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Edited Transcript of DMRC earnings conference call or presentation 26-Feb-20 10:00pm GMT

Q4 2019 Digimarc Corp Earnings Call

Beaverton Mar 24, 2020 (Thomson StreetEvents) -- Edited Transcript of Digimarc Corp earnings conference call or presentation Wednesday, February 26, 2020 at 10:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Bruce L. Davis

Digimarc Corporation - President, CEO & Chairman

* Charles Beck

Digimarc Corporation - Executive VP, CFO & Treasurer

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Conference Call Participants

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* Michael Joseph Cikos

Needham & Company, LLC, Research Division - Associate

* Rudy Grayson Kessinger

Craig-Hallum Capital Group LLC, Research Division - Research Analyst

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Presentation

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Operator [1]

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

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Bruce L. Davis, Digimarc Corporation - President, CEO & Chairman [2]

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Thank you. Good afternoon, everyone. Welcome to our conference call. Charles Beck, our CFO, is with me. On the call today, we'll review Q4 and fiscal 2019 financial results, discuss significant business developments and market conditions and provide an update on progress and execution strategy since the last update at the Needham Conference in mid-January. We've posted these prepared remarks in the Investor Relations section of our website and we'll archive this webcast there.

Please note that we will make certain forward-looking statements in this call and in the prepared remarks we filed with the SEC and posted on our website under the heading Safe Harbor Statement, regarding revenue recognition matters, results of operations, investments, initiatives, perspectives on business partners, customers, prospects, industry trends and growth strategies.

We will also discuss from time to time information provided to us by our partners and actual and potential customers. We are providing this information as we understand it was represented to us. And we do not verify nor vouch for such information.

All such statements and information are subject to many assumptions, risks, uncertainties and changes in circumstances. Any assumption we share about future performance represents a point-in-time estimate. Actual results may vary materially from those expressed or implied in such statements.

We expressly disclaim any obligation to revise or update statements or other information that we provide during this call to reflect events or circumstances that may arise after the date of this conference call.

For more information about the risk factors that may affect actual results or 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. Any links included in our prepared remarks are provided for general information and context only. The content reference is not incorporated by reference and you should not consider a part of this presentation. We do not verify nor vouch for such information.

Charles will now comment on our financial results, then I'll discuss significant business developments, market conditions and execution of strategy. Charles?

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Charles Beck, Digimarc Corporation - Executive VP, CFO & Treasurer [3]

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Thanks, Bruce. First off, I just want to give everybody a heads up that the earnings release was distributed through PR Newswire on time. However, Yahoo! Finance news feed is, for whatever reason, not picking up that release. We're working with them to make sure that the release is posted on that site. It is available through all other channel, though, including our own website as well as the SEC website.

Barcode revenue for the quarter increased 138% year-over-year to $1.4 million. Total Q4 revenue increased 2% to $5.3 million from $5.2 million in the fourth quarter of last year. The increase in Barcode revenue was offset by lower service revenue, reflecting the timing of program work with the central banks.

Barcode bookings during the fourth quarter were $1.3 million, down from $1.8 million in Q4 last year. The decrease was due to sudden and unexpected corporate cost cutting at one of our supplier partners developing supply chain applications, leading to renegotiation of our contract with them. That contract contributed $1.3 million to bookings in Q4 last year. We expect a Q1 booking from a revised contract that is being negotiated.

We expect that the new contract will have less fixed and more variable elements than its predecessor, yielding lower short-term bookings and revenues with higher potential upside. Once things are settled, I will provide additional details. This does not affect any of our retail business. This developer's focus is on supply chain improvements.

Gross margin for the quarter was 66%, up from 60% last year, primarily reflecting the impact of higher Barcode revenue. Operating expenses increased by 9% from Q4 last year primarily reflecting routine annual compensation and benefit adjustments for our employees and increased headcount to address growing demand and delivery requirements.

Net loss for Q4 was $8.7 million or $0.73 per diluted share versus a net loss of $8 million or $0.70 per diluted share in the fourth quarter last year, reflecting higher operating expenses. We ended the quarter with $36.8 million in cash and investments. We did not raise any capital under our ATM program during the fourth quarter. There is $9.7 million remaining out of the $30 million authorized. We will exercise customary care in determining the best course of action regarding the remainder of the authorization, should circumstances warrant resumption of sales under the program.

We invested $6 million of working capital during Q4, which was at the low end of the range of $6 million to $7 million we provided in our last call, largely due to favorable timing of cash receipts and payments. We used $5.6 million of cash to fund operations and $500,000 for capital expenditures.

We anticipate operating expenses in the first quarter to be between $13.6 million and $13.8 million. The roughly 10% projected increase in operating expenses over the fourth quarter reflects the impact of routine annual cost of living adjustments for employees, increased headcount and quarter-specific costs for NRF, other sales and marketing initiatives and the year-end audit.

We expect the cash usage will be between $7 million to $8 million in Q1, reflecting the reversal of a favorable timing of cash receipts and payments we saw in Q4 and the impact of the quarter-specific costs I just mentioned. We expect our average cash usage for the remainder of 2020 to be at a lower run rate than we are projecting for the first quarter and will continue to vary quarter-to-quarter depending on timing of cash receipts and payments.

Turning to results for the full year. Barcode revenue increased 105% over last year to $4.9 million. Total revenue increased 8% to $23 million from $21.2 million last year. The effect of doubling Barcode revenue was partially offset by Guardian revenue, which decreased 11% from last year to $3.2 million. Revenue from the central banks was up marginally over 2018 as expected.

Barcode bookings for the full year were up 60% to $4.9 million from $3.1 million last year. The increase in bookings reflects the impact of the Walmart contract and other new Barcode bookings partially offset by the impact of the contract renegotiation with the developer that I referenced earlier.

Gross margin for the year was up 5 points to 65% primarily reflecting the impact of higher Barcode revenue. Operating expenses for the year increased by 5% from last year primarily reflecting the impact of routine annual compensation and benefit adjustments for our employees.

Turning to the balance sheet. Cash and investments were $6.8 million lower than at the end of 2018, reflecting investments in our primary growth initiative, offset by the $19.6 million of capital we raised in the at-the-market offering during the second quarter.

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 his comments on significant business developments, market conditions and execution of strategy.

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Bruce L. Davis, Digimarc Corporation - President, CEO & Chairman [4]

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Thanks, Charles. Awareness of Digimarc and engagement have risen to much higher levels in the last few months. Website traffic is up across the board in Q4. Social media following increases as well. We are working our way up the ranking of IT priorities with retailers. Many CPGs are now engaged across the range of relevant applications in manufacturing, retail store operations and recycling.

We begin each year with the coincidence of NRF at the Needham conference. I described our progress during 2019 and some insights gained in NRF during Needham. Thus, I won't dwell on 2019 in this update. The Needham webcast is posted on our website for those who want details of our progress last year.

At a high level, the year included many important milestones as Walmart and Netto came on board, Wegmans renewed its contract and support among global brands expanded significantly. What is hard to adequately communicate is growth in our supplier network and our ability to support their essential role in our success.

As I observed the rate of progress and adoption and revenue growth, this is where we can get the most leverage. We have added staff in this area and focused a great deal of senior management on establishing effective, mutually profitable partnerships in all aspects of the developing ecosystem. Success of these endeavors will facilitate sales growth and pay rich rewards to our shareholders in the long term.

We had the best show ever at 2020 NRF, with demonstrations of efficient inventory management, food waste and shrink reduction, sustainable and connected packaging, connected apparel and print-to-web connected catalogs, print ads and promos. There were more than 3,000 booth visitors, 34 partner and 24 customer briefings, the most prominent of which are listed in the prepared remarks.

We entered into our contract with Walmart in Q2 last year for fresh product labels and packaging. The fresh product label portion is taking longer than expected. Our labels have not yet reached the stores due to some issues in system integration beyond our control that appear nearing resolution. We plan to be in the stores in Q2.

On the other hand, packaging work at Walmart is going great. Wegmans took several years to reach 2,000 packages enhanced. Netto passed this milestone in a year. Walmart is already over 2,000 after 7 months. The increases in productivity reflect maturation of our platform and support programs. These improvements are allowing a rapidly increasing share of package enhancement to be done by suppliers. This has allowed us to be more open to progress in the broader global market. It also improves our productivity, giving more time to internal experts for research and development and training. We have conducted more than 50 trainings in the past year alone.

R&D is producing important advancements in marker coder, dry offset, metal decoration, plastic molds, vending machines and fabrics that broaden our application support capabilities. Walmart's packaging suppliers continue to add hundreds of enhanced items into Walmart's supply chain monthly. Products from global brand suppliers have begun arriving in stores. Global brand progress is not limited to Walmart as Digimarc enhanced packaging is appearing on shelves across the retail landscape of America, with products from P&G, Pepsi, Frito-Lay, Quaker Oats, Pic Corporation, International Paper, Sigura, Kimberly Clark, ConAgra, General Mills and others.

Enhancement of the Walmart toy catalog opened the door to discussions of additional commercial print opportunities. We will continue to bring more innovations to Walmart to help improve the shopping experience for the customers and working to propagate successes at Walmart to other domestic and foreign retailers under common ownership.

As our NRF demonstrations indicated, there is much we can do in areas not covered by the current contract, such as apparel, home and garden, commercial print, sustainability and supply chain management directly with Walmart and with suppliers. There are many auto identification functions of store operations that can be improved through the use of our platform, including Scan & Go, shelf inspection robots, Pick & Pack for curbside delivery, consumer engagement, reordering and recycling.

We are witnessing an enormous uptake -- uptick in interest in our platform in Europe driven by awareness of the successful implementation with Netto Marken-Discount and widespread accolades and increasing interest in the Holy Grail recycling initiative.

Netto, our first major retail customer in Europe, was publicly identified with industry recognition for our mutual success. Digimarc and Netto were recognized with the Top Supplier Retail 2020 award from the EHI Retail Institute for adding Digimarc Barcode to their private label brand packaging. With the outstanding support of Netto's packaging suppliers, Shawk! and Wipak, we have made rapid progress in deployment with more than 2,000 enhanced products on shelf in more than 4,000 stores. As with Walmart, we are discussing other uses of our platform to improve operations and customer experience.

We play a role in many aspects of the circular economy, including responsible package design, consumer education, collection and waste sortation. Holy Grail is focused on waste sortation. The program was a huge success, culminating in an impressive demonstration in October of application of our platform to waste sorting, that leading to winning many awards and accolades and a feature story on BBC.

Organization of HG2.0 is underway. The primary goal of the next phase is to determine an effective path to commercialization. As the organization is being formed, we have engaged with TOMRA to create a specification for a detection module; and Berry Global, PACCOR, Sidel, ALPLA and others on how to apply our software to plastic molds.

Leadership tells us that they have confirmed interest from 160 stakeholders, including brand owners, retailers, resin suppliers, converters, packaging suppliers, Green Dots, trade associations and other interested parties. There were 29 participants in the original Holy Grail project. This initiative is being closely watched by relevant European government agencies and lawmakers.

There are nearly 60 retailers and global brands among the HG2.0 interested parties, the majority of whom are not yet customers of Digimarc. This alone could result in more than 2 dozen new customer relationships.

We have developed some programs for sale to members once the initiative kicks off. P&G has stepped up as a leading implementor when it announced last week that Lenor, Unstoppable and Fairy brands will pioneer application of Holy Grail using the Digimarc platform to improve recycling of their packaging. We hope that other brands will step up to support our critical role in this initiative. We have -- also have several proposals for paid pilots with recyclers in several European countries out for consideration as well.

In addition, we are polling venture capital and foundations for R&D funding to support Holy Grail 2. Holy Grail 2 is not the only path forward in sustainability that we are pursuing. Discussions are underway with many other interested parties concerning the funding and development of this application of our platform: in Europe, in the U.S. and elsewhere abroad.

For instance, we have recently engaged with Walmart, GS1 and the Consumer Goods Forum in discussions concerning our role in the circular economy and the need for industry leaders to provide direction and support for our efforts, with a focus on responsible package design and more effective supply chain management. These discussions are synchronous with major users of plastic packaging on the path from R&D to global standards, including soliciting advice and possible participation in funding for these activities.

Further to demonstrating our relevance and expediting the progress, we are assessing how currently enhanced packages and labels support the circular economy and how this work relates to opportunities to reduce packaging carbon footprint and waste through the product life cycle.

We have shown the ability to reduce waste in manufacturing to improve parts matching. You all are familiar with our work with Walmart, for instance, on reducing food waste. We showed examples of enhancement of clamshells typically used for the sale of fresh berries at NRF, supporting food safety and reduction in waste. In that same program, we are exploring means to improve recycling of that packaging, which today has very low recovery rates. We are working with a leading berry producer with an understanding that our work with them will be shared with industry.

Although it's not the same level of government pressure here versus Europe, there is a substantial and growing interest in mitigating the carbon footprint among many of our customers. This is motivating action among suppliers, such as the new use cases being explored by IBM Food Trust for track and trace and Verstraete, Berry Global, PACCOR, TOMRA and others for improving plastics packaging designs.

The supply chain is growing and becoming more receptive as we move to scale production with industry leaders in retail and CPG. Several of them are assuming more responsibility for application development and maintenance and system integration, as evidenced in our success with Netto.

Our software is getting better as is our support and business model. Our mission is to improve and expand the basic function of the platform and the quality of our support for these suppliers. We have created a global interactive map of the supplier ecosystem to help those who can benefit from the platform, locate and communicate with local suppliers in our network.

We have observed a generally accelerating rate of growth in Barcode bookings and revenues since early 2018, evidencing effective execution of strategy. Growing use of our platform can be tracked in our media channels and at numerous trade events listed on our website.

Effective management of working capital is always a priority. Our outreach to prospective strategic investors has provided valuable insights about direction and positioning, leading us to refine our focus and enlighten a path forward toward optimal partnerships.

Our work in sustainability has also opened doors to possible additional funding sources based on recycling. The December quarter 13F reports show an uptick in investment by European funds. I am planning a non-deal road show soon to introduce us more broadly in that community where there has been so much positive news lately.

In terms of key takeaways, Barcode revenues more than doubled in 2019 as we entered into production agreements with 2 of the world's leading retailers and gained ground with global consumer brands. We are in the final stages of packaging implementation with Wegmans, tightening up loose ends on means to complete the roll out and maximize the ROI from the now substantially complete private packaging transformation.

We move in to production with Netto and Walmart, each in their own right, a significant milestone for our company. Netto was the first supplier-led packaging implementation for a major retailer. Walmart, the world's largest retailer, is employing the same approach. This transition to supplier-led account management is an important strategic milestone.

Our end-user focus is on earning the trust and respect of Walmart, facilitating enterprise-wide adoption of our platform, and in the process, spinning up the capabilities in their massive global supply chain.

We have more openness to collaboration from suppliers than ever before. We had a successful demonstration of sorting capabilities in October; Holy Grail won 2 major awards; Holy Grail 2.0 formation is progressing; and we are exploring other opportunities in parallel.

As we work to ramp revenues and increase margins, we will continue to explore all sources of working capital, including potential strategic and European investments and nontraditional sources, including venture funds and foundations focused on ESG.

That's it for our prepared remarks for today. And now we'll open the call to questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions) And your first question comes from the line of Mike Cikos with Needham & Company.

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Michael Joseph Cikos, Needham & Company, LLC, Research Division - Associate [2]

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I wanted to ask you about this contract renegotiation that you guys are working through right now. Can you give us a sense of -- like were there any bookings that came through on this contract in Q4? Or that was just at a hold until you guys go through this renegotiation process?

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Charles Beck, Digimarc Corporation - Executive VP, CFO & Treasurer [3]

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Yes. There were no bookings in Q4 related to that contract. We're hoping to wrap that contract in Q1 which would then result in booking.

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Michael Joseph Cikos, Needham & Company, LLC, Research Division - Associate [4]

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Okay. And then just for clarity here, it says that there's going to be less fixed, more variable components, is the expectation for that contract. So I guess, the anticipation then is that lower short-term bookings in revenues in the near term. Can you help us understand what's the greater upside potential stemming from that contract? I was confused by that comment.

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Bruce L. Davis, Digimarc Corporation - President, CEO & Chairman [5]

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The prior contract had a fixed fee. And the new contract has a lower fixed fee with a variable component in order to allow us to be paid more for growth in that business.

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Michael Joseph Cikos, Needham & Company, LLC, Research Division - Associate [6]

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I see. And then one more, if I may. Just coming back to the Walmart, with the system integration issues that you guys are facing, doesn't seem like it's anything on your end there. But what gives you the confidence in being able to start delivering those labels during Q2 to stores? Is it customer conversations there? Just anything there would be helpful.

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Bruce L. Davis, Digimarc Corporation - President, CEO & Chairman [7]

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Yes, it's regular developer updates, nearly daily updates that I personally have received that give me the confidence.

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Operator [8]

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(Operator Instructions) And your next question comes from the line of Jeff Van Rhee with Craig-Hallum.

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Rudy Grayson Kessinger, Craig-Hallum Capital Group LLC, Research Division - Research Analyst [9]

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This is Rudy on for Jeff. A couple of questions from me. One, I want to start with Netto. I think a couple of quarters ago, you guys said you were expecting to be at 3,000 SKUs by the end of the year. I think I saw an article the other day, or it may have been in the prepared remarks, you said it was 2,000 currently. And then also, I'm curious if there's anything that you guys have learned from that rollout. Are the registers on in the stores? Or are there any ROI metrics that you guys could share what is -- maybe anything Netto's seen from it? Just any additional color there would be great.

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Bruce L. Davis, Digimarc Corporation - President, CEO & Chairman [10]

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Okay. First, with respect to us saying 3,000 at Netto, I'm pretty confident no one here said that, so you may have read it somewhere from someone else. And so it's more than 2,000 today, which is more than, I think, anyone would have expected in the short term that we've been working with them. And it evidences maturation of our delivery capabilities, and that was done by suppliers, not us, so even better.

In terms of how it's going in the stores, I think that's evidenced by the awards that were received and by other press that's going on in Germany right now, favorable press, including interviews with Netto. And their basic infrastructure is in place, so they're enjoying the benefits in real time.

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Rudy Grayson Kessinger, Craig-Hallum Capital Group LLC, Research Division - Research Analyst [11]

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Got it. And then also, you commented briefly on sort of some learnings that you had in the quarter from discussions with potential strategics. Could you just expand on that a bit in terms of what your takeaways were and maybe how we should think about the potential for strategic going forward?

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Bruce L. Davis, Digimarc Corporation - President, CEO & Chairman [12]

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Yes. We've talked to many of the big players now. And it's a very unusual environment for such discussions, because of the enormous success of the largest IT companies and their very high market caps and their sense of sort of unrestrained growth. So typically, in talking to large companies, you would be saying, you better act quickly because we're going down the street to your competitor. And if you just think about the largest companies who would be excellent partners of ours, that's not a very strong argument these days. And so we really need to demonstrate the -- both the short-term and long-term relevance of our business to their business on a pretty detailed level in order to get the kind of engagement that we want.

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Rudy Grayson Kessinger, Craig-Hallum Capital Group LLC, Research Division - Research Analyst [13]

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Got it. Got it. And then lastly, if I could, just real quick. Amazon opened their first full cashierless store today. Just any thoughts there on sort of longer-term potential threats to what you guys envisioned with Digimarc?

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Bruce L. Davis, Digimarc Corporation - President, CEO & Chairman [14]

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Yes. It's a little bit of the emperor has no clothes. It's not a full-sized store. They call it a grocery store rather than their first model, which you might call snack shop or a deli. So it's not nearly as big as the mass merchants. It's smaller than Walmart neighborhood markets. It's an effort to scale some, and we'll see how it goes.

But I would suggest to anyone who's interested among our shareholder base to go wander around an Amazon Go store if you have any that are reasonably accessible to you and study the lack of crowds. I understand what they're doing. I've been to many of their stores. And there is some appeal for some demographic for some shopping. But it'll be interesting to see how the grocery shopping goes. So it's a small supermarket, and we will study it carefully.

But thus far, we have not seen the ROI that one might want to see from the amazingly large IT investment necessary to operate those stores. And also take a look at how many store personnel are around and the nature of the products on the shelves and the effective use of floor space, all those things. And look at all of those things, just don't read the PR because of -- Amazon does an outstanding job of PR.

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Operator [15]

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You do have a follow-up question from the line of Mike Cikos with Needham & Company.

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Michael Joseph Cikos, Needham & Company, LLC, Research Division - Associate [16]

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Just 2 items here. First, on the OpEx, I know that you're guiding to that 10% increase in Q1 to $13.6 million to $13.8 million. Just wanted to get my arms around that. So are there onetime items that are going to be impacting that Q1? I know that you're hiring and that you have the compensation adjustments and the increased headcount. But I got to imagine that that might decline depending on trade shows, NRF, audits. Just anything that would be beneficial as we look out to the rest of the year.

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Charles Beck, Digimarc Corporation - Executive VP, CFO & Treasurer [17]

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Yes. So it's a combination of, as you said, compensation adjustments and headcount adds, which would have impact, obviously, the rest of the year. And then also some nonrecurring items. So obviously, we have our big trade show in the first quarter. We also have our year-end audit, and then there's some -- also some additional kind of nonrecurring sales and marketing initiatives that we have in the first quarter. They're kind of a...

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Michael Joseph Cikos, Needham & Company, LLC, Research Division - Associate [18]

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Is there kind of a...

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Charles Beck, Digimarc Corporation - Executive VP, CFO & Treasurer [19]

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Go ahead.

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Michael Joseph Cikos, Needham & Company, LLC, Research Division - Associate [20]

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I was going to ask you anyway the size of those nonrecurring items.

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Charles Beck, Digimarc Corporation - Executive VP, CFO & Treasurer [21]

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Yes, the nonrecurring is around $750,000, roughly, if you add up the 3 components.

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Michael Joseph Cikos, Needham & Company, LLC, Research Division - Associate [22]

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Okay. And then the second item, I know that the service revenues from the program work with the central banks came down to a timing issue. I just wanted to get a sense, could you help us size up this service work? And I just wanted to ask, in conjunction with that, should we expect that to come through in Q1? Or do you have visibility into when that does hit you guys?

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Charles Beck, Digimarc Corporation - Executive VP, CFO & Treasurer [23]

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Yes, it's a fact that we -- so we have generally a fixed budget with the central banks for the year. We did more of that work in the first 9 months. So it's specific to 2019, it's not anything that would carry over. We just did more of it earlier in the year so there was less of the budget to use in the fourth quarter. So it's purely timing. The amount of revenue that we received from the central banks this year was in line with the budget and our expectations. It was just the timing of the work.

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Michael Joseph Cikos, Needham & Company, LLC, Research Division - Associate [24]

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Okay. And I guess, if we look at 2020, then based on that fixed budget, is the expectation right now that it will be more spread out over the course of the year? Or are we expecting, again, more condensed into those first 3 quarters of the year?

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Charles Beck, Digimarc Corporation - Executive VP, CFO & Treasurer [25]

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It will be somewhat dependent upon -- so most of the budget's fixed. There are variable components and the variable components are more challenging to predict when those will occur. But generally, we do try and front-load so that we don't get caught at the end of the year with more work to do than we have resources for. So I would say that 2019 would be a pretty good indicator of what I would expect for 2020, but with growth in the overall budget that we're working with.

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Operator [26]

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And at this time, I would like to turn the call back over to Mr. Bruce Davis for any closing remarks.

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Bruce L. Davis, Digimarc Corporation - President, CEO & Chairman [27]

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All right. Thanks very much, everyone, for participating. We'll look forward to updating you again soon and thank you for your continuing support. Bye for now.

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Operator [28]

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Ladies and gentlemen, this concludes today's conference call. Thank you for your participation. You may now disconnect.