Digimarc Corp (DMRC) 2007 Q1 法說會逐字稿

My name is Tina and I will be your conference facilitator today. At this time I would like to welcome everyone to Digimarc earnings conference call. (OPERATOR INSTRUCTIONS).

Mr. Davis, you may begin your conference.

Thank you. Good morning, ladies and gentlemen. And welcome to our Q-1, 07 conference call. Mike McConnell our CFO is with me on the call. We issued a press release earlier today announcing our Q1 financial results.

The objectives of this call are to summarize and comment on these results, review significant business developments and market conditions and provide an update on the execution of our strategy for 2007. This web cast will be archived in the investor relation section of our website. Before we proceed please note during the course of our conference call we will be making forward looking statements regarding management's opinions and expectations about the business, its markets and financial performance that are based on our current understanding and expectations.

These statements are subject to assumptions, risks, uncertainties and changes in circumstances. Actual results may vary materially from those expressed or by such statements. For more detailed information about the risk factors Actual results to differ from expectations please see the company's filings with the SEC, including our form 10-Q to be filed later today and in our earnings release posted on the website.

During the course of this conference call we will also refer to certain nonGAAP financial measures as defined by the securities and exchange commission, rec D. Definitions of these nonfinancial measures and reconciliations of these nonGAAP financial measures to their most directly comparable GAAP financial measures are included in the earnings release for the quarter ended March 31, 2007. The earnings release can be found on the home page of our website. Please keep in mind 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. By way of introduction our financial results for the quarter were in line with our previous guidance.

Key financial measures of gross margin operating expenses, EPS, and adjusted EBITDA and cash flow all significantly improved from a year ago on a similar number of revenues. The bottom line improved by over $5 million as we generated more than $3.5 million dollars in adjusted EBITDA. We continued to execute the strategic plan outlined in previous calls. Marketing conditions are pretty much as we anticipated.

There was a great deal of activity in our markets following publication of the Real ID draft publication and a draft of announcements of business partners concerning expansion of the watermarking initiatives. At this point Michael will provide some commentary on Q-1 results then I will return to provide an update on progress with our 2007 annual operating plan and strategy. Mike.

Thanks, Bruce. Good morning, everyone. For the first quarter of 2007 our financial results were significantly better than the comparable quarter of last year and generally in line with our prior guidance. We had revenues of $26.9 million consistent with our seasonal revenue model where driver license revenue is lowest in the first and fourth quarters of each year.

Gross margins of 37% reflect a 9 point improvement over the prior year benefiting greatly from the financial leverage we have achieved in our cost of sales operating expense areas. Operating expenses came in at $11.4 million. A $2.6 million improvement over the prior year and their expected quarterly run rate of around $11 million a year. Reflecting these favorable impact of changes we have made in our business model over the past year.

The $1 million or $0.05 per share loss in Q-1, which includes $1 million of stock compensation expense, was an improvement of $5 million and $0.25 per share compared to the prior year. Adjusted EBITDA for the first quarter was $3.5 million dollars, an improvement of $5.3 million over the prior year. Capital expenditures were $6.9 million roughly in line with our expectations supporting several programs nearing their expected completion dates in the second half of this year.

We ended the quarter with $31.5 million in cash and equivalents, short-term investments and restricted cash, down about a $1.5 million from year end and in line with our projections. As indicated we would utilize cash in the first half of the year before for our capital investments before achieving positive cash flow in the second half and for the full year. Our renewed backlog was about $230 million reflecting normal burn off, offset by bookings during the quarter.

For further suggestion of our first quarter, our business and financial models and risks and prospects for our businesses please see the form 10-Q we expect to file later today. Bruce will now comment on how we are doing in execution of our strategy for 2007.

Thanks, Mike. Regarding execution of our strategy in relation to annual guidance and long-term market development to continue at this point in the year to operate generally according to the plan described in our guidance call at the start of the year. Our top business objective remains to deliver sustained profitable growth, capitalizing our leadership in secured and and demanded systems and in digital watermarking. We continue to see growth potential in the three drivers we have identified, Real ID, international ID and digital watermarking proliferation. The draft Real ID regulations were published March 1, 2007.

The public comment period ends shortly. The two main substances this year are privacy and costs. I am confident there are good policy and technological means to address the legitimate privacy concerns. The biggest bone of contention is cost is whether the federal government will pay a reasonable share. A recent UPI poll indicated 70% of Americans favor Real ID.

We hope the politicians are attuned to this support and federal and state officials will find a common ground on costs so we can move forward promptly with this important national security initiative. In the commercial sphere there were a number of announcements of business partners about expansion of the digital water marking offerings and customer bases. Please see industry news on the digital mark website or www.digitalwatermarkingalliance.org for more information.

In furtherance of our growth strategy we recently filed a shelf registration with the SEC to give us flexibility and raising additional capital, if necessary to support growth opportunities. Once effective the registration statement will allow us to sell up to $90 million of stock or other securities subject to market conditions as needs may arise. We believe that we have sufficient capital to support our 2007 business plan but are mindful given market conditions we could learn of attractive acquisition opportunities or experience higher growth rates than we are projecting that could require additional capital. We are encouraged by positive trend in our markets.

And improved capabilities of our company, which we believe may lead to higher growth rates. We believe this potential for growth, in conjunction with anticipated opportunities for continuing margin expansion and productivity gains, will deliver very attractive returns for our shareholders. Mike will now provide an update on our financial expectations for the second quarter and the full year 2007 and I will return with some closing remarks.

Thanks, Bruce. With respect to our key financial measures we are not making any significant changes in our guidance for 2007.

We still expect revenues to grow at least in the range of growth over the past several years. Regarding EPS, we continue to target a bit better than break even for the year, subject to the timing of various revenue growth opportunities. We continue to believe that we can be profitable at the lower end of the revenue range and demonstrate significant financial leverage if we perform at higher levels of growth. We continue to expect improved bottom line performance later in the year due to seasonality and growth in revenues in relation to our relatively flat quarterly operating expense run rate of $11 million.

We expect to generate adjusted EBITDA more than $18 million. Capital expenditures should be in the range of 15 to $18 million depending upon the pace of implementation of existing programs. The pace and funding strategy for Real ID upgrades and our success in gaining market share from new customer acquisition opportunities that may become available during the year. Operating cash flow should increase to over $15 million.

The backlog may increase in the second half of the year depending on a number of fact tore including Real ID, domestic ID market share gains, new international customers and growth in digital watermarking. Bruce will now offering closing remarks.

Mr Davis has disconnected.

Okay. I'll close and then hopefully he is able to get back on the for the Q & A. Over the course of the next few years, we see opportunities for accelerating growth rates, continuing margin expansion and productivity gains.

We anticipate market conditions that are favorable to our strategy and are ready to serve the needs of our customers. We are planning to present an upcoming financial conferences, including the AeA Micro Cap financial conference on May 6 to 8 in Monterey, California. And the Morgan Key and Homeland technology conference in New York city. This concludes our prepared remarks and we will now take questions. Operator I would like to wait a couple of minutes.

I'm back online, we lost the line.

(OPERATOR INSTRUCTIONS)

Your first question will come from the line of Jeremy Grant at Stanford Group.

Good morning, gentlemen, how are you this morning?

Great, great, Jeremy

A few questions. One, taking a look at the numbers sales and marketing was up a little bit above last quarter.

Is that because you are out there sort of planting seeds for some of the real ID upgrades? I wonder if you could discuss the factor that caused that number to go up a bit?

I can comment on that and Brice can add. I think initially we talked about previously a significant investment in expansion of our investment in our international business development area. That is one prime area. And yes, you are right, we have spent a little bit in anticipation of Real ID, educating the marketplace, educating the states on our offerings just to make sure we are in the forefront in that area.

Just to follow on to that Jeremy, a bit.

We have heavied up a little bit on our marketing and expenditures in the context of the publications of the draft regulations to help the market to get the facts necessary to make good judgments.

Okay. Wondered while we are talking Real ID if you could provide a bit of an overview that you are actually seeing in the states and the DMVs and the clients in terms of what they are asking for, what their attitudes are. Kind of how you see things going from a macroview.

Yes, boy, it is I guess what might be an expected complicated environment, in that the agencies are quite concerned about the possibility that they would be noncompliant. We have all seen in the press a number of smaller states encouraged by some extreme viewpoints to push for legislation saying do not comply. And we try our best to understand what motivates those concerns. And it appears, as I said in the prepared remarks, that they want comfort and privacy and that's fair enough.

I think that can be given. There is a little bit of a game of chicken going on, on the funding, I think as well. Where the states would like the federal government to contribute. And there is a well-reasoned argument for doing that. So they are taking a strong stand saying if you don't contribute, we're not going to do it.

Obviously if the federal government stood firm I think they would have to concede but on the other hand I hope that the pressure they are exerting will cause the federal government to contribute to the cause because I do think it's fair for them to do that. And then there's concern about implementation time tables and just whether there's enough time to be able to get everything done before the deadline. That's where the sensitivity and the good sense of the department of Homeland Security as the administering agency would come into play once the funding issue has been settled.

Great. Appreciate that. Wonder if you could provide a little bit more detail.

I know you had in the announcement a couple of days ago with a new international one in Tanzania. Wonder if you could provide just little more detail in terms of what you are providing there if there's nay number on the revenue or the timing of that, that can be disclosed and any more details or color are going to be appreciated.

The contracts that we described in Africa are not fixed, estimated prices like domestic contracts. That's why we didn't put a number out for them.

They are good, solid contracts, they are not huge. Tens of millions of more in the sort of million dollars range. But they are not a fixed sort of price like contracts typically are.

Thanks. The final question I had was on CapEx, on the high side this quarter around 6 million is that kind of a one-time burst. ? Mike mentioned a number of systems you are working on that should be completed this year that required this expenditure or is that a number we should continue to see through the other

Jeremy I'll take that, that's Mike. We said our estimate was about 15 to $18 million for the year.

Heavy up in the first half of the year as we finish up some of these programs we talked about Texas, Indiana, Oregon, Atlantic, Canada, as those become operational in Q-3 and Q-4 you'll see capital expenditures come down come down but Q-2 you'll see a pretty robust number.

Looks like things are coming together. I'll step back in the queue.

Thanks great.

(OPERATOR INSTRUCTIONS). We have no further questions gentlemen, you may continue with your closing remarks.

The question queue does show two pending questions. So let's go back to the queue.

Your next question from Kevin [Hanrahan].

We can hear you.

Good morning.

Good morning.

I want to ask a question, you know about the shelf. Looks like some of that could be debt securities or convertible securities. So can you give us a feel if you do need capital what would your split be, between debt and equity?

I know the balance sheet has been pristine in the past and maybe you want to keep it that way. But I just want to get a feel for what you were thinking.

Well, we are still in the registration process. So we are limited to what we have stated in the prospectus and discussing the financing. I think on a sort of abstract level, here is just worth noting that the filing of the registration has been accomplished.

The actual use of it will be subject to management recommendations and board approval. So it is really not possible to tell in advance what might happen. Over a course of a three-year registration period. I appreciate the implication of your statement, though. We have a range of opportunities to, to consider.

Right.

We'll do that carefully, depending on all the circumstances, if and when we decide to take down some money from the shelf.

Okay. Thanks.

(OPERATOR INSTRUCTIONS) Your next question comes from the line of Lee O'Dwyer from Sloan's Partners

God morning, gentlemen. I had a question first for Mike.

Have you guided, Mike, this year, to a total number for G& A? I know it's higher in Q-4 and Q-1.

We have not, we've given guidance on is an average run rate in that $11 million range plus or minus a few hundred thousand but we're now pretty broken out in total. We have indicated G&A will be lower in 2007 than 2006. But that is the extent of our guidance.

Okay, but in terms of modeling Q-4 and Q-1 is generally elevated because of audit and (inaudible) is that correct?

That's correct.

And then I have a couple of follow-ups from Jerry's questions. In terms of the Tanzania announcement, obviously a country adjacent to Mozambique, Bruce can you elaborate a little as to what the strategy is, what kind of resources you have in place in Africa, maybe Asia to try and get these contracts? Could we hope for somewhat of a domino effect, I guess is what I'm alluding to.

Yes. We, I believe have note noted in prior calls that our international market development activities are being fueled by greater resources this year. We feel that we have solid basis in the business having restructured the way we did and we have matured in our products strategy sufficiently that we can apply more resources to the foreign markets.

Our strategic focuses are on Latin America and Africa. And we do hope there will be a domino effect. We think you can see in what has been accomplished thus far some evidence of momentum in the African market. And we operate through employees who are based overseas, who work in conjunction with local partners on these programs and as is customary in security applications for governments, in particular in the ID area, we tend to have a local partner in almost all the deals that we do.

And we have some well-established relationships in Africa with some very, very competent firms that are helping us to further penetrate the African market. So I see great promise for us in the overseas opportunities. We're approaching them in a measured fashion.

As I noted, the Mozambique and Tanzania contracts are relatively modest. As we continue to grow and demonstrate our competence, we continue to seek large and larger contracts and we anticipate that as we develop, we'll see not only a regional expansion driven by the high quality of work that we do, but also larger and larger deals coming in over time. Very exciting opportunity overseas. We are approaching what I believe to be a sensible and measured fashion.

That's great.

In terms of Real ID, I have always considered the privacy issue somewhat more of how the regulations are actually applied. Are you seeing in the comment period any concerns or changes regarding the technology that might either delay or cause a DMV to want to accelerate their implementation.

There is a very interesting situation evolving with respect to privacy and Real ID. The antagonistic interests, those who prefer a greater degree of anonymity in America, and they are on the left-wing and the right wing of society, look for arguments to make. And obviously privacy is one that sort of strikes fear in the hearts of mere mortals. But I believe regardless of the outcome of Real ID, that privacy protection will be enhanced because of the debate.

Because of the visibility and because of the technological improvements that are complicit in the act. So contrary to what the antagonists want to argue, I think Real ID enhances privacy, it doesn't put it further at risk. But what they tend to focus on is the requirement of Real ID that the states try to ensure one driver, one license, one identity, one document. What the public doesn't know is that's already done in certain ways. There is a problem driver record that is pulled in most states to see if an applicant is doing jurisdiction shopping after they've lost their license someplace else.

There are also most of the jurisdictions check the Social Security database of the federal government to look and see if there is alleged correlation. So there is already a bunch of that stuff that goes on. But the privacy framework is not fully developed. So I think Real ID will cause that to be developed. So it's actually going to be a great boon to the privacy advocates to move forward with real ID. That is one of the areas we have tried to help the public debate by offering substantive information rather than opinion, to demonstrate to everyone this is really a step up in privacy protection.

And as I noted, the general public seems to be on board. So the state legislatures are a little bit out of line with their constituents here. I don't quite understand the possible concern and the true motives and the impact of the funding issue on all of these legislative movements. So I'm hoping the federal government will kind of call their hand and put up some money and see if there is anything left over to argue about. And the appropriation season begins shortly.

And obviously a lot of antagonism between the congress and the administration right now. But I hope this is one of the things that gets into the appropriations process in an explicit way and begins to encourage implementation by the states that want to move.

The last question I had was regarding the digital water marking. In the last few weeks we have seen an announcement by and their running marks product to water marking video on demand and a few other similar things.

In the last few weeks we have seen an announcement by Cinea and their Running Marks product to watermarking video on demand and a few other similar things. Obviously the pattern agreements you announced. Can you give us a little more color as to maybe the type of products? I know you can't talk to what your licensees are actually developing specifically. But just to update the information on the momentum that you are seeing in this area?

Yes. The recent spate of announcements came out around the national association of broadcasters meeting the NAB conference. It seems based on what was said there that what began in the IPTV set-top box realm television delivery is spreading to all the tops. And that is really exciting.

It seams as though the infrastructure is anticipating that the broadcasters would like to have the ability to identify content to a set-top box and this ties into media server trends and so forth and they're anticipating that the internet based delivery of music that has caused substantial damage to the economics of the music industry may translate within the next generation here into the homes in a different kind of distribution. Think of it like a personal domain distribution and then those get connected up and we are in big trouble for all of the higher bandwidth media. So they are getting a little ahead of the curve, which is wonderful we see them being strategic.

At the same time, the social networking sites are creating a lot of grief and a lot of press and some litigation. We have described to the appropriate people how water marking could be used to address those issues. Not in a legacy DRMs negative sense of take down notices and preventing access to content but as a means to improve accounting and marketing and the consumer experience. We think we have a new vision of DRM that will be much more appealing to the entire value chain than the historical notions promoted by the IT industries.

So all that is going on around the entire group of solution providers of watermarking. That's why rather than go through a long list in the script, I referred everyone to a couple of locations where they can read about this. Because there's just a lot of stuff going on.

Okay.

Would it be fair to say then, given your last comment and the fact that Google and Viacom is clearly the higher profile, that you have at least approached both of those parties and explained how you could be used to help everybody come to some kind of agreement?

Well, rather than talk about specific companies and meetings, I would prefer just to make a general statement that I think answers your question. I think everybody knows my view on this, that matters. So we've talked to lots of people.

And they all, I think, understand the issue. We are a technological means to foster some kind of business relations. The guys still have to decide what kind of business relations they want to have.

All right. Thank you very much.

Your next questions will come from Next question Nick Andrewes at Lazard.

Hey, guys. Solid quarter. Could you just talk a little bit more about the digital watermarking side.

We just touched about it. Looks like you guys had a pretty good, solid quarter in this quarter revenue-wise. Is there anything going forward that should suggest it's not going to be anything but the same kind of seasonality we have seen in the last year where it dips down in the second and third quarter and comes back in the fourth quarter?

Let me give you points on that, Nick. We have a number after counts that are coming up to full speed in the second half of the year.

So that's what's boosted our revenue forecast, you know, for the latter half of the year to meet our overall growth plan. We still will have a seasonal part of our business for the domestic driver license business. It does dip in the fourth quarter but as we have other revenues becoming a larger part of pie, it may in fact smooth it out a bit.

I think we're standing by our revenue goal for the year, and that indicates that these contracts that are coming to closure on operational status will generate more revenues for us.

Great. And can you guys talk a little bit on the mobile commerce side what's going on there? What we should be expecting going forward and how long it's going to take before we can see any significant revenues from that type of business?

Yes. We're in pilot stage in mobile commerce for the benefit of the others on the call what we are providing a simplified user interface from printed material to web services. We have three geographically distinct go to market partners in Asia, U.S. and Europe. We have been engaged with all of the ecosystem to move this application forward. As you know, it's a very innovative space.

And they tend to move reasonably quickly. And so we have been demonstrating what we can do. And we have excellent partners in that area. We continue technology development, and we intend, later this year, to be able to demonstrate the system on more hand sets in the U.S. And we are hoping to build some larger visibility pilot participation, as the next stage, as opposed to bursting on the market into production.

But how quickly we get to market and how big we are in the early stages will really be a function of how the major players embracing the application, you know? And when they do, it will be big and until they do, we'll continue our pilot work and technology development. So we're not anticipating in the forecast for 2007 that is going to move beyond the pilot stage. So we're seeing it really is '08 and beyond at this point. But if I see anything change, on it, in the positive fashion we would probably put out a press release and let everyone know that something has come up on it.

I think it's a very big application. I think it is a very important application and I think all the trends in the marketplace are supportive of it. And so it is one of those situations where the big players, the power brokers, if you like, in that infrastructure, need to say it's time. And when they do, we're ready I to deliver.

Great. And on the driver's license side, can you give us any update on Russia and if there's been any change there?

Russia now is celebrating the 15th year with us. And we have a very good relationship with the customer over there.

And we are cooperating with them on discussing means to continue to advance the technology they use in their documents consistent with the increasing needs within their nation. And global technology trends. So I think everything is fine there.

Okay. Great. Thanks a lot.

Good quarter thanks (OPERATOR INSTRUCTIONS) We have a follow-up question from Jeremy Grant at Stanford Group.

I wanted to delve a little more in the real ID phase. There is a number floating around Washington for Real ID funding having (inaudible) corporations process which is $300 million which is a heck of a lot of money and knowing Congress who

knows what's going to go on with that. Between that as well as a focus with immigration debate that is pending needing to have more secure documents that are out there so that employers can authenticate the legal status of workers, it seems to suggest different elements coming together that would seem to suggest some sort of decent funding push goes forward this year in the appropriations process of, wanted to get your take as to what that might mean for next year in terms of if a big chunk of money becomes available.

Obviously tough to speculate too far ahead in terms of what that could all mean. How that would change cost structures or whether there could be a one time boost in what you are seeing.

Well, I think if the Feds were to put up that amount of money, it would be off to the races. That would be awesome. I was in Washington recently and I talked to a number of members of Congress about funding. There has been sort of a suggestion made by the various state associations if it's going to cost $10 billion plus, want to see the Feds put up the billions and that's translated into some thinking how about if we do 300 this upcoming year and the notion would be 300 a year for three years. You don't have to do the billion all at once, and we can get going.

I think that it would be a terrific show of faith by the federal government and it would motivate the leading states to move forward and I think will mitigate a lot of the resistance that is being demonstrated today. And so I hope that that movement gains momentum and results in an actual appropriation. What it would mean for us in terms of '08, '09 would be that we would be able to have a great deal more confidence that we are going to see a big upswing in growth rates. As we've noted,

if you look at the historical growth rates here, last year was on the lower end of the range of prior years and as we move into this year, things are still kind of quiet. Everyone's waiting. They are waiting for the final guidance as to what is important in upgrading. Then we would love to see some funding to support, if the Feds put up the money I think that would grease the skids and get everybody moving.

Appreciate it, thanks.

We have no further questions at this time gentlemen.

Thanks very much for participating morning. We appreciate your sport. We'll look forward to talking to you again soon.

Ladies and gentlemen thank you for participating in today's Digimarc conference. You may now disconnect.