Ladies and gentlemen, greetings, and welcome to the Digimarc Corporation Fourth Quarter and Full Year 2024 Earnings Conference Call. [Operator Instructions] As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, George Karamanos. Please go ahead, sir.

Thank you. Welcome, everyone, to our Q4 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 Q4 and full year 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 hello, everyone. On our last earnings call, we stated that as a result of significant achievements in both invention and market development, the difference between what lies ahead and what lies behind had never been greater. That conviction was driven by our defining not just one, but two compelling paths to near-term profitability, while positioning ourselves to deliver dollars of free cash flow per share shortly thereafter. The first path consisted of continuing to pursue market opportunities across both identification and authentication use cases, anchored by the closure of the large deal we discussed on the Q3 call. While this was the path we felt was the most likely as of that call, we were clear to point out that the biggest risk to this deal's closure was not the customer's interest in our offering, but how much time we would be willing to give this customer to commit as there were many exciting developments in Q3 to which we could instead be allocating our resources. The second path consisted of committing our resources to these many exciting developments, which included not only incredible invention, such as significant breakthroughs in the area of copy detection, copy deterrence and tamper evidence, but also important market developments anchored by important customer and partner wins across both the physical and digital domains. Of critical importance, these technological and market developments were all in the authentication area. This provided us the opportunity to continue focusing our business by prioritizing market opportunities in a single-use case category as opposed to concurrently pursuing both categories. While there are areas of overlap in the production and support of solutions across identification and authentication use cases, there are also areas of fundamental divergence that require parallel or duplicative work. Thus, the opportunity to apply…

Thank you, Riley, and hello, everyone. Before I dive into our financial results, I want to highlight a couple of items that will impact future financial trends. First, as Riley already mentioned, we announced a corporate reorganization earlier today to better align our operations to the opportunities immediately ahead of us and to increase our ability to act with agility and speed. We expect the annualized cash savings from the reorganization to be approximately $16.5 million. We have also identified approximately $5.5 million in other annualized cash cost savings. We will recognize one-time reorganization costs of approximately $3 million this quarter. Second, Riley mentioned our increased go-to-market focus. With our tighter focus, we have been conservative in our forecasting by not just budgeting for a potential increase in churn, but also to allow us the ability to be strategically price aggressive on a handful of renewals outside of our current focus areas. Moreover, and unrelated, due to a recent change in government requirements on the eve of program launch, we expect the $3.7 million per year DRS contract we signed two years ago to lapse in Q2 of this year. We share our partner's frustration with this development. To be clear, this has nothing to do with our technology or value add to this use case. Not only do we expect to win additional business from this partner in 2025, but we also have another DRS opportunity in our pipeline that Riley mentioned earlier. Now on to our Q4 and full year 2024 financial results. Ending ARR at the end of Q4 was $20 million, compared to $22.3 million at the end of Q4 last year. Excluding the $5.8 million commercial contract that lapsed, we grew ARR $3.5 million during the year, representing year-on-year growth of 21%. As Riley mentioned…

Thank you, Charles. Focus drives results, and today we took another - yet another step forward in the application of that powerful tool to our business. Recent breakthroughs in both invention and market development have allowed us to reorganize the company to focus on the exciting opportunities immediately in front of us, something we had been reluctant to do ahead of these breakthroughs despite always having a deep appreciation of the value in so doing. To avoid any possible confusion, I want to be clear we are not permanently walking away from any opportunities. Instead, we are simply addressing our TAMs sequentially. In addition to accelerating growth in the short-term, this sequencing should allow us to maximize the shareholder metric upon which we apply our greatest focus value per share. Six quarters ago, we transitioned from talking about optimizing our subscription gross margin to optimizing our overall contribution margin, not because we were or are any less focus on our product costs. Instead, it was because we were advancing our strategic focus from just our offerings to our overall business and taking the initial steps of building the incredible operating leverage into the business we know it is uniquely capable of delivering. While that work has been evident these past few quarters, we expect the next few quarters will highlight it even more. By both growing ARR and reducing costs, we expect to achieve non-GAAP profitability by no later than Q4 of this year, a milestone this company has not achieved in 12 years. Looking ahead to 2026, we expect to deliver significant top line growth, the absolute level of which will be dictated by the trajectory of our penetration of our focus markets. Given the size of our markets, the operating leverage we've been hard at work building into the business and our relatively low share count, it will not require much penetration of these markets to deliver dollars of free cash flow per share. Being on the cusp of turning free cash flow positive provides us options heretofore unavailable, and we have decided to partner with Goldman Sachs to explore that full range of options. We have set no deadlines, nor do we plan on providing any updates unless or until there is something relevant to share. We are committed to maximizing shareholder value and optimizing any outcome for all of our investors. Brian, we will now open the call up for questions.

[Operator Instructions] The first question comes from the line of Joshua Reilly from Needham & Company. Please go ahead.

Hi, Josh.

Hi, Riley. We'll fit, great. Well, thanks for taking my questions here. So maybe just starting off, if we look at the large commercial customer opportunity, in the prepared remarks, it appears the opportunity is still there. The timeline is a bit undefined, I would say, at this point. How are you thinking about allocating resources following the reorg to this opportunity? And can you still pursue this opportunity while pivoting the go-to-market as well?

Yes. Thanks, Josh, for the, for the question. Absolutely accurate that the opportunity is still very much there. As I mentioned, we are still in conversations about potential next steps. But as to how we will resource it, this is what I was saying it could be de-scoped. Obviously, our focus is on other areas for the time being. But it was - that's why, we - I called out in my prepared remarks that there's - it will likely be de-scoped. Do not take that to me, it will be less money. And without getting into exactly what we're doing with them and, and, and why this could have taken longer than both sides have thought to close. It's hard to really explain that. But we are absolutely able to support this opportunity when the customer is ready. We are still having conversations about this opportunity. We're not building our business around it. We didn't do any 2025 planning. If this comes in, in this year, it is going to be significant upside, and we'll see what happens.

Got it. Understood. Maybe, maybe you can just help us level set here. There's a lot of information in the prepared remarks. If we think about the opportunity for sequential ARR growth throughout 2025, what products and opportunities would you highlight as having the best chance to drive kind of this near term sequential growth in ARR off the current base?

Yes. So gift cards, the one we talked about, right, that's going to be a significant contributor. And then the physical anti-counterfeit is another very large contributor. On that second portion, a lot of the truly exciting greenfield things we talked about. So new types of watermark, new application, watermarks, other things in the authentication space besides watermarks. We expect the real pig in the python in 2026. So we expect significant growth in 2025 just on what we're currently going after. But what's really exciting is what, prioritizing this and, and looking at this, this year, what it could mean for 2026 and beyond. So those are the two biggest areas, but we talked about we expect revenue from Engage, Digital Link and DPP in the U.S., sorry, in Europe, these are two macro drivers. We believe we've signed two of the largest Digital Link deals, and it's going to help us take our fair share of this market, we believe. I mentioned our digital work. We don't have anything in our projections for 2025, even though we have a growing pipeline. We're trying to be conservative there. And then our partners. I mean, we still have wonderful partners. We've been very intentional about building out the Center of Expertise. It's not just a force multiplier, it's also we've been talking about the operating leverage we know this business can manage. And they're a big part of that. So those are the areas again, it's nothing that I didn't mention in my prepared remarks, but if you're looking for the top two, would be gift cards, and the physical anti-counterfeit stuff.

Got it. That's super helpful. And then Charles, as we, as we think about the new run rate of operating expenses, maybe you can just help us think about the sequential step over the next several quarters to getting to that free cash flow breakeven or potentially even positive figure? And how much of that are you thinking is dependent on revenue growth versus cost cuts that are going to be coming into the model here?

Yes, it's, it's clearly both, and we don't give revenue guidance itself. So, I'm not going to give a specific number, but let me talk about some of the components here because people can kind of model it themselves. So, if you use Q3, Q4 as kind of a normalized level of operating expenses, you start to think about Q1. Q1 is always a little bit higher, in the fact that there's a bunch of year-end costs and then we're also going to have about $3 million of reorg costs. So, so Q1 is not going to be reflective of a go-forward rate. But if you use kind of Q3, Q4 as a baseline, and then what I said was we expect to take out about $22 million of annualized cash cost savings. Not all of those are going to kick-in in Q1, but a significant portion of those will kick-in starting in March. So you can start to see that we're going to take out a little over $5 million a quarter in cash cost. So that obviously is a, is a massive driver in it, but we also expect to see significant revenue growth as Riley said. So the trajectory of that is to be determined how quickly we get to a non-GAAP positive during the year. But you can see just with the cost reduction that, that gets us, pretty close based off of kind of what the normalized run rate has been. Does that answer your question? There is a lot of pieces there. I tried to leave a lot of little breadcrumbs throughout as far as some of the numbers and stuff so that people could kind of model that stuff out themselves.

Sure. Yes. Understood. And then last one from me is, as we think about the Belgium license that you just signed, what is the timeline of this pilot project being implemented and evaluated? And maybe what are some of the proof points you would help to show during the pilot to get really the Europe to move towards a broader commercial use of the recycling product?

Yes. So, we believe our technology has proven to work. The HolyGrail has proven that. There's some results that will be coming out that, I think independently validate that. The Belgium pilot is our central buyer. There's a central buyer in, in Belgium, who wants to get going the - we talked about our new go-to-market where we provided for less than $1 per capita, unlimited access to Digimarc Recycle. What we have done here in Belgium, they weren't ready to take all of that right now. So we're doing a limited license. We think there is two massive pieces of value that our technology brings. The first is higher quality and quantity of recyclate. That's a lot of the focus in, in Europe, at least, because they need that to comply with this upcoming regulation that's coming in the next couple of years. And so there's that. We also believe it's, a lucky happenstance because of our technology sits at the end of a product's life, right, just because that's what it's helping to do is, is waste sortation. There is novel data, data that has never been captured. That end-of-life once a product leaves the front of a store, it is a data desert. And while there's always been value in novel data in the era of GenAI or any AI, but especially a lot of these LLMs, the ability to get the company that wins is a company who has the least amount of data deserts, the company who has got the biggest part of their end-to-end value prop with clean novel data, that just so happens to be what Digimarc Recycle also. It's a byproduct of higher quality and quantity of recyclate. So, without getting into what our buyer is, is trying to do with our…

Understood. Thank you, guys.

Thanks, Josh.

[Operator Instructions] The next question comes from the line of Jeff Van Rhee from Craig-Hallum Capital Group. Please go ahead.

Hi, guys. Thanks for taking the questions. Just a few for me. On the Walmart contract, the $5.8 million ARR that lapsed in anticipation of signing of this, this transformational contract. Just want to be clear, your expectations on that $5.8 million, does that come back into play now, or is that indefinitely shelved?

Yes. So Jeff, we don't - we haven't talked about who those contracts with. But the $5.8 million contract that lapsed in Q3 of last year we were in conversations with this customer to expand that contract. And that is what we're saying on this call that, that we're still in conversations with them.

Okay. Does, I mean, I'm trying to understand the comments in the, in the, in the script about churn. So there's, there's also another $3.7 million with that same customer that is referenced in the Qs and Ks. So the --

Yes. It's a different customer that we signed a $32 million deal, I don't know, two years ago about. There were multiple. There were three products that, that customer signed up for. One of them was DRS. As Charles mentioned earlier, that rolling out that something has changed, not a result of our technology relation with the partner. So that –

Right.

That contract is, is - has lapsed. But different customers.

No, no, no, no, no. There was an original Walmart contract, which was a $3.2 million ARR. And so my question was --

So, so again, we don't talk about customers, but the - we have talked about the $3 million Walmart deal that is still in play. That's alive. We still have revenue. We - that contract that we signed for Walmart to watermark their private label contract products, it's still in force. They're still watermarking their private label contract. They - it's, you're putting me in a difficult conversation here, Jeff. I mean, I think you, you understand that. The other contract, the $5.8 million one, unrelated. Same, - we have customers that have multiple contracts with us.

Yes. I mean, I get it, Riley. Look, I'm not trying to be difficult, but these are, these are big contracts that you do break-out in the, in the queue with this customer and everybody knows that. So, I'm just trying to get a sense of whether or not, we should assume or, or believe that the $5.8 million and the $3.2 million are at risk. I'll leave that alone. You obviously don't want to go there. On the DRS contract, which is the one you just started to answer a second ago, the $3.7 million of DRS contract. Can you just expand a little bit more there obviously pretty frustrated you're into that contract and somehow they pulled the plug mid-contract. Can you just talk about that a little bit?

Yes. So Charles talked about it on the script. On the eve of rollout, the government changed the program. We talked about when we signed that deal that we were providing our technology to a company that was launching three of their own products. You can think of it, we were a sub basically on that deal. And the government changed the program.

What, I mean, does that mean the entire program is - I mean, are they going to be able to function without you? Is this just a complete redirect on their part?

I'm not going to get into somebody else's business, but it impacts our relationship with that. It impacts our contract. Our contract with that customer had three products, right? This was one of them. They're no longer taking our technology and now have access to our platform for that product, because they no longer need it. We did say a couple of quarters ago, and I reiterated in this call that we expect to launch another product with this customer. So this isn't a relationship issue with our customer. It is, their business changed with their customer, this government.

Hope, did I lose there, Riley?

No, I'm - so I don't know what else you want me to say, Jeff, but it's, it's --

Okay. Let's, let's start a third here. In the script, you said quote, we're not just budgeting for potential increase in churn, but also to allow us to the building to strategically price aggressively on a handful of renewals outside our current focus areas. Can you expand on that, because I don't understand what that is pointing to?

Yes. All we're saying, Jeff, on that specifically, we are focusing a portion of our - we are focusing on the authentication use cases. We are being conservative when we're budgeting that we're going to reach breakeven and no later than Q4 for a whole lot of things to happen. So we're trying to be conservative in our budgeting. There are - that's the churn part. The ability to be price aggressive. There are a couple of areas that we are not focused on right now that we would like to keep our footprint. If it's not an area of focus, we might be a little more price aggressive than we would historically. That's all we're saying. But the overall point, Charles was calling that out to give transparency to everybody, but also to everything that we've said, everything that Charles said in his prepared remarks is obviously incorporated in our punchline, which is we expect to be breakeven no later than Q4 of 2025.

Okay. And so I guess just last for me then on that topic. You obviously had pretty substantial sequential non-GAAP OpEx drop of roughly $2 million. Charles, you're talking $22 million in annual costs to come out. Just to be clear, are - it looks like you're down $2 million and that probably took place mid-quarter in Q4. So, I'm not sure how to read your comment. You've already got $2 million out. You had your call mid-quarter Q4. So, if you got $2 million out and you only had half a quarter, it seems like you might have taken out already $4 million. Just trying to understand what the baseline is, if you can just revisit your explanation there.

Yes. I think the way I would look at it, there were some unusual kind of fluctuations Q3, Q4. I would look at Q3, Q4 and kind of average it in a more of a normalized base.

Okay. Average those two, and then use that as a base to which you'll take the cost out?

Yes. I mean, there were some - in Q4, there was some lower headcount costs, but the reorganization itself happened today. And so, none of those costs are reflected yet in the Q4 number.

Got it. Okay. Great. That's helpful. Thanks so much.

Thanks, Jeff.

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

Yes. I was just curious on the contract that has not renewed yet that, that still might be out there. Was there any complication from that customer making a divestiture and entering a new partnership with a big player in supply chain technology?

Yes. I really don't want to get into what's going on with any of our customers, Jeff. As we described on the Q3 call, what this customer and they're still a very happy customer of two other - we still have two other live contracts with them, three other - sorry, three other live contracts with them. I was just reminded. Very happy customer. There was something that they wanted to do that would transform an industry. We've been partnering with them to do it. They have been wonderfully transparent. They've been wonderfully collaborative. We mentioned on the Q3 call, that the biggest risk to this happening was we have a lot of other things we really wanted to focus on and how long do we wait. And so that was the conversation, it is still live. I don't want to get into what's taking them longer. And I really don't want to say anything more than what I've said, but it's we're still in conversations about potential next steps. And if we were to sign this, it would probably be de-scoped versus what it originally was, but don't take de-scoped to mean lower dollar amount. There's actually a reason to believe it could be a higher dollar amount, and it's upside. We're not, we're not building our --

Okay. No, that's great. I understand.

Just one thing, this is back to what Jeff Van Rhee was asking. Everything that we've said here all comes down the punchline is we expect to be profitable, no later than Q4 of 2025, even with all of this stuff, so not getting discussed, this deal is signed. If this deal is signed, this is a significant, significant deal.

Got you. Wonderful. Understand. And then I just wanted to clarify a couple of other things. On the price look-up fraud application, I think you talked about a retailer and then you talked about Picadeli. And I'm not sure, if you were - if that's who you're talking about or et cetera. So could you just go back through the comments you made about price look-up fraud and, and just clarify what's going on there?

100%. So, Picadeli is a partner of ours. Picadeli is a salad bar provider. I think they're in, north of 2,000 stores around the globe. That's a partnership we've announced publicly. We also have a retail customer. There is a retailer, a U.S.-based retailer rolling out our technology. That is - so we have two avenues to grow this, right? One, we have all of the untapped, wonderful, Picadeli customers that we could jointly delight together. And then we also have our first customer who's now live who's to the point of making introductions to other retailers for us, because it was wonderful. Nothing is more encouraging. And when a customer becomes an evangelist for no benefit to them except for the fact they just really love this technology and is adding value to their business and they want to share with other retailers. So - but those are two, the live - Picadeli is not a customer of ours or a partner of ours. We do have a large - live retailer U.S.-based who is a customer.

Got you. Okay. And then just, just to clarify this application, I think I hate to mention the name of your large partner again. But there was recently an article going around about how Walmart had barred a customer from every Walmart in the United States, because of a fraud practice, which I think was price look-up fraud, but just want to clarify if that's your understanding.

I don't know the dealing - I don't know what you're talking about. I would say –

Oh, okay.

That, that one area, we talk about retail loss prevention, the - there are multiple use cases under retail loss prevention, right? So we have the gift card, we have the PLU fraud. There's other use cases, right? We called those two, because we think those will be the two biggest drivers of 2025 ARR. But to your point and to Jeff's question, right, our - for example, there's been press from Walmart or out of Walmart and the use of our technology and their private label to help us shrink. That absolutely happens in terms of, we add that value there as well. So there's other use cases that a retailer can benefit from our technology, that shared stack sitting at the front of the store. The two that we called out on this call is PLU fraud and, and retail for the gift cards, but that doesn't mean that there aren't others. And then over time, that's what we want to do. We want to grow that suite of offerings because you have it's the same tech stack, right, front of store scanners. Our technology is already ubiquitous there, selling into the same stakeholders at these retailers and the ability to add accretive value, right. The more solutions they take the more value they each get, is pretty powerful.

Okay. And then a couple of times you guys referred to technology advancements, unlocking applications, et cetera. And, and you also mentioned something about working with some of the major laser companies. And can you just flesh out the particulars of all that?

Yes, sure. So there is a couple of things that have happened in their physical anti-counterfeit space in the last couple of quarters. We talked about it, when I was talking about in the Q3 call and again this call in the prepared remarks, the incredible invention and market development. And the invention was in the area of physical anti-counterfeit. So there's been three areas of, I guess, growth or new greenfield opportunities. The first is technological breakthrough, so copy deterrence, making it harder to copy something, copy detection, which gives a deterministic outcome on whether this is a copy or not or tamper evident. So those are three new ways of new technologies, we're excited, new use cases, new benefits that we currently, we don't have to the level we have now. We put out a press release on the copy detection a couple of months ago. It is really, really impressive stuff and really, really meaningful and TAM expanding stuff. So that's one. Two is the new application. The other greenfield area is from new ways of applying watermarks. And I know Jeff has something you've been focused on for a while, but working with some of the world's leading laser companies to apply our watermark. It's a whole brand new area. And then the third greenfield area for us in product authentication, physical product authentication is not even related to the watermarks. We have a loyalty and reward program using serialized QR, some analytics we built-in Illuminate for - to modernize loyalty and reward programs. So a whole bunch of areas where Digimarc Validate historically I think was what most people knew, what we had. There has been progress, new areas we can get into because of invention, because of new ways applying watermark and then either new solutions we have that have nothing to do with watermarks.

Got you. Okay. And then, and then finally, you had some activities going on in factory automation. It sounds like that's another one of these categories that's going to kind of move to the side until there's customer pull that's greater, and it doesn't take-up the resources that, that you're now focusing on the areas you talked about on the call.

Yes. So, so we called that out specifically. This is a specific product where we have a really robust ecosystem of both packaging companies and technology providers that are more than capable of advancing these deals without us. This was the whole idea of building the CoE program out is to make our partners experts and I'm - that use case, the Digimarc Automate use case, that's a very robust and influential ecosystem.

Got you. Okay. That's great. Thank you.

And again, if I say beyond just that, right, we tried to make clear and I realized the prepared remarks was there was a lot there. I was - we were trying to give, as much information as we possibly could. But even beyond that, just in general, we're always open for business with our partners. We have value add and valuable partners, existing and new. So where we're focused is in the three areas of Automate, I'm sorry, of Authenticate, that's where we're focused, with our go-to-market efforts. We still have areas outside of that. You mentioned Digimarc Engage, and then we have our partners, right? And, and our partners are powerful, and whether it's existing partners or whether it's new partners who say, hey, listen, can I get trained up as a CoE for specific use case? Absolutely.

Got you. Thank you.

Thanks, Jeff.

Thank you. As there are no further questions, I will now hand the conference over to Riley McCormack for his closing comments. Riley?

Thanks, Ryan, and thank you everybody for dialing-in today. I appreciate your, your attendance on the call. Have a good rest of your day.

Thank you. Ladies and gentlemen, the conference of Digimarc Corporation has now concluded. Thank you for your participation. You may now disconnect your lines.