Bruce Davis - Chairman and CEO Mike McConnell - CFO

Bill Gibson

Good morning. My name is Jasper, and I will be your conference operator today. At this time, I would like to welcome everyone to the Digimarc’s Q1 2010 Earning 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 the call over to Mr. Bruce Davis, Chairman and CEO of Digimarc.

Thank you, Jasper, good morning everyone. Welcome to our earning conference call, Mike McConnell, our CFO, is with me. We are pleased to present our first quarter results which were issued in the press release this morning. The objectives of this call are to summarize and comment on these 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 and we expect to file our 10-Q with the SEC this afternoon providing more details on the financial results. Please note that during the course of this call, we will be making certain forward-looking statements. These statements are subject to many assumptions, risks, uncertainties, and changes in circumstances. Any assumptions we offered by future performance represent in point and time estimate. Actual results may vary materially from those expressed or implied by such statements. We expressly disclaim any obligation or revise or update any assumptions, projections or the forward looking statements to reflect event or circumstances that may arise after the date of this conference call. 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 the 10-Q we file later today and our earnings release posted on our website this morning. Mike will summarize and comment on the financial results. Following Mike's presentation, I will return to discuss some of the important events and achievements during the quarter and provide an update on execution strategy. Now we’ll open our call to your questions. Mike?

Thanks Bruce and good morning everyone. Thanks for joining us for today’s conference call. Our revenues for the quarter increased 130% to $10.2 million from $4.4 million more than doubling the same amount from a year ago. The increase was primarily the result of a $4.5 million payment in connection with the licensing arrangement with Arbitron, completion of certain of our federal government contracts and increased work with our central bank customers. Both our service and license revenues reached record levels on a quarterly basis. Our gross margin was 82% compared to 66% in Q1 of 2009. The increase was primarily attributable to increased revenues from our licensees, the most notably in those from Arbitron. Service margins also improved due to improved labor utilization. Operating expenses increased 8% to $4.1 million from $3.9 million in the first quarter of 2009. The increase reflects investments in product development and our IP marketing initiatives. Operating income totaled $4.2 million more than $5 million better than the operating loss of $1 million in Q1 of 2009. And the improvement reflects both the Arbitron licensing arrangement as well as operating leverage gain for the improving recourse management. Net income was $3.8 million or $0.51 per share which was an improvement for the net loss of $809,000 or $0.11 per share in the prior year. Our operating cash flow of $5.4 million was achieved during the quarter and reflects the improved operating results in good balance sheet management. We ended the quarter were $47 million in cash up more than $4 million from the year end and we continued to prudently invest and grow including $700,000 in our early stage during joint ventures with Nielson and incremental spending on our IP marking and this is to expand our licensing program. Before the discussion of these results our business and financial models. And risk and prospects for our business, please refer to Form 10-Q that we expect to file a little bit later today. We believe that there may be additional upside to be realized during 2010 including entering into significant new business relationships resulting from our IP marketing initiatives. On the flip-side there is a possibility that you may choose to spin above the levels discussed previously to encourage prospective partners to engage if necessary. Bruce will now provide his comments on our outlook and execution of our strategy.

Thanks Mike our financial and operational accomplishments during the first quarter represent a solid start to achieving our 2010 operating plain objectives. We continue to believe this should be quite an exiting and rewarding year for the company. On March 29, entered into the previously announced $4.5 million collaborative patent licensing arrangement with Arbitron, we are pleased to have achieved a successful outcome of this matter without litigation. The conclusion and the negotiation allows us to turn our attention to numerous additional patterns than software licensing and development services opportunities. The record Q1 results were driven largely by the Arbitron agreement. Which we believe evidence is the strength of our patent portfolio and promise over long strategy at leveraging our pattern and proprietary technologies and market experience to deliver superior growth and value for our share holders. We continue to broaden these in our pattern portfolio and licensable technologies with relevant and innovations. Our intellectual property assets continue to grow at a rapid pace, 21 patents were issued during the quarter bringing our total pattern portfolio account to over 580. We also filed over 30 applications during the quarter of maintaining a pipeline of the pending applications of more than 420. Three independent patent evaluators; The Patent Board, IEEE Spectrum and MDB Capital Group, published findings during the quarter, all noting the extraordinary quality of our assets and often ranking our portfolio among those of industry leaders many times our size. The Arbitron license and consistent high ranking by experts provide evidence to perspective licensees and investors of the extraordinary quality of our patents. (Inaudible) view that Digimarc commitment innovation IP generation and fair and reasonable licensing practices will lead the continued success, in fostering shareholder value by building and monetizing valuable long-term IP assets. We see opportunities for strong growth and patent license revenues, software license revenues and development services. We continue to estimate that the range of the potential revenue opportunities is quite large, large potential variance in revenues and margins as in patent licensing which depends on the timing of disposition of numerous marketing initiatives. Any such licenses may involve related development services collaborations and technology licenses. Our development and licensing business model is positioning us nicely for long-term success in relevant product markets permitting us to benefit from a combination of patent licensing, software licensing, joint ventures and custom technology development. We continue to execute on key elements of the strategy including broadening the relevance of patents and licensable technologies to continuing innovation for our extremely successful business partners, developing additional business relationships and joint ventures and maximizing shareholder value by balancing profitable growth with building long-term assets. The extraordinary growth and quality of technology assets at Digimarc is broadening our licensing opportunity pipeline. Notably, we have many patent technology assets to license related to helping mobile devices to better see here understand and response the world around them as well as enhance them to next generation media industry workflows. We continue to innovate at all levels of the typical technologies that including basic technologies application systems and processes. The market studies that we conduct in connection with licensing and service initiatives are broadening in concert with the expense in our asset base. Including near term opportunities previously discussed in areas such audience measurement, copyright filtering, royalty audits, mobile music discovery, visual search and brand protection. In the areas of brand protection and visual search, there was notable recent developments; one was the opposition agreement announced today, the other was a terrific display of the future of pharmaceutical packaging employment of technology by Catalent at Interphex in New York last week. AlpVision is a great addition to our business partner network, this remarkable young company has built a profitable high growth business using digital watermarking and related technologies to reduce counter selling and gray market sales of packaged goods. Catalent Pharma Solutions is a leading provider of advanced technologies as well as development and manufacturing in packaging services for the pharmaceutical and biotech industry. It was created in April 2007 when the Blackstone group acquired the Pharmaceutical Technologies and Services segment of Cardinal Heath. Catalent has nearly 75 years of experience in serving pharmaceuticals and consumer health companies around the global and nearly 20 years of experience in serving the biotech industry. Our growth strategy has many facets, all organized around coherent vision. To teach computers to see, hear and understand the world around them, simplifying access to computer technology and contributing to a future of more ubiquitous and intuitive computing. In closing, I’d like to thank our partners, clients and employees for their continued support and commitment to Digimarc's progress toward making this vision a reality. Now I will open the call to questions.

(Operator Instructions) And we do have a question in the queue coming from the line of Bill Gibson.

Hi, Bruce. Actually, mine is just sort of a technical question. I think probably for Mike. And that is from the cash flow statement we see the spending going into the joint venture and then some of that is showing up as an asset on the balance sheet. How do you determine whether or not that is being thrown down a drain pipe and what sticks.

Well there is a couple of comments on that. With the balance on the balance sheet is primarily all cash sitting in the bank accounts of the two entities and each entity has a board that directs the overall operations of the two. So, it’s pretty closely managed.

Yes, but those Bruce, we are expensing is period expenses the expenditures of those joint venture investments and so what we are seeing is just cash.

And then secondly, if the economy improves and you are in talks with multiple organizations, do you get a sense things are loosening up out there on the licensing front?

We are sort of a bit of orthogonal I think to the general economic trends as we witnessed during the downturn, we didn’t turn down very much and so in an upturn I don’t know how much correlation there is to the economy. Things are definitely better across the board we were a bit nervous in early 2009 about some of our commercial business partners and as things are getting more comfortable there and we are actually feeling substantially better about the prospects for a number of those potters that we would have sold a year ago.

(Operator Instructions) Your next question comes from the line of Andy [White].

Okay couple of questions actually. The first is for Mike, just on kind of your comments around 2010. Is the potential increase in the spending would that come in the form of additional head counts or you are just talking about incremental travel and kind of sales and marketing expenses just to go out there after those deals.

I think it could be a couple of different areas. It could be some head count particularly in the product areas as we embark upon some these market initiatives. At the same time it could be including additional litigation expense. If we’re used to, if we are required to use those types of resources to bring some these licensees.

Okay and any weightage given to quantify range of what significant means and significant new business relationships?

: : And so that’s where most of the potential volatility on the expense side resides is the legal expenses. We’re actually ramping up some of our R&D because of favorable market conditions and but that’s something that we do in a very careful way and much of that is in the short-term it’s likely to be on a variable cost basis or contract basis other than fixed cost. So it’s that kind of stuff but it doesn’t add up to a huge amount of money but because of our scale and at any given quarter it could have a significant change in the eyes of some.

And then in terms of kind of the structure of new deals, what’s going to determine which one’s are kind of one-time fees like the Arbitron one appears to be and which ones will be and ongoing royalty of some sort, how do you weigh that trade-off and how do you negotiate it?

I look to get the best shareholder return. That’s what motivates my perspective on any negotiation. And so if I can get a risk-free while cash payment upfront that equals or exceeds the net present value risk adjusted of those payment stream I’ll take it. And large companies prefer that frankly to a time-based stream of cause because they did it all behind them, all right. So it really depends and there are of factors going to at them it’s a negotiations, so it’s not really our decision in many cases. And so Arbitron, we thought it makes sense and they did too and so it was excellent resolution, money is in the bank

Okay, thanks.

And your next question comes from the line Kevin [Hanahan].

Good morning, Bruce, congratulation on a great Q1, great profit this quarter mostly due I think to the one-time payments from the return. I got a couple of questions. First one would be any guidance for 2010, which I heard you answer to our last call, so maybe we are not going to get much but I figure I’d try anyway, I was reading the annual letter in the annual report that you sent out and it said we see good opportunities for growth in both service and license revenue. And I think you said that in your prepared remarks in the call too so is there any range of guidance and I appreciate it could be a wide range. It could be a wide range of opportunity this year.

Yes, I appreciate you trying Kevin, you are right we would not let you succeed very much. Let me be as responsible as I can be, in looking after the first quarter here obviously license revenues were up significantly. But even excluding our return license and services revenues were up last from last year significantly. And it's in the nature of our business that we answer the last question we will get paid in different ways different times by different people. And we are not trying to smooth anything or trying to maximize the profit for our shareholders. And so as we negotiated additional business relationships, there could be substantial variation and the structure of the relationship and substantial variations in the amount of resources and I started to obtain it and then the amount of time necessary to liberate. When you add all of those dimensions up, its kind of a field exercise to try to make short-term projections, its just I could try, I miss most of the time in fact if you looked at Q1, anybody who was trying to guess Q1 wasn’t this pretty significantly. Thankfully, we drew all of performance substantially but we were 2X probably what people were figuring. And so, I would say as I have said now for 13 years we’d like to advance driven, we’ll like to grow step functions, we’d like to do things like that in the first quarter. I don’t think of those one time event, I think that that was as a routine event in the nature of our business as an immature holder of the very large patent estate. By the 10 years from now, 20 years from now whatever, we are still hearing to the same business model, we might be bit more predictable if we looked like Qualcomm or Dolby or one of the more mature IP companies. Given the stage of development we are at given a marvelous portfolio we have and it challenges employees and rapidly changing markets, I’d expect there to be fair amount of volatility on the upside and again as you know we have built the business model here to skew the [enter piece] of the upside, so when we talk about variations we are talking about them generally at a positive sense but that is really difficult to try to characterize them in the short-term.

Well, thanks for that answer. Another question about the digital cinema, its rather funding the lending I think that JP Morgan was going to provide and some equity I think that the movie studios or there organization was going to put in. have you seen any impact, have you seen any positive revenues of digital cinemas and… Q1 at all that might be more for money.

Yes I can answer that, yes its digital Cameron is you know is a better factor I guess of different mark cause Arbitron has gotten the Arbitron distributions fired above capital investments. So we are actually seeing quite positive trends in that area. It is good; you know it’s not used run distant force. But it is nice one and we are expected to do very well in this environment.

Okay thanks a lot Bruce.

And your next question comes from the line of Paul [Sonz].

I have a couple of questions. First is I asked this I think every quarter? One of the options for your cash is acquisitions of interesting technology. What does the market look like for that at present?

Well there are opportunities around, we haven’t found any conditionally attractive to close on. But we get a little (inaudible) open to the notion. Frankly we are very busy right now with storing anti-growth and enjoying great deal of success in our first quarter of the year. And so it would happen quite a remarkable opportunity to cause some diversed resources to non-organic growth here in short term.

Okay

We just we got going on larger things are happening in the market place and we are as you would hope quite consciously directing our resources to the best opportunity here to try and bring them home.

Good. Second question, on the deal that you just did announce what is there anyway we can assess with the potential streams coming out from this? Is it we’re more (inaudible).

Yeah, I’m going to recommend than do, we also license to AWT in Hong Kong, here in the quarter. So what I recommend to everyone who is interested in detailed study of our business is to – groups of the websites of AlpVision and Catalent and AWT and read up on them of that and then you can try some make your own assessment of the likely impact that they could have on our business. AlpVision is private but they talk now and then about their financial performance. And we have a royalty bearing relationship with them and so we hope that it’ll be – continue to be very successful and that we will in fact find ways to help them to be more successful and then it’s quite a nice company, good group of people and they’re quite adapted technology to very, very tech-savvy. And they have succeeded in a very difficult segment of the packaging market and so we’re very pleased to have them in the business relations. And then our Catalent is a big player and they are enthusiastic that Catalent relationship is more of joining R&D, its early of stage of not going to delivery or anything in the short-term here but that relationship on the exhibition that Interphex or ahead of my expectations in terms of market development, that is the – I have taught that the opportunities that we’re working on with them would be further down the road than they appear to be so I am very excited about that collaboration and about the potential, about the collaboration is seeking to exploit so all good things, AWT is a big company in Hong Kong, quite sophisticated. And very enthusiastic about the potential for our technology to be used in the Asian markets, it was a very good quarter in terms of execution strategy we got lot done, we got a lot of things from fermenting and we brought some money home so I would say that was a very nice quarter from every perspective for us,

Separate question on Shazam. What is the next the known point where you might have an opportunity to either settle or it moves on?

Well you don't talk about the in the (inaudible) submission and call, if you want talk and (inaudible) ways sort of predictable generalization you can rely upon to some degree, we don't like to negotiate in public not only these any respect and so we don't like to comment individual situations. In the Shazam case, public records would reveal the next stage in litigation would be for them to answer or complain and that's due in June.

And then the last thing is that in terms of you have cash on the balance sheet. Any thoughts on you bought some stock back earlier in the not too distant past and I wonder any thoughts of buy backs of stock here?

Yes …we have our board meeting yesterday and the board authorized a continuation of the authorization for buy back for another year and Mike and I are responsible for the management discussion on when and how much to buy we are pretty tightly constrained by regulation given relatively small trading volume of the company. So, but we remain open to buying blocks that become available at reasonable prices and to participating in the market to distinctive regulations permit. So, we are still [interested] in continuing that program only have board authorization to do it.

Well thank you very much and it sounds like things are going very well. So, I look forward to seeing the developments later in the year.

(Operators Instructions). And there are no further questions in the queue.

(Inaudible) still upon this.

Okay. Let me cover it. We have got an open line just for, some of these line, okay. All right thank you (inaudible). I appreciate your support and we’ll talk to you again in the quarter. Good bye.

And this concludes today’s conference call. You may now disconnect.