Digimarc Corporation

Greetings and welcome to the Digimar Corporation second quarter 2024 financial results 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, 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, George Karamanos. Thank you. You may begin.

Welcome everyone 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'll provide a business update and discuss Q2 financial results. This will be followed by a question and answer forum. We have posted our prepared remarks and our quarterly earnings snapshot 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.

Thank you, George, and hello, everyone. I want to begin this call by reiterating the core tenets of our strategy. When we get to the subsequent discussion of Q2, I encourage you to examine our progress with these core tenets in mind. Doing so will help frame the accomplishments we achieved in the quarter and, more importantly, provide context as to where we're going from here. As our world becomes increasingly digital and companies progress their digital transformation journeys, DigiMark maximizes the ways in which products and multimedia can digitally interact with the various systems that surround them. We excel at the identification and authentication of physical goods and digital assets, often at massive scale, and often where other means of identification or authentication don't work well or don't work at all. Our focus is on converting this large total addressable market into substantial free cash flow by positioning ourselves to deliver high and long lasting top line growth at world class operating margins. This starts with our being easy to begin doing business with and excellent at guiding customers along their DigiMark journey and is aided by four key tailwinds we have been very intentional to create. One, our incredibly deep and wide moats allow us to offer differentiated products. In turn, our differentiated products enable us to create new markets and disrupt existing ones. Two, the need to identify and authenticate physical goods and digital assets is universal, meaning almost every entity in the world is a potential DigiMark customer. Additionally, because our technology enables us to identify and authenticate things where other solutions don't work well or don't work at all, our ecosystem consists of companies incentivized to partner with us rather than posing a competitive risk. Three, there are many use cases that require companies to identify or authenticate their physical items and digital assets, and there are many ways we can configure our technology to achieve these goals. Therefore, our ability to productize new functionality is open-ended. This means our already large TAM will continue to grow as we either launch new products or add opportunity-unlocking functionality to existing ones. Four, we engineer our products to be accretive, meaning the more DigiMark products a customer buys, the more value each product delivers. This positions us to harvest a low-hanging and highly profitable fruit of cross-sales and up-sales for years to come. Turning now to Q2, we made significant progress on multiple fronts, highlighted by three developments likely to have a profound impact on the second half of this year and beyond. Before providing these important updates, I want to reiterate two points. First, because we are early in the journey to our ultimate and massive scale, our net annual recurring revenue growth can be lumpy when looked at on a quarterly basis. As a reminder, quarterly net ARR growth is the output of gross addition to ARR minus churn. In Q2, churn almost entirely offset our gross add. A significant driver of this dynamic was a transition of our preferred partner engagement model to our new center of expertise program. While this transition results in less upfront ARR, it leads to two significant benefits that should pay off for years. Greater ARR upside over time and more focused, repeatable, scalable, and profitable growth. Two things to note on this transition and its impact in our quarterly net ARR results, both in Q2 and beyond. First, even with the headwind of lower upfront ARR, we slightly exceeded the Q2 gross ad target set in our 2024 budget. Second, as of the end of Q2, the partners that remain in our historic partner program are not candidates to transition to our COE program. On our February call, we discussed the reasons why we believe so strongly in the COE program and in the June press release, we announced the program's founding members. Over the past few months, we've become even more convinced of the power of this new program, and beyond the positive impact it is already having on our sales pipeline, I am thrilled to announce we closed our first COE source contract during the quarter, a multi-year DigiMark Validate deal. Second, and as evidenced by our historic results, while this lumpiness will lead to quarters like Q2 where quarterly net AR growth is below trend, It will also lead to quarters where quarterly growth is significantly above trend. When we say we expect our business to be lumpy until we reach a larger scale, we use that term as it is truly intended, not as a euphemism for weak. This is why we prefer to measure our ARR over one-year and three-year time horizons, as we do with the quarterly earnings snapshot George referenced in his opening remarks. Focusing on the forest, not the trees, provides a better measure of our business's true growth. Moreover, our focus extends beyond any single quarter, and as I mentioned at the beginning of this call, is centered on converting our large total addressable markets into substantial free cash flow. To that end, I want to use the rest of this call to update you on key developments in two of our ecosystem-driven opportunities and preview a new market opportunity that presents a TAM as large as, if not larger than, any other opportunity we are pursuing. As a reminder, we view our business as having three pillars of shareholder values. The first pillar is our long-standing relationship with the world's central banks. Beyond the meaningful cash flow this 26-year relationship provides, our work with the central banks also acts as a source of intellectual property generation for our commercial business, gives us invaluable credibility as a trustworthy supplier, and demonstrates our ability to scale. The second pillar comprises of our SaaS and PaaS products that follow a more traditional software go-to-market model. in areas such as deal size, sales cycle, and lack of ecosystem dependencies. I touched briefly on the progress in our COE program earlier. For additional important updates from Q2 related to this pillar, I again encourage everyone to review our quarterly earnings snapshot. The third pillar consists of our ecosystem-driven opportunities. These opportunities encompass industry-wide or country-wide initiatives that, once in motion, have powerful flywheels that should drive quick, broad, and sticky adoption. but also have ecosystem dependencies that make timing unpredictable, as it is predominantly outside of our direct control. Before I provide an update on our progress in two of these opportunities, namely DigiMark Retail Experience and DigiMark Recycle, I again want to point everyone to our quarterly earnings snapshot for an update on our third ecosystem-driven opportunity, DigiMark Validate Media, which we continue to believe can deliver the safer, fairer, and more authentic Internet we all deserve. Turning to the update on DigiMark Retail Experience, recall this offering is a Razor Razorblade product. The Razor involves licensing our DigiMark Illuminate platform to retailers who use its capabilities to build out the points of detection required to enable next-generation in-store operations. The Razorblades are provided by our licensing DigiMark Retail Experience to the brands whose products are carried by that retailer, including the retailer's private label brands, allowing their products to interact with these points of detection. As stated on a prior call, we believe the TAM of licensing our platform to enable Next Generation and SOAR operations is well into the nine figures of ARR. We believe the TAM of DigiMark Retail Experience is multiple larger still. But beyond these incredibly large TAMs, DigiMark Retail Experience is also an easy way for these national brands to begin their DigiMark journey on Next. Once their products are digitized, We will have the opportunity to be excellent at guiding these brands along their journey of solving additional problems through the adoption of other DigiMark solutions. Moreover, the more national brand items digitized using our technology, the easier it is for additional retailers to license our platform to build out their own points of detection while in parallel adopting DigiMark retail experience for their private label items. We expect most retailers will use our platform to build points of detection that utilize other means of product identification beyond the 1D, 2D, and digital watermarking signal that our platform supports. In Q2, we provided our largest commercial customer with demonstrable proof that our technology can carry a very heavy load in this multi-signal future, resulting in two important developments that give us confidence this flywheel is likely to start spinning. First and most immediately, We believe this customer now understands that the more items in their stores that are digitized with our technology, including items produced by national brands, the more profound the improvement to their in-store operations will be. Second, we believe this customer also now understands the value of DigiMark delivering a greater amount of the software capabilities powering their points of detection. This should ultimately increase the size and time to market of the Razor component of this flywheel, not only with our initial customer, but with subsequent customers as well. While I cannot provide any additional details at this time, I want to emphasize two key points. First, it is difficult to overstate the importance of these developments. Second, we expect and look forward to being able to share more information soon. Turning now to Digimark Recycle, Q2 saw us make important progress on this ecosystem-driven opportunity as well. On our February earnings call, we discussed a new go-to-market avenue for this revolutionary product, in which we would work with a qualified partner who would lead a regional or country-wide rollout. On our May call, I mentioned we were in conversations with multiple parties regarding this new path. Since then, the number of parties with whom we are having conversations has increased, as has the number of countries in which we are having these conversations. Moreover, thanks to a deeply valued ecosystem participant who believes as strongly as we do in both the environmental and economic ROI of our solution, we expect to soon receive introductions to multiple large and powerful entities capable of acting as our partners in additional countries. While we expect these will be elongated sales cycles, we are pleased with the progress and believe that the opening of our first country should accelerate our conversations, both existing and future. To that end, the first qualified partner with whom we entered conversations has told us they expect to be ready to sign a deal for the initial rollout of Digimark Recycle in a European country in the second half of this year. Finally, in breaking with our practice of not discussing new products until we've signed a market customer, I want to close my prepared remarks today by talking about a new market opportunity because of our confidence in the value of our solution and the materiality to our business if we are correct. For over a quarter of a century, we have worked with the world's central banks to protect their currencies. However, one of the fastest growing and most pernicious attacks on the class of currency isn't against the bank notes issued by federal governments. but the currency issued by brands and retailers, gift cards. As I've mentioned in the past, we expect our most exciting opportunities to come from prospects experiencing problems that can be uniquely solved by our ability to identify and authenticate physical and digital items where other means of identification and authentication don't work well or don't work at all. It is then incumbent upon us to determine A, if there is a sizable and repeatable business problem, then B, additional prospects beyond the first have an urgency to solve, where C, we can provide a solution of enduring and differentiated value that D, presents us a path to fast and profitable scale. This is exactly how our opportunity in gift cards has developed. Gift cards face multiple attack factors, and the cost of these attacks, both monetary and reputational, are real and are getting worse. Moreover, existing solutions are expensive and ineffective, and it is becoming clear to the industry, both ecosystem partners and end customers, that we have a significant role to play. We believe we can provide a solution today that addresses some of the most common attack vectors, providing a significant increase in efficacy while actually reducing the current bill of materials costs, delivering a meaningful and attractive ROI. That, combined with the expected ease of implementation, should allow for rapid scaling post initial adoption. Moreover, while no material dependencies prevent any single gift card issuer from independently adopting our solution, many industry participants are aware of our work and are interested in finding a widely adoptable solution if the large and growing level of loss is leading to grave concerns in the industry. Thus, our opportunity in the gift card industry shares the most attractive attributes of our ecosystem-driven opportunities, namely the likelihood of rapid scaling and incredible stickiness once scaled, without the multi-stakeholder dependencies that characterize these opportunities as ecosystem-driven. We are likely to launch our gift card offering with a few different implementation architectures that we believe yield a U.S. market camera near from 900 million to 1.5 billion of ARR. While we are starting in the U.S. because this is where our initial prospect and partner engagements have occurred, there is nothing that we or the industry see that prevents us from being a global solution. In fact, as stated earlier, our ability to act as a universal and global solution seems to be one of the things about which the industry is most excited. Although we haven't yet conducted a detailed analysis to quantify the global TAM, it will be significantly larger than that of the U.S. alone. Moreover, as we continue to build additional features into our solution to address more attack vectors, we believe we should be able to capture a share of that added value, providing further upside to our TAM. While the excitement and urgency shown by the industry has been remarkable, there is still more to learn as we advance this work, and I want to caution that we don't know what we don't know. However, the list of things we don't know is shrinking rapidly, giving us comfort in discussing this opportunity today. In addition to our obvious excitement about this opportunity standalone, it also dovetails nicely with other retail loss prevention solutions we are progressing, including a solution addressing the theft of prepared food, for which we signed an initial deal with a regional grocer in Q2. I focused my comments today on the gift card opportunity because of the urgency with which the industry is engaging, as well as the massive talent it represents. However, it is important to note that the potential to offer a suite of value-appreciated products leveraging the same technology and sold to the same loss prevention buyers is exciting, as it provides us another avenue to be easy to begin doing business with and excellent at guiding customers along their DigiMark journey. Finally, while not an immediate focus, we believe there are future synergies that can be unlocked between our retail loss prevention offerings and DigiMark retail experience, as retail loss prevention and retail operations are closely intertwined. We will keep you updated as things progress.

I will now turn the call over to Charles to discuss our financial results.

Thank you, Riley, and hello, everyone. Financial highlights on a year-over-year basis for the second quarter included ending ARR increased 44%, Commercial subscription revenue increased 39%. Subscription gross profit margin was 89%, a 5% percentage point improvement. Total expenses only increased 2%, and non-GAAP net loss decreased 14%. We continue to focus on delivering improvement in these financial metrics as they're critical levers in reaching positive free cash flow. Ending ARR increased 44% from $16.7 million at the end of June last year, to 23.9 million at the end of June this year. The year-over-year increase in ARR largely reflects the impact of new customer contracts and several important customer upsells, partially offset by customer return. Total revenue for the quarter was 10.4 million, an increase of 1.6 million, or 19%, from 8.7 million in Q2 last year, reflecting strong growth in subscription revenue. Subscription revenue, which accounted for 61% of total revenue for the quarter, grew 36% from 4.7 million to 6.4 million. The increase reflects subscription revenue recognized on new customer contracts as well as upsells on existing customer contracts. Commercial subscription revenue grew at an even higher rate of 39%. Service revenue decreased 1% from 4.1 million to 4 million, reflecting slightly lower commercial services. Subscription gross profit margin improved from 84% in Q2 last year to 89% in Q2 this year, representing a five percentage point improvement. The significant increase year over year reflects both the strong growth in subscription revenue and a favorable mix in subscription revenue to our newer products. Service gross profit margin improved from 51% in Q2 last year to 58% in Q2 this year, reflecting a favorable change in labor mix. We expect to generate mid 50% service gross margins on a normalized basis with some fluctuation quarter to quarter. Operating expenses for the quarter was $16.8 million compared to $16.1 million in Q2 last year, an increase of 4%. Roughly half of the increase was due to lower costs being allocated from operating expenses to cost of revenue this quarter due to lower billable services. Total expenses, which exclude the impact of allocations, only increased 2% year-over-year. Comparing this number to the 39% growth we delivered in commercial subscription revenue shows the operating leverage we've been focused on building into our business. To continue driving this considerable operating leverage, we are focusing on maximizing our productivity and efficiency as an organization, including better leveraging the capability of tools like Gen AI to minimize the impact of rising labor and other costs. Non-GAAP operating expenses, which exclude non-cash and non-recurring items, were $14 million for the quarter, up 8% compared to $12.9 million in Q2 last year. Again, roughly half of this cost was due to lower costs being allocated from operating expenses to cost of revenue this quarter because of lower billable expenses. Net loss per share for the quarter is 43 cents versus 53 cents in Q2 last year. Non-GAAP net loss per share was also considerably lower for the quarter at 23 cents versus 29 cents in Q2 last year. We ended the quarter with $41.5 million in cash and short-term investments. Free cash flow usage was 6.9 million for the quarter compared to 7.9 million in Q2 last year. Given that cash flows can fluctuate quarter to quarter depending on the timing of receipts and payables, we continue to believe that a good proxy for a normalized level of free cash flow is using non-GAAP loss plus capital expenditures. While cash burn in the first half of 2024 was above this proxy, we expect the unfavorable fluctuations on timing of receipts and payables to reverse in the second half leading to full-year cash flow being generally in line with this proxy, and hence free cash flow in the second half to be much better than the first. 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. I'll now turn the call back over to Riley for final remarks.

Thanks, Charles. In Q2, we made significant progress on multiple fronts. highlighted by meaningful developments in two of our ecosystem-driven opportunities and the rapid progression of an attractive new market opportunity in protecting gift cards from the ever-increasing threats they face. The developments in the ecosystem-driven opportunities give us confidence that we are likely on the precipice of getting these two flywheels spinning. The rapid progression of our opportunity in gift cards is stand-alone exciting and could also serve as a cornerstone for a broader suite of offerings that help retailers combat one of their most pressing business challenges. the ever-increasing prevalence and cost of shrink. While we continue to expect our business to be lumpy until we reach a larger scale, the progress we've made in Q2 further demonstrates that as a result of our laser-like focus on the execution of our strategy and the core tenets therein, we are not only on track to unlock the massive TAMs on which we are focused today, but also that new TAMs can rapidly develop. We are positioning ourselves to convert our large total addressable markets into substantial free cash flow by delivering high and long-lasting growth at world-class operating margins. Our progress in Q2 gives us even greater confidence in our ability to achieve this goal. Operator will now open the call for questions.

Thank you. 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 two to remove yourself from the queue. For participants using speaker equipment, it may be necessary to pick up the handset before pressing the star key. One moment, please, while we poll for questions.

Thank you. Our first question comes from Joshua Riley with Needham.

All right, great. Thanks for taking my questions, and nice job on developing some of these product opportunities here. in the last couple of quarters, uh, maybe just starting off on, uh, net new ARR. Can you just give us some additional details on maybe what type of customer churned in the quarter? Did you consider them core to the business and maybe how the center of expertise program for partners impacted, uh, net new ARR in the quarter?

Yeah. Thanks for the question.

Um, the, uh, Most of the term was specifically related to transition in our COE program. So as Riley stated in the prepared remarks, we don't expect to see any more customers be moving in the COE program.

So we expect that most of that is behind us at this point. Yeah, Josh, maybe if I double-click on that just quickly.

Our traditional program, the bar program, there were two types of partners we had in there. We had the big partners who were technologically capable and really wanted to use Illuminate to build their own products and services on top of. And then we had a bunch of partners that maybe had less interest in building things, wanted access to our technology because they had a ton of customers and they wanted to sell our existing products. And then we had a third class of partners that would have fallen into that second category that didn't want to sign up for the bar. So we still have partners that we consider under our bar model. These are the bigger customers who want to build things on top of Illuminate. Our focus has been on the second group, is getting to a bigger group of potential partners. And that's what the COE program allows. And the reason it allows is it's lower upfront costs. We actually have a tier of COE that is free. It's our entry tier. But we're not trying to monetize the relationship as much, the direct relationship with the partner. We are trying to both have skin in the game so we can go after their customers and help their customers solve a ton of problems. So that's what I meant when the transition is low front air. Our COE deals are going to be less than our traditional bar deals on day one. But they are set up to be focused more on the massive pipeline from the end customers that we can service together. And that's why I said over time it's going to lead to a lot higher ARR. And it's also more focused because they're selling our products or they're reselling our products or they're bringing us leads for our products as opposed to them building their own things on top of it. Does that answer your question a little bit?

That's very helpful, I think, and provides some nice clarity on what's going on there. Maybe moving on here, if you look at some of the legislation that's progressing in Europe and Canada around plastic recycling, can you just give us any updates you have in terms of timelines, any change in expectations you have on how the projects will progress relative to maybe public statements you've made previously, and maybe just any other relevant information that investors should be aware of with the current recycling opportunity?

Yeah, it's great. And I'll definitely point you back to the pair of remarks where it said the first partner in our new go-to-market motion, they told us they expect to sign a deal in the second half of this year to start in a European country, which is

huge.

We're also expanding the number of partners we're in conversation with, not just number of customers, but other countries. And we expect to have a whole other wave of additional potential partners that we're getting introductions to from a very powerful and wonderful partner of ours. So that's on the opening up Digimark Recycle Markets, which is where our focus is. Holy Grail work continues. And if you refer to the quarterly earnings snapshot, you'll see that there's some revenue coming in the back half of this year from the Holy Grail work, which is important. It's continued proof of concept. I've never seen 170 organizations do a very public POC on a single company software like Holy Grail is. It's wonderful. It's in so many different ways. Now the regulation. There's a ton of regulation. This is Depending on who you talk to, the top three problems our globe faces is that we only have one planet and we've got to solve for the plastic recycling issue. So kind of regulation, We don't want to wait for regulation to be the driver. Regulation is a wonderful tailwind. People can see the writing on the wall and see what's coming down from regulation. So I think it gives an urgency to the conversation, but we don't want to rely on that. We want to drive our own urgency. And so that's what we really focus on in these conversations for this new go-to-market, this partnership model on Digimark Recycle.

Got it. That's helpful. And then you highlighted in the prepared remarks that in Q2 you demonstrated with your largest commercial customer the ability to carry a heavy load in a multi-signal future. I know that you're limited with what you can discuss with this, but can you just discuss or maybe just, you know, from a high level explain what you were referring to maybe with this particular statement?

Yeah, I would point to the two developments that I – I mean, that – fact is powerful and interesting. But what's really important is the two developments that come from that fact. First, and most immediately, we believe the customer understands the more items in their store, including items produced by the national brands, the more profound the improvement in what they're trying to do will be. And then secondly, they understand the value of our owning more of a technology stack on the Razor component. I'm using more of Illuminate's capabilities to build up the points of detection. Outside of reiterating what I said in the call, I said I can't provide any additional details, except I do want to stress two things. It's difficult to overstate the importance of these developments. These are important, important developments, and we look forward to being able to talk about it more soon.

Understood. And just one quick financial question for me. As you're looking at the operating expense growth for the balance of the year, I think, you know, aside from the adjustments that grew, total expenses grew 2% year-over-year, which is great. How should we think about any increased hiring or expenses coming into the model for the second half of the year? Thanks, guys.

Yeah. Josh, you know, without necessarily giving guidance, I can just talk. We don't expect that we need to ramp up expenses significantly at all, and quite frankly, Generally, expenses are a little bit higher in the first half of the year than they are in the second half of the year, just given some of the year-end compliance and things that we have in Q1. So we wouldn't expect to see material growth in expenses. Now, obviously, at a much higher scale of revenue, there will be some additive expenses. But as I touched on in my prepared remarks, this business, we believe, has tremendous operational leverage. And you can start to see that where we're able to grow revenue at 39% and our expenses were pretty low. I can't say that the expenses won't grow, but they shouldn't have to grow at a significant amount even to reach a much higher scale.

Awesome. Thanks, guys.

Thanks, Josh.

Once again, to ask a question, please press star 1. Our next question is from Jeff Van Rie with Craig Hallam.

Great, thanks. A couple from you guys. Maybe first, just can you quantify on the ARR, what was the actual dollar impact of that churned customer?

Yeah, so, Jeff, we're not providing any other metrics around ARR at this point. Indian ARR is really our true north as a business. Providing other metrics at this point, and Tom just giving our scale, could be misleading, and therefore, you know, we're not going to provide them at this juncture. We can't wait to be at the scale where we're providing more of those metrics like gross ads and churn and things like that. But at this point, we're not prepared to do that.

Okay. Maybe I'll try on the multi-year validate deal that you had. Can you talk more about that? You said it was a COE source deal. What's the size of the deal? What's the use case? Just a little more clarity there.

Yeah, it's low six figures per year. ARR, it's a producer of products who has tried other ways to authenticate and stop both theft as well as diversion of their products and realized that we have a pretty good solution. So there's nothing – well, I guess there is actually. This COE partner, it's a valued customer of theirs, right? So it's always great to start with a COE partner's valued customer. It shows that that relationship's off to a good start because they're putting us in front of their customers. We've got to perform. We're not just trying to solve the customer's problem. We're trying to make our partners look good and help them get more comfort in us and really build that partnership. But there's nothing, I would say, unusual or unusual We love all of our deals, right? So I'm not saying it wasn't an exciting deal, but there's nothing unusual about it. It's just our first one that came through the COE program, which is a pretty quick turnaround. We launched with Parking Q2 and signed our first partner source deal in the same quarter.

Yep. Got it. That's helpful. And then I guess just lastly that relates to the commercial customer that you referenced, what happened? I mean, I know you can't get into specifics of that account and kind of what they're doing with your product, but I mean, clearly they've had your product in hand for a long, long time. They've looked at it, and it seems highly intuitive that the more product that's marked, the more effective your platform is. And I guess just my first reaction to reading that or hearing that was, what took so long that they're finally now just getting to that realization?

Yeah, I guess if you're looking at that from the original 2019 deal, I would benchmark it versus the 2019. deal we signed a couple years ago, right? That's a different use case. It's next-gen Instar operations. And I know we talked a little about this on our fireside chat. It's ultimately up to the customer. When we're licensing our platform, it's up to the customer to really decide how best they want to build it. That was that second key development, Jeff, I was referencing here, is their understanding that the more that they use the capabilities to eliminate is a huge unlock. And then if you go back to the 2019 deal, our focus across this company is on solving the problems front of mind for our customers. And when you look at the retail industry, there's far and away two things on the front of their mind. Loss prevention, especially post-COVID, which is in general, but it's getting worse. You're seeing big retailers taking out self-checkout or putting more stuff behind locks. That is becoming real at the retail space. It really is. It's skyrocketed to one of their top concerns. And the other one is next-generation operations. The retail industry is, for the most part, they've had improvements, but it's kind of the same process for the last couple decades. If we can build solutions that can address where the industry is going versus where they are, it's a huge unlock. If our solutions can not only add value to their existing processes, but also future-proof them for the future ones, Jeff, those are wonderful conversations to be having with these people.

Got it. And maybe, sorry, this will be my last. On the gift cards, because that's very interesting. I don't know if I came out of nowhere, but it certainly showed up quickly. the materiality of it, the way you're describing it, and the pace at which it showed up. You talked about all these attack vectors on gift cards. Can you just give us a 20-second education on a little more of the opportunity around gift cards and then, I don't know, any sense on timing? I realize it's just a swag, but how quickly can these result in ARR?

So in terms of the attacks, there's multiple vectors of attacks. They... roll into a couple of big top-level ones, right? One is trading, so getting a gift card that you believe has money on it, but the money's already been stolen. And the second one is social engineering. Those are the two main vectors, but there's a bunch of other vectors, and there's a bunch of sub-attacks within those vectors. But it's basically either buying a gift card that you should have had value on it, and it doesn't when you get it, or else social engineering and attacking, again, you know, Most of these social engineering attacks go after the elderly. So those are the two big problems that have become an issue not just for the industry as a whole. The only thing is this gift card industry is massive globally in terms of the total amount of money that is stored on these cards, and it's growing at an incredibly large rate. The only thing growing faster is the attacks because this industry has tried a lot of older analog type technologies that you've just proven not to be up for the challenge of a really dedicated group of thieves because of the size of the particle at the end of the rainbow. It's tough to get into exactly how we're solving all the problems. Again, we identify and authenticate things. Identify, we love to talk about it. Authenticating, we don't want to get too far into what we're doing, but we have multiple different solutions, multiple different implementations, as I mentioned. And then it's for the timing, stay tuned. We don't know what we don't know. As I mentioned, the pace This is evolving, and the engagement is unlike anything I've ever seen. It is remarkable. The goal on this call was to introduce the idea just so you all have awareness of it because, like I said at the beginning, our confidence we have a solution and the materiality to our business if we're right. Stay tuned.

Fair enough.

Thank you. Thanks, Jeff.

Our next question comes from Jeff Bernstein with Silverburn Bernstein.

Hi, guys. Thanks for letting me ask the question. I just wanted to get an update on the California legislation and whether you think that might actually get voted through, I guess, their Senate this summer. And then I guess there's some different legislation that's starting to percolate for the U.S. government as well, you know, relating to AI and deep space.

Yeah, so on AB 3211, I mean, we're just absolutely thrilled to be part of this conversation, not only because we can make a real impact to a really pressing problem, but also because it speaks to our recognized leadership in digital watermarking, right? They approached us as the experts. And probably goes without saying, but I'll say it, we're widely in favor, not only because we know of the implementation and the solutions, and it's not just digital watermarking. This is a very comprehensive bill. 3211 will work. And the technology behind it, which is a lot of digital watermarking-based stuff, well, of course, that we know will work. Trying to predict how legislation moves through any processes is probably beyond my ability to do. I can tell you right now this is an update. It's currently in the Senate Appropriations Committee in what's called a suspense file, which is where, I forget the hurdle, but any bill that has above a certain very low bar for financial impact gets put in a suspense file. And we're waiting for progress out of that. We provided direct feedback on the content. We've testified on this. And we're just as anxious awaiting progress as you are, Jeff.

Gotcha. And then on the federal level, are they also kind of going the same path in terms of digital watermarking and other technologies that will be in there?

Yeah, at the federal level, there's a lot of different bills talking about this, but You know, if you recall, we were at the AI Insight Forums. We were also a founding member of the NIST, which is the National Institute for Standards and Technology. We're a founding member of their AI initiatives group. So we're supporting at the federal level as well. You know, what's remarkable is how quickly AB 3211 is moving. California has a history of leading, not just the country, but the world in big... Big important things. So we love all of them. And again, this is not just a problem facing the US. This is a global problem. So we're supportive and we're trying to do all we can to help educate governments and regulatory bodies globally because this is a big problem. And I think the outcome of this is wonderful. We believe this can truly deliver the safer, fairer, more authentic Internet we've all deserved since Internet was created.

It'll be great to get the 15th largest country signed up, so looking forward to that.

Yeah.

Take care, Jack.

Thank you. There are no further questions at this time, and I would like to turn the call back to Riley McCormick for closing remarks.

Well, thank you, everybody, for joining us this afternoon. I hope you have a great rest of your day. Thank you. This concludes today's conference. Thank you for your participation. You may disconnect your lines at this time. Thank you. Thank you. Thank you. you Thank you.

Greetings and welcome to the Digimar Corporation second quarter 2024 financial results 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, 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, George Karamanos. Thank you. You may begin.

Welcome everyone 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 provide a business update and discuss Q2 financial results. This will be followed by a question and answer forum. We have posted our prepared remarks and our quarterly earnings snapshot 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.

Thank you, George, and hello, everyone. I want to begin this call by reiterating the core tenets of our strategy. When we get to the subsequent discussion of Q2, I encourage you to examine our progress with these core tenets in mind. Doing so will help frame the accomplishments we achieved in the quarter and, more importantly, provide context as to where we're going from here. As our world becomes increasingly digital and companies progress their digital transformation journeys, DigiMark maximizes the ways in which products and multimedia can digitally interact with the various systems that surround them. We excel at the identification and authentication of physical goods and digital assets, often at massive scale, and often where other means of identification or authentication don't work well or don't work at all. Our focus is on converting this large total addressable market into substantial free cash flow by positioning ourselves to deliver high and long lasting top line growth at world class operating margins. This starts with our being easy to begin doing business with and excellent at guiding customers along their DigiMark journey and is aided by four key tailwinds we have been very intentional to create. One, our incredibly deep and wide moats allow us to offer differentiated products. In turn, our differentiated products enable us to create new markets and disrupt existing ones. Two, the need to identify and authenticate physical goods and digital assets is universal, meaning almost every entity in the world is a potential DigiMark customer. Additionally, because our technology enables us to identify and authenticate things where other solutions don't work well or don't work at all, our ecosystem consists of companies incentivized to partner with us rather than posing a competitive risk. Three, there are many use cases that require companies to identify or authenticate their physical items and digital assets, and there are many ways we can configure our technology to achieve these goals. Therefore, our ability to productize new functionality is open-ended. This means our already large TAM will continue to grow as we either launch new products or add opportunity-unlocking functionality to existing ones. Four, we engineer our products to be accretive, meaning the more DigiMark products a customer buys, the more value each product delivers. This positions us to harvest a low-hanging and highly profitable fruit of cross-sells and up-sells for years to come. Turning now to Q2, we made significant progress on multiple fronts, highlighted by three developments likely to have a profound impact on the second half of this year and beyond. Before providing these important updates, I want to reiterate two points. First, because we are early in the journey to our ultimate and massive scale, our net annual recurring revenue growth can be lumpy when looked at on a quarterly basis. As a reminder, quarterly net ARR growth is the output of gross addition to ARR minus churn. In Q2, churn almost entirely offset our gross add. A significant driver of this dynamic was a transition of our preferred partner engagement model to our new center of expertise program. While this transition results in less upfront ARR, it leads to two significant benefits that should pay off for years. Greater ARR upside over time and more focused, repeatable, scalable, and profitable growth. Two things to note on this transition and its impact in our quarterly net ARR results, both in Q2 and beyond. First, even with the headwind of lower upfront ARR, we slightly exceeded the Q2 gross ad target set in our 2024 budget. Second, as of the end of Q2, the partners that remain in our historic partner program are not candidates to transition to our COE program. On our February call, we discussed the reasons why we believe so strongly in the COE program and in a June press release we announced the program's founding members. Over the past few months, we've become even more convinced of the power of this new program, and beyond the positive impact it is already having on our sales pipeline, I am thrilled to announce we closed our first COE source contract during the quarter, a multi-year DigiMark Validate deal. Second, and as evidenced by our historic results, While this lumpiness will lead to quarters like Q2 where quarterly net AR growth is below trend, it will also lead to quarters where quarterly growth is significantly above trend. When we say we expect our business to be lumpy until we reach a larger scale, we use that term as it is truly intended, not as a euphemism for weak. This is why we prefer to measure our ARR over one-year and three-year time horizons, as we do in the quarterly earnings snapshot George referenced in his opening remarks. Focusing on the forest, not the trees, provides a better measure of our business's true growth. Moreover, our focus extends beyond any single quarter, and as I mentioned at the beginning of this call, is centered on converting our large total addressable markets into substantial free cash flow. To that end, I want to use the rest of this call to update you on key developments in two of our ecosystem-driven opportunities and preview a new market opportunity that presents a TAM as large as, if not larger than, any other opportunity we are pursuing. As a reminder, we view our business as having three pillars of shareholder value. The first pillar is our longstanding relationship with the world's central banks. Beyond the meaningful cash flow this 26-year relationship provides, our work with the central banks also acts as a source of intellectual property generation for our commercial business, gives us invaluable credibility as a trustworthy supplier, and demonstrates our ability to scale. The second pillar comprises of our SaaS and PaaS products that follow a more traditional software go-to-market model in areas such as deal size, sales cycle, and lack of ecosystem dependencies. I touched briefly on the progress in our COE program earlier. For additional important updates from Q2 related to this pillar, I again encourage everyone to review our quarterly earnings snapshot. The third pillar consists of our ecosystem-driven opportunities. These opportunities encompass industry-wide or country-wide initiatives that, once in motion, have powerful flywheels that should drive quick, broad, and sticky adoption, but also have ecosystem dependencies that make timing unpredictable, as it is predominantly outside of our direct control. Before I provide an update on our progress in two of these opportunities, namely DigiMark Retail Experience and DigiMark Recycle, I again want to point everyone to our quarterly earnings snapshot, for an update on our third ecosystem-driven opportunity, DigiMark Validate Media, which we continue to believe can deliver the safer, fairer, and more authentic internet we all deserve. Turning to the update on DigiMark retail experience, recall this offering is a Razer Razer Blade product. The Razer involves licensing our DigiMark Illuminate platform to retailers who use its capabilities to build out the points of detection required to enable next-generation in-store operations. The razor blades are provided by our licensing DigiMark retail experience to the brands whose products are carried by that retailer, including the retailer's private label brands, allowing their products to interact with these points of detection. As stated on a prior call, we believe the TAM of licensing our platform to enable next-generation insurer operations is well into the nine figures of ARR. We believe the TAM of DigiMark retail experience is multiple larger still. But beyond these incredibly large TAMs, DigiMark retail experience is also an easy way for these national brands to begin their DigiMark journey en masse. Once their products are digitized, we will have the opportunity to be excellent at guiding these brands along their journey of solving additional problems through the adoption of other DigiMark solutions. Moreover, the more national brand items digitized using our technology, the easier it is for additional retailers to license our platform to build out their own points of detection while in parallel adopting DigiMark retail experience for their private label items. We expect most retailers will use our platform to build points of detection that utilize other means of product identification beyond the 1D, 2D, and digital watermarking signal that our platform supports. In Q2, we provided our largest commercial customer with demonstrable proof that our technology can carry a very heavy load in this multi-signal future, resulting in two important developments that give us confidence this flywheel is likely to start spinning. First and most immediately, We believe this customer now understands that the more items in their stores that are digitized with our technology, including items produced by national brands, the more profound the improvement to their in-store operations will be. Second, we believe this customer also now understands the value of DigiMark delivering a greater amount of the software capabilities powering their points of detection. This should ultimately increase the size and time to market of the Razor component of this flywheel, not only with our initial customer, but with subsequent customers as well. While I cannot provide any additional details at this time, I want to emphasize two key points. First, it is difficult to overstate the importance of these developments. Second, we expect and look forward to being able to share more information soon. Turning now to Digimark Recycle, Q2 saw us make important progress on this ecosystem-driven opportunity as well. On our February earnings call, we discussed a new go-to-market avenue for this revolutionary product, in which we would work with a qualified partner who would lead a regional or countrywide rollout. On our May call, I mentioned we were in conversations with multiple parties regarding this new path. Since then, the number of parties with whom we are having conversations has increased, as has the number of countries in which we are having these conversations. Moreover, thanks to a deeply valued ecosystem participant who believes as strongly as we do in both the environmental and economic ROI of our solution, we expect to soon receive introductions to multiple large and powerful entities capable of acting as our partners in additional countries. While we expect these will be elongated sales cycles, we are pleased with the progress and believe that the opening of our first country should accelerate our conversations, both existing and future. To that end, the first qualified partner with whom we entered conversations has told us they expect to be ready to sign a deal for the initial rollout of Digimark Recycle in a European country in the second half of this year. Finally, in breaking with our practice of not discussing new products until we've signed a market customer, I want to close my prepared remarks today by talking about a new market opportunity because of our confidence in the value of our solution and the materiality to our business if we are correct. For over a quarter of a century, we have worked with the world's central banks to protect their currencies. However, one of the fastest growing and most pernicious attacks on a class of currency isn't against the bank notes issued by federal governments. but the currency issued by brands and retailers, gift cards. As I've mentioned in the past, we expect our most exciting opportunities to come from prospects experiencing problems that can be uniquely solved by our ability to identify and authenticate physical and digital items where other means of identification and authentication don't work well or don't work at all. It is then incumbent upon us to determine A, if there is a sizable and repeatable business problem, that B, additional prospects beyond the first have an urgency to solve, where C, we can provide a solution of enduring and differentiated value that D, presents us a path to fast and profitable scale. This is exactly how our opportunity in gift cards has developed. Gift cards face multiple attack factors, and the cost of these attacks, both monetary and reputational, are real and are getting worse. Moreover, existing solutions are expensive and ineffective, and it is becoming clear to the industry, both ecosystem partners and end customers, that we have a significant role to play. We believe we can provide a solution today that addresses some of the most common attack vectors, providing a significant increase in efficacy while actually reducing the current building materials costs, delivering a meaningful and attractive ROI. That, combined with the expected ease of implementation, should allow for rapid scaling post-initial adoption. Moreover, while no material dependencies prevent any single gift card issuer from independently adopting our solution, many industry participants are aware of our work and are interested in finding a widely adoptable solution if a large and growing level of loss is leading to grave concerns in the industry. Thus, our opportunity in the gift card industry shares the most attractive attributes of our ecosystem-driven opportunities, namely the likelihood of rapid scaling and incredible stickiness once scaled, without the multi-stakeholder dependencies that characterize these opportunities as ecosystem-driven. We are likely to launch our gift card offering with a few different implementation architectures, that we believe yield a U.S. market cam ranging from 900 million to 1.5 billion of ARR. While we are starting in the U.S. because this is where our initial prospect and partner engagements have occurred, there is nothing that we or the industry see that prevents us from being a global solution. In fact, as stated earlier, our ability to act as a universal and global solution seems to be one of the things about which the industry is most excited. Although we haven't yet conducted a detailed analysis to quantify the global cam, it will be significantly larger than that of the US alone. Moreover, as we continue to build additional features into our solution to address more attack vectors, we believe we should be able to capture a share of that added value, providing further upside to our TAM. While the excitement and urgency shown by the industry has been remarkable, there is still more to learn as we advance this work. And I want to caution, we don't know what we don't know. However, the list of things we don't know is shrinking rapidly, giving us comfort in discussing this opportunity today. In addition to our obvious excitement about this opportunity standalone, it also dovetails nicely with other retail loss prevention solutions we are progressing, including a solution addressing the theft of prepared food, for which we signed an initial deal with a regional grocer in Q2. I focused my comments today on the gift card opportunity because of the urgency with which the industry is engaging, as well as the massive TAM it represents. However, it is important to note that the potential to offer a suite of value-accreted products leveraging the same technology and sold to the same loss prevention buyers is exciting, as it provides us another avenue to be easy to begin doing business with and excellent at guiding customers along their DigiMark journey. Finally, while not an immediate focus, we believe there are future synergies that can be unlocked between our retail loss prevention offerings and DigiMark retail experience, as retail loss prevention and retail operations are closely intertwined. We will keep you updated as things progress.

I will now turn the call over to Charles to discuss our financial results.

Thank you, Riley, and hello, everyone. Financial highlights on a year-over-year basis for the second quarter included ending ARR increased 44%, commercial subscription revenue increased 39%, subscription gross profit margin was 89%, a 5% percentage point improvement, total expenses only increased 2%, and non-GAAP net loss decreased 14%. We continue to focus on delivering improvement in these financial metrics as they're critical levers in reaching positive free cash flow. Ending ARR increased 44% from $16.7 million at the end of June last year to $23.9 million at the end of June this year. The year-over-year increase in ARR largely reflects the impact of new customer contracts and several important customer upsells partially offset by customer turnover. Total revenue for the quarter was $10.4 million, an increase of $1.6 million, or 19%, from $8.7 million in Q2 last year, reflecting strong growth in subscription revenue. Subscription revenue, which accounted for 61% of total revenue for the quarter, grew 36% from $4.7 million to $6.4 million. The increase reflects subscription revenue recognized on new customer contracts, as well as upsells on existing customer contracts. Commercial subscription revenue grew at an even higher rate of 39%. Service revenue decreased 1% from 4.1 million to 4 million, reflecting slightly lower commercial services. Subscription gross profit margin improved from 84% in Q2 last year to 89% in Q2 this year, representing a 5 percentage point improvement. The significant increase year over year reflects both the strong growth in subscription revenue and a favorable mix in subscription revenue to our newer products. Service gross profit margin improved from 51% in Q2 last year to 58% in Q2 this year, reflecting a favorable change in labor mix. We expect to generate mid-50% service gross margins on a normalized basis with some fluctuation quarter to quarter. Operating expenses for the quarter were $16.8 million compared to $16.1 million in Q2 last year, an increase of 4%. Roughly half of the increase was due to lower costs being allocated from operating expenses to cost of revenue this quarter due to lower billable services. Total expenses, which exclude the impact of allocations, only increased 2% year-over-year. Comparing this number to the 39% growth we delivered in commercial subscription revenue shows the operating leverage we've been focused on building into our business. To continue driving this considerable operating leverage, we are focusing on maximizing our productivity and efficiency as an organization, including better leveraging the capability of tools like GenAI to minimize the impact of rising labor and other costs. Non-GAAP operating expenses, which exclude non-cash and non-recurring items, were $14 million for the quarter, up 8% compared to $12.9 million in Q2 last year. Again, roughly half of this cost was due to lower costs being allocated from operating expenses to cost of revenue this quarter because of lower billable expenses. Net loss per share for the quarter is 43 cents versus 53 cents in Q2 last year. Non-GAAP net loss per share was also considerably lower for the quarter at 23 cents versus 29 cents in Q2 last year. We ended the quarter with $41.5 million in cash and short-term investments. Free cash flow usage was 6.9 million for the quarter compared to 7.9 million in Q2 last year. Given that cash flows can fluctuate quarter to quarter depending on the timing of receipts and payables, we continue to believe that a good proxy for a normalized level of free cash flow is using non-gap loss plus capital expenditures. While cash burn in the first half of 2024 was above this proxy, we expect the unfavorable fluctuations on timing of receipts and payables to reverse in the second half leading to full-year cash flow being generally in line with this proxy, and hence free cash flow in the second half to be much better than the first. 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. I'll now turn the call back over to Riley for final remarks.

Thanks, Charles.

In Q2, we made significant progress on multiple fronts. highlighted by meaningful developments in two of our ecosystem-driven opportunities and the rapid progression of an attractive new market opportunity in protecting gift cards from the ever-increasing threats they face. The developments in the ecosystem-driven opportunities give us confidence that we are likely on the precipice of getting these two flywheels spinning. The rapid progression of our opportunity in gift cards is standalone exciting and can also serve as a cornerstone for a broader suite of offerings that help retailers combat one of their most pressing business challenges. the ever-increasing prevalence and cost of shrink. While we continue to expect our business to be lumpy until we reach a larger scale, the progress we've made in Q2 further demonstrates that as a result of our laser-like focus on the execution of our strategy and the core tenets therein, we are not only on track to unlock the massive TAMs on which we are focused today, but also that new TAMs can rapidly develop. We are positioning ourselves to convert our large total addressable markets into substantial free cash flow by delivering high and long-lasting growth at world-class operating margins. Our progress in Q2 gives us even greater confidence in our ability to achieve this goal. Operator will now open the call for questions.

Thank you. 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 yourself from the queue. For participants using speaker equipment, it may be necessary to pick up the handset before pressing the star key. One moment, please, while we poll for questions.

Thank you. Our first question comes from Joshua Riley with Needham.

All right, great. Thanks for taking my questions, and nice job on developing some of these product opportunities here. in the last couple of quarters, uh, maybe just starting off on, uh, net new ARR. Can you just give us some additional details on maybe what type of customer churned in the quarter? Did you consider them core to the business and maybe how the center of expertise program for partners impacted, uh, net new ARR in the quarter?

Yeah. Thanks for the question.

Um, the, uh, Most of the term was specifically related to transition of our COE program. So as Riley stated in the prepared remarks, we don't expect to see any more customers be moving in a COE program.

So we expect that most of that is behind us at this point. Yeah, Josh, maybe if I double-click on that just quickly.

Our traditional program, the bar program, there were two types of partners we had in there. We had the big partners who were technologically capable and really wanted to use Illuminate to build their own products and services on top of. And then we had a bunch of partners that maybe had less interest in building things, wanted access to our technology because they had a ton of customers and they wanted to sell our existing products. And then we had a third class of partners that would have fallen into that second category but didn't want to sign up for the bar. So we still have partners that we consider under our model. These are the bigger customers who want to build things on top of Illuminate. Our focus has been on the second group, is getting to a bigger group of potential partners. And that's what the COE program allows. And the reason it allows is it's lower upfront costs. We actually have a tier of COE that is free. It's our entry tier. But we're not trying to monetize the relationship as much, the direct relationship with a partner. We are trying to both have skin in the game so we can go after their customers and help their customers solve a ton of problems. So that's what I meant when the transition is low front error. Our COE deals are going to be less than our traditional bar deals on day one. But they are set up to be focused more on the massive pipeline from the end customers that we can service together. And that's why I said over time it's going to lead to a lot higher ARR. And it's also more focused because they're selling our products or they're reselling our products or they're bringing us leads for our products as opposed to them building their own things on top of it. Does that answer your question a little bit?

That's very helpful, I think, and provides some nice clarity on what's going on there. Maybe moving on here, if you look at some of the legislation that's progressing in Europe and Canada around plastic recycling, can you just give us any updates you have in terms of timelines, any change in expectations you have on how the projects will progress relative to kind of maybe public statements you've made previously, and maybe just any other relevant information that investors should be aware of with the current recycling opportunity?

Yeah, it's great. And I'll definitely point you back to the pair of remarks where it said the first partner in our new go-to-market motion, they told us they expect to sign a deal in the second half of this year to start in a European country, which is huge. We're also... expanding the number of partners we're in conversation with, not just number of customers but other countries. And we expect to have a whole other wave of additional potential partners that we're getting introductions to from a very powerful and wonderful partner of ours. So that's on the opening up Digimark Recycle Markets, which is where our focus is. Holy Grail work continues. refer to the quarterly earnings snapshot, you'll see that there's some revenue coming in the back half of this year from the Holy Grail work, which is important. It's continued proof of concept. I've never seen 170 organizations do a very public POC on a single company software like Holy Grail is. It's wonderful in so many different ways. Now the regulation. There's a ton of regulation. This is Depending on who you talk to, top three problem are our globe faces, right? Is that we only have one planet and we've got to solve for the plastic recycling issue. So ton of regulation. We don't want to wait for regulation to be the driver. Regulation is a wonderful tailwind. People can see the writing on the wall and see what's coming down from regulation. So I think it gives an urgency to the conversation, but we don't want to rely on that. We want to drive our own urgency. And so that's what we really focus on in these conversations for this new go-to-market, this partnership model of Digimark Recycle.

Got it. That's helpful. And then you highlighted in the prepared remarks that in Q2 you demonstrated with your largest commercial customer the ability to carry a heavy load in a multi-signal future. I know that you're limited with what you can discuss with this, but can you just discuss or maybe just, you know, from a high level explain what you were referring to maybe with this particular statement?

Yeah, I would point to the two developments that I – I mean, that – fact is powerful and interesting. But what's really important is the two developments that come from that fact. First, and most immediately, we believe the customer understands the more items in their store, including items produced by the national brands, the more profound the improvement in what they're trying to do will be. And then secondly, they understand the value of our owning more of the technology stack on the Razor component. I'm using more of Illuminate's capabilities to build up the points of detection. Outside of reiterating almost word for word what I said in the call, I said I can't provide any additional details, except I do want to stress two things. It's difficult to overstate the importance of these developments. These are important, important developments, and we look forward to being able to talk about it more soon.

Understood. And just one quick financial question for me. As you're looking at the operating expense growth for the balance of the year, I think, you know, aside from the adjustment that grew, total expenses grew 2% year over year, which is great. How should we think about any increased hiring or expenses coming into the model for the second half of the year? Thanks, guys.

Yeah. Josh, you know, without necessarily giving guidance, but any direction I can just talk, we don't expect that we need to ramp up expenses significantly at all. And quite frankly, Generally, expenses are a little bit higher in the first half of the year than they are in the second half of the year, just given some of the year-end compliance and things that we have in Q1. So we wouldn't expect to see material growth in expenses. Now, obviously, at a much higher scale of revenue, there will be some additive expenses, but as I touched on in my prepared remarks, you know, this business, we believe, has tremendous operational leverage, and you can start to see that where we're able to grow revenue at 39% and our expenses were pretty low. I can't say that the expenses won't grow, but they shouldn't have to grow at a significant amount even to reach a much higher scale.

Awesome. Thanks, guys.

Thanks, Josh.

Once again, to ask a question, please press star 1. Our next question is from Jeff Van Rie with Craig Hallam.

Great, thanks. A couple from you guys. Maybe first, just can you quantify on the ARR, what was the actual dollar impact of that turned customer?

Yeah, so, Jeff, we're not providing any other metrics around ARR at this point. Indian ARR is really our true north as a business. Providing other metrics at this point, and Tom just giving our scale, could be misleading, and therefore, you know, we're not going to provide them at this juncture. We can't wait to be at the scale where we're providing more of those metrics like gross ads and churn and things like that, but at this point, we're not prepared to do that.

Okay. Maybe I'll try on the multi-year validate deal that you had. Can you talk more about that? You said it was a COE source deal. What's the size of the deal? What's the use case? Just a little more clarity there.

Yeah, it's low six figures per year. ARR it's a producer of products who has tried other ways to authenticate and stop both theft as well as diversion of their products and realized that we have a pretty good solution so there's nothing you know well I guess there is actually this is This COE partner, it's a valued customer of theirs, right? So it's always great to start with a COE partner's valued customer. It shows that that relationship's off to a good start because they're putting us in front of their customers. We've got to perform. We're not just trying to solve the customer's problem. We're trying to make our partners look good and help them get more comfort in us and really build that partnership. But there's nothing, I would say, unusual or unusual We love all of our deals, right? So I'm not saying it wasn't an exciting deal, but there's nothing unusual about it. It's just our first one that came through the COE program, which is a pretty quick turnaround. We launched a partnership with Q2 and signed our first partner source deal in the same quarter.

Yeah, got it. That's helpful. And then I guess just lastly, that relates to the commercial customer that you referenced. What happened? I mean, I know you can't get into specifics of that account and kind of what they're doing with your product, but I mean, clearly they've had your product in hand for a long, long time. They've looked at it, and it seems highly intuitive that the more product that's marked, the more effective your platform is. And I guess just my first reaction to reading that or hearing that was, what took so long that they're finally now just getting to that realization?

Yeah, if you're looking at that from the original 2019 deal, I would benchmark it versus the deal we signed a couple years ago, right? That's a different use case. It's next-gen Instar operations. And I know we talked a little about this on our fireside chat. It's ultimately up to the customer. When we're licensing our platform, it's up to the customer to really decide how best they want to build it. That was the second key development, Jeff, I was referencing here, is their understanding that the more the capabilities to eliminate is a huge unlock. And then if you go back to the 2019 deal, our focus across this company is on solving the problems front of mind for our customers. And when you look at the retail industry, there's far and away two things on the front of their mind. Loss prevention, especially post-COVID, which is in general, but it's getting worse. You're seeing big retailers taking out self-checkout or putting more stuff behind locks. That is becoming real at the retail space. It really is. It's skyrocketed to one of their top concerns. And the other one is next-generation operations. The retail industry is, for the most part, they've had improvements, but it's kind of the same process for the last couple decades. If we can build solutions that can address where the industry is going versus where they are, it's a huge unlock. If our solutions can not only add value to their existing processes, but also future-proof them for the future ones, Jeff, those are wonderful conversations to be having with these people.

Got it. And maybe, sorry, this will be my last. On the gift cards, because that's very interesting. I don't know if I came out of nowhere, but it certainly showed up quickly. the materiality of it, the way you're describing it, and the pace at which it showed up. You talked about all these attack vectors on gift cards. Can you just give us a 20-second education on a little more of the opportunity around gift cards and then, I don't know, any sense on timing? I realize it's just a swag, but how quickly can these result in ARR?

So in terms of the attacks, there's multiple vectors of attacks. They... roll into a couple of big top-level ones, right? One is trading, so getting a gift card that you believe has money on it, but the money's already been stolen. And the second one is social engineering. Those are the two main vectors, but there's a bunch of other vectors, and there's a bunch of sub-attacks within those vectors. But it's basically either buying a gift card that you should have had value on it, and it doesn't when you get it, or else social engineering and attacking, again, you know, Most of these social engineering attacks go after the elderly. So those are the two big problems that have become an issue, not just for the industry as a whole. I mean, the only thing is this gift card industry is massive globally in terms of the total amount of money that is stored on these cards, and it's growing at an incredibly large rate. The only thing growing faster is the attacks because this industry has tried a lot of older analog-type technologies that you've just proven not to be up for the challenge of a really dedicated group of thieves because of the size of the particle at the end of the rainbow. It's tough to get into exactly how we're solving all the problems. Again, we identify and authenticate things. Identify, we love to talk about it. Authenticating, we don't want to get too far into what we're doing, but we have multiple different solutions, multiple different implementations as I mentioned. And then it's for the timing state too. We don't know what we don't know. As I mentioned, the pace This is evolving, and the engagement is unlike anything I've ever seen. It is remarkable. The goal on this, Paul, was to introduce the idea just so you all have awareness of it because, like I said at the beginning, our confidence we have a solution and the materiality to our business if we're right. Stay tuned.

Fair enough. Thank you. Thanks, Jeff.

Our next question comes from Jeff Bernstein with Silverburn Bernstein.

Hi, guys. Thanks for letting me ask the question. I just wanted to get an update on the California legislation and whether you think that might actually get voted through, I guess, their Senate this summer. And then I guess there's some different legislation that's starting to percolate for the U.S. government as well, you know, relating to AI and deep space.

Yeah, so on AD3211, I mean, we're just absolutely thrilled to be part of this conversation, not only because we can make a real impact to a really pressing problem, but also because it speaks to our recognized leadership in digital watermarking, right? They approached us as the experts. And probably goes without saying, but I'll say it, we're widely in favor, not only because we know of this that the implementation and the solutions, and it's not just digital watermarking, and this is a very comprehensive bill, 3211 will work. And the technology behind it, which is a lot of digital watermarking-based stuff, well, of course, that we know will work. Trying to predict how legislation moves through any processes is probably beyond my ability to do. I can tell you right now, this is an update, It's currently in the Senate Appropriations Committee in what's called a suspense file, which is where, I forget the hurdle, but any bill that has above a certain very low bar for financial impact gets put in a suspense file, and we're waiting for progress out of that. We provided direct feedback on the content. We've testified on this, and we're just as anxious awaiting progress as you are, Jeff.

And then on the federal level, are they also kind of going the same path in terms of digital watermarking and other technologies that will be in there?

Yeah, at the federal level, there's a lot of different bills talking about this. If you recall, we were at the AI Insight Forums. We were also a founding member of the NIST, which is a National Institute for Standards and Technology. We're a founding member of their AI initiatives group. So we're supporting at the federal level as well. What's remarkable is how quickly AB 3211 is moving. California has a history of leading, not just the country, but the world in big important things. So we love all of them. And again, this is not just a problem facing the U.S., This is a global problem. So we're supportive and we're trying to do all we can to help educate governments and regulatory bodies globally because this is a big problem. And I think the outcome of this is wonderful. We believe this can truly deliver the safer, fairer, more authentic Internet we've all deserved since Internet was created.

It'll be great to get the 15th largest country signed up. So looking forward to that.

Take care, Jeff.

Thank you. There are no further questions at this time. And I would like to turn the call back to Riley McCormick for closing remarks.

Well, thank you, everybody, for joining us this afternoon. I hope you have a great rest of your day. Thank you. This concludes today's conference. Thank you for your participation. You may disconnect your lines at this time.