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DMRC > SEC Filings for DMRC > Form 10-Q on 26-Oct-2012All Recent SEC Filings

Show all filings for DIGIMARC CORP

Form 10-Q for DIGIMARC CORP


26-Oct-2012

Quarterly Report


Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations

The following Management's Discussion and Analysis of Financial Condition and Results of Operations contains forward-looking statements relating to future events or the future financial performance of Digimarc, which involve risks and uncertainties. Our actual results could differ materially from those anticipated in these forward-looking statements. Please see the discussion regarding forward-looking statements included in this Quarterly Report on Form 10-Q under the caption "Safe Harbor Statement under the Private Securities Litigation Reform Act of 1995."

The following discussion should be read in conjunction with our financial statements and the related notes and other financial information appearing elsewhere in this Quarterly Report on Form 10-Q. Readers are also urged to carefully review and consider the disclosures made in Part II, Item 1A (Risk Factors) of this Quarterly Report on Form 10-Q and our Annual Report on Form 10-K for the year ended December 31, 2011 filed on February 24, 2012 (the "2011 Annual Report") and in the audited financial statements and related notes included in our 2011 Annual Report, and other reports and filings made with the Securities and Exchange Commission ("SEC").

Unless the context otherwise requires, references in this Quarterly Report on Form 10-Q to "Digimarc," "we," "our" and "us" refer to Digimarc Corporation.

All dollar amounts are in thousands, unless otherwise noted.

Digimarc Discover is a registered trademark of Digimarc Corporation. This Quarterly Report on Form 10-Q also includes trademarks and trade names owned by other parties, and all such trademarks and trade names mentioned in this Quarterly Report on Form 10-Q are the property of their respective owners.

Overview

Digimarc Corporation enables governments and enterprises around the world to give digital identities to media and objects that computers can sense and recognize and to which they can react. Our technology provides the means to infuse persistent digital information, perceptible only to computers and digital devices, into all forms of media content. The unique digital identifier placed in media generally persists with it regardless of the distribution path and whether it is copied, manipulated or converted to a different format, and does not affect the quality of the content or the enjoyment or other traditional uses of it. Our technology permits computers and digital devices to quickly identify relevant data from vast amounts of media content.

Our technologies, and those of our licensees, span a range of media content, enabling our customers and those of our partners to:

Quickly and reliably identify and effectively manage music, movies, television programming, digital images, documents and other printed materials, especially in light of new non-linear distribution over the internet;

Deter counterfeiting of money, media and goods, and piracy of movies and music;

Support new digital media distribution models and methods to monetize media content;

Leverage the power of ubiquitous computing to instantly link consumers to a wealth of information and/or interactive experiences related to the media and objects they encounter each day;

Provide consumers with more choice and access to media content when, where and how they want it;

Enhance imagery and video by associating metadata or authenticating media content for government and commercial uses; and

Better secure identity documents to enhance national security and combat identity theft and fraud.

At the core of our intellectual property is a signal processing technology innovation known as "digital watermarking" which allows imperceptible digital information to be embedded in all forms of digitally designed, produced or distributed media content and some physical objects, including photographs, movies, music, television, personal identification documents, financial instruments, industrial parts and product packages. The digital information can be detected and read by a wide range of computers, mobile phones, and other digital devices.

Digital watermarking allows our customers to embed digital data into any media content that is digitally processed at some point during its lifecycle. The technology can be applied to printed materials, video, audio, and images. The inclusion of these digital signals enables a wide range of improvements in security and media management, and new business models for distribution and consumption of media content. Over the years our technology and intellectual property portfolios have grown to encompass many related technologies.


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We provide solutions directly and through our licensees. Our proprietary technology has proven to be a powerful element of document security, giving rise to our long-term relationship with a consortium of central banks ("Central Banks"), and many leading companies in the information technology industry. We and our licensees have successfully propagated digital watermarking in music, movies, television broadcasts, images and printed materials. Digital watermarks have been used in these applications to improve media rights and asset management, reduce piracy and counterfeiting losses, improve marketing programs, permit more efficient and effective distribution of valuable media content and enhance consumer entertainment and commercial experiences. Our patent portfolio contains a number of innovations in digital watermarking, pattern recognition (sometimes referred to as "fingerprinting"), digital rights management and related fields. To protect our significant efforts in creating our technology, we have implemented an extensive intellectual property protection program that relies on a combination of patent, copyright, trademark and trade secret laws, and nondisclosure agreements and other contracts. As a result, we believe we have one of the world's most extensive patent portfolios in digital watermarking and related fields, with greater than 1,200 U.S. and foreign patents and pending patent applications as of September 30, 2012. We continue to develop and broaden our portfolio of patented technology in the fields of media identification and management technology and related applications and systems. We devote significant resources to developing and protecting our inventions and continuously seek to identify and evaluate potential licensees for our patents.

For a discussion of activities and costs related to our research and development, please read the section titled "Research, development and engineering" below.

Critical Accounting Policies and Estimates

Detailed information on our critical accounting policies and estimates are set forth in our 2011 Annual Report in Part II, Item 7, "Management's Discussion and Analysis of Financial Condition and Results of Operations," under the section entitled "Critical Accounting Policies and Estimates," which is incorporated by reference into this Quarterly Report on Form 10-Q.

Results of Operations

The following table presents statements of operations data for the periods indicated as a percentage of total revenue. Unless otherwise indicated, all references in this Management's Discussion and Analysis of Financial Condition and Results of Operations to the three- and nine-month periods relate to the three- and nine-month periods ended September 30, 2012 and all changes discussed with respect to such period reflect changes compared to the three- and nine-month periods ended September 30, 2011.

                                         Three                   Three                   Nine                    Nine
                                        Months                  Months                  Months                  Months
                                         Ended                   Ended                   Ended                   Ended
                                     September 30,           September 30,           September 30,           September 30,
                                         2012                    2011                    2012                    2011
Revenue:
Service                                          29 %                    36 %                    24 %                    34 %
License and subscription                         71                      64                      76                      66

Total revenue                                   100                     100                     100                     100
Cost of revenue:
Service                                          15                      19                      13                      18
License and subscription                          1                       1                       1                       1

Total cost of revenue                            16                      20                      14                      19
Gross profit                                     84                      80                      86                      81
Operating expenses:
Sales and marketing                              11                      14                       8                      12
Research, development and
engineering                                      26                      23                      18                      21
General and administrative                       26                      23                      21                      26
Intellectual property                             3                       3                       3                       3

Total operating expenses                         66                      63                      50                      62

Operating income                                 18                      17                      36                      19

Net loss from joint ventures                     -                       (8 )                    (3 )                    (7 )
Interest income, net                             -                       -                       -                        1

Income before provision for
income taxes                                     18                       9                      33                      13
(Provision) benefit for income
taxes                                            (7 )                    (2 )                   (12 )                     6

Net income                                       11 %                     7 %                    21 %                    19 %


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Summary

Total revenue for the three-month period ended September 30, 2012, compared to the corresponding three-month period ended September 30, 2011, increased 4% to $8.9 million primarily as a result of increased license payments from Intellectual Ventures ("IV") and Verance Corporation ("Verance"), offset primarily by no revenue from the joint ventures with The Nielsen Company ("Nielsen") due to the suspension of operations in the first quarter of 2012.

Total revenue for the nine-month period ended September 30, 2012, compared to the corresponding nine-month period ended September 30, 2011, increased 29% to $35.1 million primarily as a result of the $8.0 million past due royalties payment from Verance received in the first quarter in connection with the resolution of our litigation with Verance and increased license payments from IV and Verance, partially offset by lower revenue from the joint ventures with Nielsen.

Total operating expense for the three- and nine-month periods ended September 30, 2012, compared to the corresponding three- and nine-month periods ended September 30, 2011, increased slightly primarily as a result of increased investment in research and development and increased stock-based compensation, due to higher headcount and an additional layer of stock-based awards.

Revenue



                                                  Three                  Three                                                          Nine                   Nine
                                                 Months                 Months                                                         Months                 Months
                                                  Ended                  Ended               Dollar             Percent                 Ended                  Ended                Dollar             Percent
                                              September 30,          September 30,          Increase            Increase            September 30,          September 30,           Increase            Increase
                                                  2012                   2011              (Decrease)          (Decrease)               2012                   2011               (Decrease)          (Decrease)
Revenue:
Service                                      $         2,616        $         3,108        $      (492 )               (16 )%      $         8,273        $         9,342        $     (1,069 )               (11 )%
License and subscription                               6,287                  5,442                845                  16 %                26,788                 17,772               9,016                  51 %

Total                                        $         8,903        $         8,550        $       353                   4 %       $        35,061        $        27,114        $      7,947                  29 %

Revenue (as % of total revenue):
Service                                                   29 %                   36 %                                                           24 %                   34 %
License and subscription                                  71 %                   64 %                                                           76 %                   66 %

Total                                                    100 %                  100 %                                                          100 %                  100 %

We derive our revenue primarily from:

1) development services provided to government and commercial customers and

2) licensing our patents.

Service. Service revenue consists primarily of software development and consulting services. The majority of service revenue arrangements are structured as time and materials consulting agreements, or fixed price consulting agreements. The majority of our services revenue is derived from contracts with the Central Banks, IV, the joint ventures with Nielsen in the prior periods, and to a lesser extent government contractors and/or agencies. The agreements range from several months to several years in length, and our longer term contracts are subject to work plans that are reviewed and agreed upon at least annually. These contracts generally provide for billing hours worked at predetermined rates and, to a lesser extent, for cost reimbursement for third party costs and services. Increases or decreases in the services provided under these contracts are generally subject to both volume and price changes. The volume of work is generally negotiated at least annually and can be


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modified as the customer's needs change. We also have provisions in our longer term contracts that allow for specific hourly rate price increases on an annual basis to account for cost of living variables. Contracts with government agencies, other than the Central Banks, are generally shorter term in nature, are less linear in billings and less predictable than our longer term contracts because the contracts with government agencies, other than the Central Banks, are subject to government budgets and funding.

The decreases in service revenue for the three- and nine-month periods ended September 30, 2012, compared to the corresponding three- and nine-month periods ended September 30, 2011, was due primarily to no activity in the three-month period and lower activity in the nine-month period in the joint ventures, due to the suspension of operations, and the timing of program work from the Central Banks.

License and subscription. License revenue originates primarily from licensing our technology and patents where we receive royalties as our income stream. Subscription revenue consists primarily of royalty revenue related to various software products, which are more recurring in nature. Revenues from our licensed products have minimal associated direct costs, and thus are highly profitable.

The increases in license and subscription revenue for the three- and nine-month periods ended September 30, 2012, compared to the corresponding three- and nine-month periods ended September 30, 2011, was due primarily to increased license payments from IV and Verance, and the $8.0 million past due royalties payment from Verance received in the first quarter in connection with the resolution of our litigation with Verance.

Revenue by Geography



                                           Three                  Three                                                          Nine                   Nine
                                          Months                 Months                                                         Months                 Months
                                           Ended                  Ended               Dollar             Percent                 Ended                  Ended
                                       September 30,          September 30,          Increase            Increase            September 30,          September 30,           Dollar          Percent
                                           2012                   2011              (Decrease)          (Decrease)               2012                   2011               Increase         Increase
Revenue by geography:
Domestic                              $         5,830        $         5,221        $       609                  12 %       $        24,923        $        17,321        $    7,602               44 %
International                                   3,073                  3,329               (256 )                (8 )%               10,138                  9,793               345                4 %

Total                                 $         8,903        $         8,550        $       353                   4 %       $        35,061        $        27,114        $    7,947               29 %

Revenue (as % of total revenue):
Domestic                                           65 %                   61 %                                                           71 %                   64 %
International                                      35 %                   39 %                                                           29 %                   36 %

Total                                             100 %                  100 %                                                          100 %                  100 %

The increases in domestic revenue for the three- and nine-month periods ended September 30, 2012, compared to the corresponding three- and nine-month periods ended September 30, 2011, was due primarily to higher license and royalty payments from Verance and IV, partially offset by no activity in the three-month period and lower activity in the nine-month period in the joint ventures.

The decrease and increase in international revenue for the three- and nine-month periods ended September 30, 2012, respectively, compared to the corresponding three- and nine-month periods ended September 30, 2011, was due primarily to the timing of program work from the Central Banks.

We anticipate full year revenue growth for 2012, compared to 2011, from our existing customers and from new customers as we continue to expand the marketing and monetization of our intellectual property portfolio.

Cost of Revenue

Service. Cost of service revenue primarily includes costs that are allocated from research, development, engineering, intellectual property and sales and marketing that relate directly to performing services under our customer contracts, and, to a lesser extent, direct costs of program delivery. Allocated costs include:

salaries, payroll taxes and fringe benefits, incentive compensation and related costs of our software developers, quality assurance personnel, product managers, business development managers and other personnel where we bill our customers for time and materials costs;

payments to outside contractors that are billed to customers;


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charges for equipment directly used by the customer;

depreciation charges for machinery, equipment and software directly used by the customer;

travel costs directly attributable to service and development contracts; and

charges for infrastructure and centralized costs of facilities and information technology.

License and subscription. Cost of license and subscription revenue primarily includes:

patent or software license costs for any patents licensed from third parties where the party receives a portion of royalties or license revenue received by Digimarc;

internet service provider connectivity charges and image search data fees to support the services offered to our subscription customers; and

amortization of capitalized patent costs.

Changes in cost of revenue generally correspond with the volume of and mix in revenues.

Gross Profit



                                                  Three                  Three                                                          Nine                   Nine
                                                 Months                 Months                                                         Months                 Months
                                                  Ended                  Ended               Dollar             Percent                 Ended                  Ended                Dollar             Percent
                                              September 30,          September 30,          Increase            Increase            September 30,          September 30,           Increase            Increase
                                                  2012                   2011              (Decrease)          (Decrease)               2012                   2011               (Decrease)          (Decrease)
Gross Profit:
Service                                      $         1,254        $         1,443        $      (189 )               (13 )%      $         3,729        $         4,479        $       (750 )               (17 )%
License and subscription                               6,182                  5,365                817                  15 %                26,472                 17,554               8,918                  51 %

Total                                        $         7,436        $         6,808        $       628                   9 %       $        30,201        $        22,033        $      8,168                  37 %

Gross Profit (as % of related revenue
components):
Service                                                   48 %                   46 %                                                           45 %                   48 %
License and subscription                                  98 %                   99 %                                                           99 %                   99 %
Total                                                     84 %                   80 %                                                           86 %                   81 %

The decreases in service gross profit for the three- and nine-month periods ended September 30, 2012, compared to the corresponding three- and nine-month periods ended September 30, 2011, was due primarily to no activity in the three-month period and lower activity in the nine-month period in the joint ventures.

The increases in license and subscription gross profit for the three- and nine-month periods ended September 30, 2012, compared to the corresponding three- and nine-month periods ended September 30, 2011, was due primarily to the payments from IV and Verance.

The increases in gross profit as a percentage of revenue for the three- and nine-month periods ended September 30, 2012, compared to the corresponding three- and nine-month periods ended September 30, 2011, was due primarily to changes in revenue mix resulting in higher license revenue, which carries a higher margin than service revenue, as a percent of total revenue. The increase and decrease in service gross profit as a percentage of revenue for the three- and nine-month periods ended September 30, 2012, respectively, compared to the corresponding three- and nine-month periods ended September 30, 2011, resulted from changes in services cost mix provided in our various contracts.

Operating Expenses

We allocate certain costs of sales and marketing, research, development and engineering and intellectual property (primarily for support services provided to IV) to cost of service revenue when they relate directly to our service contracts.

We record all remaining, or "residual," operating costs as sales and marketing, research, development and engineering, general and administrative, and intellectual property expenses.


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Sales and marketing

                                          Three                  Three                                                      Nine                   Nine
                                         Months                 Months                                                     Months                 Months
                                          Ended                  Ended                                                      Ended                  Ended
                                      September 30,          September 30,           Dollar           Percent           September 30,          September 30,           Dollar           Percent
                                          2012                   2011               Decrease         Decrease               2012                   2011               Decrease         Decrease
Sales and marketing                  $           937        $         1,166        $     (229 )            (20 )%      $         2,914        $         3,285        $     (371 )            (11 )%
Sales and marketing (as % of
total revenue)                                    11 %                   14 %                                                        8 %                   12 %

Sales and marketing expenses consist primarily of:

compensation, benefits and related costs of sales and marketing employees and product managers;

travel and market research costs, and costs associated with marketing programs, such as trade shows, public relations and new product launches;

professional services and outside contractors for product and marketing initiatives;

incentive compensation in the form of stock-based compensation expense; and

charges for infrastructure and centralized costs of facilities and information technology.

The decrease in sales and marketing expenses for the three-month period ended September 30, 2012, compared to the corresponding three-month period ended September 30, 2011, resulted primarily from decreased marketing and professional fees of $0.3 million related to the introduction of our Digimarc Discover Platform in 2011.

. . .

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