. I was wondering if your digital watermarking licensing revenues included allocations from the ID business systems.

We do have intercompany revenue recognitions but the numbers we report externally reflects all the revenues in ID systems today.

So there's nothing up there.

Right.

Pretty much.

We do them in a company elimination.

Great. Thank you.

At this time, there are no further questions. Gentlemen, do you have any closing remarks?

No, I'd just say saw to everyone for participating today and we'll look to talking to you again after Q4.

Thank you very much. Bye, now.

This concludes today Digimarc conference call. You may now disconnect.