Digimarc Corp (DMRC) 2014 Q2 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. Mr. Davis, please proceed.

Thank you. Good afternoon, everyone. Welcome to our conference call. Charles Beck, our CFO, is with me. On the call today we will review Q2 financial results, discuss significant business development and market conditions, and provide an update on execution strategy. This webcast will be archived in the investor relations section of our website.

Please note that during the course of this call we will 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 risks assumptions, 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 on 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.

Charles will begin by commenting on our Q2 financial results and cash flow projections for the second half of the year. I'll then discuss significant business developments, market conditions, execution of strategy, and our plans for managing working capital during the development of the market for Digimarc Barcode. Charles?

Thanks, Bruce, and good afternoon, everyone. Revenue for the quarter was $5.7 million, down $4.8 million, or 46%, from the second quarter of last year. Revenue was lower primarily due to the scheduled completion of quarterly minimum licensee payments from intellectual ventures in May of last year and the Nielsen Company in January of this year. Excluding the impact of the expiration of these license fee payments, revenue was down $400,000, or 6%, reflecting primarily the timing of program work with the central banks.

Gross margin was 66% for the quarter, 14 points lower than the second quarter of 2013. The decrease in gross margin reflects the impact of lower license revenue from intellectual ventures and the Nielsen Company. Operating expenses increased by 17% over the second quarter of last year, reflecting the increased level of investment in our product development and sales growth initiatives, which center around Digimarc Discover, the Digimarc Barcode, and other aspects of our intuitive computing platform, as well as development and marketing of our second-wave patent portfolio.

We incurred an operating loss of $4.5 million during the quarter versus operating income of $1.4 million in the second quarter of 2013. Our effective tax rate for the quarter was 40%, resulting in an income tax benefit of $1.8 million on a pretax loss of $4.4 million. At the bottom line, we incurred a net loss for the quarter of $2.7 million, or $0.38 per diluted share, versus net income of $600,000, or $0.08 per diluted share, in the same quarter last year.

The balance sheet remains in good shape with $28 million of cash and marketable securities and no debt. The $4.4 million investment of our cash reserves in Q2 was higher than in Q1 due to the confluence of factors affecting revenue and expenses. The primary contributors to the change included the scheduled completion of quarterly minimum licensee payments from the Nielsen Company and timing of program work with the central banks. Coupled with the expenses associated with formation of a professional services team to expediate delivery of the Digimarc Barcode, enhancements to Web services and supporting infrastructure to enable efficient customer enrollment and engagement, and outside legal expenses associated with preparation for potential filing of patent litigation associated with the marketing of our second-wave patent portfolio.

Absent a significant uptick in revenues, we expect to continue to be using our cash reserves to support our product development and sales growth initiatives through the remainder of the year. The rate of investment is expected to be between $4 million and $5 million in Q3, and between $2 million and $3 million in Q4. The difference in our projections for Q3 and Q4 are largely due to the timing of customer receipts and vendor payments.

Later in this call, Bruce will comment on our rate of investment, offer some preliminary views on the path to return to profitability, and discuss how we propose to manage working capital in the meantime. For further discussion of our financial results and risks and prospects for our business, please see our Form 10-Q that we expect to file shortly. Bruce will now provide his comments on significant business developments, market conditions, and execution of strategy.

Thanks, Charles. I'll begin with some brief comments on areas of our business other than Digimarc Discover and Digimarc Barcode. I intend to focus this call on those two activities and associated working capital management, as I have a fair amount to cover and I believe that these are the areas of greatest relevance and interest for investors.

Revenues from established products and services were down in the quarter compared to last year, mostly due to timing of program work with the central banks. We expect these areas will generate low double-digit growth in the second half of the year over the first half of the year. As Charles noted, there was some incremental spending in Q2 for preparation - for potential filing of patent litigation involving second-wave patents. The final decision has been postponed for the time being while we discuss proposals for licenses and/or strategic business relationships with the companies involved.

We and our consultants are exploring a number of potential relationships which could give rise to income, investment and/or litigation expenses that could alter our projections on the investment of cash in the second half of the year. As you know, such developments are notoriously difficult to forecast. I will be happy to take questions about any areas of legacy business during Q&A at the end of the call.

Now let's get on to an update on Digimarc Discover and Digimarc Barcode. We continue to execute against the publicly disclosed strategic plan. As promised following on from the very successful launch of Digimarc Barcode at the end of (inaudible) in Q1, we issued a white paper in May for public comment, providing a quantitative model that estimates labor cost savings resulting from adoption of the Digimarc Barcode by high-volume retailers who are our primary target market. The paper includes an ROI calculator for potential customers to assess the value of the Digimarc Barcode can deliver to their businesses. The model estimates the Digimarc Barcode should be able to foster billions of dollars of savings annually for retailers in our target markets, resulting from faster scanning speed at checkout. The model is intended to inform retailer purchase decisions, guide resource allocations for us and our customers, and facilitate our financial planning.

As previously announced, the next step in executional strategy is to begin to deliver at least one retailer Digimarc Barcode private-label products that will lead to in-store statistical tests of the model. When a sufficient number of Digimarc Barcode products become available in our customers' stores, structured testing can begin. The purpose of the testing will be to validate key assumptions of labor cost savings set forth in the quantitative model.

Once the financial impact of faster checkout is validated, we will have a compelling value proposition to sell. As retailers gain confidence, we expect them to encourage their national brand suppliers to adopt the Digimarc Barcode as well. We're making good progress in delivering this next important milestone in our executional strategy. A joint project team has been formed with our first customer. We have settled on a good process with them and have completed the coding of initial batch of packages. These packages will be printed soon. Once the Digimarc-enabled packages are printed, we expect them to be produced and distributed in the ordinary course of business. These products should begin to reach shelves prior to year end, consistent with our published strategic objectives.

Validation of the quantitative model will provide important support for our pricing, permit prospective customers to calculate ROI estimates for adoption of the Digimarc Barcode, and refine and enhance credibility of Digimarc's estimates of the size of the addressable market and the value of delivery for the barcode. These signs will inform our projections about the course and timing of rollout, capital requirements, and the return path from investment mode back to profitable operations, sustained growth, and margin expansion. The enablement of Digimarc Barcode reading, useful in the testing described above and laying the foundation for rollout following successful proof of concept, is also progressing according to plan.

As we projected on our last call, our go-to-market partner, Datalogic, has begun shipping scanners with our software embedded. Previously shipped scanners are field-upgradable. We are beginning the conversion process for additional customers. A number of prospective customers, including at least one top-five retailer, are preparing to provide packaging files for encoding to perform proof-of-concept testing. These and other Tier 1 retailers are also proposing to test Digimarc Discover for consumer engagement. In one case, the top-10 global retailer selected joint research proposal from Digimarc and Datalogic from over 250 proposals from over 50 suppliers. The project is expected to commence later this year.

And in an important market development, Amazon announced that its new smartphone would contain a dedicated button feature called Firefly. We believe that this may be a very significant market development. Followers of Digimarc's strategy know that we anticipate that leading multinational online retailers like Amazon and eBay, and search giants led by Google, will inevitably move toward an approach to search pioneered by Digimarc that we refer to as Discovery. Discovery via Digimarc's patented intuitive computing platform simplifies the UI for search by using the cameras and microphones of smartphones to automatically identify objects of interest, particularly the brand impressions that motivate and direct shopping.

As we've discussed often over the years, the nature of the smartphone and the increasingly mobilecentrism of shopping and network access generally should compel this direction. We have for many years anticipated these market developments, and invested heavily to build a huge patent estate and licensable technology platform that can improve the businesses of such companies or permit competitors of these companies to better serve their customers. Given that the Amazon phone hasn't shipped yet, and we understand that it will becoming available today and the embargo on the press has been released so there are a number of articles out, we don't have one yet. We will get one very soon within the next day or so, and we will begin an in-depth study. It appears with the Firefly feature of the Amazon phone, Amazon is first of the majors to make a concerted move toward the seeing-hearing device concept we pioneered and patented. We intend to study the competitive and intellectual property implications of their product in detail as soon as possible.

At a minimum, we see Firefly as a clear and present threat to retailers. You need to imagine shoppers in retail stores ready to buy and then pressing the Firefly button to divert the purchase to Amazon right there in the store. We will carefully assess Amazon's solution and develop marketing programs to present Digimarc Discover and the Digimarc Barcode as an effective competitive response to this threat to all those that at risk by Amazon Firefly. We hope this will enhance demand for Digimarc Discover among Amazon's competitors in retail, most of whom are already getting to engage with us for Digimarc Discover and Digimarc Barcode.

As many of you know from prior calls and other corporate communications, we are exercising our best judgment in metering the rate of investment and the market development for the Digimarc Discover and Barcode offerings by balancing our investors' desires for rapid market development with a tolerable rate of investment in relation to our working capital. There are no easy answers in such matters, and certainly there's room for legitimate differences of opinion. I am guided by a long career in market development and making judgments regarding the necessary compromise between pace of market development and capital risk.

We file the shelf registration for $100 million on May 16. The registration statement became effective shortly after it was cleared by the SEC. Since the filing, we've done considerable diligence concerning how and when this vehicle might be employed in managing working capital, including technical and market research and discussions with numerous investment banks. We have concluded that the optimum management of working capital levels can best be realized through a financing technique known as at-the-market offering, or ATM.

The ATM process is quite simple. The Company sells new shares into the market as needed using essentially the same processes investors used to sell existing shares. Process is effectively the mirror image of a stock buyback. Like in the buyback, the Company enjoys flexibility regarding timing, size, and execution. ATMs are a relatively new form of secondary equity offering that emerged in 2008 due to regulatory changes. Although such offerings count for only about 10% of recent follow-on equity offerings, the approach is gaining share.

ATMs have many virtues in contrast to more traditional approaches. In the first academic study of ATMs published in 2013, the authors found, quote, ATM issuers appear to experience lower explicit issuance costs, less negative event returns, and less negative long-term returns compared to standard equity offering issuers, close quote. The study also found that issuers using ATM offers, like our Company, tended to be smaller and more growth oriented on average with more R&D and cash, but lower sales and profits than issuers using traditional follow-on offering methods. They went on to say the long-term share price performance was better for ATM issuers than those who employed traditional methods. The conclusions of the study support our view that the ATM approach to financing is best suited for our circumstances.

The ATM allows their company to raise capital on an as-needed, when-needed basis. It is the most cost-effective approach to raising capital primarily due to the fact that the cost of establishing and maintaining the ATM offering program are considerably less than an underwritten offering. Notably, ATMs and other financing techniques, including fully marketed and confidentially marketed offerings, are not mutually exclusive. An ATM offering program will not restrict our ability to use other approaches during the life of the program. Thus, for example, once the ATM program is in place we can take advantage of company events or favorable market conditions to raise capital and our traditional underwritten public offering or private equity or debt transaction. The ATM process is also an efficient means to accommodate strategic investment.

Currently, we expect to announce the selection of a high-quality investment bank to administer the program. Appreciating that we may be on the cusp of an inflection point in the value of our business, we intend to be parsimonious in managing working capital. We will balance having adequate capital to provide reasonable comfort to customers, business partners, and investors that we are adequately capitalized with avoidance of unnecessary dilution.

Mindful of the importance of minimizing dilution, and recognizing that our plan anticipates several more quarters of investment, we have decided to suspend the dividend. We initiated payments of dividends in early 2012 to provide income to long-term shareholders as we developed Digimarc Discover, the Digimarc Barcode, and the second-wave patent portfolio. Been a good program, serving that objective as we provided more than $7 million in income to shareholders during the past two years. At this stage in execution of the strategy, we now believe that investing the capital in delivery and operational support of Digimarc Discover and Digimarc Barcode, monetization of second-wave patent portfolio, and other growth investments will yield a better return for shareholders and reduce our financing needs.

There's been some selling pressure on our shares recently. As most of you know, it's very difficult for companies to gain insight to the trading activities. We've tried to learn what we can. We observe the short interest has increased in each two-week reporting periods since the beginning of the year as we invest in product and market development for the Digimarc Barcode, and that short interest has increased by 60,000 shares in the last couple of weeks to approximately 240,000 shares.

Additionally, we see concerted pressure on small-cap tech stocks is commenced by the Federal Reserve last week about valuation. Ownership updates available to the Company are only current through March 31, so they are not useful in understanding this recent activity. I do not know of any human shareholder selling. The selling has begun during the blackout period, so there is no insider selling involved. We've not been able to identify any block trades. We have no other information regarding this unusual selling. My best guess is that algorithmic trading may be a primary source of the selling and hedging. (Inaudible) more than 10% of our shares as the latest information to us discloses.

Raw financial information not informed by discussion of strategy or subsequent to leadership would trigger such a response. It would make sense that the computer models would act in this manner. If this is the source of pressure, then the share price should recover as evidence of continuing progress and excretion of strategy become publicly available, properly motivating demand among those who understand the strategy and appreciate the evidence of progress. We'll do our best to promptly deliver such news to investors as it becomes available.

In all material respects we are on plan and executing well against our publicly detailed strategic plan for the Digimarc Barcode, and continue to believe that it will represent an inflection point in our business and a transformative technological development of great economic significance for the retail industry.

That's it for our prepared remarks, and now we will open the call to questions.

(Operator Instructions). Josh Nichols.

Thanks for taking my call. Real quick, just want to go over a couple of things. I know there's been a couple drop-offs in some of the legacy revenue. Is there any other contracts that are coming up relatively soon with the central bank - (multiple speakers)

One moment for the first question. Mr. Nichols, proceed with your question.

Thanks for taking the call. Real quick, I know that there's been some changes obviously in the legacy revenue, some follow-ups for a couple of the 10% customers that the Company used to have. One, are there any other contracts or agreements that you might expect to roll off on the near future that were part of Q2 revenue that would cause another significant decline, or are these long-term contracts like with the central bank that you are not too worried using most of the rolloff is done?. And then quickly, would any of the revenue be coming back? And I'd like to get into a little bit more about the future plans for the Company.

Josh, if we could answer your first group of several questions and let some other people who are in line ask their questions, and come back later, I think that would be helpful. To the group if you don't mind.

So with respect to fixed fees paid over time, those were the two contracts that had those characteristics. And so they've been completed. There would be additional revenue from those sources if they needed additional licenses, but the licenses that they obtain for the products and services within the fields of use were fully paid for by those fees.

With respect to other patent licenses, they are all subject to risk, of course, in terms of the value of the IP to the customers of the businesses that we license. And many of them are private companies. And so we don't have great visibility on where those license income streams will go. But some of them have been long-standing sources of income to us, and we have some newer ones as well. And we continue to explore additional license opportunities. As I alluded to in the discussion of expenses, we are actively engaged in licensing negotiations for the second wave, and got pretty close to filing litigation during the quarter. So we will see how it goes. This was the classic problem of our Company during its R&D phase; it's difficult to predict exactly how, when, and how much will result from those activities.

All right. I could jump back in the bank and let some other people go.

That would be great. Thank you, Josh. Appreciate that.

Jeff Kessler, Imperial Capital.

I'm wondering if you could give us an update on the progress you are working with embedding with your partner, embedding the Digimarc technology at the chip level.

Yes. So as everyone knows, we have an ongoing R&D relationship with QUALCOMM, and I think we are doing well there. We don't have a product yet, and I can't scoop them on anything they might say about what we are doing at some point in the future. But we are making progress, and we continue to work on the always-on, low-power audio recognition solution. And we think it's quite impressive. And we would like to do a similar kind of research and development project with them in imaging so that our goal in terms of execution of our long-term vision is to have the seeing-hearing capability for encoded media to be a chip-level function that would be callable through APIs from the operating systems above the chips, and not to be even a button as it is on the Amazon phone or an application as it is in most other environments today.

Just as a follow-up, quickly, how well do you think - you've mentioned that you believe you are on track with all of the - with the operational progress that you are making. But how close are you to being able to - let's call it control the development of the development of your capacity with your chosen prime client? Are you able - do you feel you are in control of that process given that there are more than one company trying to pull at your shirtsleeves right now to get your attention?

We are - one of the reasons that we are running a little hot on expenses here, there are a couple of reasons. One of them has to do with a desire to accommodate some additional customer involvement. As everyone knows on the call, I believe, I have been suggesting to everybody that I'd like to limit customer involvement during 2014, so we could focus on customer number one. We're off to a nice start with customer number one. We are entering into the production process, and we do anticipate that we'll meet our goal of having products in the stores before year end. We continue to be obsessed about that. That is the right thing to be focused on as a business.

However, some additional prospective customers have come to us and asked if they can begin getting involved, and so we are not saying no to them. So I expect by year-end that there will actually be activities going on with more customers than I had anticipated. And in more ways than I have perhaps anticipated as well, and that we're working on some Digimarc Discover proof-of-concept activities as well as Digimarc Barcode activities in that regard. We also continue to do the work which is difficult to discuss publicly with business partners in R&D other than QUALCOMM. And they were kind enough to let us talk about it, but there's other stuff we are doing as well, which is also burning up some cycles here.

Thank you very much.

And the other point, Jeff, just to finish off the thought is that in the IP monetization area, that's one of our wild cards, if you like. As we had talked about our strategy here, we felt we were getting to a point where we had sufficiently mature IP in the second-wave portfolio to begin marketing. So we've begun marketing, and now we are getting more aggressive in trying to bring that to fruition early on in order to feed the engines here and to create an understanding of the value of the portfolio for investors. So we are working hard on that, and we are engaged in at least a couple of cases now, but that also leads to additional investment in the short term.

All right. Thank you. I'll get back into the queue.

Kim [Rutkowski], Vertical Group.

Could you just give us a little more color with regards to - partner number one you are working with right now, you've obviously given us indication there should be product in the store by year end. But obviously your constraint with certain things like inventory replenishment cycles, can you give us any color around timing of when you think partner number one will be up and running? And how long do you want that to stay at a current rate before you feel that proof of concept has been proven and you can kind of what the backlog of customers that you're already working with then kind of open the spigot and go forward?

Sure. I'll provide more detail on what I expect the process to be, which I think is sort of the essence of the question. And we are better informed now than we were at the last call about that. So I can't disclose the identity of the customer; it's up to them to do that whenever they feel it's appropriate. But they have a lot of private-label products, and we have begun receiving files and we have encoded the first batch of those files and returned them for QC. They will be printed shortly, and then they will move into the production process. And the production process varies by product, and it can be anywhere from a few weeks to a few months in the replenishment cycle.

And so we need to get a certain number of products on the shelves to have a good grounding in statistical relevance for extrapolating results to the universe of the industry. And so that's our goal here is to not only get in the stores but get enough product in there so we can run all the tests we want to run. And then to hopefully publish the results with the cooperation of the customer, because they understand, as we do, that it's beneficial for them to tell everybody about the savings that can be generated, because industry adoption gets more pressure on national brands which causes them to make more money.

So we think we have good alignment on publicity regarding the results once we have run the test. So stage-wise here, get the files, encode the files, print the packaging, run the inventory into the stores, build sufficient inventory in the stores to run statistical tests of the assumptions in the financial model, validate the model, then publish. So that's the process that we're involved in right now in a bit more detail than I probably have provided previously to most people on the call.

How much proof is necessary is a part of your question. I wish I knew the answer. That's a subjective matter; I can't tell you the answer on that. But I have speculated in the past we have no reason to change my speculation that it's a relatively small number of customers. It may be one, and I guess this is not more than five. So somewhere between one and five that we need to get going. And that's where some of the opportunities that are coming to us now may allow us to get two or three going before year end and have them running in parallel to get a more persuasive proof of concept done soon. So we will keep our fingers crossed on that. I can't promise it yet, but we seem to be heading in the right direction with regard to that opportunity as well.

That was great color. Thank you very much.

Robin [Nett], Janney Montgomery Scott.

Just a quick question relative to the - on your last call you mentioned you expected deliveries of the Datalogic scanners to start shortly, and on this call you said that they had begun. Can you give any additional color to that?

No, I don't have authorization from them to discuss their business in any detail. I just wanted to reassure everyone that our belief that they would ship was well-founded, and they did ship. So they shipped during the quarter, as I had proposed would happen. So they are in the field now, and we are quite comfortable that the units that shipped prior to that are easily field-upgradable.

Okay. Then just as a quick follow-up, in your most recent investor slide deck, on slide 12, you show 20-some-odd different retailers - names like Wal-Mart, Costco, Target - and I guess I'm just trying - on a bit of a fishing exhibition expedition here, I recognize and respect the fact that you cannot disclose the name of different retailers without their prior approval. But at what point in time do you think we will start to get a sense of which of these are actually good clients?

Well, I guess the enduring well-understood relationship here is where the little guys and all these guys are the big guys because they are way, way, way bigger than us. It will always be whenever they feel like it, not when we do. And so I don't know what to tell you. They will say whatever they want to say whenever they want to say it, and they usually don't let us know in advance. So that's - we have accepted that. So we are not trying to pressure anyone to tell anyone anything because we don't want it to interfere with the development of the business relationship. We will be respectful of the fact that all of our prospective customers are multibillion-dollar revenue companies and we are not. So we're just trying to be a good supplier and get them excited and have them talk because it's good for them to talk as opposed it's good for us that they talk.

Fair enough. Thanks for the clarity.

Kevin Hanrahan, KMH Capital Advisors.

I have three questions. The first one, it looks to me, just from looking at the two cash flow statements from Q1 and Q2, that you did repurchase about $600,000 in total during Q2. So I heard what you said about the dividend. My question is is the buyback - do you still have a buyback authorization, and can you provide some color about that?

Yes. Those particular shares, it was around 17,000 shares that we had bought back. That's part of our normal employee stock program, buying back shares to cover their tax withholding liability. And so there's been no change in that program at this point; it is obviously something that we could evaluate longer term, but there has been no change. We have not - and we've not purchased any shares on the open market (multiple speakers) authorization, which actually expires at the end of this year.

The authorization?

Yes, for buyback in the open market.

Okay. That's interesting. Bruce, I wanted to congratulate you on getting some coverage, Jeff Kessler from Imperial Capital. That's fabulous and much needed. My question is - because you mentioned some larger investment banks that you might be talking to in relation to the ATM. Will you be pursuing some more coverage?

Well, first with respect to financing on investment banks, as I mentioned in my remarks regarding financing, we are going to begin with an authorization for ATM, but that does not preclude any other form of financing. So I don't mean to imply mutually exclusive approaches at all. But given our circumstances and given the interest that we have in management and as shareholders as well in minimizing dilution of the potential inflection point, the ATM stands perfectly suited for that. So we will start there and see how it goes.

And then with respect to seeking coverage, Jeff is a very well-respected and seasoned analyst, and I greatly appreciate his interest that he has shown in our Company. I'm not interested in getting coverage for coverage sake because I don't want to spend my time trying to explain why analysts who aren't competent to cover the business aren't saying things about us. So it depends, is the answer. Really depends on the quality of the analyst whether we are interested or not in having them provide the coverage. So we've got a great start with Imperial and Jeff, and we will see. There are other firms that have expressed interest in potentially initiating coverage, and that's the sort of approach that we will take to those opportunities.

Okay. And my last question, I hadn't heard the term marketing opportunity in maybe a couple of years since your relationship with IV. So that would be my next question. If you are going to pursue marketing opportunities for the second wave of patents, could IV be involved, or do you think IV will not be involved in helping you with those marketing opportunities?

Yes. I probably can't get into detail on them. I suppose the honest and simple answer would be it depends, which isn't very useful. But, again, we've executed on the strategy as we forecasted we would. So in 2008, after the sale, we embarked on a heavy R&D effort. When we did the intellectual ventures deal a couple years later, we included them there as exclusive license to sublicense the more mature parts of the portfolio. And we kept only four issued patents, and now we have about 100. And we have 250 pending that are not subject to the exclusive license to sublicense to intellectual ventures. So that is our focus right now.

And as I've said to many investors with respect to intellectual ventures profit participation, obviously we've quarreled a bit about expenses, but to the extent that they produce income for us, that's great. And I think that will be how we correlate it with our success; and our success value to investors that motivates their provision of income to us will far outstrip the value of the income in determining the market value of our Company.

So I don't really focus too much on those guys as a shareholder myself. But in terms of our relationship with them, I hope we can have a nice healthy relationship and get some profit-sharing and make money together. But I am focused here on the second wave and our licenses in the second wave because I think we have some very valuable IP that we've developed over the course of the last five or six years that now has reached a sufficient scale in terms of issued patents that we have a credible offer to potential licensees and business partners. So that's what we are pushing right now: we're promoting our wholly-owned patents, not the intellectual ventures portfolio.

Great, Bruce. Thank you.

(Operator Instructions). Josh Nichols, B. Riley.

Thanks again. Real quick, just wanted to go over a couple things, just like I said a little bit more focused on the future instead of the current situation or the past. Looking at it, and I'm wondering - so it looks like there's really two things that need to happen. One is you need these scanners that can read the barcodes and then you need the barcodes. Have one of you go out and you talk to retailers or some of the manufacturers, distributors, what kind of feedback are you getting and what type of investment would they have to make?

Okay. Well, we've talked to virtually all the top 10 retailers in the world, and many others below the top 10 and the top couple hundred. And there are two value propositions associated with the Digimarc Barcode, and then there's a broader value proposition associated with Digimarc Discover; Digimarc Barcode being, in our view, a feature of that platform.

So focusing first on the barcode, we do our best to focus them on the front-of-store operations productivity gains. And we publish the model because the large-volume retailers obsess about a key performance indicator that is called items per minute, or IPM. Every one of those guys focuses on that as a matter of productivity and profitability. So because we can objectively measure our impact on IPM, we focus first on that so that once the value is established we have a very strong selling proposition.

The second value of the Barcode is more difficult to quantify. And we haven't made an effort yet to characterize whether it's smaller or larger in potential economic significance in the industry because the productivity gain estimations are so high. But that's the other benefit of the Barcode at retailers. All of the retailers we talked to get both of those arguments.

So the issue that we have right now is proof of concept. And it's the gate that every new technology must go through with these guys because they all have formal processes for assimilation of new technology. And because they are so large and they operate on such small margins, they generally will be very reluctant to differ from that process. So we are trying to go extraordinarily fast because of our situation as a microcap public Company with a pretty high investment rate. So I would say we are doing great in that process, but it is a process and it's somewhat unavoidable, we think.

The Digimarc Discover value proposition encompasses both of those and is broader to encompass all media. And so we also explained that opportunity to the retailers as brands. And they sort of get that too. So that's where I said, in the case of one of the top 10 retailers, there were 50 vendors, we submitted 250 proposals for funded R&D projects funded in terms of the retailer side of things, competing for budget. They accepted five and ours was one of the five. So there without getting into too much detail on what the project will be, it actually is the broader proposition. It's Digimarc Discover. So we've gotten all the way from a focus with customer number one on front-of-store operations productivity gains from the Barcode to a top-10 retailer who's going to be testing the broader proposition -- the broadest proposition and everywhere in between.

Okay. And then last question real quick is - I mean, for the Barcode, for the first part since the second part bigger proposition for Digimarc Discover hasn't really been quantified, any thoughts about what type of business model you've (inaudible)? Was that something that might be like a royalty and licensing model? And any idea of what type of cost it would be to the Company in potential margins? I know that's a bit of a ways off, but I'm just curious.

No, no. It's actually - we have a published business model, and it looks like it should serve us well, and that is a price per code paid by the customers. And so part of the investment that is ongoing is continuing development of our Web interface for customer enrollment and service provision. And we recently launched an outdated version of it and changed the name. We used to call it the OSP, online services portal; it's now called Digimarc ID Manager. And so any brand or any client, even individual client, can go to this Web service available through our corporate website, sign up, get codes, get the service to encode them, be on their way after making payment.

And so Jeff Bezos, in describing the Firefly feature of the Amazon Fire phone, mentioned casually, is out there about 40 million barcode products that could be identified. And that's the same number I got from some other big company, and I don't vouch for either of the numbers but I would assume Bezos would know it. So there's 40 million barcoded objects, and we are charging a $300 setup fee and the $50 per year annual fee; the math is pretty compelling in terms of business model. That's just for the Barcode - just for packaged goods.

And so packaged goods generally are presumed to have a multi-year lifecycle, and thus the renewal fees are important. For most other applications of the Digimarc Discover system, the uses tend to be more limited in duration. So we don't focus much on renewal fees. And there, we charge from $25 down to $3.50 per code depending on the client's lifetime usage of codes. So the first code costs $25. That's the business model for Digimarc Discover generally. We don't charge license fees to the enablers, the smart phone application providers, and we don't charge license fees to the professional scanning companies.

So why are we make our money from the provision of codes? Now, the Digimarc Discover system is built on our patented intuitive computing platform. The intuitive computing platform involves multiple symbologies. So it's not just Digimarc codes; it's barcodes, QR codes, and we will soon be adding some more identification means. The rest of the stuff is sort of free, so you could view our code sales as the meter mechanism for margin generation, not necessarily exactly correlated with all the uses of the system. But we think it's going to work, and it will be adequate to create a massive increase in value in a much more understandable business model and easier forecasting of how we will do. So we think there are a lot of virtues to it. But again, we will see how the markets develop and whether any changes are indicated. But that's the current plan, and it's available on the website.

Thanks very much. That was a pretty thorough answer. I appreciate it.

Jeff Kessler, Imperial Capital.

Just -

His line disconnected from the conference. Paul Sonz, Paul Sonz Partners.

I have a question regarding cash. I wondered what is sort of the minimum amount of cash you want to keep on the balance sheet, and how much do you expect do you think that you're going to need to raise?

We want to keep enough to keep everybody comfortable. So I don't want to peg a number for public consumption because it kind of depends on circumstances. So it's an ongoing assessment by management that we will clearly run by the Board at least every quarter. But the notion here is it's our full balance, so there isn't any right answer I don't think. And I will solicit everyone's views among our existing shareholders including you, Paul, on an ongoing basis of how we are doing. But Charles and I will do our best to keep the level of working capital at a comfortable level in relation to our projected investment rates. And not more than that, because we don't want to have any unnecessary dilution. So that's the management task that we have set for ourselves here. And we're going to do the best we can do in all circumstances.

Again, a great virtue of this approach to working capital management that we have settled on is that we can be pretty refined in those judgments. It's not as if we have to go out and do a road show and sell a block or something like that. It also is very helpful for potential strategic investors if they want to get involved in the business; it's a pretty easy process.

I think that what I was getting at is how much cash do you think you need as a precautionary measure against people who might want to litigate against you on the intellectual property? How much of a war chest do you need to maintain so that they know that you have enough money to litigate if they want to do that? And then the second part is how much - because you obviously have a fair amount of cash on your balance sheet right now. And the second part is trying to get an understanding of how much this increased expenditure on marketing development can we expect to see.

On the last part of your question, is that about intellectual property or product (multiple speakers)?

No. Actually I guess that it would encompass both the marketing to an intellectual property and for the development of the Digimarc Discover and Digimarc Barcode.

Okay. Well, let me separate them because they are quite different. So with respect to intellectual property marketing, we do most of that work with our staff. So there's not a lot of third-party costs unless we contemplate litigation. And when we contemplate litigation, then we need to employ an outside firm with litigators and prepare for that form of intellectual property marketing. And so unless we get to litigation, the expenses are not very big. But when you're looking at the run rate that we have, if it's a couple hundred-thousand dollars in the quarter, you guys notice. That's not, in most cases, considered a huge amount of money. But that was what was going on in the second quarter, and we only do that if we are pretty close to filing.

And has happened there, often happens, you get into a little discussion and decide to put it off because once you get it going it can be pretty expensive. Now, how expensive it is depends on the nature of the litigation, so there isn't any simple answer to your question. How much does one of these cost? And it depends on the number of patents and how long it goes and how complicated it is and what the other side does and on and on and on. But it can be - let's say hundreds of thousands a quarter would be sort of big, until you got to trial which you would see coming a year or two in advance. But the early stages are more like tens of thousands or hundreds of thousands, not more than that. For each subjectivity. And so that's for one target. And so I hope that's helpful to you. It isn't simple to generally characterize. And with respect to that plus the products and services market development, Charles gave you the estimate earlier for the next couple of quarters.

I'm sorry, I missed that. I must have - what was that number? I could just look at the transcript if you want.

No, Paul, I can share it with you. So we are projecting usage of cash without any sort of financing activities of $4 million to $5 million in Q3 and $2 million to $3 million in Q4. And there's a little bit of a difference between those quarters. The overall expense rate probably would be somewhat in line, but it really comes down to timing of payment and receipt from customers, kind of the key variation between those quarters.

Okay. All right. Thank you very much. I somehow missed that. Would we assume that that's the kind of run rate going forward into next year as well, or is that something to be determined later?

We are not intending to provide any financial guidance (inaudible) next year. As you know, we generally don't provide any. But here, we're varying from our general protocol in order to keep people comfortable that we have a plan that we have reasonable confidence in, and that the run rate of the legacy business is more predictable than the intellectual property licensing base revenue streams that dominated the revenues in prior periods.

So again, one of the potential elements of volatility is the IP marketing. And it's asymmetric; that is, there is a much bigger upside than there is a downside. But there is a possibility of spending more money than we planned or making more income than we figure.

I think that's very good. Thank you very much.

Jeff Kessler, Imperial Capital.

Please, my phone doesn't cut out this time. Just two quick follow-up questions. The first is the ebbs and flows in your legacy business, particularly with the banks. It appears that you have - this is a period of ebb, and I take it you're expecting - you're expecting a fairly stronger second half from fees from your banking partners. Is this due to a change in the number of payors, or just the size of the individual - size of the individuals that are within the EIS that are going to be paying you?

I suggest that you attach no significance at all to this quarterly variation. It's circumstantial, and it will - the flow will match the ebb year pretty quickly. It just has to do with allocation of resources on our side for the most part. We are very busy, and so we have to move people around a little bit. And we are not trying to manage the quarterly revenues, we're trying to expedite the delivery of certain things. And so that's how it happens.

Okay. I apologize for the background noise. By the way, it -

And we typically - by the way, you know, at the end of the year the fourth quarter is typically a little lower than the prior quarters. But so what you observed this quarter is a bit unusual.

Okay. Finally, with regard to the timing on the decision for the dividend, how did this discussion come about? Was this in the last month or in the last week or in the last couple of days?

No, no, this is not - none of those. We initiated the dividend a couple of years ago when we were a couple of years away from introducing the product of our R&D. And we wanted to provide income to our long-term holders as we developed the product and services that we are now beginning to deliver, and we thought that we could afford to do it, so we did it. And so as I said on the script, I'm happy to have been able to give $7 million of income to our shareholders. But it doesn't seem wise to continue the dividend in the time at which we might be raising equity capital. So I don't think anyone would want us raising money to pay a dividend given our circumstances. And given our circumstances and the potential for a great increase in value of the business from investment, the investors are better off if we spend the money on that than providing it as income. So it's something that we talked as - from day one that we decided to do it every quarter, we would have a thorough discussion with the Board about what we're doing, why we're doing it, and whether we will continue to make sense.

(multiple speakers)

We are hoping once we get the proof concept done and get a backlog built that we'll be anticipating days when we'll reinstitute a dividend and increase it. But right now it doesn't seem like it makes sense.

Again, I apologize for the background noise. Thank you.

Riley [McCormick], PCM Capital.

So a couple questions. First, Bruce, just clarifying the guidance. Would the guidance for cash burn for Q3 and Q4 includes no potential settlement with anybody who might be infringing wave to, but also no commencement of any litigation. Is that correct?

Yes, I think that's fair.

And does that cash burn also include getting customers two and three started on Barcode?

It does. As I said long ago, starting last year before the show but certainly since the show, I stated my preference sort of focused on customer number one. But I admitted then, and it's now becoming a reality, that we don't want to stiff-arm other valuable customers who want to get started early on. We've just been not aggressively pursuing them. So you can figure that they sort of let us know they were willing to go, and we are not going to say no to them.

Okay. I understand. I just wanted to make sure that's all incorporated in the cash flow guidance. Okay. You had mentioned that you were gearing up for litigation and put on hold to begin negotiations. Does this mean that you're actually close to starting litigation with a couple of infringers and then came to the table, or is the last step before beginning litigation you're reaching out one last time?

I don't want to get down a rabbit hole of detail on public calls on litigation. But without any implying any obligation to provide regular updates on details, we have a couple of companies that we think need to have a license. And we have been engaged in discussions with each of them for quite some time now. And when we were getting to the point where we thought it made sense to file and then we had some conversations and decided to defer that, and so that's what happened. It was just it got pretty close and then we backed down. I can't tell you whether we're going to go back to litigation or not. We obviously prefer not to, but we also are intent on receiving a reasonable return on investment in our inventions that people other than we use. So we feel we have a good basis for requesting the relationship, and we will see what comes out of the discussions.

The two last questions. The first couple of customers on Barcode, I assume they will be generating some revenue. Right? So products on shelves should lead to some revenue from Barcode this year even if potentially it's not tested out. We are not going to have to wait until this is proven in customer six and beyond are on Barcode to get paid. Is that correct?

Sort of. Let me give you an honest and strategic answer. It is really unproductive for me to talk about individual customer pricing in public. That's just a really bad idea to the extent anybody gets any deal that varies from the published pricing on the website. So I won't do that as a matter of course. What I have said and everyone would presume, so I feel comfortable saying, is that customer number one is going to get a discount for being customer number one. And customers two and beyond kind of depends. So I don't want to get any more specific than that because it's really not helpful given the transcript is readily available for any customer number two, three, through eternity.

That makes sense. And I guess - so all those kind of leading up to my final question, which is - and I realize the cash floor number is a moving target and you need to do what's best for the long-term of the business as opposed to short-term. But if we are looking at cash burn, you have $28 million burning maybe $4 million to $5 million this quarter with a potential of whoever this party that you are trying one last negotiation before litigation, and potentially some revenue from customers on Barcode this year. Would there be any reason to start the ATM sooner rather than later, or why not see it play out for a few months before you begin?

Well, this is the delicate question that I'm happy to get your advice on if you want to give me a call. I'm happy to share my thoughts with everyone here publicly. There isn't a magic number. There is an assessment that we make, Charles and I, based on our understanding of our clients and prospective clients, our business partners, and our shareholders. And so we constantly assess that, and we try to make a good judgment about how to maintain that confidence. And basically we don't want to have more money than that, whatever that is. And it's not a fixed number, because it kind of depends on all the circumstances. So the ATM allows us flexibility as to timing and volume to assess those circumstances and adjust accordingly. And that's why I again it's our preferred technique. So it's not that we have to make decision to do it now or later or a particular amount, we just need to maintain the level of working capital we think is comfortable. So that's our goal. And we are new to the process, and we will learn a little bit about it as we do it. We expect it to work well, and we will report on each quarter in our SEC filings and in these calls. So we won't report on it any more regularly than that because it's in essence kind of normal trading activity like the stock buyback would be.

Okay. I guess one last on that, because the way you couch that answer which is all very fair. If it's a matter of maintaining working capital, I assume it would be something where, again, outside of a strategic or something that was beneficial, there would be no reason to stockpile money through an ATM, or it would be something where your stock traded $1.5 million of volume alone a day. If you're burning a couple million dollars a quarter, there would be no reason to go out and do $15 million of ATM in the quarter. Is that fair?

Yes, it is.

Okay. Great.

You should - everyone on the call should be comfortable that we will be very conscientious about this. And with respect to the intellectual property stuff, it's kind of the same old story on that. But I don't want anyone to misunderstand that we've got five or six months left in the year here, and so the way that stuff works is that we are engaged. And if we are not going to litigate, there's a fair chance we might be able to get paid this year, which would obviously contribute to working capital and to profitability. If we have to litigate, we definitely won't be paid this year. Pretty much. But we will have an expense that as contemplated, then it will be in those sort of five-figure, six-figure ranges per quarter that I offered up when Paul asked the question. So it's somewhere in between. And it's hard to tell.

But our goal here with respect to the initial licensing of the portfolio is to have that in mind as we are thinking about all those same issues. I'm sure that all of you would appreciate if we had some more margin this year, and that we have that as a source of working capital instead of equity markets, and so we are very mindful of that in working on the licensing.

And I also don't want anyone to have the impression we think there are only a couple of companies that could benefit from a licensed (inaudible). There are and will be a growing number of them. And so we're just getting started with the marketing process. And, again, the light in the development of the market for the discover and barcode solutions, it's not a good idea for us to get too many of those going all at once. So a couple is a good number.

We are comfortable that we can manage the opportunities that we are currently working on, but we also anticipate there may be additional opportunities, particularly as the market realization of the value of our vision grows. And that's where we don't yet know what to make of Amazon, because the phone hasn't at least arrived in my hands, and we believe it's on its way here today. But we are going to take a real close look at it, and what we see there is very encouraging. Because for those long-term holders who have listened to Bruce's dreams for many years, it's happening. The big guys are seeing what we saw after we saw it, after we built considerable patent assets and technical assets, and so here they come. So I'm excited about the potential of second-wave portfolio, and these early initiatives will test some of our assumptions. But I think in general I'd be inclined to give a little more favorable deal given our current circumstances than I might a little further down the road. So I'll do what I can to have that be a source of working capital in a reasonable time horizon here, but I won't give away the store to do it, and I can't promise that we won't have to litigate to get it. So there's a wide range of potential outcomes here against skewing positively.

Fantastic. Thanks a lot guys.

Kevin Hanrahan, KMH Capital Advisors.

Thanks for taking my question, Bruce. I wondered about if you could give an update on the mobile payments. I know you were working with (inaudible) and US Bank. Can you just give us an update there because we didn't hear much about that in this call.

Yes, I can. And I just had all this other stuff I want to cover; I didn't want to go droning on for hours. But we continue to work on the mobile payments opportunity, and we are going to do a showcase at Money 2020, which is a trade show in Las Vegas in November with some other business partners. So that's kind of our public presentation akin to NRS for the barcode. And I'm not in a position to give a lot more details at this point, but that's the plan. And mobile payments continues to be a very interesting space, and I was amused today to find as I was reading through all the Amazon stuff - because they released their trade embargo I think today - that they actually have a mobile payments offer of some kind. I don't know anything about it, but it's right across 15 minutes before the call here. But I think we are right in the thick of it, which is where we wanted to be. So it's a very exciting time. And as you know, I have a theory as to why mobile payments is appropriate for us to innovate in supporting our general shoppers' journey enablement. So we are not investing a fortune in it. It is R&D, but we continue to believe that it may have an important role to play.

Okay. Thanks very much, Bruce.

Thank you, Kevin. I think we will need to wrap the call up here if it's okay with everyone. So operator?

At this time, this does conclude the question-and-answer session. I would now like to turn it back over to Bruce Davis. Sir, please proceed.

Thank you, everyone. I appreciate your support and your conscientious use of the business here. We're doing the best we can. We are executing a strategy, as we told you we would, and I think everything is going fine. So thanks again. We will talk to you in another quarter. Goodbye.

This does conclude today's conference call. Thank you, ladies and gentlemen, for joining us for today's presentation. You may now disconnect.