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DMRC > SEC Filings for DMRC > Form 10-Q on 25-Apr-2014All Recent SEC Filings

Show all filings for DIGIMARC CORP

Form 10-Q for DIGIMARC CORP


25-Apr-2014

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 consolidated 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, 2013 filed on February 21, 2014 (the "2013 Annual Report") and in the audited consolidated financial statements and related notes included in our 2013 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 except per share amounts or unless otherwise noted. Percentages within the following tables may not foot due to rounding.

Digimarc Discover and Digimarc Guardian (pending) are registered trademarks of Digimarc Corporation. This Quarterly Report on Form 10-Q also includes trademarks and trade names owned by other parties, and all other 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, "Digimarc IDs," 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 numerous applications across a wide range of media content, enabling our customers and those of our partners to:

• Improve the speed of retail checkout;

• Provide simple and intuitive mobile customer engagement experiences in stores;

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

• Deter counterfeiting of money, media and goods, and piracy of e-books, 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 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.


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Our technology allows our customers to provide persistent digital identities for 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.

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, which we refer to as the 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. Digimarc IDs 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.

Digimarc IDs are easily embedded into all forms of media and are imperceptible to human senses, but quickly detected by computers, networks or other digital devices like smartphones. Unlike traditional barcodes and tags, our solution does not require publishers to give up valuable space in magazines and newspapers; nor does it impact the overall layout or aesthetics of the publication. Our Digimarc Discover™ platform delivers a range of rich media experiences to its readers on their smartphones across multiple media including print, audio, video and packaging. Unique to the Digimarc Discover platform is its ability to use various content identification technologies as needed, including our patented technology.

As part of the Digimarc Discover platform, we recently introduced Digimarc Barcodes, which contain the same type of information found in traditional product UPC codes, but is invisibly repeated multiple times over the entire packaging. We have partnered with Datalogic, a global leader in Automatic Data Capture and Industrial Automation markets and producer of barcode readers, who has enabled its new MagellanTM 9800i multi-plane imaging scanner to detect and process Digimarc Barcodes. Digimarc Barcodes can also connect mobile-enabled consumers directly from packaging to engaging mobile experiences such as additional product information, special offers, recommendations, reviews, social networks and more.

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 more than 1,250 U.S. and foreign patents and pending patent applications as of March 31, 2014. 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. The patents in our portfolio have a life of approximately 20 years from invention date, and up to 17 years after the patent has been granted.

As part of our intellectual property marketing and patent monetization efforts, our key objectives in building relationships with potential customers and partners are to:

• make progress toward the realization of our vision to enrich everyday living via pervasive, intuitive computing;

• expand the scope of our license program;

• more effectively monetize our patent assets;

• encourage large scale adoption of our technologies by industry leaders;

• improve our financial performance;

• increase the scale and rate of growth of our products and services business; and

• lay a foundation for continuing innovation.

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


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Critical Accounting Policies and Estimates

Detailed information on our critical accounting policies and estimates are set forth in our 2013 Annual Report in Part II, Item 7 thereof ("Management's Discussion and Analysis of Financial Condition and Results of Operations"), under the caption "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-month period relate to the three-month period ended March 31, 2014 and all changes discussed with respect to such period reflect changes compared to the three-month period ended March 31, 2013.

                                                   Three             Three
                                                  Months            Months
                                                   Ended             Ended
                                                 March 31,         March 31,
                                                   2014              2013
        Revenue:
        Service                                          41 %              29 %
        Subscription                                     20                14
        License                                          39                58

        Total revenue                                   100               100
        Cost of revenue:
        Service                                          20                14
        Subscription                                      9                 6
        License                                           1                 1

        Total cost of revenue                            30                21
        Gross profit                                     70                79
        Operating expenses:
        Sales and marketing                              26                12
        Research, development and engineering            49                27
        General and administrative                       34                21
        Intellectual property                             7                 3

        Total operating expenses                        116                63
        Operating income (loss)                         (46 )              16

        Other income, net                                -                 -

        Income (loss) before income taxes               (46 )              16
        (Provision) benefit for income taxes             18                (7 )

        Net income (loss)                               (28 )%              9 %

Summary

During 2013, we increased the level of investment in our product development and sales growth initiatives. These initiatives include developing and marketing Digimarc Discover, the Digimarc Barcode and other aspects of our Intuitive Computing Platform as well as further developing our retained patent assets and exploring strategic opportunities in the mobile payments market. We expect to maintain a similar level of investment for these initiatives during 2014 as we made in the second half of 2013.

Total revenue for the three-months ended March 31, 2014 decreased 30% to $7.2 million compared to the same period in 2013 primarily due to the end of the quarterly license fee payments from Intellectual Ventures ("IV") in the second quarter of 2013 partially offset by higher royalty revenue from other licensees.

Total operating expenses for the three-months ended March 31, 2014 increased 30% to $8.4 million compared to the same period in 2013 reflecting the increased level of investment in our ongoing product development and sales growth initiatives.


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Revenue



                                          Three              Three
                                         Months             Months
                                          Ended              Ended              Dollar             Percent
                                        March 31,          March 31,           Increase            Increase
                                          2014               2013             (Decrease)          (Decrease)
Revenue:
Service                                $     2,988        $     2,929        $         59                   2 %
Subscription                                 1,412              1,384                  28                   2 %
License                                      2,805              5,930              (3,125 )               (53 )%

Total                                  $     7,205        $    10,243        $     (3,038 )               (30 )%

Revenue (as % of total revenue):
Service                                         41 %               29 %
Subscription                                    20 %               14 %
License                                         39 %               58 %

Total                                          100 %              100 %

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. Most of our service revenue is derived from contracts with the Central Banks, IV and government agency contractors. 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, 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 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 agency contractors are generally shorter term in nature, less linear in billings and less predictable than our longer term contracts because the contracts with government agency contractors are subject to government budgets and funding.

The increase in service revenue for the three-month period was primarily due to higher billable rates under our agreement with the Central Banks, partially offset by lower revenue from a government agency contractor.

Subscription.Subscription revenue includes subscriptions for products and services, is generally recurring in nature, paid in advance and recognized over the term of the subscription.

Subscription revenue was essentially flat for both our Digimarc Discover and Digimarc Guardian products for the three-month period.

License. License revenue originates primarily from licensing our technology and patents where we receive fixed license fees and/or royalties as our income stream. The majority of our current license revenue is derived from contracts with Nielsen, Verance and Civolution. Revenue from our licensed products have minimal associated direct costs, and thus are highly profitable.

The decrease in license revenue for the three-month period was primarily due to the end of the quarterly license fee payments from IV, partially offset by higher royalties from other licensees.


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Revenue by Geography



                                             Three              Three
                                            Months             Months
                                             Ended              Ended
                                           March 31,          March 31,          Dollar           Percent
                                             2014               2013            Decrease         Decrease
Revenue by geography:
Domestic                                  $     3,117        $     6,125        $  (3,008 )            (49 )%
International                                   4,088              4,118              (30 )             (1 )%

Total                                     $     7,205        $    10,243        $  (3,038 )            (30 )%

Revenue (as % of total revenue):
Domestic                                           43 %               60 %
International                                      57 %               40 %

Total                                             100 %              100 %

The decrease in domestic revenue for the three-month period was primarily the result of the end of the quarterly license fee payments from IV, partially offset by higher royalties from other licensees.

International revenue was essentially flat for the three-month period.

We anticipate a decrease in revenue for 2014 compared to 2013 primarily as a result of the end of quarterly license fee payments from IV in the second quarter of 2013 and from Nielsen in the first quarter of 2014. These declines are expected to be partially offset by increased revenue from our other existing customers and new customers as we continue to expand the marketing and monetization of our intellectual property portfolio and related products and services.

Cost of Revenue

Service. Cost of service revenue primarily includes costs that are allocated from research, development and engineering, sales and marketing and intellectual property that relate directly to performing services under our customer contracts and direct costs of program delivery for both personnel and operating expenses. Costs include:

• compensation, benefits, incentive compensation in the form of stock-based 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;

• charges for equipment directly used by customers;

• depreciation and other charges for machinery, equipment and software directly used by customers;

• travel costs directly attributable to service and development contracts; and

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

Subscription. Cost of subscription revenue primarily includes:

• compensation, benefits, incentive compensation in the form of stock-based compensation and related costs of operations personnel and the cost of contractors to provide our Digimarc Guardian subscription service;

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

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

License. Cost of license revenue primarily includes:

• amortization of capitalized patent costs and patent maintenance fees;

• 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; and

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


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Gross Profit



                                           Three              Three
                                          Months             Months
                                           Ended              Ended              Dollar             Percent
                                         March 31,          March 31,           Increase            Increase
                                           2014               2013             (Decrease)          (Decrease)
Gross Profit:
Service                                 $     1,574        $     1,526        $         48                   3 %
Subscription                                    763                749                  14                   2 %
License                                       2,722              5,834              (3,112 )               (53 )%

Total                                   $     5,059        $     8,109        $     (3,050 )               (38 )%

Gross Profit (as % of related
revenue components):
Service                                          53 %               52 %
Subscription                                     54 %               54 %
License                                          97 %               98 %
Total                                            70 %               79 %

The decrease in license gross profit, total gross profit and total gross profit as a percentage of revenue for the three-month period was due primarily to the end of the quarterly license fee payments from IV in the second quarter of 2013.

Operating Expenses

We allocate certain costs of research, development and engineering, sales and marketing, and intellectual property to cost of service revenue when they relate directly to our customer contracts.

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

We anticipate operating expenses will be higher in 2014 than 2013, reflecting the full year effect of the increased investment in our product development and sales growth initiatives partially offset by lower legal costs due to the settlement of the arbitration with IV.

Sales and marketing

                                             Three              Three
                                            Months             Months
                                             Ended              Ended
                                           March 31,          March 31,          Dollar          Percent
                                             2014               2013            Increase         Increase
Sales and marketing                       $     1,879        $     1,277        $     602               47 %
Sales and marketing (as % of total
revenue)                                           26 %               12 %

Sales and marketing expenses consist primarily of:

• compensation, benefits, incentive compensation in the form of stock-based compensation 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; and

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

The increase in sales and marketing expenses for the three-month period reflects the increased level of investment in our ongoing sales growth initiatives.


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We anticipate sales and marketing expenses will be higher in 2014 than 2013, reflecting the full year effect of the increased investment in our sales and marketing growth initiatives.

Research, development and engineering

                                             Three              Three
                                            Months             Months
                                             Ended              Ended
                                           March 31,          March 31,          Dollar          Percent
                                             2014               2013            Increase         Increase
Research, development and engineering     $     3,546        $     2,725        $     821               30 %
Research, development and engineering
(as % of total revenue)                            49 %               27 %

Research, development and engineering expenses arise primarily from three areas that support our business model:

• Fundamental Research:

• investigation of new watermarking algorithms to increase robustness and/or computational efficiency;

• mobile device usage models and imaging sub-systems in camera-phones;

• industry conference participation and authorship of papers for industry journals;

• survey and study of human and computer interaction models with a focus on mobile devices and modeling of intent;

• development of new intellectual property, including documentation of claims and production of supporting diagrams and materials;

• research in fingerprinting and other content identification technologies;

• metadata ranking algorithms for matching Internet file content against reference database; and

• investigation of substrates, printing techniques, and printing technology relating to consumer packaged goods.

• Platform Development:

• tuning and optimization of implementation models to improve resistance to non-malicious attacks and routine transformations, such as JPEG, cropping and printing;

• mobile platform creation to leverage device-specific capabilities (e.g., instruction sets and Graphics Processing Units);

• tuning big data analytics transformation and metrics aggregation engine;

• tuning data-driven Internet crawling infrastructure with policy-driven feedback loop; and

• assembly of master book publishing catalog based on aggregation and reconciliation of multiple public data sources.

• Product Development:

• deliver the Digimarc Barcode;

• maintaining the Online Services Portal to provide campaign management and routing services for the Digimarc Discover platform;

• maintaining the web-hosted image watermark embedder in support of . . .

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