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spk07: Greetings and welcome to the Digimark fourth quarter and fiscal year 2022 earnings conference call. At this time, all participants are in a listen-only mode. A brief 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. It is now my pleasure to introduce your host, Joel Meyer, Chief Legal Officer. Thank you, Joel. You may begin.
spk04: Thank you. Thank you. Welcome to our Q4 conference call. Riley McCormick, our CEO, and Charles Beck, our CFO, are with me on the call. On the call today, we will provide a business update and discuss Q4 and fiscal 2022 financial results. 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. Riley will now provide a business update.
spk05: Thank you, Joel, and good afternoon, everyone. 2022 is a transformative year for our company. In a bit, Charles will review the financial highlights from the year. I want to spend time on the strategic highlights and how they positioned us in 2023 and beyond. As you all know, we generate revenue through two primary markets, government and commercial. On the government side, we re-signed our contract with the Consortium of the World Central Banks two years before Exbury, extending it out through the end of the decade. We take great pride in our work to deter global currency counterfeiting and are excited to continue our work with our long-standing and deeply valued customers, the central banks. Moreover, this program is a wonderful testament to the power of our technology, our scalability, and our trustworthiness as a partner, not to mention our ability to build and support a massive, mission-critical, multinational, and multi-stakeholder system similar to what we are doing in recycling. On the commercial side, we closed on our acquisition of everything, launched our first products, announced our first major value-added reseller, VAR, repeatedly and publicly proved our ability to make a real impact on the global plastic problem, and signed a multi-year deal with Walmart for an exciting new use case, further strengthening our relationship with the world's largest retailer. We have combined our digital watermarking and product cloud capabilities to form the DigiMark Illuminate platform, and on top of that platform have built four products, DigiMark Engage, DigiMark Validate, DigiMark Recycle, and DigiMark Retail Experience. We also continue to progress product candidates along the rigorous process that all must endure to become launch products, including intense market research to ensure they address large and growing problems, and that illuminates functionality upon which all of our products are built, provide significant technological differentiation. We prioritize product candidates that have forcing functions, network effects, or other powerful drivers of adoption. We have multiple promising product candidates we are currently progressing. Our goal is to digitize the world's products. To accomplish this, we must be easy to begin doing business with and excellent at guiding customers along their DigiMark journey. These simple truths drive everything we do. On the channel sales side, by licensing DigiMark Illuminate to a growing number of VARs, we not only gain quickly scalable and high margin revenues as our VARs go to market with their own products and services built upon our world-leading product digitization platform, We also increase the amount of items that are digitized using our technology. This creates an ever-increasing number of upsell and cross-sell opportunities for both us and our bars. On the direct sales side, by building a growing number of our own accretive products upon the Illuminate platform, we are not only ensuring a customer is able to solve the problem that brought them to us today, but also providing them a frictionless path to solve the problems they want to solve tomorrow. Moreover, because our products are accretive, which means that the standalone value they provide is increased by the adoption of additional DigiMark products, this frictionless path forward not just solves new problems, it compounds returns from all products, existing and new. We are building the product digitization market one product and one bar at a time, solving discrete problems while watching with growing excitement as visionary companies and industry observers begin to understand that by adopting multiple products built on a single platform, our customers can solve for today's and tomorrow's discrete problems while positioning themselves to finally achieve true digital transformation as their products are no longer stranded in the analog world. This is what we mean by being easy to begin doing business with and excellent at guiding customers along their DigiMark journey. This is why we are indifferent as to where our customers decide to begin their DigiMark journey. And this is how we'll digitize the world's products. And in so doing, build a new market we are uniquely positioned to lead due to our one-of-a-kind means of identifying an item, our digital watermark, and the world's most scalable product cloud. A perfect example of this is a comment recently made to us by one of the world's largest CPGs. A current Engage customer, they are looking to dramatically increase their adoption of this product. While they know they can get lower pricing from companies that can provide some of the consumer engagement functionality we are currently providing them, It isn't just our superior functionality that is keeping them moving forward on their DigiMark journey. It's their realization that their journey will include DigiMark Recycle and potentially another DigiMark product in the not-too-distant future. Having all their products on the same platform will provide them a creative value that no stitching together of point solutions, if they were even available, would be able to replicate. This is the power of what we built in 2022. This is what gives us excitement for 2023 and beyond. Looking ahead, I want to provide an update on two of our products, the two I refer to as our top-down drivers of product digitization, because of their ability to quickly advance the market we are building. The first is Retail Experience, which we recently soft-launched and about which more is available on our website. While we are excited for a broader launch, it is in our best interest to work with the industry on this product's rollout. The potential downside of top-down drivers of product digitization is that the very fact they are top-down means we don't always control all aspects of that product's launch. The upside, of course, is that there are top-down drivers encouraging adoption. I would note that a lack of broad publicity about this launch does not mean that there is not ongoing activity nor real intent from interested parties to drive adoption to modernize the retail experience, an experience where watermarks have moved from nice to have to need to have. As stated in our last call, the serviceable addressable market for retail experience is enough to take us well into profitability by itself. The second is recycle. While the same top-down driver give and take that applies to retail experience applies here as well, the two big differences with recycle are we've been actively advancing recycle for almost a year and we are active on multiple continents and with multiple important stakeholders. We believe the per country TAM for Digimark Recycle is well under the eight figures and plan to soon publish recycled pricing on our website to provide requested transparency to multiple important stakeholders. Our activity in two countries, France and Canada, is publicly known. A few weeks ago, the industry gathered in Pertui, France, to learn more about the opportunity to make France the European pilot market for Digimark Recycle. A large CPG announced at this public gathering They are committed to being part of this pilot market at scale, and we are in discussions with multiple other brands and retailers about joining them. The group has set aggressive targets for both the scope and timing of initial adoption, and we stand by ready to assist them in their quest to make a real impact on plastics recycling. We are all aware the world is watching. Stay tuned. Moving to Canada, in Q4, we announced the results of our work with the Circular Plastics Task Force. What I have found most impressive about this group's efforts is that they are proving how quickly a small, nimble, dedicated, and motivated group can move to make a real difference to a large and growing problem. And our wonderful partnership with them continues to deepen. Here again, we expect to have more to say soon. Our work in Canada is also informing our work in other countries that are further behind both France and Canada, but where we hope to apply the learnings we are gaining in Canada to close the time and gap. Before I turn the call over to Charles, I want to talk about our path to profitability. We know that to deliver upon the immense value inherent in what we are building, we need to build a financially sustainable business that can deliver what we fully expect to be able to deliver. This includes making sure we are always investing with great responsibility across all areas of our business. We recently made the very difficult decision to streamline certain areas and reorganize in others, and in so doing parted ways with some wonderful people and talented teammates. This action was neither a reflection of our prospects or the performance of any impacted teammate. Instead, it was a reflection of our knowing that in order to change the world, we must have a durable business. The actions we recently took not only have a big impact in reducing our current cash burn, but importantly take us a big step forward on our path to profitability, something that, based on the size of the markets immediately ahead of us, coupled with the world-class contribution margins we enjoy, is squarely in both our focus and line of sight. I will now turn the call over to Charles to discuss our financial results.
spk03: Thank you, Riley, and hello, everyone. As we reflect back on 2022, there were a number of strategically important accomplishments to note, as Riley just highlighted, and there were also some important financial developments during the year I want to highlight before I dive into Q4 numbers. First, we delivered 85% year-over-year growth in first-year commercial bookings, with bookings of 19.1 million in 2022. As a reminder, the commercial market is our largest area of focus, given the enormous opportunities we are uniquely positioned to address. If you exclude our piracy intelligence product, which we have now completely sunset, our commercial bookings growth was even higher at 160% year-over-year. Second, we delivered 32% growth in subscription revenue year over year, with subscription revenue of $15.2 million in 2022. For the first time in a decade, subscription revenue accounted for over half of our total revenue, which is notable given the sale of our software subscription products is not only our most important product focus, but also our most profitable. We earn roughly 80% incremental margins on our software products right now with the potential to increase that to more than 90% at scale. If you exclude piracy intelligence, our subscription revenue growth was even higher at 77%. Third, while service revenue was flat year over year at 15 million, we expect service revenue to be higher in 2023. As a reminder, the majority of our service revenue comes from software development services we provide to the central banks. With the early extension of our contract with the central banks, which now runs through the end of 2029, we expect services revenue from that contract, which was 12.9 million in 2022, to be up over 10% in 2023. Now, as promised, I'll dive deeper into our Q4 results. First year commercial bookings were 10 million during the fourth quarter compared to 2.6 million in Q4 last year. Bookings in Q4 last year included 1.3 million from piracy intelligence. As I referenced earlier, our piracy intelligence product has now been completely sunset so that there will be no future bookings or revenues. Excluding piracy intelligence, first-year commercial bookings increased $8.7 million or 680%. First-year commercial bookings in Q4 included the remaining $7.3 million of minimum fees due from the new Walmart contract we signed in Q3, as during Q4 these fees became non-cancellable and payable within the next 12 months. Total revenue for the quarter was $7.2 million, an increase of 100,000 or 1% from $7.1 million in Q4 last year. Subscription revenue, which represented 57% of total revenue in Q4, grew 13% in the quarter from $3.6 million to $4.1 million. There are multiple factors offsetting one another that impact the overall positive trend in subscription revenue. Adding to revenue was the impact of new deals signed during 2022, including the new Walmart contract in Q3, and the addition of subscription revenue from the Everything acquisition. These additions were offset by $1.6 million of subscription revenue from Piracy Intelligence recognized in Q4 last year, which included the $1 million sale of non-core patents, versus there being no revenue in Q4 of this year. Excluding piracy intelligence, subscription revenue increased $2.1 million or 105%. Service revenue was $3.1 million in the quarter compared to $3.5 million in Q4 last year and was higher than our internal forecasts. The year-over-year decline is due to recognition of significant project work last year related to Holy Grail 2.0, while services with the central banks were marginally higher year-over-year. As a reminder to those modeling our business, our central bank business tends to be seasonal. And thus, for the last several years, our Q4 service revenue has been down sequentially from Q3. Gross profit margin for the quarter is 53% compared to 70% in Q4 last year. The decrease in margin reflects 1.1 million, or 15 percentage points, of amortization expense recorded on acquired intangible assets recognized in the acquisition accounting for everything. Excluding amortization, subscription margins were 77% and service margins were 56%. Non-GAAP gross profit margin, which excludes amortization expense as well as stock-based compensation expense, was 72% for the quarter compared to 74% in Q4 last year. The slight decrease in gross margin was driven by lower subscription gross margins year-over-year, which in turn was largely related to product mix. as legacy everything subscription business carried a lower gross margin than the legacy DigiMark subscription business. As we work to combine these two amazing technologies into one seamless platform, we have identified ways to improve our product margins and expect the combination of cost-outs and revenue growth to drive our subscription margins north of 80% in 2023, higher than they were pre-acquisition. Operating expenses for the quarter were $17.1 million compared to $13.2 million in Q4 last year. The increase reflects $3.1 million of operating expenses from everything post-acquisition. Excluding the impact of everything, operating expenses were $900,000 higher, which included $1.2 million of higher compensation costs for annual compensation adjustments and higher headcount, of which $200,000 was non-cash stock compensation expenses. Additionally, we recorded $300,000 in non-cash lease impairment charges. The higher compensation costs and lease impairment charges were partially offset by lower other expenses. The lease impairment charges related to adjusting our assumptions regarding the timing of subleasing our prior corporate office in Oregon, as well as our decision to abandon our office lease in London. Non-GAAP operating expenses for the quarter were $14.3 million compared to $10.3 million in Key 4 last year. The increase reflects 2.6 million of non-GAAP operating expenses from everything post-acquisition. Excluding the impact of everything, non-GAAP operating expenses were 1.3 million higher year-over-year, which included 1 million higher cash compensation costs. On February 16th, we announced a restructuring plan focused on streamlining our operations, removing redundancies, and improving our operating margins. While our level of optimism regarding our future business prospects only continues to grow, these reductions were the right thing to do to optimize the business for long-term sustainable success. The plan involved a reduction in our workforce of approximately 17%. We estimate the plan will result in one-time cash charges of approximately $1.5 million and non-cash charges of approximately $600,000 for accelerated stock compensation expense. We expect that most of these charges will be incurred and the plan will be substantially complete in the first quarter. The plan should result in approximately $7.4 million in annual cash savings and approximately $700,000 in stock compensation expense. We are also looking at other non-headcount related areas of the business where we can streamline our operations and reduce our costs. Offsetting some of these savings, though, is the impact of annual compensation adjustments for our employees and generally higher prices for third-party products and services due to inflationary pressures. Net loss per common share for the quarter was $0.62 versus $0.50 in Q4 last year. Non-GAAP net loss per common share, which excludes non-cash and non-recurring items, was $0.41 versus $0.30 in Q4 last year. We ended the year with $52.5 million in cash and investments. We used $3.8 million of cash and investments during the quarter compared to $10.9 million in Q4 last year. During Q4, we opportunistically raised $4.7 million of net proceeds under our at-the-market program to bolster the balance sheet. We sold 222,000 shares at an average price of $22.42. The ATM program has $1.9 million available for future sales. although we have no plans to sell any additional stock under the ATM program in Q1 as we assess the opportunities ahead of us. Excluding the net proceeds from the ATM, cash usage would have been $8.5 million. For further discussion of our financial results and risks and prospects for our business, please see our Form 10-K that will be filed with the SEC. I will now turn the call back over to Riley for final remarks.
spk05: Thanks, Charles. 2022 set the foundation for the years ahead, and we are excited to continue to build upon that foundation in 2023 and beyond. We are seeing momentum across all areas of our business, and are hard at work continuing to increase that momentum as we create a market we are uniquely positioned to lead for years to come, a market that at scale has the opportunity to be as large, if not larger, than the other legs of the digital transformation stool. There are trillions of items produced per year, and our goal is to sell multiple DigiMark products into each of them, adding exponentially accretive value as we digitize the world's products. Operator, we will now open the call up for questions.
spk07: Thank you. We will now 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 if you would like to remove your question from the queue. For participants using speaker equipment, it may be necessary to pick up your handset before pressing the star keys. One moment, please, while we poll for questions. Thank you. Our first question is from Jim Ricciuti with Needham & Company. Please proceed with your question.
spk06: Hi. Good afternoon. I'm wondering if you can elaborate on the recycle product comments that you made. Riley, the question, let me see if I can phrase it this way. Maybe you'll be able to help. Would you be surprised if we're into the second half of this year and there's still this relative lack of publicity that you're alluding to? particularly in light of some of the restructuring actions you've announced. I'm wondering if there isn't still the difficulty of predicting when the timing around, when the product gets traction in the market.
spk05: You're talking about Recycle or Retail Experience?
spk06: I'm sorry, not the Retail Experience product.
spk05: I don't, you know, Jim, The one thing I was saying, one of the wonderful things about top-down drivers are top-down drivers. One of the downsides of that is we're not going to complete control. I wouldn't confuse publicity and a broader talk about, I wouldn't confuse that with activity or there being a lack of activity or real intent. That's all I'm going to say. I think we mentioned on our last call that The new contract we signed with Walmart is a powerful anchor for this product. I think if you go to our website and look at this product, you'll understand. So I'll just leave it at that. It's in our best interest to work with the industry at the pace they want to go on all things, including publicity. But again, I would not mistake publicity for activity.
spk06: Does the pace at which the retail industry is moving, though, does that have any relation just in light of some of the actions you're taking? to ensure that you can get to profitability sooner rather than later. I'm just wondering if there's any connection, and there may not be.
spk05: I just, yeah, that's the question. Are you saying what is our, was our headcount reduction related to our belief in the inflection of our business?
spk06: The timing around it being uncertain, yeah.
spk05: No, and no. I think both Charles and I went out of our way to call that out. Okay. I think Charles' phrase was, you know, never been as confident or increasing confidence. And I said, this has nothing to do with either the people impacted or, or our beliefs and anything. So no, they were not related.
spk06: Good. Thanks for clarifying that. And then just with respect to the recycle, um, did you mark recycle product? Is there, is there a, you can, I think talk a little bit more freely about this. Is there in your mind, is there a timeline as to when this large Sam begins to convert into revenue opportunities, uh, Yeah, something along the lines of what you you highlighted.
spk05: Yeah, I mean we we there's in France we talked about there was a public meeting where a large CPG committed to getting going at scale and we're in conversations with other people. Alright, we're still early in 2023, so I would be hopeful that that happens this year and then same with Canada. I mentioned stay tuned shortly. There should be some days out relatively shortly or Canada.
spk06: Okay. It does sound like you're expecting a decent amount of news flow over the balance of the year.
spk05: Absolutely.
spk06: Thank you. Thanks, Jim.
spk07: Thank you. Our next question is from Jeff Van Re with Craig Hallam Capital Group. Please proceed with your question.
spk01: Hey, this is Daniel Hipschman on for Jeff Van Re. First question, just on the workforce reduction, what was the timing on that, as in was that in Q4 here, or is that layering in in Q1, just for thinking about whether or not that's already reflected in this quarter's numbers, or how much of a quarter of that is reflected in this quarter's numbers?
spk03: It happened mid-February, so we'll have a month and a half of kind of regular spend in Q1 before the action took place, and then we'll have about $1.5 million of cash costs in Q1 related to this event.
spk01: Okay. And then on that $7.4 million of annual cash savings, that's all in relation to that workforce reduction, or are there other pieces and parts?
spk03: That is all related to the workforce reduction.
spk01: Okay. And then on the Walmart new use case that we were talking about last quarter, you talked here on the call about the soft launch of retail experience. I don't know if that was suggesting that that was what the Walmart use case was, but just if you could update us on where we're at with Walmart and then what the current thinking is on when we would hear about what that use case is.
spk05: So on the latter, that's up to them. What do you mean by update you on where we are with Walmart? I don't understand the first part of your question.
spk01: I just mean in terms of rollout, in terms of usage at Walmart, in terms of when we might hear about what the use case is, just all of the above, anything that can be shared about that?
spk05: Yeah, I'll just repeat what I said in the call, which is, you know, it's our best interest to work with the industry on this. So that's up to them. But again, it's important to make clear that just because you don't know about it doesn't mean there's an activity going on. I don't mean that just in general, right? I don't think, you know, any of our partners are necessarily messaging to Wall Street. They're taking care of their own business. So when Wall Street finds out about it may be a very different time than when important other stakeholders find out about it.
spk01: Okay, thanks for that. And then just last of all, on the service revenue and the year-over-year decline in Holy Grail, just maybe talk us through that. What was driving that decline and then maybe what are the current expectations? for Holy Grail moving forward? I know France being the pilot project there, but just any other thoughts on how we should think about that service revenue going into 23?
spk05: Yeah, so France has nothing to do with Holy Grail. I mean, there's a lot of the same stakeholders involved, right? But Holy Grail, it was a phase three trial, and we got service revenue as part of that. That's lumpy, one-time service revenue. You heard Charles say our focus is on subscription. That is where we're going to be at 80%. gross margin next year with growth from there, which is incredible in terms of just versus the SAS universe, right? So our focus is on subscriptions, but we provided along with some really small licensing revenue to Holy Grail for this pilot that was Holy Grail with services work. So, there was just the timing of that different phases, phase one, phase two. I mean, for a couple years, there's been Holy Grail services work, but our goal would not be to have a bunch of Holy Grail services work. We want to sell DigiMark Recycle licenses. That's the focus.
spk01: Okay. Thanks for taking my questions.
spk07: As a reminder, if you would like to ask a question, please press star one on your telephone keypad. The confirmation tone will indicate your line is in the question queue. Our next question is from Matt Collard with PCB Advisory. Please proceed with your question.
spk02: Hey, Riley. Hey, Charles. Congrats on a strong year in 22. You introduced in your comments, Riley, about the value-added reseller, and I guess I just wanted to understand, do we think of that or should we think of that as a license at the individual product level? in terms of our or is it the platform level?
spk05: Platform level. So Digimark Illuminate is our platform. We're using that in two ways. We are building our own products on top of that. Those are the four products we talked about. We have other product candidates that we're working on. That's what we sell direct, right? But we also believe, and I think I mentioned this in a call ago, maybe two calls ago, We also are licensing that platform to value-added resellers to build their own products and services on top of it. And it's just like any other hyperscaler type model where the more capacity they use, the more they pay us. And there's two wonderful things, well, three wonderful things about it, I guess. The first is it's highly scalable and high margin revenue, right? As our value-added resellers are out selling whatever products or services they built upon Illuminate, that's them doing all that work. And as they need more capacity, they have to license more from us. So that's one. Secondly, it's digitizing more and more of the world's products using our technology. It's a win-win-win. It's a win for us. It's a win for the bars, and it's a win for the end customers. There's cross-sell and up-sell between that. We're building a lot of technology companies that are both platform and product that can get to channel conflicts. We're actually creating a triple win with the way we're going to market. And then, you know, the third thing is we are never going to have all the best ideas in the world. And so by letting value-added resellers make use of our platform to come up with other solves, it's wonderful.
spk02: Got it. Okay. All right. I appreciate that. And then also I appreciated the comments, you know, because we're, obviously excited about some of the potential new product candidates. I appreciate the insight into the new product candidate process, if you will. I guess the question would be, are any of the new product candidates that you're kind of referencing top-down drivers, or would you consider those also top-down drivers of product digitalization, or are they more, I don't want to use the term bolt-on, but I will because I can't think of anything else?
spk05: Yeah, you could say accretive products, maybe. Yeah, they're both. I mean, there's a reason. Here's the reality, right? And Matt, we've had this conversation. I want to be careful what I say because there's still uncertainty. And when there's uncertainty, I want to call it out. There are product candidates for a reason because we're not guaranteeing right now they're going to become products. If we knew they were going to be products, they would already be products, right? So with that caveat said, absolutely, there's a reason why I talked about how we prioritize products. what we prioritize in the product candidate roadmap, because those are really powerful, right? That having either a top-down driver or a network effect or some other forcing function is an incredible tailwind to have to a product, as opposed to your word bolt-on, you know, as just another product. So absolutely, there is You picked up on it. I think that's right. That's why I talked about how we prioritize them. So there is a mix in our product candidate pool of both single products, you know, kind of solving discrete problems that help us digitize the world's products one problem at a time. But there's also some top-down forcing function network effect products in there.
spk02: Sounds good.
spk05: And when the time is right, when we can talk about it, we'll make sure we talk about it. I appreciate that.
spk02: Thanks.
spk05: Of course. Thanks, Matt.
spk07: Thank you. There are no further questions at this time. I'd like to hand the floor back over to Riley McCormick for any closing comments.
spk05: Well, thank you, everybody. We appreciate your time. Have a great rest of your day.
spk07: This concludes today's conference. You may disconnect your lines at this time. Thank you for your participation.
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