Bruce Davis - CEO & Chairman of the Board Charles Beck - CFO & Treasurer

Rob Stone - Cowen and Company Jim Ricchiuti - Needham & Company Josh Nichols - B. Riley FBR Ilya Grozovsky - National Securities Jeff Van Rhee - Craig-Hallum Jeff Bernstein - Cowen Prime

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

Thank you. Good afternoon. Welcome to our Conference Call. Charles Beck, our CFO, is with me. On the call today, we'll review Q4 and fiscal 2017 financial results, discuss significant business developments and market conditions and provide an update on execution of strategy. We'll archive this webcast in the Investor Relations section of our website. Please note that during the course of this call, we will be making certain forward-looking statements, including those regarding revenue recognition matters, results of operations, investments, initiatives, perspectives on business partners, customers, prospects, industry trends and growth strategies. We'll also discuss from time-to-time information provided to us by channel partners and actual or potential customers about their business activities. We are providing this information as we understand it was represented to us. We do not verify nor vouch for such information. Such forward-looking statements and the statements about partners and customers are subject to many assumptions, risks, uncertainties and changes in circumstances. Any assumptions we share about future performance represent a point in time estimate. Actual results may vary materially from those expressed or implied by such statements. We expressly disclaim any obligation to revise or update any assumptions, projections or other forward-looking statements to reflect events or circumstances that may arise after the date of this conference 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 the Form 10-K that we expect to file shortly. Charles will begin by commenting on our financial results. I'll then discuss significant business developments, market conditions and execution of strategy. Charles?

Thanks, Bruce. Good afternoon, everyone. Revenue for the quarter is $4.9 million, down from $5.2 million in the fourth quarter of last year due to lower license revenue. In the third quarter, we entered into a fully paid-up license for one of the licensed fields of use of an existing licensee for a onetime fee of $3.5 million. In exchange for the upfront license fee, we waived any future royalty obligations from this licensee, which accounts for the decrease in fourth quarter license revenue year-over-year. Service and subscription revenue were essentially flat. Digimarc Discover and Barcode bookings were $1.2 million during the quarter, double our bookings from Q4 last year of $600,000. The growth in bookings was largely due to a one-year extension of an existing contract. As a reminder, we define bookings as the non-cancelable fixed value of a contract. We continue to expect lumpiness in quarterly bookings in the early stages of market development due to timing and varying provisions affecting bookings. Gross margin was 58% in the fourth quarter, down 2 points from Q4 last year, reflecting the impact of lower license revenue. Operating expenses were $2.5 million higher than the fourth quarter of last year. The increase primarily reflects previously noted increases in staffing for sales, marketing, engineering and operations to expand our capabilities in selling and delivering the Digimarc Barcode to retailers and brands. Net loss for the fourth quarter was $8.4 million or $0.76 per diluted share versus a net loss of $5.8 million or $0.57 per diluted share in the same quarter last year. During the fourth quarter, we raised $12 million of new capital through registered direct offering. We sold 330,000 shares of our common stock in response to an unsolicited offer from a high-quality, long-term bogus [ph] investor. Terms of the sale included a 6-month restriction on sale or lending of the shares. The $36.25 share price, a 21% premium over the shares sold in the August 2016 financing, was calculated using the closing market price on the date preceding the sale. There was no discount. Total transaction costs were $21,000. We invested $5.1 million of our working capital during Q4, including $3.6 million to fund operations and $1 million for capital expenditures. We ended the quarter with $67.7 million in cash and marketable securities. We anticipate cash usage will be between $4 million to $5 million in the first quarter. Our Q1 cash projection factors in receipt in January of a remaining $1.75 million from the patent license we entered into in the third quarter of 2017. Revenue for the year was $25.2 million, up 16% from $21.8 million in 2016 due to higher license revenue reflecting the $3.5 million onetime license fee we earned in Q3. Service revenue was up marginally, while subscription revenue was down marginally. Subscription revenue was impacted by lower Guardian revenue, offset by higher Digimarc Discover and Barcode revenue. Gross margin was 66% for the year, up 5 points from last year, reflecting the impact of higher license revenue. Operating expenses for the year were $8 million higher than last year, reflecting the impact of increased staffing. Our professional staff increased from 180 to 207 full-time employees during the year, with most positions focused on sale and delivery of Digimarc Discover and Barcode. Net loss was $2.44 per diluted share for the year versus $2.36 per diluted share last year. We invested $22.5 million of working capital during the year, including $17.6 million to fund operations and $3 million for capital expenditures. We raised $29.7 million of new capital during the year under 2 separate registered direct offerings, where we sold shares with no discount and minimal transaction cost. During 2017, our share price appreciated 21%, rating us in the 63rd percentile of our peer group. For further discussion of our financial results and risks and prospects for our business, please see our Form 10-K that we expect to file shortly. Bruce will now provide comments on significant business developments, market conditions and execution of strategy.

Thanks, Charles. My last update to the capital markets was at the Needham Emerging Growth Conference in New York City on January 17, the day after close of the National Retail Federation's "BIG Show". I gave a comprehensive update there on retail market conditions, expansion of the Digimarc ecosystem, the example of our approach to scaling business within accounts, a review of 2017 performance from financial and customer perspectives and an outline of our priorities for 2018. For those who did not attend or view the webcast, the presentation is available on our website. Only a month has passed since that review, I'll not repeat the information provided there. Thus, this call we'll focus on noteworthy observations and development since the Needham conference. Revenue growth in 2018 is expected to include license fees and software and service revenues from enhancement of packaging, thermal labels, hangtags and shelf labels and perhaps other media and associated applications. Thermal labels are expected to be the largest contributor. The revenue model is elaborating, not only with respect to media, but also with respect to contributions from software and services. When we originally put our market development strategy together, we focused on enhancing packaging for easy checkout and improve consumer engagement. We offer clients the option of proceeding incrementally based on price per SKU, or negotiate an enterprise license that will assume volumes and potentially, other software and services. As awareness and understanding of our benefits of our Intuitive Computing Platform have grown, a strong preference for the enterprise license route has emerged. This has led us down the path of rediscovering large-scale system sales and delivery, akin to our ID Systems business that was sold in 2008. The fundamental IP licensing model of $2 per SKU is still in place, but we are now finding ourselves with opportunities to orchestrate the delivery of numerous applications from various media, not just licensing access to the platform. I have theorized that system integrators and partners much larger than us would do the orchestration. However, on the way to scale, I think that we and our customers are better served with us in the driver's seat. The clients are asking for us as experts in the underlying technology to play this role. Although it's a familiar role from our ID Systems days, we need to rebuild our capabilities. The natural consequence of this development is proposals of larger dollar value, including the IP license fees along with software and services. Thus, we are anticipating making some substantial proposals to leading retailers during 2018 that will generally include private brand packaging and thermal label enhancements with initial application focused on improving store operations through better cashier-assisted and self-checkout, price audits, shelf compliance, inventory management and dynamic pricing. So partners may take a lead on other media and/or applications, including serialized packaging, in-store displays, shelf edge label applications, robotic self-audits and other ways to improve store operations by leveraging Digimarc Barcode. Where we take the lead, we'll be proposing appropriate fees for services. From a customer perspective, our goal is to deliver compelling proof of enterprise-wide benefits among early adopters. Thus, we have augmented and aligned our sales, marketing, client services and development teams to develop and demonstrate effective processes for achieving scale within these accounts. Wegmans is leading the industry in implementation. The generously hosted tours of international VIPs in one of their New Jersey stores during NRF showcasing enhanced private brand products, fresh product labels, some marketing materials, supporting a range of applications benefiting store operations and the customer experience. Wegmans is highly regarded as an industry leader in innovation and continues to be an extraordinary collaborator and partner. We will help them to learn their rightful place in history as the pioneer in the multi-industry modernization of auto identification. We continue working diligently with Walmart and its suppliers on application of the platform at a much larger scale than at Wegmans. Details of the work remain confidential. However, if we stay fairly close to our schedule, there should be some public visibility as the year progresses. Of course, we don't control the schedule. We have a vision of enterprise transformation employing our Intuitive Computing Platform. There are many applications enabled by a variety of enhanced media that can and should be employed. The work of numerous suppliers are involved. Changes in Walmart's business processes are necessary for implementation and optimization. I think we can make a real difference in their operational efficiency and customer satisfaction as they embrace more innovation in pursuit of better serving their customers and associates and growing revenues and profits. We're making good progress with the other previously mentioned domestic-based large retailer. Digimarc enhanced product is underway to the stores. We have a plan for scale once initial in-store assessment has been completed. As with Wegmans and Walmart, we have a clear view of the applications of our platform that will advance their strategic aims. Earlier this week, it was reported that a large regional grocer, H-E-B, is piloting self-checkout consumer mobile apps called H-E-B Go in 2 San Antonio stores that employ Digimarc software. We're being cautious about adding more domestic-based retailers due to resource constraints. In our view, in light of the constraints, a controlled rollout of applications is the best approach to this phase of market development. On the product front, we are managing a controlled rollout of Digimarc Barcode for thermal labels. We are piloting labels of Wegmans and New Seasons. And as in all betas, we are learning some things and doing some tuning of our processes and software. We expect to be in store soon with another retailer and are in the pre-sales diligence phase with others. Thermal labels amplifies the benefits of enhanced packaging and store operations. In the layers of our platform architecture, more enhanced media provides more discovery, which enables more applications and greater return on investment from each application. We begin market development with focus on two principal applications: easy checkout and consumer engagement. Progress on consumer engagement has been difficult for many reasons. The consumer products industry has struggled with improving their marketing to increasingly mobile-centric shoppers. Impediments include lack of their strategies for dealing with commoditization and changes in shopping and buying behaviors, lack of a broadly available mobile app for consumer engagement and lack of consistent and valuable responses to the mobile engagement they get. These factors undermine an important consumer engagement value proposition for including Digimarc Barcode in their package designs. Industry leaders and major trade associations, GMA, FMI and GS1, appear to be increasingly aligned on SmartLabel as a means to address these challenges. We expect that they will substantially increase marketing of the platform to consumers in 2018. I'm pleased to note that GMA released an update for the SmartLabel mobile app for iPhone and Android last week that included Digimarc Barcode reading capability for the first time. This supports flexibility for participating brands in activating consumer engagement, adding Digimarc Barcode to the improved means of connecting from the packets to SmartLabel content. We have made a lot of progress in becoming active supporters of the SmartLabel program and are engaged with several leading consumer products companies who would like to use Digimarc Barcode for SmartLabel. While we see the stronger and clearer strategy and value proposition in store operations that leads us to maintain the bias toward retailers and resource allocations, there are some very encouraging developments among consumer product companies. There are a few prominent CPGs who are working with us on tools development, business process change and supplier education and orchestration to support enterprise-wide global scaling. Along these lines, we have entered into a collaboration agreement with one of the leading CPGs to determine how to most effectively implement Digimarc Barcode in a range of applications. We are rapidly improving our software and support. These improvements foster more speed and scale of market adoption. Our work on these matters are defining the standard operating procedures for globalization of the next generation of automatic identification pioneered by the original barcode. Early experience is informing the development of these procedures. Our goal is to supplant conventional barcodes. We are enlisting the aid of retail and CPG industry leaders to advance these efforts. Our near-term focus is on nurturing a few industry leaders' enhancement of private brands and deployment of thermal label solutions supporting fast checkout, consumer engagement, associate productivity and other applications among these early adopters as case studies and successful implementation, deriving best practices from our experiences with them and applying these practices to scaling other industry leaders. We believe that this is the optimal path to near-term revenue growth. The basic building blocks are in place to work with industry leaders in the U.S., Germany and Japan to begin scaling the market. Our balance sheet's in good shape. We're making progress expanding our institutional knowledge and implementing requisite software, training and support services to foster progress in key performance indicators of increasing bookings, and providing other evidence of growing adoption to industry and to the capital markets. That's it for our prepared remarks. We'll now open the floor to questions.

Thank you, sir. [Operator Instructions] And your first question comes from Rob Stone from Cowen and Company.

Hi, guys. A couple of questions, if I may. One, with respect to the scaling up of the organization that you needed to do to address these new markets and opportunities, how should we think about the run rate and growth of operating expenses this year? Are you approaching the scale that you need to support your plans? Or should we look for more expense growth from here?

Hi, Rob. This is Charles. I think we likely may be adding a few additional headcount here or there but we don't have plans for significant headcount growth in, at least in the start of 2018. So I think looking at Q4 is probably a better comparison. We obviously ramped up headcount pretty significantly in 2017 from 180 to 207, and so that ramp is kind of reflected in our run rate in 2017. So I think Q4 is a better reflection of that.

Some increase from the Q4 run rate?

Some increase, but not to the rate of increase that we saw during 2017.

Yes. Rob, I would just add to that, that we spent a lot of time in the second half of 2017 assimilating the new employees and trying to make them as productive as possible. We're very focused this year on some key accounts and - on beginning to grow the revenue significantly. So we're trying not to have a lot more expense without a lot more revenue. So our goal here really is to improve our productivity with the base that we have. We still have a few holes, but we're going to try not to increase the run rate very much until we show some more revenue growth.

So I wanted to drill down a little bit on your comments, Bruce, about the approach - or the preferred approach maybe as you and potential early adopters have earned more about the technology and the ways it can be deployed towards sideways as opposed to counting SKUs as packages get converted. Can you give us a sense of - and I know it's early so this would be a rough cut, but would you expect to see the majority of relationships want to proceed under a site license? And can you give us any help in - a way to think about the scale of that sort of thing?

Yes, yes. So I had said previously that we want to offer flexibility so people could, like, try a few and then get going. Those who want to get going want to get going, so there's really not much of the notion of trying a few anymore. So I would say not the majority, but nearly all of the prospective clients, who aren't under contract, want to do contracts for terms of the years that have an annual fee associated with the work. When we talk about enterprise license, I don't mean to imply that sort of you get everything for one price. We have a basket of media enhancement capability and then discovery capability and then applications built on top. And so think of it as build materials with required and optional components. And what we do is as we're maturing in our development of the market, is to begin to engage more in pre-sales build to determine what is the best package for the client and what's the best plan for implementation and optimization of their resources as well as ours, and then what's the price. And so the price, typically, I expect, will escalate over some period of years to some terminal value based on the selection of media and applications by the client.

So contracts, you're saying, average contract size would increase or within a contract over the term, you will be doing more for that same customer and so the value rises from year to year?

The latter. So what we see now is - and as I went through my remarks, prepared remarks here I was saying, well, when we started out, we're talking about enhancing packaging to make checkout go better and then make consumer engagement more intuitive. And since then, of course, you see now the elaboration of media, which was contemplated at the inception of the strategy of The Barcode of Everything. Okay, fine. So we can do packets, we can do thermal labels, we can do shelf labels, we can do shelf-ready packaging, we can do POP, we can do magazines, we can do TV, we can do all of these things. Well, if you believe the strategy, which I hope you do, and then that means over time there'll be more things that can be done with the platform. So the notion of the $50 per SKU for packaging was that packaging, we view as a key medium and that would be the network, if you like, or platform license fee associated with that medium. But then you still have to buy enhancement services, you still have to buy software solutions and integration services and business process reengineering, all of those things. Some of which will be supplied by us and some by business partners. And as the market adoption grows, I would expect an increasing involvement from business partners. And so that's why the revenue mix will be all of those things all of the time. What the clients are looking for from us is to have an established viewpoint of the, I'll call, the basic cost of adoption with respect to us. And then they understand, just like SAP and Oracle and Salesforce, that once you buy the license, then you're going to be paying more money to those companies than to others to build value on the platform.

Okay. The final thought from me, thematically, retail is seeing these days in a struggle with e-commerce and one of the things that you were demonstrating with WestRock at the NRF was applying barcode to round corrugated packaging. Clearly, if that side of the supply chain became amenable to your technology, then we could characterize Digimarc as an e-commerce play as well. Can you provide any more color on - I know its early stage, but anything to say on corrugated packaging?

Thanks, Rob. Yes, a couple of things. One is that each year at NRF, we try to showcase what we view as some promising R&D. So a year ago, it was thermal labels and this year, we launched some - so this year it was corrugated and so hopefully, we're not too far from commercialization on the corrugated. Ideal of the path from R&D, the commercialization for corrugated, is strong customer sponsor and a lot the capital investment being done by one of the suppliers in that environment. And we're quite fortunate at this point with corrugated that we have some - there is some client interest that we're aware of and at least was one of the major suppliers in that business is already a business partner for ours. So we'll see how things go. But it is a very significant market opportunity. But at this point in time for us, merely R&D. And you saw the demo at the show. It was pretty cool. So we see a lot of promise. But along the way to print on corrugated, it's important for the investors to appreciate that thermal labels apply in a number of different circumstances. Basically, the inexpensive black and white labels that are printed in-store using desktop devices, which we were showing at NRF. They also are - there are mobile devices that print thermal labels for shelf labels for instance and for markdown labels used by store associates. Thermal labels are also applied by food service companies with very large equipment such as supplied by Disney, one of our business partners, and then logistics. And so there are lots of problems akin to the problems of retailers with thermal labels in logistics. So I don't want everyone to really leap over labels to the label-less future, but we do contemplate the possibility of a label-less future through print on corrugated, and we showed quite persuasively that we can provide a pretty robust signaling mechanism at NRF.

Great. Thanks, Bruce. I'll Jump in the queue.

Thank you, Rob.

And your next question comes from Jim Ricchiuti from Needham & Company.

Hi, good afternoon. Bruce, as you begin this transition to more of an enterprise license model. I'm wondering, is this - is the time line for this, does it - is it - it sounds like it's more complex than trying to get customers, early adopters under the prior way that you're going after the business, sounds like there's a longer sales cycle. Is that a fair way to think about this? And is it also a case where you've been further - already done this road in terms of talking to the customers? And again, what I'm getting - trying to get to is what might the time line be for one or more of these agreements to potentially be announced this year?

Yes. So I'll try to answer the questions in order. So I think not and hope not with regard to the longer cycle. I think it should be the opposite, depending on their confidence to deliver a persuasive and well-articulated proposal. So that was my point about going back to the ID Systems. That's how we ran the business back then, but we sold all the competence in our 2008 sale of that part of the business. So we - I would say, institutionally, we sort of get it, but we've got to rebuild our capabilities there. So we employed some consultants and we're getting quite focused on putting together high-quality proposals akin to what we did during that era. In doing that, I hope it won't take us too long to develop a number of persuasive, high-quality proposals and ship them in to the appropriate accounts and then see where we go. But I'm optimistic that, that will lead to a faster ramp in sales than going one by one. And that's because there's an assumption about liquidation of some period of value, let's say, with respect to the IT license, but also to provision the software and services, that would be naturally encompassed within those agreements. So I hoping that will have an - a beneficial effect on revenue growth and timing. And thus far, our experience is encouraging with respect to that. As to getting those proposals going and getting adoption and having that become public knowledge, we're pedalling as fast as we can to make as much of that happen during this year as we can. And so I'm not in any way suggesting that, that approach would lead to a longer sales cycle, I'm presuming it leads to a more impactful one. I'm not sure because it's been long already, maybe it can get shorter, but more impactful. And we will announce what agreements we need to announce according to securities regulations. I'm sure virtually all of our agreements, if not all of them, will be desirably confidential from the customer perspective. And then we do disclose our backlog numbers, which we provide as a window into that world to the extent we can. So does that answer all your questions, Jim?

It's helpful, Bruce. I'm wondering, and I know you can't be very specific. I understand that. But can you give us a sense as to whether you have several irons in the fire as you pursue this business, the enterprise side?

Yes. I can't probably say a whole lot more. But in reviving that capability, we've built a model which should be quite efficient in delivery of proposals with much larger dollar amount. So I'm anticipating that a very small proposal will be 6 figures. A typical one would be 7 or 8. And obviously, they can be framed over a period of years and we'll see what the market wants to do. But as I've been saying in the last couple of updates, we have sort of gotten over the question of awareness and value. People actually believed in what we're doing, people meaning industry leaders. Their question is just, how do we transform our business to accommodate the new data carrier and take advantage of all these performance improvements? And so that's really system integration work, business process reengineering, consulting and so forth. And we're not yet at a proven scale where the big SIs want to play. And so that's what I view as our sort of - at least interim role, maybe long-term role, but at least interim role is that we're stepping in and we're helping to manage these projects until we get to a larger scale, and then we'll see what happens at that point.

Okay. And I had a follow-up question. The way you're characterizing thermal, thermal labeling, it sounds like that, that is going to be one of the major sources of growth that you see in this area of the business in 2018. Is that an accurate characterization?

Yes. And it has to do with getting, I'll call them global processes in place for the private brand and global brand package enhancement. We've been, again, blessed with a great collaborator in Wegmans, and we've done obviously some work with Walmart. And as I mentioned in my remarks, we now have an agreement with a leading CPG. All intended to develop a supply chain capability for globalization. So the private brands are a bit easier in the sense that they tend to be localized brands in a geography like the U.S. or Japan or Germany. But the supply chain tends to be global, even for relatively small brands. And so we've been hard at work here, and it's hard to articulate and somewhat impossible to demonstrate building all of the tools and the business processes and the standards, if you like, ad hoc standards, for Digimarc Barcode implementation in the global supply chain. But for the biggest players to embrace that, and maybe get that in place. And so going back to the theory of market development, that's why I wanted the biggest players on our team because I need their help in doing that. And I'm getting their help in doing that. So that part's coming along well. But in terms of the growth of revenues associated with packaging, that's why it's been going slow. It's just - at first, we are improving our value prop, now it's about delivering on the value prop. And their - the desire of the major companies that we're dealing with is that we are able to support their entire product lines. And so that's what we're working on right now.

Do you see some of these customers that you've been working on with an appetite - having an appetite to move faster on thermal labeling as opposed to perhaps the enhanced packagings areas that you had been pursuing with them?

Yes, absolutely. And that's - that explains - I don't have a view on the long-term balance between packaging and thermal labels in terms of revenues and margins. I think they'll both be quite large. Obviously, the packaging addressable market is monstrous. But thermal label resonates well with retailers. And it doesn't have much of the overhead associated with packaging. And I wish I could expose to you some large companies' processes for package development, but it encompasses many stages of participation, many parts of the organization with many approvals. And so going in and making any modification introduces a lot of business process. Labels are a much simpler phenomenon in terms of business process, and that's why I think we can go faster with labels than we can with packages.

Is there just a bigger incentive for these retailers on the labeling side?

There are well-understood problems, but there's less interdepartmental coordination required. So if you think about a package design and approval process, it begins oftentimes with an external agency, with brand management developing a feature set, then they develop a host of designs. And then the designs go through legal approval, manufacturing studies, marketing studies. And then something gets approved down the road and then everybody is entrenched to that point in time. And so even a very subtle change like we might introduce needs to go back through all those loops. And with thermal labels, generally speaking, there is a design resource that resides either with the retailer, or in the case of logistics, the - what's called the user and the printer supplier. And the printer suppliers have label design software. And just as a reminder, my retrospective on ID Systems, Zebra is a major supplier of such devices, and they were our thermal printer supplier in ID Systems. So we are literally going back to the old days here. But the design is created, and you've seen the designs are quite simple, and there generally isn't much, if any, artwork involved. And so it goes through legal approval and goes through a little bit of testing and then it's ready to go. So it's just a much shorter, less complicated supply chain for labels than for packages, thermal labels.

Got it. Thank you.

And your next question comes from Josh Nichols from B. Riley FBR.

Yeah. Hi. I was just listening to some of the comments and got me thinking, how do you think Amazon's increasing encroachment into the retail ecosystem that's probably going to impact the adoption of Digimarc technologies over the last - over the next year or two. And then what surprised you over the last, say, 6 to 12 months over - regarding the rate of adoption?

So Amazon already provided a lot of inspiration with the Whole Foods acquisition. That did inspire lots of people to move, I'll say, faster, although you might not see the evidence. They're actually moving faster, and more committed. And appreciate that what Amazon is doing here is they're building out, look, we used to call them the cable television business, the last mile of the network. So they're trying to get closer to the customers. Well, Walmart and Target, Kroger, those kinds of companies are already much closer than Amazon to the customers. And Amazon is able to compete very effectively against the physical retailers for a lot of reasons but the prime membership is a big deal, a big part of it. Without Prime, I don't think Amazon could perform nearly as well as they do. And set, the Prime membership subsidizes the shipping. One of the things that Amazon needs is to reduce shipping cost, which means pushing product out to the edge of the network to lower those costs. Well, Walmart has 4,700 network nodes in the U.S. market alone, 11,000 globally. So they're way ahead in terms of network nodes. They just haven't positioned them as effectively and effectively in relation to the Amazon strategy. So we expect Amazon to keep going more physical and Walmart has already invested a lot in their online capabilities. But in the recent public statement from the CEO of Walmart, he talked about wanting to basically serve the customers wherever they are, anyway they want. And that's the goal of all retail. So you saw the proposed consolidation of Albertsons and Rite Aid earlier this week and you saw also probably the JPMorgan deal with Amazon and Berkshire Hathaway in revolutionizing health care. So what - all of these have a common goal, and that is a kind of ubiquitous commerce. So I wouldn't call it online versus off-line anymore. The ideal here is to create a network design that is optimally efficient and responsive to the consumer - modern consumer desires. So both of those things are key premises of the Digimarc Intuitive Computing Platform. We're about efficiency and reliability. We're about improving operations, and about improving consumer engagement. So we think we fit perfectly into the way in which retail is evolving. And so Amazon is a terrific inspiration to the marketplace here showing, from their perspective, how this is all evolving. But I think the other side is starting to get it now and moving back in the other direction. So it's really not that online will ever dominate physical. I think it's quite clear physical will dominate online probably forever if they do things right. But they've got to get more efficient and then they've got to get more engaging, and that's all getting worked out. So I think what - I wouldn't say it surprised me. What encouraged me in the second half of last year was this growing realization. And you can see it in lots of research that we publish, that consumers have lots of ways they'd like to shop and buy and consume and recycle. And all of the retailers are trying to figure out how to be versatile to serve those desires. And in order to do that, they've got to be much more efficient than they have been because Amazon teaches them extraordinary efficiency in everything, except for shipping so far. But with Amazon's new fleet of airplanes and their continuing encroachment in physical retail, they're going to get much more efficient in that regard as well. So I'd say Amazon was quite an inspiration in the second half of 2017 for the industry and for me.

And then last question, you talked a little bit about the opportunities and the outlook for 2018. But could you elaborate a little bit more about what you're seeing specifically in Germany and Japan, and how that fits into the company's strategy for this fiscal year?

Yes. I was trying to keep things short. So I talked a bit at the conference in January about it. So in Japan, our study group friends just completed the grocery tech trade show, a couple of our people were over there visiting with them and walked in the show. And it seems like things are moving along nicely there. We have to up our support. We're still struggling a bit here in terms of resource management and management of our working capital in trying to provide support to Japan and Europe. So we have a country manager there and we have some friends there, and we're trying to figure out how to get them organized and optimized to support commercialization of the platform in the territory. I'd like to reserve trying to give you a clear look on strategy for maybe a quarter or 2, and I intend to do it in that time frame to be able to tell you that, here's the commercialization approach in Japan. With respect to Germany and Europe in general, we're in discussions with a number of the industry leaders there. And like in the U.S., we'd like to narrow it down some and get just a small number, sort of a few or less of them on board to build the process for delivery in Europe rather than get a bunch of them because it will overburden our resources. In each of the cases, Japan and Europe, I believe that perfecting - or I should say improving the delivery model and getting some public statements of support from global leaders in the U.S. will facilitate the development of the other geographies. And so on a high level, that's the strategy. That is to continue to make great progress with U.S.-based global leaders, and then to use the fruits of that collaboration in developing the Japanese and European markets, and to continue to try to not venture beyond those geographies if we can.

Perfect. Thanks, Bruce.

Yeah.

And your next question comes from Ilya Grozovsky from National Securities.

Just a housekeeping note. If you were to back out the revenues in the year-ago quarter from that customer that you sold the license to, what would the growth have been?

You're talking about fourth quarter or third quarter?

In the fourth quarter?

There was a negative impact in the fourth quarter of the third quarter license. Is that what you're talking about?

Yes. So - right, so you guys took the onetime payment, right?

Yes, if you were to basically back everything out, look at Q1 or Q2 kind of run rate. That was our normal royalty run rate. And then in Q3, we had $3.5 million onetime fee as well as the Q3 royalty, which is around $300,000. So we had about $3.8 million in Q3 that's non-recurring.

And then minus 3...

Yes. And then in Q4, in theory there would have been $300k of additional license revenue in Q4. But as we waived those royalties, we didn't earn any royalties.

Okay. Got it. Thank you.

And your next question comes from Jeff Van Rhee from Craig-Hallum.

Great. Apologies if these have been touched on, I jumped on a little late. But, Bruce, the - as it relates to the center store theme, where are you in terms of being able to firm up the numbers so to speak with respect to what an ROI looks like, what a deal size looks like for a top 5, top 10 grocer? I know you've been working through things in trials and whatnot. Just a sense of what you know at this point about those 2 things, deal sizes and the ROI, if you can put any quantification around them?

Yes. So on thermal, I have 1 major retailer under contract and know what the economics are. I can't expose that for a lot of good reasons. But until we've gotten more deals under our belt, it's problematic to do that because if I put a number out for the capital markets, then you know that all of the product market participants are going to try to negotiate down from that to somewhere, and then you're going to tell me that I gave you the wrong number. If I give you the number that they think they end up at, then they must start at that number instead of starting at the higher one. So I don't know how to untangle that one, Jeff. I would if I could, but...

Anything then from the inverse of it, say, maybe from the ROI respect? You know whatever they're paying, this customer you're referring to, and you've certainly done some testing. Is there a framework or a broad range of how you think about the ROI on that upfront spend?

Well, that's what we're working on with Wegmans and New Seasons. And they're obviously much smaller scale than the global leaders that we're targeting. But we're trying to do some research there that informs the return size of the ROI calculus. And we're also doing some work with some larger players along the same lines. But we're - that's a great value of the relationships with the regional grocers who are working with us is that they can move a little faster maybe and we can get a little more figured out with them even though it's different in some ways. So our understanding from conversations on value from thermal label enhancement are that the ROI would be extremely attractive. That is it's not just some small percentage ROI, but magnitudes-level ROI in relation to the proposed pricing, what - I just call it our price list. So we've got to get more market experience to inform it, but the retailers' presumption is that it's very high. Nobody's trying to tell us that's not worth a lot, that doesn't mean they don't negotiate hard and try to get the lowest possible price. But no one's going in there, like, "I don't get it. I'm not sure it's meaningful. They all go, wow, yes, this would be really helpful. Let's get it going. Let's do some pilot work, beta work, and then we'll negotiate the price with you.

Yes, yes. Fair enough. So as you look at then the '18 framework and obviously, timing has proven very, very difficult because of the scope and all kinds of things. But as you sort of back of the envelope mentally what '18 bookings are going to look like, how do you, again, sort of think about the mix of those bookings for the year with respect to center store versus front? At this point, are you thinking when you look at likely bookings in '18, that we get the majority, 2/3, more than that from center store? How does that crudely balance, realizing that could swing meaningfully, but just your best sense at this point.

Our current assumption is that the perimeter of the store, the fresh products drive the forecast. So center store is the minority of the forecast, not the majority. Thermal labels always support - but both center store enhancements and perimeter enhancements support front of store. So it's really center store is typically the packaged goods, the cans of things and boxes of things, and the perimeter is fresh. So we expect fresh to contribute more than center of store in 2018.

Yes. Okay, I got it. I might have reversed those terms. So I appreciate that. And then last, again, just sort of had the chance to quickly look at numbers thus far but there was reference to registered direct in there. Can you just recap for me the year kind of in review, if you will, the trailing 12 with respect to registered directs kind of what was done when. I just want to be clear that I've caught them.

Yes. We did a registered direct in Q2, raising just under $18 million, and then did a registered direct in November, raising $12 million, both of which were done at no discount and had minimal transaction costs.

And how should we think about the path of likely registered directs going forward?

I can address that one, Jeff. The people call in to us and say they want to buy a large block of stock at market price with lock-ups on and it's pretty hard to resist. And so that's what happened in both of these cases. So there is no marketing program to do this, and there's no projection of doing it. On the other hand, you'd appreciate if people get so inspired about it, it's pretty attractive in terms of cost of capital and giving us more flexibility in the balance sheet.

Okay. That's all I had. Thank you.

All right. Thanks, Jeff.

And your next question comes from Jeff Bernstein from Cowen Prime.

Hey, guys. It just sounds like there's a little bit of a resetting of kind of order of operations of things that are going to happen here and I just wanted to have you frame that a little bit more. So in the past, you kind of talked about the expectation that, potentially, once somebody big really move, that the risk aversion that's characteristic in these retailers, might kind of move to the rear and you might start to see a bunch of people sort of rushing. You'd also seemed like places like Japan, where they already were looking into the technology together, might move faster. Can you just give an update on where we are on those things?

Yes, yes. I don't see any reset at all, frankly. So what's different here is - and I wood frame it quite positively, is we have the opportunity to make larger proposals to very large prospective customers. And I don't know that a year ago we're in a position to do that. And so in terms of the sort of tipping point theory that I've advanced, this would be the way to get there. If there are large players other than two publicly visible agreements of scale, I think that does the trick. So that will actually work. I think in terms of overall execution of strategy in line with what I had outlined when we started, we're pretty close to where I want to be. And of course, no one is happy about how long anything takes, including me. But I do think that we're very close to having what I thought would be evidence of the endgame of establishing credibility and then focusing on implementation. So we obviously are engaging with the world's largest retailer. And we mentioned in our remarks here that we have an agreement with one of the world's largest consumer products companies. And we have a common goal among the global leaders of how to facilitate this succession plan for conventional daily carriers. So I think there's a common mind in the industry to move to an improved data carrier, which I think people think is us. We're a small company operating with a small working capital budget for reasons all well understood. So we're putting as much into it as we can, and it's going the way it's going based on that. So I think we're making good progress and I think we're getting pretty close.

Okay. I guess it does sound like its more U.S. players though that are going to move before the Japanese maybe?

No, no. No, I - again, I tried to defer detail on the Japanese market because I'd rather give you a strategy than anecdotes. But there are a number of players in Japan that are moving forward much faster than any other geography but starting much later. And so I don't know whether they pass the others by or not. And in Europe, there's significant interest but a desire for, I'll call it, the plan. And it has to do with some of the global leaders' style. Let's call it, button-down style, and they just want us to give them the whole plan. And that's great news, really, I'm very happy about it. Does that go faster or slower? I don't know.

Got you. Okay. And then, Bruce, you've talked about in the past with regard to consultants and system integrators, that there was plenty of interest from someone when you were kind of ready to - or when someone was ready to hand them a million-dollar implementation contract, et cetera. Do we think that kind of thing is going to happen as a result of some of the - these more global contracts that you're looking to sign? Or is the business partner piece still a little further out?

I don't know yet, Jeff. I think I would sort of believe it's a little further out. And what's happened is this is a little nuance, so I'll try to explain it the best of my ability, is that because we are the inventors of the platform, there's - and because we have some history in doing business process transformation, creation of issuance systems, replacement of issuance systems, this - again, this is the barcode issuance system not the driver license issuance system. So there's a fair amount of customer desire for us to play a central role and yet we're 200 employees instead of 600 employees, and we've got some other things we do. So we're not nearly as capable as we were 8 years ago, or 9 years ago now. But I understand why they have the view they have. So we're trying to figure that out. I would love to get some of the big SIs involved, but they want big projects with big price tags and those aren't available yet. So I think we'll have to do this for a little while, maybe - like I said, maybe for longer.

Got you. And then you mentioned a new large retailer with products on their way to the stores. So is that a signed deal or is that a pilot or how would you characterize that relationship now?

That's the sort of previously referred to other very large retailer that we have a master services agreement with. So it's the first work order in the master services agreement that's underway.

Got you. And then - so is there still another one where you're trying to close a deal?

There are several that we've been working on there.

Got you, okay. That's great. Thank you.

Okay. Thanks, Jeff.

And at this time, this concludes our question-and-answer session. I would now like to turn the call back over to Bruce Davis. Sir, please proceed.

All right. Thanks very much, and thank you, everyone, for your support. We'll look forward to talking to you again at the end of this quarter's board meeting. And let me assure you, we're doing all we can to proceed as quickly as possible to increase the market adoption. Thanks very much, and good-bye for now.

This concludes today's call. Thank you, ladies and gentlemen, for joining us today for our presentation. You may now disconnect.