Digimarc Corp (DMRC) 2004 Q4 法說會逐字稿

Good afternoon. My name is Myles and I will be your conference facilitator today. At this time I would like to welcome everyone to the Digimarc Corporation conference call. All lines have been placed on mute to prevent any background noise. After the speaker's remarks there will be a question and answer period. If you would like to ask a question during this time simply press star and then the number one on your telephone keypad. If you would like to withdraw your question press star and the number 2 on your telephone key pad. Thank you. I would now like to turn the call over to Mr. Bruce Davis, Chief Executive Officer. Sir, you may begin.

Good afternoon, ladies and gentlemen. I'm sorry for the delay. Let me explain what's going on here and apologize for the inconvenience. We submitted an earnings release awhile back to the Business Wire and for reasons that are not clear to us it hasn't been posted yet. It was supposed to be posted two or three times according to their notices to us over the past 30 minutes. And so we've been waiting patiently. I don't feel we should wait any longer so we're going to have to improvise a bit here and we will begin talking through the prepared remarks of the script, recognizing that you have not yet gotten the press release. I have the internet running in the background and when I see that the press release has been posted I will pause and let you all know that that's the case. So, sorry about the situation here, but we are trying to give you up to the minute information and it appears that we pressed a little too close to the deadline on the release itself.

On the call today I have Mike McConnell, our CFO, Paul Gifford, our President and COO, and Bob Chamness, our General Counsel. In the press release that should be posted imminently we will be describing our 2004 results and the restatement results for 2003 and the first half of 2004. The objectives of this call are to provide an update on our SEC filing activities, summarize the unaudited 2004 results, anticipated prior period restatements and status of our Sarbanes Oxley Section 404 compliance activities. Review significant business developments and market conditions during the second half of 2004 and provide some visibility on our prospects and plans for the remainder of 2005. The audited financial information that will be discussed during this conference call has not been completed. Thus all financial information we are providing is subject to continuing review and audit by our independent registered public accounting firm and the company's audit committee. All references in the press release or this conference call, the financial results for 2003 for individual quarters within that year and for the first two quarters of 2004 refer to the company's anticipated results for such periods after giving effects to the restatement. This webcast will be archived in the Investor Relations section of our website.

Before we proceed I would like to remind everyone that during the course of this conference call we will be making forward looking statements. These statements are based on our current expectations and are subject to certain assumptions, risks, uncertainties and changes in circumstances. These statements will include without limitation statements related to the implications of the company's 2004 earnings on subsequent periods. Statements regarding management's opinions and expectations regarding any and all aspects of the business. Actual results may vary materially from those expressed or implied from such statements. For more detailed information about risk factors that may cause actual results to differ from expectations, please see the company's filings with the SEC including the MD&A section in our most recently filed forms 10-Q and 10-K, our earnings release, which will be posted shortly, and our most recently filed form 8-K. Any guidance we offer represent 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. We have not yet filed our 10-K or 10-Q for the third quarter of 2004. The 10-K will include the final restatements of financial statements for fiscal 2003 and the first two quarters of 2004. Because it's been an unusually long time since we've had the opportunity to discuss our business and financial results with you, we will take some time today to describe the business trends and market conditions we experienced in the second half of the year. And that we see impacting us as we move forward. And provide some additional elements of context to facilitate an understanding of the anticipated restatement and filings delays on our business. The filing of our form 10-K for 2004 and the third quarter of 2004 10-Q may still take a few additional days to complete.

Our SEC filings are in final drafts and we are doing all we can to assist our auditors as they finalize their documentation and related audit procedures. Due to this continuing work we have not yet filed our form 10-K and form 10-Q within the deadline prescribed by NASDAQ for continued listing of the company's common stock as set forth in a decision on March 22nd. We notified NASDAQ about the delay and have requested that they continue the listing of our shares. We can not provide any assurances they will grant our request. The restatement activities have weighed heavily on our business for many months now. Mike will describe those activities and explain the anticipated restatement of certain prior period financial statements.

The errors that led to the restatement were discovered by our finance team during a review of our financial controls and a newly implemented accounting system in connection with early Sarbanes Oxley compliance work and a continuing integration of that new accounting system. Once discovered we promptly brought the matter to the attention of our auditors and the audit committee of our board of directors. Our finance organization moved aggressively to address the situation. The resulting review has taken a long time and has led delays in filing the financial statements and reduced our interaction with the investment community. It grew into an exhaustive effort by our finance team. Looking at nearly every aspect of accounting in our ID Systems business since we acquired the underling operations from Polaroid in 2001. After seven months and more than $2 million in legal and accounting fees, we anticipate that the restatement will be limited to financial statements for 2003 and the first two quarters of 2004. We expect the resulting impact of the restatement will be to increase reported net losses over the eighteen month period by approximately $2 million.

The accumulative impact of the restatement ended up below the mid-point of the 1.2 to 3.5 million range we estimated in September of 2004. Most of the amount of the adjustment is attributable to incorrect capitalization, certain software development and project costs at our ID Systems business unit. At Digimarc we respect -- recognize and respect the heightened value investors place on public company credibility in the Sarbanes Oxley era. Even before Sarbanes Oxley was conceived, with the guidance of our board of directors we had embedded principals of honesty and integrity as the corner stones of Digimarc's corporate governance policy, value statement and codes of conduct. The following principals of good corporate governance, the audit committee of our board was actively involved in providing oversight throughout the restatement review process. The response of our management and board to the discovery of accounting errors demonstrated our resolve to adhere to these principals and serve to reinforce the associated values throughout the company.

I'm proud of the manner in which our executives have addressed the problem, the thoroughness with which our finance team has conducted the review and the professionalism with which they're implementing the necessary improvements to our accounting and project management processes. I want to thank our finance team, audit committee, legal council and auditors for their conscientious attention to these matters for many long months. With the restatement process nearly complete, we are closing the books both literally and figuratively on this chapter in our history. At this point we have hired and appointed new staff in key positions in our ID Systems business, substantially completed installation of the new accounting software, improved training for our staff in key areas and instituted other remedial measures including continuing documentation of revised policies and procedures. As we move forward we will continue our efforts to identify opportunities to improve our controls and procedures and make appropriate investments in infrastructure to support our continuing growth.

Despite having not yet brought our financial filings up to date, I can say that after many months of distraction and disruption from the restatement and related matters, we are very near the end of the process and ready to return the focus of management and the investment community to the exciting growth prospects for our business. Over the past several months we have markedly improved our infrastructure to support the growth of our business and are ready to continue to build on our market leadership in providing secure media and identity solutions and technologies. Now let's proceed to the financial review with Mike. Mike?

Thanks, Bruce. Throughout the call today we will be referring to the 2004 third quarter, 4th quarter and full year financial results and their comparative amounts for prior periods. We will also discuss restated financial statements for 2003 and the first two quarters of 2004. Keep in mind that all financial results and other financial information mentioned during this call are unaudited. We expect to file audited final numbers in our form 10-K and form 10-Q within the next few days and do not expect there to be material changes from the unaudited financial results we are presenting today. Nevertheless, the financial information that we will discuss today is subject to continuing review and audit by the company's independent registered public accounting firm and the company's audit committee and could be subject to adjustments.

All references we make to financial results for any quarter during 2003 or the first two quarters of 2004 will reflect the anticipated restatements of the financial statements for those periods which will be detailed in the form 10-K and form 10-Q that we file shortly. We do not intend to amend our previous annual reports on form 10-K or quarterly reports on form 10-Q for periods affected by the anticipated restatements. As previously noted, such previously published reports should not be relied upon. I'll start with the results for the full year 2004, then briefly cover some of the highlights for the second half of the year. Following the discussion I'll review the impact of the restatements on prior periods and the preliminary results of our ongoing Sarbanes Oxley Section 404 review process. So, looking first to our full year 2004 income statement, revenues for the year increased 7.3 million or 9% to 92.9 million from 86.5 million. ID Systems revenue increased 5.5 million or 7%, reaching 81.8 million from 76.3 million recorded in 2003. This increase primarily reflected new driver's license contracts in Florida, Latvia and a voter ID contract in Mexico, plus increased international revenues from various countries including a large voter ID program in Ghana.

Digital watermarking revenues increased 1.9 million or 20% to 11.2 million from 9.3 million, reflecting increased licensing revenues, higher revenues from our anti-counterfeiting system work, initial revenues from the IDMarc pilot program, funded by the US Department of Transportation and revenue recognize in connection with our Digimarc Mobile initiative. Looking at revenues geographically, international revenues increased 6.8 million in 2004 or 48% to 20.8 million from 14 million in 2003, reflecting initial revenues from the Latvia, Mexico and Ghana contracts that were rolled out during 2004 and general growth in many areas of our existing international business. U.S. revenues grew approximately 600,000 over 2003, largely reflecting growth in patent and technology licensing and increased revenues from our anti-counterfeiting system work.

Gross margins for 2004 were 38% compared with 45% for 2003. The decrease in gross margins resulted from a number of factors, including inventory and program asset charges related to excess obsolete and slow moving items, increased international operating costs related primarily to the ramp up of two large new programs, lower margin revenue mix during the first half of the year, including revenues from follow on film sales to a foreign customer and from certain domestic equipment sales. Cost over runs related to the installation of a driver license issuance system in the first half of the year and higher depreciation charges and some new contracts and upgrades of existing contracts. Much of the gross margin decline was due to the excess and obsolete charges and from low margin film sale to a foreign customer and the cost over runs in the domestic project installation recorded during the first half of the year.

Operating expenses for 2004 totaled 45 million, an increase of 6.3 million or 16% above the 38.7 million level of 2003. Most of this increase was centered in general and administrative costs which increased due to a variety of factors including increased compliance costs, litigation settlement charges, increased bad debt expense, charges for vacating our old building and increased cost related to higher finance and IT department staffing. We incurred higher legal, accounting and consulting fees primarily in the fourth quarter of 2004 due to restatement work and our efforts to document, evaluate and test our internal controls in accordance with Sarbanes Oxley. Full year 2004 sales and marketing expenses were 11.9 million, up from 11.6 million due to hiring management and other resources in both our ID Systems and watermarking businesses to improve our market presence and our ability to predict and drive sales performance including the development of products and leads in non-government commercial channels for certain new ID Systems projects.

We also recorded approximately $500,000 impairment charge related to investments made in 2002 in two private companies. These costs were partially offset by lower headcount and spending controls in other areas. Research and development costs were 7.2 million up $400,000 over the prior year primarily due to expenditures in new product initiatives in our ID Systems business unit such as card development, software enhancements and capture stations that we are developing for use with our core customers and for sale through distributors and other channel partners. The decreased gross margins and creased operating expenses combine to more than offset our increased revenues in 2004 resulting in a net loss of $9 million compared with a net income of 200,000 in 2003. Our balance sheet remains strong at December 31, 2004. At December 31st we had approximately 52 million in cash and cash equivalents, restricted cash and short-term investments and $49 million in working capital. These amounts compare to 79 million and 89 million respectively at December 31, 2003.

A decrease in both cash and working capital are directly attributed to nearly $40 million expended for capital projects, the majority of which related to contracted program expenditures including Mexico and Latvia internationally and for new contracts in Alabama and Florida and upgrade contracts with several other states that chose to enhance their systems. The 2004 capital investments began driving increased revenues in the latter half of 2004, a trend which we expect to continue in 2005. Lastly, 8.3 million of restricted cash was moved from current to long-term assets. Our backlog at the end of the year approximated 260 million which is comparable to the balance at the end of 2003. During the year we added to the backlog with new multi-year contracts with Ohio, Wyoming and New Jersey. In addition, several states including Texas, Virginia, West Virginia, Washington, D.C. and the province of Manitoba, Canada notified us of extensions of their existing drive license contracts. We also received an extension of the long-term agreement with the Central Banks. These gains were offset by natural consumption of the backlog during the year.

Quarterly DSO's of 62 days at the end of 2004 compares consistently with 63 days at the end of 2003. Deferred income group, 3.2 million to 4.9 million, the increase being primarily attributable to funds received for customer upgrades prior to the revenue recognition criteria being met. Cash provided from operations totaled $4.2 million during 2004 compared to 25 million -- 25.3 million in 2003, primarily reflecting increased losses in 2004 and changes in our restricted cash. We expect to continue to utilize cash in the upcoming quarters as we complete our program implementations in Florida, Alabama and Ohio and build inventory levels for these and the Mexico program as those programs reach full production. In addition, we may utilize cash resources to fund acquisitions or investments in complementary businesses, technologies or product lines. This concludes my prepared remarks for the full year 2004 results.

Next I'll briefly cover significant changes in the second half of 2004. The second half of the year 2004 experienced good revenue growth primarily in the ID Systems international business and in watermarking where we saw revenue growth from our anti-counterfeiting system work, IDMarc pilot, Digimarc mobile initiative and patent and technology licensing. Gross margins for the second half of 2004 are down compared to 2003 primarily due to low margin ID issuance programs that came on in the latter half of the year and higher operating expenses depreciation charges on new and upgrade contracts where we supply greater functionality without corresponding increases in our prices. With regard to operating expenses, we invested in sales management and other resources to improve our market presence, our ability to predict and drive sales performance and new product initiatives. We also incurred a $500,000 impairment charge related to technology and investments that I referred to a moment ago.

In addition, the bulk of our 2004 legal and accounting cost related to the restatement activities and Sarbanes Oxley efforts totaling over 2 million were incurred in the second half of the year. We also incurred some litigation settlement charges, increased bad debt expenses, charges for vacating our old building and increased costs related to higher financial staffing and consulting fees during the second half of 2004. Next I'll review the anticipated restatements that we've identified for 2003 in the first quarters of 2004. The 10-K will contain a detailed discussion of our review and impact of these restatements. After becoming aware in September 2004 for possible accounting errors at DIDS(ph), we initiate a review that determined that certain prior period financials required restatement because they contained errors. The total restatement amount is expected to be approximately $2 million or approximately $0.10 per share spread over six quarters. The quarterly impact on operating results ranged from a decrease of $0.01 per share to a decrease of $0.06 per share with approximately 1.4 million or $0.07 per share of the amount related to 2003.

The majority of the increase loss related to improperly capitalized software development costs and certain errors in project accounting. The adjustments for software capitalization relate to the software development costs under SOP 98-1 that either did not qualify for capitalization or the software project itself did not qualify as internal used software. The adjustment for project accounting relate to the failure to expense in the period incurred certain costs that were deferred as inventory or fixed assets. Other issues identified during the thorough review of ID Systems that we conducted required smaller adjustments to record -- to correctly record inventory receipts in the proper period, correct the time that revenue recognized for a maintenance contract, correct commission liability related to long-term card product contract, correct VAT payables and expenses, correct revenue recognized on a milestone based contract to match revenue recognized when the milestones where completed and correct intercompany allocations which were not properly recorded.

While the amounts associated with these other adjustments are relatively small, we believe it is appropriate to record them as part of our restatement. The adjustments led to a substantial number of new entries during the restatement process which contribute to both the length and cost of the process. In connection with the restatements, we identified and reported to the audit committee a number of areas for improvement and internal control over financial reporting. These matters constitute material weaknesses as defined under standards established by the Public Company Accounting Oversight Board or PCAOB. The areas identified as needing improvement include supervision and technical accounting expertise within the accounting and finance department, design and implementation of our new accounting system, inadequate quarterly and year-end financial statement close and review processes, controls for both determining the nature and type of costs that should be capitalized and for assuring allocation of costs to particular projects are appropriate, controls to ensure that various international tax exposures were quantified and properly accrued on a timely base, training and reconciliation processes for complex revenue recognition requirements primarily related to international transactions, controls related to system access and segregation of duties and entity level controls.

We will describe these matters and the changes we've implemented and are continuing to implement to correct these matters in detail in our form 10-K and form 10-Q filings. We will continue to look for opportunities to strengthen our internal controls and enhance our reporting processes. Likewise, we will address any items that are identified in our internal control assessment under Section 404 of the Sarbanes Oxley act of 2002 and related work which is continuing. Speaking of Sarbanes Oxley, I'd like to update you on the status of our Sarbanes Oxley Section 404 review of internal controls as of December 31, 2004. Section 404 requires that we file with the SEC a reported internal controls over financial reporting and related attestation reports of our independent registered public accounts. We are not finished with documenting and testing our systems of internal controls over financial reporting to provide the basis for the required report. The focused application of critical finance resources to the accounting review associated with the restatements has set a significant impact on the pace of progress on Section 404 compliance efforts. We will do everything we can to file a report as soon as possible. We are targeting May 2nd for our filing.

Given the time requirements necessary to test our processes, there can be no assurance there will be sufficient time and resources available for us to be compliant by that date. Due to the nature of the deficiencies identified during 2004 and time necessary to fix them, we have not effectively remediated several of the deficiencies as of December 31, 2004, the date of the required assessment of internal controls. As a result, we expect that our auditors will issue an adverse opinion on our internal control over financial reporting at the time of filing of this report. Nevertheless, we believe we have been able to employ compensating procedures that have given us and our auditors confidence that we can issue financial statements for 2004 that fairly reflect the financial performance of the company despite the internal control weaknesses that we have identified. Now I'll turn the discussion back over to Bruce to discuss significant 2004 developments, underline business trends, market conditions and our plans for moving forward.

Thanks, Mike. We've grown at an incredible rate in my eight years since I joined the company with our revenues having increased from 240,000 to close to $100 million per year. With that we have now endured some growing pains that will lead to better infrastructure. Improved infrastructure is important as we continue to grow. We had good top-line growth and a continued strong backlog in 2004. The year presented much to be encouraged about in both digital watermarking and secure personal identification. Increasing interest and attention around digital rights management, homeland security, and anti-theft, anti-fraud solutions, among other things, fueled increasing adoption of our patented technologies and solutions. These trends support our expectation of an even higher rate of growth in 2005. In 2004 we witnessed encouraging interest in growth in adoption of digital watermarking base solutions from Digimarc and many of our licensing partners addressing a number of critical anti-fraud and anti-piracy needs.

Our digital watermarking solutions and licensing teams are making progress as they work in tandem to development the market for digital watermarking fostering growing commercialization of our own products and solutions, broad licensing of our technologies and patents by other suppliers of digital watermarking based solutions and increasing awareness and acceptance of the applicability of our technologies in a widening array of industries. Our longstanding relationship continues with a consortium of leading Central Banks that rely on certain of our proprietary technologies to deter the use of personal computers and other digital imagine devices in counterfeiting bank notes. Their use of digital watermarking has accounted for the majority of our watermarking revenues in 2004 as in prior years. In 2004 we made good progress on IDMarc, one of our key initiatives. IDMarc is a digital watermarking security feature in driver's licenses that is intended to reduce the risk of counterfeiting and tampering and provide cross jurisdictional authentication of identity documents.

Our customers have recognized that digital watermarking can help improve traffic safety by keeping bad or unauthorized drivers off the road, combat identity theft and fraud by validating the authenticity of driver's licenses and enhance homeland security efforts by assisting law enforcement in verifying identity documents presented for access to restricted areas for transportation. Twelve state DMV's representing more than 20% of annual US drivers license issuance volume have now adopted this feature. And I understand our press release is now posted for those of you with internet access. In the third quarter of 2004 we entered into an agreement with the U.S. Department of Transportation to roll out a pilot program that enables law enforcement, retailers and DMV's to inspect and authenticate driver licenses containing IDMarc. This pilot with approximately $1 million of federal funding is under way with the State of Nebraska. And if successful, is expected to provide a foundation for full scale rollout across the country in the years ahead.

In new business development we are making progress in print to web connectivity using camera phones. The June 2004 launch of our Digimarc Mobile initiative was heralded with the announcement that Tokyo based Media Grid had signed a multi-year license to use Digimarc Mobile software to provide mobile commerce services to Japanese consumers. Our innovative solution uses patented digital watermarking technology to enable camera phones with internet capabilities to navigate with one click from printed materials such as magazine, packaging and posters to digital entertainment, location-based content and commercial transactions. In September we were invited to showcase our Digimarc mobile technology at DEMA Mobile, one of the most prestigious annual mobile industry events in the world. Later this year Media Grid plans to pilot this capability in Japan.

Our digital watermarking licensing did well in 2004 gaining momentum on two fronts. One is focused on evangelize and the capabilities of digital watermarking for forensic tracking, content monitoring and protecting movies and music from unauthorized copying and distribution to movie studios, TV broadcasters, record labels, digital media distributors and digital media device manufacturers. Our other major focus is actively working to license our IP to proven solution providers and help them to develop a market. Hollywood and the broadcast community have begun incorporating digital watermarking in audio and video content to monitor and track content usage. For instance, in a highly publicized legal case the FBI and Justice Department garnered a guilty plea to federal copywrite infringement charges for reproducing and distributing Academy Award screener copies of Oscar nominated films from a man who obtained them illegally from a member of the Academy in advance of the 2003 awards. Because each of the screener copies carries a unique digital water make based identifier, the authorities were able to trace the chain of custody and shutdown the serious leak of Hollywood movies into global internet distribution.

The Academy recipient was expelled from the Academy and subsequently fined $600,000 sending a powerful message to the entire motion picture community about the importance of adhering to rules that govern distribution and how new digital watermarking based solutions can help protect movie content. The success of the screener program has opened up new opportunities to extend the market for forensic tracking beyond the Academy screeners in post production environment. In 2004 Philips Electronics launched its new replitrac(ph) solution, which provides the same basic forensic tracking capability used in the Academy screener program. And relatively low cost replication equipment for use in tracking movies and other video assets throughout various stages of production. Elsewhere, Teletrax, a joint venture of Media Link Worldwide and Philips Electronics and one of our licensed partners, broadened distribution for its watermark based television broadcast monitoring solution.

During 2004 and early 2005 Teletrax reached agreements with numerous news and entertainment companies including divisions of ABC and NBC television networks to track network promotional materials aired by television stations in the top 100 U.S. markets. Adding the contract settlement to with the BBC Buena Vista Television, Tribune Entertainment, NBC Universal Television distribution, NBC News Channel, Reuters Television and Australian based Media Review International. Lastly on the licensing front, in 2004 we licensed the Family of Rights Management patents to Philips who in turn offered them to M-peg L.A., a group that enables technology and electronic companies and other standards groups to acquire patent rights necessary to use certain technology standards from multiple patent holders in a single transaction as an alternative to negotiating separate licenses for each patent. Early in 2005 m-peg L.A. deemed one of these DRM patents essential to the Open Mobile Alliance, DRM 1.0 specification for use with cellular telephones and other mobile communication devices.

My method behind the adoption of digital watermarking is increasing with new solutions and customers from our own watermarking solutions and the growing success of our licensees. During 2005 we expect continued momentum from several positive underling secular trends including increasing volume and proportions digitally produced and distributed media content, increasing number of digital media distribution channels, increasing public access to high quality imaging audio, video, printing technologies which increase the risk of unauthorized copying and distribution, the increasing cost of piracy, fraud and ineffective security measures, increasing complexity of media distribution and use and the increasing need for enhanced security and value documents and identification documents. Combine these trends in motivating potential customers to embed digital watermarks on all forms of media content which in turn fuels the need for digital watermark reading devices and network interfaces. We're adding staff and licensing in 2005 in anticipation of broadening interest in our technologies.

As always, investing in our future by developing and acquiring IP assets remain a high priority. Our patent portfolio grew from 132 patents, U.S. Patents, at the end of 2003 to 185 at the end of 2004, with approximately 400 patents pending. In the secure personal identification area we extend our position as leading supplier of driver's license issuance systems in the U.S. , serving nearly two thirds of the states and grew our international revenues by more than 40%. In the domestic market we competed effectively, gaining extensions and upgrades from a number of customers and increasing our overall share of issuance volume including long-term contracts with substantial upgrades in Iowa and Wyoming and term extensions in Indiana, Virginia, Georgia and Minnesota. We also received award through competitive bidding in Minnesota and in Ohio which had previously been a customer of one of our competitors.

In Florida we started lodge central issue production in July generating new revenue for ID Systems. At this point we are rolling out the remainder of the systems, with our production running at greater than 50% of full production rates. Revenues from these contracts are expected to fuel significant growth in U.S. driver license issuance revenues in 2005 and the succeeding years. Driver licenses are increasingly recognized the de facto of primary identity credentials for U.S. Citizens, signalling access to a wide variety of privileges including air transportation, banking and credit, access to business, government offices et cetera. Congress recognizes the growing significance of the driver license and has noted a wide disparity in security features among the 50 states. In response, a new federal intelligence Bill was passed and signed into law by President Bush in December of 2004. This new law calls for the U.S. Department of Transportation to define standards governing the application, processing and manufacture of state issued drivers licenses and ID cards.

The Bill gives the states two years to meet the new standards after they are finalized and authorizes federal grants to assist states in satisfying the new standards. We expect these new standards to motivate more states to adopt advance secure ID processes and technologies offered by Digimarc. Including such improvements as systems to capture fingerprint and facial images and used bi-metrics to deter fraud and identity theft in the application process, advanced security features such as digital watermarking, ultraviolet inks and kinegrams to better authenticate documents and deter counterfeiting. New more secure driver license production and issuance processes designed to deter collusion and fraud, and cross database verification of applicant information to prevent fraud while protecting citizen privacy.

Our leadership in this market is creating opportunities for us to leverage our digital watermarking assets for use in secure credentials as more current and potential ID Systems customers recognize how digital watermarking security features can help them combat identity theft and fraud by validating the authenticity of a driver's license at point of presentation, enhance security efforts at airports and other transportation centers by enabling the verification of identity documents presented for access to restricted areas or transportation, deter and detect tampering with the driver license or other identity document using correlated and interlocked data and improved traffic safety by helping deter sales of alcohol to underaged drivers and by keeping bad or unauthorized drivers off the road. Our international business prospered in 2004 with significant contract wins in eastern Europe and Mexico. On the European front in Latvia, Digimarc was selected as the prime contractor for design, installation, maintenance and servicing of the country's new driver license system. Supply and materials and enhanced security features including Digimarc's IDMarc, digital watermarking for secure high quality personalization and production of Latvian drivers licenses and driver learning permits.

In Mexico we announced a new contract to supply the Instituto Federal Electoral, or known as IFE, with millions of voter ID cards over a four year period. IFE issues these cards to eligible voters for both local and federal elections. Under the contract, Digimarc generates all the voter ID cards to the entire country with a secure central issuance card printing facility that we built in Mexico. With the projected value of more than $19 million over a four year term, this is one of the largest foreign contracts in Digimarc's history. In the private sector the rate of investment and prevention and protection of identity theft and financial fraud in the commercial sector is growing. The increased government and private sector focus on effective driver's license security offers expanded revenue opportunities for Digimarc. Issuers of all types of identification documents are seeking greater degrees of sophistication to meet increasing security requirements and government mandates. As the id's themselves become harder to alter or counterfeit, more attention is being directed toward effective and end solutions encompassing enrollment, document issuance and post issuance verification.

This presents an excellent opportunity for Digimarc to grow revenues by expanding our offerings to broaden the footprint with existing customers and expand our presence in related federal law enforcement and financial markets. These favorable market trends are not limited to North America. Countries around the world are evaluating their ID processes and systems in wake of heightened terrorist threats and increasing levels of identity theft and fraud. As the producer of over 60 million ID cards worldwide each year, Digimarc is well positioned to help the large emerging fragmented international market enhance and standardize its personal security identification processes to meet the challenges of the 21st century. After 2005 and beyond, we note increasing interest and attention around digital rights management, homeland security and anti-theft, anti-fraud solutions, is fueling demand for our patented technologies and solutions. And the well established expertise that we have in large scale secure credentialing systems. You see robust demands in our core market and expect that the good top-line growth that we witnessed in 2004 will accelerate in 2005.

In light of the demand profile and markets that could benefit from digital watermarking, we are increasing our marketing staff in both watermarking solutions and in licensing, sensing that momentum is building around our technologies across a range of applications and customer segments. In the ID Systems area we should have a strong growth year, too, with new customers like Florida, Alabama and Ohio reaching full production levels during 2005. We expect to bid on a number of exciting contract opportunities during the year as well. We are also encouraged by the federal interest in promoting more secure driver's licenses and the possibility of additional federal funding to support systems upgrades by our state customers. Our company has an impressive range of improvements to offers to our customers that provide a more secure processes and credentials to improve traffic safety as well as homeland security and protect citizens from identity theft and fraud. Thank you for your support and patience through the difficulties in 2004. With improved infrastructure and robust demand in our markets, we anticipate continuing growth and substantially improved financial performance in 2005. That ends our prepared remarks for today. And we'll now open the call to questions.

Thank you, sir. At this time I would like to remind everyone, if you would like to ask a question, please press star, then the number one on your telephone keypad. Star, 1 if you would like to ask a question. We'll pause for just a moment to compile the Q&A roster. Your first question comes from the line of Joel Fishbein with Janney Montgomery.

Hi, Did you guys give any guidance? If I missed it, I apologize, but if you could go over that, that would be very helpful.

We did not provide any detailed financial guidance for 2005. If that's your question, Joel.

Okay. Could you give us any, you know, what you think that each of the segments of the markets growing, just for model purposes, how we're going to model the business going forward?

We are not prepared to do that yet, Joel. We have been really consumed by this restatement process and so we will have our Q1 call in the not too distant future and at that point in time I hope we'll be able to provide better visibility for modeling purposes for 2005 and beyond. But for the purposes of this call, we're not offering any financial guidance for '05 other than that we expect revenues to be higher and at a higher rate than the rate of growth in 2004.

Okay, great. Thanks.

Again, ladies and gentlemen, if you would like to ask a question at this time feel free to press star and the number one on your touch-tone telephone keypad. We now go to the line of Steve Lidberg with PacificCrest Securities. Good afternoon, guys. I was wondering in terms of the costs of some of the new projects tied to specifically Florida as well as, I guess, Ohio. Where are we in terms of the recognition of costs associated with the ramp up of those programs and when should they start to normalize?

This is Mike, Steve. On Ohio that would begin most likely in the first quarter and continuing on thereafter. We did have an investment in inventory in assets at the end of the year, but there was no revenue or costs really booked for Ohio. For Florida we have been recording costs since July of 2004 as we opened up the central issue site. As we open up each of the OTC sites we will then begin allocating the appropriate amount of depreciation for each of those sites and also operating expenses. So that will begin in the first quarter. As will the increased revenues from those over-the-counter sites.

And I guess related to Florida, what percentage of revenue would you estimate that you're currently, I guess, recognizing in terms of the percentage completion of that contract? On an annual basis.

We -- we're at 100% of our central issuance of revenues and in the first quarter we began operating the -- having the operating sites at the OTCs become live. I'm not sure I have at my fingertips the percentage of license revenues from the central issuance to total at this point.

Okay. And I guess in terms of some of the contracts that are out for bid in 2005, Bruce, could you give us an update of where things stand, i.e. with Texas as well as, I guess, with California and maybe some of the other states that are out?

Well there are two states that are in this process, Indiana and Texas. They are both still in the process. We don't have any updates to offer on those. There are no other states out to bid at this point in time. And that is common in this line of questioning. We always defer to our customer as to whether and when they want to go out. You know, there are some states that are eligible to go to bid, but that doesn't mean they will.

Thank you.

Once again, ladies and gentlemen, if you would like to ask a question at this time, feel free to press star and the number 1 on your touch-tone telephone keypad. We now go to the line Sam at Berry Capital.

Sam Bergman, BayBerry Capital. Good afternoon, gentlemen.

Hi, Sam.

A couple questions. First of all, in terms of the licensing fee in the fourth quarter, can you give as you dollar amount on that? They're broken out at all?

No, we generally don't go to that level, the granularity. When we start to get too specific we begin to intrude on confidentially restrictions on individual contracts. And so our breakdown for revenues is at the level of -- there are a number of cuts domestic versus international product versus services and watermarking versus ID Systems. But we don't break out licensing separate from watermarkings.

In terms of eligible states that are out or could go out to bid in '05, can you tell us how many states there are?

Off the top of my head, California could go out and there's some question whether Georgia could. There is some litigation pending in Georgia. And I believe that there may be enough complications there -- I'm not sure whether they can or not. Paul, are there any other states that are eligible to go out to bid during 05? It sounds like we may have lost Paul. Paul was joining us from -- .

I'm sorry. I was just coming off mute. Yeah, Virginia is eligible, also, like California to come out to bid.

Okay. So that's it, it's a pretty quiet year in terms of the number of states that could go to bid. As you know the contracts generally run for 3 to 5 years and so they're on average would be a larger number.

I know you didn't give any predictions on guidance for '05, but can you tell us when you think the margins will trek up a little bit versus '04? I know you were at 44 or 45% in 03 and down to 38 in '04. Do you expect the margins to be better in the second half than the first half?

Well, gross margins, which I think -- I take is the focus of your question, are influenced by a lot of factors. I would propose that in an upcoming conference call, perhaps in the next one, if time allows, that we have a detailed discussion about the factors effecting margins in order to help the investors and analysts who are building models to do a better job. It's quite complex. Thus, I think, given the length of this call and the subject matter here that we best defer that. And with respect to how things are going for the next few quarters. Again, we're not going to provide any detailed financial guidance in this call.

Okay. And the last question, what was the headcount at the end of '04 and where do you expect it to be in '05?

Well, I can -- this is Mike, I'll comment on the headcount. We were at about 580 FTEs, that included about 180 of per diems and we hire per diems for the variability of work required as we roll contracts out. Obvious, as things like Florida and Alabama go live, those per diems would reduce and, again, we won't give any comment for the future period. That already depends upon new contracts and new business that we would generate that would require those type of per diem folks.

There are 400 full time employees and then a couple hundred contractors.

Okay, thank you. Good luck in the upcoming quarters.

Thanks, Sam.

And your next question comes from the line of Lisa McDonald with Artemis.

Hi, guys. On the SG&A increase can you breakout how much was compliance, bad debt, legal, consulting, one time items or how much of that would continue into next year?

This is Mike, I'll give a high level summary of that. I believe the legal and accounting in the year for the restatement efforts was about 1.4 - $1.5 million. The Sarbanes Oxley part was around 700,00 plus. We had bad debt charges of around $0.5 million and, again, the consulting was all part of that accounting and Sarbanes Oxley type charges.

Okay. And on the next issue, certain of the US driver's license business is not -- I mean, it terms of -- I guess it goes to the margin discussion that will come later. But, the business really didn't grow year-over-year, yet you had some contract wins. So, can you talk about did any business fall off or did pricing change at all or -- ?

The revenue recognition is most of the answer, there, Lisa. Okay, for the Ohio contract? Even if we're not yet being recognized in revenues during '04. '05 should show substantial growth because of those wins.

Okay. That's it, thank you.

And once again, ladies and gentlemen, if you would like to ask a question at this time, feel free to press star and the number one on your touch-tone telephone keypad. We now go to the line of Jennifer Jordan with Wells Fargo Securities.

Yes, good afternoon, gentlemen. I just want to go back to a comment that you made in your discussion where you mentioned that there were some contracts where you had additional services that you were contracted to provide but with no increase in the price of those services. Could you talk about that and how you end up in that situation and how you avoid it going forward?

I think you may have misinterpreted a remark that Mike was making. He was talking about -- when he was talking about gross margins, he was noting that in some of our contracts we've provided greater functionality without raising the price. And so that's yielding lower margins. It wasn't that we did work -- work that we didn't get paid for. So, was that the comment you were thinking of?

It is and I guess it does raise the question, though, if you supply people with greater functionality with no gain in costs aren't you diminishing the value of your technology going forward? That's really the question.

This takes us a bit into the margin discussion that needs a full context to be well appreciated. But, in competing for business in both acquiring and retaining customers, we will sometimes make judgements about what we delivery and how much we paid for it that could have a lower margin than what we had had previously or what we might get on another contract.

Okay. So, it's not that we're doing something irrational, it's actually that we're being competitive. Okay. That's fine, thank you.

And your next question comes from Kevin Henran with Harold Brown.

Hi, Bruce, can you hear me OK?

I can hear you just fine.

Okay. Can you tell me if you do file your 10-K and your 10-Q from September in a few days, as you said, would that meet the requirements for NASDAQ to take the E off. Or would that -- would the Sarbox, the complete Sarbox finally be required to get rid of the E on the end of your ticker?

This is Bob Chamness. What NASDAQ will do once our filings are all in place is go through an analysis of where we stand and they will make the decision at that point in time. Our request is that the E would be taken off once we are fully filed with these statements and we have filed our amended form KA in May.

So in answering my question, then you have to complete the Sarbox requirements in order to get rid of the E?

It's an open issue. Our position is we're compliant once we file the K and the Q. They will make their own determination at that point as to any additional issues they want to look at.

Okay. And Bruce, can you tell me if either Mizama(ph) or Lea Kop(ph) or Macrovision or Philips Electronics has any representation on the board of Digimarc?

None of them do. Oh, pardon me, Philips, you mentioned Philips. I'm sorry, I was thinking Mizama and Kop. Philips has a representative on the board of directors or there's a gentlemen who's been elected from Philips. Let me phrase it correctly.

One seat?

Yes. But it's not a Philips seat. Ultimin Lyte(ph) is the gentleman and he is an executive at Philips. But he was elected by the shareholders.

Okay. And your annual meeting, Bruce, do you anticipate that will be delayed or have you set a date for that?

We're scheduled May 12th at 9 in the morning and we do not anticipate a delay.

Do you think going forward with the controls you've put in place already, it sounds like Mike's been working on this, that you'll be able to report your quarters in a more orderly and more timely fashion?

Hi, this is Mike. That's absolutely our plan, is to be, obviously, more timely than we've been in the past few months.

Okay, thanks.

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

We should get our filings in shortly, they're quite detailed and should fill-in a lot of the blanks for those who are working on detailed models of the business. So, I, again, apologize for the continuing delay. I do recognize that our staff and our auditors and lawyers have been working extremely hard to get them done. But, it has been quite a labor intensive process, as we've looked at many periods and made a number of adjusting entries. So, I think we're just about done. And, as I said, it is time to look at the business for its intrinsic enterprise value and to begin to talk about how we continue to develop our markets, grow our revenues and improve our financial performance. So, we're all focused here, we're ready go and we're ready to put this behind us as soon as we get the filings finished in the next few days. So I want to thank everyone for participating in the call and look forward to better times. Thanks very much.

Ladies and gentlemen, this does conclude today's Digimarc Corporation conference call. You may now disconnect.