Digimarc Management Discusses Q4 2012 Results - Earnings Call Transcript

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 |  About: Digimarc Corporation (DMRC)
by: SA Transcripts

Digimarc (NASDAQ:DMRC)

Q4 2012 Earnings Call

February 21, 2013 5:00 pm ET

Executives

Bruce Davis - Chairman, Chief Executive Officer and President

Michael McConnell - Chief Financial Officer, Principal Accounting Officer, Executive Vice President and Treasurer

Analysts

Paul D. Sonz - Paul D. Sonz Partners

Operator

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.

Bruce Davis

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

Please note that during the call, we will be making certain forward-looking statements, including those regarding revenue recognition matters, results of operations, investments, initiatives and 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 our filings with the SEC, including our latest Form 10-K.

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

Michael McConnell

Thanks, Bruce, and good afternoon, everyone. 2012 revenues increased by 23% to $44.4 million up from $36 million in 2011. Our net income improved 46% to $8.3 million or $1.12 per diluted share compared to $5.7 million and $0.76 per diluted share in 2011. The balance sheet remains in excellent shape with more than $39 million of cash and securities and no debt, and throughout the year we made a number of strategic investments in our company. We purchased Attributor late in the year for $5.4 million in cash, allowing us to extend our media management and security offerings into the book market. We continue to invest in growth including developing and marketing Digimarc Discover, audio and packaging research and development, and developing the second wave of retained patents, all in support of our vision of enabling computers, networks and other digital devices to see, hear, understand and respond to their surroundings. And we also purchased more than 200,000 shares of stock for about $4.8 million.

Looking further into our 2012 financial results. We saw revenue growth was fueled by s payment of $8 million of past-due royalties from Verance, and from higher licensing revenues from both Intellectual Ventures and Verance, and these were partially offset by lower revenues from the suspension of operations of our joint ventures with Nielsen back in Q1 of 2012. Our gross margin at 85%, 4 points higher than the prior year, reflecting the greater mix of license revenues to the total. We experienced slightly higher operating expenses, the majority being associated with the fourth quarter acquisition of Attributor. Our operating expenses were -- I'm sorry, our operating profit was $14.6 million or 33% of revenues. And our tax provision came in at an estimated effective tax rate of 39%, yet our cash taxes for the year are estimated at only 14%. The difference reflecting utilization of deferred tax assets and benefits associated with stock-based compensation. I also should note that the federal research and development tax credit, that was reinstated January 2 of 2013 and retroactive to 2012, will not be reflected in our tax provision accounting until 2013, but we will benefit from that credit on our 2012 tax return.

For the fourth quarter of 2012, our results were pretty much in line with our expectations and the addition of a relatively small impact on revenues and costs from the Attributor acquisition. Overall, we saw revenues increased by 4% to $9.3 million and operating income rise 60% to $1.9 million.

Assessing our financial performance for 2012, we see that most of the financial planning assumptions we made at the beginning of the year were either met or exceeded. Specifically, we assumed double-digit revenue growth for the year and our revenues grew by 23%. We assumed a license-to-service-revenues ratio of approximately 70% to 30%, resulting in gross margins of 80%. The actual ratio turned out to be 76% to 24% with gross margins at 85%.

We expected to continue to invest in growth strategies, including directed research and intellectual property development, and marketing and product development of Digimarc Discover. We actually increased our investment in R&D and IP development by approximately 19% to $10 million and we further expanded our business by acquiring Attributor in late 2012, extending our media management and security offerings to the book market.

Our operating expenses would have come in lower than 2011, but we had some small costs associated with the acquisition of Attributor. And lastly, we assumed operating cash flow would be greater than GAAP earnings, due primarily to more than $5 million of non-cash charges associated with stock compensation and depreciation. Our operating cash flow ended up being $15.6 million compared to GAAP income of $8.3 million.

Looking forward, our basic financial assumptions for 2013 include the following: Revenues are likely to be lower in 2013 compared to 2012, primarily due to the $8 million past-due lump sum royalty payments from Verance in Q1 of 2012 and the quarterly license payment from Intellectual Ventures ending in May 2013, partially offset by expected growth in revenues associated with our recent acquisition of Attributor, our new government contract agreement with Central Banks and increases from other customers and new customers in other areas of our business. These assumptions do not include any profit-sharing payment from Intellectual Ventures.

We expect our license and subscriptions to service revenues ratio to be close to 70% to 30%, resulting in high gross margin percentages in the high-70s. Given our view of the promising nature of new markets we're developing, we expect to increase our investments in growth including marketing and development of Digimarc Discover, bringing to market our packaging and audio offerings, extending market penetration in the book publishing industry for deterrence of e-book piracy and more directed research and associated hardware, software and intellectual property development.

Our operating expenses are expected to be higher primarily due to the acquisition of Attributor, including approximately $1.3 million of non-cash charges related to the acquisition, for amortization of acquired intangibles and for stock compensations. We expect operating cash flow to be greater than GAAP earnings due primarily to more than $6 million of non-cash charges associated with stock compensation and depreciation, and from the amortization of the acquisition-related intangibles. And we expect a net income tax benefit -- or a negative income tax for our combined federal and state income taxes, primarily due to the effect of 2 years worth of the federal R&D tax credits being realized in 2013. We're not prepared to discuss an estimate of the range of this benefit at this time.

Please keep in mind that these highlights and financial assumptions and operating plans represent our current view of expected values, based upon our assessment of the most likely unfolding of events over the course of 2013. As is our general practice, we intend to update each quarter regarding strategy executions, but do not plan to provide financial guidance.

Finally, we want to note that the Digimarc Board of Directors has declared a fourth successive quarterly cash dividend of $0.11 per share of common stock. Dividends payable on March 11 to shareholders of record as of the close of business on March 4 of 2013. For further discussion of our financial results and risks and prospects of our business, I refer you to our Form 10-K that we expect to file very soon.

Now Bruce will provide his comments on execution of strategy and the outlook.

Bruce Davis

Thanks, Mike. 2012 was obviously a very good year in terms of financial performance, as revenues grew significantly, margins expanded and we delivered record profits and cash flow. Much of the profitability was due to resolving the dispute with Verance and getting them back into compliance with our licensing program. We employed the profits wisely, seeking maximum benefit for our shareholders and balancing short- and long-term returns. Our capital allocation strategy included long-term investment in new product initiatives and the acquisition of Attributor. The return of capital share -- to shareholders via institution of recurring cash dividends and improved leverage through share repurchases. We also made great progress in the execution strategy.

In addition to favorably resolving the Verance dispute, we improved the Digimarc Discover experience for publishers and their audiences, expanded distribution, developed mobile-optimized audio watermarking, made great progress in basic research on invisible barcodes, increased our patent portfolio to more than 850 issued patents and 400 pending by adding 20 new patents and 86 applications, with retained patent assets now up to 36 patents and 296 applications pending. We negotiated the 12-year extension to our contract with the central banks and continued to develop, retain and add to our extremely talented and high-quality employee base.

I believe that we're entering a phase of significant expansion of the commercialization of our R&D, both directly through the provision of software and services and through licensing. We anticipate a very busy and exciting year ahead. Our focus will be on consolidating the fruits of the last 15 years of our R&D into a robust software platform and associated services. We expect to continue to generate substantial patent assets from our increased R&D investments, as we increase commercialization of our investment around the core concept of pervasive and intuitive computing that has grown out of our pioneering work in digital watermarking.

Our product strategy is coalescing around 3 themes: Guardian, Discover and audience. Most of our historical revenues have come from media management and security applications. The Attributor acquisition extends our reach in such applications to the book publishing market. Digimarc's technologies now protect a range of media including banknotes, digital images, movies and e-books. Henceforth, the solutions that we market directly in these areas will be sold under the Guardian brand. We anticipate that movie antipiracy solutions will continue to be provided by our licensees, Civolution and Verance.

With a new contract in place, we're entering our 15th year working with central bank customers to deter banknote counterfeiting. We will be in our first year working with the book publishing industry to deter e-book piracy, following our acquisition of Attributor in December. And in the Discovery area, we have invested considerably in mobile discovery, and have made good progress in R&D and commercialization. As noted, for example, on our recently published 2012 Traction Report, that chronicles growing adoption of Digimarc Discover in the magazine industry.

Among the findings in our study of early market adoption is that much of the growth in downloads, purchase of watermarks and use by consumers, is attributable to the extraordinary successful campaigns of just a few publications, including Sports Illustrated, Seventeen and Cooking Light. The high rates of reader involvement in these publications is informing our marketing and development priorities, reinforcing our view that Digimarc technology should be a part of a redefinition of the priorities of publishers, abandoning old thinking about digital versus print, and embracing an understanding of the mobile-empowered consumers' expectations about multichannel marketing.

I see 2 particularly interesting implications. One, the careful planning and execution of an interesting and rewarding post-scan experience is critical. And two, that if we can replicate this success across the industry, we will have built a profitable business of scale in the magazine industry, which will benefit from a more substantial -- a more sustainable business model. This is but one building block in our strategic vision.

Our short- and intermediate-term goals for Digimarc Discover are to broaden the reach of our platform to support the concepts of omni-channel marketing and the shoppers journey, as referred to by retailers and brands, that is to provide mobile-empowered consumers the ability to discover, engage, become informed, purchase, get fulfillment and share post-purchase experiences in an unprecedented complex, random-access network of media, services and locations. Our strategy is to invent and deliver, directly and through licensing, a common platform that connects prospects and customers to brands across the full spectrum of this shoppers journey. Digimarc Discover enables immediate and easy access to all of these touch points via mobile devices, facilitating an efficient and engaging experience with enabled brands and retailers.

Our current research and development efforts are focused in consumer products, packaging and audio, as key vectors of growth. Expanding Digimarc Discover from newspapers, magazines and catalogs, to packaging, in-store promotion and television and radio advertising. We have promising results in our packaging research, indicating potentially very significant efficiencies in the checkout process at retail, and adding in-store and post-purchase consumer benefits with the same invisible barcode encoding. Similarly, we have conducted nationwide silent radio, television and in-store tests of our new mobile-optimized audio watermarking with good results. We plan to continue development and testing and begin commercialization in both these areas by year end.

Our long-term goal is to become the successor to conventional barcodes for much of the automatic data capture market, including retail checkout, and to deliver to consumers pre- and post-purchase benefits of digitally watermarked packaging and shopper marketing materials.

In the audience area, Nielsen and Arbitron have built profitable businesses of scale that utilize digital watermarking for efficient and reliable measurement of television and radio audiences. Our Digimarc Discover platform has the potential to add a unique and valuable perspective on consumer behavior. Our new Digimarc share service, for example, enables magazine publishers to monitor how digitally watermark content from the print editions is shared across social networks, similar to the metrics they get today from shared online content. We also see that our technologies could enable retailers and the brands to gather unprecedented consumer behavior metrics, as shoppers interact with digitally watermarked packaging media and various other marketing materials throughout their shopping journey.

As retailers and brands pursue new ways to engage with mobile-empowered consumers across a wide range of touch points, it will become increasingly important to gather and monitor the business intelligence that will emerge in a coordinated fashion. We are in the early stages of fleshing out this aspect of our product strategy, but we envision the need for platform components that will enable, manage and monitor post-scan consumer engagement experiences.

Licensing will continue to be a key element of monetization of our inventions. All these developments that I've described flow into our patented intuitive computing platform architecture. We see pervasive, intuitive computing as inevitable, expanding and simplifying access to networks across all aspects of everyday life. Eventually, many sensors will contribute to this new means of computer interface. But as in human recognition, the eyes and the ears will be key. Our R&D converges in a model of efficient and effective management of resources, supporting the seeing, hearing mobile device and intelligent networks. The markets affected by improved seeing capabilities in mobile devices are large and diverse, encompassing virtually all media in the world.

As most of you know, we have 2 waves of licensable IP: The more mature portion of our portfolio for which ID has an exclusive license to sublicense, and the growing portfolio of retained patents, applications and ongoing R&D to which they have no rights. With respect to the Intellectual Ventures aspect of our licensing program, we're continuing the process to resolve differences of opinion about allocation of costs that affect our profit participation potential. We believe that there's more money to be made by both companies if we can get the focus on monetization instead of accounting. Nevertheless, the matters that we are discussing are important, and we intend to achieve a fair and reasonable resolution.

As I noted earlier, the retained portfolio is growing at a rapid rate. We now have over 30 patents and 300 applications pending. There is a very healthy rate of new fillings flowing from our increased R&D. A key objective of the 2013 operating plan is to have sufficient licensable IP to project significant new license income sources in 2014. We are pursuing this goal by identifying target markets and specific licensing opportunities within those markets, optimizing the portfolio in relation to the target markets, requesting expedited issuance of high-value claims and preparing for marketing and enforcement, if necessary.

We have exciting prospects and a very ambitious agenda for 2013. We continue to believe that seeing and hearing will become routine functions of mobile computing devices, providing a natural successor for a substantial share of discovery, first realized on a global scale by the keyword search functionality popularized by Google, and now being shaped by the rise of mobile computing.

As I noted in prior calls, the developments that we are pioneering will foster more complete and engaging relationships between brands and their customers and prospects, providing customer engagement, accountability and access to critical information about their shopping and consumption behaviors. This dovetails nicely with the growing desire of brands to tell stories of productivity and lifestyle enrichment in the new social networks, and more effectively manage and deliver value -- value-added brand experiences to their consumers. It also fits well with the new methods of integrated media marketing, providing consumers with greater flexibility in how, when and where they get products and services, and the information that helps them to make purchase decisions.

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

Question-and-Answer Session

Operator

[Operator Instructions] You have a question from the line of Kevin Henrehan [ph] of KMH Capital Advisors.

Unknown Analyst

Mike, I had a few questions for you. Can you tell us how many shares you repurchased in Q4?

Michael McConnell

Sure. We had about 44,000 shares in total for around $900,000.

Unknown Analyst

Okay. Was some of that open market and some of that non-open market or was it all...

Michael McConnell

About a quarter of it was open market, which has been kind of our trend for the year. I think I mentioned we purchased over 200,000 shares for about $4.8 million, about 25% of that was the repurchase program and the balance relates to our program for exchanging stock for taxes for employee and stock compensation.

Unknown Analyst

Sure. And on the tax rate, I was surprised to hear what you said. So let me see if I got this right, just to summarize, the NOLs have all been exhausted right?

Michael McConnell

In this year, yes.

Unknown Analyst

And so the tax rate for this year, I just calculated it, I get a rough tax rate a little more than 39%?

Michael McConnell

Exactly.

Unknown Analyst

And so next -- for '13, you think it will be negative?

Michael McConnell

Yes. We'll have a benefit. We'll be able to utilize some additional tax assets. We did acquire tax assets in the acquisition of Attributor, and those will be outlined in the 10-K that we file here in the next day or so. And we'll get the benefit of some of those. And then on top of that, we've got 2 years of research and development credits that will be showing in 2013.

Unknown Analyst

Okay. So you haven't given any, like, numbers on how negative you think it will be?

Michael McConnell

No, we haven't.

Unknown Analyst

Okay. That's all right. I had a question for Bruce. I just wanted to ask about consulting and legal, if you can break it out, that you spent for your discussions of -- with your differences with Intellectual Ventures?

Bruce Davis

We don't break it out, but it hasn't been terribly material yet. We're continuing to have our discussions with them. If we carry on, there'll be some expense, but I don't expect it to be very significant.

Unknown Analyst

Consulting and legal?

Bruce Davis

Yes. Right.

Unknown Analyst

I think the last time you -- on the last call, I think you mentioned it was mostly over costs and expenses, not a difference of opinion over revenues?

Bruce Davis

I don't believe that's what I said.

Unknown Analyst

Is that still true?

Bruce Davis

I don't think that's what I said, Kevin, I don't have the script in front of me, but I don't think I said that. So we've got a difference of opinion about the accounting for costs. I don't mean by that statement to imply anything about all other aspects of the relationship. I think that's all I said, was that we have a difference of opinion about costs, which we do.

Unknown Analyst

Would that imply you don't have a difference of opinion about revenues?

Bruce Davis

It doesn't imply that.

Unknown Analyst

It doesn't imply that. I guess you need to be a lawyer to understand that.

Bruce Davis

No, what it means is I don't want to spend a lot of time commenting around the nuances of our relationship with them. We're focused on getting fair and accurate accounting, and we believe that if they will focus on monetization and we get proper accounting, that there's much more money to be made in the market and that we'll each profit from moving on and doing those things. But we have a difference of opinion right now.

Unknown Analyst

Can you characterize for me -- I know, I think, you started it about 1.5 years ago in October. So obviously, what you thought you had going into it is not what you have -- or not what you've seen anyway in the reports you get from IV?

Bruce Davis

I wouldn't say that. Again, I don't want to -- much of what we talk about is intended to be private and I don't see any value to making in public. But we think that there is a -- we, Digimarc, think there is a substantial and growing monetization opportunity in the marketplace. We'd like them to exploit it under their exclusive license and we'd like them to pay us fairly. That's all.

Operator

[Operator Instructions] You have a question from Paul Sonz of Paul Sonz Partners.

Paul D. Sonz - Paul D. Sonz Partners

I have two questions. One is sort of the standard ongoing question. Any movement on the government contracts?

Bruce Davis

No. I think we had said previously in terms of 2012 strategy and execution of strategy, that we had backed off trying to working in that area because it's too difficult and impossible to predict. So we're quite happy with our relationship with the central banks and we have a new long-term contract with them and we're excited to be in our 15th year of collaboration with them. But that's the government work that we're focused on. There's been a little bit of other government work, but not enough to have a lot of conversation about.

Paul D. Sonz - Paul D. Sonz Partners

Okay. Great. And the second question is, in terms of the monetization, which I think is both the opportunity and the challenge in the business, as you developed all these wonderful technologies and now, of course, you want to have widespread adoption and usage. We have 2 sort of patent groups, one, being controlled by IV and then the second group, which is -- you're continuously building. And what I wanted to ask is, what are your plans to further the monetization of your products, both in the -- in terms of that controlled by Intellectual Ventures, whether you plan to do anything to sort of to assist them in getting adopted. And then what is your plan for the other groups of intellectual property that does not fall under the IV control?

Bruce Davis

First, just to state the obvious, that the patent licensing is one of our licensings, we have many others, but focusing on the patent licensing area, we were ready, willing and able to provide all the assistance that we can and then quite experts as to Intellectual Ventures and monetization. And so that's an ongoing outstanding offer. With respect to the second wave of patents, I've outlined for you what we're doing. I don't know what more I can add to that. We're quite focused on identifying target markets, specific targets within markets, expediting relevant claims, building the marketing materials and getting ready to propose our license terms to the targets. That is what we'll be doing throughout this year. We're not going to be ready until near the end of the year, probably.

Paul D. Sonz - Paul D. Sonz Partners

All right. So that would be -- that the model then would be for you guys to do the -- in the sense of sales and marketing of the ideas yourself, as opposed to partnering with somebody again?

Bruce Davis

For the time being, that's the plan. That can change at any point if we find some means of gaining leverage from a relationship with some intermediary. But at this point in time, we plan to do it ourselves.

Paul D. Sonz - Paul D. Sonz Partners

Okay. Last question, the Traction Report I thought was exciting, although the numbers were off a low base and I wondered if you could -- if you expect this to progress at a geometric pace.

Bruce Davis

What I said earlier, I would reiterate and moderate a little bit, not that -- a lot of people make the mistake of assuming trends from early data, early data tends to move around a fair amount. But I'm encouraged by continuing favorable trends. And so I was quite cautious in telling everybody, don't get too wound up, but I'm feeling like we're making good progress and so it does appear there is a favorable trend there. I don't know how to size it just yet and how to scale it. We'll continue to update that traction report periodically, I think. But we're involved with lots of publications, running numbers with publications. We have more services. We have more downloads. We're getting more activity. We're understanding the activity better, we're shaping our development and marketing to foster those successes and to teach the industry of those successes. So we're continuing the market development, but it looks like it's going pretty well.

Operator

[Operator Instructions] This concludes the allotted time for today's question-and-answer session. I would now like to turn the floor back over to Mr. Davis for any closing remarks.

Bruce Davis

Thanks, everyone, for joining the call and we look forward to talking to you again in the quarter, if not sooner. And thank you for your continuing support.

Operator

Thank you. This concludes your conference. You may now disconnect.

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