Digimarc's (DMRC) CEO Bruce Davis on Q1 2016 Results - Earnings Call Transcript

| About: Digimarc Corporation (DMRC)

Digimarc Corporation (NASDAQ:DMRC)

Q1 2016 Results Earnings Conference Call

April 27, 2016, 05:00 PM ET

Executives

Bruce Davis - Chairman & CEO

Charles Beck - CFO

Analysts

Josh Nichols - B. Riley

Saliq Khan - Imperial Capital

Rob Stone - Cowen & Company

Glenn Mattson - Ladenburg Thalmann

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. 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. We also will discuss from time to time information provided to us by channel partners and actual and potential customers about their business activities.

Please appreciate that we are providing this information as we understand it was represented to us by these customers and partners and we do not verify nor vouch for such information. Such forward-looking statements and statements of our partners and customers are subject to many assumptions, risks, uncertainties and changes in circumstances. Any assumptions we share about future performance represent a point-in-time estimate. Actual results may vary materially from those expressed or implied by such statements.

We expressly disclaim any obligation to revise or update any assumptions, projections, or other forward-looking statements to reflect events or circumstances that may arise after the date of this call. For more information about risk factors that may cause actual results to differ from expectations, please see the company's filings with the SEC, including the Form 10-Q we expect to file shortly.

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

Charles Beck

Thanks Bruce. Good afternoon, everyone.

Revenue for the quarter was $5.6 million compared to $6 million in the first quarter of last year. Most of the difference was due to lower software licensing revenue and timing of services revenue.

Gross margin was 61% for the quarter, one points higher than the first quarter of 2015. Operating expenses were $1.1 million or 14% higher than Q1 of last year, reflecting previously noted increases in staffing for sales, marketing and operations to support our market development activities.

The net loss for the quarter was $5.4 million or $0.64 per diluted share versus a net loss of $4.2 million or $0.52 per diluted share in the same quarter last year.

Our legacy business and Counterfeit Deterrence, Copyright Protection and Licensing are stable and should grow at modest rates over time. Revenue from our legacy business however, maybe lumpy quarter-to-quarter due to timing of program work and swings and reported royalties from our licensees.

Our working capital position remains in good shape with nearly $36 million of cash and marketable securities and no debt. We invested $3.3 million of our working capital during the fourth quarter, including $2.2 million to fund operations and $700,000 for capital expenditures.

This was lower than we projected due to receiving a monthly customer payment earlier than normal. Excluding this customer payment, our working capital usage would have been $4.4 million, in line with our expectations. This means that the change in cash in Q2 could range from $4 million to $6 million depending on the timing of such payments.

The quarterly variation does not reflect any substantive change in our rate of investment. For further discussion of our financial results and risk and prospects for our business, please see our Form 10Q that we expect to file shortly.

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

Bruce Davis

Thanks Charles. We began this year with a terrific demonstration of progress in market development NRF and the number and quality of partner exhibitions and the scale and quality of prospects that we met with.

There were numerous announcements, demonstrations and testimonials prior to and after the show. Two months have passed since our last call. We’ve been nurturing relationships with some key customers, dealing with a much broader range of prospectus, establishing supports partners for our standard brand development, smartphone and media and entertainment channel partners and improving our service and support capabilities.

We're making significant progress at retailers and brands, subject to the fits and starts that are natural consequence of introducing innovations into mostly massive enterprises.

Wegmans' penetration into Digimarc barcode and their private brand products is achieving significant scale. The Seasons are second publicly disclosed retail customers in the design phase. There are small quantities of Digimarc enhanced product on the shelves at several more unannounced retailers and we have been conducting demonstrations and pilot studies with other significant retailers and brands.

Our focus continues to be North America and mid signs of growing awareness and interest in Europe, the Middle East and Asia. As I've hypothesized everyone seems to be watching everyone else to demonstrate leadership.

Evidence continues to support the notion the adoption by category leaders will significantly affect the pace and scale of early adoption. We're intensively focused on delivering evidence of such leadership during 2016. There is a sense of momentum building.

As most of you know, our platform provides objectively superior performance versus other auto identification means. Part of the sense of momentum that I alluded to a moment ago, flows from increasing recognition among industry heavyweights.

Since the last call we have provided compelling evidence of cost effectiveness of Digimarc Discover and Digimarc Barcode to important retail and brand prospectus. In addition there are very important brands who have engaged in extensive testing of study that are awaiting some developments among retailers before moving forward with implementation.

I understand this is vague. I’m sorry, but I can’t provide any more color on this for the time being.

We had tremendous support at the show from global leaders and retail scanners. Datalogic, Honeywell, MCR and Zebra all showcased products enable to read Digimarc Barcodes in their exhibits.

We expect several Digimarc-enabled fixed and handheld product releases from these vendors later this year. We're working with the Zebra to deliver Digimarc Barcode capabilities in variable way printing applications for grocery.

Our channel partner program is very important in that it allows us to focus on our core competence and identification and discovery technologies, consistent with our goal in the use of working capital and serves as a force multiplier in sales and marketing, providing ready access to multiple sources to supply fostering growth and globalization.

We're continuing training and improving our coordination and support through SGS and are being asked by some important customers to add more suppliers to the program.

Following up on the announcement of the landmark collaboration with industry association with GS1 US we're now working together to integrate the main licensed Digimarc Barcodes into their website where our barcodes are branded DW codes, so that their members can license the codes directly to the official association site where they conduct other barcode related business.

GS1 US will also market, educate, train and facilitate access to related service to their 300,000 number of businesses. The official launch of DW codes will be up at GS1 Connect Conference and the annual knowledge and networking form for GS1 members and suppliers being held in Washington DC, June 1 to 3.

We will have significant presence at the conference including a DW code experience zone, Digimarc discovered exhibit and demonstration, inclusion in keynote remarks and a workshop.

The conference kicks off the process of educating the industry served by GS1 and our DW codes can improve product's identification for a broad range of applications. Our focus at the conference will be on brands and retailers.

Digimarc discovers enabled in dozens of Smartphone applications. We understand the brands need platforms to facilitate Smartphone engagement with consumers and thus our aggressively marketing discovered retailers provide brands with a choice of third party engagement and retail applications to support and enhance consumer engagement.

Wegmans was our first retail licensee. We have other unannounced retailers who are integrating our SDK.

Looking at the market more broadly, there are signs of progress in the entertainment sectors. Without getting specific about individual partner performance, channel partners in the sector includes Neilson, Source Audio, [Verametric, Cybalution], 4C, Tele Tracks and Kantar Media.

We recently debuted in large scale entertainment venue with the Portland Trail Blazers where we hope to collaborate with the marketing team there to build models of enhanced fan engagement that can be archived more broadly in sports and music industries. We are anticipating additional announcements of our progress in media and entertainment applications during Q2.

As I mentioned in our last call, there is obviously much more to be done and continuing investment is necessary to meet our goals. Our near term operational priorities include public disclosure of support from industry-leading retailers and brands including some major accounts that have been underdeveloped for a while, implementing the GS1 collaboration, launching new scanners with Digimarc Barcode capability, deploying Discover and more retailer and consumer engagement mobile applications and activating, training and incentivizing our channel partners, improving our website as an engine of commerce and increasing positive cash flow from our guardian and payment areas of business.

We're very much aware of the need to demonstrate progress on the path to significant revenue growth and profits. Our focus is on increasing sales for Digimarc Discover and Barcode, building creditability for prosperous future for our company and as remarkable, intuitive computing platform.

I had hoped to provide details of some significant market developments by the time of this call or earlier. Some very important initiatives are in the works, but not yet right for public disclosure. We’ll continue to do our best to bring them to fruition as soon as we can.

That's it for the prepared remarks. Now we will open the floor to questions.

Question-and-Answer Session

Operator

[Operator Instructions] And our first question will come from Josh Nichols with B. Riley.

Josh Nichols

Hi, Bruce, Charles. Could you give any examples of some of the things that that company has done to really operationalize all these new partnerships and really build out a platform that’s capable of scaling since the NRF conference in January.

Bruce Davis

Sure, a lot of the work that needs to done for globalization and has to do with publishing practices to the relevant participants in the supply chain. And so we’ve done extensive study on prepress and print and understanding the existing processes and documenting the way in which what we do fit into those and then setting up the communications framework for broad discrimination of relevant information in a timely fashion.

And that’s both direct to participants in the supply chain and indirectly through our channel partners and so that's an example of getting ready operationally.

Another area of considerable investment has to do with creating quality standards and publishing them and that is consistent with the kinds of things that have been done historically for the conventional barcode symbologies.

Josh Nichols

And then I know the company recently had announcement that [Pet] is adopting Digimarc Barcode. Could you - how that come about - anyways I’m just curious I know that you already working with Pargo, any detail you can provide surrounding that.

Bruce Davis

They Bizerba - there is my Barcode does of means of helping their business to deal with both the engagement aspects of use of their products which are obviously specialty products and also management of their channels of distribution more effectively.

And obviously it's not a large product portfolio but we appreciate the early adoption and their enthusiasm and the speed which they will able to get to market.

Josh Nichols

And then I know, sales is one of the big focuses for this year. Just looking at operationally for the expenses, this quarter is that kind of decent run rate or you thinking and may be adding some additional sales, sales force to help grow the topline?

Bruce Davis

At this point I think Q1 is a reasonable metric for the rest of the year and that's as a reason to increases our sales force further which would be dictated by additional customers coming on board. But at this point in time I guess a fair metric for the rest of the year.

Josh Nichols

Okay, thanks. I’ll get back to the queue.

Operator

Your next question comes from Saliq Khan with Imperial Capital.

Jeff Kessler

Hi, it's actually Jeff Kessler. How're you doing Bruce, Charles? Following up on the question of - you are scaling globalization can you talk about the construction of your ecosystem and who you are working with, how that’s progressed since the NRF to give us a sense of not just scale but ability to actually have the entire system come to market when needed.

Bruce Davis

Yes, we put in a enormous amount of effort into continuing infrastructure build out in the last few months. So, obviously at the top of the – heap of interesting work is our collaboration with GS1.

And so they are -- we have ton of work to do and but we intend to deliver the GS1 portal capability soon and we are getting ready for the official launch of that at the GS1 connect conference and I mentioned various things that we believe that will be doing there.

We also been working with our pre-media, prepress brand deployment group, whatever name you'd like to apply us, short Perrigo and some others, who are not yet announced.

In order to continue to foster their capabilities because as you now in our model - particularly in the model of specific globalization we want clients to have a lot of choice and we want them to work in the existing relationships wherever possible in order to reduce the amount of overhead associated with setting up contractual relations and qualification of vendors.

And so we continue to train and to meet with our partners and to collaborate with them on presentations and to meet their suggestions for how we can improve our service to them so they can improve their service to their clients.

We’re also collaborating with all of the leading industrial scanner vendors to move as much product into the market as possible this year and we are marketing aggressively the integration of our mobile SDK into retailer apps and some additional consume - third party consumer engagement apps.

So there is a lot of work in every aspect of the program but the program as a whole is in very good shape and includes the essential elements of performance. We of course do a lot of work on Adobe tools on the Adobe foundation and we have a good relationship with the Adobe, they are not an active channel partner yet, that would obviously be a nice addition at some point but not a necessary step to being able to move to scale.

And so I think we’ve all the pieces in place where just now maturing our participation and our partners participation in that ecosystem.

Jeff Kessler

Okay. Just a follow up on all that number one, I wanted to just double check, you said you now relationships with all of the leading scanner vendors.

Bruce Davis

Honeywell, Zebra, and Datalogic.

Jeff Kessler

All right. And you now have SDK that you believe are - will be able to expand are fairly well standardized, and will be able to expand the community pretty rapidly on your - for installing and getting apps out there.

Bruce Davis

Yes, both in the industrial interfaces and in the consumer smartphones.

Q – Jeff Kessler

Yes, that's what I was aiming at that you have both the industrial and consumer out there?

Bruce Davis

Yes.

Q – Jeff Kessler

Okay, all right, great. Okay, thank you very much.

Operator

Your next question comes from Rob Stone with Cowen & Company.

Rob Stone

Hi, guys. I wanted to follow up on your prepared remarks a little bit, Bruce and just make I’m calibrating - how we’re categorizing these engagements properly. So you got two announced customers that are rolling out on some pace but it's a full adoption Wegman's and Seasons.

And then I think you mentioned some additional retailers unannounced but with small quantities of products in there channels and after a third category that were in pilots. So are the retailers in the second category doing in channel pilots, is that the beginning of wider roll outs or how would you characterize that?

Bruce Davis

Yes, let me provide some clarity, it's a good question Rob. So, Wegman's and New Seasons are just in production, Wegman's quite far long and Seasons getting started.

The second category product that has gone through the supply chain and so from my perspective it’s just a product, we just may begin do more product. The third category are retailers and brands who are doing structured testing and they may use mark-ups for that. They may use other company's products. It's not production and that’s why I created the third category there.

Rob Stone

Okay.

Bruce Davis

Did that help?

Rob Stone

Yeah, that’s helpful. So, when you say the second category that got products that have gone through the supply chain, does that mean it’s just a function of whatever pace they choose to continue rolling out codes or what’s the past for the second group?

Bruce Davis

Yeah, I wish it was that simple. I don’t know until we get there, exactly how simple or complicated it is. What we have established I think and I’ll try to indicate in my remarks in this call, is there is nothing new to be learnt from the test of the general value propositions that we talk about in the financial markets. We’re clearly better. There is no question about it, a lot better and in a way that makes the purchase clearly proper allocation capital.

Where we get slowed down is in the prioritization of great ideas that whoever is making decision may have. So we're obviously not the only game in town as opportunities to spend.

So, we're trying to get everybody focused and get the moving along and just like in any purchase of anything, by more if you're happy unless if you're not and we're telling everyone there is no need really to run test, it's obvious that it's a good value. You just have to determine this priority in relation to other priorities in the renovation of your business models.

And so, that’s where I believe production even in small quantity production is good and better than testing because they can do whatever test they want to do when they reach a sufficient level of volume rather than having testing being a gate that slows down their receipt of the benefits that we provide.

Rob Stone

Good. My other question has to do with if you ask to me like this engagement with GS1 potentially has a very significant impact on your ability to get past the starting inertia or prioritization challenges that you were just describing. It certainly gives you a wider interface to potential customers, given what you said about the infrastructure work that’s being done to stand up the packaging and printing guys SGS and Perrigo and others.

The fact that the scanner stuff is largely all in place and I get the impression that the portal is almost like a self service model, getting barcode design by GS1 isn’t in a lengthy process if you decide you need some.

So if there are potential adopters out there on the other side of the GS1 portal when they turn the thing on at the middle of the year; is everything in place for somebody to then go ahead and rollout to whatever pace they're ready for or is there still something that has to be built after that?

Charles Beck

We’ve created enough capacity to serve a lot of demand and as I mentioned in my prepared remarks, even asked by some customers to bring other additional suppliers on Board which we will. And so I think we can move fast enough to satisfy significant demand.

The GS1 role in market development I think is critically important and was a missing element until we came to agreement and that’s because they are an industry association that serves the industry's interest and so, rather than listening Bruce, say what he says about the transformational effect of this platform, the association ought to provide a trusted advisor role to its members on this subject and you already know that they're quite enthusiastic and appreciate that we can bring a lot of benefits to industries they serve.

But I think from the other side of the equation that the industry ought to gain comfort and bring to the association any question they might have and try to save some money by not doing redundant testing and all of those things. So, those all wait or launch in the bottom up.

And so I’m very excited about going to market with GS1 and beginning the process of educating the industry, so that we can increase the pace of adoption and do so in an efficient an effective manner for our mutual clients the member companies.

Rob Stone

Good, final housekeeping question for Charles, you answered this already, but I wanted to try for a little more nuance here if there is some. The expenses were a little bit above what we were modeling in Q1 and I know you said that's probably a good run rate for the year. You don’t need to raise it from there.

I’m just wondering if there is any seasonal impact across your quarters, I know NRF is a very important show for you and that probably costs some money or maybe other things you’re doing. Do you expect that to just continue really flat or maybe marginally move up and down through the quarters because of some of those impacts?

Charles Beck

Q1 can be marginally higher because NRF and the audit that we go through, but for that we’re not talking material differences. We think it will be in line so…

Rob Stone

Yeah, I was thinking a couple of percent different.

Charles Beck

Yeah, that’s no unreasonable.

Rob Stone

Yep. Okay. Excellent. That’s all I had guys. Thanks.

Charles Beck

Okay. Thanks.

Operator

And our final question is from the line of Glenn Mattson with Ladenburg Thalmann.

Glenn Mattson

Hi, good afternoon. Thanks for taking the question. A question Bruce on your prepared remarks, forgive me if you've answered this. I've been bouncing between two calls, but you talked about something that is missed here with something along the lines of importing and important brands are waiting developers for retailers. Exactly what -- can you give more specifics on what you mean there?

Bruce Davis

There is an impression among some in the industry that retailers will push this thing and that's why brands will adopt and that's not completely untrue but it misses the point that are brands that want to get going without being pushed, but in order for them to get going they need the support of the retailers for programs that they would like to run and so there are some.

Glenn Mattson

You mean like marketing program things like that or.

Bruce Davis

Mobile app support and permission to run programs and you know that in the retail environment all of what happens within the four walls is under control of the owner of the space. So, the brands don’t just go in there and do their thing. They have to get approval and so we’ve got some brands that want to get some things done and they're waiting for permission.

Glenn Mattson

Okay. And that permission is something you're anticipating in the medium term here it’s I guess something that’s developing as well.

Bruce Davis

I’m sure it will be given eventually. The question is whether it’s a day or a week or a month or a year. It's just pretty obvious that we need to move along. One of the audits of our platform is that although it’s an improvement on the status quo of conventional barcodes for such things as consumer engagement, its viewed as a new thing I suppose to just an improvement over an old thing.

And so some large retailers need to develop policies for us and that means some delays and I can't quantify the delay. I don’t know how long it takes to get such things done.

Glenn Mattson

Okay. And moving on just with regards to the announcement the Perrigo partnership now I realize these aren’t CEO level decision, but with the change of the CEO there, is there any chance that you lose momentum with that particular client or do you still have the backing of whatever champion you had in the company for pushing this technology ahead.

Bruce Davis

I was bumped to see that change obviously, but I don’t have any reason to believe that would affect their participation with us.

Glenn Mattson

Okay. Last one just I was thinking about this ahead into the call, the Shazam relationship, it seems they have multiple avenues for image recognition and some of these things that they're using in some instances seem more difficult than just slapping a digital watermarking code on a product.

And so I wonder can you get a sense of why Shazam is not always -- sometimes seems less eager to use your solution and to use some other image recognition technology?

Bruce Davis

Well without getting into inappropriate detail some of -- well I guess I would say all of what you observe predated us. So it’s not a question really of brining in other vendors. It's a question of us displacing legacy vendors. And so they have what they have because they had it when we got there.

But we do try to communicate as best of our ability the opportunity for superior performance through increasing use of our platform, but they have an interest in having independent technical significance too.

So they're not merely a Digimarc discover bar. So I get the landscape here and again we think more use of our technology would be good for them and their clients but they haven’t embraced that.

Glenn Mattson

Okay. All right. Great. Thanks and good luck on future progress.

Bruce Davis

All right. Thanks, Glenn.

Operator

And 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.

Bruce Davis

Yes, thanks everyone for your participation today and your continuing support. We'll do what we can to bring evidence of momentum as soon as we can get it here. Thanks very much.

Operator

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

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