Greetings, and welcome to the Digimarc's First Quarter 2024 Financial Results Conference Call. [Operator Instructions] As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, George Karamanos, Chief Legal Officer. Thank you, sir. You may begin.

Welcome to our Q1 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 Q1 2024 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, George, and welcome aboard. Hello, everyone. Thank you for joining today's call. As our world becomes increasingly digital and company progressed their digital transformation journeys, Digimarc 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 excellently guiding customers along their digital transformation journey and is aided by 4 tailwinds we've been very intentional to create. One, an incredibly deep and wide modes provide us the ability to offer differentiated products. In turn, our differentiated products allow us the ability to create new markets as well as to disrupt existing ones, all while delivering best-in-class gross margins that will continue to expand as we scale. Two, the need to identify or authenticate physical goods and digital assets is universal, and thus almost every entity in the world is a potential Digimarc customer. At the same time, our technology allows us to identify and authenticate things where other solutions don't work well or don't work at all, which means our ecosystem is comprised of companies incentivized to partner with us as opposed to companies that pose competitive risk. These 2 truths provide us the exciting opportunity to leverage our partners' customer list, pipelines and go-to-market resources and specific domain expertise to deliver quickly scalable and high gross profit margin revenue in a way that…

Thank you, Riley, and good afternoon, everyone. Continuing on the positive trends we delivered in the third and fourth quarters last year, we again delivered improved year-over-year financial performance in the first quarter this year. Ending ARR grew to $23.9 million, representing an 85% increase. Commercial subscription revenue increased 52%. Subscription gross profit margin was 87%, a 7.5 percentage point improvement. Operating expenses decreased 10% and non-GAAP net loss decreased $3.5 million or 39%. I highlight these areas again as they are all critical drivers toward reaching positive free cash flow. Before I begin a deeper review of the quarter, I want to highlight that we've posted a Quarterly Earnings Snapshot presentation to the Investor Relations section of our website, along with our normal quarterly materials. The Quarterly Earnings Snapshot is broken into 2 parts. The first part provides an overview of our business and contains, among other things, a deeper dive into our 3 different commercial Go-To-Market motions as well as key details of the 3 pillars of shareholder value, which Riley highlighted earlier. The second part provides an overview of the quarter and presents our financial KPI's with relevant comparative and trended data. As you will see, we have delivered accelerating growth in both the year -- in year 1 and 3-year periods for ARR and commercial subscription revenue, as well as a material improvement in our subscription gross profit margins. We will continue to refine the material in the Quarterly Earnings Snapshot in the quarters ahead, and we welcome your feedback as we strive to provide our investors continued clarity and transparency. ARR increased 85% from $13 million at the end of March last year to $23.9 million at the end of March this year. The increase in ARR largely reflects the impact of new customer contracts…

Thanks, Charles. Q1 was another strong quarter for Digimarc. Compared to the quarter a year ago, we grew quarter-ending ARR 85%, grew commercial subscription revenue 52%, and expanded subscription gross profit margin 7.5 percentage points to 87%. While investors remain understandably and rightfully excited about what our massive Ecosystem Driven Opportunities will contribute to our future, I am so proud of what the team is delivering in the massive opportunities in front of us today. Our top line growth has been accelerating from already high levels, our best-in-class gross profit margin continues to expand, and we are positioned to convert an incredibly high percentage of the resultant gross profit dollars to the bottom line by leveraging our partners to further boost our top line in an incredibly OpEx-efficient way. There are many things that make Digimarc a unique and generational investment opportunity. The fact we have 3 very real, tangible, and quantifiable pillars to our shareholder value story is one of the most powerful and, at the same time, perhaps the least understood. I encourage you all to review the Quarterly Earnings Snapshot deck Charles referenced for more on this front. As always, we remain focused on positioning ourselves to convert our large total addressable market into substantial free cash flow by delivering high and long-lasting growth at world class operating margins. Q1 provided multiple tangible examples of our progress against this focus and we remain excited for what's ahead. Operator, we will now open up the call for questions.

[Operator Instructions] One moment please while we poll for questions. Our first question comes from Joshua Reilly with Needham.

Nice job and congrats on the 85% ARR growth there. I'm curious what's the initial response you're hearing from customers on the next-gen digital watermark upgrade here? And how much of a factor was that in some of the deals that you kind of highlighted here in the quarter? Or is that more something that's going to be on the common as the growth driver in the second half of the year?

Thanks, Josh. Thanks for dialing in. Yes, great question. So off the top of my head, I don't think any of the deals that closed in Q1 took advantage of our next-gen digital watermark, but our pipeline is full of them. As we talked about in the last call, one of the -- there's a lot of key unlocks from the nextgen digital watermark. One of them is the apply-now activate-later functionality that we can roll out. We talked about how important that was going to be to our CoE program. And I guess stay tuned for our Q2 call. We'll give you more details on the initial up-ramp and success in our CoE program. But that's key there. But even with the brands that we're currently doing business with, having the understanding that, hey, they understand they're taking some of the Digimarc products -- some of their products today, maybe regionally with the idea that now they can, during package refresh, apply this apply-now activate-later nextgen digital watermark to all of their packaging, huge, huge, huge unlocking. So, really excited by the initial reception. It is specifically on the CoE program, something that is really driving conversations like many people that are higher CoE tier because that's the only place it's available to our partners. But even with our existing brands and understanding now that they can future-proof all of their packaging even if we're not ready to adopt immediately a Digimarc product, huge unlock and an ARR increase.

Got it. That's helpful. And then on the Digimarc Engage product, with the upgrade now, are you going to be making any changes to your Go-To-Market there? And how should we just kind of be thinking about the potential growth for that product in general with the upgrade?

You mean the upgrade by adding the digital functionality?

Yes.

Yes. It's just another differentiator, right? So there's a lot of things that, as you know, Digimarc Engage is the one product where potentially the most competitive in terms of having competitors can offer some of the functionality. This is just another differentiation. There's a lot of differentiation we have on the physical side with our thought leadership in digital link, our best-in-class redirection engine. The fact that we are a platform, right? And so a lot of consumer engagement offerings are one-stop shops. So the fact that there's so much more with Illuminate people can do besides Engage, the fact that because of Digital Link and Sunrise 2027, this is becoming more of an IT purchase as opposed to a marketing purchase. So all of those things play in there. We just opened up another front where we differentiate from everybody else, which is we can provide all that amazing functionality in the digital domain. And while that itself is exciting, both with conversations with end customers, but also partners who are really wrapping their head around what we can do, just by itself that would be exciting, the fact that we could provide a unified view and inform campaigns that are cross domain. This is rarefied air. This is sort of the holy grail of everything that every tech company is trying to do is, yes, it's interesting to track somebody or to provide people content into digital domain, and it's interesting to do that in the analog world. But, man, tying those 2 together, incredible unlock. And it's a differentiator has resonating.

Got it. That's helpful. And then last question from me. I don't think you've guided this specifically, but how are you thinking about the cash burn for the balance of the year relative to the recent capital raise and the cash that you have on your balance sheet, and kind of just thinking out in terms of capital allocation for the balance of the year?

Yes. So cash can fluctuate quarter-to-quarter as we kind of -- as I highlighted in my prepared remarks. Obviously, Q1 is a lot higher than what we think a normalized level is because of the tax payments. And that's why I highlight back to the non-GAAP loss really being a more normalized level. And so our focus is continuing to grow the top line, expand our margins, reduce costs to continue to decrease our loan GAAP loss which you can see has been trending down significantly year-over-year, down 39%. So that's the primary focus. We don't give guidance itself on cash flow. Part of that is because it's difficult to predict because of the inflows or outflows. But our mission as a company is really focused on driving down that non-GAAP loss, which will directly translate into improved free cash flow.

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

Congrats. A couple for me tonight. So just if I could start on the ARR, $24 million up from $13 million a year ago; you've added $11 million to the incremental ARR. Specifically as you're willing to, where has the incremental $11 million in ARR come from with respect to use cases?

I'd say the majority of it's come from our platform itself. But it's a combination of new contracts, the majority of it over the last year, but then also significant upsells with our customers. And Riley highlighted on several of those in Q1. We've highlighted some of those in prior periods. So it's a combination of really our platform itself and then Validate and Engage are the 2 other primary drivers.

Okay. Maybe shift gears to the sales front. As I think about how the sales team operates, I mean -- and I'm just looking at like Slide 9 in your deck today, which I appreciate -- you've got a ton of end market opportunities. And in thinking through how that sales force is structured, I know you've got greatly enhanced leadership, you're really doing some good things there. Take a minute just talk about your sales org and in particular how the Go-To-Market, how the reps are tasked? How it's broken down right now would be helpful.

Yes. So we have direct sales. People that are calling our accounts have industry-focus, geographic focus. And we have our market development team that are focused on some of the bigger opportunities. We are very specific to call it market development and not business development because business development is like 2 to 3 years, market developments 6 to 12 months maybe. Let's actually develop a market so we can unlock it and then throw a bunch more of AEs after that market. And so in the market development are some of our bigger opportunities like the ecosystem-driven opportunities would fall into there, some of the bigger one-off deals, but also lighting up our CoE partners, right? And that's the key unlock here. As to your point, there are so many verticals, so many areas that we could be going after where we don't need to go in there and become an expert in every single vertical. And even if we wanted to be the expert, we don't have the 15 years of showing up to the trade shows that people expect vendors, especially vendors in the Validate, the anti-counterfeit space, right? Our partners do. And so we have a team focused on opening up the CoE partners. The CoE partners then act as legitimizers. It's a speed to time to market, right, because they have existing customers, they have a pipeline, they have massive sales forces themselves. But it's also the domain expertise. It's coming in and saying, "Hey, we have this incredible anti-counterfeit partner that you meet called Digimarc" and making those introductions. And so then when those introductions come in, the direct reps pick it up. So that's really the focus, direct as it's been with market development and the CoE openings comes under market development and then any leads that come out of the CoE program go back to the direct reps unless they are our highest level CoE where they can actually -- the partners can actually sign deals on their own paper.

That's helpful. And then one other for me. If I go back to the Slide 9, I know you're saying here that the individual color codes are not breaking down the pipe necessarily per se by percentages for each of these opportunities. And I'm not clear if the general scope of the increase of the annual pipeline that's expressed here is accurate either. So maybe the question would just be, can you give us a sense -- some quantification of the expansion of late-stage pipeline now versus 6, 12, 18 months ago? Anything along those lines would help.

I would say the expansion of the pipeline is really passed all those key product areas. And I elected that part -- I shouldn't say elected, but did mention Automate earlier that's a product too that's contributed to ARR. So I mean it really goes across the gamut here as opportunities you look at on our pipeline. Obviously, CoE is a big area of focus, and we're continuing to improve Validate and Engage opportunities now with both upselling with new customers as well as the platform. And then we highlight on here 2 security solutions and deposit return systems. Those are big opportunities in our pipeline as we look forward as well.

Yes. And Jeff, we don't talk about our pipeline, we don't quantify our pipeline, but to answer your question, I think your holistic question, it's a lot bigger, obviously, right? We need to have the pipeline ahead of the ARR. And so look at what our AAR has done in the pipeline. Looking forward, it has to be there to support it. One of the reasons we don't quantify pipeline, right, is -- and we've had this conversation -- we have massive opportunities in our pipeline. And no matter what percentage we assign, we're going to be wrong. It's either going to close or it's not going to close, right? So it gets really tough when you're the size that we are, right? This is a reality we're always going to have. I hope we have these massive boulders in our pipeline, but when they become less massive relevant related to the size of existing, it becomes more noise. For us, it gets really hard to quantify externally pipeline because there's some really -- there's wonderfully singles and doubles type business, right? Some examples like the deals that we talked -- I talked about in prepared remarks today, but there's also the giant boulders. And it's hard to put it -- not hard, it's impossible to put a percentage on them because whatever percentage probability we assign, that's not right. It's either going to close or it's not going to close. It's either a 0 or 100%.

Our next question comes from Jeff Bernstein with TD Cowen.

Just wanted to ask a little bit more about the deposit return scheme opportunity. There's a lot written in the last couple of weeks about -- in order for these European countries to even sort of get into a positioning where they could be on track for the plastic reuse and recycling goals that they have. They almost have to get on deposit return schemes. Can you just flush that out a little bit and talk a little bit about what kind of time frames you think that stuff has to happen? And can you tell us if the one that your partner had ongoing has launched yet or kind of any learnings from that?

Yes. So the reason, Jeff, I'm guessing you've seen a lot on the DRS stuff is because of the -- I don't want to call it a leak because it came from the EU, but they haven't released the final text for the PPWR. So a lot of the questions you're asking will be in the final text. But they made it very clear that one of the things they have talked about, because they released a few the bigger policy things, that if for any country where collection is not above an incredibly high bar -- and I don't remember exactly, I think it's like 90% -- incredibly high bar. Yes, we're going to have to roll out DRS, right? And so one of the key parts of a DRS -- I mean, DRS is a pretty simple concept. You put a deposit on a bottle or a can and then when you return it, you get your deposit back. So it's not -- the systems themselves are pretty easy. The problem is the fraud. And there's a million examples. Lately there was a family in Arizona that's -- I don't know what happened, I haven't been following the case, but it was a headline where they made $6 million taking products from Arizona and bring it into California. It's rough, right? And so what they need is a way to authenticate that the products that are being returned actually were part of the deposit return scheme, that there was a $0.05 or $0.10 deposit placed against that product. There's a lot of ways to do product authentication, right? A lot of them are really expensive. Our value that we have to offer through Digimarc Validate is the same value property offered DRS and in general, lowering the cost of a DRS system -- because they are expensive -- is wonderful. We can also democratize it in so far, as in a lot of places, it's not just the cost. It's also -- they don't have 60,000 square foot supermarkets that could have one of these really expensive RVMs, reverse vending machines. People want to use their cell phone [indiscernible] on the country side, right? So that's where we come. And just like we offer a differentiated offering with Digimarc Validate for any product authentication, we can do the same thing, which is a key component of the DRS. And there is not an area that we want to get into directly ourselves. This is an area we'll go through our partners. But a really exciting opportunity. We can't wait to see the final text of the PPWR and move forward from there based on all the marching orders. And again, the key thing about the PPWR, right, is the R stands for regulation, which means it's not negotiable. The member states are going to have to adopt whatever is in this final text.

Got you. Okay. And then anything on your partner's initial win and how that's progressing and kind of any learnings from that?

Yes, progressing well. I don't really know if there's any learnings yet today, but we will -- just like with our biggest commercial customer, the best way to earn the trust every day to not talk about our customers' business on their behalf. But obviously, because this is a national scheme, I would assume it would become very public whenever the country is ready to talk about it, just rolling out I'm sure. Once we're allowed to amplify it, trust me, Jeff, we will.

Yes, understand. And then just wanted to make sure I understood on Automate. Does Automate imply that there is some factory automation element to how something's being used? Or is that not the right way to automatically think about it?

No, that's right. It's in fulfillment centers, distribution centers. It's a way to apply digital watermarks in the Illuminate platform in the process of some sort of automation, right? So multiple use cases -- sorry, multiple locations, right, distribution centers, performance centers, where this could be applied, where there's currently automation today. And either, one, there actually is an automation that's still being done by humans because of the other means identification don't work at all or there is some automation that doesn't work well or it's really expensive because others means of identifications don't work well. And that's the opportunity. If you see in our deck, we will officially launch Automate in the not-too-distant future. Incredible, we haven't even launched this product yet, and we have multiple customers not just historic, but if you paid attention to the prepared remarks, there was multiple deals in Q1 just from Automate. That is an example of having wonderful partners in this space as well as just a real demand for a high ROI return, which is either we're actually allowing the initial steps of automation that were not existing before. We're also taking an automation though it's kind of kluge here, didn't work well, and bringing it in the 21st century.

Terrific. And then last question. In terms of that newest ability, because I think you only started talking about it pretty recently, of tracking consumer interactions, both in the e-commerce world and then in the physical world, it sounds like you already are signing some deals relented to that?

On the digital side?

Yes. Or on a hybrid of -- we're going to follow both the e-commerce and physical world. Yes.

No. So nothing yet signed. We announced this not too long ago. It takes a while for pipeline. But it's an area of interest, not just directly with some existing customers, but really from our partners because this is something that they wrestle with, our partners, right, is they're getting asked to do some really difficult things. There's a very big partner of ours that's talking about how they're trying to help customers in the multimedia world, right? And they can offer stuff like content repositories or creating artwork, not just for physical packages, but for e-commerce, right? That's all really, really important, really, really interesting. The more opportunities we can offer in this hybrid world through our partners, it just makes their conversations easier. It gives them a reason to ping their existing customers. They had no way to talk in a while. We have this great new partnership that's coming called Digimarc, I tell you more. So I would assume here it's going to be partner-led only because our partners get this. And you have a conversation. This is back to the operating leverage our CoEs will give us. You have a conversation with a partner and that partner has got 1,000 salespeople, you can have 1,000 customers or 1,000 conversations with customers through that entity as opposed to us going back during QBRs with our existing customers say, hey, let's say there's a new functionality. So I would assume this one in particular. And as we've been talking about a lot of our business, customer led. But just like I think Jeff is asking about the apply-now activate-later the nextgen digital watermark, the CoEs get it. And they get it immediately and there's a lot of excitement.

Okay. And just to understand from kind of a real-world example. So you could have a packaging bar who has been discussing Digimarc watermarked packaging and the interaction that that allows with people who then is going back to say, "Oh, and by the way, the Digimarc's ability to track all of this in a cloud-based database" means that we can now also intercept when somebody has interacted online relative to some offer that you made or relative to something on social media, et cetera, et cetera. And we can wrap that into a complete view of how the person interacted, not just with the package, but with your other advertising or promotional messages.

Kind of, but really. So 2 things, right? The 2 partners that most get this are the premedia/printing partners, right? And this is where customers are coming to them and saying, "Hey, how do we apply with Sunrise 2027? You are the packaging expert" or "Hey, we want to put a QR code on our packaging for consumer engagement", right? Up until now, they're like, right, we can put a QR code on and do this stuff. They didn't have the technical back-end or the expertise or the technology to say, "I'm so glad you asked us about that". Let's talk about how we're going to apply this, not just to your physical packaging but also for all your owned multimedia. Let's have a broader conversation where we're not just talking about packaging, which tends to be a competitive industry, right, on fair purpose. Let's say let us talk about this whole thing we can offer even in the digital domain. And that makes their end customers a lot stickier because now they're not just coming to procure [indiscernible] packing, they're coming to them to solve a bigger -- to get what they wanted to do with QR codes, whether it is a direct consumer channel, but across both the packaging but also the internet. The other big area of partners are the advertising agencies, right? So these advertising agencies are in charge of coming up with campaigns and one of the things we can offer is not just stickier customers or a chance to reach out, they also can monetize and build a campaign. We don't want to be in the content creation business of putting together this -- I mean some of these campaigns are 7 figures because they are incredibly complex and beautiful and detailed, and you've…

There are no target questions at this time. I would now like to turn the floor back over to Riley McCormack for closing comments.

Well, thank you, everybody, for joining us today. That's all we have. Have a wonderful rest of your day.

This concludes today's teleconference. You may disconnect your lines at this time. Thank you for your participation.