Digimarc Corporation

Good morning and thank you for participating in today's call. Now I'll turn the call over to Chief Legal Officer, Mr. Bob Chamness. Sir, please proceed.

Thank you. And welcome to our Q3 conference call. Riley McCormick, our CEO, and Charles Beck, our CFO, are with me on the call. I'm also pleased to introduce Niall Murphy, the CEO and co-founder of Everything, who will be available for questions during the course of the call. We're hosting this call from London, England, at the corporate headquarters of Everything. On the call today, we will provide an overview of the Everything acquisition and our path forward as a combined company. We will also discuss Q3 financial results and provide a business update. This will be followed by a question and answer forum. We have posted our prepared remarks in the investor relations section of our website, and we'll archive this webcast there. Before we begin, let me remind everyone that today's discussions contain forward-looking statements that have risks and uncertainties. Please refer to our press release for more information on the specific risk factors that could cause actual results to differ materially. Charles will now comment on our Q3 financial results and discuss the financial aspects of the Everything acquisition.

Thank you, Bob, and hello, everyone. Today is a monumental day for the company as we join forces with the amazing team at Everything. Before I get into that, I want to provide a quick summary of Q3 financial results. Revenue for the third quarter was $6.4 million, up 12% from $5.8 million in Q3 last year. Service revenue increased 17% from $3.4 million to $3.9 million, reflecting higher commercial services related to Holy Grail 2.0 projects. Subscription revenue increased 4% from $2.4 million to $2.5 million, reflecting higher revenue from commercial customers. Total commercial bookings were $3 million, up 60% from $1.8 million in Q3 last year. Operating expenses for the quarter were $12.2 million, flat with Q3 last year, reflecting higher consulting and recruiting costs, offset by severance costs incurred in Q3 last year for organizational changes we made in July 2020. In September, we received confirmation from our lender that our Paycheck Protection Program loan was forgiven. This resulted in a $5.1 million gain in other income in Q3 upon forgiveness of the loan. Net loss for Q3 was $2.9 million or $0.17 per common share versus a net loss of $8.4 million or $0.68 per common share in Q3 last year. Excluding the $5.1 million gain from the forgiveness of our PPP loan, the net loss for Q3 was $8 million or $0.48 per common share. We ended the quarter with $52.5 million in cash and investments. We used $8.6 million of cash and investments during the quarter, of which $7.5 million was from operating activities and capital expenditures. For further discussion of our financial results and risks and prospects for our business, please see our Form 10Q that we will file shortly. Now back to the everything transaction. I want to first highlight a few important deal terms summarized in the 8K we filed this morning to provide more context. First off, this is a stock deal, with the consideration split into two tranches. The initial consideration will be issued at closing, which we expect to occur in January 2022, and the second tranche of consideration, if any, will be issued in September 2022. The initial consideration in January amounts to $50 million of common stock and warrants, as adjusted for everything's cash, debt, working capital, and transaction expenses at closing. We estimate that we will need to fund approximately $7.9 million at closing in order to cover everything's closing costs and other repayment obligations. We expect this cash expense to be offset largely, if not completely, by proceeds from the exercise of the warrants that we will issue to the sellers at closing. The number of shares to be issued at closing is based on a fixed value of $47.48 per share. which represents the volume weighted average price for the last 20 trading days. We have estimated the number of shares to be issued at closing at approximately 785,000 common shares and 215,000 warrants. The exercise price of the warrants will be calculated as described in the 8K. We expect that the exercise price will represent a substantial discount to our current share price. The warrants will be issued to provide Everything shareholders the opportunity to cover their cash closing costs and thus receive the full number of shares they would have received without those closing costs. The exercise price was set low to provide them extra cushion to do so. To offset this lower exercise price, the amount of shares we are withholding is higher. While I encourage you all to read more details in the 8 , the net of this is Everything shareholders exercise their warrants they get the number of shares they would have received at the $47.48 price prior to adjustment. If they do not exercise their warrants, then the total shares issued at closing will have been reduced by 30% of the cash closing cost amount that DigiMark funds. The additional closing consideration payable in September will range anywhere from $0 to $50 million of common stock. There are two features that could reduce the closing consideration from the maximum of $50 million. First, there is a traditional earn-out based on a product annual recurring revenue target. If everything meets or exceeds $10 million of product ARR as of the end of February 2022, then there is no reduction. If everything does not meet the $10 million product ARR target, then the closing consideration payable in September is reduced by 10 times the amount of the dollar shortfall in product ARR. Second, there is a reduction to the closing consideration if DigiMark stock appreciates above the $47.48 price used in determining the initial consideration, as measured during the 20-trading day period prior, ending on September 22, 2022. For example, if Digimark stock were to double as of September 2022, there would be zero additional closing consideration, irrespective of everything's product ARR results. While we are super excited by the future combined company, as you will hear Riley talk about in a bit, we are reticent to part with a single share of Digimark stock, even at almost $50 per share. And so we structured the deal with that in mind. The structure of the transaction is intended to provide us two levels of downside protection with one upside kicker. If everything does not meet the product ARR target, the closing consideration is reduced by 10 times the dollar shortfall. In addition, if DigiMark stock is below the $47.48 price, as measured during the 20-trading date period prior, ending on September 22, 2022, Any consideration owed in the second tranche is calculated using the $47.48 floor. Meanwhile, we get full credit for any stock appreciation between now and the second tranche, which in essence allows us to benefit from a signed deal today, but significantly limit the dilution if our stock is appreciably higher by September of next year. The structure is intended to result in a valuation of everything between 5x and 10x product ARR, with the ultimate valuation depending on the February 2022 product ARR and our stock price. For a high-growth, high-margin SaaS business, even before considering all of the strategic and synergistic value we expect this transaction to provide us, this is a really attractive valuation. This headline valuation multiple is a testament to the vision of the Everything shareholders, as they see something which you will hear us say many times in the future. We are just simply better together. More on that in Riley's remarks, but I want to first provide some more financial context. The financial figures I'm about to discuss have been prepared by Everything's management and have not been audited. Note that Everything prepares its financial statements in accordance with FRS 102, also known as U.S. GAAP, or U.K. GAAP, sorry. These financial figures have not been reconciled to U.S. GAAP. Everything uses the financial metrics annual contract value, or ACV, and product ARR as leading indicators of future top-line growth. While ACV is very similar to the financial metric we use for the same purpose, bookings, they're not the exact same. For the first half of 2021, everything's ACV was $3.2 million compared to ACV of $2.5 million during the first half of 2020, growth of 29% year-over-year. For the first half of 2021, total revenue was $2.5 million, of which product subscription revenue was $2.2 million, and the rest was service revenue. Product subscription revenue for the same period in 2020 was $1.8 million, or growth of 21% year-over-year. As of September 30, 2021, product ARR was $4.9 million, We believe product ARR is the best indicator of the next 12 months of subscription revenue, but it may be conservative as it does not reflect revenue growth from new customers or expansion with existing customers. It is simply an annualized snapshot of the current product subscription revenue lineup. Thus, annualizing the first half of 2021 $2.2 million in product subscription revenue, comparing that to the most recently finalized product ARR number of $4.9 million, and then looking out to everything's projected February 2022 product ARR target of $10 million, should give you a sense of the current growth rate and near-term prospects of this incredible business. Subscription gross margins are in the low 70% before any revenue share payments from deals brought in by everything's robust partner network. While this is all preliminary, we believe we can optimize their cost of sales and get subscription gross margins into the high 70s at existing revenue levels. With expected revenue growth, subscription gross margins should further expand. Everything is currently using around $2.25 million to fund its business. If they are able to increase their product ARR, the cash usage should decline significantly given the just mentioned high subscription gross margins. Riley will now provide a business update and further details on the strategy behind the everything acquisition.