Digimarc Corp (DMRC) 2013 Q3 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 Bruce Davis, Chairman and CEO of Digimarc.

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 Q3 financial results, talk about significant business developments and 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, 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. 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 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.

As was previously announced, Mike is planning to retire soon. We expect this will be his final investor update. Mike has been with us for nine and a half years, during which time he's done a terrific job of accounting for and protecting the Company's financial assets. Our shareholder returns during Mike's tenure have been outstanding. He's been a strong and able leader and a respected member of senior management. We wish him all the best.

Charles Beck, our Controller, is expected to be named as CFO by our board next week. We've been working on the transition for some time now and expect it to go smoothly. Charles is also with us on this call.

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

Thanks for the kind words, Bruce. I'd like to take this time to thank you, our board, executive team, employees and shareholders for the opportunity and pleasure to serve as Digimarc's CFO for the past nine and a half years. I expect many of the relationships I've developed over these years will continue for some time. No doubt the exciting and sometimes challenging times will be my fondest memories, and I'll miss the excitement of the coming years as our vision materializes. As a former officer and reasonably large shareholder, I'll be watching the development closely and looking forward to celebrating the successes of the future.

Now on to the financial results.

Our Q3 revenues were $7.4 million, 17% lower than the same quarter a year ago, reflecting the end of the guaranteed minimum license payments from Intellectual Ventures in Q2. The year-ago quarter included $3.2 million of license revenue from IV.

Revenues from sources other than IV licenses increased 30% due to the Attributor acquisition in Q4 and growth in the revenues from the Central Banks and from patent licensees other than IV.

Operating results were pretty much in line with our expectations and reflect the previously-discussed increases in investment in the growth initiatives, including development and marketing of Digimarc Discover and our intuitive computing platform, adding audio watermarking and packaging and developing the second wave of patents, all in support of our vision of enabling computers, networks and other digital devices to see, hear, understand and respond to their surroundings.

Looking into more of the details of the Q3 2013 financial results, we see that gross margins were at 74%, 10% -- 10 points lower than a year ago -- due to lower license revenues and an increase in subscription revenues from Guardian for eBooks acquired in December of last year. Operating expenses increased by 28% over a year-ago period, primarily due to the addition of the Attributor operations and increased investments in R&D and marketing.

Our operating loss was $2 million and logically tracks with the lower revenues and the higher-growth investments that we've made. We utilized $1.5 million of cash in our operations, reflecting the impact of this operating loss.

The $1.3 million of capital investments we made was a bit higher than usual, with about $800,000 being associated with streamlining the data center infrastructure of Guardian for eBooks. We expect this investment to provide significant efficiencies going forward, with $200,000 or more of reduced annual operating expenses.

And finally, the balance sheet remains in excellent shape with more than $38 million of cash and securities and no debt.

We still expect operating results for 2013 to be as indicated in our prior call, and mainly that revenues and profits would be considerably from last year, primarily due to the combination of $8 million of past due royalty revenues from Verance that we received and recognized in Q1 of 2012, and expiration of the $3.4-million quarterly minimum license payment from Intellectual Ventures that were received in Q2 of this year. That was partially offset by growth in revenues from the acquisition of Attributor and from Central Bank's certain licensees and new customers in other areas of the business.

Profitability is also affected by the increased investments in R&D, marketing and intellectual property development. The increased investments relate to marketing and development of Digimarc Discover, as we look to expand our offering to larger enterprises and broader markets, particularly in retail in support of the Shopper's Journey; commercializing our consumer packaging and audio watermarking solutions; directed research in a number of areas, including the intuitive computing platform and mobile payments; developing our second wave patent portfolio and associated monetization programs; and improving operational efficiency of Attributor, now known as Digimarc Guardian, and expanding its associated products and services.

Consistent with our prior discussions, the combination of lower revenues and increased investment is likely to lead to a GAAP loss for the year. Nevertheless, we expect positive operating cash flow for 2013.

There were no open market share repurchases during the quarter, and the board approved a cash dividend of $0.11 per share, payable on November 12, 2013, to shareholders of record at the close of business on November 4, 2013.

For further discussion of our financial results and risks and prospects for our business, please see the Form 10-Q that we expect to file shortly.

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

Thanks, Mike.

On the financial front, the addition of Attributor and growth in other areas was not enough to offset the expiration of minimum payments from IV. There were no substantive developments in our arbitration with Intellectual Ventures during the third quarter. The process is moving along consistent with the dispute resolution provisions of our license agreement. We will keep you apprised of any material developments.

We continue to make good progress in executing our strategy to invent and deliver, directly and through licensing, a common platform that connects prospects and customers to brands across the full experience of the shopper's journey. We intend to launch the platform at the NRF's annual show in January. We are intently focused on the launch. Preparations are going well. We anticipated in the -- or participated in the American Magazine Media Conference in New York City last week. It was a terrific event where we received great visibility and access to senior executives of major publications and group publishers. Contemporaneously with the event, we announced new clients and new features for our Digimarc Discover publishing platform that is centered on labeling shopping for magazine prints editions. Our key takeaway from the event is that the industry appears to be moving in the right direction, appreciating that print and digital operations should be managed and coordinated to build maximum brand equity with audiences. We were also reassured by industry data that print continues to dominate the distribution and profit models of publishers and that the publishing community understands the vital role that they play in the shopper's journey.

Use of Digimarc Discover in publishing now extends from magazines to catalogs, brochures, direct mail and books. We estimate that over 3 million consumer mobile devices have applications equipped with our platform. There have been over 2 million activations from more than 4,000 services in 300 issues so far this year. Coupons, recipes and sweepstakes are the most popular consumer payoffs. The US accounts for the lion's share of activity.

Our [IR&D] and IP development are prolific. The retained portfolio continues to grow at a rapid rate. 64 patents have issued thus far this year, with 31 of the 64 feeding our second wave portfolio, which has now grown to 66 issued patents. Third-quarter issuances include innovation from second screen television, the intuitive computing platform and mobile content recognition and search. We have filed over 100 patent applications thus far this year, with 33 applications in the third quarter alone, bringing the total second wave patents pending to 340. Topics included in the new filings include multispectral imaging, image processing for automated medical diagnosis, and machine learning, among other things. We have not made much progress since our last call with a significant potential licensee who we believe is using some of our patented second wave inventions. We are considering various options for moving things forward.

Preparations continue for the National Retail Federation Big Show in January, where we plan to demonstrate the full mobile optimized shopper's journey that we have developed. The show is in New York's Javits Center on January 13 and 14. If you happen to be in the area, we invite you to stop by.

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

(OPERATOR INSTRUCTIONS.) Please hold one moment for your first question. Your first question is from Bill Gibson with Legend Merchant.

Hi, Bruce. What would you hope to accomplish at the NRF show -- maybe from minimum expectation to maximum?

Yes. It's the big show for the retail industry. There are generally about 30,000 attendees, including all of the largest mass merchants in the world who are our targets. So we'd like them all to come by the booth and see firsthand what we have. And our understanding -- we've visited one show -- this is our first exhibition -- is that the big retailers will sometimes come along in a gang and ask for a demo. We hope to see as many of the top retailers as possible there. We'll be open for business. We'll be ready for anyone to buy what they want to buy, but we believe what's most likely to happen in a successful scenario is that they ask us to come out and talk with them at their locations and to describe how they could implement the system. So a reasonable expectation or reasonable range of expectations might be anywhere from lots of people are interested and say, "Come have some meetings" to someone says, "Let's get going." And what we'll be able to announce is probably too speculative to try to characterize right now. It kind of depends on how things go. But we'll be as informative as we can be after the show about how we felt how things went. And my understanding is a fair number of investors are thinking they may stop by because it is in New York City and convenient, at least for the East Coast investment community.

Good. And then a second unrelated question. You had had a press release recently on agreement with US Bancorp and Monitise. And I just want to understand what you're trying to accomplish there or what the role each plays and --

Okay. Sure.

How watermarking works in.

Yes. The press release was about some work that US Bank and Monitise and us are doing on implementation of the Discover platform in a banking-enabled application. And so think of it as Digimarc Discover with kind of a payment emphasis. And US Bank has been working with us for a long time now -- for many years -- making sure that they understand the technology, running lots of tests. And they're, I believe, getting ready for implementation. Monitise is a company that helps banks to make their services available in the mobile environment. So I don't want to put a label on them because I don't think they put a label on themselves, but something like a system integrator concept for mobile. So that's what that was about. US Bank and Digimarc have a broader relationship as well, as we hope that they'll be one of the early implementers of the virtual brand interface for their shopper's journey as it relates to banking.

Okay. Thanks, Bruce. And let me wish you the best, Mike.

Thank you, Bill.

Thanks, Bill.

Our next question is from Paul Sonz with Sonz Partners.

Good afternoon. Bruce, in the last call you talked about that you had certain development and marketing deadlines that you hoped to meet by the end of the year and to have everything fully functional by year-end. Have you been able to accomplish that?

Yes. I think we're in pretty good shape. We've still got a couple of months to go before year-end so there's obviously some things that aren't done that we expect to be done that might not make it, but right now everything looks good. And so we're looking forward to a very nice presentation at the show.

Good. Follow-up to that is you talked about that you had integrated into one company's checkout scanner and that you were hoping to add others. Any -- where does that process stand?

Well, when I said that, I wasn't meaning to imply, if you took it that way, that we'd have more at the show. That wasn't my intention. We're trying to get the other vendors up and running -- other major vendors. We're also trying to figure out how to deliver a development environment for smaller vendors that is more self-service because we do want this to be a global phenomenon and we do expect that there'll be major changes in the industry because of the shift in technology from lasers to imaging. And so we don't want to serve only the largest, but we want to start there mainly because of our scale.

Right. So this is to try and get as many people with image scanners to work with as many of those as possible. And how -- over what period of time do you feel that the industry is going to switch from the laser scanners to the image scanners?

Well, the average duty cycle for a laser scanner is 6 to 8 years. The duty cycles for imagers haven't been established yet so we might guess that they'd be -- they could be shorter or longer depending on the rate of innovation in the industry, but maybe a little longer. And so many of the vendors have imager products that they're getting ready to introduce, and the show -- there'll probably be a fair number of them at the National Retail Federation show. And so our understanding is that many of the customers are testing out those products and trying to make a judgment about what degree of future-proofing they want to do in their next CapEx purchases. And obviously, if they go with laser, then they're looking out at possible obsolescence, and if they're looking at imagers, they're looking at brand new products. So I don't know yet how they're going to go. I think we're going to have better visibility on that early next year after the show. And what we're hoping to have happen -- just so I can tie together your two questions here -- is if we have a really good show, I would expect that we'll get much greater attention from the other scanner vendors, and that even if we do very well -- on the high end of expectations -- the retailers may tell the vendors that they need to have our stuff in their products, which would be wonderful. So that's how we expect this to flow is that the impetus to work with us across the industry will hopefully flow from a successful demonstration in New York.

Let me ask a question just so I understand -- that in order -- once people start adapting image scanners, making that available for Digimarc products -- is that a software change or is there anything in the hardware that has to be done specifically to use the Digimarc Discover product?

As far as we know, it's software only. We haven't surveyed all of the products, obviously, so there could be something that we don't know. But as far as know, it should be software only. We believe all of the products will be field upgradeable -- that is, they'll be -- have a network connection, just like the software upgrades that you receive in hardware products of your own. And our preference, of course, would be to have our firmware in the product when it ships --

Right.

So it's a feature of the product.

Last question. You talked on the last call about having worked with Costco in their little brochures that they sent out and that you were hoping to develop relationships with other big box retailers -- I guess that's the way to call them. Is there any progress in developing relationships with other large retailers?

Yes but nothing announceable yet.

Okay. Alright. Well, that's all for me. And Mike, thank you very much. I've enjoyed dealing with you immensely and best of luck.

Thanks, Paul.

(OPERATOR INSTRUCTIONS.) Your next question comes from Kevin Hanrahan with KMH Capital Advisors.

Hello, Mike. I had a question about the tax rate. It looks like you had a negative tax rate in Q3. Is that correct?

That's correct. Actually the tax rate is a positive rate but it's applied to a loss. And the rate's very, very high because of the cumulative impact of the R&D credit that came through this year.

I see.

It's kind of a difficult one to track, but it's the manner of the way the accounting profession applies these types of things when you have losses.

And Kevin, this is Bruce. I'd add to Mike's answer there that apparently we have a long discussion of this in the 10-Q. Right, Mike?

There's a little discussion in the 10-Q about it --

Little.

But it follows pretty standard tax accounting. When you have losses, you apply the rate to the loss, and then when you have a year that's unique with the R&D credits, that applies further. And this year, of course, it's kind of a double whammy because in 2013, we get the 2012 credits that we were not allowed to book into last year's P&L because they weren't enacted until January, so you get two years of credit. So that even makes it even more out of whack from what one might expect.

Okay. So will that recur in Q4 or not? And how should we think about 2014? Because in the past, I had you paying taxes and this quarter you had a benefit.

Yes. Well, given that we expect a GAAP loss for the year, that we'd likely have a -- you might say a negative tax provision for the year. So there'd be some additional numbers maybe to what you've seen this quarter as well. Going forward, it all depends upon the R&D credits. Right now, it expires this year. It's not next year that has an impact. If it's instituted again, it may be more normalized. But a normal tax rate for us would be 35% to 40% -- in that range would be general -- and applied to either a positive or a negative result.

Right. Right. Mike, can I ask you about the buyback? I heard you say you had no -- you bought back no shares. Was the window open? In other words, could you have bought back or was there some material info that prevented you from being in the market?

Our program was open. We did buy about 8,000 shares under our normal employee purchase program. But in the open market, there were none. It's open, we evaluate it and we'll continue to address that going forward. But we chose not to buy any this quarter.

Okay. Thanks a lot, Mike, and best of luck in your retirement.

Thank you, Kevin.

There are currently no further phone questions.

Alright. I want to thank everyone for participating in the call. We look forward to catching up with you in the next quarterly call and seeing some of you in between now and then either at the show or on the road. Thanks, everyone. Bye.

Again, thank you for your participation in today's call. This concludes today's conference. You may now disconnect.