Digimarc Corp (DMRC) 2007 Q4 法說會逐字稿

Good morning. At this time, I would like to welcome everyone to the Digimarc earnings 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 session. (OPERATOR INSTRUCTIONS). Thank you.

Mr. Bruce Davis, you may begin your conference.

Thank you. Good morning, ladies and gentlemen. Welcome to our 2007 financial results conference call. Mike McConnell, our CFO, is on the call with me. We issued a press release earlier today announcing our Q4 and full-year of 2007 financial results. Objectives of this call are to summarize and comment on these results to review significant business developments and market conditions and provide an update on the execution of our strategy for 2008. This webcast will be archived in the investor relations section of our web site.

Before we proceed, please note during the course of this conference call, we'll be making forward-looking statements regarding management's opinions and expectations of Digimarc's business its markets and financial performance that are based on our current understanding and expectations. These statements are subject to assumptions risks, uncertainties, changes and circumstances. Actual results may vary materially from those expressed or implied by 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 our form 10Q with 10K to be filed later today and our earnings release posted on our web site. During the course of this conference call, we will also refer to certain non-GAAP financial measures as defined by the Securities and Exchange Commission regulation D. Definitions of these non-GAAP financial measures and reconciliation of these non-GAAP financial measures to their most directly comparable GAAP financial measures are included in the earnings release for the quarter ended December 31, 2007.

The earnings release can be found on the home page of our web site. Keep in mind that any guidance we offer represents a point in time estimate. We expressly disclaim any obligation to revise or update any guidance or any forward-looking statements to reflect events or circumstances that may arise after the date of this call. By way of introduction, we had a great finish to the year, reflecting effective execution of the strategic plan outlined in previous calls. The financial measures of gross margins, earnings per share, adjusted EBITDA and cash flow all significantly improved from a year ago on a similar level of revenues, evidencing our progress in building a world class organization.

2007 culminated in momentous event with the announcement of a strategic licensing and services agreement with the Nielsen Company. This great new opportunity comes amidst many other signs of progress, including more than $11 million improvement of our bottom to line, significantly better cash flow for the second year in a row with nearly $19 million of adjusted EBITDA, equaling 17% revenues. Revenue growth in 2007 was around 5%. We believe that this growth rate was lower than normal due to dampening effects of RealID ambiguities. These ambiguities were resolved in January of this year with publication of final regulations, appropriation of additional funding and establishment of a grant program to distribute to the states to help them gain compliance.

Mike will now provide additional comments on Q4 and the full financial year results and the financial outlook for 2008. Then I will return to provide an update on progress with the execution of our 2008 annual operating strategy and plan. Mike?

Thanks, Bruce. Good morning, everyone.

Our Q4 and 2007 financial results were generally in line with prior guidance and significantly better than last year. Q4 marked our second consecutive profitable quarter with revenues up 12% from the comparable period a year ago as we finished the year on an upbeat note. We made tremendous progress in 2007. More specifically, 2000 revenues were $109.8 million, 5% higher than the prior year. Gross margin for the year improved four points over the prior year to 38% and reflects significant financial leverage improvements in our operations. Overall operating expenses for 2007 were $43.4 million, down 11% for the prior year demonstrating continuing improvements in our productivity. Net operating results for the year approached break-even with a slight loss of $0.02 per share and $11 million improvement over the $0.57 loss per share in 2006.

Adjusted EBITDA for the year more than tripled to $18.9 million compared to 5.7 in 2006. And adjusted EBITDA as a percent of revenues improved to 17% from 5% during the prior year. Capital expenditures were $18 million compared to $10.5 million in the prior year reflecting program investments flowing from various contract awards during 2007 and prior years that would contribute to revenue growth in future periods. The cash flow from operations for 2007 was $16.3 million, a $7 million or 75% improvement from the prior year.

Our balance sheet remains very strong. We have $33 million in cash, investments and restricted cash, about the same amount as we began in the year. Working capital stands at more than $35 million with a current ratio of more than 3-1. We have no long term debt, and our long-term liabilities are comprised primarily of deferred revenue and some small amount of capital leases. Receivables grew about $4 million of a prior year to $18 .5 million and reflect increased revenues, particularly in Q4 where we achieved a 12% year-over-year growth and we had an increase in billings for deferred revenue that will positively impact revenues in the coming quarters.

Our inventories grew by about $700,000 over the prior year and reflect advanced purchases of consumables for first quarter international sale. Our backlog was approximately $225 million. For further discussion of 2007 results, our business and financial models and risks and prospects of our business, please see our form 10K that we expect to file later today. Now I'd like to say a few words about our financial expectations for 2008. Our views on 2008 remain pretty consistent with the guidance we gave to you in December. We're gaining clarity on a number of factors. Regarding revenues, we continue to expect our media identification and management revenues to grow more than 30%.

Our ID revenue growth rates remain a bit ambiguous. Since December, there have been a number of positive developments in the ID area, including publication of final regulations for RealID appropriations for additional federal funding for drivers license upgrade and publication of grant guidelines for awarding funds to the state. Grant applications must be filed in early March and D.H.S. says the awards will be made four to six weeks later. Meanwhile, states are studying what's necessary for compliance, developing cost estimates and preparing to request funding from their legislatures to begin necessary upgrades. We expect that parallel activities to coalesce during the second quarter to allow to us better estimate the amount of ID revenues that will be recognizable during 2008. Until we gain this clarity, we suggest continuing to model mid single digit growth in this area of our business.

Capital expenditures are likely to be a bit higher in 2007 levels at around $20 million. Actual spending may vary depending on possible delays in existing programs and the timing and type of orders received during the year. We're expecting continuing improvement in cash flow with operating cash flow and adjusted EBITDA both growing to more than $20 million. We're also expecting to generate more than $5 million of free cash flow meaning operating cash flow less capital expenditures which compares to a $2.5 million negative amount in 2007. Taking into account the effects of noncash charges of amortization of intangibles, depreciation and stock compensation, EPS may range from a small loss to a small profit subject to the timing and mix of various aspects of revenue growth in relation to some investments in supporting higher revenues in future periods that we may choose to make.

Absent any unavoidable delays in program deliveries, our first quarter 2008 is on track to improve across the board, compared to prior year, with increases in revenues, reduced losses and improvements in our key cash flow metrics. We continue efforts to better explain our financial model to investors. Following disclosure of the breakdown of revenues and growth rates for the major areas of our business in December, we're working on developing full separate P&L for each area and hope to complete this work later in 2008. Bruce will now offer closing remarks.

Thank you, Mike. After years of investment and incredible hard work by our employees and teaching the market the virtues of digital watermarking and reshaping the Polaroid assets, we believe the inflection points we've been preparing for are at hand. Two years of improvements in operational and financial performance behind us, Real I.D. ready for implementation, and the great promise of the Nielsen relationship now in development, we are shifting our priorities from building the foundation for growth to the fostering of higher rates growth.

As you know, our top business objective is to deliver sustained profitable growth, capitalizing our leadership in secure identity management systems and digital watermarking. We are ready to exploit the significant opportunities in our markets that we have identified to accelerate growth and continue expanding margins over the course of the next several years. Our employees have done a remarkable job of transforming the company as we anticipate these significant opportunities opening up in our targeted markets. This concludes our prepared remarks. Thank you very much for your interest and support. We'll now take questions.

(OPERATOR INSTRUCTIONS). We'll pause for just a moment to compile the Q & A roster. Your first question will be from the line of Jeremy Grant of Stanford Group.

Good morning, guys. Congratulations on a strong quarter.

Thanks, Jeremy.

Now that the RealID regulations are finally out, and I realize it's still taking a bit of time for states to digest them, what kind of trends are you seeing from your state customers now that they're out there? Are you starting to see what it's going to take do the upgrades? What kind of color can you give us there?

The response varies, but the general trend now is toward moving forward to getting the work done and certainly it's reduced the ambiguity that was hindering upgrades that would have been done otherwise. The states for embracing the law are moving forward with their budget estimates, applying for federal grants. There are at least 8 of our states that have applied for federal grants already. And requesting additional funding from their legislatures.

There was a significant development in Washington in the last few days. The National Governor's Association has been circulating some views and some documents that are available publicly that they want to make sure that all of the $80 million that has been appropriated goes out to the states to support their upgrades and does not go into a hub, and they've made their views clear to the Congress and to D.H.S. They have also stated the view that they would like the federal government to pay the full $4 billion and they'd like to see $1 billion in the '09 budget rather than about 150 that currently is there. And they've also requested a delay in the filing date for the grants with the current date as March 7 in order to give more states an opportunity to file their grant applications. So things are really heating up. In that communication there was none of the prior rhetoric of we don't want this. This is a bad law, blah, blah, blah, just give us the money, which is pretty exciting to us.

Sure. Given, you know that progress that's there, I know the guidance you gave back in December was essentially assuming because the government's been so, I guess, slow on getting regulations and other things out on Real I.D. that you were not assuming any Real I.D. boost in the 2008 guidance that you gave to folks on the Street. Obviously, you reiterated the outlook on this call. Any take as to when you might have visibility to be able to give revisions on that, hopefully in the upward direction?

Yes. Yes. Our conservatism there is really the confluence of a number of factors, uncertainties. Primarily around when will the federal funding be released? And so as we noted in the script here, which has been changing sort of day by day, the schedule has been early March applications four to six weeks later award. Now that may or may not be delayed. D.H.S. has not responded to the request from NGA yet. So if they were to stay on that schedule, that would mean that during second quarter, we would actually see where that money was going to go and the kinds of things that was going to be spent for and because of the rather complex revenue recognition rules that we operate under and the varying time frames and delivering the kinds of things we deliver, at that point in time, I think we would have greater clarity on the upside. Until then, it's hard for us to give a good foundation to the financial community as to the implications for the remainder of '08 of the real I.D.

And the second part of that is in parallel as the states are requesting money from their legislatures, again, we don't know how long that will take, how much they will get and then where it will be primarily directed in 2008. So we believe there's potential for significant upside, but we can't characterize it is our problem. So we're suggesting to just, you know, model single digit growth. We're comfortable with that. We're going to do our best to do better, but the upside opportunity is largely market driven rather than company driven. It will happen when it happens. We're ready for it. We're aggressively pursuing it, and we intend to get our fair share. We just don't know exactly when it will happen.

As a follow-up on that, with the aggressive pursuit, what are your assumptions right now for what sales and marketing expenses are going to be for 2008? Is it something we're going to see a steep jump in as you need to be reaching out and touching a customer base on this topic?

We expect some increase in investment in that area but I wouldn't call it a jump. We continue to be very efficient as you see for the last several years. We keep working very hard to be as lean as we can be to maximize the financial return, but there is a ton of work right now in the marketing and sales areas preparing for these upgrades and for the additional funding we expect to see.

One final question before I let the others jump in, the related project has been the enhanced driver's license which contains an R.F.I.D. chip. I know that's deployed in Washington State. Press we've seen so far has been that it's been pretty successful, more demand for it than the states see sort of a two-part question. Other states have also signed memorandums of agreements with D.H.S. to the similar project what is timing I'm seeing another state or two come into that system and then the second are you seeing anything from Washington alone that could lead to some perhaps upside I guess on revenues or margins this year?

With respect to the rollout in Washington State, have I to say everyone is delighted. It's an excellent product, a great cooperation of homeland security and the state of Washington so we were out on time with a very good product and citizens have responded well. They have a backlog of people trying to get the E.D.L. and so we're very pleased on all levels with what is happening on Washington. What impact that has on the overall business in '08 is not going to be sort of a game changer because of a single state with a single product which is a subset of their current distribution. Given the way in which the citizens are embracing, we're hoping it will become a large percentage of the licenses that the people seek, and if that becomes true on a larger basis, that would be a changer in the marketplace. It is a more sophisticated product that has a higher cost to it for the citizens paying about $15 more to get it.

With respect to when the others come on board, we hope really soon and we are obviously actively engaged with everyone who is interested in the product and we have an excellent reference account from our very good performance in Washington state and we are the only producer at this point in time of that product and as I said it's an excellent product. We're going to get more business there and get that business soon we believe and then we'll roll those systems out and the Washington state system took a little less than a year to install given it was the first one we would expect some efficiencies in later installations. This kind of goes to the '08 point that depends on when you get the order and the resources available from the state and how quickly we can begin issuance how much money can flow in '08 and '09.

Thanks.

Your next question comes from Andy Hargreaves at Pacific Crest Securities.

Is that related specifically to Real I.D. or water marking or both?

The increase investment which statement are you referring to?

Mike referred to the potential for increased investment in the back half of the year that might raise OpEx?

I think it was me actually. We're anticipating as the discrepancy indicates that our time is at hand. The growth rates will go up significantly and so when we're comfortable that they'll be going up, then there'll be some investment in those anticipated future revenues. And so again, following our guidance here, we feel comfortable that '09 is going to demonstrate a significant higher growth rate but '08 may or may not. That's why we would infer that in late '08 there could be some increase in investment in anticipation of '09 having a higher growth rate.

That would be them primarily sales and marketing investments to get these programs off and running?

Yes. We call it the front end of the business, which would be sales, marketing, and program management, the delivery of programs.

Okay. Give us any color on R&D plans. Have you got a few things that are a lot closer should expect you to flatten out, I suppose, on the r & d spending?

Well, our R & D accounting is quite complicated because much of the R & d that we do can show up in the cost of revenues as well as in the Op Ex area. As you know, because we try to break it out for people, some of our intellectual property spending goes into G&A , and it's really in our world product development, we're not able to account for it in that fashion. Then because of our intellectual property licensing, the R & D of others is R & D of ours. So if you're talking about the R & D line on the income statement, I don't expect that's going to change. Nothing

Thank you.

Your next question will be from the line of Kevin Hanahan with KNH Advisors.

Good morning, Bruce.

Hi Kevin.

I had a question. I saw in the news Social Security Administration was considering new social security cards which would cost $8 as opposed to the old cardboard cards that cost $0.50 per card. The new card will have biometric information, much more features. I just wondered if you would be interested in, you know, in putting an R.F.P. on that or if you might be a sub and if you can comment, you know in general about, you know, I.D. cards in general in the industry?

Okay. Yeah. The notion of an enhanced social security card has been around for many years now. And I still don't quite know what it would mean to have one of those because the biometrics of an infant are not very indicative of the biometrics of an adult. I don't know what they mean and I don't think they know, either, frankly. It's a concept that they want to make social security the birth registry associated with it more meaningful. I don't think it's going to go anywhere, frankly. I think the number is helpful for a lot of reasons, but that's been working well and the marginal utility in relation to the marginal cost making a more secure card that doesn't have much of a basis for distinction is probably not going to make it.

In terms of identity management, generally as you know, we participate in a number of different areas of identity management. The Real I.D. debates have been quite helpful, I think, in helping ciTizens to understand the virtues of secure Identity, and so in the two polls that were done nationwide on Real I.D., the respondents said they'd be happy to wait longer in line and pay more money to get a better I.D. because it has so much meaning in their lives generally, not just a driver license, it's a way of opening bank accounts and, establishing our identity when you get a job and all kinds of important things. I think we're on a good trajectory generally in the appreciation for effective identity management which is not just documents, by the way. And very important point that has been part of our strategy since. It's the whole process not just the documents.

So we do great documents but we also have been building out our ability to provide the full identity management solution to our customers since we entered the business and that's where Real I.D. is focused on the overall process in making it more secure. And our customers are interested in greater security but also greater efficiency. They want their customers to have a good experience. So the dual pronged approach of our business is to provide greater security with greater convenience to the citizens. We think those are not contradictory goals, and so I think we're heading down a good path here generally in identity management in the United States and globally, it's a bit more difficult to characterize the market. I still believe it's in its early stages of development and there's a ton of opportunity for improvement around the world, but we focus our energies largely in the domestic market here to build efficient and secure cost effective solutions that we hope to be able to export in an orderly fashion over the coming years into foreign markets.

Okay. Can you give us an update? I saw the Blu Ray beat out Toshiba. Both would be okay, but can you give us an update on that and also the Nielsen rollout of their product and how that's progressing as we go into 2008?

Yep. You're right that the choice of formats was not relevant because we were involved with both.

Right.

What is relevant is the assumption that analysts who understand that market better than I do have been making which is by getting rid of the format war is more likely more people will feel comfortable buying the product so it should result in a higher pickup in the early stages. That would have been true if there was a format war going on. So that's good for us. We're hopeful that Christmas '08 will be a real bang up year on Blu Ray.

We also believe that I.P. connected entertainment devices are going to be more and more common. In other words, there will be an ethernet jack or wireless connector on more and more products meaning that our technology for identifying media objects regardless of distribution channel and using identification as a trigger for application will become increasingly important. So it's all good news on that front. In terms of the Blu Ray technology choice, a reminder here goes to ambiguities that we believe will be resolved in the near term. There's an interim license out specifying water marking as a requirement for H.D. D.V.D. play back and recording devices. There was a notice to manufacturers last year. Still waiting for the final license. We're hoping it's going to be, again, within the next couple of months or so that that gets done.

Once that is done, everything is done and we'll be counting our money. But there is still that uncertainty in the marketplace of getting the final license published. All of what I'm saying is available to the public on the AACSLA.org web site. So we're watching as everyone's watching for them to get that wrapped up. I hope that answers the questions, Kevin.

Sure. I was asking, also, about Nielsen.

Oh, Nielsen. It's going great. We are cranked up. They're an excellent partner. We're in the development stage, getting the initial solutions ready for market. They will be Nielsen Solutions so Nielsen will do the positioning, the marketing, the pricing and so forth. So I'm not going to preannounce anything. That's really their job to do and their right to do, not mine. But I can say from our perspective as a development part that we're very pleased with the relationship and we're crankin' full speed on it so I'm excited about the prospects of that relationship.

Thanks a lot, Bruce.

Your next question will be from the line of Jonathan Ruykhaver of ThinkEquity Partners.

Good morning, Bruce, Mike. Can you hear me?

Sir, your line is open.

Good morning, guys. Hello?

Check to see if you have your phone on mute.

Hello?

Your next question will be from the line of Jeremy Grant of Stanford Group.

Thanks. Couple follow-ups. To talk about the Blu Ray opportunities. One thing to keep an eye on in the next couple months in the final license. I know it's tough to get into specific predictions of what revenues could be but I guess the question is, you know what sort of -- what sort of, you know, boom in Blu Ray sales assuming you're part of the licensing agreement would translate into something that would actually be material in the numbers?

That's a nicely tricky question you're asking there, Jeremy.

I work my hardest.

Let me see if I can find a way to the web to answer it. We put out a news release a while back on this because we anticipated that in future periods that it could be a material contributor to our financial performance. I still believe that to be true. The volume sales of compliant devices would only begin in the Christmas '08 and given that we are royalty based participants in that. There would be time lag associated with that. In '09 probably around the middle of '09 it could become material.

Okay. Following up on that --

I gave all the cautions that are appropriate.

I appreciate that. And keeping an eye on the final license decision as well, would there be any up-front revenue that would come with that or this would really just be a device revenues tracking back to you as a Blu Ray device sales pickup?

We're not sure on that, Jeremy, because our participation in this is on a royalty basis with the chosen technology supplier business partner of ours. We're not privy to all of the nuances of their business relationships, and so I don't know the answer to that.

Okay. And other question delving back into the driver's license market again, can you just provide a bit of an update as to what's going on in the different state procurements and sort of time lines of any major procurements in the next two or three months?

The -- we lost Virginia again.

It was under protest, right?

A while back. Yes, we did file a protest as we had done previously. New Hampshire has made an award to another vendor. That's a relatively small customer of ours but they appeared to be going with another supplier. There are three bids in progress. California is not in the bid process for 2.5 2 years or so and Georgia where they have accepted responses to the R.F.P. and are deliberations and are in Massachusetts who recently accepted the responses to April R.F.P. So that's the active part of the market. We anticipate with the finalization the real I.D. regulations that there will be a lot of activity whether that ends up in continuations through sole source negotiations and open competitive bids for us and for accounts held by other suppliers is not clear yet.

Okay.

We know we're going to be busy, we just don't know the preference of the customers as to which way they're going to go. We prefer our customers stick with us and the others come our way. We'll see how it goes.

The protest for Virginia what's the timing for resolution on that?

I really can't go into the details of that situation. It wouldn't be appropriate.

Okay.

Your next question will be from the line of James Fitzpatrick of Princeton Capital Management.

With regards to each and all of you, Bruce, I have two questions. The first one relates to the financial markets. In all these instruments created, the collateralized debt obligations, the subprime mortgage issues, issuances and the credit default swaps and regarding the documents themselves are the e-mails and voice messages that pertain to them is there market there for you as it stands or if there would if there were a spontaneous combustion in these huge compost heaps that extend this country into Europe?

We have deposed our technology for such things. We don't have an active R & D effort there but we can be used to secure and authenticate any printed materials. We'd be happy to help if we could, but we don't have any significant business in that area right now.

Any central banks, does the B.I.S. in BASEL or any leading financial institutions come to you and suggest this or explore this with you with initiatives from themselves?

Well, I can't talk about any individual central banks because I'm only known to do business with a consortium of leading central banks. That's the only disclosure I'm permitted to make. I do know a few of them, have I to admit. We are very well known in that community, and our technology is very well known. And in prior years, we have looked at other kinds of financial instruments like you're talking about and suggested that we could be helpful and we actually did some R & D and some market tests and so forth but the perception of the customers is because of the large electronic network if you like that backs up these documents. That's the marginal value we could add was not big enough to justify their deployment and paying us enough to make it worthwhile for us. They just really rely on the networks rather the documents are seen as really just symbols of the network as opposed to independent value documents like money.

That's good enough answer. I surmised the initiatives would have to come from them. It's not a market you could develop in your own right from the outside. I wouldn't be surprised if some day it's not a necessity request for help. The other question is this perception of mine correct that Digimarc has not in recent years been so free and clear of distractions and harassment as they are now? For instance, you have cleanups from Polaroid, you have a top lawyer with a frivolous suit. These -- any unanticipated costly harassment in your past that you can visualize now and are you now free of all these? It must feel very good if you are.

It does. I was getting a little queasy as you were taking a trip down memory lane. Things are very different now. We made a bold acquisition and taking the bankrupt company assets from Polaroid and it turned out to be a very difficult row to hoe and we're ready to grow and deliver profitability to our shareholders and good cash flow. So yeah, it's a very different environment. We made it through the rough patch here and we're very optimistic about our prospects. It's a lot more fun now than it was during that time.

We were very much liked and highly regarded. Thank you.

Thank you, Jim.

(OPERATOR INSTRUCTIONS). The next question will be from the line of Jonathan Ruykhaver of ThinkEquity Partners.

Good morning, can you guys hear me. Good morning.

Sir, your lane's open.

Good morning, can you hear me? Hello.

Please check to see if your phone is on mute.

Good morning, can you hear me?

There appear to be no further questions at this time, sir.

Thank you very much, everyone. We appreciate your interest and support and we'll be talking to you again soon.

This does conclude today's conference call. Thank you for your participation. You may now disconnect.