Digimarc Corporation Aktie

Greetings, and welcome to the Digimarc Corporation First Quarter 2026 Financial Results Conference Call. [Operator Instructions] As a reminder this conference is being recorded. It is now my pleasure to introduce Charles Beck. Thank you. You may begin.

Welcome, everyone, to our Q1 earnings call. I'm Charles Beck, Digimarc's CFO, and I'm joined today by Riley McCormack, Digimarc's CEO. On the call today, Riley will provide a business update, and I will discuss Q1 2026 financial results. This will be followed by a question-and-answer forum. We have posted our prepared remarks in the Investor Relations section of our website and will archive this webcast there. For those of you dialing in, this is a reminder that we are simulcasting the presentation we will walk through today. If you would like to follow along with the slides, I would encourage you to join our webcast as referenced in our earnings press release shared earlier today.

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.

Thank you, Charles, and hello, everyone. On this call, we will walk through Digimarc's Q1 performance, highlight our strategic progress across product innovation and commercial execution, share updates on financial metrics such as ARR and free cash flow, and provide clarity on where we are focused in 2026.

In Q1, we made significant progress in advancing adoption of our Secure Gift Card solution. As we shared on our last call, during Q1, we achieved a critical milestone by signing our first commercial order covering 6 Closed-Loop and Open-Loop brands. We also made headway in laying the rails for additional orders and are currently advancing initial rollout plans with 15 North American retailers, including 8 of the 20 largest as measured by sales, an increase from 8 and 4, respectively, since our call only 2 months ago. We secured upsells with 3 existing customers of our Anti-counterfeiting solution. We continue to execute against a large opportunity in Digital Trust & Integrity, securing a 6-figure upsell with an existing customer while progressing a natural and exciting extension of our trust layer strategy that provides a critical unmet need for scalable agentic AI. And we continue to add key talent across our company, especially in our go-to-market functions, including the recent addition of 2 accomplished sales leaders who have hit the ground running.

Touching on our financial highlights in Q1. We grew ending ARR 9% sequentially, while also expanding our subscription gross margin 400 basis points year-over-year. We ended the quarter with $10 million of cash and investments and no debt, and we expect to implement our new corporate structure shortly, allowing us to realize the benefits discussed on our last call. As a reminder, our 3 focus areas are Retail Loss Prevention, Product Authentication, and Digital Trust & Integrity, and we serve these markets with the 7 solutions you see listed on this slide. In addition, we continue to selectively engage outside our 3 focus areas when the opportunities represent low distraction revenue and/or advance our positioning in longer-term strategic areas.

Starting with an update on Retail Loss Prevention. We continue to make progress towards gaining widespread adoption of our Secure Gift Card solution, aided by the industry's hyper-focus on finding an answer to the fraud that is creating an existential threat to their business. Results to date demonstrate the power of our solution, significant fraud reduction, improved checkout experience and high scalability across printers, brands and retailers, all without any adverse impact on sales. As a reminder, we have posted a gift card investor supplemental on the Investor Relations section of our website, a hyper link to which can be found on this slide. We appreciate the feedback we have received regarding the benefit the supplemental has provided in helping investors better understand the opportunity ahead.

We are experiencing a noticeable uptick in market pull for our solution as the level of retailer brand and gift card network engagement has increased meaningfully, even from our last earnings call just 2 months ago. Before I provide more details on that increased engagement, I want to provide an update on the 2 rollouts we shared on our last call. First, the rollout to all Schnucks locations is underway. Next, the summer rollout with the other retailer mentioned will be more limited than originally planned with the full almost 600 location rollout now targeted for January 2027.

As discussed in our March call, the greatest source of timing risk has been the scanner vendors shipping generally available versions of their firmware running our latest software. While 8 scanner models were GA's in the requisite time frame we highlighted on that call, 2 were not, including one model critical to this retailer's front end. This delay had nothing to do with our software. Instead, it was related to base functionality key to enabling the retailer to push any firmware update in a scalable fashion leading to the smaller summer launch. The scanner vendor has subsequently shipped the updated firmware, which is currently undergoing normal acceptance testing by the retailer. Importantly, this retailer's commitment to their customers and their belief that our solution will help protect those customers remains unchanged. We look forward to partnering with them in the months and years ahead.

April is a busy month in the gift card industry as both large gift card networks, host summits, enabling their ecosystems to coordinate ahead of the holiday season. As a result of these summits as well as many other meetings, including an event at our headquarters attended by representatives from 2 very large retailers and a leading program manager, we are now advancing rollout plans with 15 North American retailers, including 8 of the 20 largest as measured by sales. This represents a meaningful increase in both metrics since our Q4 call only 2 months ago.

This momentum is being driven not only by us but also by key industry participants and in the last few weeks alone, we have heard about retailers proactively engaging with major brands to encourage their adoption of our solution as well as with other retailers to increase incentive for widely sold brands to speed their adoption. Similar momentum building actions are being undertaken by the networks and key brands, and we are focused on orchestrating the multiple moving parts to ensure initial rollouts proceed as quickly and excellently as possible.

As discussed on our last call, in Q1, we closed our first Secure Gift Card commercial order, representing over $500,000 of ARR. This order included gift cards from 6 Closed-Loop and Open-Loop brands. Just as we are on the retailer side, we continue to expand our number of brand engagements, including some of the largest Open-Loop and Closed-Loop issuers, comprising both third-party and first-party opportunities.

In addition to being a large market itself, we have discussed the value we see in Secure Gift Cards opening opportunities in a much larger retail loss prevention market. Lighting up retailers for our gift card solution provides us a key technological footprint as our software will be widely distributed across their front of store scanners. It also creates Digimarc champions in both operations and loss prevention, two teams that often have competing priorities and where we stand out with our ability to deliver value to both. This unique position should aid us in cross-selling additional solutions into our retailer customers as well as provide us differentiated and invaluable voice to market for the advancement of new solution candidates.

We are already seeing encouraging signs that provide validation of the strategy. Multiple retailers have expressed an early interest in our Product Swap Prevention solution, including one very large retailer who in addition asked about our ability to solve another problem today and the industry are facing counterfeit coupons. Without losing focus on the opportunity immediately in front of us, we are excited to engage further across all these opportunities, including the expiration of this new potential solution for counterfeit coupons as we believe our work in product authentication provides us a valuable foundation upon which to build.

Turning now to Product Authentication. ARR from our Anti-counterfeiting Solution continues to grow, driven by customer upsell and new customer wins. Brands faced rampant counterfeiting and IP theft with bad actors advancing their technology and processes to replicate packaging and security features with alarming accuracy, something made ever easier by the advancement of AI.

Decentralized supply chains and omnichannel sales make counterfeit detection more difficult, putting brands in a reactive position against emerging threats. Many security measures require trained inspectors and specialized tools, limiting accessibility, increasing costs and reducing scalability. Digimarc's secure and scalable, covert and connected proactive solution provides superior results when compared to competing analog solutions such as tags, codes, inks and labels. We closed 3 upsell deals with existing customers of our Anti-counterfeiting solution in Q1. These brands represent leading companies from different industries, pharmaceuticals, food and beverage and consumer goods, highlighting the wide applicability of our solution across many different verticals. We are fortunate to have some of the largest and most well-known companies in the world as valued customers. As we have repeatedly stated, when we solve our customers' most challenging problems, we expect to benefit from the further upsell and cross-sell revenue generation for a long time.

Turning now to Digital Trust & Integrity. We continue to execute against this large and greenfield opportunity. Problems of trust and integrity in the digital domain existed prior to the advent of AI, but AI has created new ones while making prior ones worse and/or harder to solve. The work of C2PA has created wide awareness that our technology addresses many of these problems and our history, our credibility, our expertise, our experience and our first to market with and co-leadership of the digital watermarking component of the C2PA standard are all coalescing to ensure we are well positioned to surf ever-growing wave.

We secured a 6-figure upsell with the global technology company that has adopted the Leak Detection for web content solution we discussed on our last call. We progressed discussions with the important industry trade group we have previously mentioned that is searching for an industry-wide solution to a problem they previously felt unsolvable. As a result, we expect to soon enter direct conversations with the leading companies in this industry regarding our ability to help them solve this and other problems made worse by the advance of AI. And we're seeing engagement with U.S. government innovation programs. Digimarc has been included as a potential participant in the SOFWERX Field Forward Technology Sprint, an early but tangible sign that our technology is relevant in contested mission-critical environments.

Touching quickly on product innovation in the large and rapidly evolving Digital Trust & Integrity space, we are progressing a natural extension of our trust layer strategy that directly aligns with our existing IP and operating history and addresses a critical unmet need for scalable agentic AI. While the ultimate direction in how we attack this opportunity is being shaped by real-time industry engagement, the idea that enterprises will require an ultra-scalable way to verify what is real, authentic and authorized as AI systems become more autonomous, is gaining widespread acceptance. And providing an ultra-scalable way to verify what is real authentic and authorized is an area we believe we have a unique right to win.

Agents act at machine speed, negotiating, transacting and moving information without any human review. This not only increases the attack surface, it makes the agents themselves part of that surface. Existing software security architectures were built on the underlying assumption of human involvement, a premise that is rapidly eroding. As agents shift from content creation for human review to truly autonomous action, technology must replicate human experience and judgment, or agentic utility will remain constrained by limitations placed on the tasks they are entrusted to undertake.

While we are focused on our authentication use cases, we continue to support identification use cases that could drive future growth. We are advancing our position in these longer-term strategic areas and are confident in our ability to win when the time is right to pursue them. The Belgian and German market demonstrations of our recycling solution remain on track, and we are eager for the results. We believe these live cradle-to-rebirth activities will result in the production of new fractions of PCR feedstock that is not possible using current sorting technologies, providing tangible proof of our solutions' ability to, among other things, create new end markets for recycled plastic. As a reminder, we believe this capability is crucial to the industry's ability to comply with the sunrise of the EU's Packaging and Packaging Waste Regulation. We have also closed 2 upsell deals with existing Engage customers, one in Q1 and another already in Q2. I will now turn the call over to Charles to discuss our financial results.

Thank you, Riley. Ending ARR for Q1 was $15 million compared to $20 million for Q1 last year. The decrease reflects the previously disclosed loss of 2 customer contracts in 2025, which accounted for $6.8 million of ARR. Excluding these 2 items, ARR grew $1.8 million year-over-year which included $500,000 of ARR from gift cards in Q1 this year. Sequential ARR growth was 9%.

Looking ahead, we still expect to deliver significant ARR growth in 2026 although the composition of that growth has changed. As a result of the scanner delays Riley mentioned, we no longer expect Gift Cards to be the largest contributor. This is purely a result of timing of initial rollouts as opposed to our conviction in the opportunity. There is tangible market pull for our solution and the level of retailer brand and gift card network engagement has meaningfully increased.

Total revenue for Q1 was $7.6 million, a decrease of $1.8 million from $9.4 million in Q1 last year, with the change equally split between subscription and service revenue. Subscription revenue, which accounted for 58% of total revenue for the quarter, decreased $900,000 from $5.3 million to $4.4 million. Excluding the impact of the 2 contracts I referenced earlier, which accounted for $1.5 million of subscription revenue in Q1 last year, subscription revenue would have increased $600,000. Service revenue decreased $800,000 from $4.1 million to $3.2 million. Service revenue in Q1 last year included $500,000 of revenue from HolyGrail 2.0 recycling projects compared to none this year. We don't expect further service revenue from HolyGrail 2.0 as that program has ended and HolyGrail 2030 is focused on deploying end-to-end market demonstrations.

Subscription gross profit margin was 90% for the quarter, 4 points higher than Q1 last year, largely reflecting lower subscription platform costs. We continue to drive down our platform costs, which year-over-year are now down $300,000. Service gross profit margin was 57% for the quarter, down 8 points from 65% in Q1 last year. The decrease was due to an abnormally favorable mix of revenue and cost in Q1 last year. Service gross profit margin has routinely been in the high 50s.

Operating expenses were $11.7 million for the quarter, down $6.5 million or 36% from $18.2 million in Q1 last year. The large decrease reflects $7.4 million in lower cash compensation costs due to lower headcount and $3.2 million in severance costs incurred last year, lower consulting costs of $500,000 and lower software and hardware cost of $300,000. These cost savings were partially offset by higher onetime legal and other costs of $1.2 million related to the corporate reorganization and $500,000 higher stock compensation expense. While we continue to be vigilant pursuing ways to operate more efficiently and effectively to ensure that we are maximizing the return of every dollar we spend, as mentioned on our two prior calls, we are increasing our overall investment in the business to support the growth ahead.

Non-GAAP operating expenses, which exclude noncash and nonrecurring items, were $8.1 million for the quarter, down $8.4 million or 51% from $16.5 million in Q1 last year. The large decrease reflects aforementioned lower cash compensation, consulting and software and hardware costs. Net loss per diluted share for the quarter was $0.32 versus $0.55 in Q1 last year. Non-GAAP net loss per diluted share for the quarter was $0.07 versus $0.40 in Q1 last year.

Regarding cash flow, we ended the quarter with $10 million in cash and short-term investments with no debt. We used a little under $2 million in free cash flow and $900,000 of buyback stock as part of our employee stock program. The stock buyback of 169,000 shares was higher than in recent quarters as more shares typically vest in Q1 than in any other quarter due to the timing of our annual compensation cycle.

Free cash flow usage grew $3.7 million from Q1 last year. The improvement was despite a headwind to revenue and an unfavorable change in working capital and other activity of $3.4 million year-over-year. The change in working capital was largely due to the timing amount of cash receipts and payments. Reiterating what I've shared previously, working capital can swing significantly quarter-to-quarter based on timing, which is why we believe that non-GAAP net income or loss is a better proxy for normalized free cash flow. Our non-GAAP net loss improved $6.9 million or 81% from $8.5 million in Q1 last year to $1.6 million in Q1 this year. As a reminder, in Q1 each year, we incur roughly $500,000 of costs related to public company year-end expenses. Excluding these costs, our Q1 non-GAAP loss would have been $1.1 million.

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. Before I wrap up, I did want to mention that we will be attending 2 upcoming investor conferences. The first is Needham, which is tomorrow, and the second is Oppenheimer, which is in mid-August. We will keep you all informed of any investor conferences we plan to attend. Also, we expect to finalize our new corporate structure, which was approved by shareholders on or around May 16. The new corporate structure will result in a CUSIP change. Our transfer agent, Broadridge will be contacting investors directly on how to exchange shares. I will now turn the call back over to Riley for final remarks.

Thank you, Charles. In the wake of the relentless acceleration of AI models and agents, a vacuum of trust and authenticity is being created. Trust is fast becoming the only currency that matters and the future will belong to companies that make that currency scalable. We believe Digimarc is ideally positioned to lead that charge. We are focused on delivering a future where humans and intelligent systems alike can verify what's real, protect what matters and move forward with confidence, spanning across both the physical and digital worlds. We're building the trust layer for the modern world, a foundation that is needed now more than ever and is emerging as a significant opportunity we were created to lead.

Digimarc is capitalizing on the convergence of key trends driving increased demand for our solutions, positioning ourselves as one of the select software companies to benefit from, not be a casualty of the relentless advance of AI. We grew Ending ARR 9% sequentially, while expanding our subscription gross margin 400 basis points year-over-year. We are advancing our Secure Gift Card solution by aligning key industry partners as we progress towards widespread adoption of our solution. We signed our first commercial order and are progressing initial rollout plans with 15 North American retailers including 8 of the 20 largest as measured by sales, a significant increase in both metrics since our last earnings call only 2 months ago.

ARR from our anticounterfeiting solution continues to grow, driven by customer upsells and new customer wins. In Q1, we secured 3 upsells from existing customers, representing leading companies from 3 different verticals. We continue to execute against the large opportunity in the exciting and greenfield Digital Trust & Integrity space, securing a 6-figure upsell with a global technology company, advancing engagement with important force multipliers and progressing a natural and exciting extension of our trust layer strategy that directly aligns with our existing IP and operating history and provides a critical unmet need for scalable agentic AI.

We added key talent across go-to-market functions, including 2 accomplished sales leaders. We continue to be well positioned to address very large problems outside of our current focus areas when the markets are ripe. We are eager for the results of the 2 upcoming end-to-end market demonstrations of our recycling solution as we believe they will show our ability to help the industry comply with the sunrise on the EUs PPWR.

Stacy, will now open up the call for questions.

[Operator Instructions] First question comes from Jeff Van Rhee with Craig Hallum.

This is Daniel on for Jeff. On the rollout plans with the 15 North American retailers, just to be clear on that, is this at the point where they are vetting the solution? Or are they -- actually so far as to say that they're all planning fully on buying. They're just refining how and when they roll out. Just any color on -- or maybe you can split it up into several buckets in terms of where those prospects typically are, but any color on where those 15 are in the process?

Yes, of course, Daniel. So obviously, we're talking to more than 15. The 15 that we mentioned on the call is that we're advancing rollout plans. And it's a mix. It's initial rollout planning to weekly execution calls and on-site visits to even some limited in-store testing. And in addition, besides the more direct -- I mentioned we're talking to more than 15. Beyond just these conversations, we're also having -- we're hosting broader industry events, whether they be virtual meetings or events at our headquarters, providing venues for multiple retailers and brands to not just talk to us, but talk to each other about how we really drive fast and light adoption.

Okay. That's helpful. That definitely puts some meat on the bones there. And then on the anti-counterfeiting customers, the 3 that upsold, is there any commonality you can point to in terms of what's driving those upsells, whether that's the level of technology that they're embedding where you're seeing customers coming in and typically embedding more technology or that's sort of natural flow of the life of the customer where they're scaling the deployment up or pricing changes? Just anything you can call out about what's driving that, especially in commonalities in the business?

Yes, it's a mix. Sometimes it's adding new brands, sometimes it's adding new geographies, sometimes it's adding new functionality. And so it's a mix across all of those metrics.

Okay. That's helpful. And then last of all, just in regards to Schnucks, just any additional thoughts on how that rollout is pacing relative to expected? And then just anything else on the feedback you're hearing there?

Yes, it's underway. It's all we really want to say at that point, but we truly value them as a partner as our initial retailer partner. Those cards have been in store. So they're expanding to all of their stores, but they've been carrying cards at 15 stores. Initially, it was 10. They added another 5 stores a couple of months ago, and they're very happy with the solution, and we're really thrilled with them as a wonderful partner.

[Operator Instructions] I would like to turn the floor over to Riley for closing remarks.

Okay. Well, thank you, everyone, for dialing in today's call. We hope you have a wonderful rest of your day, and look forward to seeing some of you tomorrow. Have a great night.

This concludes today's teleconference. You may disconnect your lines at this time, and thank you for your participation.

Greetings, and welcome to Digimarc Corporation's Fourth Quarter 2025 Earnings Q&A Call. [Operator Instructions] Please note, this call is being recorded.

I will now turn the conference over to Charles Beck, Chief Financial Officer of Digimarc. Sir, you may begin.

Welcome back, everyone. Charles Beck, Digimarc's CFO here, and I'm joined again by Riley McCormack, Digimarc's CEO. First off, apologies for the technical difficulties last week that was quite unexpected and unfortunate. There was an extended outage by our conference call provider ISP that caused the issue.

Today's conference call is intended to be a question-and-answer forum related to our Q4, 2025 financial results and business update, including any questions anyone might have after reviewing our Gift Card investor supplemental. While we've had a chance to connect with many of you since the call, we still felt it was important to reconvene to answer any remaining questions. We do ask that questions related to our S-4 filing and annual proxy wait until the proxy is made effective by the SEC, at which point both management and the Board look forward to engaging with our shareholders to answer any questions, and gather any feedback as part of our normal proxy outreach process.

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.

Now I will open it up to Q&A.

[Operator Instructions] And our first question comes from Jeff Bernstein with Silverberg Bernstein.

For the Gift Card supplemental, lots of great information in there. I had a couple of questions on that. You show a company, STL that, I guess, prints some of the packaging elements related to the gift cards. They look like sort of a single point of potential success in the supply chain. Can you just talk about your relationship with them and how important that will be?

Jeff, thanks for the question. And yes, STL is the dominant label provider for the gift card industry and extremely well respected and thought of in the industry, and a wonderful partner to us because a lot of our solution is software base where we're putting on our watermark and we have our detection software that incorporates not just watermark detection but AI. But a lot of it is also building the Digimarc spec, what kind of labels to use, things like that. And where STL really excels is not just producing the labels, but a lot of material science knowledge and know-how. And so they're a wonderful R&D partner to us as we advance our spec.

So wonderful company. As you point, a single point of opportunity, I like that phrase. Dominant share in this industry and a local organ company actually. So wonderful to have one of our neighbors as a partner in this.

Terrific. And if I could just get one follow-up. Blackhawk and InComm are in there and, I think, somewhat familiar to people in the gift card industry and other related cards. How important are those two guys? I know there are others as well, but they seem to come up a lot.

Yes. The gift card networks, and again, put all this in the investor supplement, everybody's got full transparency into what all these -- who all the players are in the ecosystem. But the networks, you're right, InComm and Blackhawk are the two largest gift card networks in the U.S. and massive globally as well. And they orchestrate the delivery of cards to retailers. So incredibly influential in the industry, have deep relationships with the brands, as well as the retailers, as well as the whole ecosystem, and two wonderful partners to us as well. We wouldn't be where we are without the two of them and wonderful partners, and very influential.

[Operator Instructions] And our next question comes from Scott Kimelman with Kimelman & Baird.

I actually thought the summary on the gift card business is very, very helpful in depth. It was great. I'm walking through the bottlenecks, right? So I know you made some press releases, and I know you said some positive things. I think you used the term like weeks. But where are we really in the firmware updates on the scanning side at point of sale?

Scott, yes, great question. Two, I guess, technological barriers that we've been working on the last couple of quarters.

First is, as you mentioned, is with the scanner vendors. I think we classified it in our earnings call last week as in the prepared remarks is a greatest source of historic risk. There are 3 dominant scanner vendors in the industry, Zebra Datalogic and Honeywell, and then the fourth NCR, or white labels, different models from those 3 vendors. And as we highlighted last week, two things.

One, it's been our greatest source of historic timing risk. But two is you all saw the press releases we put out with those 3 valued partners end of Q4, early Q1. And we mentioned on the call last week, it's not just what they put out a couple of months ago, it's also they're evergreening these commitments to the retailers, which are obviously very, very important customers to them as well. And as we mentioned, for the relevant models, we think we're weeks away from having this behind us. So that's on the scanner side.

And the other one is the printers, which we also talked a little bit last week. Spent the time with the printing industry, making sure that there's more than enough capacity ready to print these cards. And while we haven't quantified any guidance for this year, the capacity we have on the printer side is multiples more than we're projecting this year for gift card volume. So fully understand your focus on potential bottlenecks. And on those two, we feel very good.

There are no further questions at this time. And this now concludes our question-and-answer session. Sorry, Charles, it looks like Jeff Bernstein is joining in for another question with Silverberg and Bernstein.

Yes, just a couple of other follow-ups. So can you talk a little bit about the second leak detection win and go through a little bit about that application, and how that was brought in? Did the customer come to you? Or do you have any resellers in this area as it was a direct sale?

So a couple of things. So yes, the -- we have two versions -- and thanks again for the question, Jeff. We have two versions of our Leak Detection solution. One is for web content. The other one is for discrete media.

The Fortune 100 company that we've been talking about the last couple of quarters and put the press release out was for the web content. That's the one we spent a greater amount of time talking about on the call. The other win we got in Q4 was for the other version of Leak Detection for the media assets. And again, if you go to our website, you can see a greater description of all of these.

That was a company that came to us. They had a problem with -- they were releasing media assets to their partners under embargo, ahead of big releases and some of those were making their way to social media before they were supposed to. And so this is a real problem they had with their business. And so excited to have them on board. And as we've said in the call, they're already seeing the tangible benefits and so look to grow that relationship over time.

And I'm sorry, Jeff you had a couple of questions?

Yes, a little bit more on kind of what's the go-to-market there now then? So do you have some sales folks who are dedicated to this? Or how is that working?

Yes. So we do have people dedicated to this space. We think it's a really exciting space. There's actually a conference that some of the teams going to, I believe, on Wednesday of this week, to talk to more prospects and do demos. This is an area -- I think it's right, you talked about partners. This is an area that would be ripe for partners, right?

This is our -- of our three focus areas, this is the one that lives completely in the digital domain. So it allows a lot of the benefits of more traditional SaaS software where we can have reselling partners, we could have technological integrations. This solution would be great for either security platforms, or -- well a lot of SaaS applications. There's sensitive information being shared on those applications. So this is an area that we do have a direct sales motion right now. And as we're building this out, we think partners should be a wonderful source of either both leads, as well as technological integrations and let them resell it as part of their solutions.

Great. That's terrific. And then just one on HolyGrail and just some stuff around timing there. So you've got a second countrywide deployment, I guess, happening that they're calling a commercial deployment. It kind of feels like it's still a trial. I guess, Belgium is doing flexible packaging, if I've got that right, and the solid is Germany. And there's, the sort of, 2030 banner over all this. But how should we think about this actually becoming real commercial where there's real money getting paid to Digimarc?

Yes, it's a great question. Yes. So I think the term is an end-to-end market demonstration is what the industry is calling this. And it's -- we have a truly tested technology in terms of our efficacy. What they're doing in Belgium and Germany is, again, these products are -- these are real products appearing on shelves, getting bought by consumers and working their way through the sortation and then the recycling facilities, which is what HolyGrail has done to date. And now they're going to take that output and actually create new recyclate. So they're calling it a cradle to -- birth to rebirth, I think, is the term they're using for this, and actually showing you can touch, feel, hold the actual recyclate at the other end.

The timing for Belgium, the expectation, there's already a critical mass of stuff on shelves that needs to work its way through the shelves through pantries and then into the waste facility, and that's the expected timing of that critical mass sometime in Q2. Germany is a quarter behind that and expecting critical mass in Q3. And as you pointed out, there's the 2030 sunrise of the PPWR. There's a whole list of requirements that the industry is going to need to commit to or be able to successfully do in order to hit the requirements in the PPWR. And one of them is new fractions of recycling.

So of all the benefits, right, we help produce a higher quality, as well as quantity of recyclate, right? So more recyclate but also higher quality of recyclate. With our deterministic, we can also do new fractions of recyclate. And that's just the tangible benefits we can bring to the plastic stream. The other real benefit that we're excited about, and we think the industry is excited about is data, right? It's because take any item, it is scanned 10x before it reaches that front-of-store scanner and then it goes dark to the world, right? Any data -- any post-purchase data is all qualitative or survey data. We provide the ability to actually get quantitative data to feed back into marketing or more and more these days, obviously, an AI engine and what learnings can a CPG, or retailer gain from having actual consumption data brought to them by the end of the life scanning.

So when this leads to real commercialization, this is where we -- part of our focus strategy we talked about last year was focusing on the stuff that we think is right in front of us, but maintaining our position for things that we think will be future really, really big opportunities for us. And this is one of them. It's -- we can't make the industry move faster. All we can do is support the value that we can bring to the entire industry, and be there ready when they're ready to move forward.

Great. That's great. And then just the last one. You had a win in tax stamp authentication. Can you just talk about that application, as well as how that win came through, and what the selling motion is in that application, which seems like it would probably be a pretty big one?

Yes. So that one is through one of our partners who's taking our solution and applying it to a tax stamp solution that they're rolling out. We do have the ability -- as we talked about our -- put out a press release probably about a year ago. We do have a, I guess, for lack of a better term, a higher-grade solution. But what this company is doing is they produce tax stamps as it is. And so they have a whole solution that has multiple layers, and they're using us as not a stand-alone solution for tax stamps, but as a layer -- security layer in their tax stamp solution.

So we have an option we could sell directly that is a lot higher -- that has a lot more capabilities and features than our traditional anticounterfeiting solution. But this specific win was through a partner who just wanted our more off-the-shelf offering as a security layer in their total solution.

This now concludes our question-and-answer session. I would like to turn the call over to Riley for closing comments.

Great. Well, thank you all again. As Charles said, we apologize for the technical snafu last week. And I know we've had a chance to talk to a lot of you in the intervening time, but I appreciate you all dialing in and rejoining us today for the Q&A session. We hope you have a great rest of your day. Thanks a lot.

Ladies and gentlemen, thank you for your participation. This concludes today's conference. Please disconnect your lines, and have a wonderful day.

Greetings, and welcome to the Digimarc Corporation Fourth Quarter Conference Call. [Operator Instructions] As a reminder, this conference is being recorded.

It is now my pleasure to introduce Charles Beck, Chief Financial Officer. Please go ahead.

Welcome, everyone, to our Q4 earnings call. I'm Charles Beck, Digimarc's CFO, and I'm joined today by Riley McCormack, Digimarc's CEO. On the call today, Riley will provide a business update, and I will discuss Q4 2025 financial results. This will be followed by a question-and-answer forum. We have posted our prepared remarks in the Investor Relations section of our website and will archive this webcast there. For those of you dialing in, this is a reminder that we are simulcasting the presentation we will walk through today. If you would like to follow along with the slides, I would encourage you to join our webcast as referenced in our earnings press release shared earlier today.

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.

Thank you, Charles, and hello, everyone. On this call, we will walk through Digimarc's Q4 performance, highlight our strategic progress across product innovation and commercial execution, share updates on our financial metrics such as ARR and free cash flow, and provide clarity on where we are focused in 2026.

Since our last call, we have made significant progress in advancing adoption of our Secure Gift Card solution. We achieved a critical milestone by signing our first commercial order and are laying the rails for future orders by advancing initial rollout plans with 8 North American retailers, including 4 of the largest. We signed IP licensing agreements with 2 of the world's largest and most respected technology companies, providing validation of the relevance and value of our inventions by 2 companies widely regarded as leaders in the new era of AI.

We secured an upsell with an existing customer to expand their use of our anticounterfeiting solution to allow for the authentication of tax stamps, a new application for our solution. We added 2 new logos in the digital space, one, a global consumer goods company and the other an AI-powered content generation company, demonstrating that business model or vertical does not impact the need for digital trust and integrity solutions. And we signed a deal with another major CPG to enable their participation in end-to-end market demonstrations of Digimarc Recycle in Germany, the second European country running a scale validation of our solutions real-world ability to create higher quality and quantity of plastic recyclate.

Touching on our financial highlights in Q4 and we achieved both positive non-GAAP net income and positive free cash flow in the quarter, 2 milestones Digimarc hasn't achieved in over 12 years. We ended the year with just under $13 million of cash and investments and no debt. and we expect to generate significant ARR growth in 2026.

As a reminder, our 3 focus areas are Retail Loss Prevention, Product Authentication, and Digital Trust and Integrity, and we serve these markets with the 7 solutions you see listed on this slide. In addition, and as demonstrated by the business highlights just discussed, we continue to selectively engage outside of our 3 focus areas, when the opportunities represent low-distraction revenue and/or advance our positioning in longer-term strategic areas.

Before we dive further into the details of our progress in the quarter, I want to remind investors of the focused strategy we communicated last year as it provides important context for an issue that is front of mind for all investors, but particularly those in the software space.

Last year, we shared that in the wake of the relentless acceleration of AI models and agents, a vacuum of trust and authenticity is being created. Trust is fast becoming the only currency that matters and we believe that the future will belong to companies that make that currency scalable. This is why we are building the trust layer for the modern world, a foundation that is needed more now than ever and is emerging as a significant opportunity we were created to lead.

Today, as an investors weigh the ever-increasing risk that AI's rapid advancement closes to workflow and task automation software functionality Digimarc's strategic focus positions us as one of the select software companies poised to benefit from this irreversible trend. As opposed to threatening our business, AI's advance is instead driving an increased need for solutions that make trust verifiable and authenticity scalable. The 2 things that all of our solutions are purposely built to do.

Moreover, our competitive moats are not reliant on the size of our code base and/or our number of pre-built integrations. Instead, they are built upon our vast intellectual property, our multiple network effects and our ability to bridge the physical and digital domains, all of which remain unaffected by the advent of AI.

As a result, we are well positioned amongst our software peers because we welcome an even greater AI disruption. Instead of compromising our opportunity set and/or eroding our competitive moats. This disruption is acting as a tailwind to our business by expanding the trust vacuum our solutions are built to fill.

Our greatest near-term opportunities in retail loss prevention and more specifically, our secure gift card solution. On this front, we have made substantial progress towards gaining widespread adoption aided by the industry's hyper focus on finding an answer to the fraud that is creating an existential threat to their business.

Results to date demonstrate the power of our solution, strong fraud reduction, improved checkout experience and high scalability across printers, brands and retailers, all without any adverse impact on sales.

Due to the positive impact that we expect our Secure Gift Card solution to have on our 2026 and beyond results, we wanted to provide investors with additional information and transparency to ensure they have a full understanding of the opportunity ahead. We have posted a gift card investor supplemental on our Investor Relations section of our website, a hyperlink to which can be found on this slide.

The U.S. serviceable addressable market for our solution is an estimated 3 billion to 5 billion cards annually. The global SAM is 7.5 billion to 17 billion cards annually. Commercial activity against that SAM is accelerating, supported by ecosystem partnerships, growing regulatory pressure for secure packaging, and large retailers preparing for initial rollouts in 2026.

With key work streams to enable large gift card printers now largely compete, our focus for 2026 is commencing large-scale rollouts of Digimarc-enabled firmware across retailers' front-of-store scanners and catalyzing significant adoption of our solution by the gift card brands that are sold through those stores. As a reminder, our current go-to-market model is to monetize the gift card side of the network and provide our scanner detection software for free.

One of the longest lead time dependencies and the greatest source of historic timing risk, has been the scanner vendors shipping generally available versions of their firm running our latest software. This is a prerequisite for retailers to begin their in-store firmware refresh process. which itself is a requirement for the industry to capture the value from printers, brands and program managers licensing our solution.

Over the last few months, the 3 major scanner vendors have all publicly committed to timelines to complete this critical gatekeeping activity. More recently, based on evergreen commitments these vendors continue to make to their largest retail customers, we believe it is a matter of weeks until the most relevant scanner models from these industry-leading vendors have GA firmware that incorporates our latest software.

With the expectation that this historically significant risk factor is weeks away from being predominantly behind us, we are advancing the rollout plans of Digimarc-enabled firmware with our initial cohort of retail partners and are excited with the information we can publicly share.

We currently expect all Schnucks location to be carrying Digimarc-secured gift cards this spring and approximately 600 stores of a major U.S. retailer to be doing the same this summer with plans to greatly expand that number for holiday 2026. In addition, we are in various stages of planning initial rollouts with an additional 6 retailers, including 3 of the largest in North America. When including the major U.S. retailer that I referenced a moment ago, our initial cohort of retailers includes a humbling list of widely respected industry leaders, including 4 of the largest retailers in North America.

Turning now to gift card enablement, earlier in this quarter, we closed our first secure gift card commercial order, representing over $500,000 in ARR. This order is comprised of gift cards from 6 Closed-Loop and Open-Loop brands and represents the first batch of gift cards that will appear in Schnucks stores in early spring and the approximately 600 stores of the major U.S. retail in the summer.

As we describe in greater detail in our Gift Card Investor Supplemental, we expect our pricing to increase over 3 stages based on our solutions adoption maturity and scale. Using our current Digimarc-subsidized pricing, this first order represents less than 0.1% or 10 basis points of our U.S. SAM described earlier.

We are in conversations with additional Open-Loop and Closed-Loop brands, comprising both third-party and first-party issuers supporting the retailer rollout planning already discussed. In all instances, our conversations with the brands are being aided by the retailers and the gift card networks, both of whom hold enormous power in this ecosystem. Recall that one of the most powerful aspects of this opportunity is that fraud is a zero-sum game. The belief that laggards will face an increasing percentage of an ever-increasing amount of fraud remains at the very front of ecosystem participants' minds.

In our last few quarterly earnings presentations, we have shown a slide that described the Gift Card Ecosystem at a very high level. This updated slide replaces that slide and is included in the Gift Card Investor Supplemental that I referenced earlier. It provides more detail of the ecosystem we are enabling as we lay the rails for what we expect to accomplish in 2026 and beyond.

Turning now to Product Authentication, ARR from our anticounterfeiting solution continues to grow, driven by customer upsells and new customer wins. Brands face rampant counterfeiting and IP theft, with bad actors advancing their technology and processes to replicate packaging and security features with alarming accuracy, something made ever easier with the advancement of AI.

Decentralized supply chains and omnichannel sales make counterfeit detection more difficult, forcing brands to be reactive against emerging threats. Many security measures require trained inspectors and specialized tools limiting accessibility, increasing costs and reducing scalability.

Digimarc's secure and scalable, covert and connected solution provides superior results when compared to competing analog solutions such as tags, codes, inks or labels.

We closed multiple upsell deals with existing customers of our anti-counterfeiting solution, reflecting both increased contract value and the expansion of our solution to new geographies and new brands. As we have repeatedly stated, when we solve our customers' most challenging problems, we expect to be an upsell and cross-sell company.

We closed an upsell with an existing customer to expand their use of our anticounterfeiting solution to allow for the authentication of tax stamps, representing a new application of our solution. We also secured an upsell with one of the world's leading pharmaceutical companies as they expand our solution across more of their products around the world.

A prospect to originally contacted us to explore the use of our anticounterfeiting solution is now progressing in our digital pipeline, something that happened almost immediately after we told them about our offering in this space. This shows the synergistic nature of our authentication focus and related solutions suite as well as the greenfield nature of our work in digital trust and integrity space. Piracy of their digital assets was a problem this organization had previously thought unsolvable until they engage with us.

Looking ahead, we are soon to enter print titles for the application of our solution to cigarette tipping paper, bringing our solution down to the stick level where a large percentage of the counterfeiting occurs. There are an estimated 5 trillion cigarettes sold each year, representing a sizable unit Total Addressable Market, assuming our solution meets the market's needs.

Turning now to Digital Trust and Integrity. We exceeded our conservative 2025 ARR assumptions in this space and look to accelerate our traction throughout 2026. Problems of trust and integrity in the digital domain existed prior to the advent of AI, but AI has created new ones while making prior ones worse and/or harder to solve. The work of C2PA has created wide awareness that our technology addresses many of these problems and our history, our credibility, our expertise, our experience and our first-to-market with and co-leadership of the digital bottle market component of the C2PA standard are all coalescing to ensure that we are well positioned to surf this ever-growing wave.

I want to use this call to provide more background information on one of our 4 solutions in this area, Leak Detection, and specifically the version of our solution that provides leak detection for web content. We featured this solution in a recent press release and case study with a Fortune 100 global technology company.

Our Leak Detection for Web Content solution addresses a significant gap in the data loss prevention space: low-tech, image-based leaks of internal company information. Risk assessments sometimes refer to this as the mobile picture path, and it has long remade an identified risk without a risk-reduction method.

These leaks happen when an employee, contractor or people working at trusted third parties like suppliers or outsourcing firms use their phones to take pictures of screens, showing sensitive and confidential information. These images can be shared externally on social media, new sites, online forms and more, causing harm to the owners of that sensitive and confidential information.

Companies like Coca-Cola, HP, TD Bank, and even CrowdStrike have made the news in recent months due to image-based leaks exposing everything from dashboards, IT security details, customer data, product designs and images and factory labs. These stories reveal how low-tech leaks can bypass the best DLP stacks, resulting in financial losses, loss competitive advantage and legal and reputational harm.

While photo-based leaks are nearly impossible to prevent, especially when people work remotely, Digimarc enables companies to identify leakers quickly so they can take action, prevent future leaks and gain insights in to build a more trustworthy workforce and extended ecosystem.

Our Leak Detection for Web Content solution adds a covert security layer to on-screen content without impacting the user experience or interfering with day-to-day work activity. When sensitive information is captured via a screenshot or photo, Digimarc's covert resilient security layer is captured along with it. Then when an image is discovered online, our customers simply uploaded to the Illuminate platform to help identify the source of the leak, fast, effective and scalable across global forces and ecosystems.

Our other version of Leak Detection provides leak detection for media assets, and in Q4, we signed a deal with a global consumer goods company to help them address unauthorized sharing of sensitive digital content by trusted channels under embargo. Our customer has already received tangible benefits from our solutions real-world efficacy, and we expect to grow our deal with them over time.

We also signed an Internal Compliance deal with an AI-powered content generation company interested in supporting attribution, auditability, and responsible commercialization of their user-generated content, as rights holders scrutiny of GenAI intensifies.

While we are focused on our authentication use cases, we continue to support identification use cases that could drive future growth. We are advancing our position in these longer-term strategic areas and are confident in our ability to win when the time is right to pursue them.

An example of this is recycling, where we are progressing well in both the Belgium and Germany end-to-end market demonstrations of our solutions' ability to impact real-world change. Digimarc-enabled product volume is expected to reach critical mass in sortation centers by midyear in Belgium and by Q3 in Germany. We believe these live cradle-to-rebirth activities will result in the production of new fraction of PCR feedstock that is not possible using current sorting technologies. This would provide tangible proof of our solutions' ability to, among other things, create new end markets for recycled plastic, something that is critical for the industry's ability to comply with the sunrise of the EU's Packaging and Packaging Waste Regulation.

We also closed an upsell deal with one of our Engage customers in Q4 and have multiple opportunities in our pipeline across both our Automate and Engage solutions.

I will now turn the call over to Charles to discuss our financial results

Thank you, Riley. Ending ARR for Q4 was $13.7 million compared to $20 million for Q4 last year. The decrease reflects the loss of 2 large customer contracts outside of our focus areas, the $3.5 million DRS contract in Q2 and the $3.1 million retailer contract that I stated on the last call would lapse in Q4. Excluding these 2 items, ARR grew $400,000 year-over-year. That growth, however, was largely muted by higher other customer churn and choosing to be strategically price aggressive on solutions outside of our focus areas. As I've stated previously, we expected higher churn as we sharpened our go-to-market focus.

For 2026, we expect to deliver significant ARR growth with contributions from all focus areas, but the largest single driver being our Secured Gift Card solution. On that front, our goal is to progress our targeted retailers and brands toward meaningful adoption for holiday 2026, for which we would expect orders in summer and early fall. We also expect there to be a continued ramp for the spring 2027 refresh cycle and beyond, for which we would expect orders in late fall and early winter. Time is of the essence as we work to maximize holiday orders, and we are singularly focused on hitting the necessary deadlines to do exactly that.

As we begin to penetrate the large opportunity ahead of us in the gift card space, we will be transparent with the percentage of our ARR generated from gift card orders. At least initially, we do not believe these deals will have our typical annual contract terms, but will instead have a shorter duration. As I alluded to earlier, the gift card market is characterized by the presence of 2 recurring orders that occur at least 2 times a year, if not more frequently, which provides us some ability to project the next 12 months revenue based on incoming orders. This accounting for a shorter duration will likely understate our true run rate demand, especially as we are increasing our penetration of retail stores, brands and the percentage of SKUs issued by those brands.

Total revenue for Q4 was $8.9 million, an increase of $200,000 or 3% from $8.7 million in Q4 last year. Subscription revenue, which accounted for 60% of total revenue for the quarter, increased 6% from $5 million to $5.3 million. The increase reflects $1.4 million of license fees paid during the quarter from the 2 IP licensing deals that Riley referenced earlier. The increase from these deals as well as growth in other areas was partially offset by the impact of the 2 previously mentioned customer contracts that ended during 2025.

While we don't talk about IP licensing often, it is a normal and recurring part of our business, although that revenue can be lumpy. For background, we have generated well over $100 million of IP licensing revenue over our company's history. The reason we are highlighting the deal signed in Q4 is that, in addition to their size, they were with 2 technology market leaders and highlight the value of our IP. As a reminder, we do not include IP licensing deals in ARR.

Service revenue decreased 2% from a rounded down $3.6 million to a rounded up $3.6 million, reflecting slightly lower commercial service revenue. Subscription gross profit margin was 90% for the quarter, 5 points higher than Q4 last year, largely reflecting lower subscription platform costs. Our platform costs are now $200,000 lower per quarter than they were at the beginning of 2025. We expect further reductions in these costs in 2026 as we continue to focus on ways to optimize our platform. Service gross profit margin was 57% for the quarter, down 2 points from 59% in Q4 last year. The decrease was due to a more favorable mix of revenue and costs last year.

Operating expenses were $10 million for the quarter, down $4.4 million or 31% from $14.4 million in Q4 last year. Important to note, we incurred $500,000 of costs during the quarter directly related to the 2 IP license deals previously mentioned, otherwise, operating expense would have been down $4.9 million year-over-year.

The large reduction in expenses reflects lower head count costs due to the reorganization in Q1 of 2025 as well as lower non-headcount cash costs from our ongoing corporate streamlining efforts. While we will continue to be diligent in pursuing ways to operate more efficiently and effectively to ensure that we are maximizing the return of every dollar we spend. As mentioned on the last call, we are increasing our overall investment in the business to support growth ahead.

Non-GAAP operating expenses, which excludes noncash and nonrecurring items, were $6.5 million for the quarter, down $5.4 million or 45% from $11.9 million in Q4 last year. Excluding the aforementioned $500,000 of IP license costs, non-GAAP operating expenses would have been $5.8 million lower exceeding the target we set out on our Q4 earnings call a year ago. Again, the decrease is mostly due to the impact of the reorganization and our ongoing non-headcount streamlining efforts.

Net loss per diluted share for the quarter was $0.19 versus $0.40 in Q4 last year. Non-GAAP net income per diluted share for the quarter was $0.05 versus a non-GAAP net loss of $0.22 in Q4 last year.

Regarding cash flow, we ended the quarter with $12.9 million in cash and short-term investments with no debt. We generated positive free cash flow of $700,000 in the quarter compared to negative free cash flow of $4.4 million in Q4 last year, an improvement of $5.1 million. That improvement was despite a negative change in working capital of $1 million year-over-year, largely due to the timing of customer seats. Otherwise, the improvement would have been even greater.

For Q1, we expect a free cash flow loss of $1 million to $2 million. Included in this number are some additional head count investments I mentioned earlier that we are making to accelerate our growth as well as approximately $500,000 of year-end related public company compliance costs that we incur in Q1 over year.

Also included in this number is approximately $1 million in expenses we expect to pay in Q1, largely related to onetime tax and legal costs associated with implementing a new corporate structure. We expect a large cash-on-cash return from this investment as the new corporate structure will allow us to realize substantial ongoing cash savings primarily through implementing an alternative long-term employee equity incentive program favored by conscious entities such as REITs.

In addition to the substantial ongoing cash savings, we believe this new program will maximize shareholder value in 3 other ways when compared to the current program: by reducing future dilution, helping us attract and retain the key talent needed to drive and support our expected growth and directly tying the realization of all equity-based compensation issued under this new program, including time-based awards, to shareholder value creation.

One last point to note regarding this new structure. It will require the issuance of a new CUSIP number, something a few investors have historically expressed a desire for us to do. The details of our new corporate structure, including a robust Q&A section will be described in greater detail in our S-4 filing due out tomorrow, which incorporates our annual proxy statement. For further discussion of our financial results and risks and prospects for our business, please see our Form 10-K that will be filed with the SEC.

I'll now turn the call back over to Riley for final remarks.

Thank you, Charles. In the wake of the relentless acceleration of AI models and agents, a vacuum of trust and authenticity is being created. Trust is fast becoming the only currency that matters in the future or belong to companies that make that currency scalable. We believe Digimarc is ideally positioned to lead that charge. We are focused on delivering a future where humans and intelligence systems alike can verify what's real, protect what matters and move forward with confidence. We are focused on filling the ever-expanding vacuum by positioning ourselves to deliver trust in every interaction, spanning both the physical and digital worlds. We are building the trust layer for the modern world, a foundation that is needed more now than ever and is emerging as a significant opportunity we were created to lead.

We are capitalizing on the convergence of key trends driving increased demand for our solutions, positioning ourselves as one of the select software companies to benefit from, not be a casualty of, the relentless advance of AI. We are advancing our Secure Gift Card solution by aligning key industry partners as we progress towards widespread adoption of our solution. We signed our first commercial order and advancing initial rollout plans with 8 retailers including 4 of the largest in North America.

ARR from our anti-counterfeiting solution continues to grow, driven by customer upsells and new customer wins. We also continue to grow the universe of form factors to which the solution is applicable, securing an upsell for tax stamps and entering print trials for tipping paper, which continues to grow our TAM.

We believe our decision to prioritize the long-term opportunity in Digital Trust & Integrity is paying off. We exceeded our conservative 2025 ARR assumptions in this space and look to accelerate our traction through 2026 as early results show the near universal needs for a solution in this greenfield area.

We continue to be well positioned to address very large problems outside of our current focus areas when the markets are ripe. We signed IP licensing agreements with 2 of the world's largest and most respected technology companies, providing validation of the relevance and value of our inventions by 2 companies widely regarded as leaders in the new era of AI.

We signed a deal with a major CPG to enable their participation in end-to-end market demonstrations of Digimarc Recycle in Germany, the second European country running a scale validation of our solutions real-world impact. We achieved both positive non-GAAP net income and positive free cash flow in Q4 2025, 2 milestones Digimarc hasn't achieved in over 12 years. And we expect to generate significant ARR growth in 2026.

Paul will now open the call for questions.

Hello, Paul? Paul, can you hear us? Apologize, there may be some technical difficulties here.

We apologize, but it appears that there may be an issue on tech side with our conference call service here.

So we are unable to reach anybody at the call center service. We think their service is down. We apologize for this technical difficulty, obviously, and the investors who want to reach out to Charles and I, please do so. Have a great rest of your day. Thanks.

Greetings, and welcome to the Digimarc Corporation Q3 2025 Earnings Conference Call. [Operator Instructions] As a reminder, this conference is being recorded. I would now like to turn the conference over to your host, George Karamanos, you may begin.

Thank you so much. Welcome, everyone, to our Q3 conference call. Riley McCormack, our CEO; and Charles Beck, our CFO, are with me on the call today.

On this call, we'll provide a business update and discuss Q3 2025 financial results. This will be followed by a question-and-answer forum. We have posted our prepared remarks in the Investor Relations section of our website and will archive this webcast there.

For those of you dialing in, this is a reminder that we are casting a presentation that Riley and Charles will walk through today. If you would like to follow along with the slide, I would encourage you to join our webcast as referenced in our earnings press release shared earlier today.

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.

Thank you, George, and hello, everyone. On this call, we will walk through Digimarc's Q3 performance, highlight our strategic progress across product innovation and commercial execution, share updates on our financial metrics such as ARR and cash burn and provide clarity on where we are focused heading into the last quarter of the year.

In Q3, we made significant progress in advancing towards widespread adoption of our gift card solution and closed multiple upsell opportunities in the product authentication space, including our expansion to a sixth country with a global tobacco company.

We quickly turned an inbound inquiry from a major pharmaceutical company into a paid pilot for a novel application of our product authentication solution that depending on pilot results may have wide applicability not only across other pharmaceutical companies but additional industries as well.

We launched a revolutionary new digitized security label solution to help brands upgrade from analog, easy to replicate and low value-add holograms. And we made significant progress advancing our digital authentication offerings, while in parallel growing pipeline, setting ourselves up to take full advantage of this nascent and exciting market in 2026 and beyond.

We also continue to harvest the benefits of our recently completed corporate reorganization. Operationally, it has allowed us to increase our focus on the areas most likely to deliver the scalable and repeatable business we must always focus on delivery.

Financially, the reorganization has resulted in a meaningful reduction in operating expenses and cash usage, and we remain on track to deliver positive free cash flow and positive non-GAAP net income in Q4 of 2025 even with our recent decision to invest in more resources to accelerate growth in our focus areas of retail loss prevention and digital authentication.

As has been shared previously, our 3 focus areas are retail loss prevention, product authentication and digital authentication. We have several significant ARR generation opportunities in front of us, such as protecting the world's gift cards that exhibit strong demand pull characteristics with a goal of much quicker time to revenue relative to some of our identification use cases.

The decision to focus our time and resources on these 3 core areas was supported by deep market research, validated by customer feedback and further confirmed independently by work we commissioned from our consulting partners.

With that said, we remain firm believers in our positioning and our ability to execute on the various ecosystem-driven opportunities, as they eventually become ripe enough to actively pursue.

Our greatest near-term opportunity is retail loss prevention and more specifically, our gift card solution. On this front, we made substantial progress in our march towards gaining widespread adoption, aided in large part of the industry's hyper focused on finding a solution to the fraud that is creating an existential threat to their business.

The global gift card industry is estimated to represent approximately $1 trillion of stored value, having reached this impressive milestone due to the many benefits these cards provide all stakeholders, most importantly, consumers.

Unfortunately, this large market opportunity has not escaped the attention of sophisticated state-sponsored bad actors and industry growth is currently being negatively impacted by the ever more advanced attacks targeting this global currency.

Digimarc's 28-year history working with the World Central banks to protect the vast majority of banknotes in circulation worldwide combined with our decade-plus experience at retail front-of-store, ideally positions us to help this industry reaccelerate its growth. In addition to reducing fraud in the many direct and indirect cost of that fraud being borne by brands, retailers and consumers -- our solution also allows the entire industry to improve the marketing, merchandising and giftability of gift cards.

These 3 elements were critical pillars of the industry's historic growth. and all 3 have been negatively impacted by existing security solutions. Along with fraud reduction, the ability for the industry to reinvest in these 3 pillars to yet against supercharge sales is becoming another selling point of our solution. Our solution also allows for reduced packaging waste and improve sustainability, a value proposition that is resonating with some iconic global brands and is compliant with the ever-increasing number of regulations being put in place most front of mind currently in the U.S. are the Maryland and New Jersey laws.

As more industry participants are exposed to our solution, additional benefits become clear, a wonderful byproduct of being the first adaptable, extensible and technology-driven security layer in this dynamic industry. We provide a solution that is more secure than the highest security solutions on the market today while allowing the industry to regain the use of the powerful growth tools they've had to abandon these past few years.

Turning now to the results from our initial rollout. The first Digimarc protected gift cards reached shelfs in August. Major brands participating included Target, Home Depot, Nordstrom and Blackhawk Network multi-retailer cards. The response has been extremely positive and all KPIs have been easily surpassed. These KPIs include multiple metrics measuring the effectiveness of our solution plus our impact on the industry's operational efficiency.

As we've shared in the past, 1 of the most powerful facets of this opportunity is that laggards and the adoption of our gift card solution will bear the compounded cost of an increasing percentage of an ever-increasing amount of fraud. We and our partners believe this positions us for powerful demand pull dynamic. The detailed results of our initial role have been widely shared within the industry, and we expect multiple major retailers to start selling Digimarc protected gift cards within the next 2 quarters, carrying an expanded number of closed-loop brands as well as initial open loop cards.

As a reminder, closed loop cards are gift cards that can only be redeemed at specific retailers. -- open loop cards are issued by the credit card companies and can be redeemed at any location where that credit card is accepted. As a reminder, we intend to predominantly sell our solution to gift card manufacturers who will apply our technology during our normal printing process before delivering the cards as they currently do today.

We have built our go-to-market strategy around trying to solve for 2 often conflicting goals, providing a revolutionary new solution and minimizing impact on the ecosystem's existing workflow. We I think the team has done an incredible job of doing just that. We are currently in commercial discussions with 8 gift card manufacturers as well as 1 additional direct customer.

These discussions are being shaped as they always are, by our desire to be an excellent partner to the industry and thus balance, a, the dynamic that laggards and adoption will bear compounding cost of fraud and b, the immediacy of a much broader rollout.

Our plan is to ensure we contract for enough 2026 committed annual capacity so we can incredibly address burgeoning industry concerns about whether there will be adequate capacity to avoid the potential for involuntary laggards and then quickly move from commercial discussions to working with our initial partner or partners to flawlessly execute on the expected impending ramp of Digimarc protected gift card production.

The time lines to deliver this large ramp are very tight, and therefore, our goal is to quickly move to the contracting stage and to only contract with a small subset of these 8 printers right now, as we believe with the right partners, we can strike the optimal balance between our 2 goals.

Turning now to our product as indication solutions. We closed multiple upsell deals with existing Digimarc validate customers reflecting both increased contract value and the expansion of our solution to new geographies and new brands, including the expansion of our solution in the sixth country of a global tobacco company with operations in approximately 175 more. As we've repeatedly stated, when we solve our customers' most challenging problems, we expect to be an upsell and cross-sell company for a very long time. We also closed a paid pilot with a major pharmaceutical company that approached us with a pressing problem they've been unable to solve using other means. I am proud of how quickly and how deeply the team diligence the problem, allowing them to find a potential solution using existing Validate capabilities. I'm equally as excited for us to successfully execute on the pilot because if we can indeed solve this problem, our [indiscernible] field agents with mobile phones and other devices, providing deterministic B2B or B2C authentication with analytics all in 1 place.

Touching now on our digital authentication solutions. As mentioned on our last 3 calls, we chose to be conservative about this area's contribution to 2025 ARR. We made this decision to help ensure we remain focused on optimizing our work in this area for the long term as opposed to making decisions that might lead to short-term revenue but would come at the cost of our ultimate potential scale. Not only did we exceed our annual target in the first 6 months of the year as we shared last year, but we are now in a position to harvest the fruits of this decision in 2026 and beyond.

The twin catalyst of the relentless advance of AI models and agents in the rapid progression of content credentials have created a wave of awareness and urgency for a robust scalable, secure and imperceptible perpetual and deterministic solution to address the many trust and authenticity problems growing in the digital world.

We expect this pace to continue its recent noteworthy growth and evolution. While some of the nascent digital use cases might be served, at least in the interim with good enough offerings, what has become apparent to us in the last few months is that the aforementioned twin catalysts are opening the market for use cases we're good at not just simply will not do.

Our technology, our history, our credibility, our expertise, our experience and our first-to-market with and co-leadership of the digital watermarking component of the C2PA standard are all coalescing to ensure we are well positioned to serve this ever-growing wave. We pioneered this space. This is quite literally what we were born to do, and the market is finally here.

After deep analysis across 3 vectors, market demand, our technological differentiation and buyer synergy, we have narrowed our focus in the digital authentication space to 4 use cases. multiple flavors of leak detection, internal compliance, piracy prevention and royalty monitoring. Our pipelines of both opportunities and partners are growing prior to widespread marketing efforts and we are now resourcing this area with the expectation it will be a significant contributor to our 2026 growth and beyond.

We are confident in the opportunities provided in our 3 key focus areas and are excited by the results our increased focus are already beginning to deliver. Ecosystem-based sales are great because of their size, but the sales cycles can be slow, expensive and multiple constituencies must adopt before meaningful ROIs unlocked.

Our strategic shift allows for the building of a scalable and repeatable business where we can fail fast, iterate and win often and allow these massive, but not yet quite ripe-for-the-picking opportunities, to provide the potential for another layer of tomorrow's growth.

I will now turn the call over to Charles to discuss our financial results.

Thank you, Riley, and hello, everyone. .

Ending ARR for Q3 was $15.8 million compared to $18.7 million for Q3 last year. The decrease reflects $3.5 million from the DRS contract that lapsed in Q2 this year. Excluding this headwind, ARR grew $600,000 year-over-year. That growth, however, was largely muted by higher other customer churn and are choosing to be strategically price aggressive on products outside of our focus areas. As I've stated previously, we expected these impacts as we sharpened our go-to-market focus.

We believe the churn is now largely behind us, except for the renegotiation of the retailer contract we mentioned last quarter, which will reduce ARR by $3.1 million in the fourth quarter. Despite this headwind, we expect ARR to trough in Q4 and to reaccelerate thereafter into 2026, largely from increasing penetration of our gift card solution and growth in digital authentication.

Total revenue was $7.6 million, a decrease of $1.8 million or 19% from $9.4 million in Q3 last year. Subscription revenue, which accounted for 60% of total revenue for the quarter, decreased 13% from $5.3 million to $4.6 million. The decrease largely reflects the impact of the expired DRS contract I referenced on the prior slide.

Service revenue decreased 27% from $4.2 million to $3.1 million, reflecting lower government service revenue from the Central Banks. As expected, given the lower 2025 program budget we have discussed on prior earnings calls, and no revenue from Holy Grail recycling products in Q3 of this year as those projects concluded earlier this year. Subscription gross profit margin was 86% for the quarter, flat with Q3 last year.

On the last earnings call, I shared that we expected to see a downward blip in our subscription margins for anticipated costs we would incur to migrate our customers from legacy platforms to Digimarc illuminate. Due to some incredible work from our team, we actually saw an immediate reduction in our costs with subscription costs decreasing 13% year-over-year.

We expect to generate additional savings as we continue our work. Service gross profit margin was 57% for the quarter, down 4 points from 61% in Q3 last year. The decrease was due to a more favorable mix of revenue and cost last year. As a reminder, we expect service gross profit margin to typically be in the mid-50s.

Operating expenses were $12.8 million for the quarter, down $4.5 million or 26% from $17.3 million in Q3 last year. The large reduction in costs reflects lower compensation costs due to the reorganization in Q1 this year and lower other cash costs from our streamlining efforts. We still expect even more cost savings in Q4 from our streamlining efforts as not all the benefits were fully realized in Q3.

Non-GAAP expenses, which exclude noncash and nonrecurring items were $8.6 million for the quarter, down $5.5 million or 39% from $14.1 million in Q3 last year. Again, the decrease is due to the impact of the reorganization and streamlining efforts.

Net loss per share for the quarter was $0.38 versus $0.50 in Q3 last year. Non-GAAP net loss per share for the quarter was $0.10 versus $0.28 in Q3 last year. We remain on track to generate positive non-GAAP net income in Q4 even with our recent decision to invest in more resources to accelerate growth in our focus areas of retail loss prevention and digital authentication.

Regarding cash flow, we ended the quarter with $12.6 million in cash and short-term investments. Free cash flow usage was down considerably from $7.3 million in Q3 last year to $3.1 million in Q3 this year, a decrease of $4.2 million or 58%. The decrease largely reflects a significant reduction in our total expenses.

Looking forward, we remain on track to deliver positive free cash flow in Q4 despite our recent decision to invest in more resources to accelerate growth in our focus areas, again, of retail loss prevention and digital authentication.

Looking further ahead, we expect to rebuild our cash balance via operating cash flow throughout 2026. 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.

Thank you, Charles. In the wake of the relentless acceleration of AI models and agents, a vacuum of trust and authenticity is being created. Trust is fast becoming the only currency that matters and the future will belong to companies that make that currency scalable.

We believe Digimarc is ideally positioned to lead that charge. We are focused on delivering a future where and intelligent systems alike can verify what's real, protect what matters and move forward with confidence. We are focused on filling the ever expanding vacuum by positioning ourselves to deliver trust in every interaction, spanning both the physical and digital worlds.

We are building the trust layer for the modern world, a layer that is needed now more than ever and is forming a massive opportunity we were created to deliver.

Operator, we'll now open the call for questions.

[Operator Instructions] Our first question comes from the line of Jeff Bernstein with Silverberg Bernstein.

Just a couple of unrelated questions. One, can you just give an update now on HolyGrail? What's happening there now?

Yes. So Jeff, it's in our slide, we give an update on what we're doing and not just HolyGrail, right, across all recycling opportunities. So as we announced a couple of quarters ago, Belgium is getting going and there's conversations in Germany. And actually, we included a link in our deck, you can click on some more details on both of these.

Okay. And so these are still -- Belgium is a full country pilot essentially, right?

Yes. Jeff, you go to the website, you can see all of this. It's on flexibles, but yes, it's across all of Belgium.

Yes. Got you. Okay. All right. And then you mentioned the impact in Q4 of the retailer contract renegotiation. Does that mean that there's still some revenue there or there's still something going on there or is it just that the contract lapsed and there's the impact in Q4?

Yes. We still have a relation to the silver valley customer. We're not going to talk about any customers by name or details, but I would point you, Jeff, to what I shared in the last call in my prepared remarks and an update Charlie providing today, but they're absolutely still a customer, and have wonderful opportunities with them across [indiscernible] specifically in the gift card space.

Got you. So -- but that prior particular contract is over, not being renewed?

Correct. We have a contract renegotiated to [indiscernible], so yes. But we we still have other contracts open with them, Jeff.

Right. Understand. Understand. No, that's perfect. And then just interested in your thoughts around the -- I guess, it was AB853 in the final version or whatever, but the California AI-related law that got passed that had some digital watermarking language in it. And what, if anything it means or is it sort of really a long-term kind of opportunity?

Yes. Unfortunately, this one did not have digital watermark language. They talked about a couple of requirements that might play on this space. Our belief is a couple of things, and this hasn't changed, is that, first of all, there is not a single system of trust and authenticity in the world that is based on, I guess, fakes or synthetic content being marked as such, right?

It's always an opt-in because that's where the value comes if it is removed. So one, I would -- our belief has always been that, yes, it might be important to label certain things as AI generated. But really what's important is giving human being the ability to optionally to not mandate, right, with respect to private to mark their items as authentic. That's how systems at trust and authenticity work.

And then two, without having a permanent tether, right? So what this law is talking about is metadata. And metadata right now -- until Internet is completely re-architecture, which I don't think is going to happen in the next couple of hundred years. Metadata is stripped out. So excited to see governments take action in terms of a step in the right direction.

I don't -- our belief is this doesn't go anywhere near far enough and the previous bill from last year would have addressed all of these concerns, and we'll see how this plays out. But I would also point you to, Jeff, when we talk about our digital space, right, you'll notice that providence and authenticity is not necessarily an area we're focused on right now.

That's for a couple of reasons. This might be an area where good enough for the time being is good enough, but more importantly, regulations are not quick catalysts for revenue. So even when a regulation were to take place and -- look, we've seen this in your first question about recycling, right?

past a couple of years ago, it still takes the time. So we're not looking for regulation to drive business. I think regulation is a nice sort of cleanup, maybe to get the last 10% or 20% of the market. But we're focused on selling things that actually people are really interested to purchase themselves because of an immediate ROI, not because some government says something to some other government is going to say something else.

[Operator Instructions] Your next question comes from the line of Jeff Van Rhee with Craig-Hallum Capital Group.

This is [indiscernible] on for Jeff Van Rhee. Just kind of a quick one. You've got the first few retailers using Digimarc protected cards. Just kind of curious how that's going to ramp? Is that about winning more partners, adding more of their retailers, adding geographies? Just kind of what will be the drivers of that ramp? And what are the steps that are going to take you from A to B?

Yes. Great question, and the answer is all of the above, right? So our focus in the industry and our partners' focus is on lighting up more and more retailers, lighting up more and more brands for those cards to flow through those retailers both in the U.S. and other countries in North America and countries around the globe and also cards that aren't necessarily sold through these existing channels today.

So the answer is all of the above. What we've talked about with our initial rollout was the results, and that's giving the confidence -- the industry the confidence to take this in a broader direction across multiple different vectors.

Okay. Got it. And then just 1 more. You kind of -- you made some executive changes the sales org obviously with Tom Bene. If you could just walk us through some of the go-to-market changes that have come out of that and kind of some of the additional steps you foresee taking?

Yes, I'm not sure what you're saying in terms of what's the go-to-market. Can you ask the maybe more directly where you're trying to get at?

No, I was just curious if there's any updates there. Just anything kind of that's changed. The personnel is different.

No, nothing change. We still have the full rev team and marketing team moving forward with their jobs.

There are no further questions at this time. This now concludes our question-and-answer session. Ladies and gentlemen, thank you for your participation. This does conclude today's teleconference. You may disconnect your lines, and have a wonderful day.

Ladies and gentlemen, greetings, and welcome to the Digimarc Corporation Q2 2025 Earnings Conference Call. [Operator Instructions] As a reminder, this conference is being recorded.

It is now my pleasure to introduce your host, George Karamanos. Please go ahead.

Thank you very much. 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 will provide a business update and discuss Q2 2025 financial results. This will be followed by a question-and-answer forum. We have posted our prepared remarks in the Investor Relations section of our website and will archive this webcast there. For those of you dialing in, we have changed the format of our prepared remarks and we'll be simulcasting a presentation that Riley and Charles will walk through today. If you would like to follow along with the slides, I would encourage you to join our webcast as referenced in our earnings press release shared earlier today.

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.

Thank you, George, and hello, everyone. On this call, we will walk through Digimarc's Q2 performance, highlight our strategic progress across product innovation and commercial execution, including the pending launch of our gift card solution, share updates on our financial metrics such as ARR and cash burn and provide clarity on where we are focused heading into the second half of the year.

In Q2, we made significant progress towards launching our gift card solution, generated new ARR from a European packaging customer for a multiyear committed contract that should generate near 7 figures next year and had several upsell ARR wins with existing customers. We delivered our next-generation audio digital watermark to enable accurate compensation for creators and safeguard sensitive data. And we were recognized in Gartner’s Hype Cycle as a key vendor in the emerging TrustOps category alongside the likes of Microsoft and Google and aligned with McKinsey’s identification of digital trust as one of the top technology trends shaping the future.

We also completed our corporate reorganization in the second quarter and are seeing significant benefits across the organization as a result. Financially, the reorganization has resulted in a meaningful reduction in operating expenses and cash usage, and we remain on track to deliver positive free cash flow by Q4 2025. Operationally, it has allowed us to increase our focus on the areas most likely to deliver the scalable and repeatable business we must always focus on delivering.

I would like to thank all of my teammates for their hard work in effecting this important step in our continued evolution. While not an easy process, we are seeing positive results in our ability to execute on our business.

As has been shared previously, our 3 focus areas are retail loss prevention, product authentication and digital authentication. We have several significant ARR generation opportunities in front of us, such as protecting the world's gift cards that exhibit strong demand-pull characteristics with the goal of much quicker time-to-revenue relative to some of our identification use cases. The decision to focus our time and resources on these 3 core areas in the authentication space was supported by deep market research, validated by customer feedback and further confirmed independently by work we commissioned from our consulting partners. With that said, we remain firm believers in our positioning and our ability to execute on the various ecosystem-driven opportunities in the identification space as they eventually become ripe enough to pursue.

Our greatest near-term opportunity is retail loss prevention and more specifically, our gift card solution. We made substantial progress during the quarter on commercializing our solutions to address gift card fraud, an ever-increasing existential threat the industry is hyper-focused on solving. We are proud to announce that the first Digimarc-protected gift cards have been received by our first retailer and will appear on shelves next week.

While the initial rollout took slightly longer than planned for reasons outside of our control, it includes gift cards for multiple different brands, including some of the largest companies in the world. The interest from these brands reflects the detailed joint success planning we have been undertaking with members of the gift card industry ecosystem, including gift card network companies, gift card manufacturers, card manufacturing equipment providers, label providers, point-of-sale scanner manufacturers and, of course, retailers and brands. This joint success planning positions us to increase long-term revenue velocity as these initial cards hit shelves.

We intend to predominantly sell our solution to gift card manufacturers who will apply our technology during their normal printing process before delivering the cards that they currently do today. We have built our go-to-market strategy around trying to solve for 2 often-conflicting goals, providing a revolutionary new solution and minimizing impact on the ecosystem's existing workflow. I think the team has done an incredible job of doing just that.

From jointly building threat models that clearly show how our existing solution already reduces fraud and how our road map will drive even greater results to creating a detailed interactive pilot plan that allows for near real-time impact measurement to all the work in between, we've invested the time and resources to set up our solution for success today as well as accelerate the pace of adoption in the future. As we've shared in the past, one of the most powerful facets of this opportunity is that laggards in the adoption of our gift card solution will bear the compounded costs of an increasing percentage of an increasing amount of fraud. We and our partners believe this positions us for a powerful demand-pull dynamic. Moreover, this is a widely held view across the industry and the interest of those not yet included in next week's rollout has continued to increase.

In parallel to setting up this initial rollout for maximum success, we've been planning additional rollouts with other industry players as well. While it is hard to be certain ahead of some critical upcoming events, what impact, if any, the slight delay in our initial rollout will have on our 2025 revenue, we have lowered our internal estimate for 2025 gift card revenue. Next week marks a critical milestone and accomplishment in our work to catalyze the gift card industry towards meaningful adoption of our solution, and we believe whatever impact the pilot delay might cause to our 2025 revenue, if any, will be paid back next year and beyond.

Turning now to our focus on product authentication, I am thrilled to announce we signed a multiyear committed deal with a large European packaging company that should represent near 7 figures of ARR starting next year and beyond. In addition to providing our customer the ability to resell Digimarc Validate and Digimarc Automate directly, this deal allows our partner to roll out our deploy now, activate later offering on all the packaging they produce, seeding the market for, among other things, potential future Digimarc Recycle deals.

Just last week, I had dinner with the CEO of this valued customer, and he shared his plans for utilizing our partnership to drive messaging at an upcoming conference, stating that he believes our partnership will enable his company to stand out amongst their peers and drive new business their way. More immediately, he wants to arrange an opportunity for us to spend time with a sister company that he believes is interested in pursuing a similar relationship with us. Nothing is more powerful in driving to a scalable and repeatable business than delighting existing customers, and our focus is, as it always is, on continuing to win our customers' business every day.

We also signed upsell deals with 3 of our existing Digimarc Validate customers, reflecting both increased contract value and the expansion of our solution to new geographies and new brands. As we have repeatedly stated, when we solve our customers' most challenging problems, we expect to be an upsell and cross-sell company for a long time. While still early in that journey, the results are proving this thesis correct. Brands faced rampant counterfeiting and IP theft and our secure and scalable covert and connected solutions provide far superior results compared to competing analog solutions such as tags, codes, inks and labels.

Touching now on our digital authentication solutions. As mentioned on our last 2 calls, we chose to be conservative about this area's contribution to 2025 ARR. We made this decision to help ensure we remain focused on optimizing our work in this area for the long term. We have already exceeded these conservative assumptions. As announced in a recent press release, we recently delivered a next-generation audio digital watermark architected to address the unprecedented challenges rights holders, content creators, companies and governments face with the explosion of digital and AI-generated content and capabilities.

We recently signed a new deal with SourceAudio to embed our audio watermarks into production music for TV and commercials in order to monitor royalty rights across over 150 national channels and 100 local stations. Additionally, we have multiple deals in the pipeline as a result of our new offering, including technical testing with an AI company looking to both comply with EU regulation as well as automate internal authentication. Our next-generation offering has also caught the attention of an important industry group that is searching for solutions to an unmet need arising from emergence of AI. We look forward to proving our value to this gatekeeper and unlocking the opportunities on the other side.

Q2 also saw us grow the relationship with the Fortune 100 customer we mentioned on the last call, signing a low 6-figure deal that we believe could grow close to 7 figures starting in year 2 and beyond. In addition to our belief, this customer presents a future upsell opportunity, they have offered to be a reference account to other prospects in the future. Additionally, the implementation of our solution is being led by one of the world's largest system integrators. Success with our shared mutual customers should open future doors for us to partner with this industry giant to deter insider threats and safeguard sensitive data for additional customers across industries and sectors worldwide.

The twin catalyst of the relentless advance of AI models and agents and the rapid progression of content credentials has created a wave of awareness and urgency for a robust, scalable, secure, and imperceptible perpetual and deterministic solution to address the many trust and authenticity problems growing in the digital world. We expect this space to continue its recent noteworthy growth and evolution. While some of the nascent digital use cases might be served, at least in the interim with good enough offerings, what has become apparent to us in the last few months is that the aforementioned twin catalysts are opening the market for use cases where good enough just simply will not do.

Our technology, our history, our credibility, our expertise, our experience and our first-to-market with -- and co-leadership of the digital watermarking component of the C2PA standard are all coalescing to ensure we are well positioned to serve this ever-growing wave. We pioneered this space. This is quite literally what we were born to do. And the market is finally here. Although our focus over the near term will be on our 3 core focus areas, we continue to believe in our positioning and ability to execute in other areas when those markets are ripe for addressing.

Before I turn the call over to Charles, I want to address the development that will have a negative future impact on our near-term top line results. We are currently in contract renegotiations with a large retailer customer of a legacy solution, which will most likely result in a reduction of up to $3 million in annual revenue. As these conversations are very recent and currently ongoing, we are not able to estimate the exact impact at this time. This development also reinforces our decision to focus on our 3 authentication markets and building the trust layer for the modern world.

Solving urgent problems provides stronger protection from changes in customers' strategic focus than some of our legacy solutions did. Moreover, this retailer is an important gift card vendor, and our focus is on maximizing future revenue opportunities for our gift card solution, not on trying to maximize revenue from a use case we haven't sold in many years. We believe we continue to have an excellent relationship with this customer and that there is much to accomplish with them over the coming years. We are excited to continue to help them win.

We are also energized by moving Digimarc into a future where we're not overly reliant on any one customer and can move more quickly with the market. We are confident in the opportunities provided in our key 3 focus areas and are excited by the results our increased focus are already beginning to deliver. Ecosystem-based sales are great because of their size, but the sales cycles can be slow, expensive and multiple constituencies must adopt before meaningful ROI is unlocked. Our strategic shift allows for the building of a scalable and repeatable business where we can fail fast, iterate and win often.

Even with the expected top line impact of this contract renegotiation, we still anticipate being free cash flow positive in Q4. Reorganizing our company to focus on our authentication use cases was a difficult but necessary decision, and we appreciate our investors' patience as we navigate this transition, which we are more confident than ever is the best strategy for the company and will create the best outcome for investors. Even if timing around meaningful revenue generation from our new products were to slip 1 to 2 quarters, we believe the company is well positioned to win and reach significant scale.

I will now turn the call over to Charles to discuss our financial results.

Thank you, Riley, and hello, everyone. Ending ARR for Q2 was $15.9 million compared to $23.9 million for Q2 last year. The decrease reflects both the $5.8 million retailer contract that lapsed last year and $3.5 million from the DRS contract that lapsed in Q2 this year. Excluding these 2 headwinds, ending ARR grew $1.3 million year-over-year. That growth, however, was largely muted by higher other customer churn and our choosing to be strategically price aggressive on products outside of our focus areas, both of which had outsized impacts in the first half of 2025. As I stated on the last earnings call, we expected these impacts as we sharpened our go-to-market focus, and it is important to note that our ending ARR is in line with our original 2025 internal budget.

Total revenue was $8 million, a decrease of $2.4 million or 23% from $10.4 million in Q2 last year. Subscription revenue, which accounted for 58% of total revenue for the quarter decreased 28% from $6.4 million to $4.6 million. The decrease reflects the impact of 2 expired contracts I just referenced. Service revenue decreased 15% from $4 million to $3.4 million, reflecting lower government service revenue from the Central Banks. The decrease is generally in line with our expectation of a 12% to 14% decrease in program work for fiscal 2025 that we shared on the previous earnings call.

Subscription gross profit margin, excluding amortization expense, was 85% for the quarter, down 4 percentage points from Q2 last year, reflecting the impact of lower subscription revenue. We anticipate that subscription gross profit margins may be lower next quarter as we work to consolidate our legacy platforms. After the migrations are completed, we expect subscription gross margins to not only fully recover but to increase beyond current levels as we benefit from the efficiencies of the Illuminate platform.

Service gross profit margin was 59% for the quarter, essentially flat with Q2 last year. Operating expenses were $13.1 million for the quarter, down $3.7 million or 22% from $16.8 million in Q2 last year. Included in operating expenses this quarter was $600,000 of legal expenses largely related to an external shareholder matter. We do not expect these legal expenses to continue. Excluding these legal expenses, operating expenses were $4.3 million or 26% lower than Q2 last year.

The large reduction in costs reflects lower compensation costs due to the reorganization in Q1 this year. As we look forward, we expect to continue to see a reduction in our run rate of expenses as not all the benefits from our streamlining efforts, especially in the non-compensation cost areas were fully realized yet in our Q2 results.

Non-GAAP operating expenses, which excludes noncash and nonrecurring items, were $8.9 million for the quarter, down $5.2 million or 37% from $14 million in Q2 last year. Again, the decrease is due to the impact of the reorganization and streamlining efforts, partially offset by $600,000 of higher legal expenses. Net loss per share for the quarter was $0.38 versus $0.43 in Q2 last year, while non-GAAP net loss per share for the quarter was $0.11 versus $0.23 in Q2 last year.

Our internal plan for 2025 at the start of the year was to be non-GAAP profitable and free cash flow by no later than Q4. Even adjusting our plan to account for the risks to revenue Riley discussed earlier, namely the large customer contract renegotiation and the timing of significant gift card revenue recognition, we still believe it is likely we will achieve these targets in Q4.

Regarding cash flow, we ended the quarter with $16.1 million in cash and short-term investments. Free cash flow usage was down considerably from $6.9 million in Q2 last year to $5 million in Q2 this year. Excluding $900,000 of previously accrued severance costs from Q1, which were paid in Q2 and $300,000 of the $600,000 of higher legal costs that were paid during the quarter, free cash flow usage would have been only $3.8 million for the quarter. Free cash flow was also negatively impacted by the timing of customer receipts in Q2, which we expect will reverse in the second half of 2025.

As I noted earlier, we still have not fully realized all the cash cost savings from our reorganization and streamlining efforts put in place earlier this year, which are estimated to total $22 million on an annualized basis. As those savings start to be fully realized and with forecasted revenue growth, we expect Q3 cash flow usage to be much lower than Q2, even when factoring in the payment of the remaining $300,000 in legal cost referenced above, and we believe we are likely to deliver positive free cash flow in Q4. For further discussion of our financial results and risks and prospects for our business, please see our Form 10-Q that has been filed with the SEC.

I will now turn the call back over to Riley for final remarks.

Thank you, Charles. In the wake of the relentless acceleration of AI models and agents, a vacuum of trust and authenticity is being created. Trust is fast becoming the only currency that matters, and the future will belong to companies that make that currency scalable. We believe Digimarc is ideally positioned to lead that charge. We are focused on delivering a future where humans and intelligent systems alike can verify what's real, protect what matters and move forward with confidence. We are focused on filling the ever-expanding vacuum by positioning ourselves to deliver trust in every interaction, spanning both the physical and digital worlds.

We are building the trust layer for the modern world, a layer that is needed now more than ever and is forming a massive opportunity we were created to deliver.

I would like to conclude this call by once again thanking my amazing teammates. Reorganizing our business to increase our focus has been extremely challenging, but absolutely necessary to achieve the results we know we must deliver, fast, profitable and durable growth. I believe we are positioned to win and are on the precipice of scalable and repeatable in our commercial business. I'm excited to share our progress, especially in the quarters to come.

Operator, we'll now open the call for questions.

[Operator Instructions] Our first question comes from Jeff Van Rhee with Craig-Hallum Capital Group.

Great. So a couple for me. On the -- Charles, you mentioned the run rate expenses have come down. What is the GAAP OpEx run rate at the end of the quarter?

The non-GAAP operating expense run rate?

Yes, GAAP or non-GAAP. At the end of Q2, you said it came down quite a bit. I'm just trying to figure out how far you are...

Yes. For non-GAAP. Yes. So we were at $8.9 million of non-GAAP operating expenses for the quarter. We expect that that's going to continue to come down some as we start to realize the full benefit of all of our streamlining efforts.

And I guess what I was saying is, I know it was $8.9 million for the quarter. Based on the cuts you've made, how much lower than that $8.9 million quarterly rate is your run rate right now?

Yes. I'm not going to give exact guidance, but there's still a significant amount of savings that we can generate in Q3 and Q4.

Yes. Jeff, just to be clear on that, there is more even -- even looking at our current monthly or weekly run rate, there's still more ahead of us from non-headcount savings.

Got it. That's helpful. And then on the Central Bank business, the -- do you have visibility into the forward year this year? I think you had said expect down 10%, 15%. And that's kind of what we've seen. Do they -- I don't know when you get an indication. Just when do you get an idea of what next year looks like there.

Yes, Jeff, we do have usually a full year of visibility. But again, we wouldn't provide guidance unless we expect material changes in our business. So we generally have at least 12 to 18 months of kind of forward-looking visibility because they commit to a [ SOW ] basically a year in advance. So we have fairly good visibility there.

Okay. I mean, historically, it had been kind of flattish. You can't share if it's kind of flattish or it continues this roughly 10% decline?

What I said is if we expected a material difference, and that's something that we would disclose.

The European customer that you mentioned...

You could assume that. Means it's not going to be materially different from 2025.

Okay. The European customer that you mentioned in the quarter, nice ARR value to that. Was that signed in the quarter? And did that impact the reported ARR?

Yes, I was at the close...Sorry, go ahead, Charles.

Yes, I was going to say, yes, it was effective during Q2 and is included in ARR. Although that contract, as Riley referenced, is expected to grow in multiple years. So only the first year is reflected in ARR at this point in time. So there's some potential built-in basically upsell in future years under that contract.

[Operator Instructions] Our next question comes from Jeff Bernstein with Silverberg Bernstein Capital.

Just on the gift card business. You cited a lot of different constituents and sort of supply chain touch points that you had to make to get the first cards in the market. Can you just give us a kind of a top-down on how many card vendors are there for you guys to work with? Do you have to retouch a lot of these points again for each one? Or is a lot of that work done? It sounds like in terms of brands, you actually have -- are touching several brands already that will go into the retailer that you talked about. But just flesh out the mechanics of all that.

I'm not sure I exactly understand the question. Jeff, are you asking how many brands we're working with, how many retailers? Maybe you can repeat the question.

No. I'm asking -- yes, it's what's important? Is it just the gift card companies? And if so, are there 4 and we just got to get 3 more? Do you have to retouch all scanners? Do you have to retouch brands? Do you have to retouch retailers? Or does it all go through 3 gift card guys you have to win? Just give us the whole breakdown of how this all works.

How much time you got? But I'll try to give you a high-level fly-by. Jeff, this is the right question. So we are predominantly going to market through the gift card manufacturers i.e. the printers. That is a relatively concentrated industry. There is tens globally, but a lot more concentrated, think of the 80-20 rule. Those will, for the most part, be our customer. There are going to be 1 or 2 people we're going to go to market with directly. But again, going back to what I said, we -- the team has done an incredible job when you're rolling out a revolutionary new technology, right? And think about the gift card industry.

All of their -- this is a massive existential problem that they are facing. They are critically or hyper focused on solving it. And they're currently fighting it using analog technologies. That's what makes us so much different. We're better, we're cheaper. We're also, for the first time, a technology solution, which means we're better today and we're going to have a road map for the next 20 years as long as we continue to join this industry to fight this massive, massive fraud. So -- but when you're rolling out a revolutionary new technology and also trying to not disrupt the existing workflow, that's a really tall task. And I think the team did a really good job in planning the go-to-market strategy, which is why we're going to market through these gift card manufacturers or printers.

So that's number one. The gift card printers work with all of the brands. I mean that's obviously how the brands get their markets where their cards created. So they're going to be discussing our new solution with their customers. We're also key in this whole industry, something called the gift card network. These are -- Blackhawk and InComm are the 2 dominant ones. They touch all of the brands. So they're also having conversations with the brands about new security solutions. They also talk to all the retailers. So when you walk into a retailer store and you see called gift card mall, but like a rack full of gift cards, that's either probably InComm or Blackhawk's mall.

So they're a key part of both the brands as well as the retailers. Then finally, you're right, we absolutely do need our software running at the front of store of these retailers. This is something that we've had our presence, our footprint in most of the major scanners for years now. There is an upgrade to our software. And there -- that's part of our solution is we're not just solving -- we're not just applying technology to the gift cards, we're applying to the detection.

But it becomes really, really scalable because we are a known entity that's been running in a lot of these scanners, whether or not it's turned on, there's obviously massive retailers where it is turned on. And so it's just a matter of getting that firmware pushed. And these are big retailers, some of them update their firmware a lot, just a regular cadence, let alone for a reason like this. This is a massive problem, estimated just in the U.S. alone, north of $4 billion. And the loss to the retailers is multiples of that.

So that's pretty much it, Jeff. I don't know if that was a...

That's what I was looking for. That's fine. We can do more offline, but that was generally what I was...

I'm sure we will.

Ladies and gentlemen, at this time, there are no further questions. The conference of Digimarc Corporation has now concluded. Thank you for your participation. You may now disconnect your lines. Thank you.