Good afternoon, and thank you for participating in today's conference call. Now I will turn the call over to Bruce Davis, Chairman and CEO of Digimarc. Mr. Davis, please proceed..

Thank you. Good afternoon. Welcome to our conference call. Charles Beck, our CFO, is with me. On the call today, we will review Q1 financial results, discuss significant business developments and market conditions and provide an update on execution of strategy.

We will archive this webcast and have also posted our prepared remarks for today's conference call in the Investor Relations section of our website.

Please note that during the course of this call, we will be making certain forward-looking statements, including those regarding revenue recognition matters, results of operations, investments, initiatives, perspectives on business partners, customers, prospects, industry trends and growth strategies.

Additional forward-looking statements are identified in the prepared remarks we filed with the SEC and posted on our website under the heading Safe Harbor Statement. We also will discuss from time to time information provided to us by our channel partners and actual and potential customers about their business activities.

We are providing this information as we understand it was represented to us. We do not verify nor vouch for such information. Such forward-looking statements and statements of our partners and customers are subject to many assumptions, risks, uncertainties and changes in circumstances.

Any assumptions we share about future performance represent a point in time estimate. Actual results may vary materially from those expressed or implied by such statements.

We expressly disclaim any obligation to revise or update any assumptions, projections or other forward-looking statements to reflect events or circumstances that may arise after the date of this conference call.

For more information about risk factors that may cause actual results to differ from expectations, please see the company's filings with the SEC, including the Form 10-Q that we expect to file shortly. Any links included in this presentation are provided for general information and context only.

The content referenced is not incorporated by reference and you should not be considered as part of this presentation. We do not verify nor vouch for such information. Q1 is always a bit odd in terms of updates. We do a major update at Needham in mid-January, followed by our Q4 earnings call in mid-February.

This year, we added a Capital Markets Day presentation on March 11. Despite the near-monthly cadence of reports, we have much to discuss. As we did for the last call, we provided our prepared remarks in advance, given the positive feedback we received. We welcome any additional suggestions for improving our updates.

Charles will now comment on our financial results, then I will discuss significant business developments, market conditions and execution strategy.

Charles?.

Thanks, Bruce. Good afternoon, everyone. Q1 revenue was $5.7 million compared to $5.6 million in the first quarter of last year.

The increase in revenue was due to higher service revenue reflecting the timing of project work with the Central Banks and higher Discover and Barcode revenue, reflecting the growth in bookings over the last 4 quarters partially offset by lower Guardian revenue.

Q1 Discover and Barcode bookings were 60% higher than the first quarter last year at $800,000 versus $500,000. As a reminder, we define bookings as the non-cancelable fixed value of contract. Bookings, thus far, in Q2 exceed $800,000 compared to $200,000 for the entire quarter last year.

We will continue to experience lumpiness in quarterly bookings due to natural variations in timing and provisions of contracts during early market development and expansion into adjacencies. Gross margin for the quarter was 62%, up from 61% last year, reflecting higher revenue and lower costs.

Operating expenses increased by 3.5% from Q1 last year, reflecting the impact of annual compensation adjustments for our employees. We've kept headcount relatively flat over the last 5 quarters and plan to continue this trend until we see significant top line growth.

Net loss for Q1 was $8.5 million or $0.74 per diluted share versus a net loss of $8.1 million or $0.72 per diluted share in the first quarter last year, reflecting slightly higher operating expenses. We invested $6.2 million of working capital during Q1, which was in the middle of the range of $6 million to $6.5 million we provided on our last call.

We used $5.5 million to fund operations and $300,000 for capital expenditures. We ended the quarter with $37.5 million in cash and marketable securities. We have entered into a multiyear contract with Wal-Mart. The contract is a Statement of Work under our existing Master Services Agreement.

The SOW is program specific, covering private brand enhancement and thermal-label products. It is limited to Wal-Mart stores in the U.S. only. The agreement is effective immediately and has unlimited duration, subject to termination for convenience by Wal-Mart. The SOW has an annual fixed fee of $3 million per year.

Given the termination for convenience provision, we will book $750,000 each quarter. The first quarterly payment under the contract is reflected in the bookings number I just reported for April. From a financial perspective, Wal-Mart represents a small share of the addressable market given how we price access to our platform.

Obviously, their potential contributions to cross-side network effects is much more significant. We view successful implementation of these programs as a starting point for large-scale enterprise transformation made possible by our platform. We look forward to a long successful relationship with the world leader in retail.

We anticipate cash usage will be between $6 million to $7 million in the second quarter. For further discussion of our financial results and risks and prospects for our business, please see our Form 10-K that we expect to file shortly.

Bruce will now provide his comments on significant business developments, market conditions and execution of strategy..

There's a great future in plastics. Think about it. Will you think about it? Well, we'll have more to say on the subject as the year progresses. That's it for our prepared remarks. And I will open the floor to questions..

Thank you, sir. [Operator instructions] And our first question is from the line of Josh Nichols..

Hi, thanks for taking my question, and congratulations on the Wal-Mart news. I know it's been a long time in the making.

Any additional details you could provide as far as exclusivity? Could you roll this offer now to other players in the space as well? Opportunities for expansion internationally or pricing? Is it just at a unit level or store level or just an overall broad-based U.S.

license?.

So we will be offering our fresh product labels to everyone. And so the industry will enjoy the benefits that I've described. Our agreement with Wal-Mart is an annual fixed fee agreement with the geographic and product scope that I described in my remarks. I think that answers all your questions, Josh..

Yes. And I did want to ask, as far as for the opportunity on the recycling, you think that you mentioned in the prepared remarks that maybe one of the biggest opportunities.

What do you think that could happen -- what do you think are some of the biggest near-term catalyst that could happen that could really accelerate the pace of adoption on that front? I know you mentioned you signing the Ellen MacArthur Foundation.

Is there anything else that you think could be a big catalyst near term?.

Yes, yes. The upcoming executive summary to be provided by the project team is the conclusion of their research on means of improving recycling. That will be followed naturally by developing the commercial model and means of execution for implementing their recommendations.

And we have already begun the discussions with the key stakeholders as to how that might proceed. The primary catalyst that is quite easy to diligence is the enormous human cry and overwhelming evidence of the plastics crisis facing the world. And I won't go into them in this call. There's no time to do that.

But there's great danger in continuing unabated with the production of plastic. And so the European Union is very motivated and educated, and I think ready to take the global lead in whatever government involvement is necessary. But the industry appreciates that.

If they don't want to be told what to do with the force of law behind it, they need to get going really quickly to forestall those regulatory initiatives that they're going to. So everybody is highly motivated and move very quickly..

Thanks. And then last question for me. I know Sunrise Technologies and Kroger was one opportunity that you mentioned that the company was also excited about looking to 2019.

Any high-level details you can provide on that as far as progress?.

Well, we're engaged, at this point, with a lot of retailers and a lot of CPGs. So unless and until there's a joint sort of permission to announce details, we won't. So yes, we remain faithful to the ideals of supplier here that the customer will tell us what to disclose.

In the case of Kroger, I don't believe we have anything that we have disclosed or will disclose. So I think you're confusing one of my remarks about Kroger having a technology export initiative and Sunrise Technologies with us doing business with them. We know who they are, they know who we are.

So I'm not denying a mutual knowledge here, but I don't believe we announced that we're doing anything with them previously..

Well, congratulations again, and I’ll jump in the queue..

Yeah, thanks..

And our next question is from the line of Jim Ricchiuti. Please proceed.

Hi, good afternoon. I'll add my congratulations on the announcement yesterday.

Bruce, is there anything you can say with respect to how many stores this could be rolled out initially? I mean we know how many stores Wal-Mart has in the U.S., but is there any way you can give us a sense as to how this could roll out?.

Yes. 4,700. All of them..

I missed that.

4,700 over what time frame?.

ASAP. So the nature of our agreement with Wal-Mart is such that they have an economic incentive to move as quickly as possible until the fullest possible deployment. So we're going to move as quickly as possible is all I can say. This is not a test..

And is it -- can you say how many SKUs this would comprise in each of these stores?.

Their private brand packaged goods for general merchandise and selected SKUs from the growing number of participating national brands and all their fresh product labels..

Okay.

It sounds like a lot, but you can't really provide a number to us?.

No. A number is not actually relevant, I think, to the financial analysis. It's a fixed fee contract..

No. I understand that. I was just curious how it's going to be deployed in the stores. I saw that the terms of this.

The other question I have is, is this going to be done in tandem with traditional barcoding and then that will be phased out? I'm trying to understand how this is also going to be deployed by Wal-Mart and maybe you can say or maybe you can't..

Yes. I can't. As I alluded to in my prepared remarks, there are some aspects of this that will remain confidential for a while. And so I really can't really provide implementation details at this stage..

Okay. So you got a lot of irons in the fire. And some of them, like the European recycling project program that you're pursuing could be very sizable.

If we think about all of the various projects, and let's put aside this really nice win that you've had with Wal-Mart, put that aside for a second and look at some of the other projects that you're working with, including this European retail customer on private label.

Can you say or give us a sense which of those have the potential to have some more immediate financial impact?.

Well, it depends on the definition of immediate. So....

Give us time frame, a year?.

Yes. Within a year, yes. I think all of them can have impact within a year. I was thinking you were thinking next couple of quarters. Obviously, we just announced this major relationship with Wal-Mart. We're going to be a bit obsessed with that for the near term.

And then we will have the amplification of the side -- cross-side network effects that I hypothesized, I'm sure. And that's why I said, demand is going to grow rapidly but then that demand is going to be translated into agreements and programs and staffing and so forth. The model of the platform is a highly operationally leverage-able model.

That is that we've been investing a lot of money in the last four years in building out capabilities of the suppliers. So in the mature state of the delivery of the platform, the suppliers will do more work than they have been doing and they're in the process of doing more work. And it's not uniform. So some are doing more than others.

And so we're doing more work now on most accounts than I believe we will do in the long run with any accounts. And that the basic model of the business is an IP licensing model, okay? And the closest analogy is the one I used in Capital Markets Day, it will be Qualcomm.

So we'll do some things ourselves because they foster IP development but the core of the business will be a platform licensing business. So as more opportunity surprises everybody in the public market, it doesn't mean that we have to resource those projects significantly, necessarily.

It depends on whether we can find motivated partners who can serve those opportunities and send us money..

So again, going back to, let's call it, a year time frame, could there be somewhere between 4 and 6 customers over the course of the year as you look out, customers that you potentially are working with that could begin to generate relatively meaningful revenues to your business?.

Yes. I'll use as an example, Jim, one that we've already proven the business model for. So our Central Bank business is managed by a group of Central Banks. And so they provide a governance structure for our work there. And you know from the publicly available financial information, it's about $13 million a year or so today.

And it's in its 22nd year -- 26th year. So we could apply a model like that to recycling, for instance, okay? If some key stakeholders were to inform a governing body, the governing body then would pay us.

The governing body would administer the application of the platform to the problem, okay? So in that case, we could get significant revenue pretty quickly, and actually profitable revenue pretty quickly. We have discussed those models with some key stakeholders.

I'm not saying, it's going to end up that way yet, but that's a for instance in answer to your question, yes, we certainly could develop significant revenue during that time period with an adjacency, not even with the core market. So in the core market, of course, we could add more customers and more applications and enable more suppliers.

And we have work going on overseas in foreign territories. I don't talk about through suppliers because it's not yet material.

But as we continue to develop the supplier capability to deliver, globalization becomes more real in terms of financial performance, and that globalization biz is highly financially and operationally leveraged through the use of trained, equipped suppliers to deliver..

That's helpful. And you've been fairly good stewards of working capital.

And I'm curious now, now that you have the flexibility perhaps to put more resources into the development of the market and you've got a line of sight into some revenues each quarter, is there some thoughts maybe stepping up the investment to drive adoption a little bit faster? Or do you feel you don't have to do it?.

It's a question, Jim, largely of cost of capital. I put a stake in the ground at Capital Markets Day that I didn't like the way things have been going, okay? And so if we have ready access to capital at good prices, I think we can accelerate the development of the value of the company considerably.

I think that we're constraining it through constraint spending. Constrained spending, in order to get to the point where I get better pricing, and that's why I will not lay off at all on looking at alternative sources of capital or I think I might get better prices or more value with the capital because we have enormous opportunities facing us here.

We are not at all lacking for opportunity. We're lacking for resources, but we understand it and everyone on the call, I'm sure, understands why we've done what we've done. I think it's been a responsible approach to market development in which I hope everybody makes up very well and they should.

So that's the -- it's a little bit of a complicated answer to your question, but it is the honest answer, which is we're capital constrained against demand right now. We're not lacking for demand..

Okay, thanks very much..

And our next question is from the line of Robin Knipp [ph]. Please proceed..

Thanks for taking the call, Bruce. And in light of your prepared remarks on the cannabis space, I'm going to table that question for a future point of time. But I do have different question.

At the Capital Markets Day, you said there was a marquee retailer that was rolling out this quarter that may receive preferential pricing and it would now appear that's Wal-Mart.

Is it still fair for us to assume that the thermal label pricing should range from $2,400 to $7,200 per store per year for the rest of the market?.

It's subject to proof. So early adopters will generally get better terms than late adopters. What we gave you is our price list, and so we think that those are fair prices. And I would expect that later adopters are going to be pretty close to those prices. Early adopters still might get some advantage.

Now in the case of the agreement that we're talking about today, obviously, there is great consideration being received by our company in addition to the money. I feel very good about the discount, that is obvious here. But those who follow later shouldn't expect to get such favorable treatment..

Understood.

And I guess just as a follow-up, in general, on the cannabis market, is this something we could expect to hear more in the next 1 to 2 quarters, you think?.

It depends on the regulatory authorities, largely. They're not known for rapid entrepreneurial performance, so we'll see. Yes, I think we can help but the cannabis packaging discussions are really just a special case of a more general benefit of the platform in track and trace.

And we have a big partner here who, I think, is very well equipped to deliver better on that than we can directly, and that's HP. And so we're doing all we can to help them to move into a pole position on serialization activities generally because it's quite synergistic strategically with their very strong position in digital printing.

So I'm hoping those guys will be making more announcements than we are..

That’s great. Thanks for the time..

[Operator instructions] Our next question is from the line of Jeff Van Rhee. Please proceed..

Thank you. Bruce, congrats on Wal-Mart..

Thanks, Jeff..

So a couple of questions there. I think -- apologies, I'm jumping on late. I'm trying to catch up on some notes here, but it sounds like within that contract from Wal-Mart, there's the thermal side of things and then there's the private label and then there was also a CPG component that was discussed within the context of Wal-Mart.

Can you just circle back to that and explain that a little further?.

Sure, sure. So a number of leading suppliers to Wal-Mart have expressed interest in participating in early deployment to the shelf of products to learn about the mix of benefits that result to the retailer and to them.

And so it's a voluntary participation in the program, and there's a growing number of companies participating and the growing number of SKUs being identified. And we view it as an onramp to production for the industry. It's a great platform for them to learn from and for their suppliers to develop the means to achieve scale in.

So that's the purpose of the program. It's really intended to allow suppliers who are interested in being on the leading edge of this development in industry to get to the stores and to collaborate with the world's leading retailer on studying the effects of the platform in the retail environment..

Okay. Got it.

And then just working backward, just to be clear, did you delineate between the contract size here? Did you delineate the thermal label component versus the store brands? And what incrementally can you add about the progress on the private label there?.

There's no delineation. And the private brand news is moving from pilot to production. They're moving to the production..

Okay. Got it. And then just secondly, sort of curious, high level, when you think about -- I mean obviously, you're looking to tip an industry and redefine the way products are identified.

And with Wal-Mart's power in clout, should they mandate or put -- exert pressure in their ecosystem to label all products using the Digimarc Barcode that has very viral effects industry-wide. To the extent that they deploy Digimarc primarily within thermal, it would seem to have less of that viral impact.

It's sort of the beauty of thermal, right, that they control their own ecosystem, the scales and the printers. And so it's easier for them to force that to happen whereas somehow mandating the industry adopt does have broader sort of viral implications.

Can you just discuss sort of the balance of those two and what pressure you think this exerts on the industry, specifically around using the Barcode for product labeling?.

Well, first of all with respect to fresh product labels, I've long tried to help everyone appreciate that, I think, that can move faster than packaging. And so your comments there are all well taken. Yes, it's more under the control of the retailer. It has some additional party's printer but we're now working with the printers now for some time.

You've seen that in our trade shows. So we'll move along with fresh product labels but the big news there is the progress that we've made in coming up with some really remarkable technological advancements in addition to the original promises of that product offering.

With respect to private brand and national brands, private brands compete with national brands and so we will do our best work for all private brand suppliers and retailers in the industry to highlight the advantages of adoption of our platform.

And if you then keep in mind the nature of the multisided platform and cross-side network effects, what that means then is that in the relationship between the retailer and the national brand, less consideration is required to induce participation by the national brands to the extent they suffer from competitive pressure from private brands.

So private brands should, in my view, strategically be leading the industry here. We've obviously got national brands involved significantly already. But in my theorizing about that, that would have been the case, but it's still true.

And so the fact that Wal-Mart is going to production with their private brands is a wake-up call for the national brands and for other private brands in the industry. So we will continue our focus on private brands and encourage them to adopt early and adopt big.

With respect to the relationship between Wal-Mart and its suppliers, we're not advocating any kind of influence and certainly no mandate. What we're doing instead is increasing the amount of value the platform delivers to the CPG independent of its relationship with its trading partners.

In terms of track and trace, manufacturing quality, recycling, consumer engagement; by doing that in the platform model, then the CPGs may want to do it just for those reasons, in which case then, there is no need for anybody to issue any mandates or any preferences or any pressure. That's our ideal.

Our ideal is that all of the participants are going to receive significant value that justifies the costs and thus, will move to the new platform replacing the old visible symbiotics [ph]. So that's -- not that some poly owner should not -- obviously, trading partners are very important for all companies.

And so I would expect here that being given the opportunity to perform on the world's largest retail stage, then that will cause the industry to look more carefully at what our platform has to offer. But I think when they do, they're not going to need much persuasion from the trading partners.

They're going to do it because they know it's good for them..

Got it. Okay. And then lastly for me, in terms of -- it sounds like a full dive into the pool for thermal across the entire footprint of Wal-Mart.

When -- how does this work in terms of getting turned on at the registers versus potentially marking product, including specifically the thermal but other products? Obviously, Wal-Mart talks a lot about their adoption of Bossa Nova in the aisles to automate scanning.

Each so clearly marked product would have benefits in that respect without getting turned on at the register.

So any color as to when this might actually get turned on at the register in the sense that, clearly, the data value of going through that big of a footprint would be, I would assume very, very interesting in terms of demonstrating the IPM improvements you've long sought to prove with a great data set..

Yes. I've said previously and I think it's in the CMD [ph] deck, that the front store's already turned on. So there's no wait at all. All sort of have done. Check mark there. As for the rest of the implementation details, Wal-Mart will disclose that when they want to and how they want to, including telling me it's okay for me to say.

But right now, I don't have permission to do that..

I'm sorry, you don't have permission for what?.

To describe details of implementation..

Okay.

And so -- and lastly, just on that data then, I mean at what point do you have an adequate data set to really get those studies? To the final question I just posed, when do you get that data set? Is that part of the discussion?.

That will grow in a continuous fashion over time, without getting into the nuances of statistical analysis and confidence levels here, more is better. And I don't know that anybody really needs convincing. Justice is one of the ironies of some of the people who try to make up stupid negative cases.

It's intuitively obvious that our platform allows for faster easier checkout and better data. It's impossible for that not to be true. So we will do statistical analysis because it helps us to improve our product, and it helps to improve the business processes of our customers and their suppliers. So we'll do all of those studies.

But no one's waiting for a proof. Wal-Mart is not waiting for a proof here. They're going. That's the point of the announcement. We've been spending 4 years making proofs. We're tired of making proofs. It's time to just get going..

At this time, this concludes our question-and-answer session. I would now like to turn the call back over to Bruce Davis. Sir, please proceed..

All right. Thanks, everyone, for participating today and for your support, and it's a great day for all of us. We're moving onto the next level here, and we will keep you all informed. And as always, we'll do our best work and be responsible stewards of your capital.

So thank you very much for your support, and we look forward to talking to you again soon..

This concludes today's call. Thank you, ladies and gentlemen, for joining us today for our presentation. You may now disconnect..