Ladies and gentlemen, greetings, and welcome to the Digimarc Corporation Second Quarter 2023 Earnings Conference Call. [Operator Instructions] As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Joel Meyer, Chief Legal Officer. Please go ahead.

Thank you. Welcome to our Q2 conference call. Riley McCormack, 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 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 we 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 our actual results to differ materially. Riley will now provide a business update.

Thank you, Joel and hello everyone. Q2 was a strong quarter on many fronts, a testament to our maniacal focus on being easy to begin doing business with and excellent in guiding customers along their product digitization journey. Starting with the Easy to Begin Doing Business With portion of our mantra, I want to highlight a few wins on the direct side of our business. We added two large new customers in the pharmaceutical vertical and are hard at work expanding this flywheel to help this industry combat the massive and massively important issue of counterfeit products. We also closed deals with two separate divisions of the top 25 global CPG for a sandbox version of our platform involving factory automation and are working to pull together the ecosystem partners necessary to provide a quickly scalable and low-touch solution to the hundreds, if not thousands, of other companies that would benefit from the same. Based not just on these two initial wins nor just on our internal research, but very importantly also on our growing pipeline of opportunities as the word gets out, we are confident we have a truly differentiated and high-value factory automation solution that we can’t wait to provide to many others. On the channel side, we added two new VARs, including the large $32 million plus contract we announced a few months ago. We have high expectations that both relationships will grow as we prove Digimarc Illuminate’s value in allowing our borrowers to provide unique and differentiated solutions to their own customers. In addition, the public announcement of our large borrower deal has put us squarely on the security printing industries radar. We are in early conversations with two new prospects, each of which represent a sizable opportunity. This further validates the unique position we enjoy…

Thank you, Riley, and hello, everyone. Before I dive deeper into our Q2 financial results, there are some financial highlights that are important to emphasize. We closed $8.8 million in first year commercial bookings, up more than 300% year-over-year. We delivered 59% year-over-year subscription revenue growth from current products. We achieved 84% subscription and gross profit margin, and we significantly reduced our operating expenses and cash burn from last year. I highlight these areas as they are critical drivers as we work hard to get the business to profitability. Now on to the details. First year commercial bookings were $8.8 million during the second quarter, a 4x increase when compared to the $2.2 million booked in Q2 last year. As Riley mentioned, one source of this growth was upsells to existing customers. These upsells are important to mention as we have some very large customers and in most cases, we are in the earlier stages of account penetration, meaning we have a lot of runway to materially grow the revenue from these existing customers. These opportunities for revenue growth can come from adding new products and/or expanding usage of existing products. While not unexpected, it was an encouraging sign to see these customers not only renew their contracts, but to do so at higher levels of commitment. It’s also important to highlight that many of these deals contributing to bookings this quarter were multiyear commitments. Because we only report first year bookings, the true impact of a multiyear contract is not captured. To further this point, if we signed a 3-year committed contract, for instance, only the first year’s annual fees would ever be reflected in our reporting bookings number. Years 2 and 3 would never show up. The impact of that contract, however, is committed revenue for the next…

Thanks, Charles. Q2 was a strong quarter. On both the direct and channel front, we were successful in not just being easy to begin doing business with, but also excellent at guiding customers along their product digitization journey. As promised at the end of last quarter’s call and continues today, we are seeing momentum across all areas of our business, and that strength is showing up in our income statement and the two key financial metrics by which we obsess with 59% year-over-year subscription revenue growth from current products and a sequential addition of another 400 basis points of subscription gross margin to a near best-in-class 84%. But however, strong Q2 was, what continues to excite us most is where we are going because as we are beginning to show the results of our transformation to unlock the unparalleled hour of our world-leading product digitization hyperscaler, we are also on the cusp of extending that opportunity more fully to the digital world, a domain in which the combination of our past and present, will add to our delivery of a generational future. Ryan will now open the call for questions.

Thank you. [Operator Instructions] Our first question comes from the line of Jim Ricchiuti with Needham & Company. Please go ahead.

Hi, good afternoon. This is actually Chris Grenga on for Jim. Thank you for taking the questions. You mentioned that you expect cash usage to be lower in the back half than in Q2. Could you frame for us some of the factors that you expect to drive that result? And maybe speak to the weights of those factors in driving that result and your visibility there?

Yes. It’s a culmination of timing of customer receipts. We have some large customer receipts coming on, but also growing revenues. As we talked about on the last call, the $32 million contract has three projects to it and they start in different phases. As that continues to ramp, that will both drive revenue as well as additional cash. But some of it is also just related to the timing of cash payments, including the large contract that we have with Walmart that we signed last year.

Yes. And Chris, we grew revenue – we grew 59% year-over-year in Q2. We expanded gross margin by 1,100 basis points. That’s an incredibly strong tailwind for cash flow – for a reduction in cash burn. Those two big trends growing our top line and expanding the gross margin.

Got it. Thank you very much. And could you elaborate a bit on the Sandbox version of the factory automation? What – I guess what that entails for those customers and what they were doing before in the absence of a program like that? And yes, just elaborate on the nature of that product?

Yes, I would love to. And Chris, if you wait about five weeks or so, there will be a lot more out publicly about this. This is really, really exciting stuff. I just want to front run really strong joint comps plan that is being put together. But as on the specific use case and who the customer is, stay tuned. One of the important things, and I referenced, it’s a Sandbox version of our platform, right. So historically, we have gone to market with products and then we have gone to market with our full platform. And what we are finding is, and we are exploring and we are constantly learning. We are constantly opening up new opportunities. We are constantly learning new things. There is a market also for a Sandbox version of our platform. So Illuminate for x, in this case, Illuminate for factory automation. And so what the buyer enables as they get some flexibility from buying the platform components itself, but not paying the cost or for a lot of components of the platform they don’t need. So, it’s a really exciting go-to-market development that seems to have real legs here. So, without getting specifically into what this customer is doing and where they see the value and who the customer is, that will all be out publicly in about five weeks or six weeks. But more importantly, I think the idea here is we potentially could be opening up a third avenue to go to market. We got our products. We got our platform, and then we have Illuminate for x being in this case, factory automation, but there is a couple of other Illuminate for x we are exploring as well.

Got it. That’s very helpful. Thanks. And one more, if I may, I appreciate all the color on the Generative AI vision. Do you anticipate targeting customers that are existing customers that are moving into using Generative AI more in their operations, or would you anticipate that this would be targeting a new set of customers for the business?

Well, first of all, I would say I don’t know if not now in six months, everybody is going to be using Generative AI. So, I don’t know if there is a difference of customers who are not. I would say, again here, we are going to be out and where we have a very detailed comps plan and launch for upcoming product that we will be talking about more. But if you listen to what we are saying, there is benefits to all, right. So, watermarking digital assets to provide authenticity and at the same time there is so much value in Gen AI and itself solving the two problems of authenticity of digital assets as well as safe and fair input for the training models. But it’s beyond solving those two problems in the Gen AI world, and it’s beyond even the Gen AI world. So, stay tuned for more on that, but huge opportunity. And we are again, one that we are uniquely positioned to provide simply because of our background in digital watermark and our relationships, our expertise. It’s pretty exciting stuff.

Great. Appreciate the color. Thanks very much.

Thank you.

Thank you. Our next question comes from the line of Jeff Bernstein with Silverberg Bernstein Capital. Please go ahead.

Hi guys. Just a couple of questions for you today. Just back on the factory automation side, is this related to – this is going back quite a while, I think you guys had done some work with Cognex, with machine vision and you had very high relates on machine vision. Is that what we are talking about here?

Yes, absolutely. So, there is – without mentioning the vendors, too, and it’s more than just one camera vendor that has market share and multiple – we talk about developing an ecosystem, right. There is multiple wonderful vendors out there. Cognex, itself obviously is a wonderful vendor. And as you mentioned, the historic partner, Digimarc wonderful. But there is – a lot can be automated in a factory. There is a lot of providing identification and intelligence to items in their factory. So, yes, you are absolutely on the right track. You have mentioned one of our wonderful partners and stay tuned.

Got it. Okay. And then I just want to make sure I understood. When you talk about Sandbox, that’s not a cyber security term as in not connected to the cloud?

Sorry.

Got it. Okay. I just wanted to make sure….

We had no idea and I know it’s a lot easier to make see a word in here would Illuminate for x, meaning Illuminate for a bunch of different things. It’s just taking out – whatever functionality, again, to give a step back. Our Illuminate platform is what we build our own products upon, right. And so we are taking some of the capabilities of Illuminate in our currently four products and say we want a little bit of this capability, a little bit of that capability, we are calling that a product. Sometimes customers want, especially want our full platform. They want every lever and bell and whistle and all the wonderful capabilities within Illuminate. And then sometimes people want to solve for a problem not using one of our predefined products, but using just some of our capabilities. And so that’s what we are talking about Sandbox version is Illuminate for factory automation in this case or Illuminate for – there is a couple of other ones that potentially could be coming.

Understand. Okay. That’s great. And then you mentioned a deposit return program. So, is this a second one in addition to – I think you talked about one on the prior quarter.

Yes. So, our wonderful VAR that we announced that we signed in Q2, and we announced a couple of months ago. As Charles just mentioned, they are building three products currently on top of Illuminate. And one of them is to provide for the authenticity of a DRS system in a specific country. What I referenced on the earnings call is as soon as that press release came out, I think it was literally the next day, we got an invitation to a meeting for a very large country who is working on their own DRS scheme and wanted our insights and talk to us about the value we could have because we believe there is a huge opportunity here in terms of coverage, in terms of cost effectiveness, in terms of ease of implementation. There was – and it’s important stuff. There was an article actually that somebody sent me about a week ago, or 1.5 weeks ago about somebody family making $6 million or something by bringing cans from Arizona and getting the deposit back from California. This is a big problem. And there is ways to solve it. There is ways that existing DRS systems are using to solve it. We got a solution that can extend coverage and do it in a lot more cost-effective way. But – and that’s the one we are going to go through of our VAR. We have one VAR that we – and that’s earlier in Q2 as part of the $32 million deal, and we are looking to expand that network and also to help that VAR to be more successful in other countries.

Got it. And then you mentioned adding one more VAR. Any color on kind of the general area that VAR is in?

Yes, and they are using Illuminate. So, you mean so not what the use case are they going after, what end market they – they are packaging and label company.

Got it. Okay. Alright. And lastly, there was a mention about the product infrastructure costs coming down as customers actually utilized your product more. And it sounds a little counterintuitive to me. Could you just walk us through how that is.

Yes. I mean we are updating the platform capabilities that we have that it will provide for more efficiency from a cost perspective and be able to scale out. So, we are taking some on legacy technology and updating that to a newer platform, which is the Illuminate platform. So, as we transition customers off of our legacy platform onto that, we expect that we will continue to be able to drive the average price down.

That’s great. Thank you. Thanks for the help there.

Thanks Jeff.

Thanks Jeff.

[Operator Instructions] Our next question comes from the line of Robin Knipp with Janney Montgomery Scott. Please go ahead.

Thanks for taking the call. I appreciate it, gentlemen and congrats on a really good quarter. I suspect I know the answer to this question, but I will ask it anyway. Riley, are you able to share with us the collective total of the different contracts that were multiyear deals that we were only reporting on the first year?

Yes. We intentionally aren’t trying to throw out other metrics, but it’s into the seven figures. But I don’t want to get into it. There was a reason why we went away from reporting both total and first because it was confusing, but it was sizable.

Okay. Very good. Thanks. Appreciate it. Nice quarter.

Thanks Robin.

Thanks Robin.

[Operator Instructions] As there are no further questions, I would now hand the conference over to Riley McCormack for closing comments.

Thanks Ryan and thanks everyone. We hope you all have a wonderful rest of your day. Take care.

Thank you. The conference of Digimarc Corporation has now concluded. Thank you for your participation. You may now disconnect your lines.