Q1 2025 Digimarc Corp Earnings Call
[inaudible]
Speaker Change: Greetings and welcome to the Digimarc Q1 2025 earnings conference call. At this time all participants are going to listen only mode. A question and answer will follow the formal presentation.
If anyone should require operator assistance, please press star zero on yourself and keep that.
Speaker Change: As a reminder, this conference is being recorded. It is now my pleasure to introduce George Karamanos. Please go ahead.
George Karamanos: Thank you. Welcome to our Q1 comments call. Riley McCormack, our CEO , and Charles back, our CFO are with me on the call.
George Karamanos: On the call today, we provide a business update and discuss Q1 2025 financial results. This will be followed by a question-and-answer form. We've posted our prepared remarks in the Investor Relations section on our website and will archive this webcast there.
George Karamanos: 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 differ materially. Riley will now provide a business update.
Thank you, George, and hello everyone.
Riley McCormack: As discussed on our last earnings call, we have narrowed our immediate focus to three specific opportunity sets. Retail loss prevention, physical authentication and digital authentication.
Riley McCormack: In parallel, we have also ensured that we are positioned to benefit from our historical programs in other areas, either directly or through our valued partners.
Riley McCormack: This tightening of focus was made possible by a recent technological and market advancements in the authentication space.
Riley McCormack: As a reminder, we discussed those advancements in greater details in our last two running skulls.
Riley McCormack: It is a testament to the power of our team and our technology that we've been able to grow annual recurring revenue, or ARR, almost five times over these last four years, as we've been zeroing in on areas of deep product market fit. Most companies oscillate around flat until they reach that critical milestone.
Riley McCormack: We've accomplished this while applying the rigor and focus required to speed time to deep product market fit.
Riley McCormack: Since the middle of 2021, we have exited businesses and deemphasized offerings and business practices that didn't make strategic sense, while also moving away from pursuing non-scalable services revenue.
Riley McCormack: Adjusting for the end of life of our piracy intelligence business, we have more than the flippled commercial subscription revenue since Q2 2021.
Riley McCormack: We have also expanded our subscription gross margin almost a thousand basis points, despite no longer licensing our IP to potential competitors.
Riley McCormack: This decision was a headwind to both revenue and margins, as IP licensing carries 100% gross margin rate.
Riley McCormack: It was also unquestionably the right thing to do to ensure our long-term success
Riley McCormack: We're exciting to where we have been, however, is where we are going.
Riley McCormack: On that front, I want to take a moment to reiterate we'll be shared on our last call.
Riley McCormack: While we continue to expect lumpiness as we shift our focus to our core authentication use cases, we believe we are on the cost of sustainable free cash flow generation for the first time in over 12 years.
Riley McCormack: Moreover, beyond just achieving this important milestone, we expected to deliver significant top line growth and free cash flow generation in 2026 and beyond.
Riley McCormack: Turning now to an update on our business, our Q1 results came in above our internal plan.
Riley McCormack: These results demonstrate that it is indeed possible to deliver in our much tighter focus areas, while still positioning ourselves to potentially benefit from our historical work outside these specific areas.
Riley McCormack: Starting with our work in retail loss prevention, we expect the first gift cards protected with our solution will appear on shelves within the next month.
Riley McCormack: This is a critical milestone in our work to catalyze the industry towards meaningful adoption this year.
Riley McCormack: Moreover, while the market sizing we have shared for our gift card solution only contemplates the US market, we're beginning to work with partners to map out the opportunity in multiple other large geographies.
Riley McCormack: The driver behind narrowing our go-to-market focus is the incredible power that comes from such focus especially when trying to orchestrate a rollout as large and on as tight a timeline as we expect this gift card rollout will be.
Riley McCormack: As discussed in greater detail in our last call, the other retail loss prevention use case at the Expected Contribute to 2025 ARR is our solution addressing price look-up or PLU fraud.
Riley McCormack: On this front, our initial customer will be a featured guest on the May 29th episode of the Influential Omnitalk Podcast to talk about the power of our solution.
This level of customer advocacy is both powerful and appreciated.
Riley McCormack: Turning down to our physical authentication solutions, we expect to shortly sign a fifth deal with the Digimarc Validate customer I represent our last call. Recall the first deal they signed with us was, the first deal was signed in Q3 2024.
Riley McCormack: Our learning service engagement, and how we can replicate it, are as valuable to us as the mid-six figure revenue it represents.
Thank you.
Riley McCormack: We've also formed a partnership with the fellow supplier to one of our loyalty and reward customers.
Riley McCormack: We both agree with this shared customer that our solutions pair well together.
Riley McCormack: As a reminder, our loyalty and reward offering involves the application of serialized QR codes and Digimarc Illuminate Analytics to modernize and secure loyalty and reward programs, not the creation of the underlying programs themselves.
Riley McCormack: This new partner has already introduced us to four of their more than 1,000 customers. We look forward to strengthening this new partnership one happy customer at a time.
Riley McCormack: Touching now on our digital authentication solutions, as mentioned on our last call, we had chosen to be very conservative about this area's contribution to 2025 ARR.
Riley McCormack: We made this decision to ensure that we were focused on optimizing our work in this area for the long term.
Riley McCormack: As it turns out, it is likely this area will exceed the conservative assumptions for this fiscal year.
Riley McCormack: Now don't only do we expect to grow the relationship with the Fortune 100 customer we discussed in the last call, we are also beginning conversations with others interested in the similar solution to help fight unauthorized leaks and or the improper usage of sensitive and valuable digital assets.
Riley McCormack: Still, my message remains consistent. We will make decisions optimized for the long term, not the short term, in this area and across our entire business.
Riley McCormack: Moving now to how we have positioned ourselves to benefit from other opportunities outside of our three current areas of focus, last week we were excited to share the news but being selected by Unilever to be their digital link vendor of choice.
Riley McCormack: We also recently want to deal with another large CPG for the same use case.
Riley McCormack: With the twin tailwinds of Digital Product Passport in sunrise 2027, carving out early winds in the space sets us up to help companies with their need for upcoming compliance, whether that be directly or through our value print pack partners.
Riley McCormack: We were also excited to share the announcement from the Alliance to End Plastic Waste in Aim that now is the time to scale commercial adoption of Digimarc Recycle.
Riley McCormack: We agree in our initial win in Belgium, as well as our support for other opportunities this group is progressing, positions of squarely under that tree as this much-needed future unfolds.
Riley McCormack: Finally, with regards to our work of identifying digital assets in the era of Gen AI, we expect to be able to soon announce a win with an important division of the United States government.
Riley McCormack: When it comes to providing the safer, fair, and more transparent internet we all deserve, this win is an important beachhead as the future unfolds. It should also act as an important point of validation as we focus on opening the digital authentication market that is currently a commercial focus.
Charles Beck: I will now turn the call over to Charles to discuss our financial results.
Thank you Riley, and hello everyone.
Charles Beck: Ending an air hour for Q1 was 20 million, compared to 23.9 million for Q1 last year.
Charles Beck: Excluding the 5.8 million commercial contract that lapsed last year, we grew in an ARR $1.9 million representing your on-year growth of 11%.
Charles Beck: I want to remind everyone that on the last earnings call I mentioned the potential for an increase in customer turn and that we would be strategically price aggressive on a handful of renewals outside our current focus areas. This occurred in Q1 and we expected to continue into Q2 as we tighten our go-to-market focus.
Charles Beck: As Reilly referenced earlier, we are above our internal plan for ARR after the first quarter.
Charles Beck: Total revenue was 9.4 million, a decrease of 600,000 or 6% from 9.9 million in Q1 last year.
Charles Beck: Subscription Revenue, which accounted for 57% total revenue for the quarter, decreased 8% from 5.8 million to 5.3 million. The decrease reflects no revenue recognized on the expired commercial contract I just referenced, versus 1.1 million of revenue recognized in Q1 last year.
Charles Beck: Excluding the impact of the expired contract, subscription revenue would have increased 600,000 or 13 percent, or reflecting revenue recognized on new contracts and uptills on existing
Charles Beck: Service Revenue decreased 3% from 4.2 million to 4.1 million, reflecting lower government service revenue from the central banks, partially offset by higher commercial service revenue from Holy Grail recycling projects.
Speaker Change: As I stated on the previous earnings call, we expect government service revenue in 2025 to be 12% to 14% lower than 2024, but also to be spread more evenly in 2025 than 2024.
Speaker Change: Actual results were in line with our budget as government service revenue is down 17%, reflecting both the lower annual program budget and a smoother distribution of services in 2025.
Speaker Change: Regarding the Holy Grail recycling projects, we have now substantially completed the services related to Phase 3. We do not anticipate any future services as the industry shifts its focus to commercial
Speaker Change: Subscription gross profit margin, excluding amortization expense was 86% for the quarter, down 1% of point from Q1 last year, reflecting the impact of lower subscription revenue.
Speaker Change: We anticipate that subscription gross-profit margins may be lower the next couple of quarters as we continue to consolidate our legacy platforms.
Speaker Change: But after the migration, we expect subscription gross margins to recover and even increase over time as our illuminate platform should be more efficient than our legacy platforms.
Speaker Change: Service gross profit margin was 65% for the quarter, up 9% points from Q1 last year, reflecting a favorable service labor mix that we do not expect to continue at this elevated level.
Speaker Change: As a reminder, we expect to generate mid 50% service gross profit margins on a normalized basis with some fluctuation quarter to quarter.
Speaker Change: Operating expenses were 18.2 million for the quarter, up 6% from 17.1 in Q1 last year.
Speaker Change: The increase in operating expenses primarily reflects 3.2 million of one-time cash severance costs incurring Q1 related to the reorganization we announced in late February and 900,000 of higher professional services costs.
Speaker Change: It was personally offset by lower stock compensation expenses of 1.5 million and lower headcount cost of 1.4 million.
Speaker Change: Due to the time of reorganization, the headcount cost savings in Q1 were around $1 million, but going forward we expect the savings to be over $4 million a quarter.
Speaker Change: non-GAAP operating expenses, which exclude non-cash and non-recurring items, were 16.5 million for the quarter of 19% from 13.8 million in Q1 last year.
Speaker Change: The increase in non-GAAP operating expenses primarily reflects 3.2 million and one-time cash sevens costs incurred in Q1 related to the reorganization and 900,000 professional services cost partially offset by lower head cap costs at the 1.4 million.
As a reminder,
We do not exclude cash severance costs in our non-GAAP results.
Speaker Change: Knitloss per share for the corner was $0.55 versus $0.50 in Q1 last year.
Speaker Change: Now a gap net loss per share for the quarter was 40 cents versus 27 cents in Q1 last year.
Speaker Change: Excluding the 1x7's cost of 3.2 million, net loss per share and non-GAAP net loss per share would have been 40 cents and 25 cents respectively, both in improvement over Q1.
Speaker Change: Now it's earning a cash flow. We ended the quarter of 21.6 million in cash and short-term investments.
Speaker Change: Free cash flow usage was down considerably from 8.6 million in Q1 last year to 5.6 million in Q1 this year. Further, the 5.6 million of free cash flow usage included 2.1 million in one time sevens related costs paid during the first quarter.
Speaker Change: Excluding the one-time severance cost paid, free cashly usage would have been $3.5 million.
Speaker Change: Looking ahead, we now expect to see higher cash flow usage in Q2 than we originally expected due to significantly higher legal and public relations costs as a result of an external matter that arose near the end of March.
Speaker Change: Currently, these costs are running upwards of half a million dollars per month before accounting for the risk they introduce to an ongoing customer and partner conversations.
Speaker Change: Assuming a cessation of this external matter, after Q2, we expect normalized Casulo usage to continue to decrease with the gold becoming free Casulo positive by Q4 this year.
Speaker Change: For further discussion on our financial results and recent prospects for our business, please see our form 10Q that will be filed with the SEC. I will now turn the call back over to Riley for final remarks.
Thank you, Charles.
Speaker Change: We are excited to continue to execute against the strategy we lead out in the last call. Recent technological and market achievements have allowed us the opportunity to tighten our focus to an even greater level. And we see that opportunity knowing that the combination of focus, this team and this technology is a powerful force.
Speaker Change: While early, Q1 results demonstrate that it is important that it is possible to deliver in our much tighter focus areas while positioning ourselves to potentially benefit from our historical work outside these specific areas. We remain excited about what lies ahead.
Joe, we will now be calling for questions.
Thank you.
Speaker Change: Ladies and gentlemen, if you would like to ask a question, please press star one on your telephone keypad and a confirmation tunnel indicate your lines in the question to you. You may press star two if you would like to remove your question from the queue.
Speaker Change: for participants using speaker equipment, it may be necessary to pick up your hands up before
Speaker Change: And the first question comes from the line of Joshua Reilly with Needham, please proceed.
Joshua Riley: Oh yeah, thanks for taking my questions. Maybe just starting off on the gift card opportunity.
You know, I guess maybe...
Joshua Riley: Who would be helpful to a kind of level set for people? How are you thinking about the potential for revenue and ARR?
Joshua Riley: to actually hit the model in 2025 from the gift card opportunities.
Joshua Riley: or maybe is the right better way to think about it, like this is another year, this is a year of development.
Speaker Change: and maybe that's got more of a financial impact in 26 and 27. And then second on gift cards what is the feedback from the ecosystem on how your solution is differentiated versus what has historically been used and maybe you could just kind of touch on that a bit there as well.
Joshua Riley: Sure. Hey, Josh thanks for the questions. So on the revenue impact, as we mentioned on the last call, we expect gift cards to be a significant driver of our 2025 ARR growth. We're focused on catalyzing adoption this calendar year, which I mentioned again in this call. And in fact, this deadline was one of the drivers behind our decision to tighten our focus even further than we've done in the past, as part of what we talked about last call about why we're getting so focused.
Joshua Riley: is, you know, deadlines and milestones that we want to hit in order to make it so, in order to make it a significant driver of 2025 ARR.
Joshua Riley: I think it's a great segue of dear second question, which what is a reception like? It's a sounding. It truly is. I know that some people went to a trade show in September of last year, which you know is six months ago. Things have only progressed since then. This is a real. [inaudible]
Issue, this is an existential issue, this industry faces it.
Joshua Riley: You know, mid to high teens growth last year, flat this year, expectations. Obviously, that's not a great trend for this industry.
Joshua Riley: It is a trillion dollar global industry that is being attacked and we think we have a novel solution and we have you know we've been doing this for 26 years helping helping protect other currency fiat currency. I think we can do the exact same thing in gift cards and it's. [inaudible]
Joshua Riley: Wonderful to see the reception we're getting from the industry. This is something that I've mentioned before has a lot of characteristics of our ecosystem-driven opportunities, but none of the
Joshua Riley: Actual requirements of this being an ecosystem adoption. So it's unlike anything we've seen and it's pretty exciting. That's why we've been talking about it. That's part of our decision behind
Joshua Riley: The reorganization and focusing on authentication is this is a big driver of that.
Speaker Change: Understood, got it. And then as you look at a couple of those price sensitive renewals that you highlighted in the shareholder letter, are those actually having an impact on AR growth here in Q1 and Q2 that is enough to actually call out or are you just kind of highlighting those deals to point out a couple trends in the industry?
Speaker Change: We were highlighting the plots and trends in the industry. As you know, Josh, we don't break down ARR in any detail. There's no material movements from those, but I think that's not right. It was highly enough.
Speaker Change: as we get more price-aggressive on continuing deals it did have some impact on Q1 and likely will on Q2 but no material effort we're calling out because we don't break down ARR in any sort of you know specific pluses and minuses.
Speaker Change: It's an example of us investing in the future. These are not areas that we need to monetize right now. Maybe there are areas that are a little bit more competitive. We want to plan our flag so we can come back to them.
Speaker Change: and so we're willing to get a little more price-aggressive with the—
Again, you know, making sure that that's all right.
Speaker Change: If we decide to come back and focus on the area we're there, and also...
Speaker Change: Potentially tighten the screws on some people and some competitors that...
Reliant these areas more than we do.
Speaker Change: Understood. That's super helpful. Okay, and then last question for me is...
Speaker Change: As we kind of think about the deal with Belgium, you know, it's hard for us to get transparency.
into what's going on from... You know...
Speaker Change: The elements of the, you know, the governments over there and everything, all the different moving parts. Is there any initial proof points? You can highlight now that this has been going for a couple quarters in terms of points of success or timeline achievement that, you know, we should be considering. Thank you very much.
Speaker Change: Yeah, it hasn't been going for a couple of quarters, a couple of months, maybe. I think we announced it, or we signed it within a couple of days of our last call, whatever that was two months ago. Okay. But I would.
Okay.
Speaker Change: I would say, though, I'm not sure if the answer to your question was adoption or if there's upside. There is potential upside from this engagement. It's the initiative to move forward. So the initial ARR is not all we expect, again, as this initiative is moving forward.
Speaker Change: But it's only been a couple months since the original signing [inaudible]
Speaker Change: Understood. I think more broadly, too, I was just kind of asking, is this going to be an example that other countries are watching closely, other industry groups in Europe and maybe just touch on that aspect as well?
Speaker Change: Yeah, so as I mentioned the last call and happy to revisit here as well. Absolutely, we think this is you know
Speaker Change: There has to be a solution to the plastic pollution crisis. There does have to be. I mean, this is a single planet that the plastic is an incredible material right up until a fact you can't.
Speaker Change: Recycling, you can't reuse it, right? And that's a big...
Speaker Change: Yes, that's a big issue. There is a lot of top-down drivers, PPWR being the biggest that I think will eventually catalyze adoption.
Speaker Change: Our belief, we've always said this, is our solution not only creates a higher quality and quantity of a cyclic, but also unlocks novel data, right? And what happens to be a data desert for most of these companies? Companies have so much data between the origination or the, the, the,
Speaker Change: Creation of an item right up until it goes across that front of the store scanner. But after that period, that post-purchase period during when consumers are consuming the product, there isn't that data. There's some qualitative data, there's survey data, but there's no quantitative.
Speaker Change: Universal Data, and while that's always valuable in the era of Gen AI, having novel, clean data that feed into an AI agent is going to be transformational to these industries, to these companies, and so our belief is, you know, this is where we're focused on indulge of it.
Speaker Change: Let's prove out yet again, although I think you saw from APW names press release everybody agrees our technology is going to lead to a higher quality quantity of recycling It's about how we get to commercial scale the adoption one of the things that we want to invest in improving by giving them you know a [inaudible]
Speaker Change: Pay-as-you-go-type growth initiative in Belgium is my gosh, the value of the data because PWR is not a global
Speaker Change: Regulation. It's a European regulation. This needs to be something adopted around the world, because it is a global issue. And so we're hoping that while everybody's focused on the higher quality quantity of
Speaker Change: Recyclet, which is a massively important outcome, we can also prove the value of this data and get a lot faster, quicker adoption So that's how we're viewing Belgium is you know, I think if if if we had
Speaker Change: 10,000 people in parallel trying to go light of every country in the world is not going to make it move faster. What we got to do is execute in Belgium, prove both value props, and I think adoption will take care of itself.
Understood. Thank you guys.
Yep, thanks Josh.
Speaker Change: As a reminder, if you would like to ask a question, please press star one on your telephone
Speaker Change: And the next question comes from the line of Jeff Van Rhee with Craig Hound, please proceed.
Great. Thanks for taking my questions. I've got a few. First on
Speaker Change: ARR and the trajectory. Can you give us any sense of how you're thinking about ARR trajectory going into the end of the year? I know the prior question was around how do we size this churn and it's really tough to get a sense of the scope of the churn and then ultimately what you think you can do with ARR. So I realize you're not giving formal guidance. You probably don't want to dial it into narrowly, but any qualitative commentary you're able to share as to how we should think about ARR by your end. [inaudible]
Speaker Change: Yeah, Joe, so I would go back to some of the statements that we made on the last call that provided some kind of inputs to the modeling.
Speaker Change: We said our focus is to get to non-GAAP profitable, no later than Q4.
Speaker Change: You can kind of do some quick modeling there and get to that as we go. Don't get specific guidance.
Riley McCormack: I would also just touch on the fact that, you know, Riley just reiterated that we believe the gift card will be a significant driver to 2025 ARR, so just taking, you know, some level of market penetration.
Riley McCormack: in 2025. I think can give you a sense of magnitude there, but I really point you into the model because we don't give a specific idea.
Speaker Change: Okay, yeah, thanks, Charles. And so, and I think in terms of gift card pricing while you're on that, can you just give us a refresher? I mean, obviously you're getting further into these. You're seeing more repeatability of the contracts and getting a better sense of what baseline pricing is going to look like. How should people size the gift card tab based on how the current contracts are being priced? Okay, thanks.
Speaker Change: Yeah, it's great. I think it has changed in our, you know, we've said a couple times now, 900.
Speaker Change: Not just provide higher efficacy, but also reduce bomb, build material, so there's upside there over time.
Speaker Change: We already have a product roadmap of new features and new attacks we can help against, so just as we continue to...
Speaker Change: Rollout, different versions and defense against other types of attack, this industry is facing, shoots that upside there, and then the third one.
Speaker Change: is that was just a US number. And as I said in this column, we're already having discussions with our partners about how we open other large cities. This is a global issue, a global industry, it's a trillion dollar GMV around the world.
Speaker Change: This is a problem that travels well across borders. There's not a U.S. specific reason for this fact.
Speaker Change: Yeah, okay, and then last I guess for me on the
Speaker Change: Error Front, you know, you're nearing the portfolio from $7.89 and I don't recall the exact number of ranges, but you decided to go after these three focal areas and obviously with reduced R&D and other support for those other products.
Speaker Change: and then obviously in combination with the comments you made around increased sure in there. Can you give a crude sense of what percent of ARR right now is from the three-go-forward products?
Thank you for watching!
Speaker Change: Jeff, we just don't quantify the composition of ARR in that respect, just like the pluses and minuses of ARR at this point in time.
Thanks for watching!
Okay, Louis there. Thank you.
Thanks for watching!
Thanks Jeff.
Speaker Change: Thank you. Ladies and gentlemen, this concludes the question your answer session and this will conclude today's conference. You may disconnect your lines at this time and enjoy the rest of your day.