Digimarc Corp (NASDAQ:DMRC)
Q1 2014 Results Conference Call
April 23, 2014 / 05:00 P.M. E.T.
Bruce Davis – Chairman and CEO
Charles Beck –CFO and Treasurer
Good afternoon and thank you for participating in today's conference call. Now I will turn the call over to Chairman and CEO of Digimarc, Mr. Bruce Davis, Sr. Sir, please begin.
Bruce Davis, Digimarc Corporation
Thank you and 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'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. Charles will begin by commenting on our financial results. I'll then discuss significant business developments, market conditions and execution of strategy. Charles?
Thanks, Bruce, and good afternoon, everyone. Our Q1 financial results were in line with our expectations. Revenue for the quarter was $7.2 million, down $3 million or 30% from the first quarter of last year. Revenue was lower due to the scheduled completion of quarterly minimum license fee payments from Intellectual Ventures in May of last year. Excluding the impact of Intellectual Ventures, revenue was up $400,000 or 5%, primarily due to higher royalty revenue from other license fees and higher service revenue from the Central Banks.
We recently received our annual profit participation report from Intellectual Ventures for 2013 licensing activities and no profit sharing was earned.
Gross margin was 70% for the quarter, 9 points lower than the first quarter of 2013. The decrease in gross margin reflects the impact of lower license revenue.
Operating expenses increased by 30% over the first quarter of last year reflecting the increased level of investment in our growth initiatives including development and marketing of the Digimarc Barcode, Digimarc Discover, and our Intuitive Computing platform as well as continuing development and marketing of our second wave patent portfolio.
We incurred an operating loss of $3.3 million during the quarter versus operating income of $1.6 million in the first quarter of 2013. Our effective tax rate for the quarter was 40%, resulting in an income tax benefit of $1.3 million on a pretax loss of $3.3 million. At the bottom line, we incurred a net loss for the quarter of $2 million or $0.29 per diluted share versus net income of $1 million or $0.13 per diluted share in the same quarter last year.
We spent $2.7 million of our cash reserves during the quarter on our growth initiatives. The balance sheet remains in excellent shape with over $32 million of cash and marketable securities and no debt. We expect this general level of cash consumption will continue through the remainder of the year unless we realize significant incremental revenue from Digimarc Discover, the Digimarc Barcode, and/or the second wave patent portfolio, or the pace of early adoption by retailers and brands is greater than anticipated.
Later in this call, when discussing execution of strategy, Bruce will comment on the financial implications of our approach to development of the market for Digimarc Discover and Digimarc Barcode and our thoughts on the path to return to profitability. I'm pleased to note that the board has declared a quarterly cash dividend of $0.11 per share on the Company's common stock payable on May 12th to the stockholders of record as of the close of business on May 5th.
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. We've been very focused on getting to the market with the Digimarc Barcode since its introduction in January. We've had follow-up meetings with most of the world's largest retailers since then. Planning is underway with a couple of excellent potential customers for market trials of the Digimarc Barcode and other elements of the Digimarc Discover platform. As most of you know, our recommended approach to retailers is to begin with enablement of their private label brands. Given that the retailers control these brands, they can begin to enjoy significant savings in the short term while advocating for adoption of the Digimarc Barcode by national brands to provide the full realizable savings.
A leading research firm in the retail industry estimates that private label sales accounted for 18% of American consumer goods dollar sales in 2011. Our go to market scanning partner is Data Logic, the world's leading supplier of high volume scanning equipment for retail. Thus assuming that private label accounts for 15% to 20% of retail and recognizing that Data Logic is number one in worldwide points of sale retail scanners with approximately 33% market share, we have plenty of opportunity focused on enabling private label products of Data Logic customers.
We intend to publish our quantitative model of labor cost savings for retailers within the next week or so. The published model will address only one aspect of the benefits of our platform, the labor cost savings made possible from fast throughput at checkout due to the Digimarc Barcode. We've developed a sophisticated and transparent model based on extensive search of available data and research concerning retail transaction processing. We are seeking public comment to harden the model and solicit inputs concerning clerical assumptions. The model is intended to help prospective customers calculate the return on investment that they can expect from adopting the Digimarc Barcode. The model will inform retailer purchase decisions, guide resource allocations for us and our customers, and facilitate our financial planning.
We recognize that the theoretical model that we have constructed needs vetting in the relevant markets, thus our focus on expediting delivery of proofs of concept with early adopters to support this important work on the tool. As you know, there are many benefits to retailers, brands and consumers from our Digimarc Discover platform in addition to improving the speed of assisted checkout. Our quantitative model of projected labor cost savings alone continues to forecast the potential for billions of dollars in annual margin improvement to the retail industry.
The enabling of private label brands in conjunction with the purchase of image based scanning equipment from Data Logic will provide opportunities to objectively demonstrate the financial and other benefits of the Digimarc Barcode at point of sale to the rest of the market and lay the foundation for advocacy of adoption of the Digimarc Barcode by national brands. As this advocacy develops, we expect to contemporaneously market the many advantages of the Digimarc Barcode for the national brands independent of the increased speed of processing at point of sale.
We see in the Digimarc Barcode an opportunity to address a clear, objectively verifiable need that has massive financial implications with a proprietary solution that has sustainable competitive advantage. We are gaining confidence that the transition of retail checkout scanning from laser to imaging will happen over the next several years, providing an unprecedented opportunity for an independent software company like Digimarc to deliver multiple applications for this new technology platform. This virgin opportunity is reminiscent of the early stages of the PC software market. We are early in this market and blessed with a powerful, unique and proprietary fundamental application in the Digimarc Barcode. We expect initial shipments of Digimarc hand scanners to begin shortly. We are also encouraging retailers to integrate our software into their consumer applications for mobile devices to enable the full Shopper's Journey optimization across all media.
Once the financial impact of faster checkout is validated, we expect retailers to encourage the national brand suppliers to adopt the Digimarc Barcode. Demonstration by retailers of the effectiveness of Digimarc Discover enhancing customer engagement should provide additional justification for the suppliers to become Digimarc customers.
We are developing a low friction, highly scalable customer acquisition and service model that includes online registration, purchasing, and management of codes and associated network services. The encoding media in general is available via our website known as the online services portal. Adobe Create-A-Suite plugins and software development kits are available for advanced users.
The initial encoding and packaging will be managed differently. We have a professional services offering for encoding packaging. The service bureau approach to encoding will inform our continuing development of an efficient and high quality set of tools and processes and give us substantial control over quality in the initial installations. We expect that these various methods will persist for the foreseeable future.
We have published pricing for the Digimarc Barcode that is consistent in structure and amount with what retailers and brands pay for traditional barcodes. We view this as charter pricing. Once we have vetted our industry value delivery model and have demonstrated performance and actual implementation, we anticipate adjusting our pricing to a value based approach. We are constructing the pricing model based initially on projected labor cost savings. As credibility of the forecasted savings grows from validation and proofs of concept by retailers and public comment, we expect to begin transitioning from our current proforma pricing to a share of value formula. The details of the pricing and migration of the model are still under development. We anticipate beginning the migration in late 2014 or early 2015.
As we similarly model and validate other benefits of Digimarc Discover, we will continue to assess proper value based pricing and make appropriate adjustments on an ongoing basis. In the meantime, we expect growth in other areas of our business although that growth alone is not expected to be adequate to compensate for the investments in Digimarc Discover and Digimarc Barcode in 2014.
As detailed in the press release earlier this week, our Digimarc Discover business in publish has doubled over last year. According to the most recently published study of Mobile Activation, the magazine, during 2013, Digimarc's share of market also doubled from 6% to 12%. The primary competition is QR Codes and image recognition. The number of QR Codes actually declined for the first time since the report began tracking mobile activations in 2010. We believe we are clearly a functionally superior activation means. As with traditional barcodes, we can do what they can do, better.
Although we have this good growth and competitive performance, and have attained leading market share in print to web services for the publishing industry, overall adoption by the industry of print to web functionality has not yet achieved meaningful scale. We are having trouble getting from the early adopter experimental stage to broad and regular uses by publishers. Magazines are a primary source of purchase intent. As we focus on the Shopper's Journey enablement with leading retailers and brands, we will continue to emphasize the important connections between publishing and retail. We hope that increasing adoption of the Digimarc Barcode and other aspects of the Digimarc Discover platform will add fuel to the publishing industry's employment of mobile activations from print.
Given that magazines are a very significant source of purchase intent, and widespread adoption of the Digimarc Discover platform including the Digimarc Barcode by retailers, will make purchase of the platform and competitive advantages that we enjoy more obvious and meaningful and we hope that these developments will move the publishing industry down the path of employing Digimarc Discover more routinely to facilitate audience engagement and return on investment for advertisers.
Use of Digimarc Discover and publishing now extends to magazines, catalogs, brochures, direct mail and books. Coupons, recipes, and sweepstakes are the most popular consumer payouts. The US accounts for the lion's share of the publishing activity and there's lots of room for global expansion.
The integration of the Attributor acquisition has been completed successfully and we're now realizing the benefits of organizational integration and technology transfer. Our resulting business continues to grow with a starting antipiracy solution for publishers in North America, Europe and Japan, and we're rolling in watermark based security to enhance competitive differentiation and foster further growth. Several beta sites for the installs are operational and the initial results look good.
We're entering the second year of the contract extension with the Central Banks that runs through 2024. Our work with the Central Banks provides several strategic advantages to the company. In addition to building a strong positive reputation in the IT and printing industries, we have assembled a very talented staff with diverse skills that make valuable contributions across our other development initiatives.
Elsewhere in payments, we continue to work with the Digimarc Virtual Payment Card and have settled on the Money 20/20 conference in the fall to introduce our technology to the market. Once again, I remind everybody this is still just R&D and we have not yet demonstrated commercial feasibility. We're encouraged by our development progress and the interest from numerous potential customers and partners to continue the work. The Digimarc Virtual Payment Card has an important role in our strategy as another distinct development of the overall Shopper's Journey value proposition to the retail industry, by providing an intuitive branded mobile payments and coupon redemption interface, and as further evidence of the wisdom of the retail industry migration from laser to imaging based scanning platforms. Volatility continues to be quite high in the mobile payments market in general.
Our R&D and IP development remain prolific. The retained portfolio continues to grow at a rapid rate, 14 patents issued in the quarter with 6 of those feeding our second wave. Our second wave portfolio has grown to 83 issued patents by the end of the quarter, we filed 25 patent applications in the first quarter bringing the total second wave patents pending to over 350.
The subject matter of innovations in the new filings include multi spectral imaging and related machine learning systems for object identification, skin imaging and applications, virtual wallet and mobile payments, and advances in the watermarking of packaging in support of our retail initiatives among other things.
The timing and amounts of license income to expect in 2014 is, as always, difficult to handicap. Given that there was no profit share in the annual report from IV for licensing during last year, licensing revenues for 2014 will come from continuing royalties from existing licensees and any new license income we may derive from second wave marketing.
As we indicated on our last call, we hired an intellectual property advisor, that advisor is Blackstone IP, to perform a strategic IP appraisal of our second wave portfolio. Blackstone IP is an IP transaction advisor advising and assisting us in monetizing the second wave portfolio. The firm includes a number of experts in intellectual property transactions. They evaluated the IP and technology in the second wave portfolio, performed evaluation analysis, developed several alternatives for monetization of the IP, identified potential partners, and provided recommendations that we recently reviewed with our board.
Now that they've completed this initial assessment, we and they plan to reach out to complimentary infrastructure providers and others to explore opportunities for partnering to further develop and commercialize some of the key inventions related to digital content discovery.
Blackstone's focus is on advising and assisting us in soliciting business partners and structuring those relationships, not litigation. This does not in any way preclude us from separately pursuing enforcement actions against unlicensed use of our inventions. In all material respects we are executing well against our previously disclosed strategic plan. And that's it for the prepared remarks. We'll now open the call for questions.
(Operator Instructions). At this time there are no questions in the queue. I would now like to turn the call back to Mr. Davis for closing remarks.
Okay. Thank you, everyone, for participating in the call. We'll look forward to continuing our discussions with you and updating you again in our regular scheduled call next quarter. Thanks very much.
This concludes today's call. Thank you, ladies and gentlemen, for joining us today for our presentation. You may now disconnect.
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