Digimarc - Q2 2024

Transcript

Operator (participant)

Greetings, and welcome to the Digimarc Corporation Second Quarter 2024 Financial Results Conference Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. If anyone should require operator assistance, please press star zero on your telephone keypad. As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, George Karamanos. Thank you. You may begin.

George Karamanos (Chief Legal Officer)

Welcome, everyone, to our Q2 conference call. Riley McCormack, our CEO, and Charles Beck, our CFO, are with me on the call. On the call today, we'll provide a business update and discuss Q2 financial results. This will be followed by a question-and-answer forum. We have posted our prepared remarks and our quarterly earnings snapshot in the investor relations section of our website, and we'll 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.

Riley McCormack (CEO)

Thank you, George, and hello, everyone. I want to begin this call by reiterating the core tenets of our strategy. When we get to the subsequent discussion of Q2, I encourage you to examine our progress with these core tenets in mind. Doing so will help frame the accomplishments we achieved in the quarter and, more importantly, provide context as to where we're going from here. As our world becomes increasingly digital and companies progress their digital transformation journeys, Digimarc maximizes the ways in which products and multimedia can digitally interact with the various systems that surround them. We excel at the identification and authentication of physical goods and digital assets, often at massive scale, and often where other means of identification or authentication don't work well or don't work at all.

Our focus is on converting this large total addressable market into substantial free cash flow by positioning ourselves to deliver high and long-lasting top-line growth at world-class operating margins. This starts with our being easy to begin doing business with and excellent at guiding customers along their Digimarc journey and is aided by four key tailwinds we have been very intentional to create. One, our incredibly deep and wide moats allow us to offer differentiated products. In turn, our differentiated products enable us to create new markets and disrupt existing ones. Two, the need to identify and authenticate physical goods and digital assets is universal, meaning almost every entity in the world is a potential Digimarc customer.

Additionally, because our technology enables us to identify and authenticate things where other solutions don't work well or don't work at all, our ecosystem consists of companies incentivized to partner with us rather than posing a competitive risk. Three, there are many use cases that require companies to identify or authenticate their physical items and digital assets, and there are many ways we can configure our technology to achieve these goals. Therefore, our ability to productize new functionality is open-ended. This means our already large TAM will continue to grow as we either launch new products or add opportunity unlocking functionality to existing ones. Four, we engineer our products to be accretive, meaning the more Digimarc products a customer buys, the more value each product delivers. This positions us to harvest the low-hanging and highly profitable fruit of cross-sells and up-sells for years to come.

Turning now to Q2, we made significant progress on multiple fronts, highlighted by three developments likely to have a profound impact on the second half of this year and beyond. Before providing these important updates, I want to reiterate two points. First, because we are early in the journey to our ultimate and massive scale, our net annual recurring revenue growth can be lumpy when looked at on a quarterly basis. As a reminder, quarterly net ARR growth is the output of gross addition to ARR minus churn. In Q2, churn almost entirely offset our gross add. A significant driver of this dynamic was a transition to our preferred partner engagement model to our new Center of Expertise program.

While this transition results in less upfront ARR, it leads to two significant benefits that should pay off for years: greater ARR upside over time and more focused, repeatable, scalable, and profitable growth. Two things to note on this transition and its impact on our quarterly net ARR results, both in Q2 and beyond. First, even with the headwind of lower upfront ARR, we slightly exceeded the Q2 gross add target set in our 2024 budget. Second, as of the end of Q2, the partners that remain in our historic partner program are not candidates to transition to our CoE program. On our February call, we discussed the reasons why we believe so strongly in the CoE program, and in the June press release, we announced the program's founding members.

Over the past few months, we've become even more convinced of the power of this new program, and beyond the positive impact it is already having on our sales pipeline, I am thrilled to announce we closed our first CoE source contract during the quarter, a multi-year Digimarc Validate deal. Second, and as evidenced by our historic results, while this lumpiness will lead to quarters like Q2, where quarterly net ARR growth is below trend, it will also lead to quarters where quarterly growth is significantly above trend. When we say we expect our business to be lumpy until we reach a larger scale, we use that term as it is truly intended, not as a euphemism for weak. This is why we prefer to measure our ARR over one year and three-year time horizons, as we do in the quarterly earnings snapshot George referenced in his opening remarks.

Focusing on the forest, not the trees, provides a better measure of this business, of our business's true growth. Moreover, our focus extends beyond any single quarter, and as I mentioned at the beginning of this call, is centered on converting our large total addressable markets into substantial free cash flow. To that end, I want to use the rest of this call to update you on key developments in two of our ecosystem-driven opportunities and preview a new market opportunity that presents a TAM as large as, if not larger than, any other opportunity we are pursuing.... As a reminder, we view our business as having three pillars of shareholder value. The first pillar is our long-standing relationship with the world's central banks.

Beyond the meaningful cash flow this 26-year relationship provides, our work with the central banks also acts as a source of intellectual property generation for our commercial business, gives us invaluable credibility as a trustworthy supplier, and demonstrates our ability to scale. The second pillar comprises of our SaaS and PaaS products that follow a more traditional software go-to-market model in areas such as deal size, sales cycle, and lack of ecosystem dependencies. I touched briefly on the progress in our CoE program earlier. For additional important updates from Q2 related to this pillar, I again encourage everyone to review our quarterly earnings snapshot. The third pillar consists of our ecosystem-driven opportunities.

These opportunities encompass industry-wide or country-wide initiatives that, once in motion, have powerful flywheels that should drive quick, broad, and sticky adoption, but also have ecosystem dependencies that make timing unpredictable, as it is predominantly outside of our direct control. Before I provide an update on our progress in two of these opportunities, namely Digimarc Retail Experience and Digimarc Recycle, I again want to point everyone to our quarterly earnings snapshot for an update on our third ecosystem-driven opportunity, Digimarc Validate Media, which we continue to believe can deliver the safer, fairer, and more authentic internet we all deserve. Turning to the update on Digimarc Retail Experience, recall this offering is a razor-razor blade product. The razor involves licensing our Digimarc Illuminate platform to retailers, who use its capabilities to build out the points of detection required to enable next-generation in-store operations.

The razor blades are provided by our licensing Digimarc Retail Experience to the brands whose products are carried by that retailer, including the retailer's private label brands, allowing their products to interact with these points of detection. As stated on a prior call, we believe the TAM of licensing our platform to enable next-generation in-store operations is well into the nine figures of ARR. We believe the TAM of Digimarc Retail Experience is multiple larger still. But beyond these incredibly large TAMs, Digimarc Retail Experience is also an easy way for these national brands to begin their Digimarc journey en masse. Once their products are digitized, we will have the opportunity to be excellent at guiding these brands along their journey of solving additional problems through the adoption of other Digimarc solutions.

Moreover, the more national brand items digitized using our technology, the easier it is for additional retailers to license our platform to build out their own points of detection, while in parallel, adopting Digimarc Retail Experience for their private label items. We expect most retailers will use our platform to build points of detection that utilize other means of product identification beyond the 1D, 2D, and digital watermarking signal that our platform supports. In Q2, we provided our largest commercial customer with demonstrable proof that our technology can carry a very heavy load in this multi-signal future, resulting in two important developments that give us confidence this flywheel is likely to start spinning.

First, and most immediately, we believe this customer now understands that the more items in their stores that are digitized with our technology, including items produced by national brands, the more profound the improvement to their in-store operations will be. Second, we believe this customer also now understands the value of Digimarc delivering a greater amount of the software capabilities powering their points of detection. This should ultimately increase the size and time to market of the razor component of this flywheel, not only with our initial customer, but with subsequent customers as well. While I cannot provide any additional details at this time, I want to emphasize two key points. First, it is difficult to overstate the importance of these developments. Second, we expect and look forward to being able to share more information soon.

Turning now to Digimarc Recycle, Q2 saw us make important progress on this ecosystem-driven opportunity as well. On our February earnings call, we discussed a new go-to-market avenue for this revolutionary product, in which we would work with a qualified partner who would lead a regional or countrywide rollout. On our May call, I mentioned we were in conversations with multiple parties regarding this new path. Since then, the number of parties with whom we are having conversations has increased, as has the number of countries in which we are having these conversations. Moreover, thanks to a deeply valued ecosystem participant who believes as strongly as we do in both the environmental and economic ROI of our solution, we expect to soon receive introductions to multiple large and powerful entities capable of acting as our partners in additional countries.

While we expect these will be elongated sales cycles, we are pleased with the progress and believe that the opening of our first country should accelerate our conversations, both existing and future. To that end, the first qualified partner with whom we entered conversations has told us they expect to be ready to sign a deal for the initial rollout of Digimarc Recycle in a European country in the second half of this year. Finally, in breaking with our practice of not discussing new products until we've signed a marquee customer, I want to close my prepared remarks today by talking about a new market opportunity because of our confidence in the value of our solution and the materiality to our business, if we are correct. For over a quarter of a century, we have worked with the world's central banks to protect their currencies.

However, one of the fastest-growing and most pernicious attacks on the class of currency isn't against the banknotes issued by federal governments, but the currency issued by brands and retailers: gift cards. As I have mentioned in the past, we expect our most exciting opportunities to come from prospects experiencing problems that can be uniquely solved by our ability to identify and authenticate physical and digital items where other means of identification and authentication don't work well or don't work at all. It is then incumbent upon us to determine, A, if there is a sizable and repeatable business problem, that B, additional prospects beyond the first have an urgency to solve, where C, we can provide a solution of enduring and differentiated value, that D, presents us a path to fast and profitable scale. This is exactly how our opportunity in gift cards has developed.

Gift cards face multiple attack vectors, and the cost of these attacks, both monetary and reputational, are real, and they're getting worse. Moreover, existing solutions are expensive and ineffective, and it is becoming clear to the industry, both ecosystem partners and end customers, that we have a significant role to play. We believe we can provide a solution today that addresses some of the most common attack vectors, providing a significant increase in efficacy while actually reducing the current bill of materials costs, delivering a meaningful and attractive ROI. That, combined with the expected ease of implementation, should allow for rapid scaling post initial adoption.

Moreover, while no material dependencies prevent any single gift card issuer from independently adopting our solution, many industry participants are aware of our work and are interested in finding a widely adoptable solution, as a large and growing level of loss is leading to grave concerns in the industry. Thus, our opportunity in the gift card industry shares the most attractive attributes of our ecosystem-driven opportunities, namely, the likelihood of rapid scaling and incredible stickiness once scaled, without the multi-stakeholder dependencies that characterize these opportunities as ecosystem-driven. We are likely to launch our gift card offering with a few different implementation architectures that we believe yield a U.S. market TAM ranging from $900 million to $1.5 billion of ARR.

While we are starting in the U.S. because this is where our initial prospect and partner engagements have occurred, there is nothing that we or the industry see that prevents this from being a global solution. In fact, as stated earlier, our ability to act as a universal and global solution seems to be one of the things about which the industry is most excited. Although we haven't yet conducted a detailed analysis to quantify the global TAM, it will be significantly larger than that of the U.S. alone. Moreover, as we continue to build additional features into our solution to address more attack vectors, we believe we should be able to capture a share of that added value, providing further upside to our TAM.

While the excitement and urgency shown by the industry has been remarkable, there is still more to learn as we advance this work, and I want to caution, we don't know what we don't know. However, the list of things we don't know is shrinking rapidly, giving us comfort in discussing this opportunity today. In addition to our obvious excitement about this opportunity standalone, it also dovetails nicely with other retail loss prevention solutions we are progressing, including a solution addressing the theft of prepared food, for which we signed an initial deal with a regional grocer in Q2. I focus my comments today on the gift card opportunity because of the urgency with which the industry is engaging, as well as the massive TAM it represents.

However, it is important to note that the potential to offer a suite of value-accretive products, leveraging the same technology and sold to the same loss prevention buyers, is exciting, as it provides us another avenue to be easy to begin doing business with and excellent at guiding customers along their Digimarc journey. Finally, while not an immediate focus, we believe there are future synergies that can be unlocked between our retail loss prevention offerings and Digimarc Retail Experience, as retail loss prevention and retail operations are closely intertwined. We will keep you updated as things progress. I will now turn the call over to Charles to discuss our financial results.

Charles Beck (CFO)

Thank you, Riley, and hello, everyone. Financial highlights on a year-over-year basis for the second quarter included: ending ARR increased 44%, commercial subscription revenue increased 39%, subscription gross profit margin was 89%, a 5 percentage point improvement, total expenses only increased 2%, and non-GAAP net loss decreased 14%. We continue to focus on delivering improvement in these financial metrics as they're critical levers in reaching positive free cash flow. Ending ARR increased 44% from $16.7 million at the end of June last year to $23.9 million at the end of June this year. The year-over-year increase in ARR largely reflects the impact of new customer contracts and several important customer upsells, partially offset by customer churn.

Total revenue for the quarter was $10.4 million, an increase of $1.6 million or 19% from $8.7 million in Q2 last year, reflecting strong growth in subscription revenue. Subscription revenue, which accounted for 61% of total revenue for the quarter, grew 36% from $4.7 million to 6.4 million. The increase reflects subscription revenue recognized on new customer contracts, as well as upsells on existing customer contracts. Commercial subscription, rather, grew at an even higher rate of 39%. Service revenue decreased 1% from $4.1 million to 4 million, reflecting slightly lower commercial services. Subscription gross profit margin improved from 84% in Q2 last year to 89% in Q2 this year, representing a five percentage point improvement.

The significant increase year-over-year reflects both the strong growth in subscription revenue and a favorable mix in subscription revenue to our newer products. Service gross profit margin improved from 51% in Q2 last year to 58% in Q2 this year, reflecting a favorable change in labor mix. We expect to generate mid-50% service gross margins on a normalized basis, with some fluctuation quarter-to-quarter. Operating expenses for the quarter were $16.8 million, compared to $16.1 million in Q2 last year, an increase of 4%. Roughly half of the increase was due to lower costs being allocated from operating expenses to cost of revenue this quarter due to lower billable services. Total expenses, which exclude the impact of allocations, only increased 2% year-over-year....

Comparing this number to the 39% growth we delivered in commercial subscription revenue shows the operating leverage we've been focused on building into our business. To continue driving this considerable operating leverage, we are focusing on maximizing our productivity and efficiency as an organization, including better leveraging the capability of tools like Gen AI, to minimize the impact of rising labor and other costs. Non-GAAP operating expenses, which exclude non-cash and non-recurring items, were $14 million for the quarter, up 8% compared to $12.9 million in Q2 last year. Again, roughly half of this cost was due to lower costs being allocated from operating expenses to cost of revenue this quarter because of lower billable expenses. Net loss per share for the quarter was $0.43 versus $0.53 in Q2 last year.

Non-GAAP net loss per share was also considerably lower for the quarter, at $0.23 versus $0.29 in Q2 last year. We ended the quarter with $41.5 million in cash and short-term investments. Free cash flow usage was $6.9 million for the quarter, compared to $7.9 million in Q2 last year. Given the cash flows can fluctuate quarter to quarter, depending on the timing of receipts and payables, we continue to believe that a good proxy for a normalized level of free cash flow is using non-GAAP loss plus capital expenditures.

While cash burn in the first half of 2024 was above this proxy, we expect the unfavorable fluctuations on timing of receipts and payables to reverse in the second half, leading to full-year cash flow being generally in line with this proxy, and hence free cash flow in the second half to be much better than the first. For further discussion of our financial results and risks and prospects for our business, please see our Form 10-Q that will be filed with the SEC. I'll now turn the call back over to Riley for final remarks.

Riley McCormack (CEO)

Thanks, Charles. In Q2, we made significant progress on multiple fronts, highlighted by meaningful developments in two of our ecosystem-driven opportunities and the rapid progression of an attractive new market opportunity in protecting gift cards from the ever-increasing threats they face. The developments in the ecosystem-driven opportunities give us confidence that we are likely on the precipice of getting these two flywheels spinning. The rapid progression of our opportunity in gift cards is standalone exciting and could also serve as a cornerstone for a broader suite of offerings to help retailers combat one of their most pressing business challenges, the ever-increasing prevalence and cost of shrink.

While we continue to expect our business to be lumpy until we reach a larger scale, the progress we made in Q2 further demonstrates that as a result of our laser-like focus on the execution of our strategy and the core tenets therein, we are not only on track to unlock the massive TAMs on which we are focused today, but also that new TAMs can rapidly develop. We are positioning ourselves to convert our large total addressable markets into substantial free cash flow by delivering high and long-lasting growth at world-class operating margins. Our progress in Q2 gives us even greater confidence in our ability to achieve this goal. Operator, we'll now open the call for questions.

Operator (participant)

Thank you. At this time, we will be conducting a question-and-answer session. If you would like to ask a question, please press star one on your telephone keypad. A confirmation tone will indicate your line is in the question queue. You may press star two to remove yourself from the queue. For participants using speaker equipment, it may be necessary to pick up the handset if you are pressing the star keys. One moment please, while we pull for questions. Thank you. Our first question comes from Joshua Reilly with Needham.

Joshua Reilly (Managing Director)

All right, great. Thanks for taking my questions, and nice job on developing some of these product opportunities here in the last couple of quarters. Maybe just starting off on net new ARR. Can you just give us some additional details on maybe what type of customer churned in the quarter? Did you consider them core to the business, and maybe how the Center of Expertise program for partners impacted net new ARR in the quarter?

Charles Beck (CFO)

Yeah, thanks for the question. The most of the churn was specifically related to transition in our CoE program. So as Riley stated in the prepared remarks, we don't expect to see any more customers be moving in a CoE program. So, we expect that most of that is behind us at this point.

Riley McCormack (CEO)

Yeah, Josh, Josh, maybe if I just double-click on that just quickly. Our traditional program, the VAR program, there were two types of partners we had in there. We had the big partners who were technologically capable and really wanted to use Illuminate to build their own products and services on top of. And then we had a bunch of partners that maybe had less interest in building things, wanted access to our technology because they had a ton of customers, and they wanted to sell our existing products. And then we had a third class of partners that would have fallen into that second category but didn't want to sign up for the VAR. So we still have partners that we consider under our VAR model.

These are the bigger customers who wanna build things on top of Illuminate. We've been. Our focus has been on the second group, getting to a bigger group of potential partners, and that's what the CoE program allows. The reason it allows is it's lower upfront costs, right? There, we actually have a tier of CoE that is free. You know, it's our entry tier. But, we're not trying to monetize the relationship as much. The direct relationship with the partner. We are trying to both have skin in the game so we can go after their customers and help their customers solve a ton of problems. So that's what I meant when, you know, the transition is a long way from there.

Our CoE deals are gonna be less than our traditional ARR deals on day one, but they are set up to be focused more on the massive pipeline from the end customers that we can service together. And that's why I said over time, it's gonna lead to a lot higher ARR, and it's also more focused because they're selling our products or they're reselling our products, or they're bringing us leads for our products, as opposed to them building their own things on top of it. Does that answer your question a little bit?

Joshua Reilly (Managing Director)

That's very helpful, I think, and provides some nice clarity on what's going on there. Maybe moving on here. If you look at some of the legislation that's progressing in Europe and Canada around plastic recycling, can you just give us any updates you have in terms of timelines, any change in expectations you have on how the projects will progress relative to kind of be maybe public statements you've made previously, and maybe just any other relevant information that investors should be aware of with the current recycling opportunity?

Riley McCormack (CEO)

Yeah, that's great. And I would definitely point you back to the prepared remarks, where it said our the first partner in our new go-to-market motion. They've told us they expect to sign a deal in the second half of this year to start in a European country, which is huge. We're also expanding the number of partners we're in conversation with, both not just number of customers, but other countries. And we expect to have a whole another wave of additional potential partners that we're getting introductions to from a very powerful and wonderful partner of ours. So that's, you know, on the opening up Digimarc Recycle mar- Digimarc Recycle markets, which is where our focus is. Holy Grail work continues.

And if you refer the quarterly earnings snapshot, you'll see that, there's some revenue coming in the back half of this year from the Holy Grail work, which is important. You know, it's continued proof of concept. I've never seen 170 organizations do a very public POC on a single company software like Holy Grail is. It's wonderful. It's in so many different ways. Now on the regulation. There's a ton of regulation. This is, depending on who you talk to, top three problem our globe faces, right? Is that we only have one planet, and we gotta solve for the plastic recycling issue. So ton of regulation. We don't wanna wait for regulation to be the driver. Regulation's a wonderful tailwind.

You know, people can see the writing on the wall and see what's coming down from regulation. So I think it gives an urgency to the conversation, but we don't wanna rely on that. We wanna drive our own urgency. And so that's what we're really focused on in these conversations for this new go-to-market, this partnership model, on Digimarc Recycle.

Joshua Reilly (Managing Director)

Got it. That's helpful. And then, you highlighted in the prepared remarks that in Q2, you demonstrated with your largest commercial customer, the ability to carry a heavy load in a multi-signal future. I know that you're limited with what you can discuss with this, but can you just discuss or, or maybe just, you know, from a high level, explain what you were referring to maybe with this particular statement?

Riley McCormack (CEO)

Yeah, I would point to the two developments that I mean, that fact is powerful, right? And interesting. But what's really important is the two developments that come from that fact. The first and most immediately, we believe this customer understands the more items in their store, including items produced by the national brands, the more profound the improvement in what they're trying to do will be. And then secondly, they understand the value of our owning more of a technology stack on the Razor component, using more of Illuminate's capabilities to build out the points of detection.

Outside of reiterating almost word for word what I said on the call, is I said, I can't provide any additional details, except I do wanna stress two things: It's difficult to overstate the importance of these developments. These are important, important developments, and we look forward to being able to talk about it more soon.

Joshua Reilly (Managing Director)

Understood. Just one quick financial question for me. As you're looking at the operating expense growth for the balance of the year, I think, you know, aside from the adjustments that grew, total operating expenses grew 2% year-over-year, which is great. How should we think about any increased hiring or expenses coming into the model for the second half of the year? Thanks, guys.

Riley McCormack (CEO)

Yeah, Josh, you know, we don't necessarily give guidance, but I directly, I can just talk. We don't expect that we need to ramp up, expenses, significantly at all. And quite frankly, generally, expenses are a little bit higher in the first half of the year than they are in the second half of the year, just given some of the year-end compliance and things that we had in Q1. So we wouldn't expect to see material, growth in expenses. Now, obviously, at a much higher scale of revenue, there will be some additive expenses, but as I touched on in my prepared remarks, you know, this business, we believe, has tremendous operational leverage, and you can start to see that where we're able to grow revenue at 39%, yet our expenses were pretty low.

So, we can't say that the expenses won't grow, but they shouldn't have to grow at a significant amount even to reach a much higher scale.

Joshua Reilly (Managing Director)

Awesome. Thanks, guys.

Riley McCormack (CEO)

Thanks, Josh.

Operator (participant)

Once again, to ask a question, please press star one. Our next question is from Jeff Van Rhee with Craig-Hallum.

Jeff Van Rhee (Equity Research Analyst)

Great, thanks. A couple from you guys. Maybe first, just can you quantify on the ARR, what was the actual dollar impact of that churned customer?

Riley McCormack (CEO)

Yeah. So, Jeff, we're not providing any other metrics around ARR at this point. Ending ARR is really our true north as a business. Providing other metrics at this point in time, just given our scale, could be misleading, and therefore, you know, we're not gonna provide them at this juncture. You know, we can't wait to be at the scale where we're providing more of those metrics, like gross adds and churn and things like that, but at this point, we're not prepared to do that.

Jeff Van Rhee (Equity Research Analyst)

Hmm. Okay, maybe I'll try. On the multi-year Validate deal that you had, can you talk more about that? You said it was a CoE source deal. What's the size of the deal? What's the use case? Just a little more clarity there.

Riley McCormack (CEO)

... Yeah, it's around, it's low six figures per year ARR. It's a producer of products who has tried other ways to authenticate and stop both theft as well as diversion of their products, and realized that we have a pretty good solution. So there's nothing, you know... Well, I guess there is actually, this is this CoE partner, it's a valued customer of theirs, right? So it's always great to start with a CoE partner's valued customer. It shows that, you know, that relationship's off to a good start, because, you know, they're putting us in front of their customers. We got to perform. We're not just trying to solve the customer's problem. We're trying to make our partners look good and help them get more comfort in us and really build that partnership.

But there was nothing, I would say, unusual or we love all of our deals, right? So I'm not saying it wasn't an exciting deal, but there's nothing unusual about it. It's just our first one that came through the CoE program, which is a pretty quick turnaround. We launched the program in Q2 and signed our first partner source deal in the same quarter.

Jeff Van Rhee (Equity Research Analyst)

Yep, got it. That's helpful. And then I guess just lastly, that relates to the commercial customer that you referenced. You know, what happened? I mean, I know you can't get into specifics of that account and kind of what they're doing with your product, but, I mean, clearly, they've had your product in hand for a long, long time. They've looked at it, and it seems highly intuitive that the more product that's marked, the more effective your platform is. And I guess just my first reaction to reading that or hearing that was, what took so long, that they're finally now just getting to that realization?

Riley McCormack (CEO)

Yeah, I guess you know, if you're looking at that from the original 2019 deal, there's... I would benchmark it versus the deal we signed a couple of years ago, right? That's a different use case. It's next-gen in-store operations. And I know we talked a little about this on our fireside chat. You know, it's ultimately up to the customer. When we're licensing our platform, right, it's up to the customer to really decide how best they want to build it. That was that second key development, Jeff, I was referencing here, is their understanding that the more that they use the capabilities to Illuminate is a huge unlock.

And then, you know, if you go back to the 2019 deal, our focus across this company is on solving the problems front of mind for our customers. And when you look at the retail industry, there's far and away two things on the front of their mind: loss prevention, especially post-COVID, which is in general, but it's getting worse. You're seeing, you know, big, big retailers taking out self-checkout, right? Or putting more stuff behind locks. That is becoming real at the retail space. It really, it's skyrocketed as one of their top concerns, and the other one is next-generation operations, right? The retail industry is, for the most part, you know, they've had improvements, but it's kind of the same process for the last couple of decades.

If we can build solutions that can address where the industry is going versus where they are, it's a huge unlock. If our solutions can not only add value to their existing processes, but also future-proof them for the future ones, Jeff, those are wonderful conversations to be having with these people.

Jeff Van Rhee (Equity Research Analyst)

Mm-hmm. Yep. Got it. And maybe... Sorry, this will be my last. On the gift cards, because that's very interesting. You know, seeming, I don't know if I came out of nowhere, but certainly showed up quickly, the materiality of it, the way you're describing it, and the pace at which it showed up. You talked about all these attack vectors on gift cards. Can you just give us a 20-second education on a little more of the opportunity around gift cards? And then, I don't know, any sense on timing? Yeah, I realize it's just a swag, but how quickly can these result in ARR?

Riley McCormack (CEO)

So in terms of the attacks, there's multiple vectors of attacks. They roll into a couple of big, high, top-level ones, right? One is draining, so getting a gift card that you believe has money on it, but the money's already been stolen, and the second one is social engineering. Those are the two main vectors, but there's a bunch of other vectors, and there's a bunch of sub-attacks within those vectors. But it's basically either buying a gift card that you should have had value on it, and it doesn't when you get it, or else social engineering and attacking. Again, you know, most of these social engineering attacks go after the elderly or

Jeff Van Rhee (Equity Research Analyst)

Mm-hmm.

Riley McCormack (CEO)

You know, so those are the two big problems that become an issue, not just to the industry as a whole. I mean, the only thing, this gift card industry is, is massive globally in terms of the total amount of money that is stored on these cards, and it's growing at an incredibly big, large rate. The only thing growing faster is the attacks, because this industry has tried a lot of, older analog-type technologies, that are just proven not to be up for the challenge of, really dedicated group of, thieves, because of the size, of the, of the pot of gold at the end of the rainbow. So, you know, it's tough to get into exactly how we're solving all the problems. This is, this is a tough... Again, we identify and authenticate things.

Identify, we love to talk about it. Authenticating, you know, part of... We, we don't want to get too far into what we're doing, but we have multiple different solutions, multiple different implementations, as I mentioned. And then as for the timing, stay tuned. I mean, there's, you know, we don't know what we don't know. As I mentioned, you know, the pace at which this is evolving and the engagement is unlike anything I've ever seen, it is remarkable. The goal on this call was, was to introduce the idea, just so you all have awareness of it, because like I said at the beginning, the, the, our competency of a solution and the materiality to our business, if we're right, stay tuned.

Jeff Van Rhee (Equity Research Analyst)

Fair enough. Thank you.

Riley McCormack (CEO)

Thanks, Jeff.

Operator (participant)

Our next question comes from Jeff Bernstein with Silverberg Bernstein.

Jeffrey Bernstein (Chief Compliance Officer)

... Hi, guys. Thanks for letting me ask a question. I just wanted to get an update on the California legislation, and whether you think that might actually get voted through, I guess, their Senate this summer. And then I guess there's some different legislation that's starting to percolate for the US government as well, you know, relating to AI and deepfakes.

Riley McCormack (CEO)

Yeah. So on AB 3211, I mean, we're just absolutely thrilled to be part of this conversation. Not only because we can make a real impact to a really pressing problem, but also because it just speaks to our recognized leadership in digital watermarking, right? They approached us as the experts, and probably goes without saying, but I'll say it, we're wildly in favor, not only because we know that the implementation and the solutions, and it's not just digital watermarking. This is a very comprehensive bill. 3211 will work. And the technology behind it, which is a lot of digital watermarking-based stuff, will of course, you know, that we know will work. Trying to predict how legislation moves through any process is probably, you know, beyond my ability to do.

I can tell you right now, this is an update. It's currently in the Senate Appropriations Committee in what's called the Suspense File, which is where, I forget the hurdle, but any bill that has above a certain very low bar for financial impact gets put in a Suspense File. And we're waiting for progress out of that. We provided direct feedback on the content. We've testified on this. And we're just as anxious awaiting progress as you are, Jeff.

Jeffrey Bernstein (Chief Compliance Officer)

Gotcha. And then on the federal level, are they also kind of going the same path in terms of digital watermarking and you know other technologies that that'll be in there?

Riley McCormack (CEO)

Yeah, at the federal level, there's a lot of different bills talking about this. You know, if you recall, we were at the AI Insight Forums. We were also a founding member of the NIST, which is a National Institute for Standards and Technology. We're a founding member of their AI initiatives group, so we're supporting at the federal level as well. You know, what's remarkable is how quickly AB 3211 is moving. California has a history of leading, but not just the country, but the world in big, important things. So, you know, we love all of... And again, you know, this is not just a problem facing the US, right? This is a global problem.

So we're supportive, and we're trying to do all we can to help educate governments and regulatory bodies globally, because this is a big problem. And I think the outcome of this is wonderful. I truly, you know, we believe this can truly deliver the safer, fairer, more authentic, authentic internet we've all deserved since the internet was created.

Jeffrey Bernstein (Chief Compliance Officer)

It'll be great to get the fifteenth largest country signed up, so looking forward to that.

Riley McCormack (CEO)

Yeah.

Jeffrey Bernstein (Chief Compliance Officer)

Thanks.

Riley McCormack (CEO)

Take care, Jeff.

Operator (participant)

Thank you. There are no further questions at this time, and I would like to turn the call back to Riley McCormack for closing remarks.

Riley McCormack (CEO)

Well, thank you, everybody, for joining us this afternoon. I hope you have a great rest of your day.

Operator (participant)

Thank you. This concludes today's conference. Thank you for your participation. You may disconnect your lines at this time.