Digimarc Corp (DMRC) 2014 Q4 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.

Thanks. Good afternoon, everyone. Welcome to our conference call. Charles Beck, our CFO, is with me. On the call today, we'll review Q4 and full year 2014 financial results and the outlook for 2015. We'll discuss significant business developments and market conditions, and provide an update on execution of strategy. This webcast will be archived in the Investor Relations section of our website.

Please note that during the course of the 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. 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 we expect to file shortly.

Charles will begin by commenting on our Q4 and 2014 financial results, and 2015 outlook. I'll then discuss significant business developments, market conditions, and execution of strategy. Charles?

Thanks, Bruce. Good afternoon, everyone. Revenue for the quarter was $5.9 million, down $1 million or 14% from the fourth quarter of last year. Licensing revenue was down $1.7 million, largely due to the scheduled completion of the quarterly license fee payments from Nielsen and lower reported royalties from another licensee.

Service and subscription revenues were up $700,000 or 18% year-over-year, largely due to higher Discover and Guardian revenue. Gross margin was 62% for the quarter, 9 points lower than the fourth quarter of 2013, reflecting the impact of lower license revenue.

Operating expenses decreased by $400,000 or 4%, reflecting lower legal expenses due to the completion of the licensing audit with Intellectual Ventures in January of 2014. We incurred an operating loss of $4.2 million during the quarter versus an operating loss of $3.4 million in the fourth quarter of 2013.

At the bottom line, we incurred a net loss for the quarter of $9.2 million or $1.23 per diluted share versus a net loss of $1.3 million or $0.19 per diluted share in the same quarter last year. The net loss for the quarter included a $6.8 million noncash income tax charge to record a full valuation allowance against our deferred tax assets.

The primary trigger for this charge, according to U.S. accounting rules, is three years of cumulative loss. The rationale for our operating loss is well understood. Recording the valuation allowance does not mean that we lose the right to use these assets in the future. Reinstatement of these tax assets would occur upon returning to profitable operations. Excluding this noncash charge, net income would have been $2.4 million or $0.32 per diluted share.

We raised over $16 million of cash during the quarter under our aftermarket offering at an average sales price of $24 per share. We invested $1.8 million of our cash reserves during the quarter, including $800,000 in operations. Our cash usage was under the $2 million to $3 million range we projected. The balance sheet is in excellent shape with roughly $39 million of cash and marketable securities and no debt.

Regarding full year results, in February of last year, we described our financial assumptions for the year. Briefly, we noted that we expected lower revenues due to the expiration of the scheduled minimum license fee payments from Intellectual Ventures and Nielsen, which we expected would only be partially offset by higher subscription revenue from our Discover and Guardian products and higher service revenue from the central banks.

We expected gross margins to be around 70% based on an estimated revenue mix of 40% service, 30% subscription, and 30% license. We forecasted another year of heavy investment in the Intuitive Computing Platform, Digimarc Discover, and Digimarc Barcode, as we transition from R&D to market development and delivery, resulting in higher operating expenses than in 2013. And we anticipated that existing cash would be adequate to fund our operations.

Our 2014 financial performance finished roughly in line with these assumptions. We showed decent growth in subscription revenue from our Digimarc, Discover, and Guardian products and small growth in service revenue. We invested in building our professional services and sales team during the year in support of Discover and Barcode.

Where we varied from these assumptions was in working capital. We ended the year well ahead of expectations due to the extraordinary success of our aftermarket offering, through which we raised over $16 million of cash.

Looking forward, our 2015 financial assumptions include the following: We expect 2015 revenue to be reasonably consistent with 2014, with license revenues down year-over-year and subscriptions and services up. All areas other than licensing should grow.

We expect gross margin to be around 60% based on a projected revenue mix of 50% service, 35% subscription, and 15% license. We expect operating expenses in 2015 to be lower than 2014, reflecting lower R&D, G&A, and IP spend, partially offset by higher sales and marketing expense, evidencing a shift in spending to sales and business development.

We are now projecting any income tax benefits for 2015 as we have a full valuation allowance against our deferred tax assets as noted earlier. We expect that our existing cash reserves will be adequate to fund our operations.

Keep in mind that these highlights of our financial assumptions represent our current view of expected values based on our assessment of the most likely unfolding of events over the course of 2015. As is our general practice, we will update you each quarter regarding the execution of our strategy, but do not plan to provide updates or further details on our financial guidance. For further discussion of our financial results and risks and prospects for our business, please see our Form 10-K that we expect to file shortly.

Bruce will now provide his comments on significant business developments, market conditions, and execution of strategy.

Thanks, Charles. At this time last year, we had just returned from the launch of Digimarc Barcode at NRF, and noted that planning was underway with a retailer for testing. That retailer was Wegmans. By the end of the year, we were in production with enabled products in all 85 of their stores.

We expected first shipments of Digimarc-enabled retail scanners in Q2, which happened on schedule. We have begun working on a labor cost-savings model that we published in May. In other areas of the business, we thought that subscription on service revenues would grow to help offset some of the declines in license revenue and they did grow modestly. We contemplated the additional digital watermarking The Guardian for eBooks, which we delivered. Our relationship with the Central Bank continues to [pace].

The two areas that were somewhat disappointing were IP licensing and mobile payments. And as I've noted in numerous prior statements during 2014, the IP licensing market is in the doldrums. We have responded by temporarily reducing our investments in this area and developing and pursuing creative approaches to leveraging our IP that are less sensitive to these market conditions.

Our R&D in mobile payments, although not bearing fruit directly with the intended application, is proving valuable as an important enabler of digital driver licenses, as two states announced their intention to introduce such licenses in 2016 through our partner, MorphoTrust.

We've made great progress in the execution of strategy for our key growth initiative in '14, as evidenced by numerous announcements at the 2015 NRF concerning customers and channel partners, disclosing Wegmans as our first retailer customer and Smithfield Foods as our first consumer products customer. We introduced an impressive roster of channel partners, including SGS and Shazam, as key enablers of our platform.

We have made, and continue to make, significant investments in this growth initiative. We are executing well against the publicly disclosed strategic plan. Our focus in 2015 is now on expediting adoption of Digimarc Discover and Barcode by leading retailers and brands. We continue to believe that these initiatives represent an inflection point in our business and a transformation -- technology development of great economic significance for the retail industry. Our priority this year is to gain distribution among retailers and brands and add more channel partners.

We've added two seasoned senior sales representatives to handle major accounts. We're developing training and support services to leverage the large and growing virtual sales force of our channel partners. The NRF was productive, and we're aggressively engaging in follow-up with retailers, consumer brands and potential additional channel partners that we met with at the show.

From a financial perspective, the key themes for 2015 include growing revenues, optimizing investments, proving the business model for the new growth areas and increasing investor confidence that we'll deliver on the amazing potential of these innovations. We're confident in our technology, yet understand that we still have much more work to do in proving the value of building confidence among customers and suppliers as well as investors.

In the meantime, we'll be efficient in our use of capital, avoiding nonessential spending, focusing on selling what we have, both in the legacy and new areas of the business.

That's it for our prepared remarks for today, and I will open the call for questions.

(Operator Instructions) Your first question comes from the line of Rob Stone.

I have a few questions. My first one is for Bruce. On the outlook for Barcode, you've signed up a flagship customer, and I assume you're rolling out some products with them on a continuous basis. What else should we be looking forward to in terms of tracking the progress of this initiative between now and the next NRF?

We are focused on adding more customers. That's the name of the game in '15. So we've beefed up our sales staff. We're working on equipping the sales organizations of our channel partners. We're in negotiations to add more channel partners, and we continue to work on the web interface, which is important to globalization. So we're -- all of our focus is on the sales interface right now and on getting more customers. And so what you should see during the year, I believe, is more customers. That's really the key measure of progress that I would suggest for everyone.

So is that to imply that there isn't any other technical or organizational hurdle, something that you need to set up in order to close deals? It's just a matter of closing them?

During 2014, one of the virtues that I saw in having a narrow focus, that is not trying to get started with a lot of customers, was to build the delivery mechanism. And so our focus was on friction in the sales and delivery processes. And so we had a new organization. Our professional services organization, we needed to get in place, get trained and get productive. We found contract negotiations could slow things down, and so now we have two channel partners who have existing contracts with important people. SGS, who is a leading supplier to most of the brands, including retail private brands that we're interested in, and Shazam, who has a very large sales force and engagement model with many other potential customers.

And then to the extent anyone's concerned about quality impact of what we do, we see SGS as a great assurance to them as the -- one of the leading suppliers in the world with quality assurance, with respect to print output from digital files, such as those used in packaging and labels.

And our sales force was forming over the last couple of years, and we've now beefed up significantly with two gentlemen who have decades of experience in selling technology to retail. And so my focus in 2014 was on trying to understand what we needed to do to reduce friction in the selling process, and then in 2015 is about beefing up the sales interface to bring the customers home.

So we think we're ready, and we think the basic technology platform is competent to perform on the functions that we have been promising. We continue to do R&D for sure, but we think we're ready to go. And we want to get as many customers as we can into the process here in the next year.

Okay. A couple of housekeeping questions for Charles, if I may. One, I noticed deferred revenue was up about $1.8 million sequentially. Any color you can provide there?

I don't think there's anything really specific there that's -- actually -- oh, you're referring to versus Q3, sorry. Yes, we do have a customer that we have a prebilling that we do in Q4 that we get paid for in Q1. And as we prebill that, that sits in deferred revenue until that cash comes in. And then the related revenue is recognized over the year-long period. That's the majority of the increase.

Okay. And is the increase in days sales outstanding tied into that in some way? Or is there something else behind that?

I mean, that would factor some into the calculation. There isn't anything else there, though that's alarming or noteworthy.

Okay. And finally, you mentioned, I think, in the outlook for this year, that you expect operating expenses to be a little bit lower. Can you give us any sense of how that looks on a quarterly basis? Does that mean it should be trending down over time? Or you're -- or just going to be running at generally about the same rate each quarter, but at a lower rate than last year? Thanks.

Generally, a little bit lower each quarter.

Okay. I'll jump back in the queue, thanks, guys.

Thanks, Rob.

Our next question comes from the line of Saliq Khan with Imperial Capital.

I'm also speaking on behalf of Jeff Kessler. A couple of questions that we have for you. Certainly, as you look at the relationship that you have with Wegmans is very much, so key for you guys especially given the fact that these guys are very much influential with the rest of the retailing industry and in terms of size, it's a very manageable size as well. Any updates that you can give us aside from the conversation that we had during NRF, with how the relationship is going so far with Wegmans?

Yes, it's a terrific relationship. We had very unusual circumstances at the show, having a senior representative from Wegmans in our booth. I think it's nearly unprecedented to have a customer willing to come and represent a supplier. And they were obviously very happy with the quality of service that we provided to them and willing to talk to other retailers about that experience. So it was a very, very helpful addition to our booth to have their representative present.

And so the goal now is to proliferate the technology within the Wegmans brand. And so we're working hard with them to do that, not only in packaging, but everywhere in their stores, demonstrating the full potential of the Digimarc Discover platform to facilitate in increasing profits and customer satisfaction for retailers.

Okay, Bruce, one of the things you've mentioned previously is that you needed that first customer to help you validate the economic model that Digimarc provides for the likes of these guys. Any timeline on when we can start seeing some more concrete numbers?

No. We're going as fast as we can. And so we're working on a few things that aren't quite ripe for general discussion yet, but one of the things that I would love to be able to do is to get persuasive proof to the industry of the value proposition so that we don't have to prove it over and over again. There is a normal process that these retailers want to follow for technology acquisition, which involves proof-of-concept. I'm hoping, at some point here, in my system priorities ASAP, that we can get over that hurdle.

So as I said last year, I don't think I've changed my view very much. I don't know whether it's one, two or three customers, but I don't think it's a large number that we have to get past before we've made our point. And so that was part of the unique value that the Wegmans representation in the booth brought was they came with information. They didn't share it with financial interest, of course, but they did share their early experience with other retailers. It was very, very helpful.

But if we have two of those or three of those, I don't know what the magic number is. At some point in time, I would expect that the retailers would go, "Yes, we're not learning anything new from new proof of concept test. Let's just get going." And so that's one of our goals this year that, obviously, we can't promise to be successful on, but we are focused on and trying to deliver.

One thing is -- I'm not sure if the others understand that you guys are working with Walmart for some of their circulars that are out there right now, with the Digimarc Discover technology. What is your, I guess, thought process or some sort of a timeline, if you're able to put a timeline on it? Or at least give us some more color regarding the probability that they could be taking on Discover platform as well.

Well, our offer to all brands is the entire platform, and we are somewhat indifferent to where they begin, as long as they begin. Walmart has chosen, in terms of public disclosure, that particular aspect of the platform. So our focus is on making them very successful with that. That particular application has very broad industry relevance. As you know, even though newspapers have suffered mightily over the last decade in reduced subscription, they still all carry with them on Sunday probably a couple of hundred pages of retail advertising that we could improve the productivity for.

And so Walmart, being the beacon that they are of excellence in retail, could be a proof point that would cause others to embrace the technology for that particular aspect of the platform, and that would be a wonderful thing. So we're entirely focused on making those guys successful. That's really what we're doing, with respect to the circulars.

And the last question for us is, what do you need to be doing, essentially, to get the likes of Adobe to build your capabilities into their products?

I think the answer to that is scale. And that's why I'm obsessively focused on that in terms of this year's objectives. We need to demonstrate scale to all of our channel partners, Adobe being one of the missing elements right now, and so I want to prove our value to them. And the way to do that is through getting more customers.

Great. Thank you.

Thanks, Saliq.

And our next question comes from the line of Josh Nichols with B. Riley.

Yes, a couple of questions real quick. Just looking at Wegmans, how long -- assuming that they're going to go to full adoption, at least for all their private label, how long do you think that, that ramp up would actually take?

That's up to the customer. There are two basic models that I've described, and we're okay with either. And I'll give you my sort of theory about the two models and how they will be embraced over time. So the two models are "Whenever I'm changing my package for any other reason or designing a new package, I'll throw Digimarc in." That's the most efficient model in terms of total cost of ownership.

The other model is "Let's get it all done right away," and that involves some incremental expense for program management and for what are known as " [fleet] changes." I believe that the industry will vacillate between the two models early. That is, they'll get a chunk of product they want to get going so they can do more extended, if you like, proof-of-concept and to have more experience with real product and distribution. And then they'll make a judgment to go one way or the other. And I'm not sure all of them will go one way or the other, but I think that if the value proposition described in the white paper in -- on our website is validated through statistical evidence that just about everybody ought to go down the expedited route because they would make more money by going faster. But I think that will not happen until that proof has been established and, obviously, the adequacy of the proof is subjective. It depends on how the customers feel about it.

So I don't know when that happens or how it happens, but I suspect it will happen. In the meantime, we'll probably see a little bit of both models being embraced early on.

Okay. And then, given that Smithfield joined, I know originally, kind of the thought process was, "Well, a lot of private label brands will join and then that'll ultimately cascade to major consumer brands as well as other things on the Discover platform." Are you seeing any shift in that, where you might be able to pick up some good private label brands as well as some name brands as well in the near future?

Yes, there's a lot of stuff going on, and then I would characterize it as kind of a healthy environment. That is, the awareness of us is increasing, and so we continue to believe that the most efficient leverage for us comes from focusing on the major retailers and their private brands and their general marketing. But we've got ongoing communication with a number of leading advertising agencies. A number of brands are exploring our technology, and so it's -- again, our focus is on retailers and their brands, but our reach, if you like, both direct and through channel partners, extends far beyond.

So according to our model here, where the delivery can occur through the web, through our direct sales efforts or through our channel partners, we would expect that they'll -- each of those venues will bear fruit in somewhat unpredictable ways and aggregate into this momentum. That is the goal for our resource allocations during 2015.

So I don't know who will be next or where they'll come from or whatever. We've got lots of irons in the fire, so to speak. And I hope that they all bear fruit for us.

And then, regarding the Shazam partnership. So they use a lot of audio fingerprinting and things, but they have such a huge user base of 500 million or whatever downloads it is. But are they using digital watermarks now? Or if not, how long do you think it'll take until those are enabled on the Shazam platform? And to what extent do you see it ramping up?

We're developing our product plans with them and our marketing and sales materials along with that. I don't think we're ready to pick a date just yet, but we're trying to go as quick as we can. And I'm hopeful that we'll have them enabled by the middle of the year. I think that's a reasonable goal at this point, although, it's not a promise.

Yes, I think that's it. And then, lastly, just looking at the subscription revenue. Sequentially it was up nice. I mean, I know, like $400,000 or something. Would I be wrong to assume that the bulk of that is probably from the Discovery platform, overall? Or were there a lot of Guardian upgrades too, a good quarter for Guardian possibly, that also affected that?

It's a healthy mix of both.

Okay. Thank you. Well, thanks a lot, guys. That's it for me.

Thanks, Josh.

And your next question comes from the line of Glenn Mattson with Ladenburg and Thalmann (sic - Ladenburg Thalmann).

Good afternoon, everyone. I think just about everything has been hit already. One question still remaining, I guess, somewhat of a ancillary detail, but interesting is the R&D program, with what is, I believe, a top five retailer. Has that kicked in this year? And are you happy with how that's going so far?

Yes, it's chugging along, I would say, Glenn. I don't believe it's going to go quickly because of the size and nature of the firm. But they seem as committed as ever to making it happen. So we're trying our best to support them. But it's a slow process.

Okay, that's it for me. Thanks.

(Operator Instructions) Your next question comes from the line of Bill Gibson with Roth Capital Partners.

Bruce, I've got one follow-up question on mobile payment. You introduced the software at a show, or the development kit. What kind of feedback did you get? And where do we go from here?

Well, we got very positive feedback, but we haven't been able to translate that into a program with a sustainable economic model. That's the hang-up. And that's why when we were doing the work and going to the show, I was as tentative as I was. Not because I didn't believe in our technology, but I did believe in the complexity and power relations that riddle the payments industry. So we still haven't figured out the magic formula to get -- keep going in that space. But what's happened in the meantime was that the R&D that we did for payments has proved to be fundamental to the digital driver license initiative that is beginning to show some signs of significance, with Iowa and Delaware announcing that they want to introduce digital licenses in 2016. So it may all work out in the end, not in the way we expected, but in a way that yields a good profit off of the R&D.

Our next question comes from Kevin Hanrahan with KMH Capital Advisors.

Just had a quick comment, I remember when it used to be a lot lonely around these calls, so I'm happy that there is a lot of analyst interest in Digimarc. I had a question for Mr. Beck. Did you buy back any shares in the fourth quarter?

We did not buy back any shares in the open market. We did buy back about 17,000 shares for 460k under our employee stock plans. Part of our routine process.

Okay. Right. And the ATM, the bulk of that was the transaction with Senvest, the company from Montreal. And then a little bit more that happened during the quarter. Am I in the ballpark on those?

Correct. Yes, about 90%, 95% of it was Rima Senvest.

Right, right. So basically, you're saying you got enough cash for now and you probably won't have to ATM in the short run?

That's fair. Not saying that there couldn't be strategic reasons to raise capital in the future, but that's kind of the plan.

So if something would happen to pop up, where you see an attractive acquisition or something along those lines, in order for that to happen, what you were just talking about?

Those sorts of things, yes, would potentially interest us in wanting to raise additional capital, as they come about.

Right. Okay, well, thanks so much and congratulations.

And we have a follow-up from Glenn Mattson.

Sorry, one more thing. I was just thinking the -- first, this being the first quarter with Wegmans, was there a pent-up kind of level of product label that needed to be converted? Or is this kind of a rate at which they kind of want to go at every quarter going forward? Or anything on the -- on whether or not there was kind of a surge in Q4?

Yes. Yes, I'm reluctant to get into details of individual customer implementation because it's more their business than ours, given that the relationship -- the contract is not financially material. I don't want to spend a lot of time talking about how they're running their business because they're a private company. And that will be true, generally speaking, of any of our clients. They're all quite sensitive about us being a small public company and sort of going around, chatting about how their business is going. So we probably won't want to talk about that level of detail regarding any of our customers.

Okay, thanks.

Yes, it will get disclosed, if at all, through them or because it's financially material. I think those are the two -- would be the two ways in which there would be some disclosure.

Okay, got it, thanks.

Okay, thanks, Glenn.

(Operator Instructions) At this time, this does conclude our question-and-answer session. I would now like to turn the call back over to Bruce Davis. Sir, please proceed.

All right, thanks everyone for your continued support. We'll look forward to talking to you again in the quarter. That's it for today. Thank you very much.

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