Bruce Davis - Chairman, Chief Executive Officer Charles Beck - Chief Financial Officer.

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

Thank you. Good afternoon. Welcome to our conference call. Charles Beck, our CFO is with me. On the call today we’ll review Q2 financial results, discuss significant business developments and market conditions, and provide an update on progress and the execution strategy.

We have posted these prepared remarks in the investor relations section of our website and will archive this webcast there later.

Please note that we may make certain forward-looking statements in this call and in the prepared remarks we filed with the SEC and posted on our website under the heading “Safe Harbor Statement” regarding revenue recognition matters, results of operations, investments, initiatives, perspectives on business partners, customers, prospects, industry trends and growth strategies.

We also will discuss from time to time information provided to us by partners and actual and potential customers. We are providing this information as we understand it was represented to us. We do not verify nor vouch for such information.

All such statements and information 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 statements or other information that we provide during this call 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 our prepared remarks are provided for general information and context only.

The content referenced is not incorporated by reference and you should not consider it a part of this presentation. We do not verify nor vouch for such information. Charles will now comment on our financial results. Then I’ll discuss significant business developments, market conditions and execution strategy. Charles..

Thanks Bruce and good afternoon everyone. Revenue for the second quarter was $6.5 million, an increase of $300,000 or 5% from Q2 last year. Service revenue increased 9% due to growth in services provided to Government and Retail customers. Subscription revenue was flat year-over-year.

Subscription revenue would have increased $250,000 if not for the renegotiated contract with our supplier partner that we discussed on our Q1 earnings call. Revenue from Retail was up 10% to $1.6 million, driven by growth in Service revenue.

Revenue from Government was up 5% to $4.1 million, also driven by growth in Service revenue, while revenue from Media was essentially flat at $900,000. Retail bookings in Q2 were $1.1 million, down from $1.8 million in Q2 last year. Bookings in Q2 last year included a large multi-year committed contract, which accounts for most of the variance.

Bookings in Q2 this year included two notable developments. First, we generated our first two bookings for solutions using our variable data printing software, one for a traceability use case and the other for a brand authentication use case.

While these two bookings contributed only tens of thousands to our reported Q2 bookings, we anticipate they will become larger contributors to bookings in the second half of this year and thereafter. Both opportunities include variable fees to us based on units produced versus an upfront fixed fee, which mitigates amounts included in bookings.

These are partner-led initiatives whereby charging per unit is preferred to align our cost with their existing business models. I anticipate we will see more opportunities like these in the coming quarters as our business partners are becoming more engaged in selling Digimarc-enabled solutions.

These two use cases are also repeatable amongst a large base of prospective customers. Second, we closed our first full paid contracts for recycling use cases during the quarter.

Two of the contracts provided for enhancement of product packaging, one for consulting on optimizing the reading environment for plastic sortation, and the other on enhancing plastic packaging molds with Digimarc Barcode.

The bookings impact of these four contracts to Q2 was not significant, as the fees are variable or dependent upon meeting milestones, but we anticipate they will grow in significance going forward.

These contracts, along with other opportunities we are seeing in the sales pipeline are encouraging signs of real interest in investing and recycling use cases. Gross margin for the quarter was 67%, up from 65% last year, largely driven by an increase in Service margins.

Service margins were 59% up from 53% last year, primarily due to a favorable mix in billable expenses with higher labor and lower non-labor expenses. Labor expenses have a much higher margin than non-labor expenses in our service contracts. Subscription revenue was unchanged at 80%.

Operating expenses were $11.9 million, a decrease of 2% from Q2 last year, mainly due to lower travel, consulting and marketing costs. Operating expenses were down sequentially from last quarter, dropping $1.1 million as we successfully executed the cost-cutting measures that we shared with you on the last earnings call.

Expenses ended up even lower than the $12 million to $12.5 million range we guided to, as we identified additional expense reduction opportunities in non-essential areas. We are further decreasing spending by virtue of some corporate restructuring that is underway to improve our execution of strategy.

These changes will further reduce our operating expenses by reducing headcount by approximately 7%. We expect to incur severance costs of $900,000 during Q3, consisting of $400,000 of cash- based severance and $500,000 of stock-based severance.

Annual operating costs are expected to decrease $2.3 million as a result of these reductions, consisting of $2.1 million of cash-based compensation and $200,000 of stock- based compensation.

We anticipate operating expenses in the third quarter to be between $12.2 million and $12.6 million, which includes the $900,000 of non-recurring severance costs I just mentioned. We expect cash usage in the third quarter to be between $6.5 million and $7.5 million, including $400,000 of non- recurring cash-based severance.

We will continue to closely monitor our product and financial markets and our sales pipeline in relation to our working capital on hand and managing our rate of investment and allocation of resources.

Net loss for Q2 was lower than last year at $7.5 million or $0.62 per diluted share versus a net loss of $7.9 million or $0.68 per diluted share in the second quarter last year. We used $100,000 of cash and investments during Q2, well below the low end of the range of $1 million to $2 million we provided on our last earnings call.

Our cash usage was lower than anticipated as we reduced and deferred spending where we could, as well as restructured some vendor contracts. As noted on our Q1 earnings call, we received a $5 million Paycheck Protection Program loan in April.

We spent the entire amount on qualified expenses as defined by the Paycheck Protection Program and plan to file for forgiveness of the entire $5 million loan once the portal to apply for forgiveness is available.

Once we file, the bank has 60 days to review our application and then the Small Business Administration have 90 days to approve our application for forgiveness. We ended the quarter with $30.5 million in cash and investments. We did not raise any capital under the ATM program during the second quarter.

We filed a new Form S-3 Registration Statement with the SEC in June for $100 million as our prior Registration Statement was expiring. The old Registration Statement had $49 million remaining for future issuance that has now expired.

We continue to believe having a Registration Statement on file with the SEC is prudent to allow us maximum financial flexibility. We plan to file a Prospectus Supplement to our Form S-3 Registration Statement soon that will allow us to continue to utilize the ATM program, which has $9 million available for future issuance.

This filing is purely an administrative requirement as the ATM program was initiated on what is now an expired Registration Statement. We will exercise customary care in determining the best course of action regarding the remainder of the ATM authorization. We have also re-engaged on strategic financing in parallel.

For further discussion of our financial results, and risks and prospects for our business, please see our Form 10-Q that we expect to file shortly. Bruce will now provide his comments on significant business developments, market conditions, and execution strategy..

We received a Paycheck Protection Loan for $5 million and will be applying for forgiveness of that full amount. The net change in cash was less than $100,000. We made significant organizational changes to improve performance. The annual operating costs are expected to decrease by $2.3 million as a result of these changes.

The key market themes we’re observing our sustainability, supply chain visibility, and brand protection. So while retail is still scrambling to dealing with the coronavirus, demand from brand owners is increasing. Thank you for your support of our mission and confidence in our ability to achieve it. We wish you all the best in these difficult times.

In closing, I’d like to point out that DJ, our Head of Investor Relations, is getting settled in. With his help, we have revamped the Investor Relations section of our website. Please check it out and we welcome your feedback. That’s it for the prepared remarks for today. Now, we’ll open the call to investors..

Thank you, sir. [Operator Instructions]. You do you have a question in queue from Jeff Bernstein with Cowen. .

Hey, Bruce and Charles. Yeah, a couple of questions for you. One, could you just go back over your talk about the serialization demand and you mentioned some technology there.

Can you just go back over what that is exactly and what's happening there?.

Yes, so serialization has always been believed to be a key differentiator of our platform in relation to alternate data carriers, but the implementation was impeded by the progress of digital printing in relation to traditional offset printing and so we are kind of gated by that.

Well, in the past year we have now reached a stage of being able to deliver serialization through what’s known as industrial inkjet or marker-coder technology. And so we now can deliver serialization at very large numbers, much larger than those that would be economically feasible using the digital presses.

Second area of serialization is our work in lasers and laser - what we call laser-ablation or laser-etching.

That is an amazing area of development, not only because of its ability to deliver serialization, but also the promise perhaps of label less containers, plastic containers which would reduce contaminants and dramatically reduce the cost of production of those items in a way that would be consistent we think with the evolving consumer preference for allowing the planet to be inhabitable.

So we're working with some suppliers and customers on laser engraving of plastic materials. We also have a project we believe will begin here in Q3 that does not involve plastic, but is involved in the use of lasers for serialization of products. .

Got you.

And have you been able to prove out the laser-etching on plastic yet or is that still a concept?.

It’s more than a concept, but I wouldn't call it proven out in terms of commercialization, but it works. At this stage of our research we are very confident about the ability to impart the signal.

The question becomes the speed at which it can be done and so we're in that stage of research and development at this point with some highly qualified, very large suppliers.

They know what they are doing, they are doing great work, our team is great work and I remain optimistic that we're going to find a rather amazing implementation of the platform in this work. .

Got you, okay. And then just on the retail side, you know understandably we're moving to low touch retailers as you described it last quarter and that's now being talked about kind of everywhere. The look, it does seem like a lot of the trends in low touch would be very positive for you.

So how do you kind of see after the immediate disruption this playing out as we go forward?.

I think it's great for us Jeff. We can articulate a very powerful argument for improving not only efficiency, but not safety of shopping and then safety is becoming an important differentiation for retailers.

Several of the leading retailer CEOs have talked about that on their most recent conference calls, that people are a bit fearful and uncomfortable going to stores and so they are trying to figure out how to create a safer environment.

But it's also more complex environment, because creating a safer environment also means that there are other things going on in the stores that weren’t going on at the same level.

You probably witnessed the surge in Instacart activity and then of course all of the major retailers have been working on order-from-home and pick-up at the curb or have it delivered to your home, and that means that store associates are going to be in the stores making the picks.

And for stores who are opened 24 hours, of course then they are going to be naturally interfering with customers, but there's much more work to be done in keeping the stores safe and clean and organized and it was previously as well.

So it's a very difficult retail environment today, as they try to find a new normal and so in the new normal we are very confident that there's going to be a big movement from cashier assisted to self-checkout and then self-checkout both from the store and mobile, and then a large shift from near zero to some significant percentage of total sales being done through associate or contract shopper activities rather than direct shopping at the shelf by consumers.

So there are a lot of changes going on. All of them are considered favorable to us, because we make all of that work better and if the robots become part of the efficiency solution, you know they are in trials in a number of places then we make the robots work better too and also they make inventory management better.

So there is so many ways in which we can help the new retail gain that’s footing. The only hold up there really is the competition with urgent activities and trust me, there are many urgent, ongoing urgent activities.

That will settle down and so I don't know how long it’ll lasts, because I don't know what goes on with the pandemic, but it will get resolved and we will gain our proper place as a cornerstone of the new retail environment. .

And it seems like there's a lot of opportunities for guys like Zebra, Honeywell other in store technology type companies, the Robot Guys.

You know are those folks on track to be able to offer this stuff in an organized fashion as soon as the retailers can focus on it?.

Zebra is an excellent partner of ours as are all the other major scanner vendors, and they have a robot offering and we have done preliminary work with a number of robot companies and so we know what they are up to and when the economics justify, we are happy to participate and ultimately the robot revolution flourish if it will.

Another important dimension though of change in retail is the importance of mobile shopping and in Europe there's a dedicated model of shopping with devices, mobile devices and you can pick up in front of the store. But in the U.S. there's a growing belief that people will want to use their smartphones more while shopping.

Now there’s a bunch of work that needs to be done to do that. But one of the problems that we’ll have to overcome uniquely is how do you identify the package for the purchase and picking it up and turning it around while you’re holding the phone in your arms and many of the grocery shoppers are women.

They might have a purse or child in their arms it gets really complicated, really fast; we make it uncomplicated. So I think that we will find greater receptivity with Apple and Google and the Google OEMs that we have previously, because of the changes in the nature of shopping that are under away. .

Alright, I’m going to ask one more and I'll get back in the queue and let somebody else ask.

You talked about the brands being more motivated right now or having the ability to execute now more than the retailers, and it seems as if the store brands have taken a lot of share, because the consumers desires just to stock-up and not really caring so much about what the item is, but that it’s available.

Do the brand's kind of have to win back share here somehow? Are they more engaged because of that or how do you read that?.

I think there is an influence. So sitting in the shoes of the global brand, the competition from private brands has been intense and is getting more serious. And the consumers are becoming more concerned about health and safety, and in fact social matters, you know given the enormous impact of the Black Lives Matter movement in the United States.

And so, that’s I think and it’s just a theory, but I was a bit surprised by the surge in interest in supply chain among national brands. I think they are worried about having problems.

They went through serious issues of disruptions in the supply chain due to the pandemic just because of staffing problems, but they don't want to have health problems, they don't want to have a product that is identified as coming from slave labor or some overfish sea or whatever it might be, because damage to the brand now can have more serious consequences given that the alternative may not be another national brand or maybe the private brand.

And so there's this tension right now, great tension going on between the retailers, as they make their store safe and inviting places to shop and allowing for flexibility and help people shop, thus building greater brand loyalty with their shoppers.

How do you market effectively international brands these days? So I think international brands are enduring a painful wake-up call right now in trying to figure out how they're going to maintain competitiveness in the changing landscape, retail. And so supply chain is in areas where they have really become enlightened in.

Another influence of the pandemic I think in the sense of the constant refrain about you can't make good decisions without good data. There’s a lot of areas of supply chain that would benefit from increased visibility that we can provide..

That's great. Thanks very much. .

Yeah..

[Operator Instructions] Your next question is from Jeff Van Rhee with Craig-Hallum. .

Hey guys, this is Rudy on for Jeff.

I guess first off, on the traceability in the authentication use case that are going to be a pay by unit, could you just – I guess is there any unit economics you can share or I guess how big you think those contracts could be, I guess near term and over the longer term?.

You want to start Charles?.

Sure, yeah, I can handle that. So in this quarter, as I said there were kind of tens of thousands level. When you start looking out over more like a 12 month type horizon, I view them well into six figure kind of deals. We’re potentially full scale to be even more driven in that.

So these are big potential deals with lots of volume, but they are starting with a pay-as-you-go model. I think over time as they build up the scale they potentially may want to negotiate an annual fee, but right now given the business modes, kind of that pay-as-you-go is working well for them. .

Got it, and then you touched a lot on the retail environment and obviously the challenges they are going through. On recycling I guess it’s encouraging to see the first couple of deals signed there.

What's been the impact sort of to the whole Holy Grail and all the progress you guys were making their, with respect to COVID and disruption?.

Well, in the first quarter and continuing into the second quarter there was the sort of obviously general disruption affecting everybody; it affected everybody in that world as well as elsewhere, and so it impeded some of the organizational activities and some of the funding that we thought was nearly right.

And so what has happened now in the past – so, I'm going to say it’s the past six to eight weeks or so, is that things now are perking up.

That there is a sense of understanding the environment better, understanding how to manage workflows at the suppliers that are involved, growing interest as I said among the national brands to make sure that they remain competitive by being a trustworthy brand.

So trustworthiness compasses sustainability and social awareness, and so I think these things are driving everybody to get off the dime and get going. But also the Holy Grail initiatives has now been informed there will be a public announcement from the relevant people, a little later in the year here, but they are getting going now.

They know where they want to go and so we're really excited actually about the progress of the last month or so in that area. .

Great! That’s it from me. Thanks. .

You have an additional question in queue from Jeff Bernstein with Cowen. .

Bruce, you mentioned reengaging on the strategic financing front.

Can you just give a little more color about that?.

Yes, so it ties in a bit to the restructuring that we alluded to during the call today.

We have continued to make great strides in maturation of our platform, and so as we went out late last year and talked to some companies, I don't think we were quite as clear as we needed to be about the nature of the platform and our ability to deliver, improve self-delivery and so all of those things are concerns that we address and have made great progress on it.

So we're circling back around to some of the folks that we talked to, to talk to them about our progress and then we are targeting some other potential investors that we haven't yet approached. So we are going both ways, we are going back around to the early discussions to demonstrate our progress and then we are addressing some new opportunities.

And as – again, as the world changes fairly dramatically here in the first half of 2020, the landscape of opportunity maybe broader than we had thought previously, because I had as I put on my list in May of last year, a pretty good idea of where I wanted to go, but now there are some interesting things going on that could broaden the landscape of opportunity for us.

So we are back, I would say on the road, but not exactly the right expression any more, back in the air virtually. .

Gotcha, okay. And then can you just talk about, Wegmans I guess is furthest along of the customers at retail.

I think you talked about really kind of focusing on using them to demonstrate the depths of the effectiveness of the product, and I'm wondering how that's going and particularly with regard to low-touch shopping, if there's anything to be learned from the Wegmans experience so far. .

Efforts to move along with Wegmans have been a struggle in the first couple of quarters here of this year. They have been focused on other things and so we aren’t able to go out and visit them very effectively and so that's been going slow. I think their focus and the focus frankly of the other retailers is appropriate.

They have been buying Plexiglas and putting down vinyl on the floors and figuring out how to do home delivery and there's just a lot of stuff going on, a lot of urgent changes where the effect on operations is more profound in the media than ours and so that’s where we are.

I would say that is a general statement about retail, but particularly with respect to Wegmans, we are not as far along as I hoped we would be. .

Okay, great. Thank you. .

[Operator Instructions] and you do have a question in queue from Stephen Tomkins with Oppenheimer. .

Yes, hi Bruce. I believe last quarter you mentioned that you were working with seven of the top 11 global consumer brands, and if you can mention that, your update now. .

I think yes, I think we did mention eight in the – although I haven’t gone back to check my diagram that shows me everybody, but yes I believe it’s pretty much everybody at this point. I think we're pretty close to doing business with all of them. .

Okay, and would you say you're gaining revenue recognition from most of them or how is that working there?.

Did you say revenue recognition?.

Yes, are you seeing revenue from the top consumer brands?.

Yes. .

Okay. .

Yes, we need to grow the revenues, but yes. All of our work in the recycling and sustainability areas is funded. .

Got you. And the other question I had was regarding Japan.

Do you have any updates from there?.

Charles, why don’t I turn that one over to you. Charles, manages our work in Japan directly..

Yes, so we are working hard to work on the implementation with retailers there. We’ve got a couple of projects that are going on with some brands, but nothing quite yet where there's sufficient details. I had mentioned last quarter that we had a pilot going with large logistics company there.

That is continuing and we're trying to leverage that relationship and do some other opportunities. Once those opportunities are fired up along, then I'll provide a more detailed disclosure on them, but they're just not at the point yet where I want to. .

Excellent! Thank you very much. .

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

Alright. Thank you everyone for participating today. We’ll look forward to talking to you again soon and please get in touch if you have any questions. You can contact the appropriate folks. We now have DJ in charge of Investor Relations and he’s happy to help anyone out who needs more information. So that’s it for now. Thank you and good bye. .

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