Digimarc Reports Significant Improvement in Financial Performance in Its Third Quarter Results

Digimarc Corporation (NASDAQ:DMRC) today announced significantly improved financial results for the quarter ended September 30, 2006, on both a sequential and year-to-year basis. Third quarter results marked the Company’s first profitable quarter since the third quarter of 2003, and demonstrated the progress the Company has made in improving internal business processes and right-sizing its workforce. Third quarter consolidated revenues were relatively unchanged from the same period last year at $26.7 million. However, net income improved $4.4 million from a net loss of $(4.2) million in 2005 to net income of $0.2 million in 2006, improving diluted earnings per share from $(0.21) to $0.01. The primary contributor to the improvement in earnings was 27% lower operating expenses compared to the third quarter of 2005. Adjusted EBITDA ("earnings before interest, taxes, depreciation, amortization and non-cash stock compensation”) improved by more than $3 million, to $4.6 million from $1.2 million in the corresponding quarter of 2005. Digimarc calculates Adjusted EBITDA by adjusting net income (loss) for the effects of interest, taxes, depreciation, amortization and non-cash expenditures for stock compensation. The reconciliation of Adjusted EBITDA to net income (loss), the most comparable GAAP measure, is included at the end of this release. Third quarter was a banner quarter in bookings, too, as the estimated value of bookings exceeded $57 million, driving the Company’s backlog at September 30, 2006, to $255 million. Year-to-date bookings as of the date of this release have surpassed $100 million. "The third quarter results are a dramatic testimony to the progress that we have made in internal business processes and right-sizing of our workforce. The results include a record Adjusted EBITDA, our first profitable quarter since our third quarter of 2003, a positive change in total cash of $1 million, and an increase in backlog to over $255 million,” said Bruce Davis, Chairman and CEO, Digimarc. "This quarter’s performance was a big step forward on the road to sustained profitable growth that we are focused on delivering as the leading supplier of government-issued citizen credentials in North America and acknowledged pioneer in the exciting field of digital watermarking.” Digimarc calculates total cash by adding cash and cash equivalents, short-term investments and restricted cash. The reconciliation of total cash to the comparable GAAP financial measure is included at the end of this release. Third quarter business highlights New secure ID contracts or extensions totaling more than $57 million. Revenue backlog grows to $255 million. Expansion of driver license authentication capabilities by the Nebraska Department of Motor Vehicles, following the successful pilot demonstrating the value of digital watermarking in the fight against fake IDs. Introduction of the new Digimarc Document Inspector product to improve inspection of driver licenses by ID issuers, border crossing agents, retailers and others. Introduction of the next generation Digimarc Biometric Identification solution and early successes in use by the Massachusetts Registry of Motor Vehicles and other States to stop driver license fraud, identity theft and related crimes. Demonstration and testimony at a U.S. Senate Finance Committee hearing of Digimarc’s solutions for reading digital watermarking and other security features found in tens of millions of U.S. driver licenses that could be used to enhance U.S. border security. Continued momentum and adoption for digital watermarking solutions from Digimarc business partners and licensees in the areas of digital cinema and broadcast monitoring. Formation of the Digital Watermarking Alliance, consisting of 12 digital watermarking technology and solution providers who are committed to working together to expand the market and accelerate adoption. New developments for the Digimarc Mobile program, including a new pilot in Japan and a new U.S. partner to bring the benefits of digital watermarking-based mobile print-to-web linking capabilities to camera phone users. The U.S. District Court of Oregon’s grant of motions to dismiss the two remaining securities lawsuits against Digimarc and certain of its current and former executive officers. Early fourth quarter business highlights Sales bookings pass $100 million mark for the year. New contract with the Iowa Department of Transportation for implementation of a facial recognition-based biometrics system to deter driver license fraud. Announcement of new smart card driver license option to support States with driver license upgrades in anticipation of new Federal standards for IDs used in crossing Canadian and Mexican borders. Issuance of a new Digimarc patent (U.S. Patent No. 7,095,871) that proposes a solution for identifying copyrighted content in social networks and peer-to-peer (P2P) environments. U.S. Department of Defense funding for second phase of a project that enables the Army Night Vision Electronic Sensor Directorate to use digital watermarking for more effective identification and management of video-based military intelligence. 2006 Financial Guidance Digimarc is updating its financial guidance as follows. In the fourth quarter, the Company expects: Revenues in the range of $25.5 million to $26.5 million, up 2% to 6% from the prior year. Gross margin in the range of 37%-39%. Operating expenses approximately $600,000 to $800,000 higher than in the previous quarter primarily reflecting normal year-end increases in audit and Sarbanes-Oxley-related expenses and to a lesser extent, timing of certain expenditures in the sales, marketing and R&D areas. EPS in the range of a loss of ($0.01) to ($0.05) compared to a $.01 profit in the third quarter due to seasonally lower revenues in conjunction with the increases in fourth quarter expenses noted above. Adjusted EBITDA of $3.3 million to $4.1 million. Capital expenditures in the range of $3 million to $4 million compared to $3.5 million in the third quarter. For the full year, the Company expects: Revenues in the range of $105 million to $106 million. EPS in the range of ($0.54) to ($0.57), cutting in half the ($1.13) loss in 2005. Adjusted EBITDA in the range of $5.6 million and $6.4 million compared to a deficit of ($3.4) million for 2005. Capital expenditures in the range of $10 million to $11 million, well below last year’s $16 million level. Backlog in the range of $235 million and $245 million compared to approximately $230 million at the end of last year. Conference Call Digimarc will hold its third quarter 2006 earnings conference call on Friday, Nov. 3 2006, at 8 a.m. Pacific / 11 a.m. Eastern. The call will be open to the general public and the media, and will be broadcast live by Web cast at www.digimarc.com and www.earnings.com. At Digimarc’s Web address, the call will be available by clicking on the "Q3 2006 Earnings Release Conference Call" icon on the "Investor Relations Events” page. This Web cast will also be available for later listening at both sites for two weeks following the live call. Thereafter, the Web cast will be archived and available at http://www.digimarc.com/investor/events.asp. About Digimarc Digimarc Corporation (NASDAQ:DMRC), based in Beaverton, Oregon, is a leading supplier of secure identity and media management solutions. Digimarc provides products and services that enable the annual production of more than 60 million personal identification documents, including two-thirds of U.S. driver licenses and IDs for more than 20 countries. Digimarc's digital watermarking technology provides a persistent digital identity for various media content and is used to enhance the security of financial documents, identity documents and digital images, and support other media rights management applications. Digimarc has an extensive intellectual property portfolio, with more than 285 issued U.S. patents with more than 5,000 claims, and more than 500 pending patent applications in digital watermarking, personal identification and related technologies. The Company is headquartered in Beaverton, Oregon, with other U.S. offices in Burlington, Massachusetts; Fort Wayne, Indiana; and the Washington, DC area; and international offices in London and Mexico. Please go to www.digimarc.com for more company information. Securities Safe Harbor With the exception of historical information contained in this release, the matters described herein contain certain "forward-looking statements" that are made pursuant to the "safe harbor" provisions of the Private Securities Litigation Reform Act of 1995. Such forward-looking statements include statements regarding the Company’s ability to achieve sustainable, profitable growth, the momentum of digital watermarking solutions, the effectiveness of our new smart card option to support states with driver license upgrades, future benefits resulting from staff reductions and improvements in internal business processes, the effectiveness of new products and technology, and financial guidance for the fourth quarter of 2006 and the 2006 fiscal year,, as well as other statements containing the words "believes," "expects," "estimates," "anticipates," "will" or words of similar import or statements of management's opinion. These statements are subject to certain assumptions, risks, uncertainties and changes in circumstances. Actual results may vary materially from those expressed or implied from the statements herein or from historical results, due to changes in economic, business, competitive, technological and/or regulatory factors. More detailed information about risk factors that may affect actual results is set forth in filings by Digimarc with the Securities and Exchange Commission on Forms 10-K, 10-Q and 8-K, including but not limited to those described in the Company's Form 10-Q for the quarter ended June 30, 2006, in Part I, Item 2 thereof ("Management's Discussion and Analysis of Financial Condition and Results of Operations") under the captions "Liquidity and Capital Resources" and "Factors Affecting Forward Looking Statements" and in Part I, Item 4 thereof ("Controls and Procedures"). Readers are cautioned not to place undue reliance on these forward-looking statements, which reflect management's opinions only as of the date of this release. Except as required by law, we undertake no obligation to revise or publicly release the results of any revision to these forward-looking statements. Digimarc Corporation Income Statement Information (in thousands, except per share amounts) (Unaudited)     Three Months Ended Nine Months Ended Sept. 30, June 30, Sept. 30, Sept. 30, Sept. 30,   2006    2006    2005    2006    2005  Revenue: Service $ 22,414  $ 20,519  $ 22,372  $ 65,223  $ 63,584  Product and subscription   4,319    4,388    4,409    13,610    12,329  Total revenue 26,733  24,907  26,781  78,833  75,913    Cost of Revenue: Service 15,138  15,002  15,253  47,239  44,448  Product and subscription   1,581    1,675    1,790    5,805    5,232  Total cost of revenue 16,719  16,677  17,043  53,044  49,680    Gross Profit: Service 7,276  5,517  7,119  17,984  19,136  Product and subscription   2,738    2,713    2,619    7,805    7,097  Total gross profit 10,014  8,230  9,738  25,789  26,233    Percentage of gross profit to revenues: Service 32% 27% 32% 28% 30% Product and subscription 63% 62% 59% 57% 58% Percentage of total gross profit to total revenues 37% 33% 36% 33% 35%   Operating expenses: Sales and marketing 3,440  4,685  4,295  12,664  11,961  Research, development and engineering 2,158  2,994  3,199  8,388  9,535  General and administrative 3,684  4,172  4,852  13,066  15,870  Amortization of intangibles 537  550  1,147  1,660  3,297  Intellectual property 460  481  528  1,372  1,531  Restructuring charges, net -  547  -  547  -            Total operating expenses   10,279    13,429    14,021    37,697    42,194    Operating income (loss) (265) (5,199) (4,283) (11,908) (15,961)   Other income (expense), net   536    308    214    1,201    695  Income (loss) before provision for income taxes 271  (4,891) (4,069) (10,707) (15,266) Provision for income taxes   (58)   22    (159)   (121)   (299) Net income (loss) $ 213  $ (4,869) $ (4,228) $ (10,828) $ (15,565)   Net income (loss) per share - basic $ 0.01  $ (0.24) $ (0.21) $ (0.52) $ (0.76) Net income (loss) per share - diluted $ 0.01  $ (0.24) $ (0.21) $ (0.52) $ (0.76)   Weighted average shares - basic 20,670  20,627  20,497  20,635  20,473  Weighted average shares - diluted 21,470  20,627  20,497  20,635  20,473  Digimarc Corporation Cost of Revenue (in thousands, except per share amounts) (Unaudited)     Three Months Ended Nine Months Ended Sept. 30, June 30, Sept. 30, Sept. 30, Sept. 30,   2006    2006    2005    2006    2005  Cost of Revenue: Variable $ 7,295  $ 6,454  $ 6,877  $ 22,066  $ 21,008  Fixed field support and manufacturing 6,754  7,595  6,371  23,092  18,908  Program depreciation   2,670    2,628    3,795    7,886    9,764  Total cost of revenue $ 16,719  $ 16,677  $ 17,043  $ 53,044  $ 49,680      Cost of Revenue (as a % of total revenue): Variable 28% 26% 26% 28% 27% Fixed field support and manufacturing 25% 30% 24% 29% 25% Program depreciation   10%   11%   14%   10%   13% Total cost of revenue   63%   67%   64%   67%   65% Digimarc Corporation Balance Sheet Information (in thousands) (Unaudited)     September 30, December 31,   2006    2005  Assets Current assets: Cash and cash equivalents $ 20,251  $ 23,964  Short-term investments   1,001    739  Total cash, cash equivalents and investments 21,252  24,703  Accounts receivable, net 14,972  15,697  Inventory, net 6,016  7,451  Other current assets   2,063    2,828  Total current assets 44,303  50,679    Restricted cash 9,938  7,279  Property and equipment, net 61,662  64,108  Intangibles, net 15,853  17,164  Other assets, net   908    1,009  Total assets $ 132,664  $ 140,239      Liabilities and Stockholders' Equity Current liabilities: Accounts payable $ 4,795  $ 6,722  Accrued payroll and related costs 4,095  3,731  Deferred revenue 9,155  6,809  Other current liabilities   1,853    2,032  Total current liabilities 19,898  19,294    Other long-term liabilities 1,014  969    Stockholders' equity   111,752    119,976  Total liabilities and stockholders' equity $ 132,664  $ 140,239  Digimarc Corporation Cash Flow Information (in thousands) (Unaudited)   Three Months Ended Nine Months Ended Sept. 30, June 30, Sept. 30, Sept. 30, Sept. 30,   2006    2006    2005    2006    2005    Cash flows from operating activities: Net loss $ 213  $ (4,869) $ (4,228) $ (10,828) $ (15,565) Adjustments to reconcile net loss to net cash provided by (used in) operating activities: Depreciation and amortization 3,943  3,834  5,424  11,595  13,978  Stock-based compensation expense 707  782  153  2,283  355  Change in allowance for doubtful accounts (9) (100) (82) (173) (10) Other non-cash charges (213) (73) (3) (286) (11) Changes in operating assets and liabilities: Restricted cash 1,545  (4,703) 1  (2,659) 993  Trade and unbilled accounts receivable, net (867) (830) (723) 898  (1,152) Inventory, net 333  (506) (125) 1,435  319  Other current assets 533  (373) 349  765  (830) Other assets, net 32  36  (50) 101  82  Accounts payable (2,082) 1,551  (875) (1,927) (4,856) Accrued payroll and related costs 614  580  510  364  1,846  Deferred revenue 1,361  1,829  (223) 2,346  (257) Other liabilities   85    (107)   173    (236)   497  Net cash provided by (used in) operating activities 6,195  (2,949) 301  3,678  (4,611) Cash flows from investing activities: Purchase of property and equipment and capitalized labor costs (3,533) (2,638) (3,680) (6,940) (12,639) Purchase of intangibles -  (30) -  (30) (20) Sale or maturity of short-term investments 29,637  28,752  41,709  92,350  133,247  Purchase of short-term investments   (29,637)   (28,752)   (39,639)   (92,612)   (114,484) Net cash provided by (used in) investing activities (3,533) (2,668) (1,610) (7,232) 6,104  Cash flows from financing activities: Net proceeds from issuance of common stock 57  259  36  321  211  Principal payments under capital lease obligations   (166)   (168)   (117)   (480)   (351) Net cash provided by (used in) financing activities   (109)   91    (81)   (159)   (140) Net increase (decrease) in cash and cash equivalents $ 2,553  $ (5,526) $ (1,390) $ (3,713) $ 1,353        Supplemental disclosure of cash flow information: Cash paid for interest $ 29  $ 28  $ 15  $ 73  $ 135  Cash paid for income taxes $ 23  $ 111  $ 35  $ 134  $ 139  Supplemental disclosure of cash flow information: Equipment acquired or exchanged under capital lease obligations $ -  $ 169  $ 84  $ 582  $ 135  Grant of restricted stock $ -  $ 149  $ -  $ 1,202  $ 2,025  Digimarc Corporation Reconciliation of GAAP and Non-GAAP Financial Measures Adjusted EBITDA (in thousands) (Unaudited)   Three Months Ended Nine Months Ended Sept. 30, June 30, Sept. 30, Sept. 30, Sept. 30,   2006    2006    2005    2006    2005    Net income (loss) $ 213  $ (4,869) $ (4,228) $ (10,828) $ (15,565) Adjustments: Interest income, net (313) (313) (247) (935) (664) Provision for taxes 58  (22) 159  121  299  Depreciation and amortization 3,943  3,834  5,424  11,595  13,978  Stock compensation 707  782  153  2,283  355            Adjusted EBITDA $ 4,608  $ (588) $ 1,261  $ 2,236  $ (1,597) Digimarc Corporation Reconciliation of GAAP and Non-GAAP Financial Measures Projected Adjusted EBITDA (in thousands) (Unaudited)   Three Months Ended March 31, June 30, Sept. 30, Dec. 31, 2006  2006  2006  2006  Actual Actual Actual Forecast Total LOW: Net loss $ (6,172) $ (4,869) $ 213  $ (200) $ (11,028) Adjustments: Interest income, net (309) (313) (313) (350) (1,285) Provision for taxes 85  (22) 58  50  171  Depreciation and amortization 3,818  3,834  3,943  3,923  15,518  Stock compensation 794  782  707  712  2,995            Adjusted EBITDA $ (1,784) $ (588) $ 4,608  $ 4,135  $ 6,371        HIGH: Net loss $ (6,172) $ (4,869) $ 213  $ (1,000) $ (11,828) Adjustments: Interest income, net (309) (313) (313) (350) (1,285) Provision for taxes 85  (22) 58  50  171  Depreciation and amortization 3,818  3,834  3,943  3,923  15,518  Stock compensation 794  782  707  712  2,995            Adjusted EBITDA $ (1,784) $ (588) $ 4,608  $ 3,335  $ 5,571  About Adjusted EBITDA Adjusted EBITDA does not represent cash flows from operations as defined by generally accepted accounting principles ("GAAP”), is not a measure derived in accordance with GAAP and should not be considered by the reader as an alternative to net income (the most comparable GAAP financial measure to Adjusted EBITDA). The reconciliation of GAAP and Non-GAAP Financial Measures (i) for the three- and nine-months ended September 30, 2006, and 2005 and the three months ended June 30, 2006, and (ii) for the Company’s guidance with respect to the 3-month period ending December 31, 2006, and the year ending December 31, 2006, is included in the above tables. Management of the Company believes that Adjusted EBITDA is helpful to investors as an indicator of the current financial performance of the Company and its capacity to fund capital expenditures and working capital requirements. Due to the nature of the Company’s government programs business and revenue recognition policies and the Company’s use of stock-based employee compensation, the Company incurs significant non-cash charges for depreciation, amortization and stock compensation expense that may not be indicative of our operating performance from a cash perspective. Therefore, the Company believes that providing the calculation of Adjusted EBITDA will help investors better understand the Company’s underlying financial performance and ability to generate cash flow from operations. Digimarc Corporation Reconciliation of GAAP and Non-GAAP Financial Measures Total Cash (in thousands) (Unaudited)     September 30, June 30, March 31,   2006    2006    2006    Cash: Cash and cash equivalents $ 20,251  $ 17,698  $ 23,224  Short-term investments 1,001  1,001  1,001  Restricted cash, current and long-term   9,938    11,483    6,780  Total cash $ 31,190  $ 30,182  $ 31,005  Less: prior period ending cash $ (30,182) $ (31,005) $ (31,982) Change in total cash $ 1,008  $ (823) $ (977) About Total Cash Total Cash does not represent cash and cash equivalents as defined by generally accepted accounting principles ("GAAP”), is not a measure derived in accordance with GAAP and should not be considered by the reader as an alternative to disclosure regarding changes in cash and cash equivalents (the most comparable GAAP financial measure to Total Cash as used in this release, which includes cash and cash equivalents, short-term investments and restricted cash). The reconciliation of GAAP and Non-GAAP Financial Measures as of September 30, 2006, June 30, 2006, and March 31, 2006, is included in the above table. Management of the Company believes that Total Cash is helpful to investors as an indicator of liquidity and cash position of the Company and its capacity to fund capital expenditures and working capital requirements. Total Cash is commonly used as a measure of performance and it is used by securities analysts, investors and other parties in evaluating the Company. The Company believes that providing the calculation of Total Cash will help investors better understand the Company’s liquidity and cash position.