Digimarc CORP - Quarter Report: 2022 September (Form 10-Q)

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

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

For the quarterly period ended September 30, 2022

☐	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.)

8500 SW Creekside Place, Beaverton, Oregon 97008

(Address of principal executive offices) (Zip Code)

(503) 469-4800

(Registrant’s telephone number, including area code)

Securities registered pursuant to Section 12(b) of the Act:

Title of Each Class		Trading Symbol		Name of Each Exchange on Which Registered
Common Stock, $0.001 Par Value Per Share		DMRC		The NASDAQ Stock Market LLC

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 ☒ No ☐

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted 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 such files). Yes ☒ No ☐

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

Large accelerated filer	☐	Accelerated filer	☐

Non-accelerated filer	☒	Smaller reporting company	☒

Emerging growth company	☐

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐

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

As of October 31, 2022, there were 20,035,955 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 (Unaudited):	3
	Consolidated Balance Sheets as of September 30, 2022 and December 31, 2021	3
	Consolidated Statements of Operations and Comprehensive Loss for the three and nine months ended September 30, 2022 and 2021	4
	Consolidated Statements of Shareholders’ Equity for the three and nine months ended September 30, 2022 and 2021	5
	Consolidated Statements of Cash Flows for the nine months ended September 30, 2022 and 2021	6
	Notes to Consolidated Financial Statements	7
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	24
Item 4.	Controls and Procedures	40

PART II OTHER INFORMATION

Item 1.	Legal Proceedings	42
Item 1A.	Risk Factors	42
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	42
Item 6.	Exhibits	43
SIGNATURES		44

PART I. FINANCIAL INFORMATION

Item 1.

Financial Statements.

DIGIMARC CORPORATION

CONSOLIDATED BALANCE SHEETS

(In thousands, except per share data)

(UNAUDITED)

	September 30,			December 31,
	2022			2021
ASSETS
Current assets:
Cash and cash equivalents	$	40,355		$	13,789
Marketable securities		16,002			19,537
Trade accounts receivable, net		7,800			6,368
Loan receivable from related party		—			2,001
Other current assets		6,291			2,316
Total current assets		70,448			44,011
Marketable securities		—			8,292
Property and equipment, net		2,633			2,875
Intangibles, net		34,032			6,611
Goodwill		6,401			1,114
Lease right of use assets		5,209			1,300
Other assets		1,198			673
Total assets	$	119,921		$	64,876
LIABILITIES AND SHAREHOLDERS’ EQUITY
Current liabilities:
Accounts payable and other accrued liabilities	$	8,219		$	4,727
Deferred revenue		4,727			2,989
Total current liabilities		12,946			7,716
Long-term lease liabilities		6,051			1,028
Other long-term liabilities		96			752
Total liabilities		19,093			9,496
Commitments and contingencies (Note 15)
Shareholders’ equity:
Preferred stock (par value $0.001 per share, 2,500 authorized, 10 shares issued and outstanding at September 30, 2022 and December 31, 2021)		50			50
Common stock (par value $0.001 per share, 50,000 authorized, 20,037 and 16,940 shares issued and outstanding at September 30, 2022 and December 31, 2021, respectively)		20			17
Additional paid-in capital		361,055			261,324
Accumulated deficit		(253,361	)		(206,011	)
Accumulated other comprehensive income (loss)		(6,936	)		—
Total shareholders’ equity		100,828			55,380
Total liabilities and shareholders’ equity	$	119,921		$	64,876

The accompanying notes are an integral part of these consolidated financial statements.

DIGIMARC CORPORATION

CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE LOSS

(In thousands, except per share data)

(UNAUDITED)

	Three			Three			Nine			Nine
	Months			Months			Months			Months
	Ended			Ended			Ended			Ended
	September 30,			September 30,			September 30,			September 30,
	2022			2021			2022			2021
Revenue:
Service	$	3,735		$	3,932		$	11,858		$	11,507
Subscription		4,086			2,485			11,121			7,888
Total revenue		7,821			6,417			22,979			19,395
Cost of revenue:
Service ⁽¹⁾		1,602			1,630			5,177			4,715
Subscription ⁽¹⁾		1,006			567			2,934			1,892
Amortization expense on acquired intangible assets		1,048			—			3,362			—
Total cost of revenue		3,656			2,197			11,473			6,607
Gross profit		4,165			4,220			11,506			12,788
Operating expenses:
Sales and marketing		7,684			4,647			23,702			15,865
Research, development and engineering		7,575			4,586			19,731			12,930
General and administrative		4,132			2,943			15,027			15,611
Amortization expense on acquired intangible assets		301			—			964			—
Impairment of lease right of use assets and leasehold improvements		—			—			574			—
Total operating expenses		19,692			12,176			59,998			44,406
Operating loss		(15,527	)		(7,956	)		(48,492	)		(31,618	)

Other income:
Gain on extinguishment of note payable		—			5,094			—			5,094
Refundable tax credit		376			—			878			—
Other income (loss)		247			(2	)		336			26
Other income, net		623			5,092			1,214			5,120
Loss before income taxes		(14,904	)		(2,864	)		(47,278	)		(26,498	)
Provision for income taxes		(26	)		(7	)		(72	)		(17	)
Net loss	$	(14,930	)	$	(2,871	)	$	(47,350	)	$	(26,515	)

Loss per common share:
Loss per common share — basic	$	(0.76	)	$	(0.17	)	$	(2.51	)	$	(1.61	)
Loss per common share — diluted	$	(0.76	)	$	(0.17	)	$	(2.51	)	$	(1.61	)
Weighted average common shares outstanding — basic		19,721			16,520			18,877			16,428
Weighted average common shares outstanding — diluted		19,721			16,520			18,877			16,428

Comprehensive loss:
Unrealized gain (loss) on marketable securities, net of tax of $0	$	51		$	—		$	(199	)	$	—
Foreign currency translation adjustment, net of tax of $0		(3,118	)		—			(6,737	)		—
Other comprehensive loss	$	(3,067	)	$	—		$	(6,936	)	$	—
Net loss		(14,930	)		(2,871	)		(47,350	)		(26,515	)
Comprehensive loss	$	(17,997	)	$	(2,871	)	$	(54,286	)	$	(26,515	)
⁽¹⁾ Cost of revenue for Service and Subscription excludes amortization expense on acquired intangible assets.

The accompanying notes are an integral part of these consolidated financial statements.

DIGIMARC CORPORATION

CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY

(In thousands)

(UNAUDITED)

																Accumulated
										Additional						Other			Total
	Preferred Stock				Common Stock					Paid-in			Accumulated			Comprehensive			Shareholders'
	Shares		Amount		Shares			Amount		Capital			Deficit			Loss			Equity
Three months ended September 30, 2022:
BALANCE AT JUNE 30, 2022		10	$	50		19,959		$	20	$	357,509		$	(238,431	)	$	(3,869	)	$	115,279
Issuance of common stock		—		—		22			—		872			—			—			872
Issuance of restricted common stock		—		—		14			—		—			—			—			—
Vesting of restricted stock units		—		—		102			—		—			—			—			—
Forfeiture of restricted common stock		—		—		(5	)		—		—			—			—			—
Purchase of common stock		—		—		(55	)		—		(923	)		—			—			(923	)
Stock-based compensation		—		—		—			—		3,597			—			—			3,597
Unrealized gain (loss) on marketable securities		—		—		—			—		—			—			51			51
Foreign currency translation adjustments		—		—		—			—		—			—			(3,118	)		(3,118	)
Net loss		—		—		—			—		—			(14,930	)		—			(14,930	)
BALANCE AT SEPTEMBER 30, 2022		10	$	50		20,037		$	20	$	361,055		$	(253,361	)	$	(6,936	)	$	100,828

Three months ended September 30, 2021:
BALANCE AT JUNE 30, 2021		10	$	50		16,943		$	17	$	260,071		$	(194,896	)	$	—		$	65,242
Exercise of stock options		—		—		100			—		2,955			—			—			2,955
Issuance of restricted common stock		—		—		25			—		—			—			—			—
Forfeiture of restricted common stock		—		—		(16	)		—		—			—			—			—
Purchase of common stock		—		—		(119	)		—		(4,079	)		—			—			(4,079	)
Stock-based compensation		—		—		—			—		1,638			—			—			1,638
Net loss		—		—		—			—		—			(2,871	)		—			(2,871	)
BALANCE AT SEPTEMBER 30, 2021		10	$	50		16,933		$	17	$	260,585		$	(197,767	)	$	—		$	62,885

Nine months ended September 30, 2022:
BALANCE AT DECEMBER 31, 2021		10	$	50		16,940		$	17	$	261,324		$	(206,011	)	$	—		$	55,380
Issuance of common stock		—		—		3,044			3		90,608			—			—			90,611
Issuance of warrants for acquisition		—		—		—			—		1,601			—			—			1,601
Issuance of restricted common stock		—		—		54			—		—			—			—			—
Vesting of restricted stock units		—		—		119			—		—			—			—			—
Forfeiture of restricted common stock		—		—		(26	)		—		—			—			—			—
Purchase of common stock		—		—		(94	)		—		(1,897	)		—			—			(1,897	)
Stock-based compensation		—		—		—			—		9,419			—			—			9,419
Unrealized gain (loss) on marketable securities		—		—		—			—		—			—			(199	)		(199	)
Foreign currency translation adjustments		—		—		—			—		—			—			(6,737	)		(6,737	)
Net loss		—		—		—			—		—			(47,350	)		—			(47,350	)
BALANCE AT SEPTEMBER 30, 2022		10	$	50		20,037		$	20	$	361,055		$	(253,361	)	$	(6,936	)	$	100,828

Nine months ended September 30, 2021:
BALANCE AT DECEMBER 31, 2020		10	$	50		16,735		$	17	$	255,024		$	(171,252	)	$	—		$	83,839
Exercise of stock options		—		—		170			—		4,030			—			—			4,030
Issuance of restricted common stock		—		—		223			—		—			—			—			—
Vesting of restricted stock units		—		—		112			—		—			—			—			—
Forfeiture of restricted common stock		—		—		(51	)		—		—			—			—			—
Purchase of common stock		—		—		(256	)		—		(8,928	)		—			—			(8,928	)
Stock-based compensation		—		—		—			—		10,459			—			—			10,459
Net loss		—		—		—			—		—			(26,515	)		—			(26,515	)
BALANCE AT SEPTEMBER 30, 2021		10	$	50		16,933		$	17	$	260,585		$	(197,767	)	$	—		$	62,885

The accompanying notes are an integral part of these consolidated financial statements.

DIGIMARC CORPORATION

CONSOLIDATED STATEMENTS OF CASH FLOWS

(In thousands)

(UNAUDITED)

	Nine			Nine
	Months			Months
	Ended			Ended
	September 30,			September 30,
	2022			2021
Cash flows from operating activities:
Net loss	$	(47,350	)	$	(26,515	)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation and write-off of property and equipment		1,036			1,051
Amortization of acquired intangible assets		4,326			—
Amortization and write-off of other intangible assets		493			525
Amortization of lease right of use assets under operating leases		768			364
Amortization of net premiums (discounts) on marketable securities		—			605
Gain on extinguishment of note payable		—			(5,032	)
Stock-based compensation		9,310			10,348
Impairment of lease right of use assets and leasehold improvements		574			—
Changes in operating assets and liabilities:
Trade accounts receivable		(241	)		(427	)
Other current assets		(2,233	)		(353	)
Other assets		(611	)		(54	)
Accounts payable and other accrued liabilities		(2,153	)		1,630
Deferred revenue		233			(847	)
Lease liability and other long-term liabilities		(1,040	)		242
Net cash used in operating activities		(36,888	)		(18,463	)
Cash flows from investing activities:
Net cash paid for acquisition		(3,512	)		—
Purchase of property and equipment		(783	)		(797	)
Capitalized patent costs		(404	)		(475	)
Proceeds from maturities of marketable securities		17,498			72,141
Purchases of marketable securities		(5,873	)		(42,049	)
Net cash provided by investing activities		6,926			28,820
Cash flows from financing activities:
Issuance of common stock, net of issuance costs		58,220			—
Purchase of common stock		(1,560	)		(4,898	)
Loan repayment		(32	)		—
Net cash provided by (used in) financing activities		56,628			(4,898	)
Effect of exchange rate on cash		(100	)		—
Net increase in cash and cash equivalents		26,566			5,459
Cash and cash equivalents at beginning of period		13,789			19,696
Cash and cash equivalents at end of period	$	40,355		$	25,155
Supplemental disclosure of cash flow information:
Cash paid for income taxes, net	$	(90	)	$	(35	)
Supplemental schedule of non-cash activities:
Property and equipment and patent costs in accounts payable	$	(21	)	$	(115	)
Stock-based compensation capitalized to software and patent costs	$	109		$	111
Purchase of common stock in accounts payable	$	(337	)
Common stock issued for acquisition	$	32,393		$	—
Warrants issued for acquisition	$	1,601		$	—
Right of use assets obtained in exchange for lease obligations	$	5,176		$	—
Cashless exercise of stock options	$	—		$	4,030

The accompanying notes are an integral part of these consolidated financial statements.

DIGIMARC CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(In thousands, except per share data)

(UNAUDITED)

1. Description of Business and Significant Accounting Policies

Description of Business

Digimarc Corporation (“Digimarc” or the “Company”), an Oregon corporation, is a global leader in product digitization, delivering business value across industries through unique identities and cloud-based solutions. Digimarc’s technology highlights a product’s journey to provide complete visibility into all relevant product data, allowing companies to make intelligent business decisions.

The Digimarc Platform is a distinctive software as a service that combines Digimarc’s digital watermarks and/or Quick Response (“QR”) codes with product cloud technologies. By digitizing products using Digimarc’s unique digital watermarks and/or QR codes, products can connect with the web and interact with consumers and digital devices. Interactions are powered by the Company’s product cloud, where we provide data and instructions based on context and then capture a record of every interaction.

The Digimarc product suite is built on top of the Digimarc Platform to address specific business needs. All of the Company’s products are complementary to each other, providing exponential benefits when combined. By enabling customers to create digital identities for physical and digital media objects, Digimarc’s technologies provide many benefits, including:

•

Digimarc Validate protects product authenticity to ensure real products are in the right place. Digimarc technology delivers exclusive, covert digital watermarks and/or QR codes and a cloud-based record of product authentication information. In addition, consumer engagement capabilities provide a direct, digital communications channel with consumers.

•

Digimarc Engage unlocks an interactive communications channel connecting brands and consumers. Digimarc technology activates products and media through on-package QR codes, enabling consumers to scan for more information. Combined with cloud-based rules, brands can deliver contextually relevant content based on time, location, and more.

•

Digimarc Recycle increases the recyclability of products and packaging through unique digital watermarks. Digimarc technology activates products and packaging with unique digital watermarks to improve accuracy and performance in recycling facilities. In addition, consumer engagement capabilities deliver a direct, digital communications channel with consumers, and a cloud-based record of recycling information provides new insights.

Interim Consolidated Financial Statements

Our significant accounting policies are detailed in “Note 1: Description of Business and Summary of Significant Accounting Policies” of our Annual Report on Form 10-K for the year ended December 31, 2021, which was filed with the U.S. Securities and Exchange Commission (“SEC”) on March 4, 2022 (the “2021 Annual Report”). The Company has added “Business Combinations” below as a new significant accounting policy.

The accompanying interim consolidated 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 note disclosures normally included in financial statements prepared in accordance with Generally Accepted Accounting Principles in the United States (“GAAP”) have been condensed or omitted in accordance with the rules and regulations of the SEC.

These interim consolidated financial statements should be read in conjunction with the audited consolidated financial statements included in the 2021 Annual Report. The results of operations for the interim periods presented in these consolidated financial statements are not necessarily indicative of the results for the full year.

Principles of Consolidation

The consolidated financial statements include the accounts of Digimarc and its wholly-owned subsidiaries. All intercompany transactions and balances have been eliminated. Digimarc acquired EVRYTHNG Limited and its subsidiaries (“EVRYTHNG”) on January 3, 2022. The financial results of EVRYTHNG are consolidated with Digimarc’s financial results for the post-acquisition period. See Notes 6 and 9 for information related to the EVRYTHNG acquisition.

DIGIMARC CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(In thousands, except per share data)

(UNAUDITED)

Reclassifications

Certain prior period amounts in the accompanying consolidated 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.

Business Combinations

The Company allocates purchase price consideration to the tangible assets acquired, liabilities assumed and intangible assets acquired based on their estimated fair values. The purchase price is determined based on the fair value of the assets transferred, liabilities assumed and equity interests issued, after considering any transactions that are separate from the business combination. The fair value of equity issued as part of a business combination is determined based on the closing price of the Company’s stock on the date the acquisition closed. The excess of fair value of purchase price consideration over the fair values of the identifiable assets and liabilities is recorded as goodwill. Such fair value calculations require management to make significant estimates and assumptions, especially with respect to intangible assets and contingent liabilities. Significant estimates in valuing certain intangible assets include, but are not limited to, future expected cash flows from acquired customer bases, the cost to develop acquired technology, useful lives, and discount rates.

The estimates are inherently uncertain and subject to revision as additional information is obtained during the measurement period for an acquisition, which may last up to one year from the acquisition date. During the measurement period, the Company may record adjustments to the fair value of tangible and intangible assets acquired and liabilities assumed, with a corresponding offset to goodwill. After the conclusion of the measurement period or the final determination of the fair value of assets acquired or liabilities assumed, whichever comes first, any subsequent adjustments are recorded to earnings.

Foreign Currency Translation

The Company translates the accounts of our non-U.S. subsidiaries into U.S. dollars as follows: revenues, expenses, gains and losses are translated at average exchange rates during the period; and assets and liabilities are translated at the exchange rate on the balance sheet date. Translation gains and losses are reported in our Consolidated Balance Sheets as a component of “accumulated other comprehensive income (loss).”

Accounting Pronouncements Adopted

In October 2021, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2021-08, “Business Combination (Topic 805): Accounting for Contract Assets and Liabilities from Contracts with Customers,” which improves the accounting for acquired revenue contracts with customers in a business combination. The amendments in this update primarily address the accounting for contract assets and liabilities from revenue contracts with customers in a business combination, and improves comparability for both the recognition and measurement of acquired revenue contracts with customers at the date of and after a business combination. The amendments in this update are effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2022. Early adoption is permitted. The Company adopted this standard on January 1, 2022. The impact of adopting this standard was not material to the Company’s consolidated financial statements.

Accounting Pronouncements Issued But Not Yet Adopted

In June 2016, the FASB issued ASU No. 2016-13, “Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments,” which amends the guidance on the impairment of financial instruments. The amendments in this update remove the thresholds that entities apply to measure credit losses on financial instruments measured at amortized cost, such as loans, trade receivables, reinsurance recoverables, off-balance-sheet credit exposures, and held-to-maturity securities. Under current GAAP, entities generally recognize credit losses when it is probable that the loss has been incurred. The guidance removes all current recognition thresholds and introduces the new current expected credit loss (“CECL”) model which will require entities to recognize an allowance for credit losses for the difference between the amortized cost basis of a financial instrument and the amount of amortized cost that an entity expects to collect over the instrument’s contractual life. The new CECL model is based upon expected losses rather than incurred losses. The amendments in this update are effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2022. Early adoption is permitted. The Company does not expect the impact of the adoption of this standard to have a material impact on its consolidated financial statements.

DIGIMARC CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(In thousands, except per share data)

(UNAUDITED)

2. Fair Value of Financial Instruments

The estimated fair values of the Company’s financial instruments, which include cash equivalents, accounts receivable, accounts payable and other accrued liabilities, approximate their carrying values due to the short-term nature of these instruments. The Company’s marketable securities are now classified as available-for-sale, as the Company recently sold a marketable security, which was previously classified as held-to-maturity. The Company has reassessed classification of the remaining marketable securities and therefore adjusted them to be reported at fair value. Unrealized holding gains and losses are excluded from earnings and are reported net of tax in “accumulated other comprehensive income (loss)” in the Consolidated Balance Sheets until realized. Realized gains and losses are included in “other income (loss), net” in the Consolidated Statements of Operations and are derived using the specific identification method for determining the cost of marketable securities sold.

As of December 31, 2021, the Company’s marketable securities were classified as held-to-maturity and reported at amortized cost, which approximated fair value.

The Company’s fair value hierarchy for its cash equivalents and marketable securities was as follows:

September 30, 2022	Level 1		Level 2		Level 3		Total
Money market securities	$	4,975	$	—	$	—	$	4,975
Commercial paper		—		25,119		—		25,119
Federal agency notes		—		20,680		—		20,680
Corporate notes		—		4,389		—		4,389
Pre-refunded municipals		—		—		—		—
Total	$	4,975	$	50,188	$	—	$	55,163

December 31, 2021	Level 1		Level 2		Level 3		Total
Money market securities	$	2,478	$	—	$	—	$	2,478
Commercial paper		—		13,382		—		13,382
Corporate notes		—		9,585		—		9,585
Federal agency notes		—		3,799		—		3,799
Pre-refunded municipals		—		1,063		—		1,063
Total	$	2,478	$	27,829	$	—	$	30,307

The fair value maturities of the Company’s cash equivalents and marketable securities as of September 30, 2022, were as follows:

Maturities by Period

Total

Less than

1 year

1-5

years

5 - 10

years

More than

10 years

Cash equivalents and marketable securities

55,163

—

The Company considers all highly liquid marketable securities with original maturities of 90 days or less at the date of acquisition to be cash equivalents. Cash equivalents include money market securities, commercial paper and federal agency notes totaling $39,161 and $2,478 at September 30, 2022, and December 31, 2021, respectively. Cash equivalents are carried at either cost or fair value, depending on the type of security.

3. Revenue Recognition

The Company derives its revenue primarily from software development services and software subscriptions. Applicable revenue recognition criteria are considered separately for each performance obligation as follows:

•

Service revenue consists primarily of revenue earned from the performance of software development and, to a lesser extent, professional services. The majority of services contracts are structured as time and materials agreements. Revenue

DIGIMARC CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(In thousands, except per share data)

(UNAUDITED)

for services is generally recognized as the services are performed. Billing for services rendered generally occurs within one month after the services are provided.

•

Subscription revenue consists primarily of revenue earned from software subscriptions to the Company’s software platform and products and, to a lesser extent, the licensing and sale of the Company’s intellectual property. The majority of subscription contracts are recurring, paid in advance, and recognized over the term of the subscription, which is typically one to three years.

Customer arrangements may contain multiple performance obligations such as software development services, software platform and products, and maintenance and support fees. The Company accounts for individual products and services separately if they are both capable of being distinct and distinct within the context of the contract. In arrangements where the software platform and products require significant configuration and integration, the software development services may not be distinct within the context of the contract from the software platform and products. In those situations, the Company accounts for the software development services and software platform and products as a single performance obligation within subscription revenue.

To determine transaction price, the Company considers the terms of the contract and the Company’s customary business practices. Some contracts may contain variable consideration. In those cases, the Company estimates the amount of variable consideration based on the sum of probability-weighted amounts in a range of possible consideration amounts. As part of this assessment, the Company will evaluate whether any of the variable consideration is constrained and if it is the Company will not include it in the transaction price.

The transaction price is allocated between distinct products and services based on their stand-alone selling prices. For items that are not sold separately, the Company estimates the standalone selling price based on reasonably available information, including market conditions, specific factors affecting the Company, and information about the customer.

For distinct products and services, the Company typically recognizes the revenue associated with these performance obligations as they are delivered to the customer. Products and services that are not capable of being distinct are combined with other products or services until a distinct performance obligation is identified.

All revenue recognized in the Consolidated Statements of Operations is considered to be revenue from contracts with customers.

The following table provides information about disaggregated revenue by major target market in the Company’s single reporting segment:

	Three		Three		Nine		Nine
	Months		Months		Months		Months
	Ended		Ended		Ended		Ended
	September 30,		September 30,		September 30,		September 30,
	2022		2021		2022		2021
Government
Service	$	3,346	$	3,279	$	10,007	$	10,386
Subscription		300		300		1,088		900
Total Government		3,646		3,579		11,095		11,286
Commercial
Service	$	389	$	653	$	1,851	$	1,121
Subscription		3,786		2,185		10,033		6,988
Total Commercial		4,175		2,838		11,884		8,109
Total	$	7,821	$	6,417	$	22,979	$	19,395

The Company has contract assets from contracts with customers that are classified as “trade accounts receivable” in the Consolidated Balance Sheets. Financial information about trade accounts receivable is included in Note 8.

The Company has contract liabilities from contracts with customers that are classified as “deferred revenue” in the Consolidated Balance Sheets. Deferred revenue consists of billings in advance for services and subscriptions for which the performance obligation has not been satisfied.

DIGIMARC CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(In thousands, except per share data)

(UNAUDITED)

The following table provides information about contract liabilities from contracts with customers:

	September 30,		December 31,
	2022		2021
Deferred revenue, current	$	4,727	$	2,989
Deferred revenue, long-term		29		33
Total	$	4,756	$	3,022

The Company recognized $2,507 of revenue during the nine months ended September 30, 2022, that was included in the contract liability balance as of December 31, 2021.

The aggregate amount of the transaction prices from contractual obligations that are unsatisfied or partially unsatisfied was $20,770 and $16,870 as of September 30, 2022, and December 31, 2021, respectively.

4. Segment Information

Geographic Information

The Company derives its revenue from a single reporting segment: automatic identification solutions. Revenue is generated in this segment primarily through software development services and software subscriptions. The Company markets its products in the U.S. and in non-U.S. countries through its sales personnel and partners.

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

	Three		Three		Nine		Nine
	Months		Months		Months		Months
	Ended		Ended		Ended		Ended
	September 30,		September 30,		September 30,		September 30,
	2022		2021		2022		2021
Domestic	$	2,889	$	1,678	$	7,259	$	5,040
International (1)		4,932		4,739		15,720		14,355
Total	$	7,821	$	6,417	$	22,979	$	19,395

(1)	Revenue from the Central Banks, consisting of a consortium of central banks around the world, is classified as international revenue. Reporting revenue by country for this customer is not practicable.

Major Customers

The following customers accounted for 10% or more of revenue:

	Three			Three			Nine			Nine
	Months			Months			Months			Months
	Ended			Ended			Ended			Ended
	September 30,			September 30,			September 30,			September 30,
	2022			2021			2022			2021
Customer A		46	%		55	%		47	%		58	%
Customer B		23	%		13	%		15	%		12	%

Long-Lived Tangible Assets by Geographical Area

Long-lived tangible assets by geographic area were as follows:

	September 30,		December 31,
	2022		2021
United States	$	2,563	$	2,875
Europe		70		—
Total	$	2,633	$	2,875

DIGIMARC CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(In thousands, except per share data)

(UNAUDITED)

5. Stock-Based Compensation

Stock-based compensation includes expense charges for all stock-based awards to employees and directors. These awards include stock options, restricted stock, restricted stock units and performance stock units.

Stock-based compensation expense related to internal labor is capitalized to software and patent costs based on direct labor hours charged to capitalized software and patent costs.

Determining Fair Value

Stock Options

The Company estimates the fair value of stock options on the date of grant (measurement date) using the Black-Scholes option pricing model. The Company recognizes the fair value of stock option awards on a straight-line basis over the service period of the award.

There were 1 stock options granted during the nine months ended September 30, 2022, as replacement equity awards for vested stock options held by EVRYTHNG employees. No stock options were granted during the nine months ended September 30, 2021.

Restricted Stock

The fair value of restricted stock awards that vest upon meeting a service condition is based on the fair market value of the Company’s common stock on the date of the grant (measurement date) and is recognized on a straight-line basis over the service period of the award, which is generally three to four years for employee grants and one to three years for director grants.

Restricted Stock Units

The fair value of restricted stock unit (“RSU”) awards that vest upon meeting a service condition is based on the fair market value of the Company’s common stock on the date of the grant (measurement date) and is recognized on a straight-line basis over the service period of the award, which is generally three to four years for employee grants.

Performance Stock Units

The fair value of performance stock unit (“PSU”) awards that vest upon meeting a performance condition, such as the Company exceeding a future annual recurring revenue target, and a service condition is determined based on the probability of achievement of the performance criteria as of each reporting date (measurement date). The probability of achievement is subject to judgment, and could change from period to period, impacting the fair value of the award. The Company recognizes the fair value of the award on a straight-line basis over the service period of the award, which is generally three years for employee grants.

The fair value of PSU awards that vest upon meeting a market condition, such as the Company exceeding shareholder returns as compared to an index of peer companies, and a service condition is determined on the date of grant (measurement date) using the Monte Carlo valuation model. The Company recognizes the fair value of the award on a straight-line basis over the service period of the award, which is generally three years for employee grants.

The following inputs are used in the Monte Carlo valuation model to estimate the fair value:

Stock Price. The stock price represents the fair market value of the Company’s common stock on the date of the grant.

Expected Volatility. The Company estimates the volatility of its common stock at the date of grant based on the historical volatility of its common stock based on historical prices over the most recent period commensurate with the term of the award.

Risk-Free Interest Rate. The Company determines the risk-free interest rate using current U.S. treasury yields for bonds with a maturity commensurate with the term of the award.

DIGIMARC CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(In thousands, except per share data)

(UNAUDITED)

Monte Carlo valuation inputs:

	Three		Three		Nine			Nine
	Months		Months		Months			Months
	Ended		Ended		Ended			Ended
	September 30,		September 30,		September 30,			September 30,
	2022		2021		2022			2021
Stock price	$	—	$	—	$	32.02		$	—
Expected volatility		—		—		82.8	%		—
Risk-free interest rate		—		—		1.8	%		—

Stock-Based Compensation

	Three		Three		Nine		Nine
	Months		Months		Months		Months
	Ended		Ended		Ended		Ended
	September 30,		September 30,		September 30,		September 30,
	2022		2021		2022		2021
Stock-based compensation:
Cost of revenue	$	270	$	164	$	736	$	515
Sales and marketing		1,461		369		3,354		2,359
Research, development and engineering		916		401		2,066		1,202
General and administrative		921		667		3,154		6,272
Stock-based compensation expense		3,568		1,601		9,310		10,348
Capitalized to software and patent costs		29		37		109		111
Total stock-based compensation	$	3,597	$	1,638	$	9,419	$	10,459

The following table sets forth total unrecognized compensation costs related to non-vested stock-based awards granted under the Company’s equity compensation plan:

	As of		As of
	September 30,		December 31,
	2022		2021
Total unrecognized compensation costs	$	18,925	$	11,301

Total unrecognized compensation costs will be adjusted for any future forfeitures if and when they occur.

The Company expects to recognize the total unrecognized compensation costs as of September 30, 2022, for all non-vested stock-based awards over weighted average periods through September 30, 2026, as follows:

	Restricted
	Stock	RSUs	PSUs
Weighted average period	1.16 years	1.89 years	1.88 years

As of September 30, 2022, under the Company’s stock-based compensation plan, an additional 568 shares remained available for future grants. The Company issues new shares upon exercises of stock options, grants of restricted stock awards and vesting of RSU and PSU awards.

DIGIMARC CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(In thousands, except per share data)

(UNAUDITED)

Stock Option Activity

The following tables present the outstanding stock option activity:

			Weighted		Weighted
			Average		Average		Aggregate
	Number of		Exercise		Grant Date		Intrinsic
Three months ended September 30, 2022:	Options		Price		Fair Value		Value
Outstanding at June 30, 2022		51	$	39.14	$	21.72
Granted		—	$	—	$	—
Exercised		—	$	—	$	—
Forfeited or expired		—	$	—	$	—
Outstanding at September 30, 2022		51	$	39.14	$	21.72	$	—

			Weighted		Weighted
			Average		Average		Aggregate
	Number of		Exercise		Grant Date		Intrinsic
Nine months ended September 30, 2022:	Options		Price		Fair Value		Value
Outstanding at December 31, 2021		50	$	39.54	$	22.23
Granted		1	$	22.15	$	—
Exercised		—	$	—	$	—
Forfeited or expired		—	$	—	$	—
Outstanding at September 30, 2022		51	$	39.14	$	21.72	$	—
Exercisable at September 30, 2022		51	$	39.14			$	—

The aggregate intrinsic value is based on the closing price of $13.55 per share of Digimarc common stock on September 30, 2022, which would have been received by the optionees had all of the options with exercise prices less than $13.55 per share been exercised on that date.

Restricted Stock Activity

The following tables present the unvested restricted stock activity:

				Weighted
				Average
	Number of			Grant Date
Three months ended September 30, 2022:	Shares			Fair Value
Unvested balance, June 30, 2022		273		$	33.65
Granted		14		$	14.19
Vested		(49	)	$	34.81
Forfeited		(5	)	$	33.71
Unvested balance, September 30, 2022		233		$	32.22

				Weighted
				Average
	Number of			Grant Date
Nine months ended September 30, 2022:	Shares			Fair Value
Unvested balance, December 31, 2021		360		$	34.90
Granted		54		$	18.36
Vested		(155	)	$	32.80
Forfeited		(26	)	$	36.88
Unvested balance, September 30, 2022		233		$	32.22

DIGIMARC CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(In thousands, except per share data)

(UNAUDITED)

The fair value of restricted stock awards vested is as follows:

	Three		Three		Nine		Nine
	Months		Months		Months		Months
	Ended		Ended		Ended		Ended
	September 30,		September 30,		September 30,		September 30,
	2022		2021		2022		2021
Fair value of restricted stock awards vested	$	949	$	2,188	$	3,727	$	6,648

Restricted Stock Units Activity

The following tables present the unvested RSU activity:

				Weighted
				Average
	Number of			Grant Date
Three months ended September 30, 2022:	Shares			Fair Value
Unvested balance, June 30, 2022		437		$	27.25
Granted		65		$	19.82
Vested		(102	)	$	30.81
Forfeited		(41	)	$	26.99
Unvested balance, September 30, 2022		359		$	24.91

				Weighted
				Average
	Number of			Grant Date
Nine months ended September 30, 2022:	Shares			Fair Value
Unvested balance, December 31, 2021		—		$	—
Granted		537		$	26.57
Vested		(119	)	$	31.16
Forfeited		(59	)	$	27.42
Unvested balance, September 30, 2022		359		$	24.91

The fair value of RSU awards vested is as follows:

	Three		Three		Nine		Nine
	Months		Months		Months		Months
	Ended		Ended		Ended		Ended
	September 30,		September 30,		September 30,		September 30,
	2022		2021		2022		2021
Fair value of RSU awards vested	$	1,570	$	—	$	1,903	$	1,050

Performance Stock Units Activity

The following tables present the unvested PSU activity:

DIGIMARC CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(In thousands, except per share data)

(UNAUDITED)

				Weighted
				Average
	Number of			Grant Date
Three months ended September 30, 2022:	Shares			Fair Value
Unvested balance, June 30, 2022		144		$	32.02
Granted		1		$	18.31
Vested		—		$	—
Forfeited		(5	)	$	32.02
Unvested balance, September 30, 2022		140		$	31.93

				Weighted
				Average
	Number of			Grant Date
Nine months ended September 30, 2022:	Shares			Fair Value
Unvested balance, December 31, 2021		—		$	—
Granted		145		$	31.93
Vested		—		$	—
Forfeited		(5	)	$	32.02
Unvested balance, September 30, 2022		140		$	31.93

The fair value of PSU awards vested is as follows:

	Three		Three		Nine		Nine
	Months		Months		Months		Months
	Ended		Ended		Ended		Ended
	September 30,		September 30,		September 30,		September 30,
	2022		2021		2022		2021
Fair value of PSU awards vested	$	—	$	—	$	—	$	2,886

6. Shareholders’ Equity

EVRYTHNG Acquisition

On January 3, 2022, the Company closed on its acquisition of EVRYTHNG pursuant to the Share Purchase Agreement (“Purchase Agreement”) entered into on November 15, 2021. Upon closing, EVRYTHNG became a wholly owned subsidiary of Digimarc.

The Company acquired all outstanding shares of EVRYTHNG’s share capital in exchange for aggregate initial consideration consisting of 772 shares of common stock of the Company and warrants to purchase 231 shares of common stock of the Company. A portion of the consideration was held back by the Company to secure any post-closing adjustments to the initial consideration and the indemnification obligations of the EVRYTHNG sellers. The Company also paid $3,986 of closing costs on behalf of the EVRYTHNG sellers.

The warrants had a per share exercise price of $36.56 and could only be exercised by payment of the exercise price in cash. All of the warrants expired unexercised.

The Company granted replacement equity awards to the holders of vested and unvested EVRYTHNG stock options, pursuant to the terms of the Purchase Agreement. The replacement equity awards had substantially equivalent economic value and vesting terms as the cancelled vested and unvested EVRYTHNG stock options.

In August 2022, the Company issued an additional 22 shares of common stock of the Company to EVRYTHNG sellers as a post-closing adjustment to the initial consideration, consisting primarily of shares that were previously held back for such adjustments. Any shares held back in connection with the indemnification obligations of the EVRYTHNG sellers will not be issued, if at all, until 2023.

DIGIMARC CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(In thousands, except per share data)

(UNAUDITED)

The Purchase Agreement provided for additional shares of the Company’s common stock, subject to certain conditions, to be issued in September 2022. The number of additional common shares, before any downward adjustments, was equivalent to $50,000 of the Company’s common stock. The number of additional common shares would be adjusted downward if EVRYTHNG failed to meet its Product Annual Recurring Revenue target of $10,000 by February 28, 2022, and/or if the Company’s average stock price during the applicable measurement period was higher than its stock price as of the closing of the EVRYTHNG acquisition. No additional shares of the Company’s common stock were issued in September 2022, as the conditions for the additional shares were not met.

Registered Direct Offering

On April 5, 2022, the Company entered into purchase agreements with certain investors providing for the issuance and sale by the Company of 2,250 common shares in a registered direct offering. The common shares were offered at a price of $25.90 per share, and the gross cash proceeds to the Company were $58,275. The Company incurred $55 of legal costs related to the offering. The closing of the registered direct offering occurred on April 7, 2022.

7. Loss Per Common Share

The Company calculates basic and diluted earnings per common share in accordance with ASC 260, “Earnings Per Share,” using the two-class method because the Company’s unvested restricted stock is a participating security since these awards contain non-forfeitable rights to receive dividends. Under the two-class method, earnings are allocated to each class of common stock and participating security as if all of the earnings for the period had been distributed.

Basic earnings per common share excludes dilution and is calculated by dividing earnings to common shares by the weighted-average number of common shares outstanding for the period. Diluted earnings per common share is calculated by dividing earnings to common shares by the weighted-average number of common shares, as adjusted for the potentially dilutive effect of stock options, RSUs and PSUs. The dilutive effect of stock options, RSUs and PSUs is determined using the treasury stock method.

The following table reconciles loss per common share:

	Three			Three			Nine			Nine
	Months			Months			Months			Months
	Ended			Ended			Ended			Ended
	September 30,			September 30,			September 30,			September 30,
	2022			2021			2022			2021
Basic Loss per Common Share:
Net loss attributable to common shares — basic	$	(14,930	)	$	(2,871	)	$	(47,350	)	$	(26,515	)
Weighted average common shares outstanding — basic		19,721			16,520			18,877			16,428
Basic loss per common share	$	(0.76	)	$	(0.17	)	$	(2.51	)	$	(1.61	)

Diluted Loss per Common Share:
Net loss attributable to common shares — diluted	$	(14,930	)	$	(2,871	)	$	(47,350	)	$	(26,515	)
Weighted average common shares outstanding — diluted		19,721			16,520			18,877			16,428
Diluted loss per common share	$	(0.76	)	$	(0.17	)	$	(2.51	)	$	(1.61	)

The following table indicates the common stock equivalents related to stock options, RSUs and PSUs that were anti-dilutive and excluded from diluted earnings per common share calculations:

Three

Nine

Months

Ended

September 30,

2022

2021

2022

2021

Anti-dilutive shares due to:

Exercise prices higher than the average market price

100

Net loss

—

DIGIMARC CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(In thousands, except per share data)

(UNAUDITED)

8. Trade Accounts Receivable

Trade Accounts Receivable

Trade accounts receivable are recorded at the contractual or invoiced amount.

	September 30,			December 31,
	2022			2021
Trade accounts receivable, current	$	7,837		$	6,393
Trade accounts receivable, long-term		49			186
Allowance for doubtful accounts		(37	)		(25	)
Trade accounts receivable, net	$	7,849		$	6,554
Unpaid deferred revenue included in trade accounts receivable	$	2,118		$	1,891

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 trade accounts receivable. The Company determines the allowance based on historical write-off experience and current information. The Company reviews its allowance for doubtful accounts each reporting period. Account balances are charged against the allowance after all means of collection have been exhausted and the potential for recovery is considered remote.

Unpaid Deferred Revenue

The unpaid deferred revenue that is included in trade accounts receivable is billed in accordance with the provisions of the contracts with the Company’s customers.

Major Customers

The following customers accounted for 10% or more of trade accounts receivable, net:

	September 30,			December 31,
	2022			2021
Company A		34	%	*
Company B		29	%		43	%
Company C	*				15	%
Company D	*				11	%

*Less than 10%

DIGIMARC CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(In thousands, except per share data)

(UNAUDITED)

9. Business Combination

On January 3, 2022, the Company completed its acquisition of EVRYTHNG, a London-based product cloud company. The aggregate preliminary purchase price for the acquisition was $36,634, which included the fair value of the 772 shares issued of common stock of the Company of $31,519 and the warrants issued to purchase 231 shares of common stock of the Company of $1,601 (see Note 6 for more information). The fair value of the warrants was determined using the Black-Scholes option pricing model using the Company’s stock price on the date of issuance of $40.84, the strike price on the warrants of $36.56 and expected volatility of 60%. The aggregate preliminary purchase price also included $3,986 of cash paid by the Company to pay closing costs on behalf of the EVRYTHNG sellers, less cash acquired of $474. A portion of the consideration was held back by the Company to secure any post-closing adjustments to the initial consideration and the indemnification obligations of the EVRYTHNG sellers.

In August 2022, the Company issued 22 additional shares of common stock of the Company at the fair value of $872 which increased the purchase price to $37,506. The Company may issue the remaining consideration in 2023, for up to $500 in shares of common stock of the Company, which was held back in connection with indemnification obligations.

On December 10, 2021, the Company entered into a Loan Agreement with EVRYTHNG (the “Loan Agreement”) pursuant to the Purchase Agreement. The Loan Agreement provided a loan facility of $2,000 to EVRYTHNG at an interest rate of 1% per annum. The loan matures on December 9, 2022. The loan balance of $2,001 on January 3, 2022, was included in “loan payable to related party” below in the preliminary purchase price allocation, as the liability was assumed by the combined company. The loan payable balance is eliminated in consolidation in the Consolidated Balance Sheet as of September 30, 2022.

The following table presents the preliminary purchase price allocation:

	Preliminary
	Purchase Price
	Allocation
	January 3, 2022
Trade accounts receivable, net	$	717
Other current assets		2,188
Property and equipment, net		99
Lease right of use assets and other long-term assets		484
Intangibles		37,740
Goodwill		6,380
Accounts payable and other accrued liabilities		(6,092	)
Deferred revenue		(1,804	)
Loan payable to related party		(2,001	)
Lease liability and other long-term liabilities		(205	)
Total preliminary purchase price	$	37,506

The Company preliminarily allocated $37,740 of the purchase price to intangible assets, which was comprised of $23,990 allocated to developed technology and $13,750 allocated to customer relationships. Preliminary goodwill recognized of $6,380 from the acquisition was primarily attributed to an assembled workforce and expected synergies. The preliminary allocation above is subject to future adjustments during the measurement period. Open areas in the preliminary allocation include finalizing the opening balance sheet, the fair value of acquired intangible assets, recognition of income tax assets and liabilities and the issuance of any remaining consideration. The Company incurred transaction costs related to the acquisition of $1,140 during 2021 and $447 in 2022, respectively.

The following unaudited pro forma consolidated results of operations

DIGIMARC CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(In thousands, except per share data)

(UNAUDITED)

include the financial results of Digimarc and EVRYTHNG assuming the acquisition was completed on January 1, 2021, the beginning of the earliest period presented. Pro forma adjustments are primarily comprised of preliminary estimates of amortization expense on acquired intangible assets, transaction expenses and the elimination of EVRYTHNG’s historical interest expense on long-term debt that was settled at closing. The pro forma results of operations are presented for informational purposes only and are not indicative of the results of operations that would have been achieved or of results that may occur in the future.

	Three			Three			Nine			Nine
	Months			Months			Months			Months
	Ended			Ended			Ended			Ended
	September 30,			September 30,			September 30,			September 30,
	2022			2021			2022			2021
Revenue	$	7,821		$	7,957		$	22,979		$	23,464
Net loss	$	(14,930	)	$	(6,781	)	$	(46,903	)	$	(43,228	)
Loss per common share:
Basic	$	(0.76	)	$	(0.39	)	$	(2.54	)	$	(2.51	)
Diluted	$	(0.76	)	$	(0.39	)	$	(2.54	)	$	(2.51	)

10. Property and Equipment

Property and equipment are stated at cost. Repairs and maintenance are charged to expense when incurred.

Depreciation on property and equipment is calculated using the straight-line method over the estimated useful lives of the assets, generally two to ten years. Leasehold improvements are amortized using the straight-line method over the shorter of the estimated useful life or the lease term.

	September 30,			December 31,
	2022			2021
Office furniture and fixtures	$	1,613		$	1,648
Software		5,803			5,674
Equipment		5,532			5,250
Leasehold improvements		1,861			1,658
Gross property and equipment		14,809			14,230
Less accumulated depreciation and amortization		(12,176	)		(11,355	)
Property and equipment, net	$	2,633		$	2,875

11. Goodwill

The Company performs the annual goodwill impairment test during the second quarter of each fiscal year or whenever events or changes in circumstances indicate that the carrying value may exceed the fair value. If the carrying value exceeds the estimated fair value, an impairment is recorded. The Company operates as a single reporting unit. The Company estimates the fair value of its single reporting unit using a market approach, which takes into account the Company’s market capitalization plus an estimated control premium.

Balance at December 31, 2021	$	1,114
Goodwill acquired on January 3, 2022		5,439
Measurement period adjustments ⁽¹⁾		941
Currency translation adjustments		(1,093	)
Balance at September 30, 2022	$	6,401

(1) Measurement period adjustments include adjustments to income tax receivables and accounts payables as well as the release of holdback shares.

12. Intangibles

Intangible assets are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. No impairment charges were recorded for the nine months ended September 30, 2022 and 2021.

Patent 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 the award date, which varies depending on the pendency period of the application, generally approximating seventeen years.

DIGIMARC CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(In thousands, except per share data)

(UNAUDITED)

Amortization of intangible assets acquired is calculated using the straight-line method over the estimated useful lives of the assets.

	Estimated Life	September 30,			December 31,
	(years)	2022			2021
Capitalized patent costs	17-20	$	10,599		$	10,219

Intangible assets acquired:
Purchased intellectual property	10		250			250
Developed technology	5		21,440			1,560
Customer relationships	10		11,685			290
Gross intangible assets			43,974			12,319
Accumulated amortization			(9,942	)		(5,708	)
Intangibles, net		$	34,032		$	6,611

The amortization of capitalized patent costs, purchased intellectual property, and developed technology is recorded in “cost of revenue” and the amortization of customer relationships is recorded in “sales and marketing” in the Consolidated Statements of Operations.

Amortization expense on intangible assets was as follows:

	Three		Three		Nine		Nine
	Months		Months		Months		Months
	Ended		Ended		Ended		Ended
	September 30,		September 30,		September 30,		September 30,
	2022		2021		2022		2021
Amortization expense	$	1,496	$	146	$	4,756	$	431

For intangible assets recorded at September 30, 2022, the estimated future aggregate amortization expense for the years ending December 31, 2022 through December 31, 2026 is as follows:

	Amortization
As of September 30, 2022:	Expense
Remaining in 2022	$	1,420
2023		5,679
2024		5,666
2025		5,647
2026		5,615

13. Leases

The Company leases office space in Beaverton, Oregon. The term of the lease runs through March 2024, with remaining rent payments as of September 30, 2022, totaling $1,282 plus operating expenses, payable in monthly installments. The Company stopped using this office space as its corporate headquarters in March 2022 and is marketing the office space for sublease.

The Company entered into a sublease agreement and lease extension agreement for another facility in Beaverton, Oregon in February 2022 to move the Company’s corporate headquarters. The term of the sublease and lease extension runs through September 2030, with remaining rent payments as of September 30, 2022, totaling $8,756 plus operating expenses, payable in monthly installments. The first 26 months of rent payments and operating expenses are abated to cover the remaining lease term on the Company’s prior corporate headquarters.

The Company leases office space in London, England under an existing lease entered into by EVRYTHNG in July 2019. The term of the lease runs through July 2023, with remaining rent payments as of September 30, 2022, totaling $186 plus operating expenses, payable in quarterly installments.

The Company accounts for leases in accordance with ASC 842, “Leases.”

DIGIMARC CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(In thousands, except per share data)

(UNAUDITED)

All of the Company’s leases are operating leases. The following table provides additional details of leases presented in the Consolidated Balance Sheets:

	September 30,			December 31,
	2022			2021
Lease right of use assets	$	5,209		$	1,300
Lease liabilities, current	$	968		$	745
Lease liabilities, long-term	$	6,051		$	1,028

Weighted-average remaining life	6.7 years			2.2 years
Weighted-average discount rate		9	%		8	%

The current lease liabilities are included in “accounts payable and other accrued liabilities” in the Consolidated Balance Sheets.

The carrying value of the lease right of use assets is evaluated for impairment whenever events or changes in circumstances indicate that the carrying amount of the asset may not be recoverable. The Company recorded an “impairment of lease right of use assets and leasehold improvements” of $574 in the Consolidated Statements of Operations in March 2022. The impairment was triggered when the Company vacated its prior corporate headquarters. The impairment charge was determined by comparing the carrying value of the assets to the net present value of estimated cash flows from the future sublease of the office space over the remaining lease term.

Operating lease expense is included in “cost of revenue” and “operating expenses” in the Consolidated Statements of Operations and in “cash flows from operating activities” in the Consolidated Statements of Cash Flows. The operating leases include variable lease payments, which are included in operating lease expense. Additional details of the Company’s operating leases are presented in the following table:

	Three		Three		Nine		Nine
	Months		Months		Months		Months
	Ended		Ended		Ended		Ended
	September 30,		September 30,		September 30,		September 30,
	2022		2021		2022		2021
Operating lease expense	$	498	$	247	$	1,422	$	757
Cash paid for operating leases	$	395	$	289	$	1,185	$	880

The table below reconciles the aggregate cash payment obligations for the first five years and total of the remaining years for the operating lease liability recorded in the Consolidated Balance Sheet as of September 30, 2022:

	Cash
	Payment
As of September 30, 2022:	Obligations
Remaining in 2022	$	281
2023		991
2024		1,178
2025		1,309
2026		1,349
Thereafter		5,138
Total lease payments		10,246
Imputed interest		(3,227	)
Total minimum lease payments	$	7,019

14. Income Taxes

The benefit (provision) for income taxes reflects current taxes, deferred taxes, and withholding taxes. The effective tax rate for the nine months ended September 30, 2022 and 2021 was 0% and 0%, respectively.

The valuation allowance against net deferred tax assets as of September 30, 2022, was $75,010, an increase of $10,737 from $64,273 as of December 31, 2021. The Company continues to provide for a full valuation allowance to offset its net deferred tax assets until such time it is more likely than not the tax assets or portions thereof will be realized.

DIGIMARC CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(In thousands, except per share data)

(UNAUDITED)

Excess tax deficiencies of $2,355 and $3,170 were recognized in the provision for income taxes for the three and nine months ended September 30, 2022, respectively, which were offset by $2,355 and $3,170 of valuation allowance, respectively.

An excess tax deficiency of $1,659 and an excess tax benefit of $2,238 were recognized in the provision for income taxes for the three and nine months ended September 30, 2021, respectively, which were offset by $1,659 and $2,238 of valuation allowance, respectively.

15. Commitments and Contingencies

Certain of the Company’s contracts 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.

The Company is subject from time to time to other legal proceedings and claims arising in the ordinary course of business. At this time, the Company does not believe that the resolution of any such matters will have a material adverse effect on its consolidated financial statements.

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. 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 consolidated 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 in the audited consolidated financial statements and related notes included in our Annual Report on Form 10-K for the year ended December 31, 2021 filed on March 4, 2022 (our “2021 Annual Report”), and other reports and filings we have made with the U.S. Securities and Exchange Commission (“SEC”).

Unless the context otherwise requires, references in this Quarterly Report on Form 10-Q to “Company,” “Digimarc,” “we,” “our” and “us” refer to Digimarc Corporation. On January 3, 2022, the Company completed the acquisition of EVRYTHNG Limited and its subsidiaries (“EVRYTHNG”), a London-based product cloud company. Unless context otherwise requires, references to EVRYTHNG refer to our wholly owned subsidiaries following the acquisition.

All dollar amounts are in thousands except per share amounts or unless otherwise noted. The percentages within the tables may not sum to 100% due to rounding.

Digimarc, Digimarc Barcode, The Barcode of Everything, Barcode of Everything, and the circle-d logo are registered trademarks of Digimarc Corporation. EVRYTHNG and EVRYTHNG PRODUCT CLOUD are registered trademarks of EVRYTHNG Limited.

Overview

Digimarc Corporation is a global leader in product digitization, delivering business value across industries through unique identities and cloud-based solutions. Our technology highlights a product’s journey to provide complete visibility into all relevant product data, allowing companies to make intelligent business decisions.

The Digimarc Platform is a distinctive software as a service that combines Digimarc’s digital watermarks and/or Quick Response (“QR”) codes with product cloud technologies. By digitizing products using our unique digital watermarks and/or QR codes, products can connect with the web and interact with consumers and digital devices. Interactions are powered by our product cloud, where we provide data and instructions based on context, and then capture a record of every interaction.

The Digimarc product suite is built on top of the Digimarc Platform to address specific business needs. All our products are complementary to each other, providing exponential benefits when combined. By enabling customers to create digital identities for physical and digital media objects, Digimarc’s technologies provide many benefits, including:

•

Digimarc Validate protects product authenticity to ensure real products are in the right place. Our technology delivers exclusive, covert digital watermarks and/or QR codes and a cloud-based record of product authentication information. In addition, consumer engagement capabilities provide a direct, digital communications channel with consumers.

•

Digimarc Engage unlocks an interactive communications channel connecting brands and consumers. Our technology activates products and media through on-package QR codes, enabling consumers to scan for more information. Combined with cloud-based rules, brands can deliver contextually relevant content based on time, location, and more.

•

Digimarc Recycle increases the recyclability of products and packaging through unique digital watermarks. Our technology activates products and packaging with unique digital watermarks to improve accuracy and performance in recycling facilities. In addition, consumer engagement capabilities deliver a direct, digital communications channel with consumers, and a cloud-based record of recycling information provides new insights.

Digimarc has also maintained a relationship with a consortium of central banks (“Central Banks”) for over 20 years, providing trusted technology to help deter digital counterfeiting of currency. The relationship was the first commercially successful large-scale use of our technologies and protects billions of banknotes in circulation globally.

Our intellectual property contains many innovations in digital watermarking, content and object recognition, digital rights management, and related fields. To protect our inventions, 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 seek patent protection for our inventions to differentiate our products and technologies, mitigate infringement risks, and develop opportunities for licensing. Our broad patent portfolio covers a wide range of methods, applications, system architectures and processes. As a result, we believe we have one of the world’s most extensive patent portfolios in digital watermarking and related

fields, with approximately 1,000 U.S. and foreign patents granted and applications pending as of September 30, 2022. The patents in our portfolio each have a life of approximately 20 years from the patent’s effective filing date.

On January 3, 2022, we completed the acquisition of EVRYTHNG. The EVRYTHNG Product Cloud allows the combined company to now offer a complete automatic identification solution to existing customers and prospective customers. The aggregate initial consideration for the acquisition was 772 thousand shares of common stock of the Company and warrants to purchase 231 thousand shares of common stock of the Company at the closing. We also paid $4.0 million of closing costs on behalf of the EVRYTHNG sellers. In August 2022, we issued an additional 22 thousand shares of common stock of the Company to EVRYTHNG sellers as a post-closing adjustment to the initial consideration, consisting primarily of shares that were previously held back for such adjustments. Any shares held back in connection with the indemnification obligations of the EVRYTHNG sellers will not be issued, if at all, until 2023. The financial results of EVRYTHNG are consolidated with Digimarc’s financial results for the post-acquisition period.

COVID-19 Pandemic

The coronavirus 2019 (“COVID-19”) pandemic continues to pose significant risks to our business. The ongoing public health actions attempting to reduce the spread of COVID-19 created and may continue to create significant disruptions to consumer demand, customer and supplier relationships, sales and support processes, and general economic conditions. Accordingly, our management continuously evaluates our business operations, communicates with and monitors the actions of our customers and partners, and reviews our near-term financial performance as we manage the Company through the uncertainty related to the COVID-19 pandemic. Some of our projects with customers and partners have been delayed as a result of the COVID-19 pandemic. Delays in these projects have affected the timing of closing new business.

Critical Accounting Policies and Estimates

Detailed information about our critical accounting policies and estimates is set forth in Part III, Item 15 of our 2021 Annual Report (“Exhibits and Financial Statement Schedules”), in “Note 1: Description of Business and Summary of Significant Accounting Policies,” which is incorporated by reference into this Quarterly Report on Form 10-Q. We also added a new critical accounting policy for “Business Combinations” in Note 1 of 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. The statements of operations for the three and nine month periods ended September 30, 2022 include the combined operating results of Digimarc and EVRYTHNG subsequent to the acquisition closing on January 3, 2022.

Unless stated otherwise, all references in this Management’s Discussion and Analysis of Financial Condition and Results of Operations relate to the three and nine month periods ended September 30, 2022, and all changes discussed with respect to such periods reflect changes compared to the three and nine month periods ended September 30, 2021.

	Three			Three			Nine			Nine
	Months			Months			Months			Months
	Ended			Ended			Ended			Ended
	September 30,			September 30,			September 30,			September 30,
	2022			2021			2022			2021
Percentages are percent of total revenue
Revenue:
Service		48	%		61	%		52	%		59	%
Subscription		52			39			48			41
Total revenue		100			100			100			100
Cost of revenue:
Service ⁽¹⁾		20			25			23			24
Subscription ⁽¹⁾		13			9			13			10
Amortization expense on acquired intangible assets		13			—			15			—
Total cost of revenue		47			34			50			34
Gross profit		53			66			50			66
Operating expenses:
Sales and marketing		98			72			103			82
Research, development and engineering		97			71			86			67
General and administrative		53			46			65			80
Amortization expense on acquired intangible assets		4			—			4			—
Impairment of lease right of use assets and leasehold improvements		—			—			2			—
Total operating expenses		252			190			261			229
Operating loss		(199	)		(124	)		(211	)		(163	)
Other income:
Gain on extinguishment of note payable		—			79			—			26
Refundable tax credit		5			—			4			—
Other income (loss)		3		(—)				1		(—)
Other income, net		8			79			5			26
Loss before income taxes		(191	)		(45	)		(206	)		(137	)
Provision for income taxes	(—)			(—)			(—)			(—)
Net loss		(191	%)		(45	%)		(206	%)		(137	%)
⁽¹⁾ Cost of revenue for Service and Subscription excludes amortization expense on acquired intangible assets.

Summary

Total revenue for the three month period ended September 30, 2022, increased $1.4 million, or 22%, to $7.8 million, compared to the corresponding three month period ended September 30, 2021. The increase in revenue primarily reflects the contribution of subscription and service revenue post acquisition from EVRYTHNG and $1.1 million of subscription revenue from a new commercial contract, partially offset by $0.6 million of lower subscription revenue as a result of sunsetting our Piracy Intelligence product and $0.4 million less service revenue due to the timing of HolyGrail recycling projects.

Total revenue for the nine month period ended September 30, 2022, increased $3.6 million, or 18% to $23.0 million, compared to the corresponding nine month period ended September 30, 2021. The increase in revenue primarily reflects the contribution of subscription and service revenue post acquisition from EVRYTHNG and $1.1 million of subscription revenue from a new commercial contract, partially offset by $0.9 million of lower subscription revenue as a result of sunsetting our Piracy Intelligence product and $0.4 million less service revenue largely due to timing of program work with the Central Banks.

Total operating expenses for the three month period ended September 30, 2022, increased $7.5 million, or 62%, to $19.7 million, compared to the corresponding three month period ended September 30, 2021. The increase in operating expenses primarily reflects $4.1 million of EVRYTHNG operating expenses post acquisition, $1.7 million of higher compensation costs due to annual compensation adjustments and higher headcount, and $1.4 million of severance costs incurred for organizational changes we made in the third quarter of 2022.

Total operating expenses for the nine month period ended September 30, 2022, increased $15.6 million, or 35%, to $60.0 million, compared to the corresponding nine month period ended September 30, 2021. The increase in operating expenses primarily reflects $12.9 million of EVRYTHNG operating expenses post acquisition, $5.3 million of higher compensation costs due to annual compensation adjustments and higher headcount, $1.4 million of severance costs incurred for organizational changes we made in the third quarter of 2022, $0.8 million of higher lease asset amortization and moving costs, $0.7 million of higher travel and conference costs, $0.7 million of higher legal, accounting and tax costs primarily related to the EVRYTHNG acquisition and financing activities, and a $0.6 million non-cash impairment charge to write-down our lease right of use assets and leasehold improvements, partially offset by $6.2 million of costs recognized in the second quarter of 2021 associated with the Separation Agreement we entered into with our former chief executive officer and $1.3 million of severance costs incurred for organizational changes we made in the second quarter of 2021.

Revenue

	Three			Three									Nine			Nine
	Months			Months									Months			Months
	Ended			Ended			Dollar			Percent			Ended			Ended			Dollar		Percent
	September 30,			September 30,			Increase			Increase			September 30,			September 30,			Increase		Increase
	2022			2021			(Decrease)			(Decrease)			2022			2021			(Decrease)		(Decrease)
Revenue:
Service	$	3,735		$	3,932		$	(197	)		(5	)%	$	11,858		$	11,507		$	351		3	%
Subscription		4,086			2,485			1,601			64	%		11,121			7,888			3,233		41	%
Total	$	7,821		$	6,417		$	1,404			22	%	$	22,979		$	19,395		$	3,584		18	%
Revenue (as % of total revenue):
Service		48	%		61	%								52	%		59	%
Subscription		52	%		39	%								48	%		41	%
Total		100	%		100	%								100	%		100	%

Service. Service revenue consists primarily of revenue earned from the performance of software development services and, to a lesser extent, professional services. The majority of software development contracts are structured as time and materials agreements. Revenue for services is generally recognized as the services are performed. Billing for services rendered generally occurs within one month after the services are provided. Service contracts can range from days to several years in length. Our contract with the Central Banks, which accounts for the majority of our service revenue, has a contract term through December 31, 2024, with the option to extend the term for an additional five years by mutual agreement. The contract is subject to work plans that are reviewed and agreed upon quarterly. The contract provides for predetermined billing rates, which are adjusted annually to account for cost of living variables, and provides for the reimbursement of third party costs incurred to support the work plans.

The $0.2 million decrease in service revenue for the three month period ended September 30, 2022, compared to the corresponding three month period ended September 30, 2021, primarily reflects $0.4 million less service revenue due to the timing of HolyGrail recycling projects, partially offset by the contribution of professional services revenue post acquisition from EVRYTHNG.

The $0.4 million increase in service revenue for the nine month period ended September 30, 2022, compared to the corresponding nine month period ended September 30, 2021, primarily reflects the contribution of professional services revenue post acquisition from EVRYTHNG, partially offset by $0.4 million less service revenue largely due to timing of program work with the Central Banks.

Subscription. Subscription revenue consists primarily of revenue earned from software subscriptions to our software platform and products and, to a lesser extent, the licensing and sale of our intellectual property. The majority of subscription contracts are recurring, paid in advance and recognized over the term of the subscription, which is typically one to three years.

The $1.6 million increase in subscription revenue for the three month period ended September 30, 2022, compared to the corresponding three month period ended September 30, 2021, primarily reflects the contribution of subscription revenue post acquisition from EVRYTHNG and $1.1 million of subscription revenue from a new commercial contract, partially offset by $0.6 million of lower subscription revenue as a result of sunsetting our Piracy Intelligence product.

The $3.2 million increase in subscription revenue for the nine month period ended September 30, 2022, compared to the corresponding nine month period ended September 30, 2021, primarily reflects the contribution of subscription revenue post acquisition from EVRYTHNG and $1.1 million of subscription revenue from a new commercial contract, partially offset by $0.9 million of lower subscription revenue as a result of sunsetting our Piracy Intelligence product.

Revenue by geography

	Three			Three								Nine			Nine
	Months			Months								Months			Months
	Ended			Ended			Dollar		Percent			Ended			Ended			Dollar		Percent
	September 30,			September 30,			Increase		Increase			September 30,			September 30,			Increase		Increase
	2022			2021			(Decrease)		(Decrease)			2022			2021			(Decrease)		(Decrease)
Revenue by geography:
Domestic	$	2,889		$	1,678		$	1,211		72	%	$	7,259		$	5,040		$	2,219		44	%
International		4,932			4,739			193		4	%		15,720			14,355			1,365		10	%
Total	$	7,821		$	6,417		$	1,404		22	%	$	22,979		$	19,395		$	3,584		18	%
Revenue (as % of total revenue):
Domestic		37	%		26	%							32	%		26	%
International		63	%		74	%							68	%		74	%
Total		100	%		100	%							100	%		100	%

Domestic. The $1.2 million increase in domestic revenue for the three month period ended September 30, 2022, compared to the corresponding three month period ended September 30, 2021, primarily reflects $1.1 million of domestic revenue from a new commercial contract and the contribution of domestic revenue post acquisition from EVRYTHNG, partially offset by $0.4 million of lower domestic revenue as a result of sunsetting our Piracy Intelligence product.

The $2.2 million increase in domestic revenue for the nine month period ended September 30, 2022, compared to the corresponding nine month period ended September 30, 2021, primarily reflects the contribution of domestic revenue post acquisition from EVRYTHNG and $1.1 million of domestic revenue from a new commercial contract, partially offset by $0.5 million of lower domestic revenue as a result of sunsetting our Piracy Intelligence product.

International. The $0.2 million increase in international revenue for the three month period ended September 30, 2022, compared to the corresponding three month period ended September 30, 2021, primarily reflects the contribution of international revenue post acquisition from EVRYTHNG, partially offset by $0.4 million less service revenue due to the timing of HolyGrail recycling projects and $0.2 million of lower international revenue as a result of sunsetting our Piracy Intelligence product.

The $1.4 million increase in international revenue for the nine month period ended September 30, 2022, compared to the corresponding nine month period ended September 30, 2021, primarily reflects the contribution of international revenue post acquisition from EVRYTHNG, partially offset by $0.4 million less service revenue largely due to timing of program work with the Central Banks and $0.4 million lower international revenue as a result of sunsetting our Piracy Intelligence product.

Revenue by market

	Three		Three								Nine		Nine
	Months		Months								Months		Months
	Ended		Ended		Dollar			Percent			Ended		Ended		Dollar			Percent
	September 30,		September 30,		Increase			Increase			September 30,		September 30,		Increase			Increase
	2022		2021		(Decrease)			(Decrease)			2022		2021		(Decrease)			(Decrease)
Government:
Service	$	3,346	$	3,279	$	67			2	%	$	10,007	$	10,386	$	(379	)		(4	)%
Subscription		300		300		—			—	%		1,088		900		188			21	%
Total Government	$	3,646	$	3,579	$	67			2	%	$	11,095	$	11,286	$	(191	)		(2	)%
Commercial:
Service	$	389	$	653	$	(264	)		(40	)%	$	1,851	$	1,121	$	730			65	%
Subscription		3,786		2,185		1,601			73	%		10,033		6,988		3,045			44	%
Total Commercial	$	4,175	$	2,838	$	1,337			47	%	$	11,884	$	8,109	$	3,775			47	%
Total	$	7,821	$	6,417	$	1,404			22	%	$	22,979	$	19,395	$	3,584			18	%

Government. The changes in government service revenue for the three and nine month periods ended September 30, 2022, compared to the corresponding three and nine month periods ended September 30, 2021, largely reflects the timing of program work with the Central Banks. The increase in government subscription revenue for the nine month period ended September 30, 2022, compared to the corresponding nine month period ended September 30, 2021, reflects a $0.2 million one-time license fee payment from a government supplier in May 2022.

Commercial. The $1.3 million increase in commercial revenue for the three month period ended September 30, 2022, compared to the corresponding three month period ended September 30, 2021, primarily reflects the contribution of subscription and service revenue post acquisition from EVRYTHNG and $1.1 million of subscription revenue from a new commercial contract, partially offset by $0.6 of lower subscription revenue as a result of sunsetting our Piracy Intelligence product and $0.4 million less service revenue due to the timing of HolyGrail recycling projects.

The $3.8 million increase in commercial revenue for the nine month period ended September 30, 2022, compared to the corresponding nine month period ended September 30, 2021, primarily reflects the contribution of subscription and service revenue post acquisition from EVRYTHNG and $1.1 million of subscription revenue from a new commercial contract, partially offset by $0.9 million of lower subscription revenue as a result of sunsetting our Piracy Intelligence product.

Cost of revenue

Service. Cost of service revenue primarily includes:

•

compensation, benefits, incentive compensation in the form of stock-based compensation and related costs of our software developers, quality assurance personnel, professional services team 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 customers;

•

depreciation for equipment and software directly used by customers; and

•

travel costs that are billed to customers.

Subscription. Cost of subscription revenue primarily includes:

•

compensation, benefits, incentive compensation in the form of stock-based compensation and related costs of our software developers and quality assurance personnel when software subscription products require significant configuration and integration;

•

cost of outside contractors that provide operational support for our software subscription products;

•

internet cloud hosting costs and image search data fees to support our software subscription products;

•

license fees paid to technology solution providers when we sell a combined solution; and

•

amortization of capitalized patent costs and patent maintenance fees.

Amortization expense on acquired intangible assets. Amortization expense includes:

•

amortization expense recognized on the developed technology intangible asset acquired in the EVRYTHNG acquisition.

Gross profit

	Three			Three									Nine			Nine
	Months			Months									Months			Months
	Ended			Ended			Dollar			Percent			Ended			Ended			Dollar			Percent
	September 30,			September 30,			Increase			Increase			September 30,			September 30,			Increase			Increase
	2022			2021			(Decrease)			(Decrease)			2022			2021			(Decrease)			(Decrease)
Gross Profit:
Service⁽¹⁾	$	2,133		$	2,302		$	(169	)		(7	)%	$	6,681		$	6,792		$	(111	)		(2	)%
Subscription ⁽¹⁾		3,080			1,918			1,162			61	%		8,187			5,996			2,191			37	%
Amortization expense on acquired intangible assets		(1,048	)		—			(1,048	)		100	%		(3,362	)		—			(3,362	)		100	%
Total	$	4,165		$	4,220		$	(55	)		(1	)%	$	11,506		$	12,788		$	(1,282	)		(10	)%
Gross Profit Margin:
Total		53	%		66	%								50	%		66	%
Service ⁽¹⁾		57	%		59	%								56	%		59	%
Subscription (1)		75	%		77	%								74	%		76	%

(1)Gross Profit and Gross Profit Margin for Service and Subscription excludes amortization expense on acquired intangible assets.

The decrease of $0.1 million in total gross profit for the three month period ended September 30, 2022, compared to the corresponding three month period ended September 30, 2021, was primarily due to $1.0 million of amortization expense recognized on the developed technology intangible asset acquired in the EVRYTHNG acquisition and $0.2 million lower service gross profit due to higher costs, partially offset by the $1.2 million of gross profit contribution from higher subscription revenue.

The decrease of $1.3 million in total gross profit for the nine month period ended September 30, 2022, compared to the corresponding nine month period ended September 30, 2021, was primarily due to $3.4 million of amortization expense recognized on the developed technology intangible asset acquired in the EVRYTHNG acquisition and $0.1 million lower service gross profit due to higher costs, partially offset by the $2.2 million of gross profit contribution from higher subscription revenue.

The decreases in service gross profit margin, excluding amortization expense on acquired intangible assets, for the three and nine month periods ended September 30, 2022, compared to the corresponding three and nine month periods ended September 30, 2021, were primarily due to higher employee compensation costs.

The decreases in subscription gross profit margin, excluding amortization expense on acquired intangible assets, for the three and nine month periods ended September 30, 2022, compared to the corresponding three and nine month periods ended September 30, 2021, were primarily due to the mix of subscription revenue as some subscription products have higher margins than others.

Operating expenses

Sales and marketing

	Three			Three								Nine			Nine
	Months			Months								Months			Months
	Ended			Ended			Dollar		Percent			Ended			Ended			Dollar		Percent
	September 30,			September 30,			Increase		Increase			September 30,			September 30,			Increase		Increase
	2022			2021			(Decrease)		(Decrease)			2022			2021			(Decrease)		(Decrease)
Sales and marketing	$	7,684		$	4,647		$	3,037		65	%	$	23,702		$	15,865		$	7,837		49	%
Sales and marketing (as % of total revenue)		98	%		72	%							103	%		82	%

Sales and marketing expenses consist primarily of:

•

compensation, benefits, incentive compensation in the form of stock-based compensation and related costs of our sales, marketing, communications, product, operations and customer support personnel;

•

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

•

professional services, consulting and outside contractor costs for sales and marketing, communications and product initiatives; and

•

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

The increase in sales and marketing expenses for the three month period ended September 30, 2022, compared to the corresponding three month period ended September 30, 2021, was primarily due to:

•

EVRYTHNG sales and marketing expenses of $2.1 million post acquisition;

•

severance costs of $1.0 million incurred for organizational changes we made in the third quarter of 2022; and

•

increased compensation costs of $0.2 million reflecting annual compensation adjustments; partially offset by

•

decreased infrastructure and centralized costs of facilities and information technology of $0.2 million.

The increase in sales and marketing expenses for the nine month period ended September 30, 2022, compared to the corresponding nine month period ended September 30, 2021, was primarily due to:

•

EVRYTHNG sales and marketing expenses of $6.7 million post acquisition;

•

severance costs of $1.0 million incurred for organizational changes we made in the third quarter of 2022;

•

increased compensation costs of $0.8 million reflecting annual compensation adjustments;

•

increased travel and conference costs of $0.4 million; and

•

increased infrastructure and centralized costs of facilities and information technology of $0.3 million; partially offset by

•

severance costs of $1.3 million incurred for organizational changes we made in the second quarter of 2021.

Research, development and engineering

	Three			Three								Nine			Nine
	Months			Months								Months			Months
	Ended			Ended			Dollar		Percent			Ended			Ended			Dollar		Percent
	September 30,			September 30,			Increase		Increase			September 30,			September 30,			Increase		Increase
	2022			2021			(Decrease)		(Decrease)			2022			2021			(Decrease)		(Decrease)
Research, development and engineering	$	7,575		$	4,586		$	2,989		65	%	$	19,731		$	12,930		$	6,801		53	%
Research, development and engineering (as % of total revenue)		97	%		71	%							86	%		67	%

Research, development and engineering expenses consist primarily of:

•

compensation, benefits, incentive compensation in the form of stock-based compensation and related costs of our software and hardware developers, researchers and quality assurance personnel;

•

payments to outside contractors;

•

the purchase of materials and services for product development; and

•

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

The increase in research, development and engineering expenses for the three month period ended September 30, 2022, compared to the corresponding three month period ended September 30, 2021, was primarily due to:

•

increased compensation costs of $1.7 million reflecting higher headcount, including transfers in from other departments, and annual compensation adjustments;

•

EVRYTHNG research, development and engineering expenses of $1.1 million post acquisition; and

•

severance costs of $0.2 million incurred for organizational changes we made in the third quarter of 2022.

The increase in research, development and engineering expenses for the nine month period ended September 30, 2022, compared to the corresponding nine month period ended September 30, 2021, was primarily due to:

•

increased compensation costs of $3.5 million reflecting higher headcount, including transfers in from other departments, and annual compensation adjustments;

•

EVRYTHNG research, development and engineering expenses of $2.7 million post acquisition;

•

increased infrastructure and centralized costs of facilities and information technology of $0.5 million; and

•

severance costs of $0.2 million incurred for organizational changes we made in the third quarter of 2022.

General and administrative

	Three			Three								Nine			Nine
	Months			Months								Months			Months
	Ended			Ended			Dollar		Percent			Ended			Ended			Dollar			Percent
	September 30,			September 30,			Increase		Increase			September 30,			September 30,			Increase			Increase
	2022			2021			(Decrease)		(Decrease)			2022			2021			(Decrease)			(Decrease)
General and administrative	$	4,132		$	2,943		$	1,189		40	%	$	15,027		$	15,611		$	(584	)		(4	)%
General and administrative (as % of total revenue)		53	%		46	%							65	%		80	%

We incur general and administrative costs in the functional areas of finance, legal, human resources, intellectual property, 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 area as well as each of the areas in sales and marketing and research, development and engineering.

General and administrative expenses consist primarily of:

•

compensation, benefits and incentive compensation in the form of stock-based compensation and related costs of our general and administrative personnel;

•

third party and professional fees associated with legal, accounting and human resources functions;

•

costs associated with being a public company; and

•

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

The increase in general and administrative expenses for the three month period ended September 30, 2022, compared to the corresponding three month period ended September 30, 2021, was primarily due to:

•

EVRYTHNG general and administrative expenses of $0.7 million post acquisition;

•

increased infrastructure and centralized costs of facilities and information technology of $0.3 million;

•

increased facilities costs of $0.2 million reflecting non-cash rent expense on new corporate headquarters; and

•

severance costs of $0.1 million incurred for organizational changes we made in the third quarter of 2022; partially offset by

•

decreased compensation costs of $0.2 million reflecting lower headcount, including transfers out to other departments, partially offset by annual compensation adjustments.

The decrease in general and administrative expenses for the nine month period ended September 30, 2022, compared to the corresponding nine month period ended September 30, 2021, was primarily due to:

•

costs of $6.2 million associated with the Separation Agreement we entered into with our former chief executive officer in the second quarter of 2021 upon his retirement; and

•

decreased infrastructure and centralized costs of facilities and information technology of $0.8 million; partially offset by

•

EVRYTHNG general and administrative expenses of $2.6 million post acquisition;

•

increased compensation cost of $1.0 million reflecting annual compensation adjustments, partially offset by lower headcount, including transfers out to other departments;

•

increased facilities costs of $0.8 million reflecting non-cash rent expense on new corporate headquarters and office moving costs;

•

increased legal, accounting and tax costs of $0.5 million primarily related to the EVRYTHNG acquisition and financing activities;

•

increased consulting costs of $0.3 million related to acquisition integration and other corporate initiatives;

•

increased insurance costs of $0.2 million related to the EVRYTHNG acquisition;

•

increased operating taxes of $0.2 million reflecting the stamp tax due in the United Kingdom for the EVRYTHNG acquisition; and

•

severance costs of $0.1 million incurred for organizational changes we made in the third quarter of 2022.

Amortization expense on acquired intangible assets

	Three			Three					Nine			Nine
	Months			Months					Months			Months
	Ended			Ended		Dollar		Percent	Ended			Ended		Dollar		Percent
	September 30,			September 30,		Increase		Increase	September 30,			September 30,		Increase		Increase
	2022			2021		(Decrease)		(Decrease)	2022			2021		(Decrease)		(Decrease)
Amortization expense on acquired intangible assets	$	301		$	—	$	301	> 100%	$	964		$	—	$	964	> 100%
Amortization expense on acquired intangible assets (as % of total revenue)		4	%	—%						4	%	—%

Amortization expense on acquired intangible assets relates to amortization expense recognized on the customer relationships intangible asset acquired in the EVRYTHNG acquisition.

Impairment of lease right of use assets and leasehold improvements

	Three		Three					Nine			Nine
	Months		Months					Months			Months
	Ended		Ended		Dollar		Percent	Ended			Ended		Dollar		Percent
	September 30,		September 30,		Increase		Increase	September 30,			September 30,		Increase		Increase
	2022		2021		(Decrease)		(Decrease)	2022			2021		(Decrease)		(Decrease)
Impairment of lease right of use assets and leasehold improvements	$	—	$	—	$	—	—%	$	574		$	—	$	574	> 100%
Impairment of lease right of use assets and leasehold improvements (as % of total revenue)	—%		—%						2	%	—%

The impairment of lease right of use assets and leasehold improvements relates to our prior corporate headquarters and was triggered upon moving to our new corporate headquarters in March 2022.

Stock-based compensation

	Three		Three							Nine		Nine
	Months		Months							Months		Months
	Ended		Ended		Dollar		Percent			Ended		Ended		Dollar			Percent
	September 30,		September 30,		Increase		Increase			September 30,		September 30,		Increase			Increase
	2022		2021		(Decrease)		(Decrease)			2022		2021		(Decrease)			(Decrease)
Cost of revenue	$	270	$	164	$	106		65	%	$	736	$	515	$	221			43	%
Sales and marketing		1,461		369		1,092		296	%		3,354		2,359		995			42	%
Research, development and engineering		916		401		515		128	%		2,066		1,202		864			72	%
General and administrative		921		667		254		38	%		3,154		6,272		(3,118	)		(50	)%
Total	$	3,568	$	1,601	$	1,967		123	%	$	9,310	$	10,348	$	(1,038	)		(10	)%

The increase in stock-based compensation expense for the three month period ended September 30, 2022, compared to the corresponding three month period ended September 30, 2021, was primarily due to $1.0 million of stock-based compensation expense from one-time stock awards granted related to the EVRYTHNG acquisition, $0.6 million of non-cash stock-based compensation expense from the acceleration of stock awards associated with organizational changes we made in the third quarter of 2022, and the impact of higher annual stock award grants reflecting higher headcount largely due to the EVRYTHNG acquisition.

The decrease in stock-based compensation expense for the nine month period ended September 30, 2022, compared to the corresponding nine month period ended September 30, 2021, was primarily due to $4.0 million of non-cash stock-based compensation expense from the acceleration of stock awards associated with the Separation Agreement we entered into with our former chief executive officer and $1.0 million from the organizational changes we made in the second quarter of 2021, partially offset by $2.5 million of stock-based compensation expense from one-time stock awards granted related to the EVRYTHNG acquisition, $0.6 million of non-cash stock-based compensation expense from the acceleration of stock awards associated with organizational changes we made in the third quarter of 2022, and the impact of higher annual stock award grants reflecting higher headcount largely due to the EVRYTHNG acquisition.

We anticipate incurring an additional $18,925 in stock-based compensation expense through September 30, 2026, for awards outstanding as of September 30, 2022.

Other income, net

	Three			Three									Nine			Nine
	Months			Months									Months			Months
	Ended			Ended			Dollar			Percent			Ended			Ended			Dollar			Percent
	September 30,			September 30,			Increase			Increase			September 30,			September 30,			Increase			Increase
	2022			2021			(Decrease)			(Decrease)			2022			2021			(Decrease)			(Decrease)
Other income, net	$	623		$	5,092		$	(4,469	)		(88	)%	$	1,214		$	5,120		$	(3,906	)		(76	)%
Other income, net (as % of total revenue)		8	%		79	%								5	%		26	%

The decreases in other income, net for the three and nine month periods ended September 30, 2022, compared to the corresponding three and nine month periods ended September 30, 2021, were primarily due to the $5,094 gain on the forgiveness of our Paycheck Protection Program (“PPP”) loan in September 2021, partially offset by an estimated refundable research and development tax credit to be filed for in the United Kingdom for the 2022 tax year and by higher interest income due to higher interest rates on investments.

Income Taxes

The provision for income taxes reflects current taxes, deferred taxes, and withholding taxes. The effective tax rate for the nine month periods ended September 30, 2022 and 2021 was 0% and 0%, respectively. Our effective tax rate is significantly lower than our statutory tax rate because we have a full valuation allowance recorded against our deferred tax assets.

The valuation allowance against deferred tax assets as of September 30, 2022, was $75,010, an increase of $10,737 from $64,273 as of December 31, 2021.

We continually assess the applicability of a valuation allowance against our deferred tax assets. Based upon the positive and negative evidence available as of September 30, 2022, and largely due to the cumulative loss incurred by us over the last several years, which is considered a significant piece of negative evidence when assessing the realizability of deferred tax assets, a full valuation allowance is recorded against our deferred tax assets. We will not record tax benefits on any future losses until it is determined that those tax benefits will be realized. All future reversals of the valuation allowance would result in a tax benefit in the period recognized.

Non-GAAP Financial Measures

The following discussion and analysis includes both financial measures in accordance with U.S. Generally Accepted Accounting Principles (“GAAP”) as well as non-GAAP financial measures. Generally, a non-GAAP financial measure is a numerical measure of a company’s performance, financial position or cash flows that exclude amounts that are not normally excluded in the most directly comparable measure calculated and presented in accordance with GAAP. Non-GAAP financial measures should be viewed as supplemental to, and should not be considered as alternatives to, GAAP financial measures. Non-GAAP financial measures may not be indicative of the historical operating results of the Company nor are they intended to be predictive of potential future results. Investors should not consider non-GAAP financial measures in isolation or as substitutes for performance measures calculated in accordance with GAAP. Our management uses and relies on Non-GAAP gross profit, Non-GAAP gross profit margin, Non-GAAP operating expenses, Non-GAAP net loss, and Non-GAAP loss per common share (diluted), which are all non-GAAP financial measures. We believe that both management and shareholders benefit from referring to the following non-GAAP financial measures in planning, forecasting and analyzing future periods.

Our management uses these non-GAAP financial measures in evaluating its financial and operational decision making and as a means to evaluate period-to-period comparisons. Our management recognizes that the non-GAAP financial measures have inherent limitations because of the described excluded items.

We define Non-GAAP gross profit, Non-GAAP gross profit margin, Non-GAAP operating expenses, Non-GAAP net loss, and Non-GAAP loss per common share (diluted) excluding the adjustments in the table below. These non-GAAP financial measures are an important measure of our operating performance because they allow management, investors and analysts to evaluate and assess our core operating results from period-to-period after removing non-cash and non-recurring activities that can affect comparability.

We have included a reconciliation of our financial measures calculated in accordance with GAAP to the most comparable non-GAAP financial measures. We believe that providing the non-GAAP financial measures, together with the reconciliation to GAAP, helps investors make comparisons between us and other companies. In making any comparisons to other companies, investors need to be aware that companies use different non-GAAP measures to evaluate their financial performance. Investors should pay close attention to the specific definition being used and to the reconciliation between such measures and the corresponding GAAP measures provided by each company under applicable SEC rules.

The following table presents a reconciliation of Non-GAAP gross profit, Non-GAAP gross profit margin, Non-GAAP operating expenses, Non-GAAP net loss, and Non-GAAP loss per common share (diluted) for the three and nine month periods ended September 30, 2022 and 2021:

	Three			Three			Nine			Nine
	Months			Months			Months			Months
	Ended			Ended			Ended			Ended
	September 30,			September 30,			September 30,			September 30,
	2022			2021			2022			2021
GAAP gross profit	$	4,165		$	4,220		$	11,506		$	12,788
Amortization of acquired intangible assets		1,048			—			3,362			—
Amortization and write-off of other intangible assets		145			145			430			431
Stock-based compensation		270			164			736			515
Non-GAAP gross profit	$	5,628		$	4,529		$	16,034		$	13,734
Non-GAAP gross profit margin		72	%		71	%		70	%		71	%

GAAP operating expenses	$	19,692		$	12,176		$	59,998		$	44,406
Depreciation and write-off of property and equipment		(316	)		(334	)		(1,036	)		(1,051	)
Amortization of acquired intangible assets		(301	)		—			(964	)		—
Amortization and write-off of other intangible assets		(4	)		(35	)		(63	)		(94	)
Amortization of lease right of use assets under operating leases		(248	)		(124	)		(768	)		(364	)
Stock-based compensation		(3,298	)		(1,437	)		(8,574	)		(9,833	)
Impairment of lease right of use assets and leasehold improvements		—			—			(574	)		—
Acquisition-related expenses		—			(111	)		(447	)		(111	)
Non-GAAP operating expenses	$	15,525		$	10,135		$	47,572		$	32,953

GAAP net loss	$	(14,930	)	$	(2,871	)	$	(47,350	)	$	(26,515	)
Total adjustments to gross profit		1,463			309			4,528			946
Total adjustments to operating expenses		4,167			2,041			12,426			11,453
Gain on extinguishment of note payable		—			(5,094	)		—			(5,094	)
Non-GAAP net loss	$	(9,300	)	$	(5,615	)	$	(30,396	)	$	(19,210	)

GAAP loss per common share (diluted)	$	(0.76	)	$	(0.17	)	$	(2.51	)	$	(1.61	)
Non-GAAP net loss	$	(9,300	)	$	(5,615	)	$	(30,396	)	$	(19,210	)
Non-GAAP loss per common share (diluted)	$	(0.47	)	$	(0.34	)	$	(1.61	)	$	(1.17	)

Non-GAAP gross profit for the three and nine month periods ended September 30, 2022, increased by $1.1 million and $2.3 million, respectively, compared to the three and nine month periods ended September 30, 2021. The increase was primarily due to higher gross profit contribution from higher subscription revenue.

Non-GAAP gross profit margin for the three and nine month periods ended September 30, 2022, compared to the three and nine month periods ended September 30, 2021, changed slightly reflecting differences in the mix of subscription revenue as some subscription products have higher margins than others.

Non-GAAP operating expenses for the three month period ended September 30, 2022, increased by $5.4 million compared to the three month period ended September 30, 2021. The increase includes $3.3 million of EVRYTHNG Non-GAAP operating expenses post acquisition, after excluding the EVRYTHNG portion of the adjustments above for amortization expense on acquired intangible assets of $0.3 million and stock-based compensation of $0.5 million. Excluding the impact of EVRYTHNG, Non-GAAP operating expenses increased $2.0 million primarily due to $0.8 million of cash severance costs incurred for organizational changes we made in the third quarter of 2022 and $0.8 million of higher cash compensation costs due to annual compensation adjustments and higher headcount.

Non-GAAP operating expenses for the nine month period ended September 30, 2022, increased by $14.6 million compared to the corresponding nine month period ended September 30, 2021. The increase includes $10.5 million of EVRYTHNG Non-GAAP operating expenses post acquisition, after excluding the EVRYTHNG portion of the adjustments above for amortization expense on acquired intangible assets of $1.0 million and stock-based compensation of $1.3 million. Excluding the impact of EVRYTHNG, Non-GAAP operating expenses increased $4.0 million primarily reflecting $3.3 million of higher cash compensation costs due to annual

compensation adjustments and higher headcount, $0.8 million of cash severance costs incurred for organizational changes we made in the third quarter of 2022, $0.7 million of higher travel and conference costs, $0.5 million of higher legal, accounting and tax costs for financing and other activities, $0.3 million of higher consulting costs, $0.2 million of higher insurance costs and $0.2 million of operating taxes, partially offset by $2.2 million of cash costs associated with the Separation Agreement we entered into with our former chief executive officer and $0.3 million of cash severance costs incurred for organizational changes we made in the second quarter of 2021.

Liquidity and Capital Resources

	September 30,		December 31,
	2022		2021
Working capital	$	57,502	$	36,295
Current ratio (1)	5.4:1		5.7:1
Cash, cash equivalents and short-term marketable securities	$	56,357	$	33,326
Long-term marketable securities	$	—	$	8,292
Total cash, cash equivalents and marketable securities	$	56,357	$	41,618

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

The $14.7 million increase in cash, cash equivalents and marketable securities at September 30, 2022, from December 31, 2021, resulted primarily from:

•

net proceeds from the issuance of common stock; partially offset by

•

cash used in operations;

•

net cash paid for the acquisition of EVRYTHNG;

•

purchases of common stock related to tax withholding in connection with the vesting of restricted stock, restricted stock units, and performance stock units; and

•

purchases of property and equipment and capitalized patent costs.

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 our marketable securities with major financial institutions. At times deposits may exceed insured limits. Marketable securities primarily include commercial paper, federal agency notes, corporate notes, and pre-refunded municipals. Our investment policy requires our portfolio to be invested to ensure that the greater of $3,000 or 7% of the invested funds will be available within 30 days’ 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, cash equivalents, and marketable securities or $1,000, whichever is greater, to be invested in any one issuer except for the U.S. government, U.S. federal agencies and U.S. backed securities, which have no limits, at the time of purchase. Our investment policy also limits our credit exposure by limiting to a maximum of 40% of our cash, cash equivalents, and marketable securities, or $15,000, whichever is greater, to be invested in any one industry category (e.g., financial, energy, etc.) at the time of purchase. As a result, we believe our credit risk associated with cash, cash equivalents, and marketable securities to be minimal.

Operating Cash Flow

The components of cash flows used in operating activities were:

	Nine			Nine
	Months			Months
	Ended			Ended			Dollar			Percent
	September 30,			September 30,			Increase			Increase
	2022			2021			(Decrease)			(Decrease)
Net loss	$	(47,350	)	$	(26,515	)	$	20,835			79	%
Non-cash items		16,507			7,861			(8,646	)		(110	)%
Changes in operating assets and liabilities		(6,045	)		191			6,236			3265	%
Net cash used in operating activities	$	(36,888	)	$	(18,463	)	$	18,425			100	%

Cash flows used in operating activities for the nine month period ended September 30, 2022, increased by $18,425, compared to the corresponding nine month period ended September 30, 2021, primarily as a result of a larger net loss and changes in operating assets and liabilities, partially offset by an increase in non-cash items included in net loss. Changes in operating assets and liabilities primarily reflects changes in the timing and amounts of vendor payments reflected in other current assets and accounts payable. Non-cash items increased primarily due to the gain on forgiveness of our PPP loan in 2021, higher amortization of acquired intangible assets, and the impairment on lease right of use assets and leasehold improvements, partially offset by lower stock-based compensation.

Cash flows provided by investing activities for the nine month period ended September 30, 2022, compared to the corresponding nine month period ended September 30, 2021, decreased by $21,894, from $28,820 to $6,926, primarily as a result of lower net maturities of marketable securities and $3,512 of net cash paid for the acquisition of EVRYTHNG.

Cash flows from financing activities for the nine month period ended September 30, 2022, compared to the corresponding nine month period ended September 30, 2021, improved by $61,526, from $4,898 of cash used to $56,628 of cash provided, primarily as a result of the net proceeds of $58,220 from the registered direct offering in April 2022 and lower repurchases of shares of common stock in satisfaction of required withholding tax liability on employee stock awards.

Future Cash Expectations

We believe that our current cash, cash equivalents, and marketable securities balances will satisfy our projected working capital and capital expenditure requirements for at least the next 12 months. We continuously review our liquidity and anticipated capital requirements in light of the uncertainty created by the COVID-19 pandemic.

Registered Direct Offering

On April 5, 2022, we entered into purchase agreements with certain investors providing for the issuance and sale by us of 2,250 common shares in a registered direct offering. The common shares were offered at a price of $25.90 per share, and the gross cash proceeds to us were $58,275. We incurred $55 of legal costs related to the offering. The closing of the registered direct offering occurred on April 7, 2022.

Equity Distribution Agreement

On May 16, 2019, we entered into an Equity Distribution Agreement, whereby we may sell from time to time through Wells Fargo Securities, LLC, as our sales agent, our common stock having an aggregate offering price of up to $30,000. Wells Fargo Securities, LLC will receive from us a commission equal to 2.50% of the gross sales price per share of common stock for shares having an aggregate offering price of up to $10,000, and a commission of 2.25% of the gross sales price per share of common stock thereafter, for shares sold under the Equity Distribution Agreement. We did not sell any shares under this Equity Distribution Agreement during the nine months ended September 30, 2022 and 2021. As of September 30, 2022, $6,932 remains available for future issuance under the Equity Distribution Agreement.

Shelf Registration

On June 5, 2020, we filed a new shelf registration statement on Form S-3 that included $49,265 of unsold securities from our prior shelf registration statement filed on May 26, 2017 that expired in June 2020. Under the new shelf registration statement, we may sell securities in one or more offerings up to $100,000. As of September 30, 2022, $39,617 remains available under the shelf registration. The new shelf registration statement will expire in July 2023.

We may sell shares under the shelf registration and/or use similar or other financing means to raise working capital in the future, if necessary, to support continued investment in our growth initiatives. We may also raise capital in the future to fund acquisitions

and/or investments in complementary businesses, technologies or product lines. If it becomes necessary to obtain additional financing, we may not be able to do so, or if these funds are available, they may not be available on satisfactory terms. The COVID-19 pandemic has created substantial uncertainty and volatility in the stock market, particularly in the small-cap sector in which our stock is traded, and negatively impacted our share price. These factors may inhibit our near-term ability to obtain financing.

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, as amended (the “Exchange Act”), and Section 27A of the Securities Act of 1933. Words such as “may,” “might,” “plan,” “should,” “could,” “expect,” “anticipate,” “intend,” “believe,” “project,” “forecast,” “estimate,” “continue,” and 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. We believe that the following factors, among others (including those described in Item 1A. “Risk Factors” of our 2021 Annual Report), 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. Forward-looking statements include but are not limited to statements relating to:

•

our expectations regarding the acquisition of EVRYTHNG and its impact on our business, including our expectations regarding no additional shares being issued in connection with the acquisition except any holdback shares;

•

our beliefs regarding the possible effects of the COVID-19 pandemic on general economic conditions, public health, and consumer demand, and the Company’s results of operations, liquidity, capital resources, and general performance in the future;

•

the possible impact of COVID-19 on our ability to obtain financing through our Equity Distribution Agreement and the availability of any alternative sources of financing;

•

our forgiven PPP loan;

•

the potential impact of COVID-19 on projects with our Commercial customers and partners;

•

the concentration of most of our revenue among few customers;

•

and the trends and sources of future revenue;

•

anticipated successful advocacy of our technology by our partners;

•

our belief regarding the global deployment of our products;

•

our beliefs regarding potential outcomes of participating in the HolyGrail 2.0 initiative and the utility of our products in the recycling industry;

•

our ESG projects and ESG Impact Report;

•

our future level of investment in our business, including investment in research, development and engineering of products and technology, development of our intellectual property, sales growth initiatives and development of new market opportunities;

•

anticipated expenses, costs, margins, provision for income taxes and investment activities in the foreseeable future;

•

our assumptions and expectations related to stock awards;

•

our belief that we have one of the world’s most extensive patent portfolios in digital watermarking and related fields;

•

anticipated effect of our adoption of accounting pronouncements;

•

our beliefs regarding our critical accounting policies;

•

our expectations regarding the impact of accounting pronouncements issued but not yet adopted;

•

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

•

our estimates, judgments and assumptions related to impairment testing;

•

variability of contracted arrangements in response to changes in circumstances underlying the original contractual arrangements;

•

business opportunities that could require that we seek additional financing and our ability to do so;

•

the size and growth of our markets and our assumptions and beliefs related to those markets;

•

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

•

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

•

our capital expenditure and working capital requirements and our ability to fund our capital expenditure and working capital needs through cash flow from operations or financing;

•

our expectations regarding our ability to meet future financial obligations as they become due within the coming fiscal year;

•

the effect of computerized trading on our stock price;

•

capital market conditions, our expectations regarding credit risk exposure, 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;

•

our use of cash, cash equivalents and marketable securities in upcoming quarters and the possibility that our deposits of cash and cash equivalents with major banks and financial institutions may exceed insured limits;

•

the strength of our competitive position and our ability to innovate and enhance our competitive differentiation;

•

our beliefs related to our existing facilities;

•

protection, development and monetization of our intellectual property portfolio;

•

our beliefs related to our relationship with our employees and the effect of increasing diversity within our workforce;

•

our beliefs regarding cybersecurity incidents;

•

our beliefs related to certain provisions in our bylaws and articles of incorporation; and

•

our beliefs related to legal proceedings and claims arising in the ordinary course of business.

We believe that the risk factors specified above and the risk factors contained in 2021 Part I, Item 1A. “Risk Factors” of our 2021 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 4.

Controls and Procedures.

Evaluation of Disclosure Controls and Procedures

We conducted an evaluation (pursuant to Rule 13a-15(b) of 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 our disclosure controls and procedures (as defined in Rule 13a-15(e)) as of the end of the period covered by this Quarterly Report on Form 10-Q. These disclosure controls and procedures are designed to ensure that information required to be disclosed by us in reports that we file or submit 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 our management, including our principal executive officer and principal financial officer, as appropriate, to allow timely decisions regarding required disclosure.

Based on the evaluation, our Chief Executive Officer and Chief Financial Officer have concluded that our disclosure controls and procedures, as of the end of the period covered by this Quarterly Report on Form 10-Q, were effective.

Changes in Controls

There were no changes 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 three month period ended September 30, 2022, that have materially affected, or are reasonably

likely to materially affect, our internal control over financial reporting. We completed our acquisition of EVRYTHNG on January 3, 2022. We are working to integrate EVRYTHNG into our internal control over financial reporting, and management’s evaluation of the effectiveness of our internal control over financial reporting.

PART II. OTHER INFORMATION.

Item 1.

Legal Proceedings.

We are subject from time to time to legal proceedings and claims arising in the ordinary course of business. At this time, we do not believe that the resolution of any such matters will have a material adverse effect on our financial position, results of operations or cash flows.

Item 1A.

Risk Factors

Our business, financial condition, results of operations and cash flows may be affected by a number of factors. Detailed information about risk factors that may affect Digimarc’s actual results are set forth in Part I, Item 1A: “Risk Factors” of our 2021 Annual Report. The risks and uncertainties described in our 2021 Annual Report are those risks of which we are aware and that we consider to be material to our business. If any of those risks and uncertainties develop 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. As of September 30, 2022, there have been no material changes to the risk factors previously disclosed in our 2021 Annual Report.

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds.

We repurchase shares of common stock in satisfaction of required withholding tax liability in connection with the exercise of stock options and vesting of restricted stock, restricted stock units and performance stock units.

The following table sets forth information regarding purchases of our equity securities during the three month period ended September 30, 2022:

							(d)
					(c)		Approximate
					Total number		dollar value
					of shares		of shares that
	(a)		(b)		purchased as		may yet be
	Total number		Average price		part of publicly		purchased
	of shares		paid per		announced plans		under the plans
Period	purchased (1)		share (1)		or programs		or programs
Month 1
July 1, 2022 to July 30, 2022		—	$	—		—	$	—
Month 2
August 1, 2022 to August 31, 2022		28,222	$	19.63		—	$	—
Month 3
September 1, 2022 to September 30, 2022		24,893	$	13.55		—	$	—
Total		53,115	$	16.78		—	$	—

(1)	Stock option shares and fully vested shares of common stock withheld (purchased) by us in satisfaction of required withholding tax liability upon stock option exercises and vesting of restricted stock, restricted stock units and performance stock units.

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

101.INS		Inline XBRL Instance Document

101.SCH		Inline XBRL Taxonomy Extension Schema Document

101.CAL		Inline XBRL Taxonomy Extension Calculation Linkbase Document

101.DEF		Inline XBRL Taxonomy Extension Definition Linkbase Document

101.LAB		Inline XBRL Taxonomy Extension Label Linkbase Document

101.PRE		Inline XBRL Taxonomy Extension Presentation Linkbase Document

104		Cover Page Interactive Data File (formatted in Inline XBRL and contained in Exhibit 101)

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

Date: November 3, 2022	DIGIMARC CORPORATION

	By:	/s/ CHARLES BECK
		CHARLES BECK
		Chief Financial Officer
		(Duly Authorized Officer and Principal Financial and Accounting Officer)