Q2 2013 Earnings Call
July 25, 2013 5:00 pm ET
Bruce L. Davis - Chairman, Chief Executive Officer and President
Michael McConnell - Chief Financial Officer, Principal Accounting Officer, Executive Vice President and Treasurer
Paul D. Sonz - Paul D. Sonz Partners
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 L. Davis
Thank you, and good afternoon. Welcome to our conference call. Mike McConnell, our CFO, is with me. On the call today, we'll discuss and review Q2 2003 (sic)
financial results and 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 Relation section of our website.
Please note that during the course of this call, we'll be making certain forward-looking statements, including those regarding revenue recognition matters, results of operations, investments, initiatives and growth strategies. These statements are subject to many assumptions, risks, uncertainties and changes in circumstances. Any assumptions we share about future performance represent a point-in-time estimate. 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-K.
Mike will begin by commenting on our financial results. I'll then discuss our execution strategy and outlook. Mike?
Thanks, Bruce, and good afternoon, everyone. Our Q2 revenues were 15% higher than the same quarter a year ago. The majority of the year-over-year growth is due to the acquisition of Attributor, with most of the rest of the growth coming from our work with the central banks.
Revenues from the former Attributor business acquired in December were below expectations and well below the revenue threshold associated with the earn out consideration. At this point, we do not anticipate paying any of the contingent consideration associated with the acquisition. We've been working on restructuring and expanding the business, now being marketed under the Digimarc Guardian brand. We feel that the business is now on an upward trajectory after navigating numerous transition challenges there's a good strategy and a stable and productive team in place.
Our Q2 results included the second quarter of operations since the acquisition of Attributor and we're in the final stages of integrating the Attributor team into the operations of Digimarc. In parallel, as you know, we've ramped our investment and growth initiatives including further developing and marketing of Digimarc Discover, adding audio watermarking and packaging, and developing the second wave patents, all in support of our vision of enabling computer networks -- computers, networks and other digital devices to see, hear, understand and respond to their surroundings.
Looking further into the details of our Q2 2013 financial results, we see that gross margin was 80%, 3 points lower than a year ago due to the higher percentage of revenues from Guardian subscriptions associated with the Attributor acquisition. Operating expenses increased by 20% over the year-ago period due to the addition of Attributor operations and increased investments in R&D and marketing.
Our operating profit was $1.4 million, or 13% of revenues, and operating cash flow was $2.8 million or 27% of revenues. And the balance sheet remains in excellent shape with more than $40 million in cash and securities and no debt.
In our past 2 calls, we indicated that revenues are likely to be lower in 2013 compared to 2012 primarily due to the $8 million of past-due royalty revenues from Verance that we received and recognized in Q1 of 2012, and the quarterly minimum lease payments from Intellectual Ventures that ended during Q2 of this year, partially offset by growth in revenues from the acquisition of Attributor, our new agreement with the central banks, and increases from other customers and new customers in other areas of our business.
In our last conference call, we also indicated that we are increasing our investments in R&D, marketing and intellectual property beyond the levels contemplated in our annual operating plan to accommodate additional growth opportunities that have arisen since adoption of the plan. We expect that our current staff and consultant headcount will exceed 150 full-time equivalents by the end of Q3. We remain on that plan with the quarter-end headcount at more than 140. The focuses of these increased investments are in marketing and product development of Digimarc Discover as we look to expand our offering to larger enterprises and broader markets, particularly in retail in support of the Shopper's Journey.
Commercializing our consumer packaging and auto -- audio watermarking solutions directed research in a number of areas including exploring opportunities in mobile payments, developing our second wave patent portfolio and associated monetization programs and improving the operational efficiency of Attributor now known as Digimarc Guardian.
As discussed in this and previous financial results conference calls, the combination of lower revenues and increased investments will depress near-term income. We currently expect to report a GAAP loss in the second half of the year reflecting the completion of the minimum payments from Intellectual Ventures and the impact of our accelerated investments in our strategic initiatives. Despite what is likely to be a GAAP loss for the year, we expect operating cash flow for the year to be positive and that we'll have adequate capital to fund our investments and pay our dividends for the foreseeable future.
And speaking of dividends, the Board of Directors has declared another quarterly cash dividend of $0.11 per share of the company's common stock. The dividends is payable on August 12, 2013 to shareholders of record as of close of the business of August 5, 2013.
For further discussions of our financial results and risk and prospects for our business, please refer to the Form 10-Q that we expect to file shortly. And Bruce will now provide you his comments on our execution of strategy and of our outlook.
Bruce L. Davis
Thanks, Mike. I hope that you have -- all had an opportunity to study the mid-May supplemental presentation detailing our strategy as well as our new video showcasing our vision for the enablement of the Shopper's Journey with retailers and brands. Both are available on our website and our execution of that strategy is well underway.
We have increased our rate of investment in R&D and marketing to address certain time-sensitive market and relationship opportunities. I believe that this is a potentially pivotal year for Digimarc where we may able to realize significant increases in value of the company if we can effectively consolidate the fruits of the last 15 years of R&D into a robust software platform and associated services while generating substantial patent assets from our increased investment in R&D.
We intend to invent and deliver directly and through licensing a common platform that connects prospects and customers to brands across the full spectrum of what the retail industry refers to as the Shopper's Journey. The focus of our market development is on mass merchants. Expanding the application of Digimarc Discover for magazines and catalogs to weekly newspapers inserts, direct mail, print ads, packaging, in-store promotion and television and radio advertising.
Our publishing business continues to grow at a healthy rate. Watermark scans by readers were roughly triple last year's numbers during the quarter. The same was true for the number of watermarks purchased by magazine publishers. The number of watermarks per issue has been steady at around 10 per issue. Coupons, recipes and sweepstakes continue to garner the most hits and the vast majority of activity was in the United States. We are pleased to have the Ford Motor Company add its brochures in the mix of publications enabled for automatic mobile connections to important product information and purchases.
With a few months of enablement of Costco Connection member magazine behind us, we're seeking to expand our relationship with Costco in accordance with our retail strategy, and as outlined in previous calls. We're working to bring on board another Tier 1 retailer before year end. We introduced mobile optimize audio watermarking via our Online Services Portal. We've not yet done any significant outreach beyond the initial announcement to allow for some experimentation by prospective clients. The intended goal of this new offering is to facilitate mobile discovery for television and radio advertising and increase retail engagement with indoor location-specific merchandising and promotion. With the addition of audio watermarking, we now believe that all elements of the Shopper's Journey are ripe for mobile discovery, enabling unprecedented engagement across all touch points of the Journey.
Obviously, a key ingredient in our retail strategy is packaging. We continue to make good progress in developing invisible barcode solutions for consumer packaged goods. During Q2, we successfully integrated our software into an imaging scanner for a leading vendor. We are discussing with them how best to bring the new capability to market. In parallel, we have been expanding coverage of various form factors materials and printing processes. The industry experts we hired completed their work on models for positioning packaging and other aspects of preparing for successful market entry.
There are numerous potential relationships in the formative stages that could provide significant momentum to our quest. The big companies has provided lots of challenges as well as opportunities. We're doing our best to keep these budding relationships on the rails and supportive of our strategy without over extending our resources. We've been making great strides in improving operations with the former Attributor business. The resulting efficiency should provide a good ROI as we improve sales, marketing and development to foster growth. It's clear that the former Attributor management's forecast is unattainable. We are implementing changes in the business intended to improve profitability and growth prospects.
Licensing will continue to be a key element to monetization of our inventions. All these developments that I've described go 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, and we're not alone in our belief. Many major mobile infrastructure and technology providers are investing heavily to enable pervasive, intuitive computing also known as the Internet of Things. Our R&D converges in the model of efficient and effective management of resources supporting the seeing and hearing mobile device and intelligent networks. The markets affected by such improvement in mobile devices are large and diverse, encompassing virtually all media in the world.
There were no substantial developments in our arbitration with Intellectual Ventures during the quarter. The process is moving along consistent with the dispute resolutions provisions over our license agreement. We'll keep you informed of any material developments.
The retained portfolio continues to grow at a rapid rate. 41 patents have issued thus far this year, with 21 of the 41 feeding our second wave portfolio, which has now grown to 56 issued patents. Second quarter issuance has included innovations in copyright filtering, second screen television and indoor location. We filed 37 applications in the second quarter bringing the total second wave patents pending to 328. Topics included in the new filings include Internet of Things enablement, three-dimensional object recognition and mobile payments among other things.
During the quarter, we added to IP -- staff to IP development with an aim toward an even higher rate of filing and enhanced focus on process improvement to maximize our return on these important investments. As noted in prior calls, a key objective of the 2013 plan is to have sufficient licensable IP to project significant new license income sources in 2014. I'm pleased to report that we're a bit ahead of schedule in that we've begun an important marketing program for certain second wave assets engaging a significant potential licensee, who we believe is currently using some of our patented inventions. We are expediting examination of claims where we'll receive potential immediate relevance to the market as well.
We will be investing heavily during the remainder of this year to meet certain development and marketing deadlines. We're building or improving all aspects of the Intuitive Computing Platform with the intention of having a fully functional system ready by year-end. And with the release of audio watermarking, we have the major elements in place. We continue to develop our consumer packaging solution and are making significant improvements in our Online Services Portal including simplifying, embedding and various Adobe plug-ins for advanced users. We're also working on the user interface and performance upgrades for our mobile app.
We've completed integration of our detector into a leading checkout scanner and are working on similar integrations with other such scanners. We are improving reporting to Discover clients, supporting information requests and collaboration initiatives with numerous infrastructure providers and continuing basic R&D on our virtual wall of solutions to add simple and effective mobile payment processing to the Shopper's Journey enablement.
And finally, we are making significant changes to our Guardian solution to improve its cost effectiveness and competitive differentiation.
Fourth quarter investments include major presentations at 2 important industry events. We will be a primary sponsor at the American Magazine Media Conference in October, the magazine industry's premier conference. We've also purchased booth space at the National Retail Federation "BIG Show" in January where we plan to demonstrate the full mobile optimized Shopper's Journey that we have developed. We expect this to be largest marketing event in the company's history. In addition to these product and market development activities, we continue to ramp basic and directed research and associated IP development.
We have made several recent additions to our strategic IP development capability. The intended result of these investments is to foster an unprecedented growth in the rate of invention and the retained patent portfolio laying a solid foundation for the next wave of patent income for Digimarc.
Halfway through the year, we're making good progress in execution of our strategy. It's a very busy year with exciting prospects, a very ambitious agenda and plenty of attendant risk. We knew what we can to disclose as much as possible about our strategic performance without violating the trust of partners or customers, or creating undue stress and risks in these relationships.
As I mentioned in closing in the last quarter's call, the hallmarks success in 2013 will be patience, perseverance and orchestration. We're all shareholders and we're standing along side you in the risk and reward of our strategy and execution. Our highly talented and loyal team's fully engaged, energized, excited and confident in our direction.
That's it for our prepared remarks and now, we'll open the call to questions.
[Operator Instructions] You have a question from Paul Sonz.
Paul D. Sonz - Paul D. Sonz Partners
Bruce, what is the cost, the ongoing cost of trying to settle this matter with Intellectual Ventures?
Yes, Paul. We kind of disclosed any changes in our operating expenses in our Q and that will be filed tomorrow. But we -- I think -- we probably spent maybe a couple hundred thousand dollars in that and other royalty license audits, we have an ongoing program, and so that's what we spent.
Paul D. Sonz - Paul D. Sonz Partners
All right. So it's not a big deal one way or the other?
[Operator Instructions] At this time, there are no further questions.
Bruce L. Davis
All right. Thanks, everyone, for participating. We'll be in touch as soon as we've got some more material information for you. Thanks.
This concludes your conference. You may now disconnect.
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