Digimarc CORP - Quarter Report: 2010 September (Form 10-Q)

Large accelerated filer

Accelerated filer

Non-accelerated filer

¨ (Do not check if a smaller reporting company)

Smaller reporting company

Form 10-Q

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

x	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2010

¨	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from to

Commission File Number: 001-34108

DIGIMARC CORPORATION

(Exact name of registrant as specified in its charter)

Oregon

26-2828185

(State or other jurisdiction of

incorporation or organization)

(I.R.S. Employer

Identification No.)

9405 SW Gemini Drive, Beaverton, Oregon 97008

(Address of principal executive offices) (Zip Code)

(503) 469-4800

(Registrant’s telephone number, including area code)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes ¨ No ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

Indicate by check mark whether the registrant is a shell company (as defined in rule 12b-2 of the Exchange Act). Yes ¨ No x

As of October 26, 2010, there were 7,408,439 shares of the registrant’s common stock, par value $0.001 per share, outstanding.

Table of Contents


PART I FINANCIAL INFORMATION
Item 1.	Financial Statements:	3
	Balance Sheets as of September 30, 2010 and December 31, 2009 (Unaudited)	3
	Statements of Operations for the three- and nine-months ended September 30, 2010 and 2009 (Unaudited)	4
	Statements of Stockholders’ Equity as of September 30, 2010 and December 31, 2009 (Unaudited)	5
	Statements of Cash Flows for the nine-months ended September 30, 2010 and 2009 (Unaudited)	6
	Notes to Financial Statements (Unaudited)	7
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	20
Item 3.	Quantitative and Qualitative Disclosures About Market Risk	32
Item 4.	Controls and Procedures	32
PART II OTHER INFORMATION
Item 1.	Legal Proceedings	33
Item 1A.	Risk Factors	33
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	34
Item 6.	Exhibits	35
SIGNATURES		36

PART I. FINANCIAL INFORMATION

Item 1.

Financial Statements.

DIGIMARC CORPORATION

BALANCE SHEETS

(In thousands, except share data)

(UNAUDITED)


	September 30, 2010			December 31, 2009(1)
ASSETS
Current assets:
Cash and cash equivalents	$	7,261		$	8,884
Marketable securities		35,546			33,902
Trade accounts receivable, net		3,101			3,570
Other current assets		983			872

Total current assets		46,891			47,228
Marketable securities		2,647			—
Property and equipment, net		920			1,114
Intangibles, net		2,090			1,302
Investments in joint ventures		933			409
Other assets, net		465			430

Total assets	$	53,946		$	50,483

LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Accounts payable and other accrued liabilities	$	1,279		$	1,407
Deferred revenue		2,139			2,318

Total current liabilities		3,418			3,725
Long-term liabilities		163			99

Total liabilities		3,581			3,824
Commitments and contingencies (Note 11)
Stockholders’ equity:
Preferred stock (10,000 shares issued and outstanding at September 30, 2010 and December 31, 2009)		50			50
Common stock (7,323,927 and 7,205,701 shares issued and outstanding at September 30, 2010 and December 31, 2009, respectively)		7			7
Additional paid-in capital		51,569			49,283
Accumulated Deficit		(1,261	)		(2,681	)

Total stockholders’ equity		50,365			46,659

Total liabilities and stockholders’ equity	$	53,946		$	50,483

(1)	Derived from the Company’s December 31, 2009 audited financial statements

See Notes to Unaudited Financial Statements.

DIGIMARC CORPORATION

STATEMENTS OF OPERATIONS

(In thousands, except per share data)

(UNAUDITED)


	Three Months Ended September 30, 2010			Three Months Ended September 30, 2009			Nine Months Ended September 30, 2010			Nine Months Ended September 30, 2009
Revenue:
Service	$	2,761		$	2,827		$	9,193		$	7,882
License and subscription		2,476			1,942			11,484			5,640

Total revenue		5,237			4,769			20,677			13,522
Cost of revenue:
Service		1,410			1,499			4,693			4,396
License and subscription		59			42			173			158

Total cost of revenue		1,469			1,541			4,866			4,554
Gross profit		3,768			3,228			15,811			8,968
Operating expenses:
Sales and marketing		953			753			2,453			2,226
Research, development and engineering		1,471			1,191			4,051			3,679
General and administrative		1,842			1,521			5,414			4,597
Intellectual property		315			262			891			756

Total operating expenses		4,581			3,727			12,809			11,258

Operating income (loss)		(813	)		(499	)		3,002			(2,290	)
Other income (expenses)
Net loss from joint ventures		(558	)		(311	)		(1,576	)		(311	)
Other		62			126			184			439

Other income (expenses), net		(496	)		(185	)		(1,392	)		128

Income (loss) before provision for income taxes		(1,309	)		(684	)		1,610			(2,162	)
Provision for income taxes		(151	)		(3	)		(190	)		(12	)

Net income (loss)	$	(1,460	)	$	(687	)	$	1,420		$	(2,174	)

Earnings (loss) per share:
Net income (loss) per share—basic	$	(0.21	)	$	(0.10	)	$	0.20		$	(0.30	)
Net income (loss) per share—diluted	$	(0.21	)	$	(0.10	)	$	0.19		$	(0.30	)
Weighted average shares outstanding—basic		7,098			7,134			7,097			7,150
Weighted average shares outstanding—diluted		7,098			7,134			7,497			7,150

See Notes to Unaudited Financial Statements.

DIGIMARC CORPORATION

STATEMENTS OF STOCKHOLDERS’ EQUITY

(In thousands, except share data)

(UNAUDITED)


										Additional paid-in capital			Retained earnings (accumulated deficit)			Total stockholders’ equity
	Preferred stock				Common stock
	Shares		Amount		Shares			Amount
BALANCE AT DECEMBER 31, 2008		10,000	$	50		7,279,442		$	7	$	48,268		$	76		$	48,401
Exercise of stock options		—		—		28,343			—		273			—			273
Issuance of restricted common stock		—		—		22,200			—		—			—			—
Purchase and retirement of common stock		—		—		(124,284	)		—		(1,737	)		—			(1,737	)
Stock-based compensation		—		—		—			—		2,479			—			2,479
Net loss		—		—		—			—		—			(2,757	)		(2,757	)

BALANCE AT DECEMBER 31, 2009		10,000	$	50		7,205,701		$	7	$	49,283		$	(2,681	)	$	46,659
Exercise of stock options		—		—		833			—		8			—			8
Issuance of restricted common stock		—		—		122,960			—		—			—			—
Purchase and retirement of common stock		—		—		(5,567	)		—		(40	)		—			(40	)
Stock-based compensation		—		—		—			—		2,318			—			2,318
Net income		—		—		—			—		—			1,420			1,420

BALANCE AT SEPTEMBER 30, 2010		10,000	$	50		7,323,927		$	7	$	51,569		$	(1,261	)	$	50,365

See Notes to Unaudited Financial Statements.

DIGIMARC CORPORATION

STATEMENTS OF CASH FLOWS

(In thousands)

(UNAUDITED)


	Nine Months Ended September 30, 2010			Nine Months Ended September 30, 2009
Cash flows from operating activities:
Net income (loss)	$	1,420		$	(2,174	)
Adjustments to reconcile net income (loss) to net cash provided (used in) by operating activities:
Depreciation and amortization		484			425
Stock-based compensation		2,287			1,778
Net loss from joint ventures		1,576			311
Changes in operating assets and liabilities:
Trade accounts receivable, net		469			812
Other current assets		(111	)		(126	)
Other assets, net		(35	)		(158	)
Accounts payable and other accrued liabilities		(63	)		(280	)
Deferred revenue		(180	)		(714	)

Net cash provided by (used in) operating activities		5,847			(126	)
Cash flows from investing activities:
Purchase of property and equipment		(236	)		(374	)
Capitalized patent costs		(811	)		(621	)
Investments in joint ventures		(2,100	)		(550	)
Sale or maturity of marketable securities		78,965			20,738
Purchase of marketable securities		(83,256	)		(26,601	)

Net cash used in investing activities		(7,438	)		(7,408	)
Cash flows from financing activities:
Issuance of common stock		8			152
Purchase of common stock		(40	)		(822	)
Principal payments under capital lease obligations		—			(39	)

Net cash used in financing activities		(32	)		(709	)

Net decrease in cash and cash equivalents		(1,623	)		(8,243	)
Cash and cash equivalents at beginning of period		8,884			18,928

Cash and cash equivalents at end of period	$	7,261		$	10,685

Supplemental disclosure of cash flow information:
Cash paid for interest	$	—		$	4
Cash paid for income taxes	$	62		$	12
Supplemental schedule of non-cash investing activities:
Stock-based compensation capitalized to patent costs	$	31		$	30

See Notes to Unaudited Financial Statements.

DIGIMARC CORPORATION

NOTES TO FINANCIAL STATEMENTS

(Dollar amounts in thousands, except per share data)

(UNAUDITED)

1. Description of Business and Summary of Significant Accounting Policies

Description of Business

Digimarc Corporation (“Digimarc” or the “Company”) enables governments and enterprises around the world to give digital identities to media and objects that computers can sense and recognize and to which they can react. The Company’s technology provides the means to infuse persistent digital information, perceptible only to computers and digital devices, into all forms of media content. The unique digital identifier placed in media generally persists with it regardless of the distribution path and whether it is copied, manipulated or converted to a different format, and does not affect the quality of the content or the enjoyment or other traditional uses of it. The Company’s technology permits computers and digital devices to quickly identify relevant data from vast amounts of media content.

Joint Venture and Patent License Agreements with The Nielsen Company

On June 11, 2009 the Company entered into two joint venture agreements with The Nielsen Company (“Nielsen”) to launch two new companies. The two joint venture agreements and a revised patent license agreement expand and replace the previous license and services agreement between the Company and Nielsen that had been in operation since late 2007. Under the new agreements, the Company and Nielsen plan to work together to develop new products and services, including the expansion and deployment of those products and services that were in development under the prior agreement.

Under the terms of the patent license agreement, Nielsen agreed to pay Digimarc $18,750 during the period from July 2009 through January 2014, and Digimarc granted to Nielsen a non-exclusive license to Digimarc’s patents for use within Nielsen’s business. Unless earlier terminated in accordance with the agreement, the license will continue until the expiration of the last to expire of the licensed patents.

Joint venture I, TVaura LLC, engages in the development of copyright filtering solutions, royalty/audit solutions for online video and audio rights organizations, guilds or other organizations involved in the reconciliation of royalties, residuals and other payments, and other related products. Each of the Company and Nielsen will make initial cash contributions aggregating $3,900 payable quarterly from July 2009 through October 2011. The Company will provide technical and development services to TVaura LLC’s business for the following periods for the following minimum service fees, subject to adjustment for any development service fees paid to the Company by TVaura Mobile LLC: $1,130 paid in 2009; and $2,800 and $2,740 to be paid in 2010 and 2011, respectively.

Joint venture II, TVaura Mobile LLC, engages in the development of certain enhanced television offerings, and other related products. Each of the Company and Nielsen will make initial cash contributions aggregating $2,800 payable quarterly from July 2009 through October 2011.

Pursuant to the terms of the agreements and Accounting Standards Codification (“ASC”) 810 “Consolidation,” the joint ventures will not be consolidated with the Company.

Interim Financial Statements

The accompanying financial statements have been prepared from the Company’s records without audit and, in management’s opinion, include all adjustments (consisting of only normal recurring adjustments) necessary to fairly reflect the financial condition and the results of operations for the periods presented. Certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States (the “U.S.”) have been condensed or omitted in accordance with the rules and regulations of the Securities and Exchange Commission (“SEC”).

These financial statements should be read in conjunction with the audited financial statements included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2009, which was filed with the SEC on February 24, 2010. The results of operations for the interim periods presented in these financial statements are not necessarily indicative of the results for the full year.

Use of Estimates

The preparation of financial statements in accordance with accounting principles generally accepted in the U.S. requires Digimarc to make estimates and judgments that affect the reported amounts of assets, liabilities, revenue and expenses, and related disclosure of contingent assets and liabilities. Certain of the Company’s accounting policies require higher degrees of judgment than others in their application. Examples of these include revenue recognition on long-term service contracts, impairments and estimation of useful lives of long-lived assets and patent costs, contingencies and litigation, stock-based compensation and allowance for doubtful accounts. Digimarc bases its estimates on historical experience and on various other assumptions that are believed to be reasonable in the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.

Reclassifications

Certain prior period amounts in the accompanying financial statements and notes thereto have been reclassified to conform to current period presentation. These reclassifications had no material effect on the results of operations or financial position for any period presented.

Specifically, on the balance sheet, the “accrued payroll and related costs” and “accrued merger related liabilities” line items have been reclassed with “accounts payable and other accrued liabilities.” On the statement of operations, the “transitional services” line item has been reclassed with “general and administrative.”

Marketable Securities

The Company considers all investments with original maturities over 90 days that mature in less than one year to be short-term marketable securities. Both short- and long-term marketable securities include federal agency notes, company notes and commercial paper. The Company’s marketable securities are generally classified as held-to-maturity as of the balance sheet date and are reported at amortized cost, which approximates market. The book value of these investments approximates fair market value and, accordingly, no amounts have been recorded to other comprehensive income.

A decline in the market value of any security below cost that is deemed to be other-than-temporary results in a reduction in carrying amount of fair value. The impairment is charged to earnings and a new cost basis for the security is established. To determine whether an impairment is other-than-temporary, the Company considers whether it has the ability and intent to hold the investment until a market price recovery and considers whether evidence indicating that the cost of the investment is recoverable outweighs evidence to the contrary. There have been no other-than-temporary impairments identified or recorded by the Company.

Premiums and discounts are amortized or accreted over the life of the related security as an adjustment to yield using a method that approximates the effective interest method. Under this method, dividend and interest income are recognized when earned.

Fair Value of Financial Instruments

ASC 820 “Fair Value Measurements and Disclosures” defines fair value, establishes a framework for measuring fair value under generally accepted accounting principles, and enhances disclosures about fair value measurements. ASC 820 describes a fair value hierarchy based on three levels of inputs, of which the first two are considered observable and the last unobservable, that may be used to measure fair value, which are the following:

•

Level 1—Pricing inputs are quoted prices available in active markets for identical investments as of the reporting date.

•

Level 2—Pricing inputs are quoted for similar investments, or inputs that are observable, either directly or indirectly, for substantially the full term through corroboration with observable market data. Level 2 includes investments valued at quoted prices adjusted for legal or contractual restrictions specific to these investments.

•

Level 3—Pricing inputs are unobservable for the investment, that is, inputs that reflect the reporting entity’s own assumptions about the assumptions market participants would use in pricing the asset or liability. Level 3 includes private portfolio investments that are supported by little or no market activity.

ASC 825 “Financial Instruments” allows an entity the irrevocable option to elect fair value for the initial and subsequent measurement for specified financial assets and liabilities on a contract-by-contract basis. The Company did not elect the fair value option under this statement as to specific assets or liabilities. Therefore, through September 30, 2010, the Company has not recognized the net change in fair value of its financial assets and liabilities.

The estimated fair values of the Company’s financial instruments, which include cash and cash equivalents, short- and long-term marketable securities, accounts receivable, accounts payable and accrued payroll approximate their carrying values due to the short-term nature of these instruments. These items are valued using either Level 1 or Level 2 inputs.

The Company recorded marketable securities at amortized cost of $44,992, of which $6,799 is included in cash and cash equivalents, which approximates fair value. The fair value is based on quoted market prices in active markets for identical assets, a Level 1 input. As of September 30, 2010, the cost and fair value of the Company’s money market funds were equal to $311.

Concentrations of Business and Credit Risk

A significant portion of the Company’s business depends on a limited number of large contracts. The loss of any large contract may result in loss of revenue and margin on a prospective basis.

Financial instruments that potentially subject Digimarc to concentrations of credit risk consist primarily of cash and cash equivalents, marketable securities and trade accounts receivable. Digimarc places its cash and cash equivalents with major banks and financial institutions and at times deposits may exceed insured limits. Other than cash used for operating needs, which may include marketable securities with its principal banks, Digimarc’s investment policy limits its credit exposure to any one financial institution or type of financial instrument by limiting the maximum of 5% of its cash and cash equivalents and marketable securities or $1,000, whichever is greater, to be invested in any one issuer except for the U.S. government and U. S. federal agencies, which have no limits, at the time of purchase. The investment policy also limits Digimarc’s credit exposure by limiting the maximum of 40% of its cash and cash equivalents and marketable securities, or $15,000, whichever is greater, to be invested in any one industry category, e.g., financial or energy industries. As a result, Digimarc’s credit risk associated with cash and cash equivalents and investments is believed to be minimal.

Impairment of Long-Lived Assets

The Company accounts for long-lived assets in accordance with the provisions of ASC 360 “Property, Plant and Equipment”. This statement requires that long-lived assets and certain identifiable intangibles be reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Recoverability of assets to be held and used is measured by a comparison of the carrying amount of an asset to future net undiscounted cash flows expected to be generated by the asset. If such assets are considered to be impaired, the impairment to be recognized is measured by the amount by which the carrying amount of the assets exceeds the fair value of the assets. Fair value is determined based on discounted cash flows or appraised values, depending on the nature of the asset. Assets to be disposed of are reported at the lower of the carrying amount or fair value less costs to sell.

Software Development Costs

Under ASC 985 “Software,” software development costs are to be capitalized beginning when a product’s technological feasibility has been established and ending when a product is made available for general release to customers. To date, the establishment of technological feasibility of the Company’s products has occurred shortly before general release and, therefore, software development costs qualifying for capitalization have been immaterial. Accordingly, the Company has not capitalized any software development costs and has charged all such costs to research and development expense.

Research and Development

Research and development costs are expensed as incurred as defined in ASC 730 “Research and Development”. Digimarc accounts for amounts received under its funded research and development arrangements in accordance with the provisions of ASC 730. Under the terms of the arrangements, Digimarc is not obligated to repay any of the amounts provided by the funding parties. As a result, Digimarc recognizes revenue as the services are performed.

Patent Costs

Costs associated with the application and award of patents in the U.S. and various other countries are capitalized and amortized on a straight-line basis over the term of the patents as determined at award date, which varies depending on the pendency period of the application, generally approximating seventeen years. Capitalized patent costs include internal legal labor, professional legal fees, government filing fees and translation fees related to obtaining the Company’s patent portfolio.

Costs associated with the maintenance and annuity fees of patents are accounted for as prepaid assets at the time of payment and amortized over the respective periods, generally from one to four years.

Revenue Recognition

The Company’s revenue consists of subscription revenue, which includes hardware and software sales, royalties and revenues from the licensing of digital watermarking products and related authentication services. The Company’s revenue recognition policy follows ASC 605 “Revenue Recognition,” ASC 985, and SEC Staff Accounting Bulletin (“SAB”) No. 104 Revenue Recognition.

Other Income (Expenses), Net

The Company’s other income (expense), net consists primarily of the net losses from the Company’s joint ventures with The Nielsen Company, TVaura LLC and TVaura Mobile LLC, and interest income from the Company’s short- and long-term marketable securities.

Stock-Based Compensation

ASC 718 “Compensation – Stock Compensation” requires the measurement and recognition of compensation for all stock-based awards made to employees and directors, including stock options and restricted stock based on estimated fair values.

The Company uses the Black-Scholes option pricing model as its method of valuation for stock-based awards. The Company’s determination of the fair value of stock-based awards on the date of grant using an option pricing model is affected by the Company’s stock price as well as assumptions regarding a number of highly complex and subjective variables. These variables include, but are not limited to, the expected life of the award, expected stock price volatility over the term of the award and actual and projected exercise behaviors. Although the fair value of stock-based awards is determined in accordance with ASC 718 and SAB No. 107 Shared-Based Payment, the Black-Scholes option pricing model requires the input of highly subjective assumptions, and other reasonable assumptions could provide differing results.

Income Taxes

The Company accounts for income taxes under the asset and liability method. Under the asset and liability method, deferred income taxes reflect the future tax consequences of differences between the tax bases of assets and liabilities and their financial reporting amounts at each year-end. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. Valuation allowances are established when necessary to reduce tax assets to the amount expected to be realized.

2. Recent Accounting Standards Update

In April 2010, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2010-17, Revenue Recognition – Milestone Method (Topic 605): Milestone Method of Revenue Recognition, a consensus of the FASB Emerging Issues Task Force, which provides guidance on defining a milestone and determining when it may be appropriate to apply the milestone method of revenue recognition for research or development transactions. ASU No. 2010-17 is effective for milestones achieved in fiscal years, and interim periods within those years, beginning on or after June 15, 2010. The Company is currently assessing the potential impact that adoption of this standard will have on its financial statements.

In October 2009, the FASB issued ASU No. 2009-14, Software: Certain Revenue Arrangements That Include Software Elements—a consensus of the FASB Emerging Issues Task Force, which will significantly improve the reporting of certain transactions to more closely reflect the underlying economics of the transactions. By excluding from its scope certain software-enabled devices, multiple-element arrangements that include such software-enabled devices will now be evaluated for separation and allocation using the guidance in ASU No. 2009-13 (described below). ASU No. 2009-14 is effective for revenue arrangements entered or materially modified in fiscal years beginning on or after June 15, 2010. The Company is currently assessing the potential impact of this standard, but does not expect the adoption of the standard will have a material impact on the financial condition or results of operations of the Company.

In October 2009, the FASB issued ASU No. 2009-13, Revenue Recognition: Multiple-Deliverable Revenue Arrangements—a consensus of the FASB Emerging Issues Task Force, which eliminates the use of the residual method for allocating consideration, as well as the criteria that requires objective and reliable evidence of fair value of undelivered elements in order to separate the elements in a multiple-element arrangement. By removing the criterion requiring the use of objective and reliable evidence of fair value in separately accounting for deliverables, the recognition of revenue will more closely align with certain revenue arrangements. The standard also will replace the term “fair value” in the revenue allocation guidance with “selling price” to clarify that the allocation of revenue is based on entity-specific assumptions rather than assumptions of a marketplace participant. ASU No. 2009-13 is effective for revenue arrangements entered or materially modified in fiscal years beginning on or after June 15, 2010. The Company is currently assessing the potential impact of this standard, but does not expect the adoption of the standard will have a material impact on the financial condition or results of operations of the Company.

3. Revenue Recognition

Revenue is recognized in accordance with ASC 985 and SAB 104 when the following four criteria are met:

(i)

persuasive evidence of an arrangement exists;

(ii)

delivery has occurred;

(iii)

the fee is fixed or determinable; and

(iv)

collection is probable.

Some customer arrangements encompass multiple deliverables, such as software, maintenance and software development. If the deliverables meet the criteria in ASC 605, the deliverables are divided into separate units of accounting and revenue is allocated to the deliverables based on their relative fair values. The criteria specified in ASC 605 are as follows:

(i)

the delivered item has value to the customer on a stand-alone basis;

(ii)

there is objective and reliable evidence of the fair value of the undelivered item; and

(iii)

if the arrangement includes a general right of return relative to the delivered item, delivery or performance of the undelivered item is considered probable and substantially in the control of the vendor.

For the Company’s purposes, fair value is generally defined as the price at which a customer could purchase each of the elements independently from other vendors or as the price that the Company has sold the element separately to another customer. Management applies judgment to ensure appropriate application of ASC 605, including value allocation among multiple deliverables, determination of whether undelivered elements are essential to the functionality of delivered elements and timing of revenue recognition, among others.

ASC 985 requires that revenue be recognized using the “residual method” in circumstances when vendor specific objective evidence (“VSOE”) exists only for undelivered elements. Under the residual method, revenue is recognized as follows: (1) the total fair value of undelivered elements, as indicated by VSOE, is deferred and subsequently recognized in accordance with the relevant sections of ASC 985, and (2) the difference between the total arrangement fee and the amount deferred for the undelivered elements is recognized as revenue related to the delivered elements.

Applicable revenue recognition criteria is considered separately for each separate unit of accounting as follows:

•

Revenue from professional service arrangements is generally determined based on time and materials. Revenue for professional services is recognized as the services are performed. Billing for services rendered generally occurs within one month after the services are provided.

•

Royalty revenue is recognized when the royalty amounts owed to the Company have been earned, are determinable, and collection is probable. Subscriptions are paid in advance and revenue is recognized ratably over the term of the subscription. These revenues include the licensing of digital watermarking products and services for use in authenticating documents, detecting fraudulent documents and deterring unauthorized duplication or alteration of high-value documents, for use in communicating copyright, asset management and business-to-business image commerce solutions, and for use in connecting analog media to a digital environment.

•

Software revenue is recognized in accordance with ASC 985. Revenue for licenses of the Company’s software products is recognized upon the Company meeting the following criteria: persuasive evidence of an arrangement exists; delivery has occurred; the vendor’s fee is fixed or determinable; and collectability is probable. Software revenue is recognized over the term of the license or upon delivery and acceptance if the Company grants a perpetual license with no further obligations.

•

Maintenance revenue is recognized when the maintenance amounts owed to the Company have been earned, are determinable, and collection is probable. Maintenance contracts are, at times, paid in advance and revenue is recognized ratably on a straight-line basis over the term of the service period.

•

The Company records revenue from some customers upon cash receipt as a result of collectability not being reasonably assured.

•

Revenue earned which has not been invoiced at the last day of the period, but which is generally billed within one to two weeks of the last day of the period, is included in trade accounts receivables, net in the balance sheets.

•

Deferred revenue consists of billings in advance for professional services, licenses, subscriptions and hardware for which revenue has not been earned.

4. Segment Information

Geographic Information

The Company derives its revenue from a single reporting segment: media management solutions. Revenue is generated in this segment through licensing of intellectual property, subscriptions to various products and services, and the delivery of services pursuant to contracts with various customers. The Company markets its products in the U.S. and in non-U.S. countries through its sales personnel.

Revenue, by geographic area, based upon the “bill-to” location, is as follows:


	Three Months Ended September 30, 2010		Three Months Ended September 30, 2009		Nine Months Ended September 30, 2010		Nine Months Ended September 30, 2009
Domestic	$	1,868	$	2,165	$	11,211	$	5,718
International		3,369		2,604		9,466		7,804

Total	$	5,237	$	4,769	$	20,677	$	13,522

Major Customers

Customers who accounted for more than 10% of the Company’s revenues are as follows:


	Three Months Ended September 30, 2010			Three Months Ended September 30, 2009			Nine Months Ended September 30, 2010			Nine Months Ended September 30, 2009
Central Banks		45	%		49	%		35	%		51	%
The Nielsen Company		17	%		21	%		13	%		27	%
Civolution		17	%		*			*			*
TVaura LLC		12	%		12	%		10	%		*
Arbitron		—			—			22	%		—
* Less than 10%

5. Stock-Based Compensation

Stock-based compensation includes expense charges for all stock-based awards to employees and directors. These awards include option grants and restricted stock awards.

Determining Fair Value

Preferred Stock

The Board of Directors authorized 10,000 shares of Series A Redeemable Nonvoting Preferred stock to be issued to the executive officers. The Series A Redeemable Nonvoting Preferred stock has no voting rights, except as required by law, and may be redeemed by the Board of Directors at any time on or after June 18, 2013.

The fair value of Series A Redeemable Nonvoting Preferred stock is based on the stated fair value of $5.00 per share, and the related stock compensation expense is recognized over the non-redeemable period of 5 years, or 60 months, through June 2013 using the straight-line method.

Stock Options

Valuation and Amortization Method. The Company estimates the fair value of stock-based awards granted using the Black-Scholes option valuation model. The Company amortizes the fair value of all awards on a straight-line basis over the requisite service periods, which are generally the vesting periods. The fair value of each option grant is estimated on the date of grant using the Black-Scholes option pricing model.

Expected Term (Life). The expected life of awards granted represents the period of time that the awards are expected to be outstanding. The Company determined the initial expected life based on a simplified method in accordance with ASC 718, giving

consideration to the contractual terms, vesting schedules and pre-vesting and post-vesting forfeitures. Stock options granted generally vest over four years for employee grants and two years for director grants, and have contractual terms of ten years.

Expected Volatility. The Company estimates the initial volatility of its common stock at the date of grant based on a 50/50 blend of the Company’s own historical volatility and an independent analysis of a peer group’s historical volatility of its common stock using the Black-Scholes option valuation model based on historical stock prices over the most recent period commensurate with the estimated expected life of the award.

Risk-Free Interest Rate. The Company bases the risk-free interest rate used in the Black-Scholes option valuation model on an interest rate on a U.S. Treasury bond with a maturity commensurate with each expected term estimate.

Expected Dividend Yield. The Company has never paid any cash dividends on its common stock and does not anticipate paying any cash dividends in the foreseeable future. Consequently, the Company uses an expected dividend yield of zero in the Black-Scholes option valuation model.

Expected Forfeitures. The Company uses a zero forfeiture for both the stock options granted to employees, which vest monthly, and the stock options granted to the Company’s directors. Initial option grants, made to new directors, vest 50% on the first anniversary of the date of grant and then monthly thereafter and which the annual option grants, made to continuing directors, vest monthly. The Company records stock-based compensation expense only for those awards that are expected to vest, including awards made to directors who are expected to continue with the Company through the year following the date of grant. Stock options forfeited during the month are not expensed.

A summary of the weighted average assumptions and results for options granted as follows:


	2010			2009
Expected life (in years)		5.2 - 6.0			5.64
Expected volatility		52% - 55	%		70.45	%
Risk-free interest rate		2.5% - 3.0	%		2.17	%
Expected dividend yield		0	%		0	%
Expected forfeiture rate		0	%		0	%

Restricted Stock

The Compensation Committee of the Board of Directors awards restricted stock shares under the Company’s 2008 Stock Incentive Plan to certain employees. The shares subject to the restricted stock awards vest over a certain period, usually four years, following the date of the grant. Specific terms of the restricted stock awards are governed by restricted stock agreements between the Company and the award recipients.

The fair value of restricted stock awards granted is based on the fair market value of the Company’s common stock on the date of the grant (measurement date), and is recognized over the vesting period of the related restricted stock using the straight-line method.

Stock-based Compensation


	Three Months Ended September 30, 2010		Three Months Ended September 30, 2009		Nine Months Ended September 30, 2010		Nine Months Ended September 30, 2009
Stock-based compensation:
Cost of revenue	$	84	$	55	$	272	$	154
Sales and marketing		50		48		141		150
Research, development and engineering		79		47		225		140
General and administrative		542		449		1,576		1,282
Intellectual property		27		19		73		52

Stock-based compensation expense		782		618		2,287		1,778
Capitalized to patent costs		9		11		31		30

Total stock-based compensation	$	791	$	629	$	2,318	$	1,808

At September 30, 2010, the Company had 10,000 shares of Series A redeemable nonvoting preferred stock, 671,884 non-vested stock options and 225,410 shares of restricted common stock outstanding. As of September 30, 2010, the Company had $6,954 of total unrecognized compensation cost related to non-vested stock-based awards granted under all equity compensation plans, including preferred stock, stock options and restricted stock. Total unrecognized compensation cost will be adjusted for any future changes in actual forfeitures. The Company expects to recognize this compensation cost for stock options and restricted stock over a weighted average period of 1.23 years and 1.74 years, respectively, through September 2014.

Stock Option Activity

As of September 30, 2010, under all of the Company’s stock-based compensation plans, options to purchase an aggregate of 1.3 million shares were outstanding, and options to purchase an additional 0.9 million shares were authorized for future grants under the plans. The Company issues new shares upon option exercises.

Options granted, exercised, canceled and expired under the Company’s stock option plans are summarized as follows:


Three-months ended September 30, 2010:	Options			Weighted Average Exercise Price		Weighted Average Remaining Contractual Life
Outstanding at June 30, 2010		1,306,490		$	10.29
Options granted		—			—
Options exercised		—			—
Options canceled or expired		—			—

Outstanding at September 30, 2010		1,306,490		$	10,29		8.23 years

Exercisable at September 30, 2010		634,606		$	9.97		8.17 years


Nine-months ended September 30, 2010:	Options			Weighted Average Exercise Price		Weighted Average Remaining Contractual Life
Outstanding at December 31, 2009		1,167,323		$	9.65
Options granted		140,000		$	15.64
Options exercised		(833	)	$	9.64
Options canceled or expired		—			—

Outstanding at September 30, 2010		1,306,490		$	10.29		8.23 years

Exercisable at September 30, 2010		634,606		$	9.97		8.17 years

The following table summarizes information about stock options outstanding at September 30, 2010:


	Options Outstanding						Options Exercisable
Range of Exercise Prices	Number Outstanding		Remaining Contractual Life (Years)		Weighted Average Price		Number Exercisable		Weighted Average Price
$9.64		1,136,490		8.08	$	9.64		573,774	$	9.64
$9.91		30,000		8.58	$	9.91		30,000	$	9.91
$14.99		110,000		9.26	$	14.99		18,332	$	14.99
$18.01		30,000		9.58	$	18.01		12,500	$	18.01

$9.64 - $18.01		1,306,490		8.23	$	10.29		634,606	$	9.97

At September 30, 2010, the aggregate intrinsic value of outstanding and exercisable stock options was $17,208 and $8,559, respectively. The aggregate intrinsic value is based on the closing price of $23.46 per share of Digimarc common stock on September 30, 2010, which would have been received by the optionees had all of the options with exercise prices of less than $23.46 per share been exercised on that date.

The estimated average fair value of outstanding stock options was $6.48 per share at September 30, 2010.

Restricted Stock Activity

The following table reconciles the unvested balance of restricted stock:


Three-months ended September 30, 2010:	Number of Shares
Unvested balance, June 30, 2010		205,160
Granted		23,900
Vested		(2,000	)
Canceled		(1,650	)

Unvested balance, September 30, 2010		225,410


Nine-months ended September 30, 2010:	Number of Shares
Unvested balance, December 31, 2009		111,000
Granted		122,960
Vested		(5,100	)
Canceled		(3,450	)

Unvested balance, September 30, 2010		225,410

6. Trade Accounts Receivable

Trade Accounts Receivable

Trade accounts receivable are recorded at the invoiced amount and do not bear interest.


	September 30, 2010		December 31, 2009
Trade accounts receivable	$	3,101	$	3,570
Allowance for doubtful accounts		—		—

Trade accounts receivable, net	$	3,101	$	3,570

Unpaid deferred revenues included in accounts receivable	$	1,394	$	1,926

Allowance for doubtful accounts

The allowance for doubtful accounts is the Company’s best estimate of the amount of probable credit losses in the Company’s existing accounts receivable. The Company determines the allowance based on historical write-off experience and current information. The Company reviews its allowance for doubtful accounts monthly. Account balances are charged off against the allowance after all means of collection have been exhausted and the potential for recovery is considered remote.

Unpaid deferred revenues

The unpaid deferred revenues that are included in accounts receivable are billed in accordance with the provisions of the contracts with the Company’s customers. Unpaid deferred revenues from cash-basis revenue recognition customers are not included in accounts receivable nor deferred revenue accounts.

Major customers

Customers who accounted for more than 10% of accounts receivable, net, are as follows:


	September 30, 2010			December 31, 2009
The Nielsen Company		29	%		25	%
Civolution		25	%		*
Central Banks		22	%		38	%
Government Customer		13	%		—
* Less than 10%

7. Property and Equipment

Property and equipment are stated at cost. Property and equipment under capital lease obligations are stated at the lower of the present value of minimum lease payments at the beginning of the lease term or fair value of the leased assets at the inception of the lease. Repairs and maintenance are charged to expense when incurred.

Depreciation on property and equipment is calculated by the straight-line method over the estimated useful lives of the assets, generally two to seven years. Property and equipment held under capital leases are amortized by the straight-line method over the shorter of the lease term or the estimated useful life. Amortization of property and equipment under capital lease is included in depreciation expense.

Leasehold improvements are amortized by the straight-line method over the shorter of the estimated useful life or the lease term.


	September 30, 2010			December 31, 2009
Office furniture fixtures	$	294		$	291
Equipment		1,314			1,150
Leasehold improvements		492			423

		2,100			1,864
Less accumulated depreciation and amortization		(1,180	)		(750	)

	$	920		$	1,114

8. Intangible Assets—Purchase and Capitalized Patent Costs

Intangible assets are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable.


	September 30, 2010			December 31, 2009
Gross intangible assets	$	2,181		$	1,339
Accumulated amortization		(91	)		(37	)

Intangible assets, net	$	2,090		$	1,302

9. Other Income (Expenses), Net

Other income (expenses), net consists primarily of the net losses from the Company’s joint ventures with The Nielsen Company, TVaura LLC and TVaura Mobile LLC, and interest income from the Company’s cash and short- and long-term marketable securities.


	Three Months Ended September 30, 2010			Three Months Ended September 30, 2009			Nine Months Ended September 30, 2010			Nine Months Ended September 30, 2009
Net loss from joint ventures	$	(558	)	$	(311	)	$	(1,576	)	$	(311	)
Interest income, net		58			124			185			436
Other		4			2			(1	)		3

Total	$	(496	)	$	(185	)	$	(1,392	)	$	128

10. Income Taxes

The provision for income taxes reflects U.S. alternative minimum tax expense and withholding tax expense in various foreign jurisdictions. Withholding taxes are computed by the Company’s customers and paid to foreign jurisdictions on its behalf. Other than the U.S. alternative minimum taxes and foreign withholding tax expense, there was no provision for current income taxes related to net income because the computation of regular taxable income is fully offset by available net operating loss carry-forwards and tax credits previously offset by a full valuation allowance.

11. Commitments and Contingencies

Certain of the Company’s product license and services agreements include an indemnification provision for claims from third parties relating to the Company’s intellectual property. Such indemnification provisions are accounted for in accordance with ASC 450 “Contingencies.” To date, there have been no claims made under such indemnification provisions.

A declaratory judgment action has been filed against Digimarc in the United States District Court in Delaware by Verance Corporation, a licensee, on September 30, 2010 alleging the invalidity and non infringement of 22 patents held by Digimarc. Verance Corp. v. Digimarc Corp., 1:10-cv-00831-UNA.

The Company is subject from time to time to legal proceedings and claims arising in the ordinary course of business. Although the ultimate outcome of these matters cannot be determined, management believes that, as of September 30, 2010, the final disposition of these proceedings will not have a material adverse effect on the financial position, results of operations, or liquidity of the Company. In accordance with ASC 450, no accrual has been recorded because the amounts are not probable or reasonably estimatable.

12. Stock Repurchases

In April 2009, the Board of Directors approved a stock repurchase program authorizing the purchase, at the discretion of management, of up to $5,000 of Digimarc’s common stock through either periodic open-market or private transactions at then prevailing market prices through April 30, 2010. In April 2010, the Board of Directors approved an extension of the stock repurchase program through April 30, 2011.


	Three Months Ended September 30, 2010		Three Months Ended September 30, 2009		Nine Months Ended September 30, 2010		Nine Months Ended September 30, 2009
Purchases	$	—	$	822	$	—	$	822
Shares purchased		—		59,355		—		59,355

The Company has paid $1,560 to repurchase 111,667 shares of outstanding common stock under this program since the program’s inception.

As part of the Company’s 2008 Stock Incentive Plan, restricted stock shares are awarded to certain employees. Pursuant to the terms of the restricted stock award agreement, the Company withheld (purchased) from fully vested shares of common stock otherwise deliverable to any employee, a number of whole shares of common stock having a fair market value (as determined by the Company as of the date of vesting) equal to the amount of tax required to be withheld by law, in order to satisfy the tax withholding obligations of the Company in connection with the vesting of such shares.


	Three Months Ended September 30, 2010		Three Months Ended September 30, 2009		Nine Months Ended September 30, 2010		Nine Months Ended September 30, 2009
Restricted shares vested		2,000		—		5,100		—
Restricted shares withheld (purchased)		822		—		2,117		—
Tax withholding obligations	$	16	$	—	$	40	$	—

13. Related Party Transactions


	Three Months Ended September 30, 2010			Three Months Ended September 30, 2009			Nine Months Ended September 30, 2010			Nine Months Ended September 30, 2009
TVaura LLC:
Capital contributions	$	400		$	350		$	1,200		$	350
Revenue⁽¹⁾	$	652		$	575		$	2,026		$	575
Net loss	$	(334	)	$	(292	)	$	(1,084	)	$	(292	)

TVaura Mobile LLC:
Capital contributions	$	300		$	200		$	900		$	200
Revenue	$	—		$	—		$	—		$	—
Net loss	$	(224	)	$	(19	)	$	(492	)	$	(19	)

(1)	Technical and development services


	September 30, 2010		December 31, 2009
TVaura LLC:
Accounts Receivable	$	196	$	190
Accounts Payable	$	—	$	—

TVaura Mobile LLC:
Accounts Receivable	$	—	$	2
Accounts Payable	$	—	$	—

Summarized financial data for TVaura LLC:


	Three Months Ended September 30, 2010			Three Months Ended September 30, 2009			Nine Months Ended September 30, 2010			Nine Months Ended September 30, 2009
Revenue	$	—		$	—		$	—		$	—
Gross profit		—			—			—			—
Sales and marketing		86			37			219			37
Research and development		561			511			1,865			511
General and administrative		9			24			42			24
Operating Income (loss)		(656	)		(572	)		(2,126	)		(572	)
Net income (loss)		(656	)		(572	)		(2,125	)		(572	)

14. Subsequent Events

In accordance with ASC 855 “Subsequent Events,” the Company is required to evaluate subsequent events through the date on which financial statements are issued. Subsequent events were evaluated through the date the Company’s quarterly report on Form 10-Q for the quarter ended September 30, 2010 was filed with the Securities and Exchange Commission.

15. Quarterly Financial Information—Unaudited


Quarter ended:	March 31			June 30			September 30
*2010*
Service revenue	$	3,514		$	2,918		$	2,761
License and subscription revenue		6,678			2,330			2,476

Total revenue		10,192			5,248			5,237
Total cost of revenue		1,857			1,540			1,469
Gross profit		8,335			3,708			3,768
Gross profit percent, service revenue		49	%		49	%		49	%
Gross profit percent, license and subscription revenue		99	%		98	%		98	%
Gross profit percent, total		82	%		71	%		72	%
Sales and marketing		741			759			953
Research, development and engineering		1,259			1,321			1,471
General and administrative		1,885			1,687			1,842
Intellectual property		257			319			315
Operating income (loss)		4,193			(378	)		(813	)
Net income (loss)		3,776			(896	)		(1,460	)
Earnings (loss) per share:
Net income per share—basic	$	0.53		$	(0.13	)	$	(0.21	)
Net income per share—diluted	$	0.51		$	(0.13	)	$	(0.21	)
Weighted average shares outstanding—basic		7,096			7,097			7,098
Weighted average shares outstanding—diluted		7,387			7,097			7,098


Quarter ended:	March 31			June 30			September 30			December 31
*2009*
Service revenue	$	2,470		$	2,585		$	2,827		$	2,963
License and subscription revenue		1,959			1,739			1,942			2,586

Total revenue		4,429			4,324			4,769			5,549
Total cost of revenue		1,485			1,528			1,541			1,747
Gross profit		2,944			2,796			3,228			3,802
Gross profit percent, service revenue		43	%		43	%		47	%		43	%
Gross profit percent, license and subscription revenue		97	%		97	%		98	%		98	%
Gross profit percent, total		66	%		65	%		68	%		69	%
Sales and marketing		745			728			753			808
Research, development and engineering		1,271			1,217			1,191			1,310
General and administrative		1,628			1,448			1,521			1,702
Intellectual property		277			217			262			257
Operating loss		(977	)		(814	)		(499	)		(275	)
Net loss		(809	)		(678	)		(687	)		(583	)
Loss per share:
Net loss per share—basic & diluted	$	(0.11	)	$	(0.09	)	$	(0.10	)	$	(0.08	)
Weighted average shares outstanding—basic and diluted		7,158			7,158			7,134			7,103

Item 2.

Management’s Discussion and Analysis of Financial Condition and Results of Operations.

The following Management’s Discussion and Analysis of Financial Condition and Results of Operations contains forward-looking statements relating to future events or the future financial performance of Digimarc that involve risks and uncertainties. Our actual results could differ materially from those anticipated in these forward-looking statements. Please see the discussion regarding forward-looking statements included in this Quarterly Report on Form 10-Q under the caption “Safe Harbor Statement under the Private Securities Litigation Reform Act of 1995.”

The following discussion should be read in conjunction with our financial statements and the related notes and other financial information appearing elsewhere in this Quarterly Report on Form 10-Q. Readers are also urged to carefully review and consider the disclosures made in Part II, Item 1A (Risk Factors) of this Quarterly Report on Form 10-Q and our Annual Report on Form 10-K for the year ended December 31, 2009 (the “2009 Annual Report”) and in the audited financial statements and related notes included in our 2009 Annual Report, and other reports and filings made with the Securities and Exchange Commission (“SEC”).

Unless the context otherwise requires, references in this Quarterly Report on Form 10-Q to “Digimarc,” “we,” “our” and “us” refer to Digimarc Corporation.

All dollar amounts are in thousands, unless otherwise noted.

Overview

Digimarc Corporation enables governments and enterprises around the world to give digital identities to media and objects that computers can sense and recognize and to which they can react. Our technology provides the means to infuse persistent digital information, perceptible only to computers and digital devices, into all forms of media content. The unique digital identifier placed in media generally persists with it regardless of the distribution path and whether it is copied, manipulated or converted to a different format, and does not affect the quality of the content or the enjoyment or other traditional uses of it. Our technology permits computers and digital devices to quickly identify relevant data from vast amounts of media content. Our technology, and those of our licensees, span a range of media content, enabling our customers and those of our partners to:

•

Quickly identify and effectively manage music, movies, television programming, digital images, documents and other printed materials, especially in light of new non-linear distribution over the internet;

•

Deter counterfeiting of money, media and goods, and piracy of movies and music;

•

Support new digital media distribution models and methods to monetize media content;

•

Leverage the power of ubiquitous computing to instantly link consumers to a wealth of information and/or interactive experiences related to the media and objects they encounter each day;

•

Provide consumers with more choice and access to media content when, where and how they want it;

•

Enhance imagery and video by associating metadata or authenticating media content for government and commercial uses; and

•

Better secure identity documents to enhance national security and combat identity theft and fraud.

At the core of our intellectual property is a signal processing technology innovation known as “digital watermarking” which allows imperceptible digital information to be embedded in all forms of digitally designed, produced or distributed media content and some physical objects, including photographs, movies, music, television, personal identification documents, financial instruments, industrial parts and product packages. The digital information can be detected and read by a wide range of computers, mobile phones, and other digital devices.

We provide technology-based solutions directly and through our licensees. Our proprietary technology has proven to be a powerful element of document security, giving rise to our long-term relationship with a consortium of central banks, which we refer to as the Central Banks, and many leading companies in the information technology industry. We and our licensees have successfully propagated digital watermarking in music, movies, television broadcasts, images and printed materials. Digital watermarks have been used in these applications to improve media rights and asset management, reduce piracy and counterfeiting losses, improve marketing programs, permit more efficient and effective distribution of valuable media content and enhance consumer entertainment and commercial experiences.

Our growth strategy continues to focus on both our government and commercial businesses. We plan additional investment in research and development of a commercial mobile platform that boosts device specific capabilities.

To protect our significant efforts in creating our technology, we have implemented an extensive intellectual property protection program that relies on a combination of patent, copyright, trademark and trade secret laws, and nondisclosure agreements and other contracts. We believe we have one of the world’s most extensive patent portfolios in the field of digital watermarking and related media enhancement innovations, with over 620 U.S. and foreign patents and more than 440 U.S. and foreign patent applications on file as of September 30, 2010.

As part of our intellectual property marketing initiative and patent monetization, our key objectives in building relationships with potential customers and partners are to:

•

make progress toward the realization of our vision and mission;

•

expand the scope of our license program;

•

more effectively monetize our patent assets;

•

encourage large scale adoption of our technologies by industry leaders;

•

improve our financial performance;

•

increase the scale and rate of growth of our software and services business; and

•

lay a foundation for continuing innovation.

Pursuant to these key objectives, on October 5, 2010, we entered into a patent licensing arrangement with IV Digital Multimedia Inventions, LLC, a Delaware limited liability company affiliated with Intellectual Ventures^TM (“IV”), pursuant to which we granted an exclusive license to sublicense, subject to pre-existing encumbrances and a grant-back license, to 597 patents and to 288 patent applications held by us. We retained 4 patents and 128 patent applications that are not subject to the exclusive license, as well as 26 patents and 26 patent applications for which we hold rights with third parties.

The financial aspects of the IV agreement for us include:

•

a license issue fee of $36 million, paid to Digimarc in increasing quarterly installments over three years;

•

20% of the profits generated from the IV licensing program, which profits consist of sublicensing and other monetization revenue less specified expenses, including the license issue fee;

•

IV assumes responsibility for approximately $1 million per year in prosecution and maintenance costs previously borne by Digimarc;

•

a minimum of $4 million of paid support over five years from Digimarc to assist IV in maximizing the value of the licensed assets; and

•

a royalty-free grant-back license to the licensed patents to continue Digimarc’s existing business related to those assets, including maintaining and renewing existing patent licenses, and providing software and services.

While this arrangement includes a minimum fee guarantee plus a variable profit component that is similar to our typical license arrangements, this exclusive license to sublicense arrangement is a new marketing approach to our licensing activities. We have not yet fully determined the accounting for this transaction.

We believe recent intellectual property licensing initiatives we have commenced represent substantial opportunities for us to grow our license and subscription revenues, as well as our service revenues. These initiatives, however, may require additional investment in our intellectual property enforcement program and research and development.

Critical Accounting Policies and Estimates

Detailed information on our critical accounting policies and estimates are set forth in our 2009 Annual Report in Part II, Item 7 thereof (“Management’s Discussion and Analysis of Financial Condition and Results of Operations”), under the caption “Critical Accounting Policies and Estimates,” which is incorporated by reference into this Quarterly Report on Form 10-Q.

Results of Operations

The following table presents statements of operations data for the periods indicated as a percentage of total revenue. Unless otherwise indicated, all references in this Management’s Discussion and Analysis of Financial Condition and Results of Operations to the three- and nine-month periods relate to the three- and nine-month periods ended September 30, 2010 and all changes discussed with respect to such periods reflect changes compared to the three- and nine-month periods ended September 30, 2009.


	Three Months Ended September 30, 2010			Three Months Ended September 30, 2009			Nine Months Ended September 30, 2010			Nine Months Ended September 30, 2009
Revenue:
Service		53	%		59	%		44	%		58	%
License and subscription		47			41			56			42

Total revenue		100			100			100			100
Cost of revenue:
Service		27			31			23			33
License and subscription		1			1			1			1

Total cost of revenue		28			32			24			34
Gross profit		72			68			76			66
Operating expenses:
Sales and marketing		18			16			12			16
Research, development and engineering		28			25			20			27
General and administrative		35			32			26			34
Intellectual property		6			5			4			6

Total operating expenses		87			78			62			83

Operating income (loss)		(15	)		(10	)		14			(17	)

Other income (expense), net		(10	)		(4	)		(6	)		1

Income (loss) before provision for income taxes		(25	)		(14	)		8			(16	)
Provision for income taxes		(3	)		—			(1	)		—

Net income (loss)		(28	)%		(14	)%		7	%		(16	)%

Our revenue for the three- and nine-month periods ended September 30, 2010 increased 10% to $5.2 million from $4.8 million and 53% to $20.7 million from $13.5 million, respectively, for the prior periods. The increases were primarily the result of royalty revenues from Civolution that exceeded expectations in the second and third quarters, the receipt of $4.5 million in connection with the licensing arrangement with Arbitron in the first quarter, completion of government contracts that are non-linear in nature and increased program work from the Central Banks.

Revenue


	Three Months Ended September 30, 2010			Three Months Ended September 30, 2009			Dollar Increase (Decrease)			Percent Increase			Nine Months Ended September 30, 2010			Nine Months Ended September 30, 2009			Dollar Increase		Percent Increase
Revenue:
Service	$	2,761		$	2,827		$	(66	)		(2	)%	$	9,193		$	7,882		$	1,311		17	%
License and subscription		2,476			1,942			534			28	%		11,484			5,640			5,844		104	%

Total	$	5,237		$	4,769		$	468			10	%	$	20,677		$	13,522		$	7,155		53	%

Revenue (as % of total revenue):
Service		53	%		59	%								44	%		58	%
License and subscription		47	%		41	%								56	%		42	%

Total		100	%		100	%								100	%		100	%

We derive our revenue primarily from:

the provision of development services to the Central Banks, TVaura LLC, a joint venture between Digimarc and The Nielsen Company (“Nielsen”), from July 2009, Nielsen between October 2007 and June 2009 and other government and commercial customers and

licensing our patents.

Service. Service revenue consists primarily of software development and consulting services. The majority of service revenue arrangements are structured as time and materials or fixed price consulting agreements. The majority of our services revenue is derived from contracts with the Central Banks, Nielsen, the TVaura LLC joint venture and other government agencies. The agreements range from several months to several years in length, and our longer term contracts are subject to work plans that are reviewed and agreed upon at least annually. These contracts generally provide for billing hours worked at predetermined rates and, to a lesser extent, for cost reimbursement for third party costs and services. Increases or decreases in the services provided under these contracts are generally subject to both volume and price changes. The volume of work is generally negotiated at least annually and can be modified as the customer’s needs change. We also have provisions in our longer term contracts that allow for specific hourly rate increases on an annual basis to account for cost of living variables. Contracts with other government agencies are generally shorter term in nature, are less linear in billings and less predictable than our longer terms contracts because the contracts with other government agencies are subject to government budgets and funding.

Service revenue for the three-month period ended September 30, 2010, compared to the corresponding three-month period ended September 30, 2009, remained relatively consistent.

The increase in service revenue for the nine-month period ended September 30, 2010, compared to the corresponding nine-month period ended September 30, 2009, was due primarily to the completion of government contracts that are non-linear in nature, increased program work from the Central Banks and increased services under our joint venture agreement with Nielsen.

License and subscription. License revenue originates primarily from licensing our technology and patents where we receive royalties as our income stream. Subscription revenue consists primarily of royalty revenue from the sale of our web-based subscriptions related to various software products, which are more recurring in nature. Revenues from our licensed products have minimal associated direct costs, and thus provide very high gross margins.

The increase in license and subscription revenue for the three-month period ended September 30, 2010, compared to the corresponding three-month period ended September 30, 2009, was due primarily to increased royalties from Civolution, offset by decreased royalties from Verance, a cash basis customer, which chose to not pay its quarterly royalties and has sought legal remedies against us. See related disclosures in Part II, Item 1. Legal Proceedings of this Quarterly Report on Form 10-Q.

The increase in license and subscription revenue for the nine-month period ended September 30, 2010, compared to the corresponding nine-month period ended September 30, 2009, was due primarily to the licensing arrangement with Arbitron and increased royalties from Civolution.

Revenue by Geography


	Three Months Ended September 30, 2010			Three Months Ended September 30, 2009			Dollar Increase (Decrease)			Percent Increase			Nine Months Ended September 30, 2010			Nine Months Ended September 30, 2009			Dollar Increase		Percent Increase
Revenue by geography:
Domestic	$	1,868		$	2,165		$	(297	)		(14	)%	$	11,211		$	5,718		$	5,493		96	%
International		3,369			2,604			765			29	%		9,466			7,804			1,662		21	%

Total	$	5,237		$	4,769		$	468			10	%	$	20,677		$	13,522		$	7,155		53	%

Revenue (as % of total revenue):
Domestic		36	%		45	%								54	%		42	%
International		64	%		55	%								46	%		58	%

Total		100	%		100	%								100	%		100	%

Domestic revenue decreased for the three-month period ended September 30, 2010, compared to the corresponding three-month period ended September 30, 2009, primarily due to lower royalties from Verance, offset in part by the completion of government contracts that are non-linear in nature.

The increase in domestic revenue for the nine-month period ended September 30, 2010, compared to the corresponding nine-month period ended September 30, 2009, was due primarily to the licensing arrangement with Arbitron, the completion of government contracts and revenues received under the licensing and joint venture agreements with Nielsen.

International revenue increased for the three- and nine-month periods ended September 30, 2010, compared to the corresponding three-and nine-month periods ended September 30, 2009, primarily due to increased royalties from Civolution and increased revenue from the Central Banks.

We anticipate revenue growth for the remainder of 2010, compared to the same period in 2009 from our existing customers and from new customers as we expand the marketing and monetization of our intellectual property portfolio.

Cost of Revenue and Gross Profit

Service. Cost of service revenue primarily includes costs that are allocated from research, development, engineering and sales and marketing that relate directly to producing revenue under our customer contracts, and, to a lesser extent, direct costs of program delivery for both personnel and operating expenses. Allocated costs include:

•

salaries, a payroll tax and benefit factor, incentive compensation and related costs of our software developers, quality assurance personnel, product managers, business development managers and other personnel where we bill our customers for time and materials costs;

•

payments to outside contractors that are billed to customers;

•

charges for equipment directly used by the customer;

•

depreciation charges for machinery, equipment and software; and

•

travel costs directly attributable to service and development contracts.

License and subscription. Cost of license and subscription revenue primarily includes:

•

patent or software license costs for any patents licensed from third parties where the party receives a portion of royalties or license revenue paid to by Digimarc;

•

internet service provider connectivity charges and image search data fees to support the services offered to our subscription customers; and, to a lesser extent,

•

amortization of capitalized patent costs.

Gross Profit


	Three Months Ended September 30, 2010			Three Months Ended September 30, 2009			Dollar Increase		Percent Increase			Nine Months Ended September 30, 2010			Nine Months Ended September 30, 2009			Dollar Increase		Percent Increase
Gross Profit:
Service	$	1,351		$	1,328		$	23		2	%	$	4,500		$	3,486		$	1,014		29	%
License and subscription		2,417			1,900			517		27	%		11,311			5,482			5,829		106	%

Total	$	3,768		$	3,228		$	540		17	%	$	15,811		$	8,968		$	6,843		76	%

Gross Profit (as % of related revenue components):
Service		49	%		47	%							49	%		44	%
License and subscription		98	%		98	%							98	%		97	%
Total		72	%		68	%							76	%		66	%

The increase in gross profit for the three-month period ended September 30, 2010, compared to the corresponding three-month period ended September 30, 2009, was primarily due to increased royalty revenues from Civolution, offset by lower royalties from Verance.

The increase in gross profit for the nine-month period ended September 30, 2010, compared to the corresponding nine-month period ended September 30, 2009, primarily reflected the effect of the licensing arrangement with Arbitron and royalties from Civolution, service revenues under our joint venture agreement with Nielsen and our agreement with the Central Banks, and the completion of government contracts.

The increase in gross profit as a percentage of revenue for the three-month period ended September 30, 2010, compared to the corresponding three-month period ended September 30, 2009, was due primarily to favorable margins from our government (including the Central Banks) and Nielsen joint venture contracts primarily as a result of improved labor utilization in the variable component of our costs of services.

The increase in gross profit as a percentage of revenue for the nine-month period ended September 30, 2010, compared to the corresponding nine-month period ended September 30, 2009, was due primarily to favorable margins from our government contracts and improved labor utilization noted above, and increased revenues attributed to the licensing arrangement with Arbitron and royalties from Civolution.

Operating Expenses

Sales and marketing


	Three Months Ended September 30, 2010			Three Months Ended September 30, 2009			Dollar Increase		Percent Increase			Nine Months Ended September 30, 2010			Nine Months Ended September 30, 2009			Dollar Increase		Percent Increase
Sales and marketing	$	953		$	753		$	200		27	%	$	2,453		$	2,226		$	227		10	%
Sales and marketing (as % of total revenue)		18	%		16	%							12	%		16	%

Sales and marketing expenses consist primarily of:

•

compensation, benefits and related costs of sales and marketing employees and product managers;

•

travel and market research costs, and costs associated with marketing programs, such as trade shows, public relations and new product launches;

•

incentive compensation in the form of stock-based compensation; and

•

charges for infrastructure and centralized costs of facilities and information technology.

We allocate certain costs of sales and marketing to cost of service revenue when they relate directly to our service contracts. For direct billable labor hours, we allocate to cost of service revenue:

•

salaries;

•

a payroll tax and benefits factor; and

•

incentive compensation related to our stock compensation plan.

We record all remaining, or “residual,” costs as sales and marketing costs.

The increase in sales and marketing expense for the three- and nine-month periods ended September 30, 2010, compared to the corresponding three-and nine-month periods ended September 30, 2009, resulted primarily from:

•

increased contract labor of $0.1 million related to the mobile device market, in particular visual search, and

•

increased professional fees of $0.1 million related to developing marketing materials for our patent monetization initiative.

We anticipate that we will continue to incur sales and marketing costs at existing or higher levels to support ongoing product and sales initiatives.

Research, development and engineering


	Three Months Ended September 30, 2010			Three Months Ended September 30, 2009			Dollar Increase		Percent Increase			Nine Months Ended September 30, 2010			Nine Months Ended September 30, 2009			Dollar Increase		Percent Increase
Research, development and engineering	$	1,471		$	1,191		$	280		24	%	$	4,051		$	3,679		$	372		10	%
Research, development and engineering (as % of total revenue)		28	%		25	%							20	%		27	%

Research, development and engineering expenses arise primarily from three areas that support our business model:

•

Fundamental Research:

•

Investigation of new watermarking algorithms to increase robustness and/or computational efficiency;

•

Mobile device usage models and imaging sub-systems in camera-phones;

•

Industry conference participation and authorship of papers for industry journals;

•

Survey and study of human and computer interaction models with a focus on mobile devices and modeling of intent;

•

Development of new intellectual property, including documentation of claims and production of supporting diagrams and materials; and

•

Research in fingerprinting and other content identification technologies.

•

Platform Development:

•

Tuning and optimization of implementation models to improve resistance to non-malicious attacks and routine transformations, such as JPEG, cropping and printing; and

•

Mobile platform creation to leverage device specific capabilities (e.g. instruction sets and GPUs).

•

Product Development:

•

Migration of applications to new platforms, specifically linking Digimarc for Images (formerly known as ImageBridge) to DGSDK and Digimarc Mobile;

•

Updating Digimarc for Images Plug-Ins for Photoshop CS5, including new interfaces and translation into 27 languages; and

•

Development of the Digimarc Mobile reader prototype in support of publishing applications.

Research, development and engineering expenses consist primarily of:

•

compensation, benefits and related costs of software developers and quality assurance personnel;

•

payments to outside contractors;

•

the purchase of materials and services for product development;

•

incentive compensation in the form of stock-based compensation; and

•

charges for infrastructure and centralized costs of facilities and information technology.

We allocate certain costs of research, development and engineering to cost of service revenue when they relate directly to our service contracts. For direct billable labor hours, we allocate to cost of service revenue:

•

salaries;

•

a payroll tax and benefits factor; and

•

incentive compensation related to our stock compensation plan.

We record all remaining, or “residual,” costs as research, development and engineering costs.

The increases in research, development and engineering expense for the three- and nine-month periods ended September 30, 2010, compared to the corresponding three- and nine-month periods ended September 30, 2009, resulted primarily from increased headcount and employee compensation-related expenses from hiring additional engineers and scientists to facilitate expected growth in service revenue, and to increase our investment in research and development primarily related to the mobile device market, in particular visual search.

We anticipate that we will continue to invest in research, development and engineering expenses at existing or higher levels in the near term to support certain ongoing product initiatives and service contracts.

General and administrative


	Three Months Ended September 30, 2010			Three Months Ended September 30, 2009			Dollar Increase		Percent Increase			Nine Months Ended September 30, 2010			Nine Months Ended September 30, 2009			Dollar Increase		Percent Increase
General and administrative	$	1,842		$	1,521		$	321		21	%	$	5,414		$	4,597		$	817		18	%
General and administrative (as % of total revenue)		35	%		32	%							26	%		34	%

We incur general and administrative costs in the functional areas of finance, legal, human resources, executive and board of directors. Costs for facilities and information technology are also managed as part of the general and administrative processes and are allocated to this line item as well as to costs of services, sales and marketing, and research development and engineering.

General and administrative expenses consist primarily of:

•

compensation, benefits and related costs;

•

third party and professional fees associated with legal, accounting, human resources and costs associated with being a public company;

•

incentive compensation in the form of stock-based compensation; and

•

charges for infrastructure and centralized costs of facilities and information technology.

The increases in general and administrative expenses for the three-month period ended September 30, 2010, compared to the corresponding three-month period ended September 30, 2009, resulted primarily from:

•

increased legal and accounting fees of $0.2 million related primarily to our IV arrangements entered into in October 2010, and

•

increased stock-based compensation of $0.1 million related to a additional layers of stock-based award grants.

The increases in general and administrative expenses for the nine-month period ended September 30, 2010, compared to the corresponding nine-month period ended September 30, 2009, resulted primarily from:

•

increased legal and accounting fees of $0.3 million related to our IV arrangements and other litigation matters earlier this year, and

•

increased stock-based compensation of $0.3 million related to a additional layers of stock-based award grants.

We anticipate that we will continue to incur general and administrative expenses at least at existing levels, while continuing to examine means to reduce general and administrative expenses as a percentage of revenue in the longer term.

Intellectual property


	Three Months Ended September 30, 2010			Three Months Ended September 30, 2009			Dollar Increase		Percent Increase			Nine Months Ended September 30, 2010			Nine Months Ended September 30, 2009			Dollar Increase		Percent Increase
Intellectual property	$	315		$	262		$	53		20	%	$	891		$	756		$	135		18	%
Intellectual property (as % of total revenue)		6	%		5	%							4	%		6	%

We incur intellectual property expenses that arise primarily from costs associated with documenting, applying for, and maintaining domestic and international patents and trademarks.

Gross expenditures for intellectual property costs, before reflecting the effect of capitalized patent costs, primarily consist of:

•

compensation, benefits and related costs of attorneys and legal assistants;

•

third party costs, including filing and governmental regulatory fees and fees for outside legal counsel, and translation costs, each incurred in the patent process;

•

incentive compensation in the form of stock-based compensation; and

•

charges for infrastructure and centralized costs of facilities and information technology.

The increase in intellectual property expenses for the three- and nine-month periods ended September 30, 2010, compared to the corresponding three- and nine-month periods ended September 30, 2009, resulted primarily from increased legal and maintenance related costs associated with our patent registration activity for our growing patent portfolio.

Intellectual property expenses can vary from period to period based on the level of capitalized patent activity.

We anticipate that we will continue to incur intellectual property expenses at existing or higher levels.

Stock-based compensation


	Three Months Ended September 30, 2010		Three Months Ended September 30, 2009		Dollar Increase		Percent Increase (Decrease)			Nine Months Ended September 30, 2010		Nine Months Ended September 30, 2009		Dollar Increase (Decrease)			Percent Increase (Decrease)
Cost of revenue	$	84	$	55	$	29		53	%	$	272	$	154	$	118			77	%
Sales and marketing		50		48		2		4	%		141		150		(9	)		(6	)%
Research, development and engineering		79		47		32		68	%		225		140		85			61	%
General and administrative		542		449		93		21	%		1,576		1,282		294			23	%
Intellectual property		27		19		8		42	%		73		52		21			40	%

Total	$	782	$	618	$	164		27	%	$	2,287	$	1,778	$	509			29	%

The increase in stock-based compensation expense for the three- and nine-month periods ended September 30, 2010, compared to the corresponding three- and nine-month periods ended September 30, 2009, were primarily due to an additional layer of stock-based awards being expensed pursuant to ASC 718 “Compensation—Stock Compensation.” We anticipate incurring an additional $7.0 million in stock-based compensation expense through September 2014 for awards outstanding as of September 30, 2010. The future effect of stock-based compensation on our financial position and results of operations will be determined by stock-based awards granted in future periods and the assumptions on which the value of those stock-based awards are based. Our tax accounting may also be affected by actual exercise behavior and the relative market prices at exercise of the awards.

Other income (expenses), net


	Three Months Ended September 30, 2010			Three Months Ended September 30, 2009			Dollar Increase (Decrease)			Percent Increase (Decrease)			Nine Months Ended September 30, 2010			Nine Months Ended September 30, 2009			Dollar Decrease			Percent Decrease
Net loss from joint ventures	$	(558	)	$	(311	)	$	(247	)		(79	)%	$	(1,576	)	$	(311	)	$	(1,265	)		(407	)%
Interest income, net		58			124			(66	)		(53	)%		185			436			(251	)		(58	)%
Other		4			2			2			100	%		(1	)		3			(4	)		(133	)%

Total	$	(496	)	$	(185	)	$	(311	)		(168	)%	$	(1,392	)	$	128		$	(1,520	)		(1188	)%

Other income (expenses), net consists primarily of the net losses from the joint ventures with The Nielsen Company, TVaura LLC and TVaura Mobile LLC, and interest income from our cash and short- and long-term marketable securities.

The decreases in other income (expense), net for the three- and nine-month periods ended September 30, 2010, compared to the corresponding three- and nine-month periods ended September 30, 2009, resulted primarily from our share of net losses of $334 and $1,084 from TVaura LLC and $224 and $492 from TVaura Mobile LLC, respectively, and lower interest earned on cash and investment balances, reflecting lower interest rates paid on these balances.

Provision for Income Taxes

There was no provision for income taxes of Digimarc, other than U.S. alternative minimum taxes and foreign withholding taxes, for the three- and nine-month periods ended September 30, 2010.

Digimarc continually assesses the applicability of a valuation allowance. Based upon the positive and negative evidence available as of September 30, 2010, the Company concluded that it is not more likely than not that net deferred tax assets will be utilized. Consequently, a valuation allowance continues to offset Digimarc’s net deferred tax assets.

Liquidity and Capital Resources


	September 30, 2010		December 31, 2009
	(in thousands)
Working capital	$	43,473	$	43,503
Current (liquidity) ratio(1)		13.7:1		12.7:1
Cash, cash equivalents and short-term marketable securities	$	42,807	$	42,786
Long-term marketable securities	$	2,647		—
Total cash, cash equivalents and all marketable securities	$	45,454	$	42,786

(1)	The current (liquidity) ratio is calculated by dividing total current assets by total current liabilities.

The $2.7 million increase in cash, cash equivalents and all marketable securities at September 30, 2010 compared to December 31, 2009 resulted primarily from increased revenues, the majority associated with the revenue and related profit contribution from the Arbitron licensing arrangement and royalties from Civolution, offset by investments in our business for both capital and intellectual property initiatives and cash contributions to the joint ventures with The Nielsen Company.

Financial instruments that potentially subject us to concentrations of credit risk consist primarily of cash and cash equivalents, marketable securities, and trade accounts receivable. We place our cash and cash equivalents with major banks and financial institutions and at times deposits may exceed insured limits. Both short- and long-term marketable securities include federal agency notes, company notes, and commercial paper. Our investment policy requires the portfolio to be invested to ensure that the greater of $3 million or 7% of the invested funds will be available within 30days notice.

Other than cash used for operating needs, which may include short-term marketable securities, our investment policy limits our credit exposure to any one financial institution or type of financial instrument by limiting the maximum of 5% of our cash and cash equivalents and marketable securities or $1 million, whichever is greater, to be invested in any one issuer except for the U.S. government and U. S. federal agencies, which have no limits, at the time of purchase. Our investment policy also limits our credit exposure by limiting the maximum of 40% of our cash and cash equivalents and marketable securities, or $15 million, whichever is greater, to be invested in any one industry category, e.g., financial or energy industries. As a result, our credit risk associated with cash and investments is believed to be minimal.

A decline in the market value of any security below cost that is deemed to be other-than-temporary results in a reduction in carrying amount of fair value. To determine whether an impairment is other-than-temporary, we consider whether we have the ability and intent to hold the investment until a market price recovery and evidence indicating that the cost of the investment is recoverable outweighs evidence to the contrary. There have been no other-than-temporary impairments identified or recorded by us.

Operating Cash Flow. The components of operating cash flows were:


	Nine Months Ended September 30, 2010		Nine Months Ended September 30, 2009			Dollar Increase		Percent Increase
Net income (loss)	$	1,420	$	(2,174	)	$	3,594		165	%
Non-cash items		4,347		2,514			1,833		73	%
Changes in operating assets and liabilities		80		(466	)		546		117	%

Net cash provided by (used in) operating activities	$	5,847	$	(126	)	$	5,973		4740	%

Net income (loss).

The increase in operating results for the nine-month period ended September 30, 2010, compared to the corresponding nine-month period ended September 30, 2009, reflects higher revenues, primarily attributable to revenue received under the licensing arrangement with Arbitron and royalty revenues from Civolution, offset by increased stock compensation expense and professional fees related to our patent monetization initiative.

Non-cash items.

The increase in non-cash items for the nine-month period ended September 30, 2010, compared to the corresponding nine-month period ended September 30, 2009, was primarily the result of the net losses from the joint ventures and an additional layer of stock-based awards.

Operating assets and liabilities.

The primary changes in the operating assets and liabilities for the nine-month period ended September 30, 2010, compared to the corresponding nine-month period ended September 30, 2009, related to:

•

collection of advanced billings, as provided in our contracts with customers; offset by

•

a reduction in compensation related liabilities related to accrued bonuses at year-end that were paid compared with no bonus accrual at September 30, 2010, as a result of the elimination of the bonus program.

Cash flows from investing activities.

The primary changes in the investing activities for the nine-month period ended September 30, 2010, compared to the corresponding nine-month period ended September 30, 2009, related to:

•

decrease in investments made in property and equipment, primarily in our information technology area for computer systems and related equipment used to operate our business;

•

increase in investments made in the patent application and granting process;

•

increase in investments made in joint ventures; and

•

decrease in net activity from investing our cash and cash equivalents and short- and long-term marketable securities.

Cash flows from financing activities.

The primary changes in the financing activities for the nine-month period ended September 30, 2010, compared to the corresponding nine-month period ended September 30, 2009, related to the decrease in purchases of common stock as part of the restricted stock award agreements to satisfy tax withholding obligations, partially offset by the exercise of stock options.

Future Cash Expectations

We believe that our current cash, cash equivalents, and short-term investment balances will satisfy our projected working capital and capital expenditure requirements for at least the next 12 months. Thereafter, we anticipate continuing to use cash, cash equivalents and short-term investment balances to satisfy our projected working capital and capital expenditure requirements.

In connection with the IV arrangement, we anticipate our cash flow will improve with:

payment of the license issue fee in quarterly installments over three years,

consulting fees payable over five years, and

additional cost savings whereby IV has assumed the prosecution and maintenance costs related to the patents and patent applications that were granted to them which were previously borne by us.

As part of our stock repurchase program, of the $5.0 million that was authorized, there is $3.4 million available to purchase our common stock in the open market or private transactions through April 30, 2011.

We may also utilize cash resources to fund acquisitions or investments in complementary businesses, technologies or product lines. In order to take advantage of opportunities, we may find it necessary to obtain additional equity financing, debt financing, or credit facilities. We do not believe at this time, however, that our long-term working capital and capital expenditures would require us to take steps to remedy any such potential deficiencies. If it were necessary to obtain additional financings or credit facilities, we may not be able to do so, or if these funds are available, they may not be available on satisfactory terms.

Contractual Obligations

Pursuant to the terms of the joint venture agreements with Nielsen, we are obligated to contribute $6.7 million to the joint ventures payable in quarterly installments from October 2009 through October 2011, of which $3.5 million was outstanding as of September 30, 2010.

In May 2010 we entered into an amendment with the landlord of our corporate offices to extend the length of our facilities lease through August 2016 with rent payments totaling $5.3 million.

Our significant commitments consist of obligations under non-cancelable operating leases for our facilities, rent and various equipment leases, which totaled $5.0 million as of September 30, 2010 and are payable in monthly installments through August 2016. Other than as described above, as of September 30, 2010 there have been no material changes in the contractual obligations disclosed in our 2009 Annual Report.


	Payment Due by Period
	Total		Less than 1 year		1-3 years		3-5 years		More than 5 years
Total joint venture obligations	$	3,500	$	2,800	$	700	$	—	$	—
Total operating lease obligations		5,002		821		1,620		1,728		833

Total obligations	$	8,502	$	3,621	$	2,320	$	1,728	$	833

Off-Balance Sheet Arrangements

We do not have any off-balance sheet arrangements that have or are reasonably likely to have a current or future effect on our financial condition, changes in financial condition, revenue or expenses, results of operations, liquidity, capital expenditures or capital resources that are material to our business.

Recent Accounting Standards Update

See the disclosure related to Accounting Standards Update (“ASU”) set forth in Part 1, Item 1, under Note 2 Recent Accounting Standards Update” of this Quarterly Report on Form 10-Q.

Safe Harbor Statement under the Private Securities Litigation Reform Act of 1995

This Quarterly Report on Form 10-Q includes “forward-looking statements” within the meaning of Section 21E of the Securities Exchange Act of 1934 and Section 27A of the Securities Act of 1933. Words such as “may,” “plan,” “should,” “could,” “expect,” “anticipate,” “intend,” “believe,” “project,” “forecast,” “estimate,” “continue,” variations of such terms or similar expressions are intended to identify such forward- looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These forward-looking statements, or other statements made by us, are made based on our expectations and beliefs concerning future events impacting us, and are subject to uncertainties and factors (including those specified below), which are difficult to predict and, in many instances, are beyond our control. As a result, our actual results could differ materially from those expressed in or implied by any such forward-looking statements, and investors are cautioned not to place undue reliance on such statements. Forward- looking statements include but are not limited to statements relating to:

•

concentration of revenues with few customers comprising a large majority of the revenues;

•

trends and expectations in revenue growth;

•

our future level of investment in our business and the joint ventures in which we have invested, including investment in research, development and engineering of products and technology, development of our intellectual property, the acquisition of new customers and development of new market opportunities;

•

our ability to improve margins;

•

anticipated expenses, costs, margins and investment activities in the foreseeable future;

•

anticipated revenue to be generated from current contracts and as a result of new programs;

•

our profitability in future periods;

•

business opportunities that could require us to seek additional financing;

•

the size and growth of our markets;

•

the existence of international growth opportunities and our future investment in such opportunities;

•

the sources of our future revenue;

•

our expected short-term and long-term liquidity positions;

•

our ability to fund our working capital needs through cash flow from operations;

•

our use of cash in upcoming quarters;

•

capital market conditions, including the recent economic crisis, interest rate volatility and other limitations on the availability of capital, which could have an impact on our cost of capital and our ability to access the capital markets;

•

anticipated levels of backlog and bid activity in future periods;

•

the success of our arrangements with Intellectual Ventures;

•

protection of our intellectual property portfolio; and

•

other risks detailed in our filings with the Securities and Exchange Commission, including the risk factors set forth in Part I, Item1A (“Risk Factors”) of our 2009 Annual Report.

We believe that the risk factors contained in Part I, Item 1A of our 2009 Annual Report, among others, could affect our future performance and the liquidity and value of our securities and cause our actual results to differ materially from those expressed or implied by forward-looking statements made by us or on our behalf. Investors should understand that it is not possible to predict or identify all risk factors and that there may be other factors that may cause our actual results to differ materially from the forward-looking statements. All forward-looking statements made by us or by persons acting on our behalf apply only as of the date of this Quarterly Report on Form 10-Q. We do not undertake any obligation to publicly update or revise any forward-looking statements to reflect future events, information or circumstances that arise after the date of the filing of this Quarterly Report on Form 10-Q.

Item 3.

Quantitative and Qualitative Disclosures About Market Risk.

The market risk disclosures as set forth in Part 1, Item 7A of our 2009 Annual Report have not changed materially.

Item 4.

Controls and Procedures.

Evaluation of Disclosure Controls and Procedures

We conducted an evaluation (pursuant to Rule 13a-15(b) of the Securities Exchange Act of 1934 (the “Exchange Act”)), under the supervision and with the participation of management, including the Chief Executive Officer and Chief Financial Officer, of the effectiveness of the Company’s disclosure controls and procedures (as defined in Rule 13a-15(e) of the Exchange Act) as of the end of

the period covered by this Form 10-Q. These disclosure controls and procedures are designed to ensure that information required to be disclosed in our reports that are filed or submitted under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms. Our disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that this information is accumulated and communicated to management, including the principal executive and principal financial officers, or persons performing similar functions, as appropriate, to allow timely decisions regarding required disclosure. Based on the evaluation, the Chief Executive Officer and Chief Financial Officer have concluded that these disclosure controls and procedures were effective as of the end of the period covered by this Form 10-Q.

Changes in Controls

There was no change in our internal control over financial reporting (as defined in Rule 13a-15(f) and 15d-15(f) of the Exchange Act) that occurred during the fiscal quarter ended September 30, 2010 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

PART II. OTHER INFORMATION.

Item 1.

Legal Proceedings.

Item 1A.

Risk Factors.

Detailed information about risks that may affect our business, financial condition, results of operations, or cash flows are set forth in Part I, Item 1A thereof (“Risk Factors”) of our 2009 Annual Report.

The following additional risks relate to changes to our business subsequent to the filing of our 2009 Annual Report. The risks and uncertainties described below, and in our 2009 Annual Report, are those risks of which we are aware, that we consider to be material to our business. If any of the risks and uncertainties develops into actual events, our business, financial condition, results of operations, or cash flows could be materially adversely affected. In that case, the trading price of our common stock could decline. Our business, financial condition, results of operations and cash flows may be affected by a number of factors, including the factors set forth below and in our 2009 Annual Report.

(1) We may be adversely affected by variability of contracted arrangements.

We have frequently agreed to modify the terms of contractual arrangements with our customers, partners and licensees in response to changes in circumstances underlying the original contractual arrangements, and it is likely that we will do so in the future. As a result of this practice, the terms of our contractual arrangements with our customers, partners and licensees may vary over time and, depending on the particular modification, could have a material adverse effect on our financial position, results of operations or cash flows.

(2) We may not realize all the expected benefits of our patent licensing arrangement with Intellectual Ventures.

We recently entered into a patent licensing arrangement with Intellectual Ventures (“IV”), pursuant to which we granted an exclusive license to a substantial portion of our patent assets to IV in exchange for various strategic and financial benefits. We give you no assurance that we will realize all the expected benefits of our patent licensing arrangement with IV, including the expected full payment of the license issue fee, profit participation revenues, reduction of patent prosecution and maintenance costs, and full payment for the assistance we provide to IV with respect to the licensed patents. Any failure to realize these expected benefits could have a material adverse effect on our financial position, results of operations or cash flows.

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds.

The following table sets forth information regarding purchases of our equity securities during the three-month period ended September 30, 2010:


Period	(a) Total number of shares (or units) purchased			(b) Average price paid per share (or unit)			(c) Total number of shares (or units) purchased as part of publicly announced plans or programs		(d) Maximum number (or approximate dollar value) of shares (or units) that may yet be purchased under the plans or programs
Month 1
July 1, 2010 to July 31, 2010		—			—			—	$	3.4 million	⁽²⁾
Month 2
August 1, 2010 to August 31, 2010		822	⁽¹⁾	$	19.34	⁽¹⁾		—	$	3.4 million	⁽²⁾
Month 3
September 1, 2010 to September 30, 2010		—			—			—	$	3.4 million	⁽²⁾

Total		822	⁽¹⁾	$	19.34	⁽¹⁾		—

(1)	Fully vested restricted stock shares of common stock withheld (purchased) by us in satisfaction of required withholding tax liability.

(2)

In April 2009, the Board of Directors approved a stock repurchase program authorizing the purchase, at the discretion of management, of up to $5 million in shares of our common stock through either periodic open-market or private transactions at then-prevailing market prices through April 30, 2010. In April 2010, the Board of Directors approved an extension of the stock repurchase program through April 30, 2011. For the three- and nine-month periods ended September 30, 2010, we made no purchases under this program. We have paid $1.6 million to repurchase 111,667 shares of outstanding common stock under this program since the program’s inception, and $3.4 million remains available to repurchase common stock under the stock repurchase program.

Item 6.

Exhibits.


Exhibit Number		Exhibit Description
31.1		Rule 13a-14(a)/15d-14(a) Certification of Chief Executive Officer

31.2		Rule 13a-14(a)/15d-14(a) Certification of Chief Financial Officer

32.1		Section 1350 Certification of Chief Executive Officer

32.2		Section 1350 Certification of Chief Financial Officer

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.


Date: October 29, 2010	DIGIMARC CORPORATION

	By:	/s/ MICHAEL MCCONNELL
		Michael McConnell Chief Financial Officer and Treasurer (Duly Authorized Officer and Principal Financial Officer)