Digimarc Corp. Q2 2009 Earnings Call Transcript

| About: Digimarc Corporation (DMRC)
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Digimarc Corp. (NASDAQ:DMRC) Q2 2009 Earnings Call July 31, 2009 10:30 AM ET

Executives

Bruce Davis, Chief Executive Officer

Mike McConnell, our CFO

Analysts

Walter Schenker - Titan Capital

Paul Sons - Sons Partners

Kevin Henehan - KMH Capital Advisors

Operator

Good morning. My name is Christy, and I will be your conference operator today. At this time, I would like to welcome everyone to Digimarc’s Second Quarter 2009 Results Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers’ remarks, there will be a question-and-answer session. (Operator Instructions)

Thank you. I'll now turn today's conference over to Mr. Bruce Davis.

Bruce Davis

Thank you. Welcome, and good morning. Mike McConnell, our CFO, is with me. We issued a press release earlier today announcing our second quarter 2009 financial results. The objectives of this call are to summarize and comment on this results, review significant business developments and market conditions and provide an update on strategy and operations. This webcast will be archived in the Investor Relations section of our website.

Before we proceed, please note that during the course of this call, we will be making forward-looking statements regarding management’s opinions and expectations about Digimarc’s business, its markets, and financial performance. These statements are subject to assumptions, risks, uncertainties, and changes in circumstances. Actual results may vary materially from those expressed or implied in such statements. For more detailed information about risk factors that may cause actual results to differ from expectations, please see the company’s filings with the SEC, including our Form 10-Q that we expect to file later today and our earnings release posted on our website earlier today.

During the course of this conference call, we will also refer to certain non-GAAP financial measures as defined by the SEC and Reg G. Definitions of these non-GAAP financial measures and reconciliations of these measures to their most directly comparable GAAP financial measures are included in the earnings release for the quarter.

Any assumptions we offer about future performance represent a point in time estimate. Given the current economic climate, we believe it is prudent to embrace a very cautious posture toward assumptions and in general. We described various assumptions and projections in this call for the limited purpose of giving you a sense of our planning assumptions and to assist analysts who solicit our views as one of their sources for modeling possible future performance, so obviously very challenging for anyone to try to forecast the general economy and derivatively its impact on individual businesses like ours.

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.

Mike will begin this update call by commenting on our financial results. Then I will update our financial and product market outlooks and strategy and operating plans for the remainder of 2009. Mike?

Mike McConnell

Thanks, Bruce, and good morning, everyone. I’ll begin by reminding everyone of the basis of accounting used in presenting our historical financial results. The digital watermarking business that forms the basis for the current new Digimarc was spun out from old Digimarc last summer, just prior to the sale of old Digimarc to L-1 Identity Solutions.

As explained previously in our calls and SEC filings, the basis of accounting used for the digital watermarking business prior to the spin-off and up through August 1, 2008 is referred to as a carve-out of digital watermarking assets, liabilities, and results of operations from the old Digimarc business that included the ID systems operations that were sold to L-1.

It is difficult to meaningfully compare the new and the old financial results due to the different basis of accounting used in light of the spin-off transaction. Please keep this in mind as we discuss changes in results from our prior periods.

Q2 financial highlights included revenues achieving $4.3 million, and they were lower by 15% year-over-year and they reflect the impact of variations and scheduled payments in our revenue sources according to the terms of our contracts, continuing delays in federal defense contracts that had been earmarked in our favor as we have noted in previous calls and to a lesser extent lower royalties from some of our licensees, reflecting general economic conditions.

Gross margin was 65% compared to 67% in Q2 2008. The two point change primarily due to a mix where lower margin service revenues accounted for a greater part of the total and to a lesser extent the impact of a different basis of accounting for expenses that I had mentioned earlier.

Operating expenses increased from 3 to $3.6 million, primarily reflecting the change in basis of accounting between the two periods and to a lesser extent the impact of increasing our investment in R&D resources that we noted in prior calls. Also like to note that operating expenses decreased by about $300,000 from those incurred in Q1 of this year.

Our cash and marketable securities investment balances at June 30 were slightly down from the end of Q1 to about $45 million. And revenue backlog at the end of the quarter was $50 million reflecting the net booking activity and the normal burn-off of backlog.

For a further discussion of these results, our business and financial models and risks and prospects of our business, refer you to Form 10-Q that we expect to file later today.

Looking forward, we continue to advice investors that our discussion of financial assumptions in the context of prevailing general economic conditions should continue to be viewed cautiously. With this in mind, our assumptions for the balance of the year reflect higher second half revenues notwithstanding the potential deferral of revenues associated with the federal earmarked referred to earlier, revenues for the year could be slightly lower than 2008 given the continued deferral of these federal earmarks and moving up some of those revenues into 2010.

Given that the contracts have not yet been signed, there is a possibility that no revenues might be realized, however, the positive note negotiations on these contracts have accelerated mid to late second quarter and they are continuing.

Financial results, excluding the impact of joint venture activities are expected to better than the first half of the year and the losses from the joint venture activity should not exceed the previously disclosed $1.1 million contribution and they could even be less.

We are working on a number of interesting opportunities, which would impact the later part of 2009 and 2010 financial performance, but that impact is too speculative tomorrow at this point. We also expect that 2009 operating expenses, which include the majority of our $2.3 million of stock compensation charge, will be about $15 million and possibly be even slightly less than that.

Stock compensation is allocated between operating expenses and the cost of revenues. So at these baseline levels and with composition of revenues and expenses, we expect gross margin to be in the mid 60s for the year, GAAP losses including a loss of investment in the new joint venture of up to 1.1 million to be around $2.5 million. Adjusted EBITDA, or earnings before interest, taxes, depreciation, amortization and stock compensation to be near breakeven assuming a maximum loss of 1.1 million for the joint ventures and some revenues to be generated from the federal contracts.

We expect to utilize between 1.5 and $2 million in cash for the year reflecting our joint venture investments, lower expected revenues and their related impact on operating results and to a lesser extent some changes in our balance sheet accounts due to tiny differences. The primary explanation of differences between adjusted EBITDA versus GAAP loss is the $2.9 million of non-cash charges for stock comp and depreciation.

Bruce and I'll provide an update about our market strategy and operating plans for 2009 and beyond. Bruce?

Bruce Davis

Thanks, Mike. Other the delayed comments on the work on the federal projects, we are executing on our strategy generally according to plan, making good on our key objectives. And then other things, the biggest news for the quarter, of course, was the expansion of our relationship with Nielsen, whereon we agreed to form two new joint ventures to combine the respected strengths of our companies to bring important innovations and media distribution and consumption to market and broaden the scope for the Nielsen license.

In industry news, The Recording Industry Association of America, trade associations for music industry, published a watermarking specification for its members. For more information, see www.riaa.org.

We saw progress in motion picture industry as well, with publication of the final license for the Blu-ray security that requires watermarking details on this, see www.aacsla.org and www.derance.com.

On the intellectual property front, our patent portfolio ranking in the Top 50 Innovative Companies in Information Technology as published by the Wall Street Journal improved from 29th to 27th place based on more than 50 indicators of the companies' innovation, technology and science strengths.

Through mid-July, we had 38 patents issued year-to-date, bringing our total U.S. informed patent count to over 525.

We engaged in quite a bit of business development activities in the quarter. Including pursuing relation [sales] with potential new licensing partners in different areas of business where IT and technology are relevant. As evidenced by our dealings with partners like Neilson the formation of such relationships can include a combination of licensing and collaboration on new offering or ventures in which various forms of consideration are exchanged.

Please keep in mind that the outcome and timing of such initiatives are inherently uncertain and such initiatives can take many forms and could provide upside to our revenue expectations and/or could involve increased legal expense particularly if we were forced to resort to legal action to enforce our IT. As was done by licensees in the past we've stated our views in detail and have encouraged potential partners to work with us to develop creative approaches to provide reasonable a compensation for our intellectual property in fair and mutually supportive relationships.

In addition, we have identified several more potential licensees and are engaged in detailed analysis of these opportunities. Regarding a stock purchase program authorized by the Board earlier this year we've not yet repurchased any shares under the program due to self imposed trading restrictions based on the Neilson negotiations prior to public disclosure. Followed by our routine end of quarter restrictions.

In closing, I'll note that we are very busy working on numerous initiatives, including our new joint ventures with Neilson, initiation of licensing discussions with several potential licensees, assessment of additional prospects, out reach to several other potential business partners. And research and development initiatives in print, imaging, and mobile applications.

This concludes our prepared remarks, thank you very much for your interest and support and we will now take questions.

Question-and-Answer Session

Operator

(Operator Instructions). Your first question comes from the line of Walter Schenker of Titan Capital.

Walter Schenker - Titan Capital

Two question actually, the first of which is, you may have indicated in the past, the defense contract, which is coming on slower than expected. Have you indicated roughly what sort of revenue that might generate?

Bruce Davis

I don’t recall, Mike?

Mike McConnell

We have not, its two different contracts and they are reasonably substantial, because we, you know were a bit lower than we’d like to be on the revenue side and we may have little or color on that next quarter about what the aggregate of those might be.

Bruce Davis

I think if we go back Walter, we just double on our [web]. Speculate here on what we may have said quite a long-time ago. There were press releases associated with the awards, I believe and which may have done some indication of value. But the delay in getting to work on these is the most substantial part of the difference between where started the year on our assumptions for revenues and where we are now.

You know, as everything else can go and we thought we are going to go expect for those and it's just have been bare to get them underway. And I frankly don’t know all the reason why its taking so long because of the nature of the work that were being asked to do and the kind of people who are involved in the Department of Defense, and with the change of administration, and the recession, and Congress all wrapped around the axel, just everybody seems to be wondering around chasing the tail. And so we continue to believe we’re going to get the work and we’re going to get started on pretty soon, but we just caution everybody as we did last quarter of that, you know what we are not yet doing the work and so we’re experienced then, the related revenue impact on our assumptions about how we will do on revenues.

Walter Schenker - Titan Capital

Last week, there was an article AP creates way to track distribution of articles online with the Associated Press, about trying to identify their use of certain articles that these papers produce, 1,400 papers produced online. I was curious of that is, your technology is something else’s?

Bruce Davis

It’s not ours nor related to us as far as you know so far. We’re getting in touch with AP and see if we can help them out. What we think they are doing based on what we’ve seen is that they are trying to find a way to secure and get payment for text based news, which we don’t have much to do with. We have some R&D. we could theoretically if I want it, where we can help them is with their images and we could be very helpful there. And so I didn’t see anything in the announcement nor in any of the commentary about the announcement having to do with their approach to images.

We’ll see. There maybe an opportunity for us there.

Operator

(Operator Instructions) Your next question comes from the line of [Paul Sons of Sons Partners].

Paul Sons - Sons Partners

In talking just as a side note, and talking to the people at AT. They indicated to me that the text was a start and then if this worked out, they were going to move into images. So I think that is probably a fruitful area for you to follow up. They also did not indicate any knowledge of Digimarc and did not have particularly [safer] view of watermarking at least the gentleman I talked to. You mentioned moving on that in the enforcement of IP, I wondered if you mentioned that because you have become aware of people who are violating your IP this moment.

Bruce Davis

We are actually a bit ahead of our own schedule in our marketing plans for IP, and as I characterized our strategies, [indiscernible] to well we are a little behind on the federal stuff, but we are actually a bit ahead on the IP initiatives and we have identified several potential partners and we have contacted them and begun process with them to have them consider being business partners of ours.

And in addition to the several that we've already began the process with, we have identified several more. So it appears that the market opportunity is becoming more fertile. We want to see what we get out of all this, but we were anticipating in our planning that we'll be doing the kinds of things we began doing in Q2 towards the end of this year and over the next year.

And so as we go back how we started off the year in our strategy as I described it to you all guys, we want to be quite conservative in first half of the year while chaos reined in the general global economic. As we are now entering the second half of the year, we feel more confident making the more outreach and getting some of these relationship, dealing opportunities underway. So I am pretty excited about the way market is shaping up, I see lots of opportunity for us and getting more interesting by the day.

And again our approach here is to just try to develop creative relationship on which we develop value not only for ourselves but for the licensees and so it will take a while for this to bear fruit probably and some of them may or may not work out in a friendly way but at this point in time we see opportunities for expansion in the business, but they are quite attractive to us.

Paul Sons - Sons Partners

So in other words, there are some ideas that you see out there where people have developed products that they hadn’t given you a call and said, we understand we're using your IP?

Bruce Davis

Well, I think there are a couple of things, Paul, to say about that. One is that our vision is becoming a reality. I think on the virtues of IT, it has been a little early. It's not a bad thing, it's actually a good thing and we were quite a bit early in our vision of how the media landscape would evolve well lately -- and this is in last year or so in an accelerating way, but when you guys noticed we're getting more optimistic about a year and half ago or so.

Media object recognition is becoming quite fashionable. Everybody is thinking about it and some people are starting to act on it. Well, as they act on it, they may or may not appreciate the broad relevance of our portfolio and there are people who want to use watermarking and should have a relationship with us about that technology, but our portfolio has much broader relevance than just watermarking.

That’s where we started, that’s a core technology that we pioneered, but we’ve been working on this now for 15 years and we have 525 issued patents and they cover a wide range of innovations that are relevant to what's going on broadly in the media market today.

So when we talk about establishing partnerships, don’t think just watermarking. Think about content identification and management and think about object recognition, think about the mobile marketplace and all the things that are going on there. There are whole bunch of companies that are trying to develop pieces of our vision of seeing and hearing computers and when they do that, it will be helpful for them to have a relationship with us.

Could you give us an idea of – you indicated a very broad range of new businesses coming around ranging from people coming to you to you reaching out and suggesting things to other people. Could you give us an idea of what specific areas these are in and in terms of the areas they may be in, how near term they maybe and what is potential in terms of revenue generation?

Bruce Davis

Well, it would speak too much for me to talk about the areas because it’d be rather easy to figure out the targets, which should be rude in the way that these processes run, so I’d rather not go down that path. But I can adjust some of the risk and opportunity and timeline piece and that’s where I – this is my custom here to caution everybody that there is great uncertainty when you dig in the process. You don’t quite know how long it will take and how it will end up and what twists and turns it will take along the way.

As I noted in our prepared remarks, we are very tenacious people, we are very serious people. We have spent a long time and a lot of hard thinking in preparing for making an overture to various potential partners. And so we think that we stated our views quite clearly and that they should be persuasive and if they are not, then we will use whatever means we need to make our point. All in the context of trying to find ways not only to get fair compensation for our IP but to build more value for our potential business partner.

So given our approach and given the nature of what we are doing which is intellectual property licensing, it can take a lot of time. Neilson, took a couple of years to get done. So it's anywhere from if someone gets a revelation and says, yeah, you know well let's do a deal and sounds great, we'll get it done, which is probably a two or three month process to couple of years or even if there is litigation three or four years.

So, it's really hard to tell timing wise and it's also treacherous to try to predict success in every initiative. And so we obviously have the capital base and we have the sophistication and determination to move our views forward and so we are hopeful that people will see the virtues of working with us and enter into deals and, that's why when Mike talked about the rest of the year, you know there could be some upside from some of the stuffs that work and I am going to try to tell. So we are not going to tell you guys we are going to deliver it and let [you down] we will see if we can bring it in.

Paul Sons - Sons Partners

Right. Any update on the Neilsen JVs and when we might see product offered by either one of them?

Bruce Davis

Well the official commencement of the JVs is July 1, so Mike is going to be required to report to you on financial performance going forward, because of the -- unless work is not material. On the strategy execution level things are going just fine. In JV one, which is oriented towards the activities of our prior work for Neilsen that you are aware of. We believe we won't be able to get some customers up and running this year and get some revenues going. And that ones, closer to market than the other.

Paul Sons - Sons Partners

Right.

Bruce Davis

The other was purposefully quite vague about or describe it as a big idea, is not likely to get to market this year and may or may not get this close to the market this year. So, that's one is a little longer gestation and has both technical and marketing requirements that we need to satisfy to move forward.

Paul Sons - Sons Partners

Last question. The stock buyback program, at this moment does it appear that you'll be able to initiate the buyback program after earnings quiet period or are your still involved in so many things that you think that probably is not going to happen?

Bruce Davis

The honest answer is I don’t know. If we’re able to purchase shares and we think it's in the interest of you and other owners of the business to do it, will do it and if either of those conditions are not there, then we won't.

Paul Sons - Sons Partners

Okay what was the…

Bruce Davis

So we really have to play it by year.

Paul Sons - Sons Partners

How many days after earnings you have to wait before you are allowed in the marketplace?

Mike McConnell

See, for the third day after.

Paul Sons - Sons Partners

Say it again mike.

Mike McConnell

The third day after.

Paul Sons - Sons Partners

Third day after. All right. All right gentlemen, well it sound greats. Thank you very much.

Operator

(Operator Instructions) Your next question comes from the line of [Kevin Henehan] with KMH Capital Advisors.

Kevin Henehan - KMH Capital Advisors

Hello Bruce. Congratulations again on the Neilsen joint ventures. I had two questions, really the first one surrounds Corbis which I saw, you know one of your customers I saw a Corbis gentleman on TV on CNN, was surrounding that tragic death of Michael Jackson. But I just want to know if you could comment on that a little bit, it was a surprise to see Corbis on TV, because they don’t [need] a lot of publicity but maybe some of these images of Michael Jackson pictures or you could have lots of other cases like that became very valuable suddenly?

Bruce Davis

So you'd like me to comment on Corbis?

Kevin Henehan - KMH Capital Advisors

Yes.

Bruce Davis

Corbis has a very intimate role in our history. They are one of the sources, on the foundational element of our intellectual property portfolio. Couple of gentlemen there in the 90s did some terrific innovation and we acquired all of the rights from Corbis from their work and then nurtured it into one of the foundational elements of the portfolio. So we’re quite grateful to Corbis and to Bill Gates for giving us that opportunity, and to the gentlemen who created the innovations.

So Corbis not only is a source of intellectual property for us, but our oldest customer in terms of relationship. They have been our customer now since 1996. And we have been doing some unprecedented R&D in the print and imaging space this year [apply] our headcount went up. We hired 10 engineers at the start of the year here and invested significantly greater resources in R&D and much of that relates to print and imaging facilitating work like we do with Corbis on the imaging side and then enhancing our prospects for the mobile space and the recognition of print materials as a portal to web services.

So in the digital imaging space, were Corbis operates we are working with some prospective partners to develop a broader and richer more valuable offering for customers like Corbis that we hope to be able to talk in detail about before the end of this year. That will hopefully significantly increase the use of our technology in digital imaging space, stock photography, commercial photography, journalism, marketing of goods and services and so forth.

So that's the area of intense research and development activity today, and Corbis is aware of what we are doing and supportive and providing helpful advice to us in that process.

Kevin Henehan - KMH Capital Advisors

Okay. Thanks, Bruce, that's great. And I have second question which is basically a similar question that I asked I think in the call last November, in this regard the rollout of the digital cinema and they were trying to get some funding to accelerate the rollout of digital cinema. And I think they had some kind of commitment from an organization to help them to do that but then the credit markets almost ceased completely.

So now that the credit market seem to have a slightly better tone, it's lifted a little bit, have you seen anything on that front in terms of I think their interim (inaudible) to rollout the digital cinemas faster?

Bruce Davis

Yeah I think your characterization is consistent with my impression which is that they are squeezed for capital right now like everyone else and so it will probably not rollout as fast as they thought it would last year. But they continue to roll it out and I know they are committed to it and I think that they are enjoying some of the expected benefits, substantial benefits of digital distribution and a fact from our work with the studios that all of the studios are anticipating going all what they called file based as quickly as possible, which means there will be no film being used in the process at some point in the future at the major studio. So they are all going to file based. So digital cinema is where it's going to be.

The question of how quick though, which is [fairly] a capital access question.

Kevin Henehan - KMH Capital Advisors

And then, it would help your revenues from digital cinema going forward as it rolls out?

Bruce Davis

Yes. Absolutely.

Operator

Your next question is a follow-up from the line of [Paul Sons of Sons Partners].

Paul Sons - Sons Partners

Just one follow-up, on the JV 2 for the transformational television, is there anything more you can say about what that would look like, I mean literally?

Bruce Davis

No, it wouldn’t be appropriate. We have some work to do and some preparation and when we describe what we’re doing, we want to be quite articulate about it and position what we are doing properly. It's braver to pull it off -- it's really quite a big deal and so I don’t want to leak out different pieces about it and have people perhaps speculating wrong about what we are doing, rather wait until we are ready to tell the world what's up and then see if we can have a big impact.

Paul Sons - Sons Partners

Okay. Let me follow up and ask a different question, which in some way has something to do with it, but also your traditional business. To get to where we are, it took a while because you had to build this sort of an infrastructure where people consume your product and you had to seed the market. At this point, with the products you’re looking at, what percentage of the stuff you’re looking at would require more infrastructure to be built out before they could consume your product. For example, if it's in television, would it require new equipment to be given for people to buy or for distributors to get out to the hands of consumers. In terms of walking seeing computer, is there other technological innovations that would have to be developed and then distributed before they could consume your product?

Bruce Davis

I think you should have been a lawyer Paul. I feel like I am being deposed here. You will not cleverly get into disclosing that which I chose not to disclose.

Paul Sons - Sons Partners

All right, that’s fine, but can you just – forget the television then. But in general, is there any it’s sort of a timing thing, trying to understand –

Bruce Davis

Well, yes –

Paul Sons - Sons Partners

And if you want to –

Bruce Davis

I know what you are trying to do. With respect to the broader set of initiatives, they actually are in different application areas. The first few that we are underway on and I think if you want to look directionally at market opportunity, that what I believe is the most rapidly developing and interesting space is mobile.

Paul Sons - Sons Partners

Right.

Bruce Davis

There is lot of stuff going on there and we anticipated that and we have relevant IP, and so we are quite excited about that space. And one thing that I was talking about R&D kind of this question probably to say a little bit about our digital imaging R&D. Likewise we are making excellent progress on R&D and in the print area. And what we anticipate on full length quite rapidly here over the next few years is a desire by major players to want to have mobile phones recognize what they see. And so there are a few different ways in which that is currently being done. For example, it's being done based on finger printing.

Paul Sons - Sons Partners

Right.

Bruce Davis

It's being done based on image analysis that is comparing characteristics of images against the database, but not a finger print, not a [hash], not an extract, just looking at the image, sending the whole image of some place to be analyzed. It's being done by crowd sourcing where you take a picture of something and people in lower income areas of the world sit around on their computers and guess that what it is, and when they guess right they get paid a few pennies here and there.

So lot of ways of time to identify objects that are being tried and we think we have the superior means of doing that for most objects, but not the only means. And so our IP relates not only the best means, which we think is part of digital watermarking, but other means as well. And so as people move down that path they are going to find us more relevant to them as they move further down the path, ditto audio recognition. So, that's the area if you want to sort of keep an eye on the market, that’s as very interesting space.

Operator

There are no further questions at this time.

Bruce Davis

All right thanks everyone. We appreciate your support and your interest and we’ll keep (inaudible) we can here. We look forward to talking to you again next quarter. Have a good day.

Operator

This concludes today's conference call you may now disconnect.

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