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Edited Transcript of DMRC earnings conference call or presentation 29-Apr-20 9:00pm GMT

Q1 2020 Digimarc Corp Earnings Call

Beaverton May 17, 2020 (Thomson StreetEvents) -- Edited Transcript of Digimarc Corp earnings conference call or presentation Wednesday, April 29, 2020 at 9:00:00pm 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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* Jeffrey Lee Van Rhee

Craig-Hallum Capital Group LLC, Research Division - Partner & Senior 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. Now I will turn the call over to Bruce Davis, Chairman and CEO of Digimarc. Mr. Davis, please proceed.

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

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Thank you. Good afternoon. Welcome to our conference call. Charles Beck, our CFO, is with me. On the call today, we'll review Q1 financial results, discuss significant business developments and market conditions and provide an update on progress and execution of strategy. We have posted these prepared remarks in the Investor Relations section of our website and will archive this webcast there.

Please note that we may 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 and prospects; industry trends and growth strategies.

We also will 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. 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 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 statements or other information we provide during this call 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-Q 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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Thank you, Bruce. Good afternoon, everyone. First off, you may have noticed some changes to our income statement. We revised our income statement to improve visibility into the return on investment in growth initiatives, targeting retailers and consumer brand owners and to facilitate more effective comparisons with our peers.

We incorporated license revenue into subscription revenue and reclassified a small amount of revenue from subscription to service. We've also incorporated intellectual property expense into general and administrative expense. These changes reflect the evolution of our business from IP licensing to provision of software and services based on our auto identification platform. The focus of patent development has shifted from monetization to support licensing of our software.

The designations of Barcode and Guardian are no longer relevant considering our approach to platform monetization. Assessment of return on investment is facilitated via reporting revenue by target markets. The key market categories are government, retail and media. Government includes services and subscriptions provided to the Central Banks and other government agencies. Retail includes services and subscriptions provided to retailers, brands, their suppliers and related solution providers. Retail is mostly what we used to refer to as Barcode revenue, but also includes revenue from retail customers formerly categorized as Guardian and license revenue. Media includes all other services and subscriptions provided to media, entertainment, education and other customers. Media comprises mostly what we used to refer to as Guardian and license revenue, but also includes Barcode for commercial print and audio for non-retail customers. We anticipate adding other market categories as the business expands to facilitate your evaluation of our investment spending and returns.

Given that retail is the primary area of investment and driver for top line growth, we will focus disclosure on retail bookings in our quarterly reports. Bookings for government and media are relatively consistent year-over-year, and therefore, we do not intend to disclose bookings in these areas unless we observe something that is likely to significantly impact those trends. We have recast the 2019 bookings and revenue figures we provided last year to reflect this new reporting structure. The recast had minimal impact on the classifications of amounts previously reported.

Now to our Q1 results. Revenue for the first quarter was $6.2 million, an increase of $500,000 or 9% from the first quarter last year. Subscription revenue increased 33% to $2.5 million, while services revenue was essentially flat. Revenue from retail was up 70% to $1.3 million from $700,000 in Q1 last year. Revenue from government and media was essentially flat at $4 million and $900,000, respectively. Most of our revenues are recurring.

Q1 retail bookings, which includes bookings from contracts with retailers, brands, their suppliers and related solution providers, doubled to $1.8 million, up from $900,000 in Q1 last year. Bookings included $450,000 for the contract renegotiation that we mentioned on our last earnings call with our supplier partner focused on supply chain improvements. As we expected, the fixed amount of the new contract is lower than the original. The program has potential upside in the future as it expands to more customers.

Gross margin for the quarter was 64%, up from 62% last year, primarily reflecting the impact of higher subscription revenue. Subscription margin was 79%, while service margin was 55%.

Operating expenses were $13 million, an increase of 7% from Q1 last year, primarily reflecting increased headcount to address growing demand and delivery requirements and routine annual compensation adjustments for our employees. Operating expenses were below the low end of the range of $13.6 million to $13.8 million that we provided on our last earnings call due to cost cuts and deferrals. We will continue to closely monitor our product and financial markets and our sales pipeline in relation to our working capital on hand in managing our rate of investment.

Net loss for Q1 was $8.9 million or $0.74 per diluted share versus a net loss of $8.5 million or $0.74 per diluted share in the first quarter last year.

Strategic financing discussions have been paused as potential investors assess their circumstances. Before the market collapsed due to the pandemic, we raised $600,000 of capital under the ATM program by selling 28,000 shares at an average price of $22. There is substantial uncertainty and volatility in the small cap sector of the stock market that has negatively impacted our share price, which is inhibiting potential use of the ATM. After the end of the quarter, we received the Paycheck Protection Program loan that will give us more time to observe financial market trends and assess the effects of the pandemic on our prospects to determine the best course of action concerning financing the business. I will summarize the details of the loan in a moment.

We invested $6.2 million of working capital during Q1, below the low end of the range of $7 million to $8 million we provided on our last earnings call. In addition to the ATM proceeds, we were able to reduce our cash spend from initial estimates by deferring headcount additions, capital expenditures and other discretionary spending.

On April 16, we executed a promissory note with Stearns Bank for $5 million pursuant to the Paycheck Protection Program under the CARES Act. The note matures in 24 months, bears interest of 1% per annum, provides for 6 months of payment deferral and requires no collateral or guarantees. The note is also subject to forgiveness provisions of the program. The amount to be forgiven is determined based on the amount of the loan used to pay for qualified payroll costs, including group health care benefits, rent and utilities for the first 8 weeks after the note is issued. We anticipate a significant majority of the loan amount will be forgiven.

We ended the quarter, prior to receiving the loan proceeds, with $30.6 million in cash and investments.

We will continue to be careful in spending, deferring open headcount positions and CapEx where possible and cutting or eliminating professional service fees as well as other expenses. For instance, we anticipate future cost savings as the result of moving Public Relations and Investor Relations in-house with the hiring of a Senior Director of Corporate Communications. I believe this move will have the added benefit of a more nuanced understanding of our execution and strategy and relationship with our shareholders.

We anticipate operating expenses in the second quarter to be between $12 million and $12.5 million. We expect cash usage in the second quarter to be between $1 million and $2 million after reflecting the $5 million of loan proceeds received in April.

For further discussion of our financial results and risks and prospects for our business, please see our Form 10-Q that we expect to file shortly.

Bruce will now provide his comments on significant business developments, market conditions and execution strategy.

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

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Thanks, Charles. Our company has responded effectively to the pandemic crisis so far. The first stage of response focused on health and safety of our employees. The next stage focused on productivity of an entirely remote workforce, providing tools, training and support to optimize the work streams. Both stages have been executed well. In parallel, we grew revenues, reduced expenses and secured interim financing via the Paycheck Protection Program. Our focus now is on assessing the effects of the crisis on our business prospects, short and long term.

The pandemic has resulted in many changes in how the world operates, the path and pace of economic recovery and the shape of the new normal are uncertain. The effects on our business are difficult to predict. These uncertainties led us to apply for and receive a Paycheck Protection Program loan. This gives us a little more time to assess what the new normal will look like, the timing and nature of the path there and its implications for our business. The PPP loan is having the intended effect of allowing us more time to assess how our business will go before making any significant changes to our business. As you see from the Q1 results, we have been reducing expenses wherever possible without reducing our workforce or disrupting the productivity of our employees. Given the nature of our work and the skills required, keeping our team intact is very important to achieving our goals.

Retail has been dramatically affected by the pandemic. We believe our importance has increased. Shoppers' concern about health and safety have affected how they choose to shop with much more online purchasing and what they shop for, considering the loss of income and uncertainties about the path forward. Automatic identification is a key to addressing necessary changes for retailers and their suppliers. Digimarc has an important role to play in many aspects of their businesses to improve health, safety and productivity. The fundamental signaling techniques and massive mathematical and graphical redundancy of our platform outperform traditional barcodes in ease of use, reliability and efficiency throughout demand and supply cycles. These advantages are more important than ever due to the COVID-19 coronavirus pandemic.

Q1 was a busy quarter for engagement with retailers and consumer brand owners, following on a very successful NRF. We made great progress during the quarter with suppliers and select end users in improving our platform support for applications spanning the full product life cycle. With this said, it's a very unusual time with lots of entropy. There are increases in both demand and deferrals, a sense of urgency among some prospects and distraction from other priorities for others. I am optimistic about our long-term prospects and increasingly confident in the value of our work. My greatest concern is still the pace of progress in relation to access to capital. We have no inventory. We have no supply chain risk. We license software. We have a terrific foundation of recurring revenues with the Central Banks and Walmart. We've improved working capital with the ATM and the PPP loan. The loan will be very helpful in bridging the gap of uncertainties we face from the pandemic.

So far, our business with existing customers is healthy, subject to my pacing comments a few moments ago. We are in the final stages of packaging implementation with Wegmans, working on means to maximize the ROI from now substantially complete private packaging transformation. Netto progress continues apace. Walmart private brand enhancement is going great. We have begun expansion into general merchandise. Thermal labels were initially slowed by integration with a critical supplier, that looks to have been resolved. The software is in test. Moving into stores may still happen in Q2, but is at risk to the higher priorities flowing from the pandemic response. In the meantime, our support for Walmart continues to expand, most recently, into in-store entertainment marketing, pursuant to a new statement of work, activating in-store signage for movie properties to improve consumer engagement. We're also working directly with some product suppliers to activate their in-store print advertising.

The industry is taking notice of our progress. Work has begun with another top 5 U.S. retailer, beginning with a focus on what are known as bottom of the basket items to help reduce shrink at checkout. With checkout options expanding, this is becoming a greater concern. There is also evidence of momentum in Europe, where Netto's success is inspiring sales progress in negotiations with other leading retailers there. Of course, all this is entangled in the complications flowing from the pandemic. Nevertheless, we find this very encouraging and consistent with our theory of market development.

Grocery, our target market, is the most robust sector of the economy. Grocery retailers are on the frontlines and redefining the shopping experience. There is an increasing appreciation that Digimarc can help transform retail into a safer and more productive experience. For example, Digimarc on packaging and labels can: speed up all forms of checkout and reduce congestion in stores; enable scan-and-go models for less person-to-person contact, while reducing hand-keying of items and providing for less package handling; and enable faster pick-and-pack for store employees to fulfill mobile orders and curbside pickups, et cetera. Think low-touch shopping.

We recently initiated a campaign targeting more than 100 grocers in the U.S. and Europe. Outbound calling efforts are underway. Digital and social marketing, and a webinar is planned for June. The campaign is designed to foster broad understanding of Digimarc's benefits and industry accomplishments, inspire conversations with decision-makers in these accounts and influence retail technology plans and budgets, as these retailers look for new ways to digitize store operations and supply chains for greater safety and efficiency.

Our supplier network is growing at a rapid pace. There is also more openness to collaboration from suppliers than ever before. Increasing inquiries from interested pre-media and printing companies around the world have led us to create fee-based supplier services bundles as a way for these companies to get educated on Digimarc for packaging and provide an access to our platform software and tools. We are making it quick, easy and inexpensive for them to get started with 3-tiered bundles to choose from based on their specific needs. We continue to educate the supplier and academic community, recently completing a training program with Clemson University students and planning webinars with one of the leading printing associations this summer.

As previously reported, we had a hiccup in one of our supply chain-oriented developers in Q4 that impact bookings growth when unrelated corporate events there led to a sudden widespread cost-cutting effort. We have successfully renegotiated that contract. Another company has recently gotten involved. We are assessing existing customer relationships and prospects to determine the optimal path forward for the new collaboration. The effects of the pandemic and other suppliers is difficult to assess in the near term. There have not been other notable disruptions since the outbreak.

In Europe, HolyGrail 2.0 may finally be getting organized. We've been negotiating a governance agreement with a potential leader for the industry initiative, license agreements with leading waste equipment suppliers and golden thread projects in several countries. Golden threads are consortia led end-to-end studies of the impact of Digimarc's platform on the Circular Economy. In the meantime, P&G is moving forward with products in several of their brands for initial distribution in Germany and the U.K. We expect more CPGs to go live in 2020. There are increasing investments in Digimarc-capable infrastructure by several leading retailers in Europe, and the supplier network is expanding. All encouraging signs.

We are also seeing some signs of traction in Japan. For example, we're collaborating with supplier partners in a pilot program with one of the largest logistics companies in Japan. They are using our thermal label software to create serialized codes to improve the efficiency and reliability of tracking roll box pallets within warehouses and delivery trucks. Adoption by retailers in Japan has been slowed by less effective scanners at front of store compared to the U.S. and Europe. We're working with relevant suppliers to remedy the situation. There is important retailer interest once these matters have been resolved.

Serialization is emerging as a significant new source of demand. The primary use cases are track and trace, brand protection and other supply chain applications. New approaches for applying Digimarc post print, including laser ablation and marker-coder overprinting, are opening doors for Digimarc and allowing us to leapfrog the slowly evolving digital printing market that has previously governed the pace of adoption of our platform for serialization. Our work with initial customers indicates our superiority over QR codes, Data Matrix and GS128 in first pass read rates, lower ink use and faster scan speeds.

The primary use cases are track and trace and brand protection. We are developing several new customer supplier relationships in this area.

It's a very exciting time in R&D, where we've had some amazing accomplishments during the quarter, including a pilot of automatic enhancement, which would dramatically reduce enhancement cost and time for some packages, a warping tool to minimize the effects of geometric distortion supporting an important customer and industry initiatives regarding plastic packaging, laser etching and mold design to expand the coverage of Digimarc Barcode in complex package designs containing plastic substrates; support for numerous business opportunities with industry leaders in fast-moving consumer packaged goods and quick service restaurants, and optimization and elaboration of apparel enhancement involving several suppliers and prospective customers. The platform is expanding and maturing.

We published an important technical and market analysis white paper earlier today, entitled Beyond the UPC: Digimarc Makes Retail Operations Safer and More Profitable. It summarizes findings of a GS1 U.S. sponsored study explaining retail -- the retail industry's need to move beyond the UPC and provides a detailed technical case for the superiority of Digimarc Barcode over all other potential successor data carriers. I recommend that you read it to better understand our role in the future of automatic identification for retail. It explains our general superiority and how, for example, we address problems posed by the pandemic like no other barcode, just as we do for plastics recycling and sustainability. I am more confident than ever, Digimarc Barcode is the successor to the UPC, and we will have a profound impact on the global supply chain.

Charles described changes in our financial statements and related measures that are intended to facilitate better analysis of our execution of strategy. We have observed a generally accelerating rate of growth in these measures since early 2018, consistent with effective execution. Detailed updates of the expanding use of our platform can be tracked on our website and other media channels. We will be engaging in more outreach to you and the rest of the investment community once our new Director of Corporate Communications gets settled in.

The loan from the federal government is serving its intended purpose, giving us time to further assess the impact of the pandemic. Given the important role that our platform can play in health, safety and efficient retail and supply chain, the pandemic effects on the nature of shopping may better encourage adoption as we help retailers and consumer brand owners adapt to the new normal, where reliably efficient auto identification is a cornerstone. On the other hand, the health and economic uncertainties that make judging the pace of change more difficult than ever. We are managing our working capital carefully, encouraging and facilitating extraordinary efforts by our team, and doing the best we can to articulate our value to customers and suppliers.

With the help of the Paycheck Protection Program, we will traverse the pandemic disruption. Factors in our favor include growing bookings and revenues, enough cash to fund operations through 2020, no inventory, no supply chain risk, Walmart and Central Banks as our largest customers, a target market that's the most robust sector of the economy, and a platform that addresses needs aggravated by the pandemic.

The key takeaways include: Q1 revenues and EPS exceeded analyst estimates; total revenue grew 9% year-over-year; subscription revenue was up 33% and retail bookings doubled; our balance sheet was strengthened with the influx of capital from the ATM and the PPP loan; our largest customers are Central Banks and Walmart, where the footprint continues to expand; we're in the final stages of packaging implementation with Wegmans, discussing means to maximize the ROI from the now substantially complete private brand packaging transformation; there's more openness to collaboration from suppliers than ever before; HG2.0 formation is progressing finally; negotiations are underway with a potential leader, brands, equipment suppliers and golden thread consortia; the Paycheck Protection Program loan has boosted working capital, most of it is expected to be forgiven; our target market is the most robust sector of the economy, grocery; social distancing will pressure physical retail to increase efficiency; shopping and retail operations management will elevate the importance of low touch; our platform addresses the needs aggravated by the pandemic, likely making Digimarc a long-term beneficiary of the crisis; and we will continue to effectively manage working capital.

Hopefully, the PPP loan is a bridge to a healthier and more predictable capital market, resumption of strategic investment discussions and further proof of unrecognized business value in fostering a safer and more productive retail environment. In the meantime, we will continue to manage our capital carefully as we make our platform more efficient, reliable and robust, expand application support, and add customers and suppliers. Digimarc's important role in facilitating safe and efficient retail has been accentuated by the coronavirus crisis.

Effective management of working capital remains a critical concern. I have led the company for 23 years, during which time, we've overcome many challenges. We will work our way through this one, too. Thank you for your support of our mission and confidence in our ability to achieve it. We wish you all the best in these difficult times.

That's it for our prepared remarks, 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 Mr. Davis, there -- we did just get one question in queue, and that is from Jeff Van Rhee with Craig-Hallum.

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Jeffrey Lee Van Rhee, Craig-Hallum Capital Group LLC, Research Division - Partner & Senior Research Analyst [2]

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A couple for me. The -- Bruce, just one quick clarification. I think in the script, when you were talking about the bookings that push from Q4 to Q1, you said "another company" has gotten involved. I'm not clear what that meant. Maybe you could just clarify on that. And then I do have two other follow-ups.

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Bruce L. Davis, Digimarc Corporation - President, CEO & Chairman [3]

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Yes. So our contract that got changed was with a supplier. And now that supplier and another supplier are going to be participating together. The original supplier will be transitioning some of their responsibilities over to a different supplier. So the 3 of us are getting together and having discussions about how to have an effective collaboration. Well, actually, I think we'll be making an announcement about this sometime in the not-too-distant future.

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Jeffrey Lee Van Rhee, Craig-Hallum Capital Group LLC, Research Division - Partner & Senior Research Analyst [4]

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Got it. Okay. And then in terms of the barcode pipeline coming into the impacts of corona, can you just talk about kind of the developments and the near-term deals you saw prior to the -- some more severe impacts of corona? And then any sort of up-to-date read on where those deals might be in terms of how they're coping? And I'm assuming they've paused, but just maybe a sense of how the pipe was going in, at least.

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

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Sure. So some things have paused and some things have accelerated, as I pointed out in the script that it's a bit schizophrenic, which you would expect because of the uncertainties in the economy and then particularly in retail operations and the suppliers to retail. I would say on the whole, there's a greater sense of urgency and an increasing appreciation of the benefits that we provide in what is expected to be the new normal, the new normal, not capable of being entirely described just yet, but probably including people feeling more nervous about safety and health, and there being a general desire to have low-touch, is an expression that's being used now in the industry, low-touch shopping, low-touch operations.

And then I think it significantly increased need for efficiency because of lower productivity from the real estate for place-based retailers. And everyone in the supply chain, and you certainly have seen in many places, the new spacing requirements and plastic shields and PPE, that's going to change the economics of many of our suppliers and customers in ways that cry out for greater efficiency, and auto identification is the classic tool of increasing efficiency in the demand and supply chains. So I'd say on -- it's a little hard to tell because it's only been about 6 or 8 weeks now that there's been the full recognition of the crisis. But we have some new demand because of it. We have increased demand because of it, and we have delays because of it. So it's a bit hard to sort out just yet. I do hope -- and I don't know how to predict how the health aspect of this is going to roll out as people try to move back out of shelter in place. If another crisis emerges, who the hell knows. But if they do find a way at least through the summer months to regain some semblance of what things look like in the past. I do think there'll be enduring changes that, again, create increased demand for our platform.

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Jeffrey Lee Van Rhee, Craig-Hallum Capital Group LLC, Research Division - Partner & Senior Research Analyst [6]

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Got it. Okay. And Charles, I think you mentioned that the bookings, obviously, you've changed the way you're reporting them that the bookings have been recast. Do you have the bookings the way -- in terms of retail bookings for last year's Q2, 3 and 4 handy?

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Charles Beck, Digimarc Corporation - Executive VP, CFO & Treasurer [7]

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Yes, I do. And they didn't change more than $100,000. Some of it's rounding, but I can -- so it was $900,000 in Q1, $1.8 million in Q2, $1.2 million in Q3 and $1.4 million in Q4.

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Operator [8]

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(Operator Instructions) And there are no further questions at this time. I would now like to turn the call back over to Bruce Davis. Sir, please proceed.

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Bruce L. Davis, Digimarc Corporation - President, CEO & Chairman [9]

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All right. Thanks again, everyone, for your support. And as I said, thus far, we've managed very effectively through the effects of the pandemic, and we feel confident that we will do a good job continuing to manage through its implications to some new normal, but optimistic the new normal will be one in which we play a more important role. And the uncertainty that exists today regards the pace of negotiations and implementations because of the changes in availability of labor and travel. And I think we'll work our way through it with the help of the PPP loan. That's been a really helpful addition to working capital that will carry us through the most uncertain times. And so I look forward to talking to you again in the next conference call, and thank you for your support. So goodbye for now.

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Operator [10]

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