Digimarc Corporation

Good day and welcome to the Digimark Q3 2022 earnings conference call. All participants will be in a listen-only mode. Should you need assistance, please signal for a conference specialist by pressing star and then zero on your telephone keypad. After today's presentation, there will be an opportunity to ask questions. To ask a question, you may press star and then one on your telephone keypad. And to withdraw your question, you may press star and then two. Please note this event is being recorded. I'd now like to turn the conference over to Mr. Joel Meyer, the Chief Legal Officer. Please go ahead, sir.

Thank you. Welcome to our Q3 conference call. Riley McCormick, our CEO, and Charles Beck, our CFO, are with me on the call. On the call today, we will discuss Q3 financial results and provide a business update. This will be followed by a question and answer forum. We have posted and prepared 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 Q3 financial results.

Thank you, Joel, and hello, everyone. First-year commercial bookings were $3.2 million during the third quarter compared to $2.9 million in Q3 last year. Bookings in Q3 last year included $600,000 from our piracy intelligence product that we are now nearly complete and winding down. There will be no future bookings from this product category. Excluding piracy intelligence, our first-year commercial bookings increased 800,000 or 35%. Bookings for the quarter included $1.2 million from a new multi-year agreement we signed in Q3 with Walmart. The new agreement provides for a minimum payment of $2.7 million in year one and more than doubles to $5.8 million in year two. These minimum payments are incremental to the $3 million annual payments we receive under the existing agreement. We expect the remaining contract value of $7.3 million to be booked in the fourth quarter upon receiving customer acceptance. Riley will have more to say about this exciting new development later in the call. Revenue for the third quarter was $7.8 million, up 22% from $6.4 million in Q3 last year. Subscription revenue grew 64% in the quarter from $2.5 million to $4.1 million. The new Walmart contract provided for $1.1 million of subscription revenue during the quarter. We expect a similar quarterly revenue run rate for this contract over the next seven quarters with potential upside above the minimum payments. Beyond the Walmart contract, 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. The impact of sunsetting this product on the quarter was in line with our expectations of 600,000 less revenue than Q3 last year. There will be a similar year-over-year variance in the fourth quarter. Excluding piracy intelligence, subscription revenue increased 2.2 million, nearly 120% year-over-year. Service revenue was 3.7 million in the quarter, compared to 3.9 million in Q3 last year. The change is largely due to the timing of Holy Grail 2.0 recycling work, as we had significant project work last year, but phase two has since completed. Gross margin for the quarter was 53% compared to 66% in Q3 last year. The decrease in margin reflects $1 million of amortization expense recorded on acquired intangible assets recognized in the acquisition accounting for everything. Excluding amortization, subscription margins were 75% and service margins were 57%. Non-GAAP gross profit margin, which excludes amortization expense and stock-based compensation expense, was 72% for the quarter compared to 71% in Q3 last year. Operating expenses for the quarter were $19.7 million compared to $12.2 million in Q3 last year. The increase reflects 4.1 million of operating expenses from everything post-acquisition and 1.4 million of one-time severance costs incurred for organizational changes we made during the quarter. The severance costs were comprised of $800,000 of cash costs and $600,000 of stock-based compensation expense. These organizational changes were made to streamline the business in order to better optimize our go-to-market strategy. Excluding the impact of everything in the severance charge, Operating expenses were $2 million higher year-over-year, which included $1.7 million from higher compensation costs from annual compensation adjustments and higher headcount. Half of the $1.7 million increase in compensation costs was in the form of stock-based compensation. The increase in compensation and headcount since last year has been necessary in order to retain and attract the talent we need on the team to accelerate our go-to-market strategy. Non-GAAP operating expenses for the quarter were $15.5 million compared to $10.1 million in Q3 last year. The increase reflects $3.3 million of non-GAAP operating expenses from everything post-acquisition and $800,000 from the one-time severance costs I just referenced. While these severance costs are one-time in nature, severance itself is not a non-recurring activity, so we do not back it out in determining our non-GAAP measures. Excluding the impact of everything and the cash severance charge, non-GAAP operating expenses were $1.3 million higher year over year, which included $800,000 from higher cash compensation costs from annual compensation adjustments and higher headcount. As part of the organizational changes to optimize operations, we reorganized some of our reporting structures, which impacted the classification of headcount and related costs between departments. This is evident in comparing Q3 operating expenses to Q2, whereby R&D and engineering increased while sales and marketing and G&A decreased. Net loss per common share for the quarter was $0.76 versus $0.17 in Q3 last year. The net loss in Q3 last year was benefited by a $5.1 million non-recurring gain in other income. Non-GAAP net loss per common share, which excludes this $5.1 million gain last year, was $0.47 versus $0.34 in Q3 last year. We ended the quarter with $56.4 million in cash and investments. We used $12 million of cash and investments during the quarter compared to $8.6 million in Q3 last year. The increase reflects cash usage by everything post-acquisition and $700,000 of the $800,000 of one-time cash severance costs that were paid during the quarter. Excluding the severance costs, cash usage would have been $11.3 million. Last quarter, I mentioned that internally we look at non-GAAP net loss, which excludes non-cash expenses, and later on cash used for capital expenditures and share repurchases as our metric to estimate normalized levels of cash flow. For the third quarter, this metric was $10.1 million, factoring in our non-GAAP net loss of $9.3 million. plus $200,000 of capital expenditures and $600,000 for share repurchases. The difference between the $11.3 million of cash used after excluding the cash severance and the $10.1 million is the timing of cash receipts and payments. We anticipate this swinging in a favorable direction in Q4. For further discussion of our financial results and risks and prospects for our business, please refer to our Form 10-Q that will be filed with the SEC. Riley will now provide a business update.