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Edited Transcript of DMRC earnings conference call or presentation 26-Apr-17 9:00pm GMT

Thomson Reuters StreetEvents

Q1 2017 Digimarc Corp Earnings Call

Beaverton Apr 29, 2017 (Thomson StreetEvents) -- Edited Transcript of Digimarc Corp earnings conference call or presentation Wednesday, April 26, 2017 at 9:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Bruce L. Davis

Digimarc Corporation - Chairman, CEO and President

* Charles Beck

Digimarc Corporation - CFO, CAO, EVP and Treasurer

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Conference Call Participants

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* Glenn George Mattson

Ladenburg Thalmann & Co. Inc., Research Division - VP of Equity Research

* James Andrew Ricchiuti

Needham & Company, LLC, Research Division - Senior Analyst of Advanced Industrial Technologies and Display, Vision and Imaging Technologies

* Jeffrey Van Rhee

Craig-Hallum Capital Group LLC, Research Division - Partner and Senior Research Analyst

* Michael Joshua Nichols

B. Riley & Co., LLC, Research Division - Senior Analyst, Discovery Group

* Riley Young McCormack

Tracer Capital Management L.P. - Co-Founder

* Robert Warren Stone

Cowen and Company, LLC, Research Division - MD and Senior Research Analyst

* Robin Knipp

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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 will now 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 - Chairman, CEO and President [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 execution of strategy. This webcast will be archived in the Investor Relations section of our website.

Please note that during the course of this call, we'll 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 also will discuss from time to time, information provided to us by channel partners and actual and potential customers about their business activities. Please appreciate that we are providing this information as we understand it was represented to us by customers, prospects and partners, and we do not verify nor vouch for such information.

Such forward-looking statements and 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 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.

Charles will begin by commenting on our financial results. I will then discuss significant business developments, market conditions and execution of strategy. Charles?

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Charles Beck, Digimarc Corporation - CFO, CAO, EVP and Treasurer [3]

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Thanks, Bruce. Good afternoon, everyone. Revenue for the quarter was $6.1 million, up from $5.6 million in the first quarter of last year. The increase was primarily due to higher service revenue, reflecting more program work from the Central Banks and a government agency contractor. Subscription revenue was flat, reflecting higher Barcode revenue, offset by lower Guardian revenue. License revenue was higher, primarily due to higher reported royalties from a patent licensee.

Q1 Digimarc Discover and Barcode bookings were up 100% year-over-year, but down from last year at $200,000. Although we think bookings is the usual measure of progress, it does not capture all agreements. There were a couple of important agreements that do not have much impact on bookings. One is a master services agreement with a top 10 global retailer that includes a first statement of work for a pilot project with clear milestones to finding a path to production at scale. The master services agreement is structured to permit efficient addition of new projects. This agreement was not included in Q1 bookings because its payments are based on milestones, and we define bookings as the noncancelable fixed value of the contract.

Similarly, we signed our largest ever Guardian for Images contract during the quarter. Yet the effect on Q1 bookings of this multi-year agreement was not significant because the contract has a 30-day termination clause. We continue to expect lumpiness in quarterly bookings in the early stages of market development due to timing and varying provisions affecting bookings as just explained.

Gross margin was 62% for the first quarter, up 1 point from Q1 last year. Service and license margins were essentially flat. Subscription margins were up 7 points, reflecting higher barcode revenue and lower cost of service delivery.

Operating expenses were $1.4 million or 15% higher than the first quarter of last year. The increase 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. We hired 7 employees during the first quarter and anticipate hiring an additional 20 to 25 staff in the next 6 months.

Net loss for the first quarter was $6.2 million or $0.61 per diluted share versus a net loss of $5.4 million or $0.64 per diluted share in the same quarter last year. We invested $4.3 million of working capital during Q1, including $3.1 million to fund operations and $800,000 for capital expenditures.

Cash usage was lower than last quarter due to the receipt of a large annual license fee that is billed in Q4 and collected in Q1 each year. We ended the quarter with over $56 million in cash and marketable securities. We anticipate cash usage will be between $5.5 million and $6.5 million in the second quarter.

For further discussion of our financial results and risk 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 of strategy.

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

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Thanks, Charles. In the past couple of months since our last call on February 22, we've been very busy dealing with the significant increase in interest from existing prospects and customers as well as new prospects that we discussed in the last call. The activities span retailers' brands and noncore prospects involving applications addressing a wide range of product life-cycle operations and consumer engagement.

We have expanded and improved our marketing and delivery capabilities. As our share of voice has been increasing along with our willingness to engage in Europe and Japan, opportunities have multiplied. While we continue to focus most of our resources on the domestic market, as promised in our financing, we are increasing our support for key foreign markets. We conducted in-depth training during the quarter for the Japan study group leader, DNP. Several members of the group exhibited at RETAILTECH Japan 2017 in March and report that the response was very favorable. The next plenary session is in June. I will be attending and meeting with members and prospective clients while there. The group is contemplating several proof-of-concept projects during the balance of 2017 and the launch of the platform in 2018.

We recently opened an office in Cologne, Germany, home of GS1 Germany, and assigned a German-speaking member of our senior technical staff to head up client services in Europe.

As Charles noted in his remarks, we entered into a master services agreement during the quarter with a leading retailer. We're just beginning work on supply chain assessment and mapping the implementation process. So far the customer and suppliers have been very responsive. The terms of the agreement and the statement of work are confidential. This is the second master services agreement we have entered into with a top 10 retailer. The other relationship is further a long and involves lot of moving parts and is taking some time to mature. There have been some encouraging developments in that relationship lately. We are diligently pursuing supply chain strategies that will support scaling our business with both of these accounts.

Now that we have the foot in the door with numerous leading retailers and CPGs, we need to build sustainable and scalable support for large-scale global production. We have developed a good understanding of the significant complexities inherent in managing these enormous customers in educating, training, motivating and ensuring quality in their global supply chains.

Much of my focus lately has been on enhancing our company's capabilities to address these opportunities and the associated challenges. Thus operational excellence is at the forefront of execution of strategy. The company must continue to evolve to keep pace with progress in market development. I believe we've made excellent progress in this regard.

At this stage, of development, we need to delivery with quality to those accounts we have, close on sales with prospects and grow our share of wallet with all of these companies. We have been adapting the leadership of our organization to meet the requirements for continuing progress in the evolution of emerging market for Digimarc Discover and Barcode.

In July last year, we hired 25-year tech veteran, Heidi Dethloff to head marketing. In Q3, we expanded our Board of Directors adding 2 accomplished executives from the consumer products industry. Since then, we have restructured management, merging product management and engineering to improve efficiency and accountability and creating 2 new executive positions. Our new client services leader, who's joined in Q1 is Scott Wilcox, a 25-year veteran, Pre-Media executive. He is responsible for all of our delivery systems, including in-house and partners.

Our most recent augmentation to critical leadership is Aimee Arana, who brings more than 20 years of retail sales and business development experience to Digimarc. Aimee joins Digimarc from Nike, where she was Vice President and General Manager of the North American Women's Division responsible for managing customer relationships, directing sales teams and driving sustainable growth.

I described our 2017 priorities at the Needham Conference in January. At the top of the list is adding customers and growing bookings. This requires closing more business, shortening sales cycles and expanding production with undisclosed customers.

Improving supply chain support as well as our own internal business processes will foster more speed and scale in accomplishing these goals. We have relationships in place with industry-leading suppliers and relevant industry associates -- associations in our target geographies. Our focus now is more on improving the effectiveness of these relationships and less on adding more partners for a while despite continuing pressure to expand the supplier network.

We have enough important relationships in place to get those significant business done. Regardless of what we do, we remain cognizant, as should you, of the challenges associated with gaining footholds for our transformational platform and helping customers to revise business processes to exploit the benefits of the platform at scale. 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.

Macro technology trends continued to be favorable. Lately, augmented reality has been the big buzz in tech. Most of the demos that you see presume the essential step, a reliable efficient identification of the thing being augmented. Get that wrong, then the augmentation is problematic. In real-world applications, Digimarc Barcode can provide that first critical step in the process: reliable and efficient identification for all media.

We are participating in a number of financial conferences during Q2, including conferences sponsored by Needham, B. Riley, Craig-Hallum and Cowen and Company and numerous industry events. You can find dates and details of our participation in the Events section of our website.

The basic building blocks are in place to make progress and to make public relationships with leading brands and retailers. We continue improving the tools, training and technical support for our supplier-side partners and expanding awareness and understanding of the platform with customers, business partners and policymakers. We will continue to add expertise and develop and refine our internal business processes to meet the needs of customers and partners.

Our engagement with industry-leading retailers, brands, licensing authorities and trade associations as well as our supply chain partnerships are growing in number and effectiveness. We have a strong balance sheet, effective working capital management, expanding institutional knowledge and are making progress in implementation of requisite software training and support services fostering progress in key performance indicators of increased bookings and providing other evidence of growing adoption to the industry and the financial markets.

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

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Questions and Answers

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Operator [1]

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(Operator Instructions) Our first question comes from Jim Ricchiuti with Needham & Company.

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James Andrew Ricchiuti, Needham & Company, LLC, Research Division - Senior Analyst of Advanced Industrial Technologies and Display, Vision and Imaging Technologies [2]

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Wanted to pursue the master services agreement that you alluded to. And I realize there are things you're not going to be able to talk about. But Bruce, can you maybe discuss when you first began to have discussions with this retailer? And how long it took before you were able to reach certain milestones and hammer out another agreement?

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

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It actually was not terribly long. We found an enthusiastic response and a starting point for a relationship, and so it's just a matter of months in putting together the master services agreement. And the reason for the master services agreement is an assumption on both sides that once we've demonstrated our competence as a supplier that there are probably many things we can do together. So rather than do with an agreement specific to an application area, we did the MSA with the statement of work structure, which is structurally identical to what we have with another top 10 retailer.

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James Andrew Ricchiuti, Needham & Company, LLC, Research Division - Senior Analyst of Advanced Industrial Technologies and Display, Vision and Imaging Technologies [4]

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In the other agreement that you have, can you -- maybe just discuss when that was secured? And maybe how it's progressed?

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

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It's difficult for me to comment much on it because of the sensitivity of the customer to disclosure.

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James Andrew Ricchiuti, Needham & Company, LLC, Research Division - Senior Analyst of Advanced Industrial Technologies and Display, Vision and Imaging Technologies [6]

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Okay. Maybe just going back to the one, the more recent one, can you maybe help us understand what prompted this customer, this retailer now? Why now? What was the catalyst for it?

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

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Yes, I probably can't go down that route without being -- it's sort of inappropriate with respect to my relationship with the account. There was a specific impetus, but I'm not comfortable saying what it was.

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James Andrew Ricchiuti, Needham & Company, LLC, Research Division - Senior Analyst of Advanced Industrial Technologies and Display, Vision and Imaging Technologies [8]

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Can we maybe revisit what's been happening with the 2 supermarket chains that you've been working with that have begun converting over some of their private label programs to the Barcode -- to the Digimarc Barcode? I mean, to what extent are we seeing maybe these early adoptions that have helped demonstrate the potential of the technology to other customers -- prospective customers?

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

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I believe you're talking about Wegmans and New Seasons there?

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James Andrew Ricchiuti, Needham & Company, LLC, Research Division - Senior Analyst of Advanced Industrial Technologies and Display, Vision and Imaging Technologies [10]

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Yes.

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Bruce L. Davis, Digimarc Corporation - Chairman, CEO and President [11]

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They're both excellent early customers and collaborators. Wegmans, obviously, is renowned for the quality of its marketing and focus on consumers, and is an acknowledged industry leader in innovation. New Seasons is obviously much smaller entity, local company. And in the case of New Seasons, their focus actually -- they're very customer-centric too, like Wegmans. And so they're looking at what we have as a means of enhancing the experience at checkout for the consumer. They'll certainly take operational efficiency benefits. They don't have a mobile app at this point of time. And so their whole goal is to just improve the customer experience. Wegmans has a larger agenda and has a larger and more involved account. So we're making progress in implementation of both of them. And again, we let our customers speak for themselves. So we don't go into any level of detail that they haven't already publicly disclosed.

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James Andrew Ricchiuti, Needham & Company, LLC, Research Division - Senior Analyst of Advanced Industrial Technologies and Display, Vision and Imaging Technologies [12]

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And 2 final questions, and I'll jump back in the queue. First question, it sounds like your hiring plans have gone up a bit since we last spoke in February. Is this hiring more in the international markets because you see some opportunities? And then final question, and this is maybe for you, Charles, is maybe how we should think about operating expense over the next 1 to 2 quarters?

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Bruce L. Davis, Digimarc Corporation - Chairman, CEO and President [13]

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Okay. Yes, I'll take the first part of that. The hiring is mostly domiciled domestically, serving all of the geographies for the time being. And the work that we're doing now is in building scalable business processes for globalization. And that comes from increasing confidence that the value of what we have is becoming well understood and acknowledged. And so that sort of shifts all of our ambition over to trying to figure out how to scale this in a high-quality and cost-effective manner for clients. And so we've learned a lot from our relationship with Wegmans. They've been extremely helpful to us and candid in our relationship. Now we're beginning work with some very large companies who have very complex supply chains and have lots of overhead associated with quality assurance for their products. So we need to be able to articulate how such processes ought to be supported. Again, our strategy is not for us to continue to scale our business to serve those needs, but more to define the infrastructure that the supply chain needs to provide to its clients and then to educate and train and motivate and provide quality oversight for the suppliers serving their clients. So that's, if you like, the bulk of our work right now is trying to get the supply chain prepared to take this on for the very large clients so that we don't have to play as much of a front-line role as we've played in the early market development. Charles?

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Charles Beck, Digimarc Corporation - CFO, CAO, EVP and Treasurer [14]

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Yes. And then on the staffing side, I don't necessarily want to put specific dollars to it, but we're looking to hire 20 to 25 staff in the next 6 months. Several of those positions are -- we expect to be hired shortly. So we'd have an impact to Q2, some of them will fall into Q3. I think you can use kind of an average assumption of cost of labor to kind of layer on what the incremental cost is there.

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James Andrew Ricchiuti, Needham & Company, LLC, Research Division - Senior Analyst of Advanced Industrial Technologies and Display, Vision and Imaging Technologies [15]

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Okay. And Charles, the Central Bank revenue stream, how stable is that? How much visibility do you have in that? And then how big a contributing factor was that in revenues this quarter?

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Charles Beck, Digimarc Corporation - CFO, CAO, EVP and Treasurer [16]

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Yes. So Central Banks is a significant component of service revenue, and we also had an uptick in the amount of work that we have from our government agency contractor, but that's relatively small in comparison to the banks. So the majority of the service revenue is related to the banks. As far as visibility, we know what our minimum budget is for the year. They provide that, actually, 2 years in advance. We have a stated salary in place. Generally, what happens is there's usually an uptick of additional work that comes in through the year, we have some visibility there. But it's the majority of the revenue associated with that contract is known at this point in time. So there's only upside.

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Operator [17]

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Our next question comes from Josh Nichols with B. Riley.

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Michael Joshua Nichols, B. Riley & Co., LLC, Research Division - Senior Analyst, Discovery Group [18]

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I was wondering could -- any updates you could provide regarding work that company is doing as it pertains to the FDA's Safe and Accurate Food Labeling Act and updates on that front?

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Bruce L. Davis, Digimarc Corporation - Chairman, CEO and President [19]

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Yes. It's obviously, the change in administration kind of threw things up in the air for a while, but the Secretary of Agriculture has been confirmed we understand and the budget has been put in place for the regulatory studies that were contemplated. And so we expect them to start moving soon. So there's been a bit of hiatus due to the changes in administration. But now it looks like they're going to get down to doing some work. We don't know yet what their posture will be. Of course, President Trump's general position on regulation is let's lighten up, not make it heavier, but the GMO legislation was driven by a need for preemption of the Vermont State action. So I don't think that they'll just not do anything, but I'm not sure what it is they'll do in relation to the range of regulatory affect they could have based on the law. So we're digging in. We're quite involved and staying in tune with what's going on and trying to help the Congress and the department to make good judgments on how to serve the consumer interest that's involved here.

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Michael Joshua Nichols, B. Riley & Co., LLC, Research Division - Senior Analyst, Discovery Group [20]

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And then last question from me. Anything you could say broadly as it pertains to MSAs regarding kind of the size and the scope of this -- of the statements for work?

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Bruce L. Davis, Digimarc Corporation - Chairman, CEO and President [21]

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Well, the nature of the agreement is such that we can add to it quickly. And so it doesn't have, if you like, a fixed scale. It's quite the opposite and it has a flexible scale. And it's a good model. I like it. It's one that the customers appear comfortable with. So we get all -- there's a lot of, call it rigmarole. There's a lot of work to do to get qualified as a vendor with these big companies involving IT policies and security and insurance and on and on and on. And so we wade through that as quickly as we can. And then we then have -- the general term is 'settled in the MSA'. And then leaves really just statements of work and pricing to the appendices. And so that's the structure we have in place in these 2 agreements I alluded to in the call.

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Operator [22]

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Our next question comes from Rob Stone with Cowen and Company.

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Robert Warren Stone, Cowen and Company, LLC, Research Division - MD and Senior Research Analyst [23]

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Wanted to follow up on a comment that you made on the last call. You talked about being at some level of engagement with all 10 of the top 10 global retailers and 6 of the global CPG top 10, if I remember the stats correctly. I wonder if you could just update us on that situation, if you've added to that list. And I know you can't go into individual examples, but some color on, if things are progressing in general, what's driving that? Is it a desire for cost savings or brand engagement or some other factor? And then, as you get down deeper into the next level, you talked a lot about standing up the supply chain. What's the -- what are the attractions and deterrents for these various partners that you need to bring along with each of these big companies?

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Bruce L. Davis, Digimarc Corporation - Chairman, CEO and President [24]

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Okay. With respect to sort of a general market update, it's only been a couple of months since the last call. So there haven't been dramatic shifts. So I would say we continue to be engaged with most of the biggest players in the world at some level. The -- and then I'll segue that to sort of motivations, if you like. We have been defining initial set of solutions that we have come to understand are interesting to those companies. And obviously, the tent poles of strategy are easy checkout and consumer engagement. We've also talked about in the consumer engagement area SmartLabel as yet another area of interest. And then we have talked previously and shown that are out the printer scale label application. And we've alluded in our prior calls to there being other applications that various companies are asking us to do as proof-of-concept, and there is maybe a handful of those which we can't get into because it would, again, lead us down a rat hole of trying to give you more detail than we can. So I'm viewing those solutions as we're defining them as kick-starting the application developer community. And again, I could be wrong in this assumption, but I'm assuming that once the platform has been embraced by industry leaders, that other people will want to build things for them rather than us building most of the stuff ourselves. If I'm wrong, it's okay because it's just -- it's a bit different model, but it should be quite healthy profitable business. So with respect to [Eastman] of the prospects and the early customers, they have different orientations along that solution range. And so they don't all start with easy checkout or all start with consumer engagement or all start with SmartLabel or printer scales. They have a hot button, for instance. And that's often driven by a leadership personality within the enterprise. So someone says, yes, I really need what you guys have. Please show me that you can make it effective and that we can integrate it into our supply chain, and we're -- it's going to be off and running. So it's really ad hoc with respect to solutions as to how we start from company to company. We have a surprisingly broad range of early engagement with CPGs in relation to what I come to understand as the financial industry perspective. Most people have felt that retailers are going to get onboard first and then they're going to encourage their suppliers to get onboard, and that's really not turning out that way. There is a lot of pressure on retailers and brands to become digital, to digitize their business, to modernize it. And as we present the benefits of our platform to these enterprises, we can address many of the desires that they express and particularly at senior levels of the organization about where they'd like to go with things because we provide a range of opportunities addressing the 2 key variables affecting retailers and their suppliers, which are operational efficiency and consumer engagement. And without belaboring the point, because I made it before, that's where the action is. Everybody needs to be as efficient as they can be. But for place-based retailer, you got to make it engaging, you want to make it fun and interesting. And then I think, that's where again we're blessed with our first significant customer with Wegmans because they get it. They do great job. They're industry leaders in that regard. But they're also wanting to get operational efficiency out of the platform. So we think we have the way to solve what appears to be a dilemma for these enterprises of how do you get more engaging cheaper, right? And we think we're the answer that we can do both of those things, and we can do it across a wide range of business characteristics of these large enterprises. And so that's -- it's really it's an ad hoc sort of nose under the tent, foot in the door, get going, improve ourselves, build out the share of pocket. And that's why I'm very pleased to have Aimee on board because Aimee is skilled in the art of closing the sale and building the share of pocket with the customer. So that's what we need to do now. We have enough interest. We have enough prospects and early customer engagement. We need to become more relevant to them, and we need to do that by enhancing the capabilities of their supply chain to deliver this benefit to the enterprise. And then you know our model is we have the license we would like to receive for having created and continuing to support the platform. And that's how we intend to grow our bookings and revenues and our path to profitability.

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Robert Warren Stone, Cowen and Company, LLC, Research Division - MD and Senior Research Analyst [25]

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So against the industry backdrop of pricing pressure for the last year plus, margins coming down, is cost of implementation a hurdle? Or does the market situation actually drive greater urgency to do something about efficiency?

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Bruce L. Davis, Digimarc Corporation - Chairman, CEO and President [26]

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Well, one of the challenges of market development for any breakthrough technology is there's no established ROI. So fair amount of early work involves sort of proving the obvious. One of the great virtues of our platform is it's pretty obvious that we make identification better. Quantifying it is not possible in the early stages of market development. We've done experiments. We're written white papers. We've shown everybody stuff. They still want to sort of see it in action. So that's part of this early-stage market development that maybe is not well understood by some in the financial community. It's a bit of a brand. We've got to show that we can have an impact and that it's a significant one, but then that information needs to be disseminated. And one of the sensitivities that we're all aware of here and bound by is the desire for competitive advantage and confidentiality dearly held by some of these large enterprises. They just don't want to tell other people what they're doing. And our more publicly acknowledged customers as regional retailers have, if you like, a more protected competitive position than a global enterprise. And so it's not something that we can talk a lot of, unfortunately. And so the involvement that we have with the large enterprises, for the most part, we think will have to be incidentally disclosed [whether] it will just people learn about it in the industry first and then the financial markets will learn about it and then obviously to the extent we can pass on an amplified publicly available information, we'll try to do that without jeopardizing our business relations. But it's -- and that's where the [Japan 30] group is different. Again, they're not publicizing all of their findings outside of the group. But within the group, there is a sharing. There's maybe 30 of them now in the group. And then, in Europe, with the help of GS1 Germany, we're hoping that they can share some information that will be helpful to industry there to embrace the platform more quickly than we've experienced here in the U.S. So we'll see.

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Robert Warren Stone, Cowen and Company, LLC, Research Division - MD and Senior Research Analyst [27]

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Last quick question, if I may. Can you just quickly summarize for us besides the 2 chains that we know are going into full production, how many others have done at least some form of production of barcodes either for limited shelving or pilot program? Just some rough numbers would be helpful.

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Bruce L. Davis, Digimarc Corporation - Chairman, CEO and President [28]

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Yes. I can't give you a reliable number, Rob, because when someone ask us to do 2 or 6 or 12 or whatever, if I give that number to you today, you'll ask me next quarter, what's the number. And I don't know where's it going with the program, all right? So maybe they're going to pause or they're going to...

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Robert Warren Stone, Cowen and Company, LLC, Research Division - MD and Senior Research Analyst [29]

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Of packages, I just meant how many active relationships in that regard that have done at least some form of production?

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Bruce L. Davis, Digimarc Corporation - Chairman, CEO and President [30]

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I don't have the number top of mind. I would say it's not hundreds, it's just tens, probably 30 to 50. But don't hold me to that. I haven't counted it actually, frankly. I just look at the reports. There's a pile of them. I look at who's in the list and how big the list is.

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Operator [31]

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Our next question comes from Jeff Van Rhee with Craig-Hallum.

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Jeffrey Van Rhee, Craig-Hallum Capital Group LLC, Research Division - Partner and Senior Research Analyst [32]

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Great. Bruce, just couple of questions. I guess last quarter, you had talked about a top 10 retailer communicated with you in Q3 that they wanted to begin pricing implementation discussions. Just to be clear, is that the one that's signing this MSA here?

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Bruce L. Davis, Digimarc Corporation - Chairman, CEO and President [33]

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Yes.

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Jeffrey Van Rhee, Craig-Hallum Capital Group LLC, Research Division - Partner and Senior Research Analyst [34]

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Okay. So can you just, in simplest terms, talk about this MSA and sort of give me the -- a quick 2 or 3 bullet points on why you think this one -- I guess how it varies from the other? And in particular, obviously, I'm most interested in the time line to revenue/certainty to revenue. Can you just -- I realize your hands are tied somewhat, but just help me understand how this is different than the prior.

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Bruce L. Davis, Digimarc Corporation - Chairman, CEO and President [35]

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That's a trickier question than you probably understand it to be. Let me see if I can give you some substantive response. So the newer customer has a pretty tight focus in terms of entry point, and the other customer has a broader sort of posture. So I don't know who will actually go faster because we're just in the early stages with the second of these. But the first customer just, there's a lot of that we can do for them, and they've been exploring lots of different things. And that's created the complexity that doesn't yet exist in the second situation.

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Jeffrey Van Rhee, Craig-Hallum Capital Group LLC, Research Division - Partner and Senior Research Analyst [36]

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Okay. Got it. And is it -- so if this is the model that you prefer or you like this structure, just to read it back to you, is this unit unlikely that we will see large enterprise deals upfront that show up in the deferred revenue balance?

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Bruce L. Davis, Digimarc Corporation - Chairman, CEO and President [37]

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Let me see if I understand the question correctly. If everybody want this route, is that sort of the premise of the question?

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Jeffrey Van Rhee, Craig-Hallum Capital Group LLC, Research Division - Partner and Senior Research Analyst [38]

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Well, it sounded like you like this structure, which seems to have incremental scope of work that you gradually lay out and build and go perform. And I think you had talked previously about larger customers likely wanting to sign large enterprise license deals that, in fact, would show up at signing on the deferred -- on the balance sheet and the deferreds.

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Bruce L. Davis, Digimarc Corporation - Chairman, CEO and President [39]

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Yes, I haven't changed my perspective on the market. I still think that the -- this tipping point notion I've talked about will come into effect at some point. And when it does, I think, everything changes. And I don't know when that happens. But prior to that, I would expect most customers would not want to put down a bunch of money, I'll call betting on the come, all right? But when competitive pressure comes into play, I think some will as a means of mitigating cost. So my answer depends on time frame. The master services agreement format actually doesn't in any way negate those opportunities for large payments. In fact, it's kind of -- if you like, it's a middle ground between what I've said. It could be one approach which is buy one at a time until I'm comfortable that I'm embracing it long term versus I'll pay you a liquidated amount so that I don't have to go one at a time. This is sort of in the middle, if you like. It's more -- it's a flexible implementation that once behind us allows us to do business very efficiently. So I like it because of the efficiency, but I don't think it has much impact on the general economic patterns that will emerge.

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Jeffrey Van Rhee, Craig-Hallum Capital Group LLC, Research Division - Partner and Senior Research Analyst [40]

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Is it -- is it a reasonable basis for us to think that store brands remain the starting ground where most are going to get their -- that's the initial scope of work probably in those cases? And then understanding there's all kinds of complexities in terms of building the model because you have a bunch of revenue streams that you've outlined that are likely to show up here, is the -- does the most logical remain $50 SKU and work at along that math? Or asked differently, has your thinking there changed at all in terms of what the structure of these contracts look like and what the revenue potential there is and is to be based off?

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Bruce L. Davis, Digimarc Corporation - Chairman, CEO and President [41]

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I think that the $50 license fee remains a key tenant of the economic model. But what's been happening, we're trying to get our arms around and that is that we think there's a service offering that we ought to be pricing that will create a significant revenue stream. And our initial applications, what I call the tent pole applications are ones that we're not charging an incremental price for, although our business partners who are enablers of those things, some are charging and some aren't and the amounts vary a bit. And when they are charging, we generally will share in what they charge. But for some of the solutions work that were being asked to do go that today we have classified internally as custom work or solutions under development that are not generally marketed yet, we're contemplating that we may price them too add as supplements to the basic license fee. Because in our strategy, we'd like other people be doing them and us collecting the basic license fee. But if you're doing the work and we're investing the R&D and we're providing the ongoing support for the applications, then we would expect to be paid for those too. So the basic business model that you're familiar with may get elaborated, and we're right in the middle of that right now, trying to figure out what that ought to look like.

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Jeffrey Van Rhee, Craig-Hallum Capital Group LLC, Research Division - Partner and Senior Research Analyst [42]

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Okay. Just 2 last brief questions for me then the -- just if you could explain just very quickly in terms of skill sets that you're hiring in this next wave of hiring, I'm sure it's a little bit of everything, but where is it concentrated? And secondly, the GS1 relationship, can you dial that in a little more specifically in terms of the traction that you're seeing? And can you quantify the volume of events, lead flow, some way to give us a sense of comparison of momentum in terms of that relationship?

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Bruce L. Davis, Digimarc Corporation - Chairman, CEO and President [43]

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Sure. So on the hiring front, a lot of the staffing will go into our product development and client services areas. And it's consistent with what I was just saying, both in the prepared remarks and in the Q&A here that we're building infrastructure models that we can export to the supply chain. And so we're bringing more people in to get that stuff done. But also to the extent there's a sustained interest in us building solutions, we need people to build them and support them. So we're going to staff up some building those exportable models and then we're going to keep them or export. But in either case, we'll be, I think, in good shape. As far as the GS1 relationship, when you say GS1, of course, there's GS1 U.S. and GS1 Germany and GS1 Japan so far and then GS1 global. So the purpose of all of those relationships is strategic and that is that we want to be supportive of global standards for identification of things. And GS1 is the worldwide licensing authority for that. And so we keep them very well informed. They are very helpful to us in understanding customers and segments and we go on joint calls together in both domains, U.S. and Germany. The Japanese GS1 is a government agency. So they're not allowed to do such things. They provide more of an oversight function. And so we -- as we build scale, one of the ways to provide comfort to customers in embracing the platform is that we are, in fact, supportive of those standards. So it's a key strategic role, and we have excellent working relationships with both of the entities, those in Germany and in the U.S., and the GS1 Japan organization is really, at our request, providing some oversight to make sure that we're again being supportive of global standards.

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Operator [44]

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Our next question comes from Glenn Mattson with Ladenburg Thalmann.

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Glenn George Mattson, Ladenburg Thalmann & Co. Inc., Research Division - VP of Equity Research [45]

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Bruce, you might have just hit on this, I missed part of the last question. But between the signing the agreements and generating significant revenue, just exactly like, can you talk about how much work is needed to be done? What's the gating factor at this point between the agreement and the actual revenue generation?

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Bruce L. Davis, Digimarc Corporation - Chairman, CEO and President [46]

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Is that a general question? I'll take it as a general question.

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Glenn George Mattson, Ladenburg Thalmann & Co. Inc., Research Division - VP of Equity Research [47]

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For either of them or for in general, yes. Sure.

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Bruce L. Davis, Digimarc Corporation - Chairman, CEO and President [48]

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I'll answer it generally because again I'm not going to go into details of specific agreements. So generally, we're a new technology. We're in innovation. We need to demonstrate that we can perform within the existing business processes and describe what adaptation is necessary to embrace the platform. So early work with all of the customers relates to what impact do we have on their business process, and how can they adapt the business process to accommodate this new technology, all right? So that's the gate, if you like, at the start of every relationship unless and until we become routine, which is always a way. So that's where we are with the --

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Glenn George Mattson, Ladenburg Thalmann & Co. Inc., Research Division - VP of Equity Research [49]

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So that's work that still needs to be done. It's not work that would have been done before these agreements are ironed out?

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Bruce L. Davis, Digimarc Corporation - Chairman, CEO and President [50]

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It's work that will always need to be done. It's an ongoing requirement of supporting the market. We -- we're -- I know everybody likes to be impatient about how fast things go here, but we're very young in this market. And we have tons of work to do associated with enormous opportunities. So that will be ongoing. It's not like we're going to -- we got it done 3 months ago and we're going to just to sit on our hands here. And a lot of it has to do really with business process reengineering. And so if I could just briefly provide an example, what I mean by that, we met recently with one of the leading -- world's leading design firms. And if we were allowed to start at the ideation phase of design, then the entire process becomes more efficient and more reliable. In most cases, we start with an existing design for a package, often an iconic design, and our job is to -- and perceptibly enhance it and to convince everybody in the supply chain that it's okay for us to intrude. So that's early-stage activity that will not be relevant later on in the development of the market. So we need to educate the people involved in the early stages of the process about a new model, if you like, which is becoming obvious to industry that the package design of the 20th century, which focused largely on catching consumers eye on the shelf, is just one application in a growing number of applications of package design. And we represent the avant-garde of design, meaning the new requirements having to do with direct-to-home shipping, easy reorder, increasing government regulation, the desire for a smartphone enablement shelf edge cross-selling within the stores, revitalizing the center store. All of those things, have to really be thought about at the beginning of design. So much of our work right now is not that, all right? Much of our work is trying to show people that we can fit into an existing design. So there's a ton of opportunity that needs to be exploited at the early stages of design, which is one of our infrastructure builds that will be exportable.

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Operator [51]

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Our next question comes from Robin Knipp with Janney Montgomery.

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Robin Knipp, [52]

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Bruce, I've noticed the last few months more and more visible barcodes that are scanning with the Discover app are returning CPG-specific content. So whereas 3 months ago, I was getting mostly generic Google search results for most UPCs. Now when I scan products from Coke and Pepsi of Smuckers, from McCormick or Procter & Gamble among others, I'm getting directed directly to their websites or more interactive slide presentations, if you will. Can I assume that these are more than just early-stage work that we're doing with these companies?

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Bruce L. Davis, Digimarc Corporation - Chairman, CEO and President [53]

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I wouldn't assume too much from that. It's more indicative of progress in building digital assets that can be related in consumer engagement models than it is telling you about the stages of our development of our relationship with those accounts. So -- one of the problems that the industry has had to address in order to take advantage of our consumer engagement capabilities is when the consumer scans, what do they get. And you've been observing a rapid progress by industry to provide some meaningful engagement, not really just a Google link somewhere, but don't take too much away from what that means in relation to us.

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Robin Knipp, [54]

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Then let me reframe the question in a slightly different format. When I get to some of the slide decks, if you will, from some of these CPGs, they are truly engaging. And I can see how it would make a difference to the customer, whether it's in the future inserting a $0.50 off coupon or whatever. Is that part of the ongoing discussion?

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Bruce L. Davis, Digimarc Corporation - Chairman, CEO and President [55]

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Those concepts are -- yes, those concepts are part of all of our discussions.

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Operator [56]

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Our next question comes from Riley McCormack with Tracer Capital.

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Riley Young McCormack, Tracer Capital Management L.P. - Co-Founder [57]

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Guys, a couple of questions. First of all, just following up on Robin's question, Bruce. But if we're using the Digimarc Discover app, not a generic app, how are they in your registry?

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Bruce L. Davis, Digimarc Corporation - Chairman, CEO and President [58]

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Can't really go into that.

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Riley Young McCormack, Tracer Capital Management L.P. - Co-Founder [59]

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Okay, okay. And then secondly, just talking about the statement of work piece on this new MSA. Can you give us any idea as to the size of the milestones? Or how big the statement work might be if all milestones are hit or over what time? Any more quantitative data on that?

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Bruce L. Davis, Digimarc Corporation - Chairman, CEO and President [60]

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No, no. It's -- that would be inconsistent with our general posture of not giving financial projections. So -- and that would also be a violation of our NDA and also problematic in the trade. So no.

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Riley Young McCormack, Tracer Capital Management L.P. - Co-Founder [61]

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Okay. Even the -- over what time these milestones? I mean, are we talking roughly, is it 6 months to prove something out? Is it 3 years to get a project launched? Any more color?

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Bruce L. Davis, Digimarc Corporation - Chairman, CEO and President [62]

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We're just getting started, Riley, so I know what the schedule is, but I'm not going to tell the schedule so that you can hold me accountable for it when I don't have any basis for assessing it. So it's not many years long. But we'll see how it goes. It involves the supplier and the customer, and we need to build the rapport with both of them and see how effective our process will be that will then affect the pace. So we're trying to move pretty quickly and so far, it's been really a great start. But it's young. We're just getting going. So I don't have confidence to try to project the pace.

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Riley Young McCormack, Tracer Capital Management L.P. - Co-Founder [63]

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Okay. So the milestones aren't necessarily based on time. They are based on milestones, I guess, are chiefly...

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Bruce L. Davis, Digimarc Corporation - Chairman, CEO and President [64]

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They're performance, they're performance.

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Riley Young McCormack, Tracer Capital Management L.P. - Co-Founder [65]

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Performance. Okay. Yes.

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Bruce L. Davis, Digimarc Corporation - Chairman, CEO and President [66]

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Yes. They're getting -- they're proving things as opposed to meeting a date.

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Riley Young McCormack, Tracer Capital Management L.P. - Co-Founder [67]

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And why the milestone format is -- I think this is my next question, which is, is it -- are the milestones dependent on proving out the technology, so questionable as to whether you get? Or is it based on the quantity, so basically buying barcodes or whatever for the deliverables and buckets? Is it more -- I guess, I don't know if you understand my question, but...

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Bruce L. Davis, Digimarc Corporation - Chairman, CEO and President [68]

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Yes, it's both. It's both. So it's just -- it's showing that we can ramp the scale. We can do big volume.

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Riley Young McCormack, Tracer Capital Management L.P. - Co-Founder [69]

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Okay. And -- but what would be the risk there? I mean you do -- how many trillion bank notes are in circulation over the years. I'm trying to understand -- you're trying to ramp -- is it more testing the customers' supply chain as opposed to your ability to...

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Bruce L. Davis, Digimarc Corporation - Chairman, CEO and President [70]

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Yes. It's about supply chain. And each of these large enterprises has a complex supply chain, no 2 of which are the same. So the first step in engagement with these big companies is usually do a couple of proofs, hey, this is what it looks like and how it performs. And they go, "Okay, cool." Okay, now can you work with our supply chain?

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Riley Young McCormack, Tracer Capital Management L.P. - Co-Founder [71]

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And I'm assuming the proofs have been done. You don't get an MSA just to do a proof, right? Or would they?

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Bruce L. Davis, Digimarc Corporation - Chairman, CEO and President [72]

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The MSA doesn't address such things in statements of work. So the MSA is general terms and conditions. So the statement of work is not about showing them a couple of samples.

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Riley Young McCormack, Tracer Capital Management L.P. - Co-Founder [73]

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Got it. Okay. I guess, you mentioned early on, can you give us any -- it's unclear, obviously, what the first MSA is or when it was signed, et cetera, but it doesn't seem to be necessarily progressing at lightening. Is there any reason -- I think you've made a few comments about optimism on this one, in particular, and things seem to be going better, so far. Can you just give us any other color on why you feel optimistic on this potentially being a faster progression?

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Bruce L. Davis, Digimarc Corporation - Chairman, CEO and President [74]

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No. No, I don't think it would be appropriate. It's just that, we've been getting a little better movement lately and maybe, we're going to find a way to move to large scale production and public awareness. So we're not stalled, we're making progress. It's just -- it's complicated.

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Riley Young McCormack, Tracer Capital Management L.P. - Co-Founder [75]

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I guess last -- okay. That's fair. I didn't mean to cut you off. I think you were going to say something else.

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Bruce L. Davis, Digimarc Corporation - Chairman, CEO and President [76]

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No. That's it. We'll need to move on to the next person in the queue in a moment if you have one more question.

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Riley Young McCormack, Tracer Capital Management L.P. - Co-Founder [77]

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Yes, I do have one last question. Is there any reason why they would do a MSA in a statement of work if they weren't contemplating additional statements of work in the future? Or is it something that -- I mean, doing an MSA and the statement of work as 2 separate documents or as part of appendix to the document that you described it as, I assume that it means a plan on further statement of works depending how you deliver this first one?

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Bruce L. Davis, Digimarc Corporation - Chairman, CEO and President [78]

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Yes, yes. They're assuming that we're going to do a lot of stuff together.

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Operator [79]

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Our final question today comes from the line of Jim Ricchiuti with Needham & Company.

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James Andrew Ricchiuti, Needham & Company, LLC, Research Division - Senior Analyst of Advanced Industrial Technologies and Display, Vision and Imaging Technologies [80]

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I was just wondering if you can maybe talk a little bit about the resources that are required to support these 2 MSA clients, particularly, the second one. I mean, can you give us some sense as to the kind of resources you might be allocating?

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Bruce L. Davis, Digimarc Corporation - Chairman, CEO and President [81]

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[Let me]...

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James Andrew Ricchiuti, Needham & Company, LLC, Research Division - Senior Analyst of Advanced Industrial Technologies and Display, Vision and Imaging Technologies [82]

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I mean, professional resources.

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Bruce L. Davis, Digimarc Corporation - Chairman, CEO and President [83]

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Yes, yes, yes. I'll try to give you a general answer to that, Jim. It's a good question and it circles around the core theme of this update. And that is that our strategy is to equip the supply chain with training and tools and support and have them basically run with this and send us money. So that necessarily involves us proving that stuff out. So we've got to do a bunch of work too. And do the work firsthand, that is delivered ourselves, so that we can show how it works and then give it to them and hopefully, they take it over. What we don't know yet, and that was the uncertainty I was a expressing earlier is how readily they take it over and then they take it over. So how much work we have to do ourselves versus them doing it. And that goes come back around you the business model and charging people for what we do if they want us to do it, which haven't been contemplated. So that can be a revision in our basic strategy here. So we're in this curious situation where we have a really impressive lineup of supply side partners and they vary in the level of investment they're willing to make and yet, we're getting pressure to add more. And so we're basically pushing back and we're saying, well, let's get our revenues growing here. Let's get the financial community comfortable that we're on right track here before we add a lot more suppliers. And so that then leads to a negotiation between the end-user, the retailer or more CPG and their suppliers and us. And so I don't know the outcome of those negotiations yet. And there won't be a single one, they'll be in fact different outcomes. And so we have in most recent supply chain partnerships, the WestRock announcement and then they're up, and they've been awesome. I mean, they're just -- they're really committed to this, working real hard. Then we've got many other suppliers who are involved in the process, where perhaps they're waiting to get pushed more by a client or they're waiting for some tools from us or they want to try to get bigger margins. And so there's a lot of work involved in managing supply chain partnerships. And I said that from the beginning that sophisticated enough to know that putting a bunch of logos on a slide isn't very meaningful. We have to really work hard to get those guys to a point where they're making some nice margin from working with us. So that's where we are now. We're just in the midst of really improving our support for the suppliers, so that we can scale this thing. And that's where most of the investment and most of the staffing is being applied right now. And it will either endure and get paid for directly by the end users or it will enliven greater supplier participation, which will yield nice economic benefits. So I think, we see a way to win either way, but it's really uncertain about the -- how that transition occurs and exactly when it occurs. So that's sort of where we are now.

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James Andrew Ricchiuti, Needham & Company, LLC, Research Division - Senior Analyst of Advanced Industrial Technologies and Display, Vision and Imaging Technologies [84]

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Bruce, can you say whether some of the planned staffing additions, the decisions you're making are directly related to this most recent MSA?

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Bruce L. Davis, Digimarc Corporation - Chairman, CEO and President [85]

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Not very much. Actually, the motivation is coming from an abundance of opportunity that I referred to in the last call. It's just after the show and after our involvement with the FMI Executive Conference in Phoenix, just things seem to kick into gear. So we've got too much to do right now, frankly. And so we need to manage our working capital responsibly, which we care deeply about, but we've got to add some more resources, so that we can meet make these requirements and show the top line growth that you guys are waiting for. So it's a result of having a lot of opportunity.

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Operator [86]

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And this does conclude our question-and-answer session for today's program. I will hand the call back over to Bruce Davis for any additional or closing remarks.

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Bruce L. Davis, Digimarc Corporation - Chairman, CEO and President [87]

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Okay. Thank you very much, everyone, for your continued support and confidence in the company. We greatly appreciate it. We'll be in touch soon with another update. And again, I want to remind everyone there is an abundance of financial conferences coming up, where either Charles or I will be present providing updates as of the date of those conferences.

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Operator [88]

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Ladies and gentlemen, this does conclude Digimarc's First Quarter 2017 Conference Call. Thank you for participating. You may now disconnect.