Digimarc Corp (DMRC) 2009 Q2 法說會逐字稿

Good morning. My name is Christie, and I will be your conference operator today. At this time, I would like to welcome everyone to the Digimarc Second Quarter 2009 Results Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer session. If you would like to ask a question during that time, simply press star then the number one on your telephone keypad. If you would like to withdraw your question, press the pound key. Thank you. I will now turn today's conference over to Bruce Davis.

Thank you. Welcome and good morning. Mike McConnell, our CFO, is with me. We issued a press release earlier today announcing our second quarter 2009 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 our strategy and operations. This webcast will be archived in the Investor Relations section of our website.

Before we proceed, please note that during the course of this call we'll be making forward-looking statements regarding management's opinions and expectations about Digimarc's business, its markets and financial performance. These statements are subject to assumptions, risks, uncertainties and changes in circumstances.

Actual results may vary materially from those expressed or implied in 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 10-Q that we expect to file later today and our earnings release posted on our website earlier today.

During the course of this conference we'll also refer to certain non-GAAP financial measures, as defined by the SEC and Reg G. Definitions of these non-GAAP financial measures and reconciliations of these measures their more directly comparable GAAP financial measures are included in the earnings release for the quarter.

Any assumptions we offer about future performance represent a point-in-time estimate. Given the current economic climate, we believe it's prudent to embrace a very cautious posture towards assumptions and projections in general. We describe various assumptions and projections in this call for the limited purpose of giving you a sense of our planning assumptions and to assist analysts who solicit our views as one of their sources for modeling possible future performance. It's obviously very challenging for anyone to try to forecast the general economy and derivatively its impact on individual businesses like ours. We expressly disclaim any obligation to revise or update any assumptions, projections or other forward-looking statements to reflect events or circumstances that may arise after the date of this call.

And Mike will begin this update call by commenting on our financial results. Then, I will update our financial product market outlooks, strategy and operating plans for the remainder of 2009. Mike?

Thanks, Bruce, and good morning, everyone. I'll begin by reminding everyone of the basis of accounting used in presenting our historical financial results. The Digital Watermarking business that forms the basis for the current new Digimarc was spun out from old Digimarc last summer just prior to the sale of old Digimarc to L-1 Identity Solutions.

As explained previously in our calls and SEC filings, the basis of accounting used for the Digital Watermarking business prior to the spin-off and up through August 1st of '08 is referred to as a carve-out of Digital Watermarking assets, liabilities and results of operations from the old Digimarc business that included the ID Systems operations that were sold to L-1.

It's difficult to meaningfully compare the new and old financial results due to the different basis of accounting used in light of the spin-off transaction. Please keep this in mind as we discuss changes in results from our prior periods.

Q2 financial highlights include revenues achieving $4.3 million, and they were lower by 15% year over year, and they reflect the impact of variations in scheduled payments in our revenue sources in accordance with the terms of the contract, continuing delays in the federal defense contracts that had been earmarked in our favor, as we had noted in previous calls and, to a lesser extent, lower royalties from some of our licensees, reflecting general economic conditions.

Gross margin was 65% compared to 67% in Q2 of '08, the two-point change primarily due to a mix where lower margin service revenues accounted for a greater part of the total and, to a lesser extent, the impact of a different basis of accounting for expenses, that I mentioned earlier.

Operating expenses increased from $3 million to $3.6 million, primarily reflecting the change in basis of accounting between the two periods and, to a lesser extent, the impact of increasing our investment in R&D resources that we've noted in prior calls. I'd also like to note that operating expenses decreased by about $300,000 from those incurred in Q1 of this year.

Our cash and marketable securities investment balances at June 30th were down slightly at -- in -- from the end of Q1 to about $45 million, and revenue backlog at the end of the quarter was $50 million, reflecting the net booking activity and the normal burn-off of backlog.

For further results of -- further discussion of these results, our business and financial models and risk and prospects of our business, refer you to Form 10-Q that we expect to file later today.

Looking forward, we continue to advise investors that our discussion of financial assumptions in the context of prevailing general economic conditions should continue to be viewed cautiously. With this in mind, our assumptions for the balance of the year reflect higher second-half revenues notwithstanding the potential deferral of revenues associated with the federal earmarks referred to earlier. Revenues for the year could be slightly lower than 2008, given the continued deferral of these federal earmarks and moving of some of those revenues into 2010.

Given that the contracts have not yet been signed, there is a possibility that no revenues may be realized. However the positive note, negotiations on these contracts have accelerated mid to late the second quarter, and they are continuing.

Financial results, excluding the impact of joint venture activities, are expected to be better than the first half of the year, and the losses from the joint venture activities should not exceed the previously disclosed $1.1 million contribution, and they could even be less.

We are working on a number of interesting opportunities that would impact the latter part of 2009 and 2010 financial performance, but that impact is too speculative to model at this point. We also expect that 2009 operating expenses, which include the majority of our $2.3 million of stock compensation charge, will be about $15 million and possibly be even slightly less than that. Stock compensation is allocated between operating expenses and cost of revenues.

So at these baseline levels and with the composition of revenues expenses, we expect gross margin to be in the 60s, mid-60s, for the year, GAAP losses, including a loss investment in a joint venture of up to $1.1 million, to be around $2.5 million, adjusted EBITDA, or earnings before interest, taxes, depreciation, amortization and stock compensation, to be near break-even, assuming a maximum loss of $1.1 million for the joint ventures and some revenues to be generated from the federal contracts.

We expect to utilize between $1.5 million and $2 million in cash for the year, reflecting our joint venture investments, lower expected revenues and their related impact on operating results, and to a lesser extent, some changes in our balance sheet accounts due to the timing differences. The primary explanation of differences between adjusted EBITDA versus GAAP loss is the $2.9 million of non-cash charges for stock comp and depreciation.

Bruce will now provide an update about our markets, strategy and operating plans for 2009 and beyond. Bruce?

Thanks, Mike. Other than the delayed commencement of work on the federal projects, we're executing on our strategy generally according to plan, making good progress on our key objectives. Among other things, the biggest news for the quarter of course was the expansion of our relationship with Nielsen, whereon we agreed to form two new joint ventures to combine the respective strengths of our companies to bring important innovations of the media distribution and consumption to market and broaden the scope of the Nielsen license.

In industry news, the Record Industry Association of America, trade association for the music industry, published a watermarking specification for its members. For more information, see www.riaa.org. We saw progress in the motion picture industry as well with publication of the final license of BluRay security that requires watermarking. For details on this, see www.aacsla.org and www.verance, v-e-r-a-n-c-e.com.

On the intellectual property front, our patent portfolio ranking in the top 50 innovative companies in information technology as published by the Wall Street Journal improved from 29th to 27th place, based on more than 50 indicators of the company's innovation technology and science strengths. Through mid-July, we have 38 patents issued year-to-date, bringing our total US and foreign patent count to over 525.

We engaged in quite a bit of business development activities in the quarter, including pursuing relationships with potential new licensing partners in different areas of business where our IT and technology are relevant. As evidenced by our dealings with partners like Nielsen, the formation of such relationships can include a combination of licensing and collaboration on new offerings or ventures in which various forms of consideration are exchanged.

Please keep in mind that the outcome and timing of such initiatives are inherently uncertain, and such initiatives can take many forms and it could provide upside to our revenue expectations and/or could involve increased legal expense, particularly if we're forced to resort to legal action to enforce our IP.

As we've done with our licensees in the past, we have stated our views in detail and have encouraged potential partners to work with us to develop creative approaches to provide a reasonable compensation for our intellectual property in fair and mutually supportive relationships. In addition, we have identified several more potential licensees or are -- and are engaged in detailed analyses of these opportunities.

Regarding our stock purchase program authorized by the Board earlier this year, we have not yet repurchased any shares under the program due to self-imposed trading restriction based on the Nielsen negotiations prior to public disclosure followed by our routine end-of-quarter restrictions.

In closing, I note that we are very busy working on numerous initiatives, including our new joint ventures with Nielsen, initiation of licensing discussions with several potential licensees, assessment of additional prospects, outreach to several other potential business partners and research and development initiatives in print, imaging and mobile applications.

This concludes our prepared remarks. Thank you very much for your interest and support, and we'll now take questions.

At this time, I would like to remind everyone in order to ask a question, please press star and the number one on your telephone keypad. We'll pause for just a moment to compile the Q&A roster. Your first question comes from the line of Walter Schenker of Titan Capital.

Thank you. Hi, guys.

Hello.

Two questions actually, the first of which is -- you may have indicated in the past, the defense contract, which is coming on slower than expected, have you indicated roughly what sort of revenue that might generate?

I don't recall. Mike, have we --?

We have not. It's two different contracts, and they're reasonably substantial because we -- we're a little bit lower than we'd like to be on the revenue side. And we may have a little bit more color on that next quarter about what that aggregate of those might be.

I think if you go back, Walter, we just don't want to speculate here on what we may have said a long time ago. There were press releases associated with the awards, I believe, and with -- may have done some indication of value.

Okay.

But the delay in getting to work on these is the most substantial part of the difference between where we started the year on our assumptions for revenues and where we are now.

Okay.

In other words, everything else is kind of going like we thought it was going except for those, and it's just [not there] to get them underway and quite frankly don't know all the reasons why it's taking so long because of the nature of the work that we're being asked to do and the kind of people who are involved in a -- in the Department of Defense, and with the change of administration and the recession and the Congress all wrapped around the axle. It's just everybody seems to be wandering around chasing their tail, and so we continue to believe we're going to get the work and that we're going to get started on it pretty soon. But we just caution everybody, as we did last quarter, that we're not yet doing the work, and so we're experiencing then the related new impact on our assumptions about how we'll do our revenues.

Okay. And the second question, I think last week there was an article, AP Creates Way to Track Distribution of Articles Online, with the Associated Press, about trying to identify their use of certain articles that these papers produce, 1,400 papers produce online, just curious if that is your technology or someone else's?

It's not ours nor related to ours as far as we know so far. We're getting in touch with AP and see if we can help them out. What we think they're doing, based on what we've seen, is that they're trying to find a way to secure and get payment for text-based news, which we don't have much to do with. We have some R&D we could theoretically apply if we wanted to. Where we can help them is with their images, and we could be very helpful there. And so, I didn't see anything in the announcement nor in any of the commentary about the announcement having to do with their approach to images.

Okay, thank you.

But, we'll see. There may be an opportunity for us there.

Okay.

Once again, if you would like to ask a question, please press star and the number one on your telephone keypad. Your next question comes from the line of Paul Sonz of Sonz Partners.

Good morning, gentlemen.

Good morning.

Paul.

In talking just as a side note, in talking to the people at AP, they indicated to me that the text was a start, and then if this worked out they were going to move into images. So I think that is probably the fruitful area for you to follow up. They also did not indicate any knowledge of Digimarc and did not have a particularly insightful view of watermarking, at least the gentleman I talked to.

All right.

You mentioned -- moving on, that -- and the enforcement of IP. I wondered if you mentioned that because there is -- there -- you have become aware of people who are violating your IP at this moment?

We're actually a bit ahead of our own schedule in our marketing plans for our IP and, as I -- you know, I characterize our strategies of the execution, I say we're generally doing what we said we're going to do. Well, we're a little behind on the federal stuff, but we're actually a bit ahead on the IP initiatives. And we have identified several potential partners, and we have contracted them and begun a process with them to have them consider being business partners of ours.

And in addition to the several that we've already begun a process with, we've identified several more. So, it appears that the -- that the market opportunity is becoming more fertile. We're going to see what we get out of all of this, but we were anticipating in our planning that we'd be doing the kinds of things we'd begun doing in Q2 toward the end of this year and early next year.

And so, if we go back to how we started off the year in our strategy, as I described it to all you guys, we wanted to be quite conservative in the first half of the year while chaos reigned in the general global economy. And as we're now entering the second half of the year, we feel more confident making more outreach and getting some of these relationship-building opportunities underway.

So, I'm pretty excited about the way that market's shaping up. I see lots of opportunity for us and getting more interesting by the day. And again, our approach here is just to try to develop creative relationships in which we develop value, not only for ourselves but for the licensee, and so it'll take a while for these to bear fruit probably, and some of them may even -- may not work out in a friendly way. But at this point in time, we see opportunities for expansion of the business, but -- that are quite attractive to us.

So in other words, there are some ideas that you see out there where people are -- have developed products that they hadn't given you a call and said, "You know, we understand we're using your IP?"

Well, I think there a couple of things, Paul, to say about that. One is that our vision is becoming a reality. I think we -- on the virtues of IP is -- being a little early is not a bad thing. It's actually a good thing, and we were quite a bit early in our vision of how the media landscape would evolve. Well lately, and this is in the last year or so in an accelerating way but starting when you guys noticed me getting more optimistic about 1.5 years ago or so, media object recognition is becoming quite fashionable. Everybody's thinking about, and some people are starting to act on it.

Well, as they act on it, they may or may not appreciate the broad relevance of our portfolio. And there are people who want to use watermarking and should have a relationship with us about that technology, but our portfolio has much broader relevance than just watermarking. That's where we started. That's the core technology that we pioneered, but we've been working on this now for 15 years, and we have 525 issued patents, and they cover a wide range of innovations that are relevant to what's going on broadly in the media market today.

So when we talk about establishing partnerships, don't think just watermarking. Think about content identification and management, and think about object recognition. Think about the mobile marketplace and all of the things that are going on there. There are a whole bunch of companies that are trying to develop pieces of our vision of seeing and hearing computers. And when they do that, it will be helpful for them to have a relationship with us.

Could you give us an idea of -- you indicated a very broad range of new business that's coming around, ranging from people coming to you to you reaching out and suggesting things to other people. Could you give us an idea of what specific areas these are in and -- in terms of the areas they may be in, how near-term they may be and what is the potential in terms of revenue generation?

Well, it would speak too much for me to talk about the areas because it would be rather easy to figure out the targets, which would be kind of rude in the way that these processes run, so I'd rather not go down that path. But I'll kind of address sort of the risk and opportunity and timeline piece of -- and that's where I -- that's just my custom here to caution everybody that there's great uncertainty. When you begin the process, you don't quite know how long it will take and how it will end up and what twists and turns it will take along the way.

As I noted in our prepared remarks, we're very conscientious people. We're very serious people, and we have a spent a long time and a lot of hard thinking in preparing for making an overture to various potential partners. And so we think that we've stated our views quite clearly and they be persuasive. And if they're not then we will use whatever means we need to make our point, all in the context of trying to find ways, not only to get fair compensation for our IP but to build more value for our potential business partner.

So, given our approach and given the nature of what we're doing, which is intellectual property licensing, it can take a lot of time. You know, Nielsen took a couple of years to get done. I -- so, it's anywhere from -- someone gets the revelation and says, "Well, let's do a deal, and it sounds great and we'll get it done," which is probably a two or three-month process to a couple of years or, even if there's litigation, three or four years.

Okay.

So, it's really hard to tell timing-wise, and it's also treacherous to try to predict success in every initiative. And so, we obviously have the capital base and we have the sophistication and determination to move our views forward. And so, we're hopeful that people will see the virtues of working with us and enter into deals. But, that's why when Mike talked about the rest of the year, there could be some upside from some of the stuff that we're working, but it's hard to tell. So, we're not going to tell you guys we're going to deliver and let you down. We'll see if we can bring it in.

Right. Any update on the Nielsen JVs and when we might see a product offered by either one of them?

Well, the official commencement of the JVs was July 1, so Mike's going to be required to report to you on the financial performance going forward because -- unless we're -- it's not material.

Good.

On the strategy execution level, things are going just fine. In JV 1, which is oriented toward the activities of our prior work for Nielsen that you're aware of, we believe we might be able to get some customers up and running this year and get some revenues going, and so that one's closer to market than the other.

Right.

The other, which I'm purposely quite vague about, you've got to describe it as a big idea, is not likely to get to market this year and may or may not get disclosed to the market this year. So, that one's a little longer gestation and it has both technical and marketing requirements that we need to satisfy those to move forward.

Is -- last question, in the stock buyback program, at this moment does it appear that you will be able to initiate the buyback program after earnings quiet period? Or, are you so involved in so many things that you think that that probably is not going to happen?

I don't know. The honest answer is I don't know. If we're able to purchase shares and we think it's in the interest of you and other owners of the business to do it we'll do it, and if we -- either of those conditions are not met we won't.

Okay. What was the --?

And we would have to play it by ear.

What would be the -- how many days after earnings do you have to wait before you're allowed in the marketplace?

Yes, it's the third day after.

Say that again, Mike.

The third day after.

Third day after, all right. All right, gentlemen, well it sounds great. Thank you, very much.

Thanks, Paul.

Thanks, Paul.

As a reminder, if you would like to ask a question, please press star and the number one on your telephone keypad. Your next question comes from the line of Kevin Hanrahan of KMH Capital Advisors.

Hello, Bruce. Congratulations again on the Nielsen joint ventures. I had a -- two questions really. The first one surrounds Corbis, which I saw -- one of your customers. I saw a Corbis gentleman on TV on CNN surrounding that tragic death of Michael Jackson. But I just wondered if you could comment on that a little bit? I was surprised to see Corbis on TV because they don't get a lot of publicity, but maybe some of these images of Michael Jackson's, pictures or, which could have lots of other cases like that, became very valuable suddenly.

So, you'd like me to comment on Corbis?

Yes.

Yes. Corbis has a very intimate role in our history. They are -- they're one of the sources on the foundational element of our intellectual property portfolio. A couple of gentlemen there in the 90s did some terrific innovation, and we acquired all of the rights from Corbis for their work and then nurtured it into one of the foundational elements of the portfolio. So, we're quire grateful to Corbis and to Bill Gates for giving us that opportunity and to the gentleman who created the innovations.

So Corbis not only is a source of intellectual property for us but our oldest customer in terms of relationship. They've been a customer now since 1996. And we have been doing some unprecedented R&D in the print and imaging space this year, that's why our headcount went up. We hired ten engineers at the start of the year here and invested significantly greater resources in R&D, and much of it relates to print and imaging, facilitating work like we do with Corbis in the imaging side and then enhancing our prospects for the mobile space and the recognition of print materials and -- as a portal to web services.

So in the digital imaging space where Corbis operates, we are working with some prospective partners to develop a broader and richer, more valuable offering for customers like Corbis that we hope to be able to talk in detail about before the end of this year. That will hopefully significantly increase the use of our technology in the digital imaging space, stock photography, commercial photography, journalism, marketing of goods and services and so forth. So, that's an area of intense research and development activity today. And Corbis is aware of what we're doing and supportive and providing helpful advice to us in that process.

Okay, thanks, Bruce. That's great. And the question, which is basically a similar question that I asked, I think, on the call last November, and this regards the rollout of the Digital Cinema. And they were trying to get some funding to accelerate the rollout of Digital Cinema, and I think they had some kind of a commitment from an organization to help them do that. But then, the credit markets almost seized completely. So now that the credit markets seemed to have a slightly better tone, in other words it's lifted a little bit, are you seeing anything on that front in terms of -- I think they were going to try and borrow to roll out the Digital Cinemas faster.

Yes. No. I think your characterization is consistent with my impression, which is that it's -- they're squeezed for capital right now, like everyone is. And so, it will probably not roll out as fast as they thought it would last year, but they continue to roll it out. And I know they're committed to it, and I think that they're enjoying some of the expected benefits, substantial benefits, of digital distribution. And I know for a fact from our work with the studios that all of the studios are anticipating going all, what they call, file-based as quickly as possible, which means there will be no film being used in the process at some point in the future.

Right.

Other than major studios, but they're all going file-based. So, Digital Cinema is where it's going to be. It's just a question of how -- we did feel a capital access question.

And that would help your revenues from Digital Cinema going forward as it rolls out?

Yes.

Thanks.

Absolutely.

Okay, thanks a lot, Bruce.

All right.

Your next question is a follow-up from the line of Paul Sonz of Sonz Partners.

Hi, just one follow-up. On the JV 2 for the transformational television, is there anything more you can say about what that would look like? I mean literally.

No. No, it -- it wouldn't be appropriate. We have some work to do and preparation, and when we describe what we're doing we want to be quite articulate about it and release on what we're doing properly. It's -- if we're able to pull it off, it's really a -- quite a big deal, and so I don't want to leak out bits and pieces about it and have people speculating, perhaps speculating wrong, about what we're doing. I'd rather wait until we're ready to tell the world what's up and then see if we can have a big impact.

Okay. Let me follow-up and ask a different question, which in some way has something to do with it, but also with your traditional business.

To get to where we are now, it took a while because you had to build this sort of an infrastructure where people could consume your product, and you had to seed the market. At this point, would the products you're looking at -- what percentage of the stuff you're looking at would require more infrastructure to be built out before they could consume your product? For example, if it's in television would it require new equipment to be given to -- for people to buy or for distributors to get out into the hands of consumers? In terms of walking, seeing computers, is there other -- are there other technological innovations that would have to be developed and then -- and distributed before they could consume your product?

I think you should have been a lawyer, Paul. I feel like I'm being deposed here. You will not cleverly get me into disclosing that which I choose not to disclose.

All right. That's fine, but it's just -- forget the television then. But in general, is there any -- is -- is this sort of a timing thing? Trying to understand --?

Yes. Well -- yes --.

And if you --?

I know what you're trying to do. With respect to the broader set of initiatives, they actually are in different application areas, the first few that we are underway on. And I think if you want to look directionality at market opportunity that -- what I believe is the most rapidly developing and interesting space is mobile.

Right.

And it's just a lot of stuff going on there, and we anticipated that and we have relevant IP. And so, we're quite excited about that space.

And one of the things I hadn't -- when I was talking about R&D -- Kevin's question prompted me to say a little bit about our digital imaging, our R&D. Likewise, we're making excellent progress on R&D in the print area. And what we anticipate unfolding quite rapidly here over the next few years is a desire by major players to want to have mobile phones recognize what they see. And so, there are a few different ways in which that is currently being done. For example, it's being done based on fingerprinting.

Right.

It's being done based on image analysis that is comparing characteristics of images against a database but not a fingerprint, not a hash, not an extract, just looking at the image -- sending the whole image --.

Right.

Off somewhere to be analyzed, it's being done by crowd sourcing where you take a picture of something and people in lower-income areas of the world sit around on their computers and guess at what it is. And when they guess right, they get paid a few pennies here and there, so a lot of ways of trying to identify objects that are being tried.

And we think we have the superior means of doing that for most objects, but not the only means, and so our IP relates not only to the best means, which we think is digital watermarking, but other means as well. And so as people move down that path, they're going to find us more relevant to them as they move further down the path. Ditto, audio recognition, so that's the area if you want to sort of keep an eye on the market, that's a very interesting space.

Great. All right, thank you very much.

All right. Thank you, Paul.

There are no further questions at this time.

All right. Thanks, everyone. We -- again, I appreciate your support and your interest, and we'll keep -- try to move as fast as we can here, and we look forward to talking to you again next quarter.

Have a good day.

This concludes today's conference call. You may now disconnect.