Digimarc Corporation
Q3 2012 Earnings Call Transcript

Published: 26 Oct 2012

[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:]

Good afternoon. Thank you for participating in today's conference call. Welcome. Michael McConnell, our CFO, is with me. On our call today, we will review and discuss Q3 2012 financial results, talk about significant business developments and market conditions and provide an update on our strategy and operations. This webcast will be archived in the Investor Relations section of our website. Please note that during the 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. These statements are subject to many assumptions, risks, uncertainties and changes in circumstances. Any assumptions we share about future performance represent a point-in-time estimate. Actual results may vary materially from those expressed or implied by such statements. We expressly disclaim any obligation to revise or update any assumptions, projections or other forward-looking statements to reflect events or circumstances that may arise after the date of this call. For more information about risk factors that may cause actual results to differ from expectations, please see the company's filings with the SEC, including our latest Form 10-K. Now Mike will begin by commenting on our financial results, then I'll discuss our execution strategy and outlook. Mike?

[Michael McConnell:]

Thanks, Bruce, and good afternoon, everyone. Revenues for the quarter was $8.9 million for 2012, an increase of 4% from $8.6 million in the third quarter of 2011. Our licensing revenues increased 16%, primarily due to increased revenues from Intellectual Ventures and Verance. Our service revenues were down 16%, mostly due to the suspension of the joint ventures with Nielsen in the first quarter. Our gross margin increased 84% in the current quarter from a year ago and primarily due to a higher proportion of licensing revenues versus service revenue. Our operating income increased 11% to $1.6 million or 18% of revenues in the third quarter from $1.4 million or 17% of revenues in the same quarter a year ago. And the increase is primarily due to higher gross margin. Our pretax income more than doubled to $1.6 million, due largely to the elimination of approximately $700,000 of Nielsen joint venture losses recorded in the year ago quarter that were not incurred this quarter due to the previously announced suspension of the joint venture operations with Nielsen. Our income taxes were 39% of pretax income for the quarter compared to 17% in the prior year, with the 2012 results reflecting a more normalized tax rate after benefiting from utilization of NOLs and deferred tax assets in 2011. Our net income increased by 57% to $1 million this quarter compared to $600,000 in the third quarter of last year. Our balance sheet remains in excellent shape with about $43 million of cash and market securities and no long-term debt. Our operating cash flow was $1.3 million or 15% of revenues, and we purchased about 73,000 shares of common stock during the quarter at an average price of $23.44. Our financial performance, thus far, in 2012 is within the range of our expectations at the start of the year. Note that the current year's licensing revenues reflect the $8 million past due royalty payment from Verance received in Q1 of this year, and the current year service revenues reflect approximately $1.8 million lower revenues from the Nielsen joint ventures. Excluding the impact of the Nielsen joint ventures and the Verance items from our revenues, we see a 6% revenue growth year-to-date in 2012 versus 2011, and the primary contributors to this growth was in licensing from Intellectual Ventures and in our government services area. And finally, I'm pleased to note that Digimarc's Board of Directors has declared a cash dividend of $0.11 per share of the company's common stock. The dividend is payable on November 20 to shareholders of record as of the close of business on November 6, 2012. For a further discussion of our financial results and risks and prospects of our business, please refer to our Form 10-Q for the third quarter that we expect to file very soon. Bruce will now provide his comments on our execution of strategy and outlook.

[Bruce Davis:]

Thanks, Mike. The level of activity on all fronts escalated in Q3. I'll touch on some of the highlights that are ripe for public disclosure. First, I'm pleased to announce that we've agreed on a budget for 2013 with our Central Bank customers that anticipates approximately 14% revenue growth with higher gross margins. Next, concerning Intellectual Ventures. And as you know, our agreement with IV provides a 20% profit participation after contractually authorized costs are deducted from revenues attributable to our portfolio. As previously discussed, we have received 2 profit participation reports from IV

[Operator:]

[Operator Instructions] You have a question from Walter Schenker of MAZ Partners.

[Walter Schenker:]

Listening to a very long menu of things you're hoping to accomplish or move forward on in 2013. The first item, which is government you indicated, you gave us some indication of what at least the revenue implications might be. As you look down that list, which items should start to generate meaningful incremental revenue -- incremental -- meaningful to a whole company in 2013 [ph] incrementally and which are early still in development as you move forward and probably won't be showing up in 2013 in any meaningful way in the company's revenue? I mean, can you semi-prioritize or give us some feel for at least from a revenue standpoint, which are more significant?

[Bruce Davis:]

Sure. The Central Bank business is the easiest to project because we have a budget, okay? And that's why I called that out specifically. We will continue to get license income from all of our existing license sources, all of whom can grow. And some of those are on a payment schedule, in essence, so are not likely to grow a lot. Others are more variable, could decline or grow. One of the significant expected growth areas is in Digimarc Discover, in the publishing industry. We also have a number of other initiatives that are too early to speculate as to 2013 revenue production, having to do with the various relationships that we're putting in place. And the last piece, of course, is Intellectual Ventures and whether there will be profit participation in the March reporting -- March 2013 report.

[Walter Schenker:]

And then just one more question. On the -- since you brought it out, on the publishing industry and the use of Digimarc Discover, the per-application fee is very low but you're therefore expecting that, when we have this call a year from today, you'll be able to call out that operation as being a -- hopefully being a noticeable in the incremental growth of the business. That's a correct statement?

[Bruce Davis:]

Yes, that's what we hope will be true, Walter. As we look at the early development of the market here, again, not done through enough early market development to not get too far ahead of the curve on trying to project how trends will go. Because they can go up, down and all around for while. But we think if we can get the publishing industry to appreciate the opportunity that our technology provides to the brands, that is to the entire brand of any publisher, not just to their print publication but to their digital editions as well. If they will understand that and they will go to routine use rather than experimental use, we actually think we'll begin making quite good money as early as next year. But there are a bunch ifs in there that we have to work our way through in order to get to the sustainable, large income stream. Now the activities that we have succeeded in delivering so far is a very, very small share of the addressable market. So looking at different metrics and market data available to us, we're somewhere ranging from less than 1% to between 1% and 2% penetrated, using different measures of market penetration. So if we could just get to, say, 10% or 15%, we would have a very nice business. So we're going to try to figure out how to get this past the experimental phase during the remainder of this year and going into '13. So that's the critical assumption on the publishing business.

[Walter Schenker:]

Okay. And just -- and I'll get off. I would -- as a shareholder, I appreciate that you've been buying stock. And hopefully, you will continue to do it, since I think it will accrete pretty good value to us over time.

[Operator:]

Your next question comes from Paul Sonz of Sonz Partners.

[Paul D. Sonz:]

The question I have is, Bruce, you talked about the revenues in the Intellectual Ventures deal. Are the revenues open to interpretation? Or have you settled on that -- is that the revenues numbers you gave us agreed upon now and that's settled and now you just moved on to talking about the allocation of expenses?

[Bruce Davis:]

Let me see if I can give you a clear answer to that. So we gave you a couple of numbers. We gave you revenue recognized and received and then an estimate of additional revenue that hasn't yet been received. So the first part of that is reported revenue received. The second part is an estimate, our estimate, okay? Just to be clear about that. With respect to all aspects of the reports, our study and discussions are still under way. And so there could be some changes in any of the numbers that I've given you. I'm more confident about the revenue numbers than the expense numbers at this point in time, that's why I shared the revenue numbers. I think they're reasonable estimates.

[Paul D. Sonz:]

All right. And then the second revenue number you gave us, it represents revenue that, under no circumstances, would be considered to have been received this year but is subject to be -- to receipt over the next 4, 5, 6 years, whatever, I can't remember the number of years you gave me.

[Bruce Davis:]

Yes. The way the profit participation is defined in our relationship, the revenues have to be both recognized and received to count. The expenses, however, particularly those associated with the money being paid to us, are accrued even before paid.

[Paul D. Sonz:]

Got it. I see, I see. In terms of the -- can you give us a sense of how meaningful the discrepancy is between yourself and IV?

[Bruce Davis:]

No.

[Operator:]

The next question comes from Keith Maher of Singular Research.

[Keith Maher:]

Just letting you know, I got knocked off there at the start of the QA – the Q&A, so if I ask a question that's already been asked, just let me know and I can go back to the transcript. But with the -- starting just with regard to the work with the Central Bank, is this an expansion in the scope of the work? Or is it just increased pricing that's driving, I think you said, a 14% growth next year?

[Bruce Davis:]

Yes, it's both.

[Keith Maher:]

Okay. Could you talk -- I mean, could you divide it up or...

[Bruce Davis:]

No, we don't want to get into that level of granularity on an individual contract.

[Keith Maher:]

Okay. Okay. Okay, sure. Next, with -- on the Intellectual Ventures differences you're having. If you cannot amicably resolve this, I mean, would you need to go into -- would the next step, for example, be arbitration? I mean, I assume that might be in the contract. I mean, can you talk any about that? Or how you would resolve some of these differences?

[Bruce Davis:]

Yes. I don't want to forecast the failure of our discussions here. We'll go where we need to go in order to get to a fair result. At this point in time, we're continuing to have meaningful discussions with our colleagues there, and we hope to work out a way in which we can maximize the profit from the portfolio and share reasonably in it. And I think that's certainly our goal, and I believe they share that. We just have some different views on how the accounting is -- has been done and some continuing uncertainty regarding some of the items. So we're working that through, and we'll see where it ends up. I don't know where it will end up just yet, but I'm optimistic.

[Keith Maher:]

Okay, fair enough. And finally, you were talking about the operating budget next year, kind of not needing to increase that. Is R&D separate from that? Or were you just talking about SG&A in the operating budget?

[Bruce Davis:]

It's total budget. Even though I outlined an ambitious and sophisticated agenda for 2013, much of what we're doing in '13 is bringing together the elements of the platform into what we hope will be valuable demonstrations of capability and expanded license opportunities. And so nothing of what we're talking about there is new to '13. But rather than working on the pieces, as we've been working on the pieces in prior years, we're more focused on bringing those pieces together in '13, both at a development level and a marketing level.

[Operator:]

[Operator Instructions] Your next question comes from Kevin Hanrahan [ph] of KMH Capital Advisors.

[Unknown Analyst:]

Bruce, I had a question about the IV relationship, but not similar to the other ones we've heard. When you announced that deal about 2 years ago, and I was in your office I think the next day, you were talking at that time about service contracts. As -- hopefully, the patent portfolio would generate more license deals, but no one would know how to implement them better than Digimarc. So can you tell us, in addition to those numbers you mentioned, I think $27 million and $23 million to be recognized over time, do you have any service revenues yet that have been generated from the IV deal?

[Bruce Davis:]

You're talking about providing implementation services to licensees.

[Unknown Analyst:]

Yes, that's right. Yes.

[Bruce Davis:]

Yes. That hasn't played out yet, and it was an assumption that I had, including the other relationships. I'm still not sure it's a failed assumption, it just hasn't happened yet. So there are some indications that it may prove to be a good one but may take a little more time. And this goes to another point that I've tried to make and I hope everyone appreciates, is that, whatever our complexities in our relationship with Intellectual Ventures may be, the key to our mutual success is generating greater adoption of our technology. And so the big players are still heading in the right direction but not there yet. So that would explain why I'd say what I would do with respect to potential implementation services. But I'm still hoping the big guys are going to get onboard pretty soon. And when they do, I hope they'll come to us for help. We'll be happy to give it to them. But when you look around, there are lots of good leading indicators, seem to be indicating that the big players are moving in the right direction. Particularly, for instance, Yahoo!'s conference call earlier in the week said focus on mobile, a lot of criticisms from the financial community about Facebook and Google not having robust mobile strategies. I remain firmly convinced that the future of Discovery with the mobile device is not typing in keywords with your thumbs. I know that's not the answer. And I believe we have a lot of invention that is relevant to the right answer and a lot of patent coverage over it. So I think it's all going to work out, but it's really a question of the pace of development in the market that we can't influence. So we just got to ride along and make sure that we're there and in a good shape to get our fair share when it comes.

[Unknown Analyst:]

So no service revenue for implementation yet. Would you think there might be a small amount next year?

[Bruce Davis:]

There's actually not none.

[Unknown Analyst:]

Or do you think it might take longer?

[Bruce Davis:]

There's actually not none. There's some, but it's not material.

[Unknown Analyst:]

Not material, okay. And If I can ask Mike a question, Mike, you said you brought back 73,000 shares during Q3. Can you break that down for us and tell us how many were bought back on the open market versus how many were bought back for a tax thing for shares that might have been sold by insiders.

[Michael McConnell:]

Yes. I think I have that information here. The shares in the open market were about 13,000, and the remaining was for the tax -- primarily the tax swap for options and shares from employees.

[Unknown Analyst:]

So about 60,000 shares for the employees.

[Michael McConnell:]

Yes, correct.

[Operator:]

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

[Bruce Davis:]

Thank you very much. And thank you to everyone who participated in the call. We appreciate your involvement in the company and look forward to updating you again in about 3 or 4 months, a little bit longer here because it will be end of the year. So we'll talk to you in February. Thank you.

[Operator:]

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