Digimarc Corp (DMRC) 2015 Q1 法說會逐字稿

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

Thank you. Good afternoon. Welcome to our conference call. Charles Beck, our CFO is with me. On the call today, we'll review Q1 Financial Results, 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 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 assumptions, risks, and 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 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-Q we expect to file shortly.

Charles will begin by commenting on our Q1 financial results. I will then discuss significant business developments, market conditions, and execution of strategy. Charles?

Thanks, Bruce. Good afternoon, everyone. Revenue for the quarter was $6 million, compared to $7.2 million in the first quarter of last year. Licensing revenue was lower by $2 million, while service and subscription revenue grew by $800,000. License revenue declined as expected due to the completion of the quarterly license fee payments from Nielsen and quarterly royalty payments from Verance during 2014. Service revenue was up largely due to timing and amount of program work and subscription revenue was up largely due to increased Digimarc Discover revenue.

Gross margin was 60% for the quarter, 10 points lower than the first quarter of 2014, reflecting the impact of lower license revenue. Operating expenses decreased by $600,000 or 8%, primarily reflecting lower investment in R&D, partially offset by higher investment in sales and marketing as we continue to transition from research and product development to market development and delivery of Digimarc Discover and Barcode. Legal and third-party IT consulting costs were also lower year-over-year due to non-recurring costs incurred in 2014.

Operating loss was $4.2 million during the quarter versus an operating loss of $3.3 million in the first quarter of 2014. At the bottom line, the net loss for the quarter was $4.2 million, or $0.52 per diluted share, versus a net loss of $2 million, or $0.29 per diluted share, in the same quarter last year. No income tax benefit was recorded during the quarter as we have a full valuation allowance recorded on our deferred tax assets.

Overall, financial results were in line with our expectations. License revenues were down year-over-year due to expiration of license payments from Neilson and Verance. The payments area of our business is performing well. We suspect that some of the Q1 performance may be due to timing of various projects; nevertheless, we expect a good year in payments.

Bookings for our Guardian anti-piracy service are lagging leading to a softening in our forecast for the year. In response, we are taking steps to improve margins and lower costs in the area. Digimarc Discover and Barcode are not yet generating material revenues; as such, growth in subscription and services is not yet adequate to compensate for the decline in license revenues.

As we noted entering the year, we will be efficient in the use of capital, avoiding non-essential spending and focusing on selling what we have both in the legacy and new areas of the business.

We used $2 million of our cash reserves during the quarter, largely in support of our operations. The balance sheet is in excellent shape with roughly $37 million of cash and marketable securities and no debt.

We did not raise any capital under our at-the-market offering during the quarter. 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. The key themes for 2015 from a financial perspective include growing revenues, optimizing investments, proving the business model to the new growth areas, and increasing investor confidence that we will deliver on the amazing potential of our innovations.

We are confident in our technology and its prospects, yet we appreciate we have great deal more to do to build trust and confidence among customers and suppliers as well as investors in the value proposition.

A little over two months have passed since our last update call. In that call, I summarized our success -- it's been a rough 2015 -- and noted that we were focused on increasing our sales and marketing for Digimarc Discover and Barcode. As you know, our top priorities this year are to gain distribution among retailers and brands, train and equip our new direct sales staff and channel partners, improve the sales effectiveness of our website, and add more channel partners. The focus on sales and marketing is yielding good results.

The two seasoned senior sales reps we added during Q1 to help handle major accounts are off to a good start. Our existing channel partners are also doing a great job. Datalogic, SGS, and Shazam are delivering a steady and growing stream of qualified prospects. Datalogic is now marketing a nearly full line of Digimarc-enabled products. SGS is ramping up customer presentations and capacity to provide services. The integration of our software into the Shazam platform is progressing well toward an early summer launch.

Our channel program spans all media. There is growing interest in and experimentation with our mobile optimized audio identification capabilities. We signed our first customer source audio during April who is providing an improved platform for monitoring the use of production music and associated royalty obligations. Production music, also known as stock music or library music, is the name given to recorded music that is licensed for use in film, television, radio, and other media.

Several additional channel partner relationships are in the works. Notably, we are making good progress implementing our software with other leading retail scanning vendors. We have begun exploratory conversations with two large specialty printing, scanning, and machine vision suppliers based on recommendations from prospective customers. Our marketing department is developing training and support services to leverage the large and growing virtual sales force of our channel partners.

We've embarked on a continuous improvement program for our web interfaces to customers, developers, and channel partners and have added experienced staff and contract resources to support improvements in lead generation, management, and service delivery.

These enhancements to our direct channel and web sales capabilities are resulting in dramatic growth and market development. We have some level of engagement, ranging from initial presentations to production, with the majority of the top 10 retailers and brands in the world.

Obviously, most of these activities are in the early stages, and I don't intend to provide blow-by-blow progress reports on these accounts. I expect the pace to continue to ramp as we continue our sales and marketing focus during the year.

Wegmans has told us they will be ramping production in a manner that should be sufficient to provide sample sizes adequate to provide reliable data on the impact of Digimarc Barcode in what we refer to as mixed basket environments where not all the products in the basket are Digimarc enabled.

We believe that even in such suboptimal conditions, our solutions can significantly improve scanning speed. We also intend to run structure tests once there are sufficient numbers of enabled products across a representative sample of product and packaging types.

Another large retailer has informed us of intent to begin pilot production soon. The same retailer has begun integration of our software into their mobile app. There are several proof-of-concept studies relating to front-of-store operations as well as consumer engagement in the planning stages at major retailers and brands.

Several new applications have been proposed by potential customers and business partners including improving labels for variable weight fresh items, facilitating healthcare for retail pharmacy customers, improving quality control and manufacturing, improving accountability and efficiency in shelf compliance programs, increasing efficiency in field sales inventory management, gaining efficiency in packaged delivery systems, enhancing product authentication, encoding variable product information, and supporting product personalization programs. I believe that these expressions of interest are indicative of the broad relevance of our inventions which would extend well beyond our current value propositions and market focus.

The channel partner program relevance extends beyond providing a forced multiplier in sales and market development more generally. The program is building out key elements of infrastructure to enable this widening range of applications such as the ones listed above.

The key elements of infrastructure for Digimarc Discover and Barcode are the registration of eligible media objects, discovery of these objects by relevant computer interfaces, and the provision of applications based on the Discovery. You can expect to see expansion and elaboration of infrastructure via our channel partner program as we continue to focus our core competence in the identification and discovery processes.

During the quarter we got more information concerning the size of the addressable market for Digimarc Barcode. Chinese online shopping giant Alibaba launched a one-day sales campaign on March 8 as part of an effort to cultivate the habit among consumers of shopping by scanning barcodes. The one-day campaign attracted over 1 million shoppers.

According to Alibaba's COO, they began encouraging suppliers to provide product barcodes and now will have over 100 million items in stock. According to a report published by 86Research on March 9, Alibaba's database of barcodes is over 200 million for merchandise sold by 8 million merchants or collected by government. These estimates are far larger than our prior assumptions regarding barcoded products addressable market.

Barcoded merchandising is a subset of the addressable market for Digimarc Barcode. We believe that our patented platform can do everything a conventional barcode does more reliably, faster, and with no human artifacts.

Our proprietary advantage as we develop this transformational technology is very strong. With nearly 850 issued and 400 pending domestic and foreign patents and significant ongoing investments in R&D and patent development to ensure a sustainable competitive advantage. In particular, we are not aware of any meaningful alternatives to Digimarc Barcode other than RFID which we view as complementary.

We will be participating in a number of financial market and trade events in the second quarter. I will be presenting at the B. Riley Investor Conference in Los Angeles on May 13 and at the Cowen & Company Annual Technology Media & Telecom Conference in New York City May 26 to 28. The exact date for our presentation has not been set yet.

Trade events including presentations -- include presentations at the GS1 Connect Conference in Austin, Texas, May 31 to June 4 and sponsorship of the emerging trends and retailing event at the University of Arkansas, Walden College Centre for Retailing Excellence on June 11. Featured speakers at that conference include the CEOs of Wal-Mart and J.M. Smucker Company and other senior executives from Wal-Mart, Sam's Clubs, MPD Group, Kantar Retail, and other retail industry leading companies. We have also been invited to present at the Needham Interconnect Conference at the Westin Grand Central Hotel in New York on August 4 to 5.

We are very busy doing just what I hoped we would be doing at this stage in the execution of strategy. There is growing awareness of our potential in relevant industries. Our task is to convert that awareness into adoption, leading to profitable growth and significant appreciation in the value of our company. There is obviously much more to be done to meet our goals this year. We are heads down, driving towards these goals.

That's it for our prepared remarks for today. Now we will open for questions.

Thank you, sir. (Operator Instructions) Our first question comes from the line of Josh Nichols with B. Riley.

Hi, Bruce. Looking at Shazam for a little bit, are watermarks now enabled, has been built into the Shazam software where they could use it for audio, video, and print identification yet or is that still underway?

The development is underway and is likely to become available in early summer, within the next couple of months.

Okay, and I was looking -- I know Shazam has some other partnerships, as they are looking to transition from music identification to really like more of a customer engagement company. But whenever I look at Mood Media, that's another one that has a lot of audio recognition, are they using fingerprints or do you have any information as far as what they have been using to identify audio, video, as well as print?

They are using a high frequency encoding method that is watermarking but not in the same area of spectrum that we operate in, so think of it as audio watermarking.

Okay and then last question. I know in the beginning it looks like some of the subscription revenue with Digimarc Guardian is coming on a bit slower, at least initially. Does that mean that the company is looking for slight revising down for total revenue for the year to be a bit less than flat compared to fiscal 2014 for 2015?

Yes, the bookings in the first part of the year for Guardian are soft and so there will be some softening of the revenue from that part of the business. Rest of the business is doing fine.

Okay, thanks a lot.

Our next question comes from the line of Rob Stone with Cowen & Company. Please proceed.

Bruce, I wanted to ask about the trend and visibility, to the extent that you have some, on licensing. I understand the expiration of prior agreements that was mentioned in the script, but do you see sort of a bottoming in your quarterly licensing revenue? What is your outlook just directionally for the year on that segment?

We've pretty much bottomed out, Rob, in my view. We are not actively seeking to monetize the portfolio, and it's a combination of factors.

In the past few calls, I've talked about the difficulties in the market in general that are obvious from other companies' reports having to do with some litigation decisions and some regulatory changes. I don't think it's going to get any worse at this point in time, and it may get a bit better, but we're focused on delivery of product this year. And the relevance of our patents is providing a sustainable competitive advantage for the product offering more so than direct monetization as it has in the past.

And we'll see how things play out. If we continue to make good progress in marketing our products and services, the patent licenses are generally relevant in a situation where there is some either unsupportable demand applications that we are not involved in or competition and none of those are present in any scale today.

Okay. With respect to Barcode, I know you said you are not going to give a blow by blow on everything that's going on. It sounds like there is a lot with multiple partners and channels and so forth.

But I wonder if you could just give a sense of an overview in terms of the cycle and sequence of steps that you see in general for customers to go from a pilot to full-scale deployments. And specifically, do you feel like other prospective customers are either keying off of progress that you might measure with Wegmans, getting to a mixed basket test as you mentioned? Or do you think that customers will want to pursue their own path, pilot, and measure based on their own environment?

That was a series of questions, I will try to capture them all, Rob. Let me know if I miss any important points. I will actually start at the end and work backward.

I do think that momentum plays a large role in this industry, and probably in most industries these days. And so, as I have said in the past many times, there will be tipping points. I can't really predict when they will happen and exactly what they will be, but I can predict they will happen and have that impact.

And so, we just need to press hard to get more demonstrations of value. At some point it will kick in and then there will be a pile on.

In terms of getting the customers to production, it depends on the area that we are discussing. The purpose of elaborating the list of applications being proposed by prospective customers and channel partners is that we may even be surprised where that momentum emerges from. Could be in manufacturing, for instance, or in self compliance; not in the areas that we focus on in our discussions here in management or in the eyes of investors because all that stuff is beginning to foment.

In terms of my ability to report on progress of individual customers, I had warned some of your colleagues and some investors as we entered this year that we'd have increasing complexity in sales and marketing and less personal involvement by me because of that. Thus, my ability to assess the nuances of how things are going becomes diminished as the scale grows.

Well, the scale has grown very dramatically from the show. We have lots and lots of meetings with lots and lots of brands, retailers, and channel partners that are going on through our direct sales force and through our channel partners and through our website. And so, I only have a sense of the scale. It is really hard to assess how we are doing in each of those accounts except for the more prominent ones that I do keep very close track of.

So, all I can say with regard to the first few months of the year here and the first couple of months since our last call is that there is a dramatic increase in activity. And we are being sensible about application of our own resources but we are also enjoying the benefits of having leverage from our channel partners and we intend to continue to add channel partners, which will increase further the amount of activity.

And so the effectiveness of that increased activity is largely a function of our support of those sales interfaces. That is where we are focusing and where I am focusing is on making sure that we have good training and materials and technical support for those sales interfaces so that we can get to closure as quickly and as effectively as possible.

Great, that is a good segue into my last question, which is again keying off the prepared remarks relative to maybe Guardian being a little softer and being careful about OpEx. How should we think about the run rate altogether of operating expenses by quarter going forward now?

Rob, this is Charles. I think I would expect, and I think I may have covered this on the February call. Hopefully I have not the exact same remark here, but we do expect OpEx to be relatively consistent quarter-over-quarter at this point with not huge increases or decreases based on our current strategy.

Okay, so your comment relative to the Guardian softness doesn't lead you to want to dial back in any planned level of expenses, at least at this point?

We will be looking at the level of investment for Guardian and Discover as we move forward. At this point in time I am not expecting material changes.

Okay, thank you.

Our next question comes from the line of Jeff Kessler with Imperial Capital.

Could you go through the components of service and subscription with a little more detail, break it out a little bit more?

As far as what products are included in there or --?

Yes, how the products sold against each other. I mean, there were some nice gains in those two areas and I'd like to see how the business is shaping up.

I mean we generally don't go to too much individual breakout by product, but let me give you kind of the broad view of it. The service component includes primarily professional services for the central banks and other government agency contractors. That revenue is up this quarter compared to Q1 of last year. We think that's kind of a combination of both timing of work as well as the amount of program work that we'll do for those customers. All that billing is time and material based.

Then subscription really is Guardian, Discover, and Barcode are really the three primary components there. And we saw an uptick year-over-year in the subscription line, primarily reflecting higher Digimarc Discover revenues.

Okay. And of Digimarc and Barcode which of those two had the greater growth?

This is Bruce. We are not going to do the breakout with that level of specificity for the time being. Because the numbers are fairly small and so we start then to risk making disclosures about individual contracts that we are obliged not to make and it would not be in our best interest to make.

Okay. Could you -- you went through the three key infrastructure elements a little bit too fast. I apologize my hand just couldn't write that fast. Could you just go through them again?

Sure. We identified, let's call it objects or media objects, if you like, through various means. Then we discover those objects and so the identification of an object could be through a barcode, a QR code, a fingerprint sample or digital watermarking. So that's the identification step.

The discovery takes place at a computer interface. That computer interface could be a Blu-ray disc player, a smartphone, or a retail flatbed scanner or handheld scanner at the front of the store. And then the discovery leads to some form of engagement or application. The applications can vary from a point of sale application to a mobile optimized webpage to a refusal to operate the device. So identify, discover, and engage or provide applications.

Right, great. Hey, thank you very much.

And just to add there, our focus is on the identification and discovery aspects of that system.

Right.

(Operator Instructions) Our next question comes from the line of Glenn Mattson with Ladenburg Thalmann.

Hi. Good evening, gentlemen. So congratulations on all the progress you are making for Discover. I hate to -- I don't want to harp on kind of Guardian and the bad side because I realize there is a lot of good things happening on that side, but I am curious. I think you guys said that bookings were slower than you expected, but I guess this quarter was slower as well. So was there any sign that this has been happening for a while?

It looks like before subscription kind of took an uptick in Q4 it had been running at like the 1.4 million or 1.5 million or so per quarter for about six quarters now. So is that -- could maybe a little bit some of the reasons as to why that business is slowing down or stalling and why maybe you didn't realize it until now?

This is Bruce. So revenues have been growing, just not at the rate that we had anticipated they would; the rate that would justify the investment being made. And faithful to our promise at the beginning of the year that we would use our working capital wisely, we don't believe that would be a wise use of working capital to try to continue to support growth in the business that we are not confident will occur.

And so we are throttling back on that investment. We will focus on the bottom line of that business more than the top line to put it in its proper role as a slower growth area of the businesses that should be contributing capital and not using capital. And that is the process that's underway now.

Okay. Can you point to some of the reasons why it may have throttled back on the growth on that business? In other words, why the market isn't performing as you expected?

It is a little hard to tell. There is some competition in the business, but also it appears that the e-book market may not be growing at the pace that I had anticipated it would grow when we made the acquisition. And there is a sort of common view or commonly held view that everything goes digital, but in books it is not turning out to be true. People still like to read the paper copies of books apparently.

Yeah, I did see an article recently showing that people have chosen digital or hard copy and at this point there is not a lot of movement beyond where we have seen. So, did that business though, do you think it grew year-over-year still or is it just kind of flat at this point?

It grew last year over the year before and we anticipate it will grow this year over last year. But again it is not part of the investment thesis for the business. It was intended at the time of the acquisition to provide a nice little adjunct to the business, and I went through various reasons for the doing the acquisition, which included an assumption that the market would continue to grow and we would grow with the market.

And so over the course of the last few quarters, as we observed the growth in relation to the forecast in relation to the cash flow of the business, we concluded that we are better off focusing on having it be a source of cash not a use of cash. And management detention should not be diverted to it because of its role in the business.

So we are all focused on the growth thesis that you are focused on and we don't want that business to be a distraction. We would like it to be a healthy part of the base of the business. So that is what we are going to get it to as quick as we can.

Okay. Great, thanks. And then, just curious, I understand it is great news that there is a lot of trials going on and it certainly seems like the market is moving ahead very rapidly.

Curious though, you guys kind of gave directional guidance a little bit last quarter for 2015 about kind of how to think about Discover a little bit. To come inside of that range that you gave, do you think you need to sign some customers within the next quarter or two to get to those numbers, or can you get there just from kind of the work you are doing and some of the -- maybe the pilots, if you are getting paid for any of those? Or any comments there?

I am not sure what numbers you are referring to. Our focus is on gaining distribution and so the nature of the contracts that will be done, the way in which the relationships will begin are all fairly ambiguous to us. I always had the view that the short-term revenue is difficult to forecast because of the wide range of potential for those variables.

But we are really not trying to focus on generating maximum revenue in 2015; that is not our goal. Our goal is maximizing distribution and trying to gain as much leverage in distribution as possible. Not only directly through customers among retailers and brands, but also through the channel relationships and the improvements to the website so that we come out of the year with momentum. That is our focus.

Yeah, okay. Good, makes sense. Thanks for the time guys.

All-righty.

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

Let's give this a second for any additional questions.

Certainly, sir. (Operator Instructions) Our next question comes from the line of Kevin Hanrahan with KMH Capital.

Hi, Bruce. I had two questions; first one is about Qualcomm. I think you've talked about Qualcomm in the past and the chip that you are trying to get embedded. Is that still the goal? Are you still going forward with that?

We are ready to go once there is a commercialization opportunity. So the R&D is, from our perspective, pretty well done and successful. So we need to get a Qualcomm OEM to sign up and we're not at this point in time at Digimarc going to invest in marketing to that level because that will flow from the work we are focused on over a bit of time.

And Qualcomm, as you know, has been going through a fair amount of change lately and they have been suffering from the weak licensing market as well, so we are not pressing that one. The work is pretty well done.

I see. Is Shazam's technology and your technology and Qualcomm's all going to work together toward that solution?

Yes, we should all work together very well.

Okay, thanks a lot Bruce.

You're welcome.

(Operator Instructions) Our next question comes from the line of John Grimley with TJW Capital.

Hey, Bruce. Congrats on your progress. So really just want to get a better understanding -- can you hear me? Bruce, can you hear me? Hello?

Go ahead with your question John.

Hello, can you hear me?

Yes, we can hear you fine. Can you hear us now?

I can hear you fine. I had started asking a question, but I think something must have happened to the line.

First off, congrats on your progress and then just really want to get an understanding for the ecosystem, kind of where we are in the build out, both on the brick and mortar retail side but then it sounds like the bigger market might end up being the internet retailer side. And it seems like what you'll need to offer are pretty different for both parties. I'd love to just get a better understanding how I should be thinking about that from a big picture.

Sure, sure. The big picture is we are a successor to the conventional overt symbologies that have facilitated commerce for the last 40 or 50 years, the UPC and EIN and QR codes and so forth. Through the advancements in technology that we've embraced and built algorithms for we can do what was done there but we can do it faster, more reliably, with better scalability and no visible artifacts. The best system in the visual realm; there is a similar kind of technological argument in the audio realm.

And so anything that a barcode does is fair game. I like to try to keep things narrowly focused for the investment community so that we can create benchmarks for progress. But if you want the big picture that's the big picture; it's that whatever barcode does we can do better.

Got it. And then, as far as the ecosystem goes, I know you have a partnership with Datalogic. I would assume to really penetrate the market you'll probably need to do deals with the other scanner companies as well, so just kind of if you could touch on what else needs to happen for this to be broadly adapted in brick-and-mortar retail.

And then also, it seems like there is a couple of really big players in Internet retail that your solution would be superior than what they are using most likely, but obviously that doesn't happen overnight.

We are in development with all the major retail scanner vendors and expect to have product released this year. And we have now began work with some specialty, let's call them imaging specialists to broaden the term a little bit beyond retail scanners, who also focus on automatic identification of objects. We've gotten enquiries about logistics. We have enquiries from online merchants as well as bricks and mortar.

I mentioned Alibaba because I thought their announcement was very exciting, very interesting, and a bit unexpected. And that is that they spent a pile of money encouraging consumers to use barcodes to shop. The reason they are doing that, of course, is the reliable identification -- reliable, efficient identification of the product brings a shopper to them better than conventional means of shopping.

But in the same exercise they work the other side of the equation. They told all their suppliers you need to barcode all your products. And not all products are barcoded. But we know, for instance, that Amazon has 280 million items in inventory. I'm sure all of them are not barcoded, but we now know that Alibaba has over 100 million that are barcoded.

And the barcodes serve lots of purposes for all retailers and for all logistics suppliers. And we think we can add lots of value to the online retailers as well as the bricks and mortar retailers, as well as the CPGs, as well as the logistics suppliers. And again I would just fall back for simplicity on knowing what you know about what we have, John, we are an invisible barcode and so anything a barcode does we can do. So if you think about the role of the barcode in the economy and society that is the role we intend to fill.

And we don't need to have it go away. We can just make it work better until it goes away. But we are in fact, I think, a technological imperative to succeed the barcode. I don't have any doubt about it. The only doubt I have is how to get there quickly and effectively maintaining the confidence of you and other shareholders and adequate sources of capital, if we ever need any. So we are on our way towards that world which is a very big idea, much bigger than just having a means of enhancing productivity from store operations or enhanced consumer engagement.

Got it, thanks. And then, I don't know, one of the things that I think investors can track to get a sense of how barcode is progressing is deferred revs. Do you guys breakout what percentage of deferred revs or do you plan on breaking that out by division or by unit or what percent is barcode?

We don't break those out currently nor have any immediate plans to do so, unless we are required to under the SEC rules.

Okay, that's great. I appreciate you taking the time. Thank you.

Thank you.

Thanks, John.

At this time there are no additional questions in the queue. I would like to turn it back over to Bruce Davis. Please proceed sir.

Alright, thanks very much. Thank you everyone for your participation. We look forward to talking to you again in a few months. Bye for now.

Thank you all for your continued support and confidence in Digimarc. You may now disconnect.