Digimarc Corp (DMRC) 2004 Q1 法說會逐字稿

Good afternoon. My name is Deborah. And I will be your Conference Facilitator. At this time, I would like to welcome everyone to the Digimarc Corporation Quarter One 2004 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 during this time simply press star, then the number one on your telephone keypad. If you would like to withdraw your question press star, then the number two on your telephone keypad.

At this time, I will turn the call over to Mr. Bruce Davis, Chairman and CEO. Thank you. Mr. Davis, you may begin your conference.

Thank you. Good afternoon. With me today are E.K. Ranjit, our CFO, and Paul Gifford, our President and Chief Operating Officer. We released first quarter 2004 financial results earlier today. The purpose of this call is to provide a summary, and an explanation of these financial results, and an update on significant business developments and market conditions, and financial guidance for Q2 ’04 and for the remainder of 2004. We’ll respond to your questions at the end of the call.

E.K. will begin by reviewing and commenting on the financial information contained in our press release. E.K.

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’ll be making a number of forward-looking statements, in particular with regard to guidance which are identified by words such as ‘believes, expects, estimates, anticipates,’ or words of similar import or statements of management’s opinion. These statements are based on management’s current expectations and are subject to certain assumptions, risks, uncertainties, and changes in circumstances. Actual results may vary materially from those expressed or implied from such statements.

For more detailed information about risk factors that may cause annual results to differ from expectations and guidance please see the company’s filings with the Securities & Exchange Commission, including the risks discussed in our business and [MB&A] [ph] sections of our most recent Form 10-K.

Any guidance we offer represents a point-in-time estimate. We expressly disclaim any obligation to revise or update any guidance or other forward-looking statements to reflect events or circumstances that may arise after the date of this conference call.

Second, a replay of this conference call will be available for later listening at www.digimarc.com/investor/event.asp and www.streetevents.com for two weeks following this call. Thereafter, the webcast will be archived and available at [httpwww.digimarc.com/investor/event.asp] [ph] under the subcategory webcast archive.

Before we discuss first quarter financial results I would like to provide an update on the status of our accounting system conversion. As promised, we took a very substantive approach to financial reporting for the quarter which enhanced the checks and balances and focused the senior management attention. We are happy to report that we have essentially completed our conversion to the new system and are already realizing many benefits that the system provides, with its enhanced accounting, financial planning and forecasting functions.

Now, back to the first quarter results. With respect to our financial results total revenues of 23.5m and earnings per share of three cents were within the range of guidance that we provided for the first quarter. First quarter 2004 total revenues of 23.5m were up 4.4m or 23 percent from the prior quarter, and up 1.8m or eight percent from the comparable quarter a year ago. The growth in revenues in primarily due to our ID Systems business which delivered on a large international contract within the quarter and the increased revenues in the watermarking area from the bank note counterfeit deterrents project. The [major bridge] [ph] and patent licensing revenues were in line with our expectations.

Post quarter 2004 gross margin was 42 percent, four percent lower than last quarter, as expected, and at the high end of our guidance of 38 to 43 percent. First quarter 2004 gross margin was three percent lower than the comparable period a year ago. The lower first quarter gross margin is primarily due to the large international film based program referred to [about] [ph]. We expect to [attain] [ph] to such modestly profitable contracts from time to time to maintain market percents, and customer, and partner relationships as such programs transition to digital technologies during the coming years. These contracts generally have relatively low margins and may cause multiple spikes in quarterly revenue trends. On balance, we consider them to be good business for the reasons stated above.

Post quarter gross margin associated with these revenues excluding the international film based program was in line with our historical run rates. The gross margin for watermarking revenues improved to 68 percent.

Operating expenses for the first quarter of 2004 were in line with our expectations at 9.4m, up 500,000 or six percent from the prior quarter, but down 400,000 or four percent from the comparable quarter a year ago.

Total other income of approximately 200,000 was in line with our expectations, and up from prior years due to higher average cash balances.

The provision for income taxes of approximately 50,000 relates to estimated taxes we expect to pay in foreign countries from profitable operations. No provision has been made for U.S. taxes due to offsetting loss carry forwards.

The activities discussed above results in net income of 525,000 for the first quarter of 2004 or diluted earnings per share of three cents on 20.62m weighted average shares. This compares to a net income of 29,000 or a basic and diluted earnings per share of zero cents in the first quarter of 2003, and a net loss of 70,000 or basic and diluted earnings per share of zero cents in the previous quarter.

EBITDA, earnings before interest, taxes, depreciation, and amortization improved to 3.2m in the first quarter of 2004 from 2.7m before that in the first quarter of last year. This improvement came primarily as a result of higher net income. The reconciliation of EBITDA to net income, the most comparable GAAP financial measure is included in our first quarter 2004 financial results release that we issued earlier today, and that’s available on our web site at www.digimarc.com.

Our cash, cash equivalent, restricted cash, and short-term investment balances were 73.7m, down approximately 5m from the prior quarter but up approximately 23m from the same period a year ago. We generated positive cash from operations. The net decrease in cash from the prior quarter relates to investments in significant new program implementations, including the Florida driver license system and the Mexico border identification program, in excess of the positive cash flow from operations.

The net accounts receivable balance was 16.6m at March 31, 2004, up approximately 3m from the prior quarter and higher sales. DSO was at 57 days compared to 63 days reported in the fourth quarter of 2003.

Inventory net of reserves was 6.1m, up 350,000 from the 5.7m reported last quarter. Inventory includes materials to be used in producing ID cards and consumable supplies that we sell directly to our customers.

Long-term assets increased from 62.2m in the fourth quarter to 68.8m in the first quarter as a result of program asset additions net of depreciation of assets already in use. The additions relate primarily to new program implementation, such as the Florida and Mexico programs mentioned above.

Accounts payable balance at March 31 was 10.2m, up 3.6m primarily as a result of increased level of activity associated with new program deployments discussed above.

Deferred revenue for the first quarter of 2004 decreased slightly to 2.8m compared to 3.2m reported in the prior quarter as a result of regular amortization of deferred revenue balances, offset by additions related to payments we received from our customers.

During the first quarter of 2004 and the fourth quarter of 2003 we entered into various capital equipment leases at competitive rates to partially finance capital purchases required for new disk program implementations. We intend to continue to lease finance equipment as appropriate, given the current attractive interest rates.

In summary, Q1 revenues and earnings per share were in line with our guidance. We generated positive cash from operations which was offset by investments in significant new programs that will benefit us going forward. And our DSO improved from the previous quarter.

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

Thanks, E.K.

Q1 results were in line with our expectations. It was a busy quarter with an overlay on normal business operations of fixing the issues that we had in the forecasting and accounting systems that surfaced in Q4. We made an intensive effort during the quarter to document, test, and implement robust and reliable systems processes and controls. As E.K. pointed out above, we believe we have substantially completed our work in this area, and now have reliable and efficient systems in place that will support timely and accurate reporting for internal and external audiences.

We recently increased our level of financial reporting detail to assist investors and analysts in better understanding our business. In our reports on quarterly results now we break out the split revenues between ID systems and digital watermarking, identify gross margins associated with each of the revenue streams, and calculate EBITDA.

Today we add another metric that we believe may be valuable in understanding and valuing our business, by providing an estimate of our backlog of estimated revenues under contract. It is an impressive number and a useful barometer of the health of our business. We employ a well established and understood definition of backlog orders in making these estimates. The definition that we use is contained in the instructions for narrative descriptions of businesses in SEC filings. The definition appears in SEC regulation [FK] [ph], item 101, section C1A.

With an estimated backlog of $255m we have a very strong foundation for profitable growth. The composition of the backlog roughly tracks our current split of revenues between ID systems and watermarking. We expect approximately $60m of the backlog to be consumed during the last three quarters of 2004. This accounts for over 80 percent of projected revenues during the remainder of the year. The backlog is replenished by new backlog orders from time to time in the normal course of business, and may rise and fall from current levels from quarter to quarter.

Although others in the industry talk of backlog we do not know whether they use the same definition for their estimates, and so we caution investors to exercise care in making comparisons unless or until there is clarity as to the meaning of the expression ‘backlog’ as used by others.

As we noted in a recent press release, Digimarc is gaining momentum in the driver’s license issuance business. As E.K. noted above our team of DIBS is very busy with a number of major system installations. During the quarter we completed new issuance programs in Missouri and Oregon, and there are several other domestic program installations and upgrades underway in places such as Alabama, Colorado, Florida, Kansas, Michigan, New Jersey, and Wyoming. And two international programs in Mexico and Latvia.

Two programs, in particular, are expected to significantly contribute to revenue growth in the second half of the year, the Florida driver license issuance system, and the Mexico voter identification system. We expect each of them to begin generating revenues – pardon me – we expect to begin generating revenues in Q2 from the Florida program and complete installation by September 30, 2004. The Mexico program is currently going through its production ramp-up phase. We expect to reach full volume production during the latter part of Q2. Since we are in the first months of production we are still calibrating our issuance volume model. Delaying completing the Florida program or lower than anticipated volumes in the Mexico program could negatively impact projected revenues for the second half of the year.

On April 16 we provided detailed information regarding our performance in the U.S. driver license market, since we entered the business in 2001 through the acquisition of certain assets from Polaroid Corporation.

I need to correct a minor error in the release that understated our success. Delaware which changed vendors in 2002 shortly after we entered the business was identified in the release as a customer of Polaroid, our predecessor. It was, in fact, a Datacard customer at the time. We noted in the release that we have increased our share of issuance volume and revenues. With this correction it’s now obvious that we gain share regardless whether one measures progress in terms of number of States, issuance volume, or revenues.

Updating the information that we provided in the release, we have been notified that the State of Hawaii has filed a motion to dismiss our protest, arguing that the protest was not timely filed. There is a hearing on the motion scheduled for May 11. There’s a risk that the State may choose to reinstate its award to a competitor if our protest is dismissed. We believe that the right thing for the State to do is to rebid the program, and we are continuing to encourage them to do this.

We’re active in product development, as well. Designing and building a number of enhancements for our driver license issuance systems, including the new source verification system that we are developing in partnership with ChoicePoint. One of the largest sources of driver license fraud is the use of false source documents to establish identity during the application process. For our strategic partnership with ChoicePoint we intend to market a powerful new application to issuing authorities that uses ChoicePoint’s industry leading data searching tools to authenticate an applicant’s identity data before documents are issued. Thus helping to close a major loophole in most current issuance processes. ChoicePoint is a leading source of decision making intelligence for business and government.

In the area of domestic bid activity Ohio and Minnesota are currently evaluating responses to RFPs. We have been informed by the State of Wisconsin that they expect to issue an RFP in early May. Ohio and Wisconsin are not currently DIBS customers, and thus, represent opportunities for significant near-term incremental growth for Digimarc if we are awarded the contracts. Indiana has not announced any plans to issue another RFP, and the Georgia litigation continues in this discovery phase with no date set for trail.

International sales during Q1 were brisk with over $19m in new bookings, including the Latvian driver’s license system, Brazil immigration card, additional orders for the Russian driver’s license program, and a foreign voter identification program that we referred to above.

We are developing new sales channels in domestic and foreign markets for certain components of subsystems of our domestic driver license solutions. The initial product portfolio includes new card materials, security over laminates, cashier stations, and camera towers. The channel partners that we are talking with are established players in the secured identification marketplace in their specific geographies.

Digimarc products will enhance the current product portfolios and improve their competitive positioning. In return, they will augment our market reach and help to sell the Digimarc brand in these ancillary markets. We expect these channel sales to contribute significantly to revenues later in the year, as Digimarc products get placed in the programs and start generating recurring revenue streams. Given that this is an emerging area of the business there are risks that the channels will not develop in the manner or along the timeline that we are projecting.

The watermarking side of the business had a good quarter. In development and marketing we announced that our solutions for managing and tracking digital images would be slid into two offerings, image for [genaprise] [ph] and [my picture mart] [ph] to clearly differentiate enterprise and individual workstation offerings and permit optimization of the products to best serve the needs of the distinct market segments.

Image genaprise will focus on providing enhanced tracking of inventory outside the corporate firewall, enhancing a company’s ability to implement and monitor internet marketing initiatives, and to implement rights management compliance programs.

My picture mart will focus more on photographers and digital imaging enthusiasts, providing them with the means to communicate ownership, encourage licensing, and enhance management of their image portfolios.

Our efforts to market [ID Mark] [ph] as a machine readable cross-jurisdictional security feature in the secure identification marketplace continues to deliver impressive results. During Q1 Wyoming became the tenth State to adopt ID Mark. We now have several programs in production and in the quarter the number of circulating driver’s licenses with ID Mark surpassed the 2m mark.

Our print to internet initiative to simplify navigation for users of smart phones and wireless PDAs is expanding. We are continuing to work with Intel to optimize our wireless print to internet solution for the next generation processor for smart phones. Digimarc applications were showcased at several Intel developer forum events throughout the world in Q1, including stops in the U.S., Japan, Taiwan, India, and China. Intel executives highlighted our wireless print to internet application at the announcement event for the new Intel PXA270, showing the power that one handed point-and-click navigation from print to rich media and e-commerce content can bring to Wi-Fi and 3G networks.

In licensing we were encouraged by an increasing number of inquiries about licensing terms, including initial expressions of interest from some major corporations. We see the recent Microsoft settlement with InterTrust as a promising signpost on the road to implementation of effective media rights management, and the acknowledgment of the enormous value of seminal patents in the field. InterTrust technologies and digital watermarking are quite complementary. And we feel that DRM, particularly in the entertainment field without digital watermarking is an incomplete architecture that is obviously easily circumvented. We believe that our core intellectual property holdings cover an essential ingredient of the emerging architectures for DRM and management of rights and permissions for analog incarnation of the digital media that will be covered by such technologies.

We got a testimonial to the effectiveness of digital watermarking as a video piracy deterrent at a meeting of the Motion Picture Association of America during the quarter, when a number of those present were reported in the press as having attributed a portion of the 50 percent reduction in piracy year-over-year in the Academy Screeners Program to digital watermarking. The quoted remarks included the following statement by an industry trade association executive who said, ‘the FBI found watermarking as an important enforcement tool.’ It just seemed like the first time we had heard that watermarking is without question an effective enforcement tool for finding out who leaks screeners. As noted here, word is getting around about the benefits of digital watermarking in forensic tracking. We expect continuing growth in the use of watermarking for forensic tracking in both prereleased movies and in music.

On the intellectual property front our portfolio continues to grow. We just received notice of the issuance of our 150th U.S. patent. We now have over 3,100 claims in our issued patents, and approximately 400 more patents pending in digital watermarking, and personal identification systems, and related technologies.

E.K. will now provide financial guidance for Q2 of 2004 and for the remainder of the year. E.K.

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 will not include the potential impact of any investment outside the ordinary course of business or mergers and acquisitions.

Our estimates for the second quarter of 2004 are as follows. Total revenues in the range of 21.8m to 22.8m. Gross margins in the range of 44 percent to 46 percent. Combined operating expenses for research and development and engineering, and selling, general and administrative expenses in the range of approximately 9.7m to 10.3m. Other income consisting mainly of interest income of approximately 175,000, assuming no material change in average cash balance or interest rates from the first quarter and in cash balance. And a provision for taxes of approximately 50,000.

Based on the above assumptions we estimate diluted earnings per share to be in the range of two cents to four cents for the second quarter of 2004 based on 20.8m weighted average shares. For the full year 2004 we are maintaining our previous revenue guidance of 94m to 97m. We are looking to our prior full year guidance on diluted earnings per share, we have a [total] [ph] investment in certain areas, in several areas, since our last call. Specifically to strengthen our finance and IT organizations, add resources in the marketing and licensing areas of our watermarking business, and have experienced channel sales resources to drive, identify market expansion opportunities in our ID systems business. In addition, we have increased our budgetary reserves related to laying down the necessary infrastructure for Sarbanes-Oxley compliance.

These additional investments are being made in anticipation of strong growth during the second half of 2004, continuing into 2005, and beyond. These additional investments will improve our ability to capitalize on growth opportunities and to manage the fruits of that success more effectively. As a result, this anticipated increase in spending we are bringing our full year diluted earnings guidance in line with the current Street consensus, EPS range of 27 to 32 cents, based on approximately 21.2m weighted average shares.

We expect EBITDA for the year to be in the range of 17 to 18.7m.

On the cash flow front we expect that investments in new programs throughout the year will consume cash and equivalent cash flow from operations for at least the next couple of quarters. Our balance sheet can easily accommodate these requirements. Some of the investments may be funded through equipment lease financing.

With respect to the second quarter we expect these program costs to cause a decrease in our total cash balance including short-term and [expense] [ph], that will be smaller than in Q1. We expect net cash flow to improve during the second half of the year unless we win substantial additional issuance programs.

Bruce will now offer a few concluding remarks.

We continue to anticipate a very good growth year on the top and bottom lines of our business, with the lion’s share of the growth happening in the second half of the year. Key activities during the next couple of quarters include ramping up production in the Florida driver’s license program and the Mexico voter identification program, successfully bidding on a number of domestic driver license programs, developing and delivering a number of significant enhancements to our credentialing systems, building channel relationships to sell products and services into adjacent Federal and commercial channels here and overseas, and adding significant new licensees to our [Groton] [ph] global technology licensing program.

This concludes our presentation for today. We will now welcome your questions.

[Caller instructions.]

Your first question comes from Chris Kincaid, SG Cowen and Company.

It looks like gross margins in watermarking were up pretty significantly, both sequentially and on year-over-year basis. I was wondering if you could comment on that? And was also wondering if there are any significant changes in the customer mix for watermarking beyond your one main customer?

Chris, the improvement in the watermarking revenues is primarily a result of the revenue mix. And that will vary from quarter to quarter. We expect in the long-term that that gross margin will continue to improve as the bulk of our revenue shifts more towards licensing side of the revenues. So away from the service side of the revenues. So it’s strictly a function of the revenue mix.

Okay.

It’s a part, Chris, of the general trend that we have told you you should expect to see. As E.K. points out, there may be some variation quarter to quarter but the general trend should be in the direction that you’re witnessing.

And then, can you comment on the margin trends by segment in Q2? I would expect DIBS gross margins to be up because you have, you know, no longer the impact of the low margin international sales. Your blended gross margin guidance of 44 to 46 percent seems to imply that the ID margins don't necessarily return to typical levels, say between 44 and 45 percent, unless you’re expecting watermarking margins to decline sequentially? Can you comment on the trends there?

Yes. Our gross margins, we expect ID systems to return to normalized gross margins, in general. Our overall gross margins are in line with the historical performance of 44 to 46 percent . The best gross margin quarter that we have had in the last 12 months was Q3, which was about a little over 47 percent. And so it’s pretty much in line with, you know, what we’ve been running, and that’s what we expect to see going forward.

And so you expect to see typical DIBS gross margins around 44, 45 percent?

I would say between around 42 to 45 percent, somewhere in that range.

45 percent. Okay. Thanks a lot.

Your next question comes from [Brian Rutenbur] [ph], Morgan Keegan.

Yes, this is Brian Rutenbur. The question I had is about the mix of revenue going forward. I think it was addressed a little bit last, on the last question. You had great watermarking sequential growth, and can we expect to see sequential growth in watermarking going forward? Or is it going to be a leveling out?

As I answered on the last question, there may be variations from quarter to quarter, but the trend you should see is improvement going forward for the foreseeable future. And so we are anticipating in our annual projections significant growth in watermarking. You’ve seen margin expansion and growth, those are the general trends we expected to observe. But that doesn’t mean that there will be sequential quarterly growth. I’ve cautioned everyone who knows us well that in early stage market development things don’t grow in that fashion. And so on an annual basis you should see significant growth. On a quarterly basis there may be a little bit of volatility.

Can you tell us why the growth is taking place now, and you know, why it’s picked up here recently? And is it, you know, on the ID side that you’re getting the traction on the digital watermarking or is it something else?

Business is good everywhere. We’re anticipating significant growth in all parts of our business, and improved profitability. And so, just business is good. On the watermarking side we are, you know, building on the [imagery] [ph] product line, as I’ve described our expansion plans there and the product strategy. Licensing continues to improve. And our Central Bank relationship is a good, healthy relationship. It doesn’t have high growth, generally, but it does have reasonable margins for us. And that really is the sum of the watermarking business today.

What we see going forward is great promise in the licensing area, and continuing growth in the product area. And the beginnings of generation of significant revenues within the next 12 months or so in the ID Mark new product initiatives. And so this looks pretty good across the board, I think.

Okay. And then, on investments, you know, you’re going to have it looks like a heavy year of investments this year. Is that primarily because of ramping new programs, and then in ’05 we’re going to see a lot less investments and more cash to the balance sheet generation, is that the idea?

Well, I actually hope not. With respect to ’05. The reason that we’re ramping the expenditures in ’04 is because of strong growth. And so I’m actually hoping that we’ll see even stronger growth in ’05. We already from our vantage point in terms of our backlog anticipate a very strong growth year in 2005.

And so, given the nature of our revenue recognition policies with respect to our secured potentials, part of our business we invest up front and then recognize revenues. And so you’ll see, hopefully, continuing wins in programs here and abroad, that’s our intention. And as we win more programs we’ll be spending money to put them in place, and then generating a substantial profitable annuity for our shareholders for many years to come.

And so, but the increase in spending here, you see here, is a leading indicator of good times. It’s anything but a problem. It’s really something that you should not be daunted by if you see in ’05, as long as the revenues both in what we deliver and what we forecast continue to show the strong growth that we’re going to be showing here in the second half of ’04 and into ’05.

Okay. And then the last question is about kind of the year is very backend weighted, and yet the revenue at least according to your guidance doesn’t appear to be ramping that significantly to have such a significant EPS ramp in the second half of the year. Maybe you can talk about profitability in the third and fourth quarters and why they’re going so much higher than the first and second quarters on, you know, on the revenue that’s not ramping as fast? If you see what my question is?

Yeah, although I think I see the figures a little bit differently. Our guidance from 94m to 97m, and so there is actually substantial revenue growth in the second half.

But it’s relatively small. You’re talking about, you know, third quarter is going to be 22m to 23m, something, I know you gave the exact figures but my rounded numbers. You know, that would mean that the remainder of the year would be another 50m, or 25m or 26m, in that ballpark. It’s a rough ballpark.

Right.

But yet your profitability is going to go from making three to four cents, or two to four cents per quarter on 22m, to on 25m, 26m making eight to 10 cents, just doing mathematically what the quarter is going to have to be for the next two quarters, or in the third and fourth quarter. And I was wondering what is driving that? Is it a mix of business, is it the licensing business, the ID business is ramping, but it becomes that much more profitable? I’m just trying to understand why that’s so much more profitable?

Well, Paul is going to give you a little color on the detail in the second half of the year.

Yes, this is Paul. I’d say there are three primary factors you should look at. One is the second half of the year, you know, existing driver’s license issuing programs tends to be from a seasonality point of view the higher periods of issuance, and so Q3 in particular is a very strong quarter for issuance. Q4 drops off a little bit as we’ve seen in past end of year quarters, but still is stronger than for example Q1. Typically it is again based upon seasonality.

The issuance for us because we’ve got essentially a fixed field operation structure in terms of its costs, and relatively flat or slowly growing operating expense structure in the ID business, is on an incremental basis is very profitable for us. And so each incremental dollar of issuance that we bring in has a very nice margin impact on the bottom line. And so that’s the one primary factor.

Another factor as Bruce covered in his comments, is we have two really large long issuing systems coming online. New systems in Florida and in the Mexico voter identification programs. And so these offer us incremental issuance volumes. And again, with very nice margin structures associated with them. And that’s a second primary impact, and so new issuance programs are coming online in full in Q3 and Q4.

And then, finally, as Bruce also talked about, we intend to develop new distribution channels for our subsystems and products associated with our driver’s license business. And those are pretty leveraged. These are existing channels that provide such materials to customers and international geographies, and then commercial markets here in the United States. And so for us there’s little incremental expense associated with building these channels. And so the profitability based upon our forecast looks pretty encouraging.

Brian, let me add something to what Paul just said. Also, if you look at Q4 to Q1 we added about 4.5m in revenues in one quarter. And from that point we continued to add revenues going forward. The growth from Q4 to Q1 is primarily a good buy at low margin, international revenue that we discussed, okay. But going forward, that mix will get much richer with the new programs coming onboard. And so we demonstrated to you in terms of the backlog, we have 80 percent of the revenue already covered by the backlog. And the margin looks pretty healthy, in the second half, with the product mix we have seen. And so we are comfortable with our projections for the second half of the year.

Okay, well, thank you very much. I appreciate it.

You’re welcome.

Your next question comes from Steve Lidberg, PacificCrest Securities.

Good afternoon, guys. First of all, I’m in an airport and so I’ll just ask the questions, and then you can throw me on mute. But first of all, headcount, where is it at the end of Q1? Secondly, as you look at the licensing discussions that you’re holding, Bruce, where are you in the process of those discussions? At the stage as more of an [education] [ph], or are we moving beyond that stage? And then, I guess a similar question as it relates to your channel partners that you’re looking to ramp-up in the second half, and related it to that, how significant a contribution are you looking at from those partners in Q3, Q4? Thanks.

Steve, let me address the headcount. We are approximately at 500 people at the end of last quarter. We added approximately 30 people during the quarter, okay. And when we talk about the headcount numbers that includes employees as well as contract people that we employ.

Okay, and Steve, with respect to licensing negotiations, we’re seeing, as I’ve started the year with some guidance, what may be an inflection point in licensing. For the first time in our history we have potential licensees coming to us offering to take licenses. And you know, from our history that in the early stages of development of our program we had to litigate several times, and you know, we’ve had to go out and sort of beat the bushes in developing our initial licensees.

That’s all, appears to be changing. People now understand that we’ve done an excellent job in creating a substantial and very meaningful asset in our intellectual property portfolio, that we have the means and skill to represent it well in the marketplace. And so we have had a number of companies come to us and ask to license our patents. And we are at various stages with various people. But we think we’re really in very good position with respect to the patent portfolio and gaining not only more licensees, but more substantial licensees, and seeing a continuing proliferation of watermarking applications in all of the major media markets.

And so that’s about all I can say at this point. I can’t give you any specific timetables, but I can say that things have changed. And we’re seeing a validation of our strategy as we move into 2004.

As to channel partners, I’ll turn over the floor to Paul to give you something of what our strategy is there and our status.

Hi, Steve. This is Paul. We’ve been really developing this program going back into the second half of ’03. And in the current period we’re just now coming online with the products that we think will be differentiated within these channels. And cause some excitement with our partners. We’ve gone through some extensive testing in Q4, and again in Q1. And aspects of our cards is their durability, their performance, and high-end cards for laser engraving, things along that line. And the results coming back are, have been uniformly very much in line with our expectations, and have given us the confidence that we have provided the forecast that we have today.

In terms of the types of partners I’d characterize it as there is two general types of partners. There’s large integrators and international [lithographies] [ph] which prime or supply a lot of the issue and subsystem equipment itself. And for us then they represent opportunities to provide consumables into long-term contracts or programs, such as national ID cards and the like, and other geographies, where we don’t have established sales and marketing organizations.

The other type of channel partner that we’re working with today would be best characterized as equipment suppliers, printer vendors and others who build subsystems for the issuance market, and who routinely provide consumables for their customers, whether it be dealers or integrators, or VARs in other geographies. And our consumables will be positioned as kind of a premium offering, kind of a high-end offering, and security and laminates, and so forth. And so those are the kind of the characteristics of who we’re talking to and who we plan on working with.

In Q1 we entered into our first relationship or contract of any significance, and we recognized very modest revenues in Q1 associated with that first engagement. That will carry into Q2, and during the quarter we expect to enter into a couple more similar relationships and begin to see the ramp occur.

In terms of total revenues for the year, we don’t really break that out, but it would be something less than 10 percent of total revenues is what our expectation is for the full year.

[Caller instructions.]

Your next question comes from Julie Holland, DA Davidson and Company.

Hi, guys. I just had a question about New Jersey. In January you said that there was a delay in the billable activities, and I was wondering where that stood at this point in time? I’m assuming that since you mentioned that you’re going through an upgrade that that’s still the case?

Yeah, this is Paul. The New Jersey program is a little bit different type of program than many of our, most of our domestic issuing programs, in that the structure here is one in which the title for the issuing equipment passes to the customer in New Jersey per their rollout of the new offices across the State. And then the ongoing relationship with New Jersey would be the supply and consumables, and other support to the issuing program.

And so I believe what you’re referring to was a delay really that has to do with the State’s own progress in bringing on new networks and overall State infrastructure, supports the new issuing program. And so we’re still kind of a mixed situation where we’re providing materials for the old film based program, while rolling out new offices each week across the State as they switch over to digital.

And so, we’re a little bit behind schedule, several months behind the original intended schedule when we entered into the contract. And we’re, there’s really no kinks or bumps, it’s just kind of a little bit of a stretch that has occurred here. And so, we have some delays in the shipment of some of that front-end equipment into the State.

Do you know when that should be resolved? Have they given you any idea?

You know, well, the current schedules indicate that we should be fully up and deployed, and everything should be for the most part substantially completed during Q2.

Okay. Also, with Maryland and Oklahoma, are you still seeing some wind-down there, and if so, when do you expect those to be completed?

Both of those programs we ended at the end of last year.

Oh, they did, okay. And then, also, I was wondering if there was any incremental revenue that you see as ID Mark as added to contracts?

There’s not a significant amount of revenue associated with the license to the States that have the data in the licenses. Our business model is to make it easy for the States to adopt and then to charge the application vendors the derived value from the data that’s embedded in the licenses.

Okay, okay. And one last thing, is there anything new on the CFO front?

Yes, we’ve been making good progress. We’re quite far along in the search, and we’ve identified a couple of excellent candidates. And believe that we should be able to complete the search shortly.

Okay, great. Thank you.

At this time, there are no further questions. Mr. Davis, are there any closing remarks?

I’d like to thank everyone for participating today, and we’ll look forward to talking to you again in another quarter.

Thank you very much.

Thank you. Bye.

This concludes today’s Digimarc Corporation Quarter One 2004 Conference Call. You may now disconnect.