Bruce Davis - Chairman and Chief Executive Officer Michael McConnell - Chief Financial Officer, Principal Accounting Officer, Executive Vice President and Treasurer

Corey Barrett Paul Sonz - Sonz Partners Nick Zamparelli Kevin Hanrahan - KMH Capital Advisors

Good afternoon, and thank you for participating in today's conference call. Now, I will turn the call over to Chairman and CEO of Digimarc, Mr. Bruce Davis. Sir, please proceed.

Good afternoon, and welcome to our conference call. Mike McConnel, our CFO, is with me. The objectives of this call are to review and discuss 2010 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 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 offer about future performance represent a point in time estimate and 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-Q. Mike will begin by commenting on our financial results. I will then discuss our outlook and execution strategy. Mike?

Thanks, Bruce, and good afternoon, everyone. With extraordinary success in our licensing activities in 2010, we saw revenues grow 63% to $31.2 million, resulted in $4 million net income. The revenue increase was driven primarily by our licenses with Arbitron in the first quarter, and with Intellectual Ventures in the last quarter. We generated significant positive operating cash flow, ending the year with a strong balance sheet with more than $45 million in cash and related investments and no debt. During the year, we continue to make significant investments in growth initiatives, including the marketing of our intellectual property, our joint ventures with Nielsen, development of additional intellectual property and Digimarc Discover, all centered on our vision of enhancing computers, networks and other digital devices to see, hear, understand and respond to their surroundings. Our Q4 2010 financial highlights included a record revenues of $10.5 million or 89% higher than the prior year, with the majority of the increase due to our new license arrangement with IV, where we received two of twelve expected quarterly payments aggregating $5.3 million for the $36 million minimum license fee. Gross margins at 82%, reflecting the impact of higher licensing revenues as a percent of the total revenues. Higher operating expenses that reflected increased investments in new product initiatives and IP marketing initiatives, as well as litigation and transaction-related expenses. And operating profit of $3.1 million or 30% of revenues, and a $700,000 capital contribution to our joint ventures with Nielsen, where our share of the net loss was $600,000. Our observations and current planning assumptions regarding potential 2011 financial performance include the following: Double-digit revenue growth for the year, with nearly $30 million coming from our beginning backlog; a license-to-services revenues ratio of approximately 60% to 40%, resulting in gross margins above 70%; revenues and operating income should be more consistent on a quarter-to-quarter basis in 2010, with the first quarter being the smallest of the four; continued investment and growth initiatives, particularly in the areas of directed research and IP development; and product development and marketing, associated with both Digimarc Discover and our joint ventures with Nielsen. Operating cash flow, that's greater than GAAP earnings due primarily to approximately $5 million of non-cash charges associated with stock compensation and depreciation. As a reminder, these highlights of financial assumptions and operating plans represent our current view of expected values based on our assessment of the most likely unfolded events over the course of 2011. As is our general practice, we intend to update you each quarter regarding strategy execution, but do not plan to provide detailed financial guidance. For further discussion of Q4 2010 results, our business and financial models and risk and prospects of our business, please see the Form 10-K that we expect to file a bit later this week. Bruce will now provide his comments on our outlook and execution of our strategy.

Thanks, Mike. We had a terrific year in 2010. Our accomplishments and investments during the year significantly increased our base line financial performance and laid a foundation for the next level of growth for our strategy. We believe in our opportunities for growth in all areas of our business. Key areas of focus in 2011 include fostering success of our new licensing partner, Intellectual Ventures, developing the market for Digimarc Discover and working with another important partner, the Nielsen Company, to continue the development and foster adoption of Media-Sync for social interactive's television. Maximizing the success of our new relationship with IV is an obvious top priority. Things are going well so far. We entered into the relationship with IV to facilitate large-scale licensing and accelerate broadscale adoption of our proprietary technologies in various product markets. The key goal of the collaboration is to create network effects wherein freedom to operate the Intellectual Ventures licensing for some large companies fosters demands for our software and services, creating competitive advantage for early adopters that disadvantages competitors who, in turn, will seek licenses from IV and services on support from Digimarc to remain competitive. Our strategy is to create a virtuous cycle of demand creation through licensing and software and services. In parallel to the IV activities, they are dedicating substantial resources to the launch of Digimarc Discover, our platform for the seeing and hearing device. We believe that the market is moving rapidly toward increasing enablement of pervasive intuitive computing. We launched our platform of Mobile World Congress and are in the early stages of a beta period scheduled to run for the next few months. During this time, we are encouraging free trials of the platform, so that we can refine our offering, study demand and prepare for active marketing in the second half of the year. As we begin commercialization of Digimarc Discover, we are increasing research and development of subsequent phases, which include improving our digital watermarking performance, broadening and integrating various means of object recognition and innovating higher order of task with sense of fusion and inference. As you know, our ultimate goal is to teach these devices to see, hear, understand and respond with optimize network services when instructed by users to look or listen. By doing so, we believe we can contribute significantly to a momentous step in the evolution of computing toward pervasive intuitive computing. In television, we are anticipating considerable progress in our Media-Sync joint venture with Nielsen. ABC has followed on from the fall pilot project to use the platform to enhance the viewer's experience for Grey's Anatomy, we anticipate other programmers coming on-board shortly. There are many signs of transformation of the television viewing experience along the lines we anticipated. A more engaging and a more social television paradigm is developing rapidly with many suppliers jockeying for position. We believe that we have sufficient competitive advantages to be a leader in this space. Lastly, in the Government sector, we expect to enjoy good growth both in our anti-counterfeiting program and military and intelligence applications. All in all, we anticipate a very exciting and rewarding year ahead. In closing, I'd like to thank our partners, clients and employees for their continued support and commitment to Digimarc's progress through making our vision a reality. Now we'll open the call to questions.

[Operator Instructions] We have a question from Kevin Hanrahan of KMH Capital Advisors. Kevin Hanrahan - KMH Capital Advisors: I have a question about share buyback. Based on your press release that you put out in January regarding the shares you bought back from Royal Philips, it looked to me like you bought those at a price of about $26.97. But I also see from the cash flow statement, it looks like you bought back some shares earlier than that in Q4 just under $5.8 million. Mike, can you tell us how many thousands of shares you bought back in Q4?

Sure. What that amount relates to in the statements that you saw is our stock exchange for taxes program, where restricted stock best options that are exercised. We use the company's cash to buy back shares to pay taxes. So effectively, it's reducing the amount of shares in the marketplace. Kevin Hanrahan - KMH Capital Advisors: So would it be fair to say that you bought back no shares on the open market in Q4?

That's correct. Kevin Hanrahan - KMH Capital Advisors: Bruce, can you talk about the recent launch you did with Digimarc Discover and just give us a 20,000-foot view on that? It's hard to understand some of this stuff and how that could apply to a mobile computing going forward?

Sure. We launched the platform at Mobile World Congress in Barcelona, Spain almost two weeks ago. And it is an open beta period, so actually you or anyone can go to digimarc.com, go enter the beta program on the online services portal, which will allow you to encode digital watermarking into some kind of print objects and [indiscernible] typically. When you print it out, you can then use an application downloaded from iTunes or Android on your mobile device to read the watermark and connect to whatever network service you chose in the portal. So that's the sort of simple overview of how the system works. And it's available to everybody right now. Does that answer your question? Kevin Hanrahan - KMH Capital Advisors: Well, can you give us -- I mean, where do you think that -- how could that benefit Digimarc over the long haul? Where do you think this product can take us?

Well, it's all part of facilitating the ability of users to point their mobile devices at things and have the devices recognize what is being pointed at. So the target for the first version of Discover embodied in the public data is magazines and newspapers. So the publishers would use the portal to encode their publications and connect the publications to network services of any kind. Anything they're interested in providing to their readers. That then facilitates more engaged advertising where you can have a full sales cycle or additional marketing or passed on marketing, and additional editorial opportunities where you can create continuity add multimedia and enjoy the benefits of the Internet through the publication. And we get paid for each link established, that's how it done for Digimarc. So we benefit the marketplace by providing the network attributes for printed publications, and we get paid for doing that.

Your next question comes from Corey Barrett of Pacific Crest Securities.

This is Corey in for Andy. Just a couple of quick questions. First, in thinking about services revenue in 2011, can you talk about the opportunities or momentum you're seeing in services as the direct result of the IV deal?

As I said, I think all areas of our business have the potential to show good growth. So in the services area, we have our Government business, and we have an approved budget for anti-counterfeiting activity, which would indicate will be some growth. And then we have the Defense and Intelligence business, which is more difficult to predict, but we hope likewise will show good growth. And then in the software area, of course, we're going to begin marketing the online services portal and the Digimarc Discover platform in the second half of the year. So we'll see how that goes.

And how are you impacted by just general federal budget squeezes?

We're not.

We've been seeing online and application services that provide media recognition, albeit not through watermarking. How does your IP relate to such services?

In complicated ways. So a lot of which you're seeing, we think, has some overlap with our IP and some of it may not. It's all dependent on detailed legal analysis. But we are working with Intellectual Ventures to study all of the opportunities for licensing and then they will determine how to approach those opportunities.

And then lastly, you commented on a general outlook for R&D and IP expenses in 2011. Could you repeat that briefly?

Yes, we increased our run rate 2011 or 2010 in order to invest in growth initiatives. And those growth initiatives are focused on a couple of areas. One is basic research, called directed research because it's not just general research but directed toward some application areas, and the associated IP development so that we can facilitate the development of the second wave portfolio. And then the other area of increased investment is in Digimarc Discover as we are launching the new service and begin marketing it.

Your next question comes from Paul Sonz of Sonz Partners. Paul Sonz - Sonz Partners: I have several questions. First, after buying back the stock, it would seem that you have $31 million on the balance sheet but that is expected to go up over the course of the year. Any further thoughts on what you're going to do with that cash?

Nothing different than what we've said in the past. Each quarter at our board meetings, we talk about how to optimize the return for shareholders across the spectrum of investment activities, and so we look at all things all the time in trying to optimize the return. Nothing in particular. Paul Sonz - Sonz Partners: What is the fully diluted share count at this point after the buyback?

The outstanding shares around about $6.9 million. If you wanted to then add the dilutive impact of the restricted stock and options, I believe, it's about $500,000 on top of that. Paul Sonz - Sonz Partners: As some may know, Shazam has an application out there for syncing with a TV show called White Collar. And which brings me to the question, how are the negotiations? Are there any going on with Shazam right now for licensing the technology?

There are ongoing discussions but we'll not get into detailed characterization in the interim about them. But we're still having productive discussions with them. The discussion now included Intellectual Ventures, given their role as exclusive sub-licensor of our portfolio that we alleged earlier was infringed by Shazam. Paul Sonz - Sonz Partners: Next question, this may seem a little odd, but is it possible to watermark sounds that are above the level of the human ear that we hear easily that could be perceived by smartphone, is that possible?

Leaving aside, we're in the spectrum that occurs, yes. Audio watermarking is very common. It's not used in the mobile detection environment yet. But the answer to the general question is yes, but not necessarily above where people hear outside the normal realm of audio perception of humans. It's a complicated signal processing task. It's not just high frequencies, in other words. Paul Sonz - Sonz Partners: The thought just being that, that information could be transmitted not just by having the camera look at things but could just be sort of ambient in an environment that the phone would pick up but wouldn't annoy the person holding the phone.

Yes, that's how Media-Sync works. It's already deployed. Media-Sync does just what you say. It happens to be a television audio stream rather than a radio audio stream. But same difference. Paul Sonz - Sonz Partners: And then lastly, in terms of the intelligence work, is there any additional information on this? Or is it still up in the air that the general contractor has worked for the government and you haven't heard anything back from them? Is there any more information on that?

Although I wouldn't agree with your characterization, I wouldn't say there isn't any information I can share. That space is difficult to talk about. So what will most likely be the only way that we talked about it is explaining some revenue growth when we get it. It's a complicated space and difficult to talk about publicly. Paul Sonz - Sonz Partners: And if it was to be broadly adopted in the intelligence community, would this be a meaningful increase in your revenues?

Sure.

[Operator Instructions] Your next question comes from Nick Zamparelli of Chartwell Investment Partners.

Just a quick one on Digimarc Discover. Curious as to how the technology is different, or is the technology meaningly different from apps that we're seeing out there now from Microsoft, for example, I think offers a free app called Microsoft Tag? Is the technology that you have meaningfully different?

Yes, there are couple of bookends, if you like, in the market conceptually on our visual search technology. Let's use Microsoft Tag as one end. What they have is referred to as a 3D bar code. And it's kind of a intricate design with color and the color is the third dimension, so it has horizontal, vertical and color dimensions to data storage. And so that's one competitor. On the other bookend is Google Goggles, which does image analysis and matches it up against characteristics of various things they have in their database. And so that's a space we operate in. Well, we're potentially in between them and Google relies on estimation, something called interpolation, whether just trying to figure out from a bunch of characteristics what the thing is that the device is looking at. And sometimes they guess right and sometimes they guess wrong. And Microsoft has a specific identifier embodied in there visible symbology, which is a bunch of data akin to what we use. So we are more reliable than Google Goggles because we have a specific identifier like Microsoft Tag. And we consider ourselves to be advantageous over Microsoft Tag because we're not visible and we don't take up real estate. And in the world of publishing, both aesthetics and space are very significant issues, generally, space costing money and aesthetics affecting the reader's perception of the publication. So we think we compete effectively with both ends of the book. And yet, they're obviously companies of substantial means, so we don't take them lightly. But we'll see how things go during the remainder of this year, we think we'll do fine against those guys for those reasons.

And then just a quick follow up on the commercialization plan of the technology. How exactly are you going to market this? How are you going to differentiate it on the marketing side from those two, for example?

Well, we're refining our marketing plans using the beta period. That's one of the reasons we have the beta period to test some assumptions. But our assumption is that we will be preferred over Microsoft Tag because we're invisible, and over Goggles because we're more reliable. So a simple market. That's a simple marketing message. It's quite straightforward. We're very economical in the pricing model that we are entering with, and so I don't think price is going to be an issue. Those guys are free because we offer other advantages that they don't, which is that indicates a Google Goggles, that's meant to feed the Google engine. And lots of brands don't want to concede their customer interface and their marketing to Google. We offer private marketing channel to brands, akin to what Microsoft could do with Microsoft Tag. But Microsoft Tag is big and ugly. And it is Microsoft, which also carries with it some baggage. So we think as an independent small company with an imperceptible symbology that provides reliable identification of the print publication and allows recreation of private marketing channel from the publisher and the associated brands to audiences and qualified prospects for purchases that we've got a good marketing proposition. We'll see. We're going to test it and we'll go out and do our best. And I'm feeling pretty good that we've got a good clear competitive differentiation that we can market.

And other than the two bookends there, are there other smaller companies kind of competing in the space that you know of that are posing a threat?

Yes, there's a little company called Amazon and another one called eBay. So those are the little guys. And they are both using 1D bar code or 2D bar code symbologies in their efforts to build the market. Amazon also has something in their search, which they have referred to by an odd name called Mechanical Turk, and that is using crowdsourcing to try to identify ambiguous objects. Again, these estimation techniques, if they can't figure it out, they send it out to the world and they pay micro payments to people in developing nations to try to identify things by aggregating the identification as statistical process. So yes, it's a bunch of efforts to do this kind of thing. Most of them relate to visible symbologies, 1D, 2D and 3D bar codes. Google is the most prominent initiative on image analysis and estimation. And because of our strong IP position in our investments over the years and our sort of unwavering vision, we are the primary advocate of this imperceptible digital data that allows for reliable identification. So we've got a pretty clear position in the marketplace or bunch of guys in the bar code space, and there's Google Goggles and a few small players trying to move into the image analysis space, and then you got Amazon sort of in both spaces.

[Operator Instructions] You have a follow-up question from Paul Sonz of Sonz Partners. Paul Sonz - Sonz Partners: Gentlemen, how is the other JV going with Nielsen?

The TV or JV is focused on building and enabling technologies that relate object identification to watermark into the various data capacities of Nielsen. And so that's what it's doing. Paul Sonz - Sonz Partners: And any interest on the horizon there? Or it's still a technology in search of a market?

Well, it's being used to support JV two, and we have a pilot going with one video distributor on the Internet and we are in conversations with a bunch of people about possibilities in connected TV. So those are the actual and potential uses of JV one technology so far.

You also have a follow-up question from Kevin Hanrahan of KMH Capital Advisors. Kevin Hanrahan - KMH Capital Advisors: Bruce, I just have a follow-up question. If you can give us if there's any update to the Verance situation or not?

Yes, we've been engaged in what's called motion practice in Delaware and Oregon. And so we filed a motion to dismiss the case in Delaware when we filed a contract, breach of contract action in Oregon. And there are some services where you can get access to the filings that are not under seal. So the best one I think or the one I'm familiar with is called PACER, P-A-C-E-R. In this case, unfortunately, for you, many of the pleadings are under seal because of nondisclosure agreements that cover a lot of the allegedly relevant facts than positions with parties. So you'll find some stuff but not as much as you would like. Kevin Hanrahan - KMH Capital Advisors: And that relates to your Blu-ray royalties that you would receive?

Yes.

At this time, there are no further questions. I'll now hand the call back over for any closing remarks.

All right. Thank you very much, everyone, for your support and confidence. We look forward to talking to you again in a month or two, I guess, when we do the Q1 call. Thanks and goodbye.

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