Company Overview
Digimarc Corporation (NASDAQ: DMRC) is a pioneering global leader in digital watermarking technologies, which have been transforming industries for nearly three decades. As the company continues to push the boundaries of innovation, its solutions are empowering businesses and governments worldwide to tackle pressing challenges in authentication, automation, sustainability, and consumer engagement.
Founded in 1995, Digimarc has established itself as a trailblazer in the digital watermarking space, amassing an extensive patent portfolio of over 820 U.S. and foreign patents granted and applications pending as of September 30, 2024. The company's breakthrough technologies have found applications across a diverse array of sectors, from protecting currency and product packaging to enabling seamless consumer experiences and enhancing recycling processes.
Digimarc operates in a single reporting segment - product digitization solutions. The company derives its revenue primarily through two main revenue streams: subscription and service. Subscription revenue consists primarily of revenue earned from subscription fees for access to Digimarc's SaaS platform and products, as well as licensing fees for software products. Service revenue consists primarily of revenue earned from the performance of software development services and, to a lesser extent, professional services.
Technology and Innovation
Digimarc's flagship Digimarc Illuminate platform is a cloud-based suite of tools that allows customers to apply advanced digital watermarks and dynamic QR codes to physical and digital items. This enables various systems and devices to interact with these data carriers, providing a centralized platform for capturing insights and automating activities. The company's product portfolio, built upon this versatile platform, addresses specific business needs in areas such as automation, authenticity, sustainability, and customer trust and connectivity.
One of Digimarc's landmark achievements was its longstanding relationship with a consortium of central banks, which has made the company a trusted partner in deterring digital counterfeiting of currency for nearly three decades. This pioneering work has been a testament to Digimarc's innovative capabilities and the resilience of its technology in mission-critical applications. This partnership marked the first commercially successful large-scale use of Digimarc's technologies, protecting billions of banknotes in circulation globally.
Throughout its history, Digimarc has faced and overcome various challenges. In 2023, the company recorded an impairment charge related to the lease on its former corporate headquarters in Beaverton, Oregon, which expired in March 2024. Additionally, Digimarc had to navigate the impact of the COVID-19 pandemic on its business operations and customer relationships. Despite these obstacles, the company has continued to innovate and expand its reach, demonstrating resilience and adaptability in the face of adversity.
In the third quarter of 2024, Digimarc experienced a significant quarter, marked by substantial progress in both invention and market development. The company made advancements in areas it previously did not believe addressable in the near term, opening up new avenues of opportunity. CEO Riley McCormack described this quarter as "the most significant" he has witnessed since joining the company, highlighting the transformational nature of the deals and developments underway.
Financial Performance
However, Digimarc's third-quarter financial results did not fully reflect this progress, as the company's revenue was impacted by the delayed renewal of a major commercial contract. This contract, which is expected to include a substantial upsell, has taken longer to close than anticipated due to its transformational scope and industry-wide implications.
Despite the temporary gap between the company's forward-looking initiatives and its lagging financial indicators, Digimarc remains steadfast in its commitment to maximizing long-term value. The company's decision to prioritize the strategic significance of this deal over the immediate financial impact demonstrates its focus on positioning itself for sustained success.
For the nine months ended September 30, 2024, Digimarc reported total revenue of $29.76 million, up 16% compared to the prior year period. Gross profit increased 32% to $18.97 million, reflecting higher subscription revenue and improved gross profit margins. The company continued to invest in research, development, and engineering, with expenses of $19.87 million for the nine-month period. Digimarc reported a net loss of $30.36 million for the nine months ended September 30, 2024.
In the third quarter of 2024, Digimarc reported revenue of $9.44 million, net income of -$10.75 million, operating cash flow of -$7.09 million, and free cash flow of -$6.96 million. The decrease in revenue, net income, operating cash flow, and free cash flow was primarily due to the delayed renewal of the significant commercial contract, resulting in no revenue being recognized from it in Q3.
Digimarc's subscription revenue, which accounted for 56% of total revenue in the third quarter, grew 9% year-over-year, reflecting the company's ability to secure new customer contracts and upsell existing ones. The service revenue segment remained flat, with higher commercial service revenue from HolyGrail recycling projects offsetting lower government service revenue due to timing.
The company's annual recurring revenue (ARR) as of September 30, 2024, stood at $18.7 million, a decrease of $900,000 from the same period last year. This decline was primarily attributed to the delayed renewal of the significant commercial contract, which contributed a $5.8 million reduction in ARR. However, this decrease was partially offset by new net additions to ARR from other customer engagements.
Digimarc's subscription gross profit margin improved slightly to 86% in the third quarter, compared to 85% in the same period last year and 89% in the prior quarter. The sequential drop in subscription gross profit margin was due to the absorption of fixed costs over a lower subscription revenue number, a trend that would have been significantly higher had the delayed contract closed within the quarter as originally expected.
The company's service gross profit margin increased from 54% in the third quarter of 2023 to 61% in the same period of 2024, reflecting a favorable change in labor mix. Digimarc expects to generate mid-50% service gross profit margins on a normalized basis, with some quarter-to-quarter fluctuation.
Operating expenses for the third quarter of 2024 were $17.3 million, compared to $16.4 million in the same period of 2023, an increase of 5%. This increase was primarily driven by $600,000 in one-time cash severance costs for organizational changes made during the quarter and $400,000 in higher operating expenses due to lower labor costs allocated to cost of revenue, reflecting the amount and mix of billable labor hours incurred.
Digimarc's net loss per share for the third quarter of 2024 was $0.50, compared to $0.53 in the same period of 2023. On a non-GAAP basis, the company's net loss per share was $0.29 in both periods.
The company generates the majority of its revenue internationally, with 79% of Q3 2024 revenue coming from international markets, up from 68% in the prior year quarter. Domestic revenue decreased 31% year-over-year.
For the full fiscal year 2023, Digimarc reported revenue of $34.85 million, net income of -$45.96 million, operating cash flow of -$21.99 million, and free cash flow of -$22.74 million.
Liquidity and Cash Flow
As of September 30, 2024, Digimarc had $33.7 million in cash and short-term investments. Free cash flow usage was $7.3 million for the quarter, compared to $400,000 in the third quarter of 2023. The variation year-over-year was primarily due to the timing of cash receipts from the delayed contract. However, the company expects its fourth-quarter free cash flow usage to be significantly improved from the third quarter, and potentially positive if the contract is executed and paid before the end of the year.
The company's financial position remains strong, with a debt-to-equity ratio of 0.07 as of September 30, 2024. Digimarc has no outstanding credit facilities or credit lines. The current ratio and quick ratio both stand at 4.0 as of September 30, 2024, indicating a solid liquidity position.
Future Outlook
Digimarc's gift card opportunity has also gained momentum, with the company recording some revenue in the third quarter and expecting it to be a significant contributor to its 2025 results. The company's reception in the gift card industry has been phenomenal, as the sector grapples with increasing fraud and seeks novel solutions to address these challenges.
Furthermore, Digimarc's partnership with the European Brands Association (AIM) in the HolyGrail recycling initiative in Europe continues to progress, with the company expecting a contract signing in the fourth quarter. This development aligns with the growing industry focus on improving the quality and quantity of recycled materials, a trend that Digimarc's digital watermarking technology is well-positioned to address.
Despite the temporary disconnect between Digimarc's financial results and its strategic progress, the company remains focused on maximizing long-term value. The delayed contract renewal, while impacting the third-quarter financials, is expected to be transformational for both Digimarc and the industry it aims to revolutionize.
As the company navigates this transition, it remains committed to transparent communication with its shareholders. Digimarc plans to provide a comprehensive update on its strategic priorities, quarterly highlights, and financial results in an interim call, should the delayed contract be finalized before the next scheduled earnings call.
The company believes the digital watermarking and product authentication markets present significant growth opportunities, with the potential to address massive total addressable markets. Digimarc's key products and solutions, including Digimarc Automate, Digimarc Engage, Digimarc Recycle, Digimarc Retail Experience, and Digimarc Validate, are well-positioned to capitalize on these opportunities across various industries.
In conclusion, Digimarc's pioneering work in digital watermarking and authentication technologies continues to position the company as a trailblazer in its industry. While the third-quarter financial results did not fully reflect the company's advancements, Digimarc's unwavering focus on long-term value creation and its transformative pipeline of opportunities suggest a promising future ahead. The company's strong liquidity position, innovative product portfolio, and strategic initiatives in high-growth markets provide a solid foundation for future growth and value creation.