Digimarc Corporation (DMRC) Earnings Call Transcript & Summary

Greetings. Welcome to the Digimarc Q2 2026 Earnings Conference Call. [Operator Instructions] Please note, this conference is being recorded. I will now turn the conference over to Charles Beck, Chief Financial Officer. Thank you, Charles. You may begin.

Thank you, Max. Welcome, everyone, to our Q2 earnings call. I'm Charles Beck, Digimarc's CFO, and I'm joined today by Paul Carreiro, Digimarc's CEO. On the call today, Paul will share his plans for the next 90 days, and I will provide a business update and discuss our Q2 2026 financial results. This will be followed by a question-and-answer forum. 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 specific risk factors that could cause actual results to differ materially. Paul, I'll turn the call over to you now.

Great. Thank you, Charles. Hello, everyone. Before I walk through the plan, I want to spend a moment on why I took this role. Just the lens through which everything else I say today should be understood. When I looked at Digimarc, I saw a company trading well below the value of what had actually been built on, proprietary technology, a genuinely differentiated platform and real provable customer outcomes already in production, held back by commercial execution gap that is entirely fixable. That is rare and, frankly, an exciting setup. The hardest part, building durable technological differentiation, has already been done. What was missing was leadership focus, structure and accountability to convert that differentiation into revenue at the pace it deserves. I built my career around finding exactly this, kind of, situation, and I'm genuinely energized by how much upside sits on the other side of straightforward execution discipline. That conviction is the foundation for everything you'll hear from me on this call. 30 days into this seat, my conclusion is not that Digimarc lacks a differentiated technology position. The platform, the IP underlying our digital and physical watermarking capability and the depth of our Illuminate stack should not be in question. What has been a question is commercial execution, whether the organization could reliably convert genuine technological differentiation into a forecastable and repeatable revenue motion. That is the constraint we will address, and it is the lens through which I would ask you to evaluate everything else in this plan. The first concrete evidence of that shift are 2 early leadership hires. We have brought in a Chief Revenue Officer who now holds quota, pipeline and forecast accountability across every vertical, a single point of ownership that simply did not exist before. And that alone is one of the highest leverage changes we can make. Diffuse commercial accountability is one of the more common and, importantly, one of the more correctable causes of underperformance in businesses our size, and we've now closed that gap. Alongside that, we've hired a VP of Retail Solutions, who I know well, think of our largest and fastest-moving vertical, dedicated leadership rather than share part-time attention it received historically. Both hires matter to this narrative for the same underlying reason. They provide focus and dedicated ownership and accountability, and that is what produces forecast results and reliability. We are standing up a real go-to-market engine and leadership team, which I have built successfully a number of times over my career, external messaging discipline, a functioning revenue operations capability, a presales value engineering capacity in support of our new leadership model rather than layered into the old structure. We are tightening forecast and pipeline rigor to the standard this market should expect, and I'm confident we'll get there quickly because the underlying demand signals and proof points I'll walk you through shortly are already strong. We are redesigning our organization in order to achieve discipline, focus and accelerated growth. We have a plan already in motion, and that is a difference between a company with a problem and a company executing an accelerated transformation. The plan itself rests on 4 priorities. I want to walk you through not just what they are, but why they are sequenced the way they are, because the sequencing is itself the statement about capital and operating discipline. The first priority is narrowing our industry focus and our messaging while rebuilding our commercial engine focused on our 2 highest vertical industries: retail, anchored by our Secure Gift Card solution and CPG. We're evolving our messaging around 3 questions in cascading order: which industries we serve? Which problems do we solve in those industries? And what value do we create in doing so? All enabled by our common platform. The second priority is evolving our organizational design to support and accelerate that focus. We are building up a CRO, Head of Marketing, CPO, revenue operations, value engineering and a dedicated partner and ecosystem leadership function and using that foundational structure to stand up 2 purpose-built sales teams, one for retail, one for CPG, rather than single generalized sales organization asked to cover 5 industries with random attention. The third priority is reorienting how we engage with all of our customer and prospect relationships. We are implementing a formal 360-degree customer engagement model, turning account management into a repeatable discipline applied to every relationship. These actions will not only accelerate our upsell, cross-sell opportunity, but also increase retention. The fourth priority is organizing a roadshow to take our exciting go-forward story directly to the market. The recent new hires announced is a strong indication of how purposeful I'm being to drive changes needed. Now let me briefly walk you through each of these priorities. Priority 1 is where I would ask analysts to focus first because it's the one area of our plan where we already have measurable proof rather than a forward promise. In retail, our Secure Gift Card program is live today, anchored by our Schnucks chain-wide deployment across 115 stores, clearly demonstrating that the solution can be successful driving value in a live retail environment. A little more on that later. Gift card fraud is not a hypothetical problem we are proposing to solve. It is real dollarized leakage that retailers already measure and already budget against. CPG is another exciting industry for Digimarc. A great example is a global CPG manufacturer and distributor using our Digital Link platform. It is a live global rollout spanning 45,000 SKUs across the multiple global brands available in every household. It is positioned directly ahead of 2 external forcing functions, the GS1 Sunrise 2027 global initiative and the EU Digital Product Passport mandate. This is not a discretionary purchase that a CPG customer can defer. It is a compliance requirement already fixed on the calendar. To support these industries and to scale quickly, we will have dedicated go-to-market ownership across the full customer life cycle. This is what is needed in order to provide a repeatable, forecastable revenue model, which this business does not reliably have. Let me also provide you with a further update on our retail Secure Gift Card program rollout. As you have heard from us previously, our Secure Gift Card program has rapidly moved from proof-of-concept to live in production deployment, anchored by Schnucks, as I noted previously. Anchored this program success, we will now build out our global partner ecosystem needed to scale quickly rather than reinvent it deal by deal. We're partnering with Blackhawk Network and InComm on card issuance and program distribution, Zebra Technologies, Datalogic and Honeywell on point-of-sale and scanning infrastructure, Graph-Tech USA, STL Labels on secure card production and serialization and WestRock on packaging integration, a supply chain that's truly integrated end-to-end. That alignment is precisely why we're confident in an accelerated rollout from here. The technology is proven, and the partnerships are in place. The remaining work is pipeline build-out and execution, not partnership building or infrastructure development. At the start of this year, we were only working with a single retailer. Today, our pipeline has grown over 30x, and we have more than 31 large and midsized retailers at various stages of engagement, ranging from early discovery through active pilots and production rollouts and rapidly growing. Priority 2 is organizational. Structure determines the speed and consistency with which strategy converts into real results. The structure that brought Digimarc to this point was not designed for our next stage of growth, so we are not tuning it incrementally. We are redesigning it around where the business is going rather than where it has been. Our Chief Revenue Officer recently hired will unify global sales, partnerships, customer success under a single owner, closing the accountability gaps I described earlier. Our Chief Operating Officer owns cross-functional execution, people, global marketing and operating strategy. Our Chief Product Officer will build and define our value-based road map strategy and will function as the interpreter defining the business problems our platform solves across our entire industry platform. Additionally, we'll be hiring a VP of Partner and Ecosystem, which will build and manage our global partner community. Of course, we'll maintain and enhance our CTO and CFO functions as we progress and evolve. We are not asking the market to underwrite a series of reorganizations. We are asking it to underwrite one durable structural decision. The third and fourth priorities are where strategy becomes visible to the 2 audiences who ultimately have to believe it for any of this matter, customers and our shareholders. On the customer side, our 360-degree customer engagement model will ensure our go-to-market teams will personally engage with every account in person. This approach will ensure we engage with all accounts well ahead of contract decision point to significantly increase retention and maximize upsell, cross-sell opportunities with existing customers. On the shareholder side, we will continue to take this narrative directly to the market in a roadshow targeted for existing and new investors in the coming weeks, led jointly by myself and our CFO, Charles. Our goal is to continue to provide the investment community with enough confidence that it is really going to be different this time. We'll be leading with proof, not promise. I'm going to close on market framework. This slide will answer a question I would expect every analyst on this call to be asking directly. If you are narrowing commercial focus to 2 industries, what happens to the others? And are you leaving revenue and TAM on the table by doing so? The answer is that we are not exiting the other industries we serve today. We are changing how we reach them. Retail and CPG, as mentioned, will receive dedicated focus as that is where our platform's value proposition is greatest and most defensible today. Each of the solutions you see noted help solve specific definable business challenges with a quantifiable cost of inaction, which is exactly the, kind of, proof point this plan was built around. Pharma, life sciences, media and technology and government solutions, with the exception of our expanding work with the Central Bank Counterfeit Deterrence Group will transition to be reached horizontally. Still leveraging our road map and product portfolio, but mainly through our partner ecosystem rather than through dedicated vertical sales capacity. This is not a retreat from total addressable market, just a capital and operationally efficient sequencing and prioritization decision. I would flag one item inside that horizontal category because I believe it's more consequential than the current classification suggests. Our media and technology exposure with content provenance, C2PA compliance and AI agent authentication is one of the more underappreciated, potentially category-defining opportunities we are watching closely. As the AI Act enforcement matures in Europe and globally and as agent-to-agent authentication becomes a genuine infrastructure requirement and critical risk, we believe Digimarc's role could become a much larger part of the story. We are not resourcing it as a primary vertical today, and I want to be disciplined about that. But I would not want this call to end without analysts understanding that we see it and that our platform and road map already positions us for it without requiring separate investment to own that category as the market quickly evolves. Thank you for giving me this time to speak with you, and I look forward to updating you all as our exciting story continues to progress. I will now hand it over to Charles to go through our financial results.

Thank you, Paul. Earlier, Paul highlighted several important developments related to our Secure Gift Card solution, and I'd like to provide some additional detail before I cover Q2 financial results. We are pleased to see continued momentum among retailers. Two additional retailers have committed to deploying our Secure Gift Card solution across their stores, with one rolling out beginning later this month and the other scheduled for October. We have also made progress with the large retailer that postponed its pilot earlier in the year due to software availability constraints. The retailer is now planning to launch a pilot in September at a smaller scale than originally contemplated, with the objective of supporting a broader deployment beginning in the first quarter of 2027. Additionally, several other retailers are actively planning to start rolling out our solution in the first half of 2027. We are also continuing to see increasing interest from major brands that are exploring opportunities to enable their gift card programs with our solution. As these deployments expand, we look forward to demonstrating the effectiveness and scalability of our solution across a broader set of retail environments. These initial implementations are an important step toward broader industry adoption and, over time, position us to participate in what we believe is a significant market opportunity. Ending ARR was $11.6 million at the end of Q2 compared to $15.9 million a year ago. The change primarily reflects 2 previously disclosed events, the expiration of a $3.1 million contract in October 2025 and a $2.6 million contract reduction in June 2026, partially offset by net ARR growth of $1.5 million. As a reminder, the contract reduction related to 2 projects that were canceled following changes in requirements imposed by the government end customer. We are working with our direct customer to restructure the agreement and pursue the recertification of 3 legacy projects and the certification of 2 new projects. If successful, these efforts could, at a minimum, restore a meaningful portion of the lost ARR and potentially grow ARR much higher. However, the timing and outcome of these efforts remain uncertain. Based on the magnitude of the contract reduction, the absence of the committed upsell from the customer at this time and the limited time remaining in 2026, we no longer expect to achieve our original target for significant ARR growth by year-end. That said, our confidence in the underlying opportunities remain unchanged. The anticipated ARR growth from gift cards has largely been deferred due to timing related to the alignment with our go-to-market partners, a process that has now been completed. As a result, while the timing has shifted a few quarters, we continue to expect meaningful ARR growth as this initiative moves forward. Total revenue for Q2 was $7.4 million compared to $8 million in Q2 last year. Subscription revenue, which accounted for 51% of total revenue for the quarter, decreased $900,000 from $4.6 million to $3.7 million. The customer contract that expired in October 2025 accounted for substantially all the change. Service revenue increased $300,000 from $3.4 million to $3.6 million, with both commercial and government parts of our business contributing to the increase. Subscription gross profit margin was 89% for the quarter, up 4 percentage points from Q2 last year. The improvement primarily reflects lower subscription platform costs, which decreased by $300,000 year-over-year. Service gross profit margin was 60% for the quarter, up 1 percentage point from Q2 last year. The improvement was primarily due to a favorable mix of service revenue. Operating expenses were $16.7 million for the quarter compared to $13.1 million in Q2 last year. Operating expenses for the quarter included $5.4 million of stock-based compensation expense and $700,000 of severance costs related to our former CEO. Excluding these onetime costs, operating expenses were $10.6 million for the quarter, down $2.5 million or 19% from Q2 last year. The decrease reflects lower other stock-based compensation expenses of $1.4 million and lower cash compensation costs of $1 million. Non-GAAP operating expenses, which exclude noncash and nonrecurring items, were $8.1 million for the quarter, down $800,000 or 9% from $8.9 million in Q2 last year. The decrease primarily reflects lower cash compensation costs and other operating costs, partially offset by severance costs associated with the CEO transition. Net loss per diluted share was $0.54 for the quarter compared to $0.38 in Q2 last year. Non-GAAP net loss per diluted share was $0.08 for the quarter compared to $0.11 in Q2 last year. Turning to cash flow. We ended the quarter with $8.8 million in cash and short-term investments and no debt. During the quarter, we used $1.0 million of free cash flow and $600,000 to repurchase shares associated with our employee equity programs. We also raised $300,000 of cash proceeds on our ATM program at an average price of $12.59 per share. For additional information regarding our financial results and risks and prospects for our business, please refer to our 10-K, which will be filed shortly with the SEC. Max, please open the call up for questions.

[Operator Instructions] Thank you. Our first question is from Joshua Reilly with Needham & Co.

In terms of the go-to-market rebuild here, can you just discuss in more detail why retail and CPG are the right industries to be focusing on for sales going forward? And in terms of the org redesign, what are you thinking in terms of the time line to get all of these senior positions in place and working to execute the strategy as one team?

Yes. Thanks for the question, Joshua. If we take a look at why those 2 industries, not only is it because those are the 2 industries that are very well developed already today. And we -- in terms of solutions that we already provide to those 2 industries as well as we believe that's where we have the greatest differentiation in our current product portfolio today, and I tried to provide a little bit of the solution overview in the deck that I provided earlier that you saw. And if not, you'll have it shortly. So that's, kind of, just a quick summary where we believe we can build the greatest moat as well, particularly with our retail gift card program as you're already starting to see the beginnings of that. In terms of the go-to-market team build-out, as you've already seen and have heard, we're moving pretty quickly with that. We've hired a VP of our Retail Solutions business. We've hired a CRO -- and I would expect a couple more hires by the time, at least 1 or 2 more hires by the time we get out of August, September. I would expect that full team build-out, at least at the senior level, to be complete by the time we get out of Q3 and then adding capacity at the account executive level as we progress through Q3 and Q4.

Got it. And then as you think about the restructuring of the business model here to some degree, how are you thinking about the pricing and packaging model and contract structure for customers? And does that need to evolve as well along with the go-to-market strategy? Or is it -- how are you thinking about that?

It does need to evolve. However, for our retail gift card program -- the pricing structure that we have in place for that as well as the solution packaging is already very well defined. I'm pleased with what I've seen. And I think that's a program -- in fact, I'm confident that's a program that we can accelerate very quickly with the pricing and packaging structure we have today. The other areas are going to take a little bit of work, and I'm comfortable that we can get through that very, very quickly. In fact, as I noted in my narrative, one of the areas that we are reforming the go-to-market teams against is clearly defining the 2 industries that we're going to market in, as I noted, being CPG and retail, clearly defining the solutions that we solve in those 2 industries and the value that we create in solving those particular problems in those industries. That's where we're going to get the most amount of stickiness. And so we're going to be matching the solutions that we have today to those problem statements. And that's a very rapid exercise that we're going through now. So that's where the repackaging, if you will, will be occurring here in the short term.

Got it. And then the commentary implies a greater ramp for gift cards in 2027, if I'm understanding that correctly. How do we think about what's the opportunity through the holiday season here in '26 in terms of revenue that could be coming through in Q3 and Q4 there? And is there any possibility for a bit of upside to the 2026 holiday season on gift cards?

I would not anticipate that there would be additional that I can commit to at this point for the gift card program through the balance of 2026, while the build-out in the partnership structuring has already been completed, as you heard me go through from the InComm and the Blackhawks on the aggregator side, the Datalogics and the Zebras on the scanner side and WestRocks on the packaging side, that's a tremendous amount of heavy lifting. And at the same time, we're building a pretty significant moat that is becoming impenetrable. So that's where a lot of the leg room has been happening. Now together with those aggregators, the InComm, the Blackhawk as well as directly to those large retail partners and customers that we're working with. A lot of that significant demand will be built up through the balance of the second half. And that's why I'm saying we expect the build-out to really happen and the demand start to happen towards the end of Q4, beginning of Q1 '27.

Got it. That's really helpful. And then just one financial question. As we look at the exit rate of ARR here for Q2, is there any considerations in terms of customer churn that we should be anticipating for the second half of the year? And how do you feel about your current visibility on this base of ARR and potential churn?