Digimarc Corporation

Greetings and welcome to the Digimart Corporation second quarter 2022 earnings conference call. At this time, all participants are in a listen-only mode. A question and answer session will follow the formal presentation. If anyone should require operator assistance during the conference, please press star zero on your telephone keypad. As a reminder, this conference is being recorded. I would now like to turn this conference over to your host, Mr. Joel Meyer, Chief Legal Officer. Sir, please proceed.

Welcome to our Q2 conference call. Riley McCormick, our CEO, and Charles Beck, our CFO, are with me on the call. On the call today, we will discuss Q2 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 discussion contains 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 Q2 financial results.

Thank you, Joel. And hello, everyone. First year commercial bookings were $2.2 million during the quarter compared to $2.3 million in Q2 2021. Bookings in Q2 last year included $800,000 from our piracy intelligence product. that we are nearly complete in winding down. We are not signing any new Piracy Intelligence deals and we have now effectively exited most of our legacy customer contracts. Excluding Piracy Intelligence, our first year commercial bookings increased 700,000 or 44%. As a reminder, we are now selling a combined solution of Digimark Watermarks and the Everything Product Cloud, which makes it impractical to provide a breakout of bookings and revenue for each. Revenue for the second quarter was $7.7 million, up 23% from $6.3 million in Q2 last year, reflecting growth in both subscription and service revenue. Subscription revenue grew 30% in the quarter, from $2.5 million to $3.2 million. Keep in mind there are two offsetting factors impacting our year-over-year growth. The addition of subscription revenue from everything, offset by the decline in subscription revenue from sunsetting our piracy intelligence product. As we previewed last quarter, the sunsetting of the piracy intelligence product was going to have a meaningful impact on subscription revenue starting in Q2, which it did. The product was generating $600,000 of revenue per quarter before we started exiting. And now that we are more than halfway through that process, our revenue is only $300,000 in the second quarter. We expect this revenue to be insignificant going forward as we finalize the wind down process. These offsetting factors as well as the vagaries of revenue recognition rules that have an impact on our reported revenue at this stage in our growth is why we believe first year bookings is the best leading indicator of growth of our business. As a reminder, first year bookings are committed first year contract amounts and will typically flow into revenue in the 12 months after contract signing. Service revenue grew 19% in the quarter from 3.8 million to 4.5 million. The increase largely reflects higher service revenue from Holy Grail 2.0 recycling projects, the majority of which relates to the recycling contract we referenced on the last earnings call. We are nearly complete with that contract, so we do not anticipate significant revenues in Q3 from this contract, and thus service revenue should revert to more normalized levels. First profit margin for the second quarter was 52% compared to 67% in Q2 last year. The decrease in margin reflects 1.1 million of amortization expense recorded on acquired intangible assets recognized in the acquisition accounting for everything. Non-GAAP gross profit margin, which excludes amortization expense and stock-based compensation expense, was 71% in Q2 2022, compared to 72% in Q2 2021. Operating expenses for the quarter were 18.9 million, down 700,000 from Q2 last year. Last year, we incurred 6.2 million of expense, related to the separation agreement we entered into with our previous CEO and $1.3 million of severance costs related to organizational changes we made in Q2 2021. Excluding these costs, operating expenses increased $6.8 million, reflecting the operating expenses of everything and higher compensation costs due to higher headcount and annual compensation adjustments. Non-GAAP operating expenses for the quarter were $15 million, up $2.4 million from Q2 last year, Everything added $3.3 million of non-GAAP operating expenses in the second quarter. Excluding everything, non-GAAP operating expenses decreased $900,000, reflecting the cash costs associated with the separation agreement we entered into with our previous CEO and cash severance costs related to organizational changes we made in Q2 2021, which totaled $2.5 million, partially offset by higher cash compensation costs due to higher headcount and annual compensation adjustments. Net loss per common share for the quarter was 75 cents versus 94 cents in Q2 last year. Non-GAAP net loss per common share for the quarter was 47 cents versus 49 cents in Q2 last year. We ended the quarter with 68.4 million in cash and investments. We used 14.7 million of cash and investments during the second quarter if you exclude the impact of the 58.2 million of capital we raised in April. The $14.7 million included roughly $3 million of cash to pay larger than usual outstanding payables at March 31st. We incurred several large expenditures in Q1 related to the acquisition, financing, and other activities that were not paid until April due to timing of receiving the invoices and processing the payments. Excluding the impact of paying off these higher payables, we used $11.7 million of cash and investments during the quarter, compared to $9.6 million in the second quarter of 2021. The last two quarters' cash flows have been higher than our expected normalized rate going forward due to some non-recurring items. Internally, we look at non-GAAP loss, which excludes non-cash expenses, and layer on cash use for capital expenditures and share repurchases to estimate our normalized level of cash flows. We expect cash flows each quarter may fluctuate from this metric due to timing of customer receipts and vendor payments, but it provides a good indicator of normalized cash flow at existing revenue levels. For further discussion of our financial results and risks and prospects for our business, please see our Form 10-Q that will be filed with the SEC. Riley will now provide a business update.

Thanks, Charles. According to our relaunch, I'm pleased with where we are as well as our direction of travel. I want to use today's call to share where we stand, where we're going, and importantly, provide some examples of progress between those two points. I've mentioned in the past why we made the move from selling tools to selling products. I won't reiterate that here. But driving this journey is our internal mantra that we must be easy to begin doing business with and excellent at guiding customers along their DigiMark journey. Our goal is simple. We want to digitize the world's products, and in doing so, allow our customers to complete their digital transformation journey, a journey many are pursuing but can't complete if their products remain stuck solely in the analog world. In deciding what products to build, we are focusing on those that address large and growing problems and hence allow us to participate in large and growing markets. We are prioritizing our efforts by applying the lines of whether our platform, upon which all of our products are built, provides significant technological differentiation. We are being purposeful in making sure our products are accretive to each other, which means that the value a customer unlocks from any single DigiMark product is greater than more DigiMark products to which they subscribe. And we are fortunate because based on the almost unlimited applicability of our platform, we believe we'll be productizing new functionality for years. And in many cases, the spark of those new products will be prospect-led demand. But we also realize we will never have a monopoly on all good ideas or the best avenue with which to address all potential customers' problems. While we will constantly add new products to our product suite, We also realize there's value to selectively metering out access to our platform so that others can build their own products. Because not only will metering out that access generate compounding revenue, it will further our goal of digitizing the world's products using our technology, allowing those digitized products to benefit from our DigiMark built solutions at some point down the road. So that's the strategy in a nutshell. Build an ever-expanding product suite of wide moat products a luxury afforded to us by the unique and synergistic nature of our platform. Make sure those products address large, fast-growing markets where not only do we enjoy the most provided to us by our platform, but whose existence is often initially brought to our attention by prospects who are anxious for us to solve their problems. Use the accretive nature of our products to add ever more value to our customers by cross-selling them additional Digimark-built products. And at the same time, smartly meet our access to our platform so others can build upon it. which is a very profitable way to digitize the world's products using our technology and allows us a luxury rare among platform-based technology companies. Done this way, not only will we avoid channel conflict, we and our channel will provide each other compounding value, which ensures we will always have a large and robust ecosystem surrounding our platform. Q2 brought demonstrable progress across all these fronts. Starting with brand integrity, we did indeed close the second division of the large CPG company I referenced in our March call. Moreover, we are in talks to further expand our brand integrity offering with the first division of that company, are in conversations with additional divisions at the CPG, all while discussing what a brand integrity enterprise deal might look like, at least for part of the company. Beyond a single company, we are in active discussions with others in the same industry who also want to benefit from our brand integrity product, and we are anxious to begin the same land and expand strategy with them and expect to make progress on that front starting this quarter. In other words, we seem to have found product market fit and are hard at work analyzing how we can use those learnings to get even better. This virtuous cycle from minimally viable product to finding product market fit to being intentional about creating a feedback loop so we can take those learnings and build even better product is made possible by having a product focus. The multi-tiered opportunities from this single early success present great standalone potential. But the process that now surrounds it should give rise to a forest, not just a single tree, starting this quarter. Moving to consumer engagement, we are applying the same discipline. We are being intentional about learning what we can from customers that came to us in the everything deal so that our consumer engagement product is always getting stronger. As a result, our consumer engagement pipeline is growing. And more importantly, we expect to begin closing on that pipeline this quarter as well. Included in that pipeline are new customers as well as expansion opportunities with existing consumer engagement customers. Moreover, the fact that our products are accretive, meaning the more products you adopt, the more value they each create, is resonating not just in slide decks but in customer interest. We have one company that came to us for consumer engagement and is now also exploring brand integrity for these same items as part of their first contract. I don't know if the realization of accretive value will be done most often after adoption of the first product or while the customer is still a prospect. But having a clear product focus and benefiting from the learnings this focus allows will enable us to be prescriptive in helping our customers in their DigiMark journey. Does the expansion of the first conversation slow down the time to value realization or does it speed it up? If there is a delay, are there specific actions we can take to eliminate them? If it speeds up the time to value realization, how do we improve that time to value even more while amplifying that message to other prospects? Does the answer vary by prospect or product type? This is all data we are now positioned to capture, and this data will inform us in our quest to always get, be, do better. DigiMark Recycle is an example of a DigiMark product that incorporates the base functionality of another DigiMark product, in this case consumer engagement, into its core functionality, making the initial accretive value immediate. Importantly, this embedded base functionality is resonating. The conversations we mentioned in the last call that would begin in Q2 are helping raise awareness that beyond just providing a higher quality and quantity of recycling, and in addition to the novel unmined data set that will come from having, for the first time ever, actual versus survey post-purchase data, DigiMark Recycle Adoption provides a content creation-free means of engaging consumers on a topic about which they and regulators care. And the easy upgrade path to full consumer engagement from the embedded base functionality found at Digimark Recycle should provide a win to all three stakeholders, our Digimark Recycle customers, their customers, and us. These conversations are happening against the backdrop of the June 30th announcement of the TOMRA Phase 2 results, which provided even more evidence Digimark Recycle can make a real impact on this ever-increasing global problem. These results, coupled with the March 30th release of the Pelling Phase 2 results, provides clear validation to our simple message. Two independent third-party tests have shown almost the exact same incredible results in real-world conditions, results that can save this planet. The time to adopt is now. We are currently active in two continents with Digimark Recycle. In Europe, there are two upcoming document releases that we believe will add to the course that now is the time to adopt. And as we announced in June, The global nature of our Solve gained momentum with the announcement of our partnership with the Circular Plastics Task Force here in North America. Conversations to expand into other geographies are also taking place. Underlying these newer conversations is the fact there is nothing left to be learned by running trials. As I described in our last call, there is unlikely to be as accurate or precise measurements of how our technology performs in a real-world setting as the two Holy Grail Phase II results. And at the risk of being repetitive, Those results left no doubt as to the real step change value we provide. Also announced in June was our partnership with Sealed Air. Sealed Air, as many of you know, is a tech-forward, innovative company with an incredible array of packaging solutions, as well as a large and loyal customer base. Sealed Air chose to combine their new digital printing and packaging solution, Prismic, with our product digitization platform as a means to add intelligence to their widely adopted packaging solutions. This is the most public example of our metering out access to our platform, and we stand by eager to help our wonderful partner advance their own customers in their digital transformation journeys. In terms of the almost unlimited applicability of our platform and how prospects can spark the exploration of potential product candidates, one of the deals we closed in Q2 was for an application of our platform we believe might have a bright future as a new DigiMark product. Reinforcing that view is another deal in the pipeline of significantly larger size that we expect to close in the back half of this year. The product team is hard at work researching the opportunity to productize this solution as a potential addition to our product suite. Nearer term, the product candidate we've discussed in the past that could act as a top-down driver of product digitization and thus provide a huge boost in our goal of digitizing the world's products continues to move forward, and we expect to be able to share more on this in the near future. Stay tuned. As I said, a quarter in, I am pleased with where we are as well as our direction of travel. There is no doubt in my mind that we're on the right path, and the fruits of this transformation, already beginning to show, will only get more obvious in the months ahead. A quarter in, we're taking early wins and learning from them. Having a product focus allows for these wins to not only be repeatable, but improved upon. I am thankful for all the hard work of my teammates over this past quarter as we begin to see the fruits of our year-long transformation. Laura? We will now put up the call for questions.

At this time, we will be conducting a question and answer session. If you would like to ask a question, please press star 1 on your telephone keypad. A confirmation tone will indicate your line is in the question queue. You may press star 2 to remove your question from the queue. For participants using speaker equipment, it may be necessary for you to pick up your handset before pressing the start keys. One moment while we poll for questions. As a reminder, if you would like to ask a question, please press star 1 on your telephone keypad. A confirmation symbol indicating your line is in the question queue. You may press star 2 to remove your question from the queue. For participants using speaker equipment, it may be necessary for you to pick up your handset before pressing the start keys. One moment while we poll for questions. Ladies and gentlemen, we have reached the end of today's question and answer session. I would like to turn this call back over to Mr. Riley McCormack for closing remarks.

Well, thanks, Laura, and thank you, everybody, for attending today's call, and I hope you have a great rest of your day.

This concludes today's conference. You may disconnect your lines at this time. Thank you for your participation. Enjoy the rest of your day.