Digimarc Corp (DMRC) 2009 Q4 法說會逐字稿

Good morning, my name is Celeste, and I will be your conference operator today. At this time, I would like to welcome everyone to the Digimarc fourth quarter 2009 earnings 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. (Operator Instructions) At this time, I would like to turn the call over to Mr. Bruce Davis. Please go ahead, sir.

Thank you. Welcome to our conference call. Mike McConnell, our CFO is with me. We issued the press release last night announcing our 2009 financial results. The objectives of this call are 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 will be making certain forward-looking statements. These statements are subject to many assumptions, risks, uncertainties and changes in circumstances. Actual results may vary materially from those expressed or implied by such statements. Any assumptions we offer about future performance represent a point in time estimate. We describe various assumptions and projections in this call for the limited purpose of giving you a sense of our planning assumptions. 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 conference call. 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-K that we'll file later today and our earnings release posted on our website this morning.

During the course of this conference call, we will also refer to certain non-GAAP financial measures as defined by the SEC in Reg G. Definitions of these non-GAAP financial measures or reconciliations of these non-GAAP financial measures to their most directly comparable GAAP financial measures are included in the earnings release. Mike will begin by commenting on our financial results. I will then comment on our outlook and execution of strategy. Mike?

Thanks, Bruce, and good morning, everyone. The completion of our fourth quarter marked the first comparable quarterly period of operations of new Digimarc since the spinoff from old Digimarc back in Q3 of 2008. Full year results will still need to be viewed in context of the basis of accounting use presenting those 2008 financial statements. As we have consistently explained in our calls and SEC filings since the spinout, the basis of accounting used for the digital watermarking business prior to the spinout and through August 1, 2008, is referred to as a carve-out of the digital watermarking assets, liabilities and results of operations from the old Digimarc business that included our ID systems operations that were sold to L-1, thus making it difficult to meaningfully compare the new to the old financial results due to the different basis of accounting. Please keep this in mind as you review and compare our full year-to-year results.

Reflecting obviously challenging economic times for our business partners and licensees during 2009, our revenues came in roughly the same as in 2008. Notwithstanding the flat revenues in 2009, we achieved positive operating cash flow and ended the year with a strong balance sheet with approximately $43 million in cash and no debt and we had a backlog of about $42 million. We continued to invest prudently in our business, including a $1.1 million investment in our early stage joint ventures with Nielsen, $1.6 million of share repurchases to improve liquidity and financial leverage for our shareholders, continued employee and internal process development designed to increase our operating leverage as we plan for growth and accelerating our IP marketing initiatives to expand our licensing program.

Our Q4 2009 financial highlights include revenues of $5.5 million. They were higher by 19% year-over-year, but the majority of the increase attributed to services rendered under our previously announced federal defense contracts. Both service and license revenues reached record levels on our quarterly basis, and our gross margins at 69% were consistent with those achieved in the fourth quarter of 2008. Operating expenses, which are comparable for the first time since the spinout of old Digimarc -- from old Digimarc reflect the continued investments in new product initiatives, as well as increased investments in connection with our IP marketing activities. Our operating loss of $300,000 was the lowest since the spinoff. We invested $550,000 in our joint venture with Nielsen, and we purchased just over 52,000 shares of our stock at an average price of $14.11 a share. For further discussion of these results, our business and financial models and risks and prospects of the business, we refer you to the Form 10-K that we expect to file a bit later today.

Looking to 2010, our observations and current planning assumptions regarding potential 2010 financial performance include the following. Thus far, financial performance in Q1 is tracking for revenues of just over $5 million, up from $4.4 million recorded in Q1 of 2009. The current expectation reflects some lumpiness in our licensing revenues on a quarterly basis that we experience from time to time based on our licensee royalty reporting and receipts from our cash basis customers. Our first quarter GAAP operating loss is expected to be approximately $1 million, comparable with our Q1 2009 results, and that reflects research and engineering investments and new technologies and products, the cost of numerous IP marketing initiatives, including litigation costs and higher stock compensation amortization associated with the second layer of a compensation strategy where we had previously reduced our overall cash compensation in exchange for longer term stock-related incentives. We expect financial performance to improve as the year progresses due to growth in revenues and a higher proportion of licensing in the revenue mix.

Our operating expenses for the year expected to be around $17 million, including the majority of a $3.1 million stock-based compensation expense, which will be allocated between operating expenses and cost of revenues. At these levels and the composition of revenues expenses, we would expect gross margin percent for the year to be in the high 60s or better, depending on the outcomes of our licensing initiatives, GAAP earnings to be near break even with large potential swings either way based upon the nature and extent of our IP marketing efforts and results, adjusted EBITDA, or earnings before interest, taxes, depreciation, amortization and stock compensation, would be in the range of $2.5 million to $3 million or better. Free cash flow defined as operating cash flow less capital expenditures would be positive after taking into account approximately $1 million dollars of capital expenditures, the majority of which are expected to relate to patent costs. Both our adjusted EBITDA and free cash flow would be better than GAAP earnings, due primarily to approximately $3.7 million of non-cash charges for stock compensation and depreciation.

As a reminder, our financial projections and operating plans represent expected values based on our assessment of the most likely unfolding of events over the course of 2010. We continue to believe that there may be upside to our projections, including entering into new significant business relationships from our IP marketing initiatives. On the flip side, there's a possibility we may choose to spend above the levels discussed previously to encourage prospective partners to engage, if necessary. Bruce will now provide his comments on our outlook and execution of our strategy.

Thanks, Mike. Digimarc shareholders enjoyed another good year of growth and value in 2009. In our first full year post spinoff, we focused on enhancing marketing of our large and growing intellectual property portfolio and on providing excellent quality of service to our customers. Our relationships with the Central Banks and Nielsen are the bulwark of our current revenue model. One of the highlights of 2009 was the expansion of our relationship with Nielsen which include the formation of two joint ventures aimed at combining the respective strengths and assets of the partners to bring important innovations in media management and consumption to market. We added 72 patents to our portfolio in 2009, giving us a total of over 560 with over 420 pending applications as of the end of the year.

In the second half of the year, we initiated several significant IP marketing initiatives to expand our licensing program. These ongoing initiatives provide the potential for substantial growth opportunities for our Company, but may require additional time and investment to conclude. We remain optimistic about our near term prospects and longer term vision for intuitive computing. In particular, we see signs portending a promising future for the concept of transformation of the mobile phone into a seeing, hearing and understanding device embodying our innovations. In 2009, we completed substantial improvements to our core mobile technology, witnessed the launch of our technology with several magazines and newspapers in Europe and filed numerous patent applications covering the relevant inventions. Other key investment areas during the year included intellectual property initiatives to enhance our portfolio and expand our license program, establishment of our joint ventures with Nielsen, share repurchases to improve liquidity and financial leverage for our shareholders and investment in employee development and processes designed to increase operating leverage as we execute our strategy.

Digimarc's long term growth strategy is largely unchanged as we begin 2010. We intend to continue delivering superior investment returns by providing exceptional service to our business partners, patenting innovations that result in valuable new technologies and solutions and continued growth of our IP portfolio and by providing a caring and interesting work environment for our employees. It should be a very exciting year with new product introductions, upgrades to current solutions, progress with our Nielsen joint ventures and ongoing negotiations with many potential new business partners. We see opportunities for good growth in both service and license revenues and are well positioned for another year of healthy growth in shareholder value. We see opportunities for good growth in both services and license revenues. In our view, the range of potential revenues is quite large. Most of the variance in revenue expectations is in licensing, depending on the timing and disposition of numerous licensing activities. Our expenses may vary, largely depending on the paths and the timelines of our IP marketing initiatives.

Our key objectives are unchanged from those described in our last conference call. They include continuing a high rate of valuable innovation, broadening the relevance of our IP by fostering adoption of digital watermarking and extending the scope of our patent portfolio to related technologies, entering into one or more significant new business relationships, providing excellent quality of service to the Central Banks and US Department of Defense, growing our image business through product upgrades and technology alliances, expanding Digimarc Mobile to newspapers and magazines in the US, developing successful joint ventures with Nielsen and improving financial performance while continuing to build long term shareholder value. The high rate of growth in IP assets at Digimarc is broadening our licensing opportunity pipeline.

We are expanding the breadth of our portfolio with research and development related to helping mobile devices to better see, hear, understand and respond to the world around them. Layered in coating of media and other enhancements of next generation of media industry workflows. We continue to patent at all levels of the typical technology stack, including basic technologies, application, systems and processes. The market studies associated with our licensing initiatives are broadening in concert with the expansion of our IP asset base to areas such as audience measurement, bold music identification, digital search, copyright filtering, royalty audits and brand protection.

Emerging target markets include ubiquitous computing, entertainment on the Internet, journalism, object oriented search and sensor based mobile device applications. Our growth strategy has many facets, all encompassed within a coherent vision. The bedrock of our Company is our government business, which includes our long stranding Central Bank relationship. In the commercial realm, we believe we can play an important role in the evolution of computing to a model that is more ubiquitous, pervasive and intuitive. As the media and computing markets evolve, we are seeking new business partners, fostering the success of existing partners, evangelizing our vision and doing whatever else we can to broaden and deepen the relevance of our innovations. As we do these things, please keep in mind there is a substantial range of potential outcomes of our various IP initiatives in terms of timing and dollars. The outcomes can provide revenue upside that is difficult to predict.

On the other hand, the initiatives can get bogged down, take a long time to resolve and involve substantial increases in legal expenses, particularly if we're forced to resort to litigation to enforce our IP rights. We continue our constructive approach to licensing in which we generally state our views in considerable detail and encourage potential partners to work with us to develop creative approaches and that provide reasonable compensation for our IP and fair and mutually supportive relationships, and we are very excited about our prospects.

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

(Operator Instructions) We'll pause for just a moment to compile the Q&A roster. (Operator Instructions) Your first question comes from the line of Aalok Shah with DA Davidson.

Hi, guys. Just a couple quick questions. On the backlog numbers that you guys provided in the release, can you give us a sense of how we should think about the backlog? Is that a six month number, a 12 month number? And then what is the likelihood that we start to recognize that backlog a little bit faster? Typically -- how does that typically work for you guys?

Hi Aalok, it's Mike McConnell. I can give you some color on that. The backlog really spans a number of years based upon the term of all of our licensing and service contracts. Out of that $42 million or so, we've got about $17 million of that that rolls into 2010 that's pretty well locked in.

Okay. And then is there -- in terms of how that works, though, is that licensing and royalty in that backlog number, or is it all just kind of a blended kind of service royalties that you'll receive over the year or a couple years?

It's a combination of service revenues from our service contracts, which comprise of the Nielsen joint venture, the Central Banks and our federal contracts. And then the licensing revenue from all our licensing customers, and it's a blend, yes.

Okay. All right, great. Thank you very much.

Sure.

Your next question comes from the line of Bill Gibson with Waluga Capital Advisors.

Hi. I could use just sort of a refresher on the JVs. Do we continue to see a half million dollar investment each quarter? Is that what happens this year in 2010?

That's correct. I think it might increase just slightly in 2010, but you have pretty much seen the run rate there.

Okay. And we didn't get much of an update either on TV or the second JV. Could you give us maybe a little more color around that?

Yes. Hi, Bill. The -- we continue to work on both. We haven't said much at all about JV2. With respect to TV or -- we're still trying to figure out how to get into the market in a profitable fashion that's -- the copyright filtering area is still littered with the half dead venture investments that were overfunded in 2007, 2009 period based on the initial Viacom lawsuit against YouTube. So we still see a lot of -- a smaller number, but still a handful, I would say, of companies out there that are trying to offer service without supporting business models. So we're doing a lot of study of the market trying to figure out the right way to operate profitably in that area.

And I know you talked about potential upsides. I'm assuming JV2 still fits in that category.

Not with respect to my use of upside in the script. The upside I was talking about in the script related to 2010 financial performance.

Yes.

JV2 is longer term upside.

Okay. Now closer to home and it gets down to pretty much a body language read, but I sense things may be heating up in just the way you presented the talking to potential licensees. Is that fair to say, or are people showing more interest now that the economy improves?

It's fair to say that I'm enthusiastic about our prospects, Bill. We have underway a number of initiatives that have been underway for some time. We continue discussions with potential new partners, and that's a good thing to be continuing discussions. And then I continue to see the market moving in the direction that our strategy anticipates, and so there should be more opportunities arising in the near term as well. So yes, I think it's going to be a very exciting year. I'm hoping to deliver some upside. We've got here as a clear objective for management to close some deals to give you guys more than a good feeling. I want to give you some money.

Good. Thanks, Bruce.

Going to work harder on that.

Thank you.

Your next question comes from the line of Andy Hargreaves with Pacific Crest.

Hey, any sense for, or can you give us any sense for where the licensing deals that you're looking at may come from, just from an industry or vertical perspective?

Yes. That's -- in my prepared remarks, I talked about the market opportunities, Andy. Those are it. So if you go back in my remarks where I was talking about, let's see, on my exact language so I can be quite specific. Let's see, okay. It is audience measurement, mobile music identification, visual search, copyright filtering, royalty audits and brand protection, those were the areas that identified. Those are the immediate targets.

Okay.

In terms of sectors.

Thank you. And then you guys, I think in the press release mentioned federal business that had pushed into the first half of this year. Is -- are we getting some of that in the first quarter, or is most of that going to be in the second quarter?

Yes. We'll have some of that in the first quarter.

Okay. Any meaningful impact from Blu-Ray audio-related revenues at this point?

It's a bit hard to tell. Our licensee in that area is a company called Verance . They're a private company, and they're quite private about their business. And so, we receive royalty statements which are obviously lagging indicators. The Blu-Ray initiative has not yet published what's called a Sunrise date for manufacturers and so if and when they do that, and I hope it's more when than if, that then should create a substantial lift in royalties for us, but that hasn't happened

And then --

The Sunrise date is a date that the licensing authority gives to all the manufacturers that says you have some number of months, usually about 10 months, to implement this in your product or you can't ship. So what's been happening since the final license was published is that the manufacturers have been anticipating the need to do that. Some have been building technology for inclusion in their product. Some have built technology into their products, but the industry is not yet in full implementation mode.

Okay, got it. And then just, Mike, can you give us a sense for -- on the cost expectations, you mentioned the number, the target for the full year. Am I reading you right that most of that increase is going to be in the sales and marketing side? And then, is that headcount increases or just specific marketing programs geared around certain initiatives?

I think we talked about increased investment in our research area, which may include some headcount increases and also, in our licensing and potential legal area that would fall under our G&A and intellectual property lines.

Andy, our business is a bit weird in that our marketing expenses go into G&A.

Yes, I know.

We do what we have to do in terms of the way the accounting forces us to report.

Lawyers got to eat, too.

Yes.

And then lastly, just, I know you guys haven't talked much about JV2. Any timing for when you might talk about JV2?

Still consistent with prior calls, hoping later this year to begin talking. We don't expect to have any revenues from it this year.

Okay, thank you.

We hope to be able to talk about what we're doing later it this year.

Your next question comes from the line of Paul Sonz with Sonz Partners.

Good morning.

Hey, Paul.

I have a few questions. JV1, I know that there was some engineering that was being done to finish up on the product, and I wondered where that stood.

Well, we continue to do a fair amount of engineering on the appliance, and what we've been doing here that is complicated and natural early stage and thus, somewhat uncertain, is trying to figure out how to fit the technology into the internet infrastructure in a way that's going to make us a good profit and not end up costing us a bundle of money for a low return. So that's what we're doing now.

We've been working on that quite diligently for quite a while now, but I've been personally involved in that assessment for the last four or five months. And we're exploring all means to profitably participate in that space, including teaming up with teaming up with other companies that are already there, potentially selling what we have to others or buying what others have and putting it with others. So it's -- we're about where I figured we'd be in terms of the natural development of a new venture, and we're not yet in a space where I've got a solid business model that I can describe to you and projections as to financial performance.

So this is -- it's further along than JV2, but it's still at best a later in the year kind of project?

It's hard to tell. Again, this is -- we are doing these joint ventures with Nielsen because we think they're a great partner and they have great assets to deploy, but generally speaking, you guys as public investors are not accustomed to early stage investment. That's what this is. And with that, it carries a fair amount of vagueness and naturally so. So we're just in the early stages of trying to penetrate the market. We have done technology development for a couple of years under the old agreement with Nielsen paying us to do it. We built some technology and then in the new format since the summer of last year, we've been jointly investing to continue the development and the marketing studies.

A couple of other questions. Is there any update you can give us on the Arbitron and Shazam discussions? They're public. I was hoping that you might be able to say something, especially on Arbitron where we saw the rather dramatic change of CEOs earlier a few months ago, and so that would be my next question.

Yes. Those kinds of changes create some ambiguity, clearly. So it's hard to tell what impact that has. We have had discussions with both companies, and the discussions have been continuing. If they don't result in favorable outcome pretty soon, we'll have to go to litigation. So you guys should be prepared for that, if necessary. And so consistent with my general outline of how these things usually work, we have been talking to try to avoid litigation, and we should be reaching a conclusion pretty soon about whether we're going to have a negotiated license or we're going to have to get some help from the court. And so we'll go one way or the other pretty soon, I suspect on both of those cases.

Now in case of Shazam, we actually have filed a lawsuit against them, and -- for patent infringement, but we haven't yet formally served them. So the next step would be for us to serve them if we have to and then for them to answer, which they get a month or two to do. And so if we begin the litigation process in the case where we're the plaintiff, then it won't begin with a bang. There will be some -- we'll tell people that we've done that, but then there will be a legal process that will carry through for a couple months before the next development. In the case of Arbitron, they sued us. So we're obliged to answer the complaint when we conclude that, our discussions aren't going to result in a negotiated license if that happens. So that's where we are in each of those situations.

Okay. Just two more. One is, last year I remember you talked about the fact that having cash was a wonderful asset, especially when there's a bunch of venture capital investments that sometime were going to run out of gas and might look like attractive acquisition candidates. I wondered where you stood on that part of the business plan.

We continue to be open to such opportunities. We've looked at many of them, haven't found anything worth buying at a price that's reasonable to pay yet. So we're open to that. We just haven't seen anything that we find sufficiently attractive to move on.

All right. Last question, last year towards the end of, maybe September, I can't remember, you mentioned that there's a potential for a deal that could move the dial in terms of your revenues in last year, and that obviously did not come to fruition, and I just wondered where that stood in terms of this year's plans.

I believe what I was probably referring to is among the initiatives that are still underway. I don't believe that there was anything last year that I believed might happen that I have concluded will not happen.

Okay.

So this is the point about how these things work in the IP licensing arena. It's very difficult to predict timing, and I won't call it volume, but the scale of the outcome, they're both quite uncertain till you're nearly done.

All right. Well, look, thank you very much.

All right. You're welcome, Paul.

Your next question comes from the line of Andrew Weiner with Burnham Assets.

Good morning, Bruce.

Hi, Andrew.

I was hoping maybe you could elaborate. You talked a little bit about some of the intuitive computing initiatives, as well as the idea of making a mobile device more functional by sort of seeing, hearing and point to click applications which have started to gain a fair amount of notoriety, I guess, in the marketplace and I guess a sort of aversion of point to click or point to hear, if you will, Shazam, we've sued. Perhaps you could talk a little more about our IP in the space, sort of how broad it is and how sort of core it is to applications in this area.

Yes. The premise of the business when I got started about, I guess 13 years ago now, was to have every media object have an inherent identity. Technologies have evolved over that period consistent with the vision that that should be true, and so the big change that has occurred in the last several years has been the evolution of mobile devices with sensors that are capable of identification, but they weren't built for that, and so we have IPed back to the beginning of time, beginning of our Company, that is relevant to this, but we also have been building additional IP for many years now around these concepts and then accelerating our IP development in the last couple of year.s. And our more recent filings, which will be published soon if they haven't been already, revolve around the modeling of cognitive processes in known and anticipated digital designs for mobile devices. And so human beings tend to take for granted how our sensors translate into understanding, but when you try to emulate that in a relatively low power digital device, there are a lot of innovations necessary to optimize the processes.

So we have IT across the board on all of that down to the semiconductor level, and so we're quite focused on it and I'm very excited about it. I feel like it's sort of the second wave of the Company, that our first wave focused on identification of objects and the second wave is on this seeing, hearing, understanding device. So it's a big deal here. And we are working on some demonstrations and prototypes, and we had anticipated originally delivering not toward the end of this year or early next year, but we're accelerating the R&D to bring the concept to the market. Not the product, but the concept, so that we can better teach innovations and establish license relationships that will bring the product to market. So that's part of why I say it's going to be an exciting year. Later in the year, we'll be able to show you more of exactly what I mean in demonstration devices.

On a second issue, I saw some articles around JPMorgan providing financing for -- or finally providing the financing for aggressive role as part of the digital cinema initiative. Have you got any feedback from your partners in that area?

Yes. Should be a good year for that. There's still a bit of push and pull in the theatrical distribution about transformation of the theaters to digital in terms of who pays what. There's kind of a natural tension in the distribution, but the theater operators, based on the success of Avatar, I believe mostly, will feel compelled to move more rapidly toward digital distribution than they would have had Avatar not happened. So they can't do 3-D without this stuff, and Hollywood is just gaga over 3-D. So I think it's going to push everybody to accelerate their change in technology.

Thank you.

Thanks.

(Operator Instructions) Your next question comes from the line of Kevin Haranahan with KMH Capital Markets.

Hello, Bruce and Mike. Congratulations on your continued share buyback. I had a question about legal expense which I understand is in you G&A under marketing opportunities. So it looks like G&A was up a little more than $1 million for '09 compared to '08. So if some of these litigation things happen, I would assume that legal expense would go up in 2010.

Yes. Let me add to that, Kevin. The first point is that the comparability to '08 is a little bit tough on the increases because of the shared services allocation methodology that we employed for almost three full quarters of '08.

For old Digimarc, right.

For the old Digimarc. So what the run rate you see for '09 is probably more representative for a normal situation, although we did have some legal expenses in third and fourth quarter that we -- in preparing for litigation and actually some of the filings that have been made. Going forward, we've talked about expenses increasing next year in the G&A line. That's one of the areas of expense increase that we are projecting.

Yes, Kevin, just to add a couple of points to Mike's answer. Again, for us, litigation expense is marketing expense but it goes into the G&A line.

Right.

And so when we talk about our expected expense run rate for this year, we do have a risk adjusted incremental marketing expense in G&A. So a portion of what we're anticipating would be increased G&A would be litigation expense, but, we may not spend it. On the other hand, we may spend more. So that's my point to you and other owners is that you just have to appreciate that we will do what we need to do based on an investment model which we think will give an excellent return if we make the investment. But we have a licensing program in which we are not focused on litigation. We'd prefer not to do it, and so we always talk first and see if we can come up with a reasonable outcome without having to make the investment. So the OpEx could be above or below where we are planning. Assumption says it would be, depending on the level of cooperation of these prospects.

Right. So I should look at that more like as a range, a high and a low what maybe your baseline assumption in the middle.

Yes. What we try to do just so, just so -- when we talk about planning assumptions, we do intend that it not be guidance per se, like a promise we're doing. It's how we're thinking about our business. And the way we come up with these numbers is we use expected values. So we do calculations of the range of reasonable potential outcomes that we apply factors to those, and we come up with a number in the middle somewhere that reflects our assessment of the range of probabilities between the high and low reasonable expected outcomes. So yes, it can be plus or minus. This year quite a lot, because we are pursuing some pretty big opportunities. So what you see there is just our best guess as to where we think we might end up, but we could range considerably one side or the other. It could be lower or higher than what we're saying.

Okay. Thanks a lot, Bruce.

Yes, you're welcome, Kevin.

(Operator Instructions) And you have no further questions at this time.

All right. Terrific. Well, thank you one and all for your support, and I'll look forward to updating you again after our next board meeting following Q1. So have a good day.

Ladies and gentlemen, this concludes today's conference call. You may now disconnect.