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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-Q

(Mark One)    

ý

 

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

For the quarterly period ended September 30, 2009

OR

o

 

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)

Delaware
(State or other jurisdiction of
incorporation or organization)
  26-2828185
(I.R.S. Employer Identification No.)

9405 SW Gemini Drive, Beaverton, Oregon 97008
(Address of principal executive offices) (Zip Code)

(503) 469-4800
(Registrant's telephone number, including area code)

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

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

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

Large accelerated filer o   Accelerated filer o   Non-accelerated filer o
(Do not check if a smaller
reporting company)
  Smaller reporting company ý

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

        As of October 26, 2009, there were 7,256,200 shares of the registrant's common stock, par value $0.001 per share, outstanding.


Table of Contents

Table of Contents

PART I FINANCIAL INFORMATION

   

Item 1.

 

Financial Statements:

 
3

 

Balance Sheets as of September 30, 2009 and December 31, 2008 (Unaudited)

  3

 

Statements of Operations for the three-months ended September 30, 2009, for the Period August 2, 2008 through September 30, 2008 and for the Period July 1, 2008 through August 1, 2008 (Unaudited)

  4

 

Statements of Operations for the nine-months ended September 30, 2009, for the Period August 2, 2008 through September 30, 2008 and for the Period January 1, 2008 through August 1, 2008 (Unaudited)

  5

 

Statements of Stockholders' Equity as of September 30, 2009 and for the period August 2, 2008 through December 31, 2008 (Unaudited)

  6

 

Statements of Cash Flows for the nine-months ended September 30, 2009, for the Period August 2, 2008 through September 30, 2008 and for the Period January 1, 2008 through August 1, 2008 (Unaudited)

  7

 

Notes to Financial Statements (Unaudited)

  8

Item 2.

 

Management's Discussion and Analysis of Financial Condition and Results of Operations

  30

Item 3.

 

Quantitative and Qualitative Disclosures About Market Risk

  54

Item 4T.

 

Controls and Procedures

  54

PART II OTHER INFORMATION

   

Item 1.

 

Legal Proceedings

 
55

Item 1A.

 

Risk Factors

  55

Item 2.

 

Unregistered Sales of Equity Securities and Use of Proceeds

  56

Item 6.

 

Exhibits

  57

SIGNATURES

 
58

2


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PART I. FINANCIAL INFORMATION

Item 1.    Financial Statements.

        


DIGIMARC CORPORATION

BALANCE SHEETS

(In thousands, except share data)

(UNAUDITED)

 
  Successor   Successor  
 
  September 30,
2009
  December 31,
2008(1)
 

ASSETS

             

Current assets:

             
 

Cash and cash equivalents

  $ 10,685   $ 18,928  
 

Marketable securities

    30,760     21,240  
 

Trade accounts receivable, net

    3,027     3,839  
 

Other current assets

    1,001     875  
           
   

Total current assets

    45,473     44,882  

Marketable securities

    2,087     5,744  

Property and equipment, net

    1,180     1,212  

Intangibles, net

    1,088     456  

Other assets, net

    544     147  
           
   

Total assets

  $ 50,372   $ 52,441  
           

LIABILITIES AND STOCKHOLDERS' EQUITY

             

Current liabilities:

             
 

Accounts payable and other accrued liabilities

  $ 767   $ 937  
 

Accrued payroll and related costs

    246     42  
 

Accrued merger related liabilities

    144     386  
 

Deferred revenue

    1,716     2,418  
           
   

Total current liabilities

    2,873     3,783  

Long-term liabilities

    134     257  
           
   

Total liabilities

    3,007     4,040  

Commitments and contingencies (Note 11)

             

Stockholders' equity:

             
 

Preferred stock (10,000 shares issued and outstanding at September 30, 2009 and December 31, 2008)

    50     50  
 

Common stock (7,256,200 and 7,279,442 shares issued and outstanding at September 30, 2009 and December 31, 2008, respectively)

    7     7  
 

Additional paid-in capital

    49,406     48,268  
 

Retained earnings (accumulated deficit)

    (2,098 )   76  
           
   

Total stockholders' equity

    47,365     48,401  
           
   

Total liabilities and stockholders' equity

  $ 50,372   $ 52,441  
           

(1)
Derived from the Company's December 31, 2008 audited financial statements

See Notes to Unaudited Financial Statements.

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DIGIMARC CORPORATION

STATEMENTS OF OPERATIONS

(In thousands, except per share data)

(UNAUDITED)

 
  Successor   Successor    
  Predecessor  
 
  Three
Months
Ended
September 30,
2009
  Period
August 2,
2008
through
September 30,
2008
   
  Period
July 1,
2008
through
August 1,
2008
 

Revenue:

                       
 

Service

  $ 2,827   $ 1,645       $ 921  
 

License and subscription

    1,942     1,536         829  
                   
   

Total revenue

    4,769     3,181         1,750  

Cost of revenue:

                       
 

Service

    1,499     890         527  
 

License and subscription

    42     44         25  
                   
   

Total cost of revenue

    1,541     934         552  

Gross profit

    3,228     2,247         1,198  

Operating expenses:

                       
 

Sales and marketing

    753     390         589  
 

Research, development and engineering

    1,191     780         239  
 

General and administrative

    1,566     932         442  
 

Intellectual property

    262     120         176  
 

Transitional services

    (45 )   (196 )        
                   
   

Total operating expenses

    3,727     2,026         1,446  
                   

Operating income (loss)

    (499 )   221         (248 )

Other income (expense), net

    (185 )   179         75  
                   

Income (loss) before provision for income taxes

    (684 )   400         (173 )

Provision for income taxes

    (3 )            
                   
   

Net income (loss)

  $ (687 ) $ 400       $ (173 )
                   

Earnings (loss) per share:

                       

Net income (loss) per share—basic

  $ (0.10 ) $ 0.06            

Net income (loss) per share—diluted

  $ (0.10 ) $ 0.06            
 

Weighted average shares outstanding—basic

    7,134     7,143            
 

Weighted average shares outstanding—diluted

    7,134     7,143            

Pro-forma loss per share:

                       

Net loss per share—basic

                  $ (0.02 )

Net loss per share—diluted

                  $ (0.02 )
 

Weighted average shares outstanding—basic

                    7,143  
 

Weighted average shares outstanding—diluted

                    7,143  

See Notes to Unaudited Financial Statements.

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DIGIMARC CORPORATION

STATEMENTS OF OPERATIONS

(In thousands, except per share data)

(UNAUDITED)

 
  Successor   Successor    
  Predecessor  
 
  Nine
Months
Ended
September 30,
2009
  Period
August 2,
2008
through
September 30,
2008
   
  Period
January 1,
2008
through
August 1,
2008
 

Revenue:

                       
 

Service

  $ 7,882   $ 1,645       $ 6,456  
 

License and subscription

    5,640     1,536         5,494  
                   
   

Total revenue

    13,522     3,181         11,950  

Cost of revenue:

                       
 

Service

    4,396     890         3,519  
 

License and subscription

    158     44         145  
                   
   

Total cost of revenue

    4,554     934         3,664  

Gross profit

    8,968     2,247         8,286  

Operating expenses:

                       
 

Sales and marketing

    2,226     390         1,928  
 

Research, development and engineering

    3,679     780         2,071  
 

General and administrative

    4,750     932         2,349  
 

Intellectual property

    756     120         1,102  
 

Transitional services

    (153 )   (196 )        
                   
   

Total operating expenses

    11,258     2,026         7,450  
                   

Operating income (loss)

    (2,290 )   221         836  

Other income, net

    128     179         590  
                   

Income (loss) before provision for income taxes

    (2,162 )   400         1,426  

Provision for income taxes

    (12 )           (11 )
                   
   

Net income (loss)

  $ (2,174 ) $ 400       $ 1,415  
                   

Earnings (loss) per share:

                       

Net income (loss) per share—basic

  $ (0.30 ) $ 0.06            

Net income (loss) per share—diluted

  $ (0.30 ) $ 0.06            
 

Weighted average shares outstanding—basic

    7,150     7,143            
 

Weighted average shares outstanding—diluted

    7,150     7,143            

Pro-forma earnings per share:

                       

Net income per share—basic

                  $ 0.20  

Net income per share—diluted

                  $ 0.20  
 

Weighted average shares outstanding—basic

                    7,143  
 

Weighted average shares outstanding—diluted

                    7,143  

See Notes to Unaudited Financial Statements.

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DIGIMARC CORPORATION

STATEMENTS OF STOCKHOLDERS' EQUITY

(In thousands, except share data)

(UNAUDITED)

 
  Preferred stock   Common stock    
  Retained
Earnings
(Accumulated
Deficit)
   
   
 
 
  Additional
paid-in
capital
  Net Parent
Investment
  Total
stockholders'
equity
 
 
  Shares   Amount   Shares   Amount  

PREDECESSOR

                                                 

BALANCE AT AUGUST 1, 2008

   
 
$

   
 
$

 
$

 
$

 
$

47,793
 
$

47,793
 
                                   

 

 

SUCCESSOR

                                                 

August 2, 2008: Stock issued through spin-off of Digimarc

    10,000   $ 50     7,143,442   $ 7   $ 47,736   $   $ (47,793 ) $  

Issuance of restricted common stock

            136,000                      

Stock-based compensation expense

                    532             532  

Net income

                        76         76  
                                   

BALANCE AT DECEMBER 31, 2008

    10,000   $ 50     7,279,442   $ 7   $ 48,268   $ 76   $   $ 48,401  
                                   

Exercise of stock options

            15,713         152             152  

Issuance of restricted common stock

            20,400                      

Purchase and retirement of common stock

            (59,355 )       (822 )           (822 )

Stock-based compensation expense

                    1,808             1,808  

Net loss

                        (2,174 )       (2,174 )
                                   

BALANCE AT SEPTEMBER 30, 2009

    10,000   $ 50     7,256,200   $ 7   $ 49,406   $ (2,098 ) $   $ 47,365  
                                   

See Notes to Unaudited Financial Statements.

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DIGIMARC CORPORATION

STATEMENTS OF CASH FLOWS

(In thousands)

(UNAUDITED)

 
  Successor   Successor    
  Predecessor  
 
  Nine
Months
Ended
September 30,
2009
  Period
August 2,
2008
through
September 30,
2008
   
  Period
January 1,
2008
through
August 1,
2008
 

Cash flows from operating activities:

                       
 

Net income (loss)

  $ (2,174 ) $ 400       $ 1,415  
 

Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities:

                       
   

Depreciation and amortization

    425     69         568  
   

Stock-based compensation expense

    1,808             914  
   

Net loss from joint ventures

    311              
   

Decrease in allowance for doubtful accounts

                (43 )
   

Other non-cash charges

                405  
   

Changes in operating assets and liabilities:

                       
     

Trade accounts receivable, net

    812     (502 )       718  
     

Other current assets

    (126 )   4,182         (4,370 )
     

Other assets, net

    (158 )   20         (103 )
     

Accounts payable and other accrued liabilities

    (155 )   (383 )       744  
     

Accrued payroll and related costs

    204     (399 )       1,854  
     

Accrued merger related liabilities

    (242 )   (8,860 )       10,766  
     

Deferred revenue

    (714 )   343         (677 )
     

Other liabilities

    (87 )   50         19  
                   
       

Net cash provided by (used in) operating activities

    (96 )   (5,080 )       12,210  

Cash flows from investing activities:

                       
 

Purchase of property and equipment

    (374 )   (24 )       (799 )
 

Capitalized patent costs

    (651 )   (187 )        
 

Investment in joint ventures

    (550 )            
 

Sale or maturity of marketable securities

    20,738     69,674         136,767  
 

Purchase of marketable securities

    (26,601 )   (70,745 )       (137,048 )
                   
       

Net cash used in investing activities

    (7,438 )   (1,282 )       (1,080 )

Cash flows from financing activities:

                       
 

Cash from Parent stock activity

                23,862  
 

Net activity with Parent

                (13,237 )
 

Issuance of common stock

    152              
 

Purchase of common stock

    (822 )            
 

Principal payments under capital lease obligations

    (39 )            
                   
       

Net cash provided by (used in) financing activities

    (709 )           10,625  
                   
       

Net increase (decrease) in cash and cash equivalents

    (8,243 )   (6,362 )       21,755  
       

Cash and cash equivalents at beginning of period

    18,928     50,900         29,145  
                   
       

Cash and cash equivalents at end of period

  $ 10,685   $ 44,538       $ 50,900  
                   

Supplemental disclosure of cash flow information:

                       
 

Cash paid for interest

  $ 4   $ 1       $ 7  
 

Cash paid for income taxes

  $ 12   $       $ 11  

See Notes to Unaudited Financial Statements.

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DIGIMARC CORPORATION

NOTES TO FINANCIAL STATEMENTS

(Dollar amounts in thousands, except per share data)

(UNAUDITED)

1. Description of Business and Summary of Significant Accounting Policies

Description of Business

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

Acquisition of Old Digimarc and Separation of DMRC Corporation

        On June 29, 2008, the former Digimarc Corporation ("Old Digimarc") entered into an amended and restated merger agreement, as amended by Amendment No. 1 dated as of July 17, 2008, which we refer to as the Old Digimarc/L-1 merger agreement, with L-1 Identity Solutions, Inc. ("L-1") and Dolomite Acquisition Co. ("Dolomite"), a wholly owned subsidiary of L-1, pursuant to which Dolomite, in a transaction which we refer to as the offer, purchased more than 90% of the outstanding shares of Old Digimarc common stock, together with the associated preferred stock purchase rights, for $12.25 per share. On August 13, 2008, following the completion of the offer, Dolomite merged with and into Old Digimarc with Old Digimarc continuing as the surviving company and a wholly owned subsidiary of L-1.

        On August 1, 2008, prior to the initial expiration of the offer, Old Digimarc contributed all of the assets and liabilities related to its digital watermarking business, which we refer to as the Digital Watermarking Business, together with all of Old Digimarc's cash, to DMRC LLC. Following the restructuring, all of the limited liability company interests of DMRC LLC were transferred to a newly created trust for the benefit of Old Digimarc record holders. DMRC LLC then merged with and into DMRC Corporation, and each limited liability company interest of DMRC LLC was converted into one share of common stock of DMRC Corporation. After completion of the Old Digimarc/L-1 merger, DMRC Corporation changed its name to Digimarc Corporation. The shares of Digimarc common stock were held by the trust until the Form 10, General Form for Registration of Securities, was declared effective by the Securities and Exchange Commission ("SEC") on October 16, 2008, at which time the shares were distributed to Old Digimarc record holders, as beneficiaries of the trust, pro rata in accordance with their ownership of shares of Old Digimarc common stock on August 1, 2008 at 5:30 pm Eastern time, the spin-off record date and time. Each Old Digimarc record holder was entitled to receive one share of Digimarc common stock for every three and one half shares of Old Digimarc common stock held by the stockholder as of the spin-off record date and time.

Joint Venture and Patent License Agreements with The Nielsen Company

        On June 11, 2009 the Company entered into two joint venture agreements with The Nielsen Company ("Nielsen") to launch two new companies. The two joint venture agreements and a revised patent license agreement expand and replace the previous license and services agreement between the

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DIGIMARC CORPORATION

NOTES TO FINANCIAL STATEMENTS (Continued)

(Dollar amounts in thousands, except per share data)

(UNAUDITED)

1. Description of Business and Summary of Significant Accounting Policies (Continued)


Company and Nielsen that has been in operation since late 2007. Under the new agreements, the Company and Nielsen plan to work together to develop new products and services, including the expansion and deployment of those products and services that were in development under the prior agreement.

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

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

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

        Pursuant to the terms of the agreements and Accounting Standards Codification ("ASC") 810 "Consolidation" (formerly Emerging Issues Task Force ("EITF") Issue No. 96-16, "Investor's Accounting for an Investee When the Investor Has a Majority of the Voting Interest but the Minority Shareholders Have Certain Approval or Veto Rights"), the joint ventures will not be consolidated with the Company and will be separately disclosed in the financial statements and notes to financial statements.

Interim Financial Statements

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

        These financial statements should be read in conjunction with the audited financial statements included in the Company's Annual Report on Form 10-K for the year ended December 31, 2008, which was filed with the SEC on February 27, 2009. The results of operations for the interim periods presented in these financial statements are not necessarily indicative of the results for the full year.

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DIGIMARC CORPORATION

NOTES TO FINANCIAL STATEMENTS (Continued)

(Dollar amounts in thousands, except per share data)

(UNAUDITED)

1. Description of Business and Summary of Significant Accounting Policies (Continued)

Basis of Accounting: Predecessor Financial Statements

        The predecessor financial statements include certain accounts of Old Digimarc and the assets, liabilities and results of operations of Old Digimarc's Digital Watermarking Business that were separated, or "carved-out" from Old Digimarc. The operating expenses included in the predecessor financial statements include proportional allocations of various shared services common costs of Old Digimarc because specific identification of the expenses was not practicable. The common costs include expenses from Old Digimarc related to various operating shared services cost centers, including executive, finance and accounting, human resources, legal, marketing, intellectual property, facilities and information technology.

        Management believes that the assumptions underlying the predecessor financial statements are reasonable. The cost allocation methods applied to certain shared services common cost centers include the following:

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DIGIMARC CORPORATION

NOTES TO FINANCIAL STATEMENTS (Continued)

(Dollar amounts in thousands, except per share data)

(UNAUDITED)

1. Description of Business and Summary of Significant Accounting Policies (Continued)

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DIGIMARC CORPORATION

NOTES TO FINANCIAL STATEMENTS (Continued)

(Dollar amounts in thousands, except per share data)

(UNAUDITED)

1. Description of Business and Summary of Significant Accounting Policies (Continued)

        The financial information in the predecessor financial statements does not include all of the expenses that would have been incurred had the predecessor been a separate, stand-alone public entity. As such, the predecessor financial information does not reflect the financial position, results of operations and cash flows of Digimarc's current business, had the predecessor operated as a separate, stand-alone public entity during the periods presented in the predecessor financial statements. Additionally, the predecessor financial statements include proportional allocations of various shared services common costs of Old Digimarc because specific identification of these expenses was not practicable. It is expected that the initial operating costs of Digimarc on a stand-alone basis will be higher than those allocated to the predecessor operations under the shared services methodology applied in the predecessor financial statements. Consequently, the financial position, results of operations and cash flows reflected in the predecessor financial statements may not be indicative of those that would have been achieved had the predecessor operated as a separate, stand-alone entity for the periods reflected in the predecessor financial statements.

Use of Estimates

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

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DIGIMARC CORPORATION

NOTES TO FINANCIAL STATEMENTS (Continued)

(Dollar amounts in thousands, except per share data)

(UNAUDITED)

1. Description of Business and Summary of Significant Accounting Policies (Continued)

Marketable Securities

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

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

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

Fair Value of Financial Instruments

        ASC 820 "Fair Value Measurements and Disclosures" (formerly SFAS 157, "Fair Value Measurements") defines fair value, establishes a framework for measuring fair value under generally accepted accounting principles, and enhances disclosures about fair value measurements. ASC 820 describes a fair value hierarchy based on three levels of inputs, of which the first two are considered observable and the last unobservable, that may be used to measure fair value, which are the following:

        ASC 825 "Financial Instruments" (formerly SFAS No. 159, "The Fair Value Option for Financial Assets and Financial Liabilities") allows an entity the irrevocable option to elect fair value for the initial and subsequent measurement for specified financial assets and liabilities on a contract-by-contract basis. The Company did not elect the fair value option under this statement as to specific assets or liabilities.

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DIGIMARC CORPORATION

NOTES TO FINANCIAL STATEMENTS (Continued)

(Dollar amounts in thousands, except per share data)

(UNAUDITED)

1. Description of Business and Summary of Significant Accounting Policies (Continued)

Therefore, through September 30, 2009, the Company has not recognized the net change in fair value of its financial assets and liabilities.

        The estimated fair values of the Company's financial instruments, which include cash and cash equivalents, short- and long-term marketable securities, accounts receivable, accounts payable and accrued payroll approximate their carrying values due to the short-term nature of these instruments. The carrying amounts of capital leases approximate fair value because the stated interest rates approximate current market rates. These items are valued using either Level 1 or Level 2 inputs.

        The Company records marketable securities at amortized cost of $32,847, which approximates fair value. The fair value of the marketable securities at September 30, 2009, excluding accrued interest, was $32,782. The fair value is based on quoted market prices in active markets for identical assets, a Level 1 input.

        The Company records money market funds at cost and continues to carry those amounts at cost which equals fair value. The fair value is based on quoted market prices in active markets for identical assets, a Level 1 input. As of September 30, 2009, the cost and fair value of the Company's money market funds were each equal to $10,685.

Concentrations of Business and Credit Risk

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

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

Impairment of Long-Lived Assets

        The Company accounts for long-lived assets in accordance with the provisions of ASC 360 "Property, Plant and Equipment" (formerly SFAS No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets). This statement requires that long-lived assets and certain identifiable intangibles be reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Recoverability of assets to be held and used is measured by a comparison of the carrying amount of an asset to future net undiscounted cash flows expected to be generated by the asset. If such assets are considered to be impaired, the impairment to be recognized is measured by the amount by which the carrying amount of the assets exceeds the fair value of the assets. Fair value is determined based on discounted cash flows or appraised values, depending on the nature of the asset. Assets to be disposed of are reported at the lower of the carrying amount or fair value less costs to sell.

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DIGIMARC CORPORATION

NOTES TO FINANCIAL STATEMENTS (Continued)

(Dollar amounts in thousands, except per share data)

(UNAUDITED)

1. Description of Business and Summary of Significant Accounting Policies (Continued)

Software Development Costs

        Under ASC 985 "Software" (formerly SFAS No. 86, Accounting for the Cost of Computer Software to Be Sold, Leased, or Otherwise Marketed), software development costs are to be capitalized beginning when a product's technological feasibility has been established and ending when a product is made available for general release to customers. To date, the establishment of technological feasibility of the Company's products has occurred shortly before general release and, therefore, software development costs qualifying for capitalization have been immaterial. Accordingly, the Company has not capitalized any software development costs and has charged all such costs to research and development expense.

Research and Development

        Research and development costs are expensed as incurred as defined in 730 "Research and Development" (formerly SFAS No. 2, Accounting for Research and Development Costs). Digimarc accounts for amounts received under its funded research and development arrangements in accordance with the provisions of ASC 730 (also formerly SFAS No. 68, Research and Development Arrangements). Under the terms of the arrangements, Digimarc is not obligated to repay any of the amounts provided by the funding parties. As a result, Digimarc recognizes revenue as the services are performed.

Patent Costs

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

        Costs associated with the maintenance and annuity fees of patents are accounted for as prepaid assets at the time of payment and amortized over the respective periods, generally from one to four years. These costs were expensed in the predecessor financial statements.

Revenue Recognition

        The Company's revenue consists of subscription revenue, which includes hardware and software sales, royalties and revenues from the licensing of digital watermarking products and related authentication services. The Company's revenue recognition policy follows ASC 605 "Revenue Recognition," ASC 985 (formerly Statement of Position ("SOP") No. 97-2, Software Revenue Recognition, as amended by SOP No. 98-9, Modification of SOP No. 97-2, Software Recognition, With Respect to Certain Transactions, and SOP 81-1 Accounting for the Performance of Construction Type and Certain Production-Type Contracts, and EITF Issue No. 00-21, Revenue Arrangements with Multiple Deliverables), and SEC Staff Accounting Bulletin ("SAB") No. 104 Revenue Recognition.

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DIGIMARC CORPORATION

NOTES TO FINANCIAL STATEMENTS (Continued)

(Dollar amounts in thousands, except per share data)

(UNAUDITED)

1. Description of Business and Summary of Significant Accounting Policies (Continued)

Stock-Based Compensation

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

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

Income Taxes

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

2. Recent Accounting Standards Update

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

        In October 2009, the FASB issued ASU No. 2009-13, Revenue Recognition: Multiple-Deliverable Revenue Arrangements—a consensus of the FASB Emerging Issues Task Force, which eliminates the use of the residual method for allocating consideration, as well as the criteria that requires objective and reliable evidence of fair value of undelivered elements in order to separate the elements in a

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DIGIMARC CORPORATION

NOTES TO FINANCIAL STATEMENTS (Continued)

(Dollar amounts in thousands, except per share data)

(UNAUDITED)

2. Recent Accounting Standards Update (Continued)

multiple-element arrangement. By removing the criterion requiring the use of objective and reliable evidence of fair value in separately accounting for deliverables, the recognition of revenue will more closely align with certain revenue arrangements. The standard also will replace the term "fair value" in the revenue allocation guidance with "selling price" to clarify that the allocation of revenue is based on entity-specific assumptions rather than assumptions of a marketplace participant. ASU No. 2009-13 is effective for revenue arrangements entered or materially modified in fiscal years beginning on or after June 15, 2010. The Company is currently assessing the potential impact of this standard, but does not expect the adoption of the standard will have a material impact on the financial condition or results of operations of the Company.

        In June 2009, the FASB issued ASU 2009-01, Amendments based on Statement of Financial Accounting Standards No. 168—The FASB Accounting Standards Codification™ and the Hierarchy of Generally Accepted Accounting Principles, to codify in ASC 105, Generally Accepted Accounting Principles, FASB Statement 168, The FASB Accounting Standards Codification™ and the Hierarchy of Generally Accepted Accounting Principles, which was issued to establish the Codification as the sole source of authoritative U.S. GAAP recognized by the FASB, excluding SEC guidance, to be applied by nongovernmental entities. The guidance in ASC 105 is effective for financial statements issued for interim and annual periods ending after September 15, 2009. The Company has revised its references to pre-Codification GAAP and noted no impact on the financial condition or results of operations of the Company.

3. Revenue Recognition

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

        Some customer arrangements encompass multiple deliverables, such as software, maintenance fees, and software development fees. If the deliverables meet the criteria in ASC 605 (formerly EITF Issue No. 00-21), the deliverables are divided into separate units of accounting and revenue is allocated to the deliverables based on their relative fair values. The criteria specified in ASC 605 are as follows:

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DIGIMARC CORPORATION

NOTES TO FINANCIAL STATEMENTS (Continued)

(Dollar amounts in thousands, except per share data)

(UNAUDITED)

3. Revenue Recognition (Continued)

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

        ASC 985 (formerly AICPA SOP No. 98-9) requires that revenue be recognized using the "residual method" in circumstances when vendor specific objective evidence ("VSOE") exists only for undelivered elements. Under the residual method, revenue is recognized as follows: (1) the total fair value of undelivered elements, as indicated by VSOE, is deferred and subsequently recognized in accordance with the relevant sections of ASC 985, and (2) the difference between the total arrangement fee and the amount deferred for the undelivered elements is recognized as revenue related to the delivered elements.

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

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DIGIMARC CORPORATION

NOTES TO FINANCIAL STATEMENTS (Continued)

(Dollar amounts in thousands, except per share data)

(UNAUDITED)

3. Revenue Recognition (Continued)

4. Segment Information

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

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

 
  Successor   Successor    
  Predecessor   Successor    
  Predecessor  
 
  Three
Months
Ended
September 30,
2009
  Period
August 2,
2008
through
September 30,
2008
 

  Period
July 1,
2008
through
August 1,
2008
  Nine
Months
Ended
September 30,
2009
 

  Period
January 1,
2008
through
August 1,
2008
 

Domestic

  $ 2,165   $ 1,541       $ 960   $ 5,718       $ 6,274  

International

    2,604     1,640         790     7,804         5,676  
                               
 

Total

  $ 4,769   $ 3,181       $ 1,750   $ 13,522       $ 11,950  
                               

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

 
  Successor   Successor    
  Predecessor   Successor    
  Predecessor  
 
  Three
Months
Ended
September 30,
2009
  Period
August 2,
2008
through
September 30,
2008
 

  Period
July 1,
2008
through
August 1,
2008
  Nine
Months
Ended
September 30,
2009
 

  Period
January 1,
2008
through
August 1,
2008
 

Consortium of Central Banks

    49 %   44 %       40 %   51 %       39 %

The Nielsen Company

    21 %   35 %       38 %   27 %       38 %

TVaura LLC

    12 %               *          

*
Less than 10%

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DIGIMARC CORPORATION

NOTES TO FINANCIAL STATEMENTS (Continued)

(Dollar amounts 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 option grants and restricted stock awards.

        Stock-based compensation expense was allocated to the predecessor based on a combination of specific and shared services resource allocations from Old Digimarc. All cash flow related to stock compensation generated by Old Digimarc was retained by Digimarc. Stock-based compensation recognized in the three- and nine-month periods ended September 30, 2009 was based on the value of the portion of the stock-based award that vested during the period. Compensation cost for all stock-based awards is recognized using the straight-line method.

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

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

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

        Expected Term (Life).    The expected life of awards granted represents the period of time that they are expected to be outstanding. The Company determined the initial expected life based on a simplified method in accordance with ASC 718 (also formerly SAB No. 110 "Shared-Based Payment"), giving consideration to the contractual terms, vesting schedules and pre-vesting and post-vesting forfeitures. Stock options granted generally vest over four years for employee grants and two years for director grants, and have contractual terms of ten years.

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

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

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DIGIMARC CORPORATION

NOTES TO FINANCIAL STATEMENTS (Continued)

(Dollar amounts in thousands, except per share data)

(UNAUDITED)

5. Stock-Based Compensation (Continued)

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

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

        A summary of the weighted average assumptions and results for options granted during the period August 2, 2008 through September 30, 2009 is as follows:

 
  Range

Period August 2, 2008 through September 30, 2009:

   
 

Expected life (in years)

  5.6 - 6.0
 

Expected volatility

  70% - 72%
 

Risk-free interest rate

  2.8% - 2.9%
 

Expected dividend yield

  0%
 

Expected forfeiture rate

  0%

        The estimated average fair value of outstanding stock options was $6.28 per share at September 30, 2009.

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

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

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DIGIMARC CORPORATION

NOTES TO FINANCIAL STATEMENTS (Continued)

(Dollar amounts in thousands, except per share data)

(UNAUDITED)

5. Stock-Based Compensation (Continued)

 
  Successor   Successor    
  Predecessor   Successor    
  Predecessor  
 
  Three
Months
Ended
September 30,
2009
  Period
August 2,
2008
through
September 30,
2008
 

  Period
July 1,
2008
through
August 1,
2008
  Nine
Months
Ended
September 30,
2009
 

  Period
January 1,
2008
through
August 1,
2008
 

Stock-based compensation:

                                       
 

Cost of revenue

  $ 57   $       $ 14   $ 156       $ 99  
 

Sales and marketing

    50             32     152         208  
 

Research, development and engineering

    47             4     140         34  
 

General and administrative

    451             81     1,290         537  
 

Intellectual property

    24             5     70         35  
                               

Total stock-based compensation

  $ 629   $       $ 136   $ 1,808       $ 913  
                               

        At September 30, 2009, the Company had 10,000 shares of Series A redeemable nonvoting preferred stock, 1.0 million non-vested options to purchase common stock and 141,400 shares of restricted common stock outstanding. As of September 30, 2009, the Company had $6,906 of total unrecognized compensation cost related to non-vested stock-based awards granted under all equity compensation plans, including preferred stock, stock options and restricted stock. Total unrecognized compensation cost will be adjusted for any future changes in estimated forfeitures. The Company expects to recognize this compensation cost for stock options and restricted stock over a weighted average period of 1.54 years and 1.82 years, respectively, through June 2013.

        As of September 30, 2009, under all of the Company's stock-based compensation plans, options to purchase an aggregate of 1.2 million shares were outstanding, and options to purchase an additional 1.1 million shares were authorized for future grants under the plans. The Company issues new shares upon option exercises.

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DIGIMARC CORPORATION

NOTES TO FINANCIAL STATEMENTS (Continued)

(Dollar amounts in thousands, except per share data)

(UNAUDITED)

5. Stock-Based Compensation (Continued)

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

Three-months ended September 30, 2009:
  Options   Weighted
Average
Exercise
Price
  Weighted
Average
Remaining
Contractual
Life

Outstanding at June 30, 2009

    1,224,000   $ 9.65    
 

Options granted

           
 

Options exercised

    (15,713 ) $ 9.64    
 

Options canceled or expired

           
               

Outstanding at September 30, 2009

    1,208,287   $ 9.65   9.09 years
             

Exercisable at September 30, 2009

    249,573   $ 9.65   9.10 years
             

 

Nine-months ended September 30, 2009:
  Options   Weighted
Average
Exercise
Price
  Weighted
Average
Remaining
Contractual
Life

Outstanding at December 31, 2008

    1,194,000   $ 9.64    
 

Options granted

    30,000   $ 9.91    
 

Options exercised

    (15,713 ) $ 9.64    
 

Options canceled or expired

           
               

Outstanding at September 30, 2009

    1,208,287   $ 9.65   9.09 years
             

Exercisable at September 30, 2009

    249,573   $ 9.65   9.10 years
             

        The following table summarizes information about stock options outstanding at September 30, 2009:

 
  Options Outstanding   Options Exercisable  
Range of Exercise Prices
  Number
Outstanding
  Remaining
Contractual
Life (Years)
  Weighted
Average
Price
  Number
Exercisable
  Weighted
Average
Price
 

$9.64

    1,178,287     9.08   $ 9.64     239,573   $ 9.64  

$9.91

    30,000     9.58   $ 9.91     10,000   $ 9.91  
                             

$9.64 - $9.91

    1,208,287     9,09   $ 9.65     249,573   $ 9.65  
                             

        At September 30, 2009, the aggregate intrinsic value of outstanding and exercisable stock options was $6,698 and $1,382, respectively. The aggregate intrinsic value is based on our closing price of $15.19 per share on September 30, 2009, which would have been received by the optionees had all of the options with exercise prices less than $15.19 per share been exercised on that date.

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DIGIMARC CORPORATION

NOTES TO FINANCIAL STATEMENTS (Continued)

(Dollar amounts in thousands, except per share data)

(UNAUDITED)

5. Stock-Based Compensation (Continued)

        The following table reconciles the unvested balance of restricted stock:

Three-months ended September 30, 2009:
  Number of
Shares
 

Unvested balance, June 30, 2009

    133,400  
 

Granted

    8,000  
 

Vested

     
 

Canceled

     
       

Unvested balance, September 30, 2009

    141,400  
       

 

Nine-months ended September 30, 2009:
  Number of
Shares
 

Unvested balance, December 31, 2008

    121,000  
 

Granted

    20,400  
 

Vested

     
 

Canceled

     
       

Unvested balance, September 30, 2009

    141,400  
       

6. Trade Accounts Receivable

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

 
  Successor   Successor  
 
  September 30,
2009
  December 31,
2008
 

Trade accounts receivable

  $ 3,027   $ 3,839  

Allowance for doubtful accounts

         
           

Trade accounts receivable, net

  $ 3,027   $ 3,839  
           

Unpaid deferred revenues included in accounts receivable

  $ 1,179   $ 2,155  
           

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

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DIGIMARC CORPORATION

NOTES TO FINANCIAL STATEMENTS (Continued)

(Dollar amounts in thousands, except per share data)

(UNAUDITED)

6. Trade Accounts Receivable (Continued)

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

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

 
  Successor   Successor  
 
  September 30,
2009
  December 31,
2008
 

Central Banks

    45 %   58 %

The Nielsen Company

    33 %   27 %

7. Property and Equipment

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

        The property and equipment related to the Company were separated from Old Digimarc and recorded at net book value (cost less accumulated depreciation) and classified as used property and equipment.

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

 
  Successor   Successor  
 
  September 30,
2009
  December 31,
2008
 

Office furniture fixture

  $ 291   $ 291  

Equipment

    1,073     793  

Leasehold improvements

    413     320  
           

    1,777     1,404  

Less accumulated depreciation and amortization

    (597 )   (192 )
           

  $ 1,180   $ 1,212  
           

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DIGIMARC CORPORATION

NOTES TO FINANCIAL STATEMENTS (Continued)

(Dollar amounts in thousands, except per share data)

(UNAUDITED)

8. Intangible Assets—Purchase and Capitalized Patent Costs

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

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

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

 
  Successor   Successor  
 
  September 30,
2009
  December 31,
2008
 

Gross intangible assets

  $ 1,113   $ 462  

Accumulated amortization

    (25 )   (6 )
           

Intangible assets, net

  $ 1,088   $ 456  
           

9. Other Income (Expense), Net

 
  Successor   Successor    
  Predecessor   Successor    
  Predecessor  
 
  Three
Months
Ended
September 30,
2009
  Period
August 2,
2008
through
September 30,
2008
 

  Period
July 1,
2008
through
August 1,
2008
  Nine
Months
Ended
September 30,
2009
 

  Period
January 1,
2008
through
August 1,
2008
 

Interest income, net

  $ 124   $ 196       $ 75   $ 436       $ 590  

Net loss from joint ventures

    (311 )               (311 )        

Other

    2     (17 )           3          
                               
 

Total

  $ (185 ) $ 179       $ 75   $ 128       $ 590  
                               

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

10. Income Taxes

        Old Digimarc.    The provision for income taxes reflects withholding tax expense in various foreign jurisdictions. For all historic periods reported in the financial statements, Old Digimarc maintained valuation allowances against its net deferred tax assets, including net operating loss carry-forwards, because it was not more likely than not that such deferred taxes would be realized. The provision for income taxes included foreign taxes withheld by Old Digimarc's customers and paid to foreign

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DIGIMARC CORPORATION

NOTES TO FINANCIAL STATEMENTS (Continued)

(Dollar amounts in thousands, except per share data)

(UNAUDITED)

10. Income Taxes (Continued)

jurisdictions on its behalf. The predecessor financial statements indicate cumulative losses through August 1, 2008.

        Furthermore, the amounts of cumulative expenses in the financial statements that were not allowed for federal and state income tax purposes were not sufficient to result in positive taxable income which would have required the Company to record income tax expense. As a result, no Federal or state income tax benefit was recognized for the book losses that were incurred in those periods prior to 2007 and no income tax expense was recognized during the 2007 and 2008 periods because any expense was offset by the benefit of net operating loss carry-forwards. Digimarc as a separate legal entity will not benefit from any of the carry-forward tax attributes of Old Digimarc, including net operating loss carry-forwards.

        Digimarc.    The provision for income taxes reflects withholding tax expense in various foreign jurisdictions. These withholding taxes are computed by the Company's customers and paid to foreign jurisdictions on its behalf. There was no provision for current income taxes related to net income because the computation of taxable income resulted in a net operating loss for the period.

11. Commitments and Contingencies

        Certain of the Company's product license and services agreements include an indemnification provision for claims from third parties relating to the Company's intellectual property. Such indemnification provisions are accounted for in accordance with ASC 450 "Contingencies" (formerly SFAS No. 5, Accounting for 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. Although the ultimate outcome of these matters cannot be determined, management believes that, as of September 30, 2009, the final disposition of these proceedings will not have a material adverse effect on the financial position, results of operations, or liquidity of the Company. No accrual has been recorded because the amounts are not probable or reasonably estimatable in accordance with ASC 450.

12. Stock Repurchases

        In April 2009, the Board of Directors approved a stock repurchase program authorizing the purchase, at the discretion of management, of up to $5,000 of our common stock through either periodic open-market or private transactions at then prevailing market prices over a period of up to two years through April 30, 2010. For the three- and nine-month period ended September 30, 2009, the Company had paid $822 to repurchase 59,355 shares of outstanding common stock under this program since the program's inception.

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DIGIMARC CORPORATION

NOTES TO FINANCIAL STATEMENTS (Continued)

(Dollar amounts in thousands, except per share data)

(UNAUDITED)

13. Related Party Transactions

        In connection with the two joint ventures entered into with Nielsen in July 2009, the Company recognized $575 in revenues for the three- and nine-month periods ended September 30, 2009 in connection with technical and development services provided to TVaura LLC.

        The net loss from the joint ventures included in other income (expense), net for both the three- and nine-month periods ended September 30, 2009 were $(292) for TVaura LLC and $(19) for TVaura Mobile LLC.

        There were net accounts receivable of $214 and $6 from TVaura, LLC and TVaura Mobile, LLC at September 30, 2009, respectively. There were no net accounts payable to either joint venture at September 30, 2009.

14. Subsequent Events

        In accordance with ASC 855 "Subsequent Events" (formerly SFAS 165, Subsequent Events), the Company is required to disclose the date through which subsequent events have been evaluated for disclosure. Subsequent events were evaluated through October 29, 2009, which is the date the Company's quarterly report on Form 10-Q for the quarter ended September 30, 2009 was filed with the Securities and Exchange Commission.

15. Quarterly Financial Information—Unaudited

 
  Successor   Successor   Successor  
Quarter ended:
  March 31   June 30   September 30  

2009

                   

Service revenue

  $ 2,470   $ 2,585   $ 2,827  

License and subscription revenue

    1,959     1,739     1,942  
               

Total revenue

    4,429     4,324     4,769  

Total cost of revenue

    1,485     1,528     1,541  

Gross profit

    2,944     2,796     3,228  

Gross profit percent, service revenue

    43 %   43 %   47 %

Gross profit percent, license and subscription revenue

    97 %   97 %   98 %

Gross profit percent, total

    66 %   65 %   68 %

Sales and marketing

    745     728     753  

Research, development and engineering

    1,271     1,217     1,191  

General and administrative

    1,688     1,496     1,566  

Intellectual property

    277     217     262  

Transitional services

    (60 )   (48 )   (45 )

Operating loss

    (977 )   (814 )   (499 )

Net loss

    (809 )   (678 )   (687 )

Loss per share:

                   

Net loss per share—basic & diluted

  $ (0.11 ) $ (0.09 ) $ (0.10 )

Weighted average shares outstanding—basic and diluted

    7,158     7,158     7,134  

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DIGIMARC CORPORATION

NOTES TO FINANCIAL STATEMENTS (Continued)

(Dollar amounts in thousands, except per share data)

(UNAUDITED)

15. Quarterly Financial Information—Unaudited (Continued)

 

 
  Predecessor   Predecessor   Predecessor    
  Successor   Successor  
 
   
   
  Period
July 1
through
August 1
   
  Period
August 2
through
September 30
   
 
Quarter ended:
  March 31   June 30  


  December 31  

2008

                                   

Service revenue

  $ 2,548   $ 2,987   $ 921       $ 1,645   $ 2,419  

License and subscription revenue

    2,537     2,128     829         1,536     2,232  
                           

Total revenue

    5,085     5,115     1,750         3,181     4,651  

Total cost of revenue

    1,408     1,704     552         934     1,428  

Gross profit

    3,677     3,411     1,198         2,247     3,223  

Gross profit percent, service revenue

    47 %   45 %   43 %       46 %   44 %

Gross profit percent, license and subscription revenue

    98 %   97 %   97 %       97 %   97 %

Gross profit percent, total

    72 %   67 %   69 %       71 %   69 %

Sales and marketing

    656     683     589         390     764  

Research, development and engineering

    922     910     239         780     992  

General and administrative

    980     927     442         932     1,945  

Intellectual property

    478     448     176         120     184  

Transitional services

                    (196 )   (84 )

Operating income (loss)

    641     443     (248 )       221     (578 )

Net income (loss)

    924     664     (173 )       400     (324 )

Earnings (loss) per share:

                                   

Net income (loss) per share—basic & diluted

                        $ 0.06   $ (0.05 )

Weighted average shares outstanding—basic and diluted

                          7,143     7,156  

Pro-forma earnings (loss) per share:

                                   

Net income (loss) per share—basic & diluted

  $ 0.13   $ 0.09   $ (0.02 )                

Weighted average shares outstanding—basic and diluted

    7,143     7,143     7,143                  

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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, which involve risks and uncertainties. Our actual results could differ materially from those anticipated in these forward-looking statements. Please see the discussion regarding forward-looking statements included in this Quarterly Report on Form 10-Q under the caption "Safe Harbor Statement under the Private Securities Litigation Reform Act of 1995."

        The following discussion should be read in conjunction with our financial statements and the related notes and other financial information appearing elsewhere in this Quarterly Report on Form 10-Q. Readers are also urged to carefully review and consider the disclosures made in Part II, Item 1A (Risk Factors) of this Quarterly Report on Form 10-Q and our Annual Report on Form 10-K for the year ended December 31, 2008 filed on February 27, 2009 (the "2008 Annual Report") and in the audited financial statements and related notes included in our 2008 Annual Report, and other reports and filings made with the Securities and Exchange Commission ("SEC").

        Unless the context otherwise requires, references in this Quarterly Report on Form 10-Q to (i) "Digimarc," "we," "our" and "us" refer to Digimarc Corporation and (ii) "Old Digimarc" refers to the former Digimarc Corporation, which merged with and into a wholly owned subsidiary of L-1 Identity Solutions, Inc. ("L-1") on August 13, 2008, and its consolidated subsidiaries (other than us).

The Separation of the Digital Watermarking Business from Old Digimarc

        On August 1, 2008, Old Digimarc spun off the common stock of Digimarc, which held all of the assets and liabilities of Old Digimarc's Digital Watermarking Business.

        Until August 1, 2008, we were a wholly owned subsidiary of DMRC LLC, which immediately prior to the spin-off was a wholly owned subsidiary of Old Digimarc. DMRC LLC was formed in Delaware on June 18, 2008, in anticipation of the spin-off of the Digital Watermarking Business. Prior to the spin-off, in a transaction which we refer to as the restructuring, Old Digimarc contributed all of the assets and liabilities related to its Digital Watermarking Business, together with all of Old Digimarc's cash, including cash received upon the exercise of stock options, to DMRC LLC. The restructuring did not result in the loss of any significant Digital Watermarking Business customers or contracts.

        Following the restructuring, all of the limited liability company interests of DMRC LLC were transferred to a newly created trust for the benefit of Old Digimarc record holders on the basis of one limited liability company interest of DMRC LLC for every three and one-half shares of Old Digimarc common stock held by the stockholder as of the spin-off record date and time. DMRC LLC then merged with and into DMRC Corporation, and each limited liability company interest of DMRC LLC was converted into one share of common stock of DMRC Corporation. After completion of the acquisition of Old Digimarc by L-1, DMRC Corporation changed its name to Digimarc Corporation. As a result, upon effectiveness of the Form 10 on October 16, 2008, each Old Digimarc record holder received one share of Digimarc common stock for every three and one-half shares of Old Digimarc common stock held by the stockholder as of the spin-off record date and time, and we became an independent, publicly-traded company owning and operating the Digital Watermarking Business.

Recent Developments—Nielsen Joint Venture

        On July 1, 2009, we commenced operation of two joint ventures with The Nielsen Company (US) LLC, or Nielsen. In connection with these joint ventures, we terminated our agreement with Nielsen, dated as of October 1, 2007, to enter into the joint venture agreements, and entered into a new patent license agreement. Under the terms of the new patent license agreement, we granted Nielsen a non-exclusive license to Digimarc patents for use within Nielsen's business and Nielsen

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agreed to pay us $18.75 million as follows: $2.0 million for the remainder of 2009; $3.6 million in 2010; $4.0 million in each of 2011, 2012 and 2103; and $1.15 million in 2014.

        Under the first joint venture, TVaura LLC, Digimarc and Nielsen will engage in the development of copyright filtering solutions, royalty/audit solutions for online video and audio rights organizations, guilds or other organizations involved in the reconciliation of royalties, residuals and other payments, and other related products. Under the second joint venture, TVaura Mobile LLC, Digimarc and Nielsen will engage in the development of certain enhanced television offerings, and other related products. We will provide technical and development services to TVaura LLC's business for the following periods for the following minimum service fees, subject to adjustment for any development service fees paid to Digimarc by TVaura Mobile LLC: $1.13 million for the remainder of 2009; $2.80 million in 2010; and $2.74 million in 2011.

        The initial cash contribution of each of Digimarc and Nielsen to TVaura LLC will be an aggregate of $3.9 million payable in quarterly installments from July 2009 through October 2011. The initial cash contribution of each of Digimarc and Nielsen to TVaura Mobile LLC will be an aggregate of $2.8 million payable in quarterly installments from July 2009 through October 2011. Each of Digimarc and Nielsen own approximately half of each joint venture.

Overview

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

        Our technology, and those of our licensees, span the complete range of media content, enabling our customers and those of our partners to:

        At the core of our intellectual property is a signal processing technology innovation known as "digital watermarking" which allows imperceptible digital information to be embedded in all forms of digitally designed, produced or distributed media content and some physical objects, including

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photographs, movies, music, television, personal identification documents, financial instruments, industrial parts and product packages. The digital information can be detected and read by a wide range of computers, mobile phones, and other digital devices.

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

        To protect our significant efforts in creating our technology, we have implemented an extensive intellectual property protection program that relies on a combination of patent, copyright, trademark and trade secret laws, and nondisclosure agreements and other contracts. We believe we have one of the world's most extensive patent portfolios in the field of digital watermarking and related media enhancement innovations, with over 545 U.S. and foreign patents and more than 410 U.S. and foreign patent applications on file as of September 30, 2009.

        Backlog.    Based on projected commitments we have for the periods under contract with our respective customers, we anticipate our current contracts as of September 30, 2009 will generate approximately $46 million in revenue during the contractual terms of such contracts, currently up to five years. We expect more than $5 million of this amount to be recognized as revenue during the remainder of 2009.

        Some factors that lead to increased backlog include:

        Some factors that lead to decreased backlog are:

        The mix of these factors, among others, dictates whether our backlog increases or decreases for any given period. There is no assurance that our backlog will result in actual revenue in any particular period, because the orders, awards and contracts included in our backlog may be subject to modification, cancellation or suspension. We may not realize revenue on certain contracts, orders or awards included in our backlog or the timing of such realization may change.

Critical Accounting Policies and Estimates

        Detailed information on our critical accounting policies and estimates are set forth in our 2008 Annual Report in Part II, Item 7 thereof ("Management's Discussion and Analysis of Financial Condition and Results of Operations"), under the caption "Critical Accounting Policies and Estimates," which is incorporated by reference into this Quarterly Report on Form 10-Q, and have not changed.

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Results of Operations—the Three Months Ended September 30, 2009 compared to the Periods July 1, 2008 through August 1, 2008 (predecessor) and August 2, 2008 through September 30, 2008 (successor)

        The following table presents our statements of operations data for the periods indicated as a percentage of total revenue.

 
  Successor   Successor    
  Predecessor   Total*  
 
  Three
Months
Ended
September 30,
2009
  Period
August 2,
2008
through
September 30,
2008
   
  Period
July 1,
2008
through
August 1,
2008
  Three
Months
Ended
September 30,
2008
 

Revenue:

                             
 

Service

    59 %   52 %       53 %   52 %
 

License and subscription

    41     48         47     48  
                       
   

Total revenue

    100     100         100     100  

Cost of revenue:

                             
 

Service

    31     28         30     29  
 

License and subscription

    1     1         1     1  
                       
   

Total cost of revenue

    32     29         31     30  

Gross profit

    68     71         69     70  

Operating expenses:

                             
 

Sales and marketing

    16     12         34     20  
 

Research, development and engineering

    25     25         14     20  
 

General and administrative

    33     29         25     28  
 

Intellectual property

    5     4         10     6  
 

Transitional services

    (1 )   (6 )           (4 )
                       
   

Total operating expenses

    78     64         83     70  
                       

Operating income (loss)

    (10 )   7         (14 )    
                       

Other income (expense), net

    (4 )   6         4     5  
                       

Income (loss) before provision for income taxes

    (14 )   7         (10 )   5  

Provision for income taxes

                     
                       
   

Net income (loss)

    (14 )%   13 %       (10 )%   5 %
                       

*
Used for comparative purposes

        Our revenue for the three-month period ended September 30, 2009 decreased 3% to $4.8 million from $4.9 million compared to the combined periods July 1, 2008 through August 1, 2008 and August 2, 2008 through September 30, 2008. The decrease was primarily the result of lower license and royalty revenues from a few of our customers based on a combination of contractual revenue provisions, lower royalty reporting from our licensees whose revenues were lower and receipt of cash from our cash basis customers whose revenues are non-linear in nature, offset in part by increased project work from the consortium of Central Banks. In addition, as further discussed below, we incurred higher operating expenses for the period during which we operated as a stand-alone company.

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  Successor   Successor    
  Predecessor   Total*    
   
 
 
  Three
Months
Ended
September 30,
2009
  Period
August 2,
2008
through
September 30,
2008
   
  Period
July 1,
2008
through
August 1,
2008
  Three
Months
Ended
September 30,
2008
  Dollar
Increase
(Decrease)
  Percent
Increase
(Decrease)
 

Revenue:

                                         
 

Service

  $ 2,827   $ 1,645       $ 921   $ 2,566   $ 261     10 %
 

License and subscription

    1,942     1,536         829     2,365     (423 )   (18 )%
                                 
   

Total

  $ 4,769   $ 3,181       $ 1,750   $ 4,931   $ (162 )   (3 )%
                                 

Revenue (as % of total revenue):

                                         
 

Service

    59 %   52 %       53 %   52 %            
 

License and subscription

    41 %   48 %       47 %   48 %            
                                   
   

Total

    100 %   100 %       100 %   100 %            
                                   

*
Used for comparative purposes

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

        The increase in service revenue for the three-month period ended September 30, 2009, compared to the combined periods July 1, 2008 through August 1, 2008 and August 2, 2008 through September 30, 2008, was due primarily to increased revenue from additional program work from the Central Banks and government contract revenues that are non-linear in nature, offset in part by lower consulting revenues from Nielsen, including the revenues from the joint venture TVaura LLC, where we were engaged at an accelerated level of services in the initial year of the contract with Nielsen.

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

        The decrease in license and subscription revenue for the three-month period ended September 30, 2009, compared to the combined periods July 1, 2008 through August 1, 2008 and August 2, 2008 through September 30, 2008, were due primarily to lower royalty reporting and lower receipts of cash from our cash basis customers.

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  Successor   Successor    
  Predecessor   Total*    
   
 
 
  Three
Months
Ended
September 30,
2009
  Period
August 2,
2008
through
September 30,
2008
   
  Period
July 1,
2008
through
August 1,
2008
  Three
Months
Ended
September 30,
2008
  Dollar
Increase
(Decrease)
  Percent
Increase
(Decrease)
 

Revenue by geography:

                                         
 

Domestic

  $ 2,165   $ 1,541       $ 960   $ 2,501   $ (336 )   (13 )%
 

International

    2,604     1,640         790     2,430     174     7 %
                                 
   

Total

  $ 4,769   $ 3,181       $ 1,750   $ 4,931   $ (162 )   (3 )%
                                   

Revenue (as % of total revenue):

                                         
 

Domestic

    45 %   48 %       55 %   51 %            
 

International

    55 %   52 %       45 %   49 %            
                                   
   

Total

    100 %   100 %       100 %   100 %            
                                   

*
Used for comparative purposes

        Domestic revenue decreased for the three-month period ended September 30, 2009, compared to the combined periods July 1, 2008 through August 1, 2008 and August 2, 2008 through September 30, 2008, due primarily to lower revenues from Nielsen, including the revenues from the joint venture TVaura LLC, and to a lesser extent lower revenues from our royalty reporting licensees.

        International revenue slightly increased for the three-month period ended September 30, 2009, compared to the combined periods July 1, 2008 through August 1, 2008 and August 2, 2008 through September 30, 2008, due primarily to increased revenue from the Central Banks, offset by lower revenues from our royalty reporting licensees.

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

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

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Table of Contents

 
  Successor   Successor    
  Predecessor   Total*    
   
 
 
  Three
Months
Ended
September 30,
2009
  Period
August 2,
2008
through
September 30,
2008
   
  Period
July 1,
2008
through
August 1,
2008
  Three
Months
Ended
September 30,
2008
  Dollar
Increase
(Decrease)
  Percent
Increase
(Decrease)
 

Gross Profit:

                                         
 

Service

  $ 1,328   $ 755       $ 394   $ 1,149   $ 179     16 %
 

License and subscription

    1,900     1,492         804     2,296     (396 )   (17 )%
                                 
   

Total

  $ 3,228   $ 2,247       $ 1,198   $ 3,445   $ (217 )   (6 )%
                                 

Gross Profit (as % of related revenue components):

                                         
 

Service

    47 %   46 %       43 %   45 %            
 

License and subscription

    98 %   97 %       97 %   97 %            
   

Total

    68 %   71 %       69 %   70 %            

*
Used for comparative purposes

        The decrease in gross profit dollars for the three-month period ended September 30, 2009, compared to the combined periods July 1, 2008 through August 1, 2008 and August 2, 2008 through September 30, 2008 primarily reflect the impact of variations in scheduled payments in certain of our long-term contracts; lower consulting revenues from Nielsen, including the revenues from the joint venture TVaura LLC; and to a lesser extent, lower royalties from some patent and technology licensees.

        The decrease in gross profit as a percentage of revenue for the three-month period ended September 30, 2009, compared to the combined periods July 1, 2008 through August 1, 2008 and August 2, 2008 through September 30, 2008, was due primarily to:

Operating Expenses

        The financial information in the predecessor financial statements does not include all of the expenses that would have been incurred had the predecessor operated as a separate, stand-alone public entity. As such, the predecessor financial information does not reflect the operating expenses of Digimarc's current business had the predecessor been a separate, stand-alone public entity during the periods presented in the predecessor's financial statements. Additionally, the predecessor financial statements include proportional allocations of various shared services common costs of Old Digimarc because specific identification of these expenses was not practicable. It is expected that the initial operating costs of Digimarc on a stand-alone basis will be higher than those allocated to the predecessor operations under the shared services methodology applied in the predecessor financial statements. Consequently, the operating expenses reflected in the predecessor financial statements may not be indicative of those that would have been achieved had the predecessor operated as a separate, stand-alone entity for the periods reflected in the predecessor financial statements. The operating

36


Table of Contents


expenses for the three-month period ended September 30, 2009 are consistent with our expectations as a stand-alone entity.

 
  Successor   Successor    
  Predecessor   Total*    
   
 
 
  Three
Months
Ended
September 30,
2009
  Period
August 2,
2008
through
September 30,
2008
   
  Period
July 1,
2008
through
August 1,
2008
  Three
Months
Ended
September 30,
2008
  Dollar
Decrease
  Percent
Decrease
 

Sales and marketing

  $ 753   $ 390       $ 589   $ 979   $ (226 )   (23 )%

Sales and marketing (as % of total revenue)

    16 %   12 %       34 %   20 %            

*
Used for comparative purposes

        Sales and marketing expenses consist primarily of:

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

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

        The decrease in sales and marketing expense for the three-month period ended September 30, 2009, compared to the combined periods July 1, 2008 through August 1, 2008 and August 2, 2008 through September 30, 2008, resulted primarily from delayed spending on various projects due to the effects of the slowdown in the economic environment, offset in part by higher expenses for the period during which we operated as a stand-alone company compared to the shared services allocation methodology applied in the predecessor financial statements.

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

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Table of Contents

 
  Successor   Successor    
  Predecessor   Total*    
   
 
 
  Three
Months
Ended
September 30,
2009
  Period
August 2,
2008
through
September 30,
2008
   
  Period
July 1,
2008
through
August 1,
2008
  Three
Months
Ended
September 30,
2008
  Dollar
Increase
  Percent
Increase
 

Research, development and engineering

  $ 1,191   $ 780       $ 239   $ 1,019   $ 172     17 %

Research, development and engineering (as % of total revenue)

    25 %   25 %       14 %   20 %            

*
Used for comparative purposes

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

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Table of Contents

        Research, development and engineering expenses consist primarily of:

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

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

        The increase in research, development and engineering expense for the three-month period ended September 30, 2009, compared to the combined periods July 1, 2008 through August 1, 2008 and August 2, 2008 through September 30, 2008, resulted primarily from:

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

 
  Successor   Successor    
  Predecessor   Total*    
   
 
 
  Three
Months
Ended
September 30,
2009
  Period
August 2,
2008
through
September 30,
2008
   
  Period
July 1,
2008
through
August 1,
2008
  Three
Months
Ended
September 30,
2008
  Dollar
Increase
  Percent
Increase
 

General and administrative

  $ 1,566   $ 932       $ 442   $ 1,374   $ 192     14 %

General and administrative (as % of total revenue)

    33 %   29 %       25 %   28 %            

*
Used for comparative purposes

        We incur general and administrative costs in the functional areas of finance, legal, human resources, executive and board of directors. Costs for facilities and information technology are also

39


Table of Contents


managed as part of the general and administrative processes and are allocated to this line item as well as each of the line items in costs of services, sales and marketing, and research development and engineering. General and administrative expenses consist primarily of:

        The increases in general and administrative expenses for the three-month period ended September 30, 2009, compared to the combined periods July 1, 2008 through August 1, 2008 and August 2, 2008 through September 30, 2008, resulted primarily from higher expenses for the period during which we operated as a stand-alone company compared to the shared services allocation methodology applied in the predecessor financial statements.

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

 
  Successor   Successor    
  Predecessor   Total*    
   
 
 
  Three
Months
Ended
September 30,
2009
  Period
August 2,
2008
through
September 30,
2008
   
  Period
July 1,
2008
through
August 1,
2008
  Three
Months
Ended
September 30,
2008
  Dollar
Decrease
  Percent
Decrease
 

Intellectual property

  $ 262   $ 120       $ 176   $ 296   $ (34 )   (11 )%

Intellectual property (as % of total revenue)

    5 %   4 %       10 %   6 %            

*
Used for comparative purposes

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

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

        Prior to August 2, 2008, the predecessor accounted for gross expenditures for intellectual property costs as expenses. On August 2, 2008 we began capitalizing patent application and award costs.

        The decrease in intellectual property expenses for the three-month period ended September 30, 2009, compared to the combined periods July 1, 2008 through August 1, 2008 and August 2, 2008 through September 30, 2008, resulted primarily from capitalized patent application and award costs

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Table of Contents


aggregating $0.2 million, offset by expenses related to legal services in support of intellectual property licensing activities.

        We anticipate that we will continue to invest in intellectual property expenses at current levels or higher.

        In connection with the sale of Old Digimarc's Secure ID Business and the spin-off of the Digital Watermarking Business, Old Digimarc and Digimarc entered into a transition services agreement to provide one another with transition services and other assistance substantially consistent with the services provided before the spin-off.

        To enable Old Digimarc to continue its operation of the Secure ID Business and facilitate the effective transition of the Digital Watermarking Business to Digimarc, under the transition services agreement Old Digimarc provides the following services or support to Digimarc: information technology services and legal services. Similarly, Digimarc provides the following services or support to Old Digimarc: accounting and tax services, information technology services, legal services, human resource services and facilities.

        The fees for the transition services generally are intended to cover each party's reasonable costs incurred in connection with providing the transition services. Hourly rates for personnel performing transition services were determined based on fully loaded costs, taking into account base pay, a bonus based on obtaining target earnings, payroll taxes, benefit costs, a pro rata portion of overhead charges paid by Old Digimarc or Digimarc, as applicable, and the current year stock compensation charge for the individual, divided by the total hours available for the employee for the year, taking into account the need for administrative time.

        The net transitional services expenses reimbursed to Digimarc aggregated less than $0.1 million for the three-month period ended September 30, 2009 and $0.2 million for the period August 2, 2008 through September 30, 2008, and are expected to decline through the end of the year 2009 as the amount of transition services decline.

 
  Successor   Successor    
  Predecessor   Total*    
   
 
 
  Three
Months
Ended
September 30,
2009
  Period
August 2,
2008
through
September 30,
2008
   
  Period
July 1,
2008
through
August 1,
2008
  Three
Months
Ended
September 30,
2008
  Dollar
Increase
  Percent
Increase
 

Cost of revenue

  $ 57   $       $ 14   $ 14   $ 43     307 %

Sales and marketing

    50             32     32     18     56 %

Research, development and engineering

    47             4     4     43     1,075 %

General and administrative

    451             81     81     370     457 %

Intellectual property

    24             5     5     19     380 %
                               
 

Total

  $ 629   $       $ 136   $ 136   $ 493     362 %
                               

*
Used for comparative purposes

        Old Digimarc accounted for stock-based compensation in accordance with Accounting Standards Codification ("ASC") 718 "Compensation—Stock Compensation" (formerly Statement of Financial Accounting Standards ("SFAS") No. 123(R), Share-Based Payment (Revised 2004)), which requires the

41


Table of Contents


measurement and recognition of compensation for all stock-based awards made to employees and directors, including stock options, employee stock purchases under a stock purchase plan and restricted stock awards based on estimated fair values. Stock compensation expense was allocated to the predecessor based on a combination of specific and shared services resource allocations from Old Digimarc.

        The increase in stock-based compensation expense for the three-month period ended September 30, 2009, compared to the combined periods July 1, 2008 through August 1, 2008 and August 2, 2008 through September 30, 2008, resulted primarily from Digimarc applying ASC 718 with respect to our initial stock-based awards compared to the shared services allocation methodology applied in the predecessor financial statements.

 
  Successor   Successor    
  Predecessor   Total*    
   
 
 
  Three
Months
Ended
September 30,
2009
  Period
August 2,
2008
through
September 30,
2008
   
  Period
July 1,
2008
through
August 1,
2008
  Three
Months
Ended
September 30,
2008
  Dollar
Increase
(Decrease)
  Percent
Increase
(Decrease)
 

Interest income, net

  $ 124   $ 196       $ 75   $ 271     (147 )   (54 )%

Net loss from joint ventures

    (311 )                   (311 )   (100 )%

Other

    2     (17 )           (17 )   19     112 %
                               
 

Total

  $ (185 ) $ 179       $ 75   $ 254     (439 )   (173 )%
                               

*
Used for comparative purposes

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

        The decrease in other income, net for the three-month period ended September 30, 2009, compared to the combined periods July 1, 2008 through August 1, 2008 and August 2, 2008 through September 30, 2008, resulted primarily from the net losses of $(292) and $(19) from TVaura LLC and TVaura Mobile LLC, respectively, and lower interest earned on cash and investment balances, reflecting lower interest rates paid on these balances.

        Old Digimarc.    The provision for income taxes reflects expected tax expense from profitability in certain foreign jurisdictions. The predecessor recorded a full valuation allowance against net deferred tax assets at August 1, 2008 due to the uncertainty of realization of net operating losses. As a separate legal entity, we will not benefit from any of the carry-forward tax attributes of Old Digimarc, including net operating loss carry-forwards.

        Digimarc.    There was no provision for income taxes of Digimarc, other than foreign withholding taxes, for the three-month period ended September 30, 2009 since the estimated effective tax rate for the period ending December 31, 2009 is expected to be zero.

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Table of Contents

Results of Operations—the Nine Months Ended September 30, 2009 compared to the Periods January 1, 2008 through August 1, 2008 (predecessor) and August 2, 2008 through September 30, 2008 (successor)

        The following table presents our statements of operations data for the periods indicated as a percentage of total revenue.

 
  Successor   Successor    
  Predecessor   Total*  
 
   
 
 
  Nine
Months
Ended
September 30,
2009
  Period
August 2,
2008
through
September 30,
2008
   
  Period
January 1,
2008
through
August 1,
2008
  Nine
Months
Ended
September 30,
2008
 

Revenue:

                             
 

Service

    58 %   52 %       54 %   54 %
 

License and subscription

    42     48         46     46  
                       
   

Total revenue

    100     100         100     100  

Cost of revenue:

                             
 

Service

    33     28         30     29  
 

License and subscription

    1     1         1     1  
                       
   

Total cost of revenue

    34     29         31     30  

Gross profit

    66     71         69     70  

Operating expenses:

                             
 

Sales and marketing

    16     12         16     15  
 

Research, development and engineering

    27     25         17     19  
 

General and administrative

    35     29         20     22  
 

Intellectual property

    6     4         9     8  
 

Transitional services

    (1 )   (6 )           (1 )
                       
   

Total operating expenses

    83     64         62     63  
                       

Operating income (loss)

    (17 )   7         7     7  
                       

Other income, net

    1     6         5     5  
                       

Income (loss) before provision for income taxes

    (16 )   13         12     12  

Provision for income taxes

                     
                       
   

Net income (loss)

    (16 )%   13 %       12 %   12 %
                       

*
Used for comparative purposes

        Our revenue for the nine-month period ended September 30, 2009 decreased 11% to $13.5 million from $15.1 million compared to the combined periods January 1, 2008 through August 1, 2008 and August 2, 2008 through September 30, 2008. The decrease was primarily the result of lower license and royalty revenues from a few of our customers based on a combination of contractual revenue provisions, lower royalty reporting from our licensees whose revenues were lower and receipt of cash from our cash basis customers whose revenues are non-linear in nature, offset in part by increased project work from the consortium of Central Banks. In addition, as further discussed below, we incurred higher operating expenses for the period during which we operated as a stand-alone company.

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Table of Contents

 
  Successor   Successor    
  Predecessor   Total*    
   
 
 
   
   
   
 
 
  Nine
Months
Ended
September 30,
2009
  Period
August 2,
2008
through
September 30,
2008
   
  Period
January 1,
2008
through
August 1,
2008
  Nine
Months
Ended
September 30,
2008
  Dollar
Decrease
  Percent
Decrease
 

Revenue:

                                         
 

Service

  $ 7,882   $ 1,645       $ 6,456   $ 8,101   $ (219 )   (3 )%
 

License and subscription

    5,640     1,536         5,494     7,030     (1,390 )   (20 )%
                                 
   

Total

  $ 13,522   $ 3,181       $ 11,950   $ 15,131   $ (1,609 )   (11 )%
                                 

Revenue (as % of total revenue):

                                         
 

Service

    58 %   52 %       54 %   54 %            
 

License and subscription

    42 %   48 %       46 %   46 %            
                                   
   

Total

    100 %   100 %       100 %   100 %            
                                   

*
Used for comparative purposes

        Service.    The decrease in service revenue for the nine-month period ended September 30, 2009, compared to the combined periods January 1, 2008 through August 1, 2008 and August 2, 2008 through September 30, 2008, was due primarily to lower consulting revenues from Nielsen, including the revenues from the joint venture TVaura LLC, where we were engaged at an accelerated level of services in the initial year of the contract with Nielsen, offset in part by increased revenue from additional program work from the Central Banks.

        License and subscription.    The decrease in license and subscription revenue for the nine-month period ended September 30, 2009, compared to the combined periods January 1, 2008 through August 1, 2008 and August 2, 2008 through September 30, 2008, was due primarily to lower license revenue from Nielsen in accordance with contractual terms, and lower royalty reporting and receipt of cash from our cash basis customers.

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Table of Contents

 
  Successor   Successor    
  Predecessor   Total*    
   
 
 
   
   
   
 
 
  Nine
Months
Ended
September 30,
2009
  Period
August 2,
2008
through
September 30,
2008
   
  Period
January 1,
2008
through
August 1,
2008
  Nine
Months
Ended
September 30,
2008
  Dollar
Increase
(Decrease)
  Percent
Increase
(Decrease)
 

Revenue by geography:

                                         
 

Domestic

  $ 5,718   $ 1,541       $ 6,274   $ 7,815   $ (2,097 )   (27 )%
 

International

    7,804     1,640         5,676     7,316     488     7 %
                                 
   

Total

  $ 13,522   $ 3,181       $ 11,950   $ 15,131   $ (1,609 )   (11 )%
                                   

Revenue (as % of total revenue):

                                         
 

Domestic

    42 %   48 %       53 %   52 %            
 

International

    58 %   52 %       47 %   48 %            
                                   
   

Total

    100 %   100 %       100 %   100 %            
                                   

*
Used for comparative purposes

        Domestic revenue decreased for the nine-month period ended September 30, 2009, compared to the combined periods January 1, 2008 through August 1, 2008 and August 2, 2008 through September 30, 2008, due primarily to lower revenues from Nielsen, including the revenues from the joint venture TVaura LLC, and to a lesser extent lower revenues from our government contracts and our royalty reporting licensees.

        International revenue increased for the nine-month period ended September 30, 2009, compared to the combined periods January 1, 2008 through August 1, 2008 and August 2, 2008 through September 30, 2008, due primarily to increased revenue from the Central Banks, offset by lower revenues from our royalty reporting licensees.

 
  Successor   Successor    
  Predecessor   Total*    
   
 
 
   
   
   
 
 
  Nine
Months
Ended
September 30,
2009
  Period
August 2,
2008
through
September 30,
2008
   
  Period
January 1,
2008
through
August 1,
2008
  Nine
Months
Ended
September 30,
2008
  Dollar
Decrease
  Percent
Decrease
 

Gross Profit:

                                         
 

Service

  $ 3,486   $ 755       $ 2,937   $ 3,692   $ (206 )   (6 )%
 

License and subscription

    5,482     1,492         5,349     6,841     (1,359 )   (20 )%
                                 
   

Total

  $ 8,968   $ 2,247       $ 8,286   $ 10,533   $ (1,565 )   (15 )%
                                 

Gross Profit (as % of related revenue components):

                                         
 

Service

    44 %   46 %       46 %   46 %            
 

License and subscription

    97 %   97 %       97 %   97 %            
   

Total

    66 %   71 %       69 %   70 %            

*
Used for comparative purposes

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Table of Contents

        The decrease in gross profit dollars primarily reflect the impact of variations in scheduled payments in certain of our long-term contracts; lower consulting revenues from Nielsen, including the joint venture TVaura LLC; and to a lesser extent, lower royalties from some patent and technology licenses.

        The decrease in gross profit as a percentage of revenue for the nine-month period ended September 30, 2009, compared to the combined periods January 1, 2008 through August 1, 2008 and August 2, 2008 through September 30, 2008, was due primarily to:

Operating Expenses

        The operating expenses for the nine-month period ended September 30, 2009 are consistent with our expectations as a stand-alone entity.

 
  Successor   Successor    
  Predecessor   Total*    
   
 
 
   
   
   
 
 
  Nine
Months
Ended
September 30,
2009
  Period
August 2,
2008
through
September 30,
2008
   
  Period
January 1,
2008
through
August 1,
2008
  Nine
Months
Ended
September 30,
2008
  Dollar
Decrease
  Percent
Decrease
 

Sales and marketing

  $ 2,226   $ 390       $ 1,928   $ 2,318   $ (92 )   (4 )%

Sales and marketing (as % of total revenue)

    16 %   12 %       16 %   15 %            

*
Used for comparative purposes

        The decrease in sales and marketing expense for the nine-month period ended September 30, 2009, compared to the combined periods January 1, 2008 through August 1, 2008 and August 2, 2008 through September 30, 2008, resulted primarily from delayed spending on various projects due to the effects of the slowdown in the economic environment, offset by higher expenses for the period during which we operated as a stand-alone company compared to the shared services allocation methodology applied in the predecessor financial statements.

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Table of Contents

 
  Successor   Successor    
  Predecessor   Total*    
   
 
 
   
   
   
 
 
  Nine
Months
Ended
September 30,
2009
  Period
August 2,
2008
through
September 30,
2008
   
  Period
January 1,
2008
through
August 1,
2008
  Nine
Months
Ended
September 30,
2008
  Dollar
Increase
  Percent
Increase
 

Research, development and engineering

  $ 3,679   $ 780       $ 2,071   $ 2,851   $ 828     29 %

Research, development and engineering (as % of total revenue)

    27 %   25 %       17 %   19 %            

*
Used for comparative purposes

        The increase in research, development and engineering expense for the nine-month period ended September 30, 2009, compared to the combined periods January 1, 2008 through August 1, 2008 and August 2, 2008 through September 30, 2008, resulted primarily from:

 
  Successor   Successor    
  Predecessor   Total*    
   
 
 
   
   
   
 
 
  Nine
Months
Ended
September 30,
2009
  Period
August 2,
2008
through
September 30,
2008
   
  Period
January 1,
2008
through
August 1,
2008
  Nine
Months
Ended
September 30,
2008
  Dollar
Increase
  Percent
Increase
 

General and administrative

  $ 4,750   $ 932       $ 2,349   $ 3,281   $ 1,469     45 %

General and administrative (as % of total revenue)

    35 %   29 %       20 %   22 %            

*
Used for comparative purposes

        The increase in general and administrative expenses for the nine-month period ended September 30, 2009, compared to the combined periods January 1, 2008 through August 1, 2008 and August 2, 2008 through September 30, 2008, resulted primarily from higher expenses for the period during which we operated as a stand-alone company compared to the shared services allocation methodology applied in the predecessor financial statements.

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Table of Contents

 
  Successor   Successor    
  Predecessor   Total*    
   
 
 
   
   
   
 
 
  Nine
Months
Ended
September 30,
2009
  Period
August 2,
2008
through
September 30,
2008
   
  Period
January 1,
2008
through
August 1,
2008
  Nine
Months
Ended
September 30,
2008
  Dollar
Decrease
  Percent
Decrease
 

Intellectual property

  $ 756   $ 120       $ 1,102   $ 1,222   $ (466 )   (38 )%

Intellectual property (as % of total revenue)

    6 %   4 %       9 %   8 %            

*
Used for comparative purposes

        The decrease in intellectual property expenses for the nine-month period ended September 30, 2009, compared to the combined periods January 1, 2008 through August 1, 2008 and August 2, 2008 through September 30, 2008, resulted primarily from capitalized patent application and award costs aggregating $0.6 million, offset by expenses related to legal services in support of intellectual property licensing activities.

 
  Successor   Successor    
  Predecessor   Total*    
   
 
 
   
   
   
 
 
  Nine
Months
Ended
September 30,
2009
  Period
August 2,
2008
through
September 30,
2008
   
  Period
January 1,
2008
through
August 1,
2008
  Nine
Months
Ended
September 30,
2008
  Dollar
Increase
(Decrease)
  Percent
Increase
(Decrease)
 

Cost of revenue

  $ 156   $       $ 99   $ 99   $ 57     58 %

Sales and marketing

    152             208     208     (56 )   (27 )%

Research, development and engineering

    140             34     34     106     312 %

General and administrative

    1,290             537     537     753     140 %

Intellectual property

    70             35     35     35     100 %
                               
 

Total

  $ 1,808   $       $ 913   $ 913   $ 895     98 %
                               

*
Used for comparative purposes

        The increase in stock-based compensation expense for the nine-month period ended September 30, 2009, compared to the combined periods January 1, 2008 through August 1, 2008 and August 2, 2008 through September 30, 2008, resulted primarily from Digimarc applying ASC 718 with respect to our initial stock-based awards compared to the shared services allocation methodology applied in the predecessor financial statements.

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Table of Contents

 
  Successor   Successor    
  Predecessor   Total*    
   
 
 
   
   
   
 
 
  Nine
Months
Ended
September 30,
2009
  Period
August 2,
2008
through
September 30,
2008
   
  Period
January 1,
2008
through
August 1,
2008
  Nine
Months
Ended
September 30,
2008
  Dollar
Increase
(Decrease)
  Percent
Increase
(Decrease)
 

Interest income, net

  $ 436   $ 196       $ 597   $ 793     (357 )   (45 )%

Net loss from joint ventures

    (311 )                   (311 )   (100 )%

Other

    3     (17 )       (7 )   (24 )   27     113 %
                               
 

Total

  $ 128   $ 179       $ 590   $ 769     (641 )   (83 )%
                               

*
Used for comparative purposes

        The decrease in other income, net for the nine-month period ended September 30, 2009, compared to the combined periods January 1, 2008 through August 1, 2008 and August 2, 2008 through September 30, 2008, resulted primarily from the net losses of $(292) and $(19) from the joint ventures TVaura LLC and TVaura Mobile LLC, respectively, and lower interest earned on cash and investment balances, reflecting lower interest rates paid on these balances.

        Old Digimarc.    The provision for income taxes reflects expected tax expense from profitability in certain foreign jurisdictions. The predecessor recorded a full valuation allowance against net deferred tax assets at August 1, 2008 due to the uncertainty of realization of net operating losses. As a separate legal entity, we will not benefit from any of the carry-forward tax attributes of Old Digimarc, including net operating loss carry-forwards.

        Digimarc.    There was no provision for income taxes of Digimarc, other than foreign withholding taxes, for the nine-month period ended September 30, 2009 since the estimated effective tax rate for the period ending December 31, 2009 is expected to be zero.

Liquidity and Capital Resources

 
  Successor   Successor  
 
  September 30,
2009
  December 31,
2008
 
 
  (in thousands)
 

Working capital

  $ 42,600   $ 41,099  

Current (liquidity) ratio(1)

    16:1     11.9:1  

Cash, cash equivalents and short-term marketable securities

  $ 41,445   $ 40,168  

Long-term marketable securities

  $ 2,087   $ 5,744  

Total cash, cash equivalents and all marketable securities

  $ 43,532   $ 45,912  

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

        The $1.5 million increase in working capital resulted primarily from the maturity of some of our long-term investments, offset by investments in our business for both capital and intellectual property initiatives, cash contributions to the joint ventures with The Nielsen Company and repurchases of our common stock as part of our stock repurchase program.

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Table of Contents

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

 
  Successor   Successor    
  Predecessor   Total*    
   
 
 
   
   
   
 
 
  Nine
Months
Ended
September 30,
2009
  Period
August 2,
2008
through
September 30,
2008
   
  Period
January 1,
2008
through
August 1,
2008
  Nine
Months
Ended
September 30,
2008
  Dollar
Increase
(Decrease)
  Percent
Increase
(Decrease)
 

Net income (loss)

  $ (2,174 ) $ 400       $ 1,415   $ 1,815   $ (3,989 )   (220 )%

Non-cash items

    2,544     69         1,844     1,913     631     33 %

Changes in operating assets and liabilities

    (466 )   (5,549 )       8,951     3,402     (3,868 )   (114 )%
                               

Net cash provided by (used in) operating activities

  $ (96 ) $ (5,080 )     $ 12,210   $ 7,130   $ (7,226 )   (101 )%
                               

*
Used for comparative purposes

        Net income (loss).    The decrease in operating results primarily reflects lower revenues, higher expenses for the period during which we operated as a stand-alone company compared to the benefits received from the shared services cost allocation methodology in the predecessor financial statements and initial losses from our new joint ventures with Nielsen.

        Non-cash items.    The increase in non-cash items was primarily the result of the shared services allocation methodology applied in the predecessor financial statements to both depreciation of property and equipment, stock compensation and net losses from the joint ventures.

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

        The primary changes in the operating assets and liabilities for the nine-month period ended September 30, 2008 relate to:

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Table of Contents

        Cash flows from investing activities.    The primary changes in the investing activities for the nine-month periods ended September 30, 2009 and 2008 relate to:

        Cash flows from financing activities.    The primary changes in the financing activities for the nine-month period ended September 30, 2009 relate to purchases of common stock as part of the stock repurchase program, partially offset by the exercise of stock options.

        The primary changes in the financing activities for the nine-month period ended September 30, 2008 were the result of cash transactions associated with Old Digimarc in accordance with the basis of accounting used in our financial statements. Specifically,

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

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

Contractual Obligations

        Pursuant to the terms of the joint venture agreements with Nielsen, we will be contributing $6.7 million to the joint ventures payable in quarterly installments from July 2009 through October 2011, which $6.2 million is outstanding as of September 30, 2009.

        Our significant commitments consist of obligations under non-cancelable operating leases for our facilities, rent and various equipment leases, which totaled $1.7 million as of September 30, 2009 and are payable in monthly installments through February 2013. Other than as described above, as of September 30, 2009, there have been no material changes in the contractual obligations disclosed in our 2008 Annual Report.

Adjusted EBITDA

        We define Adjusted EBITDA as net earnings before interest expense, income taxes, depreciation, amortization and non-cash expenditures for stock compensation. Adjusted EBITDA is not a measure of

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Table of Contents


financial performance under generally accepted accounting principles. Management uses Adjusted EBITDA in internal analyses as a supplemental measure of our financial performance to assist it in determining performance comparisons against its peer group of companies, as well as capital spending and other investing decisions. Adjusted EBITDA is also a common alternative measure of performance used by investors, financial analysts, and rating agencies to evaluate financial performance. Adjusted EBITDA should not be considered in isolation or as a substitute for net earnings, operating income, cash flows provided by operating activities or other income or cash flow data prepared in accordance with U.S. GAAP and this non-GAAP measure may not be comparable to similarly titled measures of other companies.

        The following table presents a reconciliation of Adjusted EBITDA to net earnings:

 
  Successor   Successor    
  Predecessor   Total*    
   
 
 
  Three
Months
Ended
September 30,
2009
  Period
August 2,
2008
through
September 30,
2008
   
  Period
July 1,
2008
through
August 1,
2008
  Three
Months
Ended
September 30,
2008
  Dollar
Increase
(Decrease)
  Percent
Increase
(Decrease)
 

Net income (loss)

  $ (687 ) $ 400       $ (173 ) $ 227   $ (914 )   (402 )%

Adjustments:

                                         
 

Provision for income taxes

    3                     3     100 %
 

Interest income, net

    (124 )   (196 )       (75 )   (271 )   147     (54 )%
 

Depreciation and amortization

    149     69         122     191     (42 )   (22 )%
 

Stock compensation

    629             136     136     493     363 %