Greetings, and welcome to the Digimarc Corporation Third 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. Thank you. You may begin.

Thank you. Welcome to our Q3 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 Q3 2023 financial results. This will be followed by a question-and-answer forum. We have posted our prepared remarks in the Investor Relations section of our website and will archive this webcast there. Before we begin, let me remind everyone that today’s discussion contains forward-looking statements that have risks and uncertainties. Please refer to our press release for more information on the specific risk factors that could cause actual results to differ materially. Riley will now provide a business update.

Thank you, Joel, and hello everyone. Q3 was another strong quarter for Digimarc. While Charles will provide a more detailed discussion on the financial results during his remarks, there are two metrics I want to highlight at the top of the call because their absolute levels as well as our expectation they will get even stronger are important markers of our progress in building a high quality, high growth, and highly cash flow generative business. First, we grew our annual recurring revenue, or ARR, 54% year-over-year. As mentioned during the last few earnings calls, first year bookings has become a less relevant metric as our focus is on growing our recurring and high-margin subscription revenue, and signing those customers to multi-year deals. Our decision to begin reporting our quarter-end ARR reflects our desire to provide investors transparency into the results of that focus as well as a greater understanding of our true underlying growth. And while a 54% year-over-year growth rate is objectively high, we believe we are capable of more. In fact, while it is still early in the current quarter, we expect our year-over-year ARR growth in Q4 will be noticeably greater than it was in Q3. Second, we expanded our subscription gross profit margin to 85.5%, an increase of 1,000 basis points year-over-year and 200 basis points sequentially. On our Q4 2022 call, Charles mentioned our expectation of driving subscription gross profit margin north of 80% in 2023, and three quarters into the year, we have not only exceeded this target in every single quarter, but our gross profit margin is now closer to 90% than 80%. There is no better predictor of a company’s ultimate level of profitability, nor better proof of the depth and width of its moats, than subscription gross profit margin, and at…

Thank you Riley, and hello everyone. Before I dig deeper into our Q3 financial results, I wanted to share some financial highlights from the third quarter. We ended the quarter with $19.6 million of annual recurring revenue or ARR, representing 54% growth year-over-year. I will talk more about this important performance metric in a minute. We achieved 85.5% subscription gross profit margin; we reduced our operating expenses year-over-year by 17%; and our free cash flow usage was only $400,000 for the quarter. I highlight these areas as they are all critical drivers towards reaching profitability. Now onto the details. As we mentioned on previous earnings calls, we have been working to select a new reporting metric to replace first year commercial bookings that would provide a better indicator of our progress in growing our high-margin commercial subscription business. As Riley already mentioned, we have decided on annual recurring revenue as it’s a key performance metric we are now using to run our business. We intend to report ending ARR each quarter with comparative periods so you can measure our progress. We calculate ARR using the annual recurring fees stated in our sales contracts, thus mirroring the underlying economic value of these contracts. Also, ARR only includes recurring subscription fees from commercial contracts. Government contracts, service fees and non-recurring subscription fees are excluded from our reported ARR. The reason for this is, the most important growth driver we are all focused on is recurring commercial subscription revenue. We have included a table within the earnings script that reports our ARR at the end of each of the last eight quarters for comparative purposes. In addition to focusing on growing our high-margin commercial subscription business, we are also focusing on making sure the payment terms in our sales contracts are consistent with…

Thanks Charles. We are seeing momentum across all areas of our business, and are hard at work continuing to increase that momentum as we create a market we are uniquely positioned to lead for years to come, a market that at scale has the opportunity to be as large if not larger than the other legs of the digital transformation stool. With our recent expansion of Digimarc Validate into the digital domain, that opportunity has become significantly larger. And because we are unique in being able to bridge both the physical and digital worlds, not only has our TAM become larger, but our moats have become wider. As those of you with whom I have spoken with over the years know, I think there’s a really easy way to identify once-in-a-generation investment opportunities before they become obvious to the rest of the world. It’s simply a matter of TAM, moats, and execution. As just mentioned, our massive TAM has become that much more massive, and our incredibly wide moats have become that much wider. In addition, as our financial results in the last few quarters combined with our comments about Q4 show, we’re executing. We appreciate your interest as we continue to progress this generational opportunity. Diego, we’ll now open the call up for questions.

Thank you. [Operator Instructions] Our first question comes from James Ricchiuti with Needham & Company. Please state your question.

Hi. Thank you. Good afternoon. By the way, thanks for the additional information on ARR. The question I have is just with respect to the subscription revenue that you’re seeing. Is there -- you see more activity from upsells on existing -- with existing customers, or with new customers?

The impacts definitely come from both, but it’s been more from new customers. We’ve had a couple of handfuls of really nice upsells that we highlighted on the last call this year, but the majority of the new revenue’s coming from new contracts.

Okay. Got it. And then maybe a little bit of color on the -- if you can, on the expected deal you alluded to with a company that’s presumably tied to this rollout in France. I’m wondering, what’s driving this? Is this an existing customer, someone you’ve been talking to?

I’m sorry. Jim, you broke up. Are you asking the customer we alluded to being close to signing in France?

Yes, I am. Thank you.

Yes. So it’s a new customer. It’s a new logo. It’s an incredibly impressive logo. And the point I was trying to make in that part of the call was this wasn’t even a company that was listed in that initial press release, which I forget exactly, came out a couple of weeks ago, some time in that period of time. So I think their interest is in helping make a difference in the environment in France. And I think, to your point, I was going to add -- if I could add on to what Charles was saying is, Jim, we had this conversation in the past of we expect to be enough in cross-sell opportunity for decades. And so it’s important to get those new logos. We view them as future upsell and cross-sells. And that’s how we view Recycle, right, is that one of the wonderful things about how we’ve architected our platform and our products is very accretive. So, we don’t care where somebody starts their product digitization journey. Our goal is to guide them and be excellent guides at continuing their product digitization journey.

Got it. Final question. And I’ll jump back in queue. Early days, I know, with Validate, but I’m just wondering what kind of traction do you anticipate from this over the next year.

It’s hard to quantify it at this point. I can tell you we’re having -- I chose the words very carefully of saying we’re having conversations across the full gamut. We are talking to some very large, both on the content creator and content owner side as well as on the nodes side, on the detection point side, we are talking to the biggest of the big. We also expect that this will be a web sale opportunity, too, and so we have some smaller opportunities we’re progressing as well.

[Operator Instructions] Our next question comes from Jeff Van Rhee with Craig-Hallum Capital.

Riley, just back to the France opportunity, I mean maybe just spend a minute or two more. At a very basic level, what -- how do you envision that rolling out? What kind of signings, what kind of pace of signings, what kind of vendors, use case? Just kind of what do you anticipate over -- I mean, you can be as precise as you like, but just how does France play out and really start moving the needle on revenue? How do you sort of over-under? When does it really start to make a difference?

Yes. The wonderful thing about France is it’s the first Digimarc Recycle country we’ve opened. So I don’t have -- I’d like to stick with what we know as opposed to what we think. I can tell you that when you asked who the customers are, they’re going to be the brands in retail, so people putting plastic packaging into the French market. So we’ll see. We’ll keep you all updated as we know more. But we’re -- and what is exciting about it is the initial interest are from the big companies. You saw a couple of the logos that were listed in the press release. That’s the size of company we’re talking to.

You had the large win a couple of quarters ago and in there, you had some security printing customers in particular. How are those going? And any other follow-ons similar to those working through the pipe?

Yes. So, there is follow-on in the pipe, absolutely. When you said how is that going -- that was what I referenced, if you remember that customer who signed up or is using Illuminate to build three products. One of them is a deposit return scheme. And as I mentioned in the prepared remarks, I was in-country maybe about a month ago, a few weeks ago, maybe about a month ago, and initial production of their logo is rolling out, being produced on very high volume, very iconic products. So, it’s going well.

And then just lastly, maybe open-ended because I know you said you tried to address your comments on the call for questions people are asking, but maybe just describe what’s in the pipeline, what are you seeing, and how has that evolved in the last six months, if it wasn’t already touched on.

You’re talking about -- you mean product mix, or are you talking -- could you be a little more specific?

Deals that are late stage in the pipeline now versus six months ago.

You mean how does it relate to where it was six months ago?

Yes.

It’s growing. I mean, I think you can look at our ARR growth, right? We grew ARR 54%. And so, there’s -- and if you listen to -- if you look at what I said, we expect ARR growth to be greater in Q4 on a year-over-year basis than it was in Q3.

Thank you. There are no further questions at this time. I’ll hand the floor back to Riley McCormack for closing remarks.

Well, thank you, Diego, and thank you, everybody, for joining us today. We hope you have a great rest of your day.

Thank you. And with that, we conclude today’s conference call. All parties may disconnect. Have a great evening.