Digimarc Corp (DMRC) 2012 Q1 法說會逐字稿

Good afternoon and thank you for participating in today's conference call. Now I will turn the call over to Chairman and the CEO of Digimarc, Bruce Davis. Mr. Davis, please proceed.

Thank you and good afternoon. Welcome to our conference call. Mike McConnell, our CFO, is with me. On the call today we'll review and discuss Q1 2012 financial results; talk about significant business developments; the market conditions and provide an update on our strategy and operations. The webcast will be archived in the investor relations section of our website.

Please note that during the course of this call we'll be making certain forward-looking statements including those regarding revenue recognition matters, results of operations, investments, initiatives, dividends, and growth strategies. These statements are subject to many assumptions, risks, uncertainties and changes in circumstances. Any assumptions we share about future performance represent a point in time estimate; actual results may vary materially from those expressed or implied by such statements. 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.

For more information about risk factors that may cause actual results to differ from expectations, please see the Company's filings with the SEC, including our latest Form 10-K.

Mike will begin by commenting on our financial results. I'll then discuss execution strategy and outlook. Mike?

Thanks, Bruce, and good afternoon, everyone. Overall, Q1 2012 revenues increased by 88% to $17 million from $9.1 million in 2011 and net income improved more than 5-fold, to $5 million or $0.70 per diluted share compared to $900,000 and $0.12 per diluted share in 2011, both benefiting from the legal settlement with Verance and for getting their quarterly revenues back on track. The balance sheet remains in excellent shape with more than $44 million in cash and securities and no outstanding debt.

Also of note, late in the first quarter, Nielsen and Digimarc decided to reduce their investments in their joint ventures to a minimum level while assessing alternative approaches to achieve each company's goals in the emerging market opportunity of synchronized second screen television. Bruce will discuss this a little bit more later on.

In connection with the suspension of operations, the remaining first-quarter operational expenses and the expenses associated with the suspension were accrued as of March 31, including severance costs for the joint venture employees. Our net contribution to the joint venture for the first-quarter operating expenses and the suspension costs were approximately $700,000.

We continue to invest in other growth initiatives, including Digimarc Discover and the second wave of retaining patents. Spending in the quarter was impacted by extraordinary litigation expense associated with the Verance litigations that were settled favorably in January 2012, resulting in an extension of our license with them and payment by them of $8.9 million of royalties for current and prior periods.

Q1 financial highlights include the 88% revenue growth, primarily due to the Verance settlement litigation, where we received $8 million of prior-year royalties through September 30, 2011 and about $900,000 for the fourth quarter of 2011. Higher service revenues from the central banks and from Intellectual Ventures were offset by reduced development services for the Nielsen joint ventures.

Gross margin was 89%, 7 points higher than the prior year reflecting a greater mix of license revenues to the total. We experienced operating expenses at similar levels to Q1 of 2011 continuing to reflect investments in new product initiatives and approximately $500,000 of Verance litigation expenses.

Operating income was $9.2 million or 54% of revenues and income taxes were $3.1 million, a 38% effective tax rate. Also note that our cash taxes on this booked tax provision will be only about $1 million, the difference being primarily attributable to stock compensation, tax benefits, and research and engineering tax credits.

Our financial performance thus far is within the range of our expectations at the start of the year. As is our general practice, we intend to update you each quarter regarding strategy execution but do not plan to provide financial guidance.

For further discussion of the financial results, our business and financial models, and risk and prospects of our business, please refer to Form 10-Q that actually we'll be filing today.

Bruce will now provide his comments on our outlook and execution of strategy. Bruce?

Thanks, Mike. There were several noteworthy events in Q1. The most obvious was settlement of litigation with Verance, resulting in payment of back royalties and a 3-year extension of our license with them. The settlement paved the way for an extraordinarily profitable quarter, a lower rate of G&A spending going forward, and a continuing income stream from this important licensee.

In other licensing news, we received our first full-year report from Intellectual Ventures. Although the details of the report are confidential, I can tell you the license revenues attributable to our portfolio were substantial, but not sufficient to cover the $36 million of minimum guarantee and other IV cost associated with development and monetization of our portfolio.

Given that this is our first full-year report, we have spent considerable time with Intellectual Ventures developing an understanding of how the allocation of revenues and costs works. We are continuing those discussions.

We are not yet in a position to assess the likelihood or magnitude of profit participation once the guarantees have been fully paid over the 5 quarters remaining in the guarantee. That will be a function of the rate and scope of adoption of our patented inventions; the general performance of IV and licensing its portfolio; and the associated costs attributable to our assets. We at Digimarc are doing all we can to foster adoption of our inventions and assist IV in development and monetization of the patent assets that we licensed to them.

In another significant development during the quarter, we and Nielsen decided to reduce our investment in our joint ventures to a nominal level for the foreseeable future as we assess how to best achieve our goals in the emerging market opportunities of synchronized second screen television. The Media-Sync joint venture has been working on a software and service platform to facilitate such experiences for the past couple of years. The market opportunity has inspired a great deal of investment across a wide range of companies leading to a crowded and competitive environment. This, in turn, has upped the table stakes for competing as an operating entity in this space.

As I have said many times, we have two ways to participate in this growth opportunity -- investment and creation of an operating business via joint venture and the licensing of our IP. Based on our current assessment of the market and competition, we have concluded that licensing is the better path to maximum profit. Our view of the likelihood that television will undergo those changes that we contemplated when forming the venture has been strengthened by our experience and observations.

Digimarc Discover market development continues apace. We have been making inroads into publishing and have had some experimentation going on in other application areas. Sports Illustrated's use of our Digital Watermarking in the Swimsuit Edition was our highest profile used thus far. Our technology perform flawlessly. The visibility created by the SI issue has enlivened considerable interest in the publishing industry. We are working on many leads.

All these developments taken together lay the foundation for a year of significant growth in revenues, profits, and cash flow. Anticipating excellent financial performance in 2012 and a bright future in our target markets, we have authorized our first cash dividend. We feel that the dividend is an appropriate addition to our capital allocation strategy, providing income to our current shareholders and, hopefully, a means to broaden the seal of our Company among potential investors.

In closing, I'd note that we are anticipating excellent financial performance in 2012. We do not anticipate increasing our operating budget in order to accomplish this. Within these constraints, we are devoting a greater share of our budget to R&D and IP development to foster long-term sustainability and growth. We intend these investments to lead to substantial growth in licensable technology and patent assets in the coming years, addressing numerous exciting advancements in media identification, management, and enhancements.

That's it for our prepared remarks. Now we'll open the call to questions.

(Operator Instructions). [Kevin Hanrahan, KMH Capital Advisors].

Congratulations on your initial dividend.

Thank you, Kevin.

I had a few questions. If I ask anything more about IV, are you going to tell me?

No. (laughter)

Okay, thanks for your honesty. I guess I will refrain then.

I had a question for Mike. Mike, it looks like from looking at the cash flow statement that I can see right now that you bought back some shares in Q1. Can you tell me how many shares you bought back?

You know, I do have that. The shares in the open market were less than 10,000 shares, as I recall. And then we have our ongoing stock for taxes trade with employees that was the difference.

So I'm just guessing, there was maybe like 15,000 or 18,000 shares for the employees?

Yes, I think that is close to it. I don't have that specifically right at my fingertips here.

Okay. Do you have a breakdown of how much you spent for the open market purchases in dollars?

A couple of hundred thousand dollars.

Okay.

Are you talking about during the quarter, Kevin?

Yes, during the quarter.

Yes, just during Q1.

Yes, a couple of hundred thousand I think is about right.

Okay, thanks. I'll step back in the queue.

(Operator Instructions). Andrew Weiner, [Simjo] Capital.

Mike, I just wanted to confirm -- so operating expenses -- you take out the $500,000 of Verance and it's about $1.5 million of non-cash operating expenses, so is the quarterly cash rate about $4 million?

That is a reasonable assessment given those facts, yes.

And the comments on the call were the expectation is spending to remain relatively stable at that level?

Yes, we gave -- give some indication last call that we would -- our expenses would lower beginning second quarter and we don't have any litigation and that was a pretty significant part of that.

Bruce, when you talk about licensing versus an operating business as far as monetizing that the [JV] sync or whatever you want to call it opportunity, is that going to be exclusively through the IV relationship? Or was there incremental either product development or IP developed within the JV? And if there was, and I believe that has marketable value, is that something that the JV itself will market or will Digimarc take responsibility or will that go to Nielsen?

We believe that clearly the patent assets license to IV will be relevant in the space. We also have numerous assets in the second wave that are in the process of maturing in 2 issued patents. There are about 20 issued patents now in the second wave and about 250 pending. And so, we anticipate as that group of assets matures, that there may be some additional inventions that are implicated by the companies that are seeking to be suppliers in this space.

The joint venture was focused on software and services and not IP development, so I don't anticipate that will be a patent rights belonging to the joint ventures that will be licensed.

Okay. And when you said materially reducing I'm not sure if I missed it, but Mike, could you give a quarterly run rate for the expense around the JV? Or will it go basically to zero?

It's going to be nominal. It won't be material, Andrew.

The next question I had was I believe in the recent past you discussed that the Company was seeking to secure a long-term extension or renewal of the Central Bank contract. I was wondering where that stood. And to the extent you've been able to secure that, how and when it would start to change the economics we see on the operating statement.

It is not yet signed, but the process is going along very well. And we hope that we'll begin to see some beneficial financial effects beginning next year.

Okay. And then the last question and I'll get back into the queue is has there been any change or progress related to some of the defense opportunities that we've talked about in the past?

As we have talked about in the past, it's hard to tell. Yes, we are working on several. And the prospective customers continue to engage with us, but they're not sending money. So I don't know. It's about where it was before in terms of there are lots of expression of interest. We have a large funnel and we have no revenues to speak of. So it's still there as an upside opportunity during the year, but we're now 4 months in and I haven't been able to deliver anything to you guys.

Now, in listening to that, is there a possible belief on our behalf that our technology is being used and we're just not being paid? Or is it that the projects -- we believe the projects haven't moved forward and received funding?

Well, with respect to work done in classified areas or areas that are high national security interest, it's hard to tell who's doing what, obviously. So it's not so much that we fear that our technology is being used by others, although that certainly could be true and we don't know it. We don't have any evidence of that.

No, more my frustration is that we think we have obvious relevance. We think that prospective clients within that community understand that. But I'll be damned if we can get the money freed up to get work going. That's the problem.

So it's just an obvious match there but the processes are opaque. They are dominated by large suppliers and we're not a large supplier. So we muddle our way through the ambiguities, trying to get some money freed up to provide some valuable services and technology to the appropriate customers. And we still think it may happen, but we really have no means to handicap it very reliably.

Okay, thank you.

(Operator Instructions). Paul Sonz, Sonz Partners.

Good afternoon. The question I had is, Bruce, could you -- you went through in your comments a description of the discussions you are having with IV now. And I wondered if you could go over that again -- exactly what you're talking to them about.

Yes, we're making sure that we understand the report and the way in which revenues and expenses were allocated. Because it's our first full-year report. We had a report previously that covered just a couple of months and we didn't view that as particularly instructive. And so, we've been talking to the folks there about all of the elements of the report that we did receive and there are ongoing discussions there.

This may seem a little odd to me, but I don't understand why this would be something that needed to be discussed. Wouldn't this all have been laid out in advance? What one would expect and how this thing would happen?

The structure for the relationship is contractually determined in that document, but accounting involves lots of judgments. And so we're trying to understand all the judgments to make sure that we agree.

Okay. All right, thank you.

(Operator Instructions). Kevin Hanrahan, KMH Capital Advisors.

Bruce, I had a follow-up question. So basically you get this report and you got that I think in mid-March, right?

Yes.

And the confidential report so like none of that will be in the 10-K, right?

Right.

So you'll get another report around a year from now in mid-March as well, right?

That's right.

And then, we'll find out more about how it's going.

Yes, that's the way it works. I wish there was more visibility, but it is what it is. And we're collaborating with them on lots of opportunities and they have been successful in generating some significant revenues and so we'll work hard with them.

The profit participation, the existence of it and the scale of it will be significantly influenced by our effectiveness in getting adoption of our technology. So I think that's -- our discussions with them have to do with just the methodologies that they are using for allocating revenues and costs. And that's important to us that we understand what they're doing and feel comfortable with it.

But the crux of making more money is really in adoption and we're doing all we can to foster that.

Okay. Can you tell us anything, if you can divulge it, about Shazam, in particular?

Yes, as you know, we sued them and then we had some discussions. Then we did the IV deal so the relevant assets became the domain of Intellectual Ventures to license. Intellectual Ventures is a very thorough company in their license program, so we've been working on this. That's about all I can say at this point in time. But they are quite aware of the opportunity and they and we have worked on it.

That was my point. Because it sounded like you were suing Shazam and then you withdrew and it sounds like there was a friendly press release there that said you were trying to work things out. And then we never heard what happened but I understand that those patent assets got turned over -- at least partially turned over to IV to work on that.

Yes, that is what happened. And just to help everyone on the call understand the Shazam opportunity a bit better, they are a private venture-backed company but under the UK Companies Act, they are required to file annual financial statements, which they do. And so, we get a chance to see how they're doing in terms of scale. And in the most recent report, which is for financial statements ending in June of 2011, they're running about $30 million of revenues. And so, I don't want everyone to get crazy ideas about how much royalty income they could generate because they're not that big a company. Even though they have a big voice, they haven't yet generated a lot of revenue.

Now we'll get their next report in a couple of months for the period ending in June of 2012, but we'll see what that shows in terms of growth. Maybe they've grown a lot. But that's as much as we know from the publicly available information so far about their scale.

Okay, thanks.

Matthew Galinko, Sidoti.

Thanks, guys. Just curious if you can read into the winding down of the JV, if you are having particular success in licensing the other second screen players through IV.

I think what you ought to read there just is what I said and maybe to say it in a little bit different terms. Nielsen and Digimarc entered into the joint ventures because of certain interests that we had that were well known to each other, but different that we thought could be well served by the joint venture structure. And as we built some demonstrations and delivered them through ABC and the Weather Channel and the Oprah Network and so forth, this kind of intense interest in the category emerged, and with it a substantial deployment of capital in potentially alternative suppliers, including IntoNow which was acquired by Yahoo! and Shazam, who alleged they got $35 million dedicated to this opportunity, and a cast of dozens of others.

And so, as time passed and we assessed the marketplace, we made individual judgments that happen to be very well aligned that we thought we could satisfy our objectives without having to defeat that competition essentially, which would be the proposition we would have to have in mind if we continued to invest significantly in heightened competitive environments with greater capital in an operating business. And so, from our -- I don't mind stating our objectives, I don't want to speak for Nielsen because they can speak for themselves, but for us our objective was to make money -- pretty simple stuff.

And so, we believe now based on how the market has developed, that we can make the most money through licensing rather than parallel paths of licensing an operating company or an operating company alone. Now, we would never have an operating company alone because Intellectual Ventures has relevant IP. So, there would be a licensing opportunity. But the objective of the management of the joint venture would be to defeat the competition, to be the primary supplier. And we're not certain any longer that that would be the best outcome.

We actually think -- we wish all of the respective suppliers the best of luck. We hope they're all hugely successful.

What we've gained from the experience in the venture and from the observations of the market is that -- we hope they are all right with putting all that capital in with so many suppliers announcing their intentions and with so many businesses redefining their businesses to participate. If all of that is true, then we're going to do great in licensing. So that's really a more elaborate explanation of the motivations for the change.

Okay, thanks.

Paul Sonz, Sonz Partners.

Bruce, in the second, in the new IP that you're generating, that is not dedicated to IV, is it too early to expect that there will be licensing of that IP or interest in it?

Yes and no. Yes to the first part and no to the second part. So, with only 20 issued patents it's a pretty small portfolio and so we would generally not be inclined to go out and aggressively market the 20 patents. But that doesn't mean that others might not be interested in a license discussion because behind the 20 patents are another 250 applications and a growing number of applications and a continuing stream of innovation, some of which is relevant to this space.

So yes, we're not going to go out -- we're not ready yet. It's not ripe enough for us to go out in that active licensing program, but that doesn't mean people won't come to us.

The second question is -- I've noticed a real pick up in the use of Digimarc Discover. I just saw Brides Magazine which, I think, has an unusually large number of watermark photos in the magazine. At what point does this become a real business?

As soon as we can make it that. Brides Magazine did a terrific job. We're very happy about the work they did. Again, they're demonstrating to the industry how to do it. House Beautiful remains a terrific role model for the industry. Obviously, Sports Illustrated is the biggest brand in circulation that we've dealt with and it happened to be their key property in the Swimsuit Edition.

So, we're making good progress. We're getting better visibility. There's still experimentation with uses and development of engagement models and a bunch of work being done that we're trying to foster to the best of our ability within our means. And we also see a lot of great work from a group publisher in Australia called Pacific Magazines.

And so we're making progress. And the way these things tend to work is that there's a tipping point, which oftentimes can't be identified in advance, that happens and then everything starts really moving. So we're heading in the right direction but we haven't hit the tipping point yet. So, I don't know when that will come. If I see it, let you know for sure.

But we think we know what is missing in the demand equation, and we're working on software development to try to address that and on relationships, which are another part of the work. But some of it just has to do with adoption and creativity and commitment of publishers, brands, and agencies that we don't control.

And I assume that -- I have not seen anything in newspapers, I'm assuming that newspapers are still not availing themselves of Digimarc Discover.

No, I wouldn't assume that. What you ought to assume is narrower than that which is we're not investing significantly in newspapers.

Okay.

There is actually some work going on there that could yield good results, but we're -- what I said in the prior call was that we were backing off on our investment because we were frustrated with the kind of despondent view of the newspaper managements in general. But there are some bright people and some guiding lights and some aspiring managers in the business who know of our technology and may end up again teaching the industry some wisdom about how to foster survival through the use of the technology. We backed off on the investment because we didn't feel that we could influence it very much.

All right. Thank you very much.

You are welcome, Paul.

(Operator Instructions). Matthew Galinko, of Sidoti.

So, I guess a follow-up on Sports Illustrated. Can you say if there's any ongoing relationship there? If there's any potential for future use in that magazine?

Yes to all of the expressed and implied questions and the Time Inc. Publishing Group -- they are quite well aware of how the program went and what the results were, which are again not our data to share. But I think everybody was quite happy with the results. And again, the industry is trying to figure out what the formula is for what is generically referred to by one of our business partners as action codes with the notion of connecting from publications to network services. It's gaining in popularity and use but it's still in what I would call experimental stage where the business models and the marketing models are not mature and often repeated.

So, that's what we're working on right now. We think our basic encoding and reading technologies are working superbly. We think we have done that piece very well. And so, our focus and the focus of the industry is on, okay, now we know we can do it. What do we do with it?

And that's where I refer to tipping points. It may come category by category or industry-wide, but some publications are going to figure out the formula and then all their competition is going to emulate what they do. And I think we're well on our way in that direction. I'm optimistic about the outcome, I just don't know what the timing is.

Okay.

At this time, there are no further questions. I'll now turn the floor back over to Mr. Davis for any closing remarks.

All right, great. Thank you to everyone for participating and listening in on the call. This concludes our call for this quarter. We look forward to talking to you again in another quarter or in between in our informal discussions. Thank you all for your support. Appreciate it.

Thank you. This concludes today's conference. You may now disconnect.