Q3 2023 Digimarc Corp Earnings Call
Greetings and welcome to the did you Mark Corporation third quarter 2023 earnings Conference call.
At this time all participants are in a listen only mode. A question and answer session will follow the formal presentation.
Once you require operator assistance during the conference. Please press star zero on your telephone keypad.
As a reminder, this conference is being recorded.
It is now my pleasure to introduce your host Joel Mayer 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.
Reilly will now provide a business update.
Okay.
Thank you, Joe and Hello, everyone.
Q3 was another strong quarter for Denmark.
Charles will provide a more detailed discussion on the financial results. During his remarks, there are two metrics I want to highlight the top of the call because their absolute levels as well as our expectation they won't 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 <unk>, 54% year over year.
As mentioned during the last few earnings calls first year bookings has become a less relevant metric because our focus is on growing our recurring and high margin subscription revenue.
Signing those customers to multiyear deals.
Our decision to begin reporting our quarter end are our reflects our desire to provide investors transparency with the results of that focus.
It was a greater understanding of our true underlying growth.
And while the 54% year over year grocery is objectively high we believe we are capable of more.
In fact, while it is still early in the current quarter, we expect our European your arrow growth rate 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 a 1000 basis points year over year, and 200 basis points sequentially.
On our Q4 2022 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 and every single quarter, but our gross profit margin is now closer to 90% and 80%.
There's no greater predictor of accompanies ultimate level of profitability no better proof of the depth and width of it what's the smokes and subscription gross profit margin and an 85, 5%. We are near best in class similar to the levels of other high quality and wide motive SaaS businesses that enjoy the extra gross profit margin tailwind that comes from being a.
A much much larger than we are today.
Like our AOR growth rate, we believe we will improve from these already high levels.
Yeah.
The combination of high and accelerating era of growth and our significant gross profit margin expansion not only speaks to the quality of the business. We are building and the differentiated products, we were able to deliver but acts as a potent cocktail and getting us to cash flow breakeven and beyond.
Yeah.
I wanted to spend the rest of my prepared remarks discussing three specific areas that we know are of interest to investors, but before I do I want to stress it I'm focusing only on these three simply because of time limitations not because they are the only areas by which we are excited.
In fact, if one were to compare my prepared remarks over the past few quarters to the news we have delivered and some in the subsequent quarter, you'll notice little correlation of topics.
I view my prepared remarks, as a forum to provide updates on areas in which we have received the most questions as well as an opportunity to continue providing transparency into the different parts of our business not as a sneak preview of upcoming news we prefer to let the news I E. The results speak for themselves.
Starting with Citron Macrocycle, we recently announced that France will be the first country wide rollout of this world changing product.
Did you Mark recycled represents a revolution in the sortation industrial cycling of plastic waste.
The power did not just increase the quantity and quality of classic recycled, but also uncovered never before seen data about the post purchase product journey.
According to the Ellen Macarthur Foundation.
Quality plastics recycling was also one of the most impactful things we can do as a planet to reduce carbon emissions and Moreover, it comes in a negative financial costs.
This means there is an economic return on investment from achieving higher quality classics are cycling. In addition to the obvious environmental benefits something that are recently industry Commission steady on Digi Macrocycle independently corroborated.
It is for all these reasons and more that fortune recently right. The 17 weeks on their esteem 2023 change the world list. Despite their stated preference for companies generating generating over $1 billion of revenue.
Which we don't have yet.
The news regarding the country wide rollout in France is a major milestone for our company and a testament to the power of our technology and our team.
We are dedicated to working with this initial group of visionaries to help expand adoption in France and on that front I'm excited to share that we are close to signing a deal with a very large company that was not even listed in our press release from only a few weeks ago.
Beyond France weird progressing activities in multiple other countries as we pursue the country by country Avenue for driving did you macrocycle adoption.
Important to note two weeks ago, the European Commission.
Voted on amendments to the packaging and packaging waste regulation for P. P. W. R is that important law progression towards Finalization.
Included in the new amendments the timeline to implement digital marketing was shortened by six months.
We applaud that he sees vision and their urgency.
We are also pursuing additional go to market avenues for cogent macrocycle in parallel with this country by country approach, including partnering directly with global brands and retailers to push adoption in multiple countries at once.
Working with prospects to open a market via a closed loop solution, which can then act as a catalyst for wider in country adoption.
Progressing our work in lighting up deposit return scheme.
You added resellers, which then acts as a profitable wedge to open did you mark recycled conversation in those countries.
On this last time I was recently in country meeting with our first year as far and it was accelerating to see initial production epic D. R. S logo being applied to real world part products.
I believe one of our greatest strengths will always be the awesomeness of our bars and I expect when the world sees the tangible results of this far as easy and cost effective and quick to say at scale solution interest in <unk> ability to help improve upon existing P. RF solutions will significantly increase.
One last thing to highlight on recycle while historically our focus has been on the application of Digi Macrocycle for the plastic pollution crisis recently, there has been interest by other substrate ecosystems to solve their own end of product life issues.
Obviously and customer synergies as retailers and brands use multiple different materials in their packaging and our proven results in plastics objectively lessen the need for proof of concept work in other substrates.
Also worth noting the P. P WR doesn't restrict the digital market requirement to just plastic packaging.
Yeah.
Next I'd like to spend some time on did you mark illuminate for factory automation.
This compelling offering brings the power of the illuminate product digitization platform into a production fulfillment or distribution facility.
The ability to identify specific products had robust deterministic in novel ways unlocks important new automation not otherwise possible.
In the specific case of the deal we discussed last quarter, one of the world's largest cpg's was interested in removing excess packaging from one of our marquee products in an effort to save both money and the planet, but and so Julian would've lost the ability to differentiate between different variations of this product something required for their exacting standards of quality assured.
Yes.
Andrew did you Mark illuminate for factory automation and its ability to connect physical products to their digital twins be our unique bridge did you Mark digital watermarks.
This cost environment, an environment saving application is something that has sparked the interest of other prospects as well as multiple ecosystem partners, who could act as force multipliers in our quest to digitize the world's products.
In fact, one of our partners will be presenting our offering at an important industry event next week.
The potential here is enormous as we have all the necessary ingredient ingredients for success.
<unk> Roy a wonderful environmental impact are robust and interesting ecosystem of force multipliers and extremely happy customer and of course, a unique solution that only because you mark illuminate platform is capable of providing.
Other prospects are exploring using did you mark illuminate for factory automation to provide novel automation that differ from the maintenance of production my quality control when removing excess packaging. Examples include solving for coda collusion caused by harsh factory conditions, and automating workflows that don't lend themselves to the perfect presentation of the single.
Good.
Recall, the multiple characteristics of <unk>.
<unk> digital watermark box culvert ubiquitous redundant insecure.
And recall that for use cases that require one some or all of these attributes did you Mark digital Watermarks series, the best choice for the only choice for connecting physical products to their digital twins.
When it comes to automating factory I automate our operations. We are finding there are multiple reasons why one some or all of these attributes are required as you know.
Only product Digitization platform capable of using digital watermarks as the bridge between a physical object in those digital twin we believe the sandbox version of our platform version of our platform did you Mark illuminate for factory automation as a bright future and helping our customers solve some really pressing problems and so doing.
Allowing them to either start or continue a longer product digitization journey.
In terms of market size as I mentioned last quarter.
We believe this solution is applicable to hundreds if not thousands of potential customers and the single deal. We signed in Q2, which covers a single product across two countries represents mid six figures of a R. R.
Finally, moving to did you Mark validate it is incredible to look back on the progress we have made since our last call.
The launch of our product just over a month ago.
Our legacy is being the pioneer and widely recognized leader in digital water market.
Technology that has been universally accepted as having a key role to play in the new world of generative AI.
Coupled with our experienced until the massive multinational multi stakeholder in mission critical systems are trusted authenticity upon that technology spend our entre into important conversations across the ecosystem we.
We are actively engaged with governments standards bodies.
Content creators and technology partners and prospects of all sizes.
Jenny I didn't create the deep fake issue, but it did democratize it.
And if the world is to enjoy the benefits of this powerful new technology action must be taken to protect against its risks.
This is not a view we are unique in having and the speed at which all stakeholders are moving is astounding.
We believe the results is the world will look back at jet AI as a catalyst for the delivery of something long overdue anyway, a safe pair trusted authentic internet.
Did you Mark validate is ideally positioned to be the foundational element that's such a future.
On the government front, we've been engaging with leadership at the highest levels to discuss the need for tools to support the protection and authentication of digital assets and the journey.
We have met with senior leaders at the White House executive agencies and departments and in Congress and in these bipartisan meetings, our history proven technology and ability to work across images and audio, especially on device is helping drive awareness of what's possible.
We've been asked by multiple groups to help educate and inform the conversation commitments coming regulation and our ideas have been well received.
We expect to continue participating in discussions at the highest levels to shape the future of artificial intelligence.
And the broader digital ecosystem and we feel confident that did you Mark validate has an important role to play and effectively protecting the rights of content creators and owners. While also building the foundation of true digital asset authentic authentication.
On the standards body front, we are a member and heavily involved in the coalition for content provenance and authenticity otherwise known as C. G. P. A.
For those of you not familiar with C. G. P. A it is a group of industry leaders working to address the prevalence of misleading information online through the development of technical standards for certifying the source in history or provenance of media content.
We are appreciative of all of this hard smart work. This group has been doing.
I'm thrilled they understand digital watermark and has a role to play in proving the authenticity of digital content.
I know there've been some questions around C. T P H contact credentials and if this is competitive to validate and the answer is no.
In fact gets you mark will be supporting contact credentials as part of our upcoming registry because while industry standards are necessary. They are not items self sufficient.
I think credentials are an elegant means of organizing and recording metadata, but the risk. The metadata is that it can be altered and is removed by common workflows, such as editing software and social networks rendering it useless for the purpose of intellectual property protection and authentication in such scenarios.
Just like in the physical world, our digital watermarks without cause unique necessary and a beautiful bridge between the data and the object, allowing the content owner to control their digital asset story.
On top of this governmental and standards bodies engagement of course, we are building or did you Mark validate business did you Mark validate provides value to content creators and their consumers as well as owners of detection points running the gamut of Gen. AI engines E Commerce sites network security companies and device vendors.
We are engaging with prospects with partners across the full spectrum of size and we intend to make it as difficult to counterfeit counterfeit content and identity in the digital world as we have currency in the real world.
In addition to the massive opportunity ahead of us.
We are uniquely qualified and positioned to address it.
There are two perhaps not obvious important points worth highlighting about our entre into the digital domain.
The first is that our ability to bridge, both the physical and digital domains is a key differentiator of our platform our products and our digital watermarks and nowhere is that becoming as obvious as the benchmark validate.
And secondly, as I know at least a few investors have noticed the visiting our web site. The expansion of did you Mark validate with digital domain allows us to open a fully digital sales motion.
In terms of our mantra of being easy to begin doing business with an excellent guiding customers along their product Digitization journey. This web based sales motion has opened a new door to easy.
Thus the expansion of benchmark validating the digital domain, that's not only dramatically increased our overall total addressable market. It has also increased our opportunity that physical domain, adding width and depth to the moat surrounding all of our offerings.
I will now turn the call over to Charles to discuss our financial results.
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 <unk>, representing 54% growth year over year.
I'll 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 400000 for the quarter.
I highlight these areas as they are all critical drivers toward reaching profitability.
Now onto the details.
As already mentioned, we have decided on.
Recurring revenue as it's a key performance metric we are now using to run our business.
We intend to report Indian Air are each quarter with comparative periods. So you can measure our progress.
Calculate ear are using the annual recurring fees seeded in our sales contracts.
The underlying economic value of these contracts.
Also there are only includes recurring subscription fees from commercial contracts government contracts service fees and nonrecurring subscription fees are excluded from our reported error.
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 are are are 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 that the payment terms in our sales contracts are consistent with traditional SaaS terms, which results in the collection of the annual payments upfront.
I call. This out because it is yet another benefit of our transition to becoming a product and platform company and allows our air outgrowth to having more immediate impact on improving cash burn.
Okay.
And then are for the quarter was $19 6 million, representing net <unk> growth of $6 9 million or 54% year over year.
Total revenue for the quarter was $9 million, an increase of $1 2 million or 15% from $7 8 million in Q3 last year.
Subscription revenue, which accounted for 53% of total revenue for the quarter grew 18% from $4 1 million to $4 8 million.
The increase reflects subscription revenue recognized on new customer contracts signed this year as well as upsells this year on existing customer contracts.
Service revenue increased 12% from $3 7 million to $4 2 million.
The increase reflects a larger annual budget from the central banks for project work. In 2023, then 2022, which includes both higher billing rates and project hours.
Subscription gross profit margin improved from 75% in Q3 last year to over 85% in Q3 this year.
The large increase year over year reflects two positive trends. We've highlighted previously both a favorable mix of subscription revenue to our newer products and lower product infrastructure costs.
We expect these trends to continue resulting in further expansion over time towards subscription gross profit margins.
Services gross profit margin decreased from 57% in Q3 last year to 54% in Q3 this year.
The decrease reflects a more favorable labor mix last year than this year.
We continue to expect services gross profit margin to be in the mid fifties on average going forward with some fluctuation quarter to quarter, depending on labor mix.
Operating expenses for the quarter was $16 4 million compared to $19 7 million in Q3 last year, a decrease of 17%.
The large decrease in operating costs, largely reflects lower head count, partially offset by annual compensation adjustments and lower contractor and consulting costs.
Additionally, in Q3 last year included $1 4 million of severance costs for organizational changes.
non-GAAP operating expenses, which excludes noncash and nonrecurring items were $13 2 million for the quarter down 15% compared to $15 5 million from Q3 last year.
Net loss per share for the quarter was 53 versus 76 cents in Q3 last year.
non-GAAP net loss per share was also considerably lower for the quarter at 29 cents versus <unk> 47 in Q3 last year.
We ended the quarter with $33 3 million in cash and investments.
Free cash flow usage was 400000 for the quarter compared to 11 4 million used in Q3 last year.
We used an additional 800000 of cash in Q3 for share repurchases.
Q3 shows the power of my earlier comments about our focus not just on growing our subscription business, but also in our opinion in terms of that business.
And while we expect Q4 free cash flow usage to be higher than the 400 K we used in Q3.
It will be significantly lower than prior quarterly trends.
Last quarter I mentioned, we expected our free cash flow usage for the final six months of 2023 to be notably less than the $7 9 million. We used in Q2 alone we are reiterating that statement today.
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 will now turn the call back over to rally for final remarks.
Thanks Charles.
We're 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 our market. Then it 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 <unk> validating 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 is our can become larger but our moats have become wider.
As those of you with whom I have spoken over the years now I think there is a really easy way to identify what's in generation investment opportunities before they become obvious to the rest of the world. It is simply a matter of Tam moats and execution.
As just mentioned our massive Tam has become that much more massive and are incredibly wide moat to become that much lighter in.
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.
Diego will now open the call up for questions.
Thank you.
Ladies and gentlemen, we will now.
Now conduct a question and answer session. If you would like to ask a question. Please press star one on your telephone keypad, a confirmation tone will indicate that your line is in the question queue. You May press. The star key followed by the number two if you would like to remove your question from the queue for participants using speaker equipment, it may be necessary to pick up here.
Handset before pressing the star keys.
Our first question comes from James Ricchiuti with Needham <unk> Company. Please state your question.
Hi, Thank you good afternoon and by the way thanks for the additional information on the E. R. R.
Gosh I have is just with respect to the subscription revenue that you're seeing is there.
Are you seeing more activity from upsells on existing with existing.
Adjusting customers award.
Or with new customers.
And the impacts definitely come from both but it's been more from new customers. We've had our hands on a couple of handfuls of really nice upsells that we highlighted on the last call this year, but the majority.
New revenue is coming from new contracts.
Okay got it and then yeah, maybe a little bit of color on the if you can on the expected deal you you alluded to with a company that's presumably.
Tied to this rollout in France, Yeah, I'm wondering what's driving this is this an existing customer someone you've been talking to.
Yeah.
I'm, sorry, Jim you broke up.
Are you asking the customer we alluded to be close to siding in France.
Yes, I am. Thank you yeah. So it's a new customer it's a new logo, it's incredibly impressive logo.
And the point I was trying to make in that part of the call is 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 sometime in that period of time. So I think their interest is in helping.
Helping make a difference in the environment in France.
Got it.
I think I was going to add and I can add on to what youre, saying.
Jim We had this conversation in the past.
We expect to be in and cross sell opportunity for decades.
So it's important to get those new logos.
And its future.
Selling 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 as they are accretive so we don't care, where somebody starts a product digitization journey.
Our goal is to guide them to be excellent guide that.
Continuing to product Digitization journey.
Got it and final question.
Back in the queue early days I know with valid, but I'm just wondering.
What kind of traction do you anticipate some notes over the next year.
It's hard to quantify it at this point I can tell you we're having.
Those are the words very carefully are saying, we're having conversations across the whole gamut. We are talking to some very large both on the on the.
Content creators content owner side as well as on the nodes.
Nodes side on the detection side, we were talking to the biggest of the big.
We also expect that this will be a a web scale.
[noise] opportunity too and so we have some smaller opportunities were progressing as well.
Got it thanks very much.
Thanks, Jim.
Thank you and a reminder to ask a question press star one on your telephone keypad to remove yourself from the queue Press star two.
Our next question comes from Jeff Van <unk> with Craig Hallum Capital. Please state your question.
Great. Thanks for taking my questions Ravi.
Back to the France.
The 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.
Just kind of what do you anticipate over here.
He is precisely as you like but just how does <unk> play out and you know.
Really start moving the needle on revenue how do you know sort of over under when does it really start to make a difference.
Yes.
The wonderful thing about France as the first stage of macrocyclic country. We've opened so I don't have I I'd like to stick with what we know is that's what we think.
I can tell you that you know when you're asked to that who the customers are there going to be that brands and retailers are people putting plastic packaging.
Into the French market.
So we'll see we'll keep you all updated as we know more.
Sure.
Right.
Yes.
And what's exciting about it is the initial the initial interest or from the Big Company you saw a couple of the.
Logos that were listed in the press release.
That's the size of the company we're talking to.
Okay.
You had the large win a couple of quarters ago within there you had some security printing customers.
Customers in particular, how are those going and any other follow ons similar to those working through the pipe.
Yeah. So there is follow on in the pipe absolutely.
When you said how is that going up that was what I referenced if you remember that customer signed up.
Or is using illuminate to build three products one of them is a deposit return scheme.
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.
Their logo is three.
Throwing out being produced on very high volume very iconic products.
It has gone well.
Okay. Okay.
Okay.
Thank you and then just lastly, maybe open ended because I know you said you tried to address your comments on the call to 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.
Youre talking about the product mix or are you talking I'd give you almost.
Working 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 Greg I mean, I think you can look at our air growth rate, we grew air or 54%.
And so there's and I if you listen to if you look at what I said, we expect <unk> growth to be greater in Q4 on a year over year basis than it was in Q3.
Okay.
All I have thank you.
Thanks, Jeff.
Thank you there are no further questions at this time I'll hand, the floor back to Riley Mccormick 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.