Digimarc Corporation

Greetings and welcome to the Digimar Corporation third quarter 2023 earnings conference call. At this time, all participants are in a listen-only mode. A question and answer session will follow a 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. You may begin.

Thank you. Welcome to our Q3 conference call. Riley McCormick, our CEO, and Charles Back, our CFO, are with me on the call. On the call today, we will provide a business update and discuss Q3 2023 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 will 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.

Thank you, Joel, and hello, everyone. Q3 was another strong quarter for DigiMark. While Charles will provide a more detailed discussion on the financial results during his remarks, there are two metrics I want to highlight at the top of the call, because their absolute levels, as well as our expectation they will get even stronger, are important markers of our progress in building a high quality, high growth, and highly cash flow generative business. First, we grew our annual recurring revenue, or ARR, 54% year over year. As mentioned during the last few earnings calls, First-year bookings has become a less relevant metric as our focus is on growing our recurring and high-margin subscription revenue and signing those customers to multi-year deals. Our decision to begin reporting our quarter-end ARR reflects our desire to provide investors transparency to the results of that focus, as well as a greater understanding of our true underlying growth. And while a 54 percent year-over-year growth rate is objectively high, we believe we are capable of more. In fact, while it is still early in the current quarter, we expect our year-over-year ARR growth rate in Q4 will be noticeably greater than it was in Q3. Second, we expanded our subscription gross profit margin to 85.5 percent, an increase of 1,000 basis points year-over-year and 200 basis points sequentially. On our Q4 2022 call, Charles mentioned our expectation of driving subscription gross profit margin north of 80 percent in 2023. and three quarters into the year, we have not only exceeded this target in every single quarter, but our gross profit margin is now closer to 90% than 80%. There is no greater predictor of a company's ultimate level of profitability, nor better proof of the depth and width of its moats than subscription gross profit margin. And at 85.5%, we are near best in class, similar to the levels of other high-quality and wide-moded SaaS businesses that enjoy the extra gross profit margin tailwinds that come from being much larger than we are today. Like our ARR growth rate, we believe we will improve from these already high levels. The combination of high and accelerating ARR growth and our significant gross profit margin expansion not only speaks to the quality of the business we are building and the differentiated products we are able to deliver, but acts as a potent cocktail in getting us to cash flow break even and beyond. I want to spend the rest of my prepared remarks discussing three specific areas that we know are of interest to investors. But before I do, I want to stress that I am focusing only on these three, simply because of time limitations, not because they are the only areas about which we are excited. In fact, if one were to compare my prepared remarks over the past few quarters to the news we have delivered in the subsequent quarter, you'll notice little correlation of topics. I view my prepared remarks as a forum to provide updates on areas in which we have received the most questions, as well as an opportunity to continue providing transparency into the different parts of our business, not as a sneak preview of upcoming news. We prefer to let the news, i.e. the results, speak for themselves. Starting with Digimark Recycle, we recently announced that France will be the first countrywide rollout of this world-changing product. DigiMark Recycle represents a revolution in the sortation and thus recycling of plastic waste. It has the power to not just increase the quantity and quality of plastic recycling, but also uncover never-before-seen data about the post-purchase product journey. According to the Ellen MacArthur Foundation, higher-quality plastics recycling is also one of the most impactful things we can do as a planet to reduce carbon emissions, and moreover, it comes at a negative financial cost. This means there is an economic return on investment from achieving higher quality plastics recycling in addition to the obvious environmental benefits, something that a recently industry commissioned study on Digimark Recycle independently corroborated. It is for all these reasons and more that Fortune recently ranked the 17th on their esteemed 2023 Change the World list, despite their stated preference for companies generating over a billion dollars of revenue, which we don't have yet. The news regarding the countrywide rollout in France is a major milestone for our company and a testament to the power of our technology and our team. We are dedicated to working with this initial group of visionaries to help expand adoption in France. And on that front, I'm excited to share that we are close to signing a deal with a very large company that was not even listed in our press release from only a few weeks ago. Beyond France, we are progressing activities in multiple other countries as we pursue the country-by-country avenue for driving DigiMark Recycle adoption. Important to note, two weeks ago, the European Commission voted on amendments to the Packaging and Packaging Waste Regulation, or PPWR, as that important law progresses towards finalization. Included in the new amendments, the timeline to implement digital marketing was shortened by six months. We applaud the EC's vision and their urgency. We are also pursuing additional go-to-market avenues for DigiMark Recycle in parallel with this country-by-country approach. including partnering directly with global brands and retailers to push adoption in multiple countries at once, working with prospects to open a market via a closed-loop solution, which can then act as a catalyst for wider in-country adoption, and progressing our work in lighting up deposit return scheme value-added resellers, which then acts as a profitable wedge to open DigiMark Recycle conversations in those countries. On this last front, I was recently in country meeting with our first DRS FAR, and it was exhilarating to see initial production of the DRS logo being applied to real-world products. I believe one of our greatest strengths will always be the awesomeness of our VARs, and I expect when the world sees the tangible results of this VAR's easy, cost-effective, and quick-to-scale solution, interest in DigiMark's ability to help improve upon existing DRS solutions will significantly increase. One last thing to highlight on Recycle. While historically our focus has been on the application of DigiMark Recycled to the plastic pollution crisis, recently there has been interest by other substrate ecosystems to solve their own end-of-product life issues. There's obviously end-customer synergies as retailers and brands use multiple different materials in their packaging, and our proven results in plastics objectively lessen the need for proof-of-concept work in other substrates. Also worth noting, the PPWR doesn't restrict the digital market requirement to just plastic packaging. Next, I'd like to spend some time on DigiMark Illuminate for factory automation. This compelling offering brings the power of the Illuminate product digitization platform into a production, fulfillment, or distribution facility where the ability to identify specific products in robust, deterministic, and novel ways unlocks important new automations not otherwise possible. In the specific case of the deal we discussed last quarter, One of the world's largest CPGs was interested in removing excess packaging from one of their marquee products in an effort to save both money and the planet, but in so doing would have lost the ability to differentiate between different variations of this product, something required for their exacting standards of quality assurance. Enter DigiMark Illuminate for factory automation and its ability to connect physical products to their digital twins via our unique bridge, DigiMark Digital Watermarks. This cost and environment-saving application is something that has sparked the interest of other prospects, as well as multiple ecosystem partners who can act as force multipliers in our quest to digitize the world's products. In fact, one of our partners will be presenting our offering at an important industry event next week. The potential here is enormous, as we have all the necessary ingredients for success. Approvable ROI, a wonderful environmental impact, a robust and interested ecosystem of force multipliers, an extremely happy customer, and of course, a unique solution that only the DigiMark Illuminate platform is capable of providing. Other prospects are exploring using DigiMark Illuminate for factory automation to provide novel automations that differ from the maintenance of production line quality control when removing excess packaging. Examples include solving for code occlusion caused by harsh factory conditions, and automating workflows that don't lend themselves to the perfect presentation of a single code. Recall the multiple characteristics of DigiMark's digital watermarks. Covert, ubiquitous, redundant, and secure. And recall that for use cases that require one, some, or all of these attributes, DigiMark digital watermarks are either the best choice or the only choice for connecting physical products to their digital twins. When it comes to automating factory operations, We are finding there are multiple reasons why one, some, or all of these attributes are required. As the only product digitization platform capable of using digital watermarks as the bridge between a physical object and its digital twin, we believe the sandbox version of our platform, DigiMark Illuminate for factory automation, has a bright future in helping our customers solve some really pressing problems, and in so doing, allowing them to either start or continue along their product digitization journey. In terms of market size, as I mentioned last quarter, we believe this solution is applicable to hundreds, if not thousands, of potential customers, and the single deal we signed in Q2, which covers a single product across two countries, represents mid-six figures of ARR. Finally, moving to DigiMark Validate, it is incredible to look back on the progress we have made since our last call, including the launch of our product just over a month ago. Our legacy of being the pioneer and widely recognized leader in digital watermarking, the technology that has been universally accepted as having a key role to play in the new world of generative AI, coupled with our experience in building massive, multinational, multi-stakeholder, mission-critical systems of trust and authenticity upon that technology, has fed our entree into important conversations across the ecosystem. We are actively engaged with governments, standards bodies, and content creators and technology partners and prospects of all sizes. GenAI didn't create the deepfake issue, but it did democratize it. And if the world is to enjoy the benefits of this powerful new technology, action must be taken to protect against its risks. This is not a view we are unique in having, and the speed at which all stakeholders are moving is astounding. We believe the result is the world will look back at GenAI as the catalyst for the delivery of something long overdue anyway. a safe, fair, trusted, and authentic internet. And DigiMark Validate is ideally positioned to be the foundational element of such a future. On the government front, we've been engaging with leadership at the highest levels to discuss the need for tools to support the protection and authentication of digital assets in the Gen AI era. We have met with senior leaders at the White House, executive agencies and departments, and in Congress. And in these bipartisan meetings, our history, proven technology, and ability to work across images and audio, especially on device, is helping drive awareness of what's possible. We have been asked by multiple groups to help educate and inform the conversation, commitments, and coming regulation, and our ideas have been well received. We expect to continue participating in discussions at the highest levels to shape the future of artificial intelligence and the broader digital ecosystem, and we feel confident that DigiMark Validate has an important role to play and effectively protecting the rights of content creators and owners, while also building the foundation of true digital asset authentication. On the standards body front, we are a member and heavily involved in the Coalition for Content Providence and Authenticity, otherwise known as C2PA. For those of you not familiar with C2PA, it is a group of industry leaders working to address the prevalence of misleading information online through the development of technical standards for certifying the source and history or provenance of media content. We are appreciative of all the hard, smart work this group has been doing and thrilled they understand digital watermarking has a role to play in proving the authenticity of digital content. I know there have been some questions around CTPA's content credentials and if this is competitive to validate, and the answer is no. In fact, DigiMark will be supporting content credentials as part of our upcoming registry because while industry standards are necessary, they are not by themselves sufficient. Standards need companies to support them for their meaningful adoption, and we recognize we have an important role to play. Content credentials are an elegant means of organizing and recording metadata, but the risk to metadata is that it can be altered and is removed by common workflows such as editing software and social networks, rendering it useless for the purpose of intellectual property protection and authentication in such scenarios. Just like in the physical world, Our digital watermarks will act as a unique, necessary, and immutable bridge between the data and the object, allowing the content owner to control their digital asset story. On top of this governmental and standards body engagement, of course, we are building our DigiMark Validate business. DigiMark Validate provides value to content creators and their consumers, as well as owners of detection points running the gamut of Gen AI engines, e-commerce sites, network security companies, and device vendors. we are engaging with prospects and partners across the full spectrum of size, and we intend to make it as difficult to counterfeit content and identity in the digital world as we have currency in the real world. In addition to the massive opportunity ahead of us and the fact we are uniquely qualified and positioned to address it, there are two perhaps non-obvious important points worth highlighting that are on trade to the digital domain. The first is that our ability to bridge both the physical and digital domains is a key differentiator of our platform, our products, and our digital watermarks. And nowhere is that becoming as obvious as with DigiMark Validate. And secondly, as I know at least a few investors have noticed in visiting our website, the expansion of DigiMark Validate in the digital domain allows us to open a fully digital sales motion. In terms of our mantra of being easy to begin doing business with and excellent at guiding customers along their product digitization journey, this web-based sales motion has opened a new door to EASY. Thus, the expansion of DigiMark Validate to the digital domain has not only dramatically increased our overall total addressable market, it has also increased our opportunities in the physical domain, while adding width and depth to the moat surrounding all of our offerings. I will now turn the call over to Charles to discuss our financial results.