Edgar Filing: Digimarc CORP

Large accelerated filer

Accelerated filer

Non-accelerated filer

¨ (Do not check if a smaller reporting company)

Smaller reporting company

Form 10-Q

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

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

For the quarterly period ended March 31, 2012

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

For the transition period from to

Commission File Number: 001-34108

DIGIMARC CORPORATION

(Exact name of registrant as specified in its charter)

Oregon

26-2828185

(State or other jurisdiction of

incorporation or organization)

(I.R.S. Employer

Identification No.)

9405 SW Gemini Drive, Beaverton, Oregon 97008

(Address of principal executive offices) (Zip Code)

(503) 469-4800

(Registrant’s telephone number, including area code)

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

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

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

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

As of April 23, 2012, there were 7,092,690 shares of the registrant’s common stock, par value $0.001 per share, outstanding.

Table of Contents


PART I FINANCIAL INFORMATION
Item 1.	Financial Statements (Unaudited):	3
	Balance Sheets as of March 31, 2012 and December 31, 2011	3
	Statements of Operations for the three-months ended March 31, 2012 and 2011	4
	Statements of Shareholders’ Equity as of the periods ended March 31, 2012 and December 31, 2011	5
	Statements of Cash Flows for the three-months ended March 31, 2012 and 2011	6
	Notes to Financial Statements	7
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	20
Item 3.	Quantitative and Qualitative Disclosures About Market Risk	32
Item 4.	Controls and Procedures	33
PART II OTHER INFORMATION
Item 1.	Legal Proceedings	34
Item 1A.	Risk Factors	34
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	34
Item 5.	Other Information	35
Item 6.	Exhibits	35
SIGNATURES		36

PART I. FINANCIAL INFORMATION

Item 1. Financial Statements.

DIGIMARC CORPORATION

BALANCE SHEETS

(In thousands, except share data)

(UNAUDITED)


	March 31, 2012		December 31, 2011(1)
ASSETS
Current assets:
Cash and cash equivalents	$	8,547	$	3,419
Marketable securities		22,328		22,244
Trade accounts receivable, net		2,470		3,502
Other current assets		1,134		1,306

Total current assets		34,479		30,471
Marketable securities		13,130		7,715
Property and equipment, net		1,400		1,395
Intangibles, net		3,215		2,808
Investments in joint ventures		—		415
Deferred tax assets		1,929		2,634
Other assets, net		272		355

Total assets	$	54,425	$	45,793

LIABILITIES AND SHAREHOLDERS’ EQUITY
Current liabilities:
Accounts payable and other accrued liabilities	$	1,629	$	952
Income tax payable		1,018		—
Deferred revenue		2,580		2,660

Total current liabilities		5,227		3,612
Deferred rent and other long-term liabilities		441		464

Total liabilities		5,668		4,076
Commitments and contingencies (Note 12)
Shareholders’ equity:
Preferred stock (10,000 shares issued and outstanding at March 31, 2012 and December 31, 2011)		50		50
Common stock (7,092,690 and 7,008,031 shares issued and outstanding at March 31, 2012 and December 31, 2011, respectively)		7		7
Additional paid-in capital		36,552		34,511
Retained earnings		12,148		7,149

Total shareholders’ equity		48,757		41,717

Total liabilities and shareholders’ equity	$	54,425	$	45,793

(1)	Derived from the Company’s December 31, 2011 audited financial statements

See Notes to Unaudited Financial Statements.

DIGIMARC CORPORATION

STATEMENTS OF OPERATIONS

(In thousands, except per share data)

(UNAUDITED)


	Three Months Ended March 31, 2012			Three Months Ended March 31, 2011
Revenue:
Service	$	3,048		$	3,069
License and subscription		13,998			6,022

Total revenue		17,046			9,091
Cost of revenue:
Service		1,697			1,584
License and subscription		113			65

Total cost of revenue		1,810			1,649
Gross profit		15,236			7,442
Operating expenses:
Sales and marketing		1,007			1,102
Research, development and engineering		1,998			1,775
General and administrative		2,758			2,847
Intellectual property		319			301

Total operating expenses		6,082			6,025

Operating income		9,154			1,417
Net loss from joint ventures		(1,107	)		(537	)
Interest income, net		58			58

Income before provision for income taxes		8,105			938
Provision for income taxes		3,106			—

Net income	$	4,999		$	938

Earnings per share:
Net income per share—basic	$	0.74		$	0.14
Net income per share—diluted	$	0.70		$	0.12
Weighted average shares outstanding—basic		6,738			6,864
Weighted average shares outstanding—diluted		7,140			7,505

See Notes to Unaudited Financial Statements.

DIGIMARC CORPORATION

STATEMENTS OF SHAREHOLDERS’ EQUITY

(In thousands, except share data)

(UNAUDITED)


	Preferred stock				Common stock					Additional paid-in capital			Retained Earnings		Total shareholders’ equity
	Shares		Amount		Shares			Amount		Additional paid-in capital			Retained Earnings		Total shareholders’ equity
BALANCE AT DECEMBER 31, 2010		10,000	$	50		7,443,450		$	7	$	49,609		$	1,493	$	51,159
Exercise of stock options		—		—		169,420			—		1,651			—		1,651
Issuance of restricted common stock		—		—		190,180			—		—			—		—
Forfeiture of restricted common stock		—		—		(18,120	)		—		—			—		—
Purchase and retirement of common stock		—		—		(776,899	)		—		(22,046	)		—		(22,046	)
Stock-based compensation		—		—		—			—		4,231			—		4,231
Tax benefit from stock-based awards		—		—		—			—		1,066			—		1,066
Net income		—		—		—			—		—			5,656		5,656

BALANCE AT DECEMBER 31, 2011		10,000	$	50		7,008,031		$	7	$	34,511		$	7,149	$	41,717
Exercise of stock options		—		—		7,500			—		72			—		72
Issuance of restricted common stock		—		—		112,520			—		—			—		—
Forfeiture of restricted common stock		—		—		(3,975	)		—		—			—		—
Purchase and retirement of common stock		—		—		(31,386	)		—		(799	)		—		(799	)
Stock-based compensation		—		—		—			—		1,433			—		1,433
Tax benefit from stock-based awards		—		—		—			—		1,335			—		1,335
Net income		—		—		—			—		—			4,999		4,999

BALANCE AT MARCH 31, 2012		10,000	$	50		7,092,690		$	7	$	36,552		$	12,148	$	48,757

See Notes to Unaudited Financial Statements.

DIGIMARC CORPORATION

STATEMENTS OF CASH FLOWS

(In thousands)

(UNAUDITED)


	Three Months Ended March 31, 2012			Three Months Ended March 31, 2011
Cash flows from operating activities:
Net income	$	4,999		$	938
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization, property and equipment		143			153
Amortization of intangibles		66			26
Stock-based compensation		1,406			986
Net loss from joint ventures		1,107			537
Deferred income tax expense		711			—
Tax benefit from stock-based awards		1,335			—
Excess tax benefit from stock-based awards		(1,335	)		—
Changes in operating assets and liabilities:
Trade accounts receivable, net		1,032			756
Other current assets		166			533
Other assets, net		83			54
Accounts payable and other accrued liabilities		(77	)		119
Income tax payable		1,060			—
Deferred revenue		(83	)		(239	)

Net cash provided by operating activities		10,613			3,863
Cash flows from investing activities:
Purchase of property and equipment		(148	)		(165	)
Capitalized patent costs		(446	)		(129	)
Investments in joint ventures		—			(700	)
Sale or maturity of marketable securities		22,993			42,234
Purchase of marketable securities		(28,492	)		(28,315	)

Net cash provided by (used in) investing activities		(6,093	)		12,925
Cash flows from financing activities:
Issuance of common stock		72			—
Purchase of common stock		(799	)		(15,705	)
Excess tax benefit from stock-based awards		1,335			—

Net cash provided by (used in) financing activities		608			(15,705	)

Net increase in cash and cash equivalents		5,128			1,083
Cash and cash equivalents at beginning of period		3,419			6,340

Cash and cash equivalents at end of period	$	8,547		$	7,423

Supplemental disclosure of cash flow information:
Cash paid for income taxes	$	—		$	—
Supplemental schedule of non-cash investing activities:
Stock-based compensation capitalized to patent costs	$	27		$	11
Investments in joint ventures, net	$	692		$	—

See Notes to Unaudited Financial Statements.

DIGIMARC CORPORATION

NOTES TO FINANCIAL STATEMENTS

(Dollar amounts in thousands, except per share data)

(UNAUDITED)

1. Description of Business and Summary of Significant Accounting Policies

Description of Business

Digimarc Corporation (“Digimarc” or the “Company”), an Oregon 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. The Company’s inventions provide 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 and reliably identify relevant data from vast amounts of media content.

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 note disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States (the “U.S.”) have been condensed or omitted in accordance with the rules and regulations of the Securities and Exchange Commission (“SEC”).

These financial statements should be read in conjunction with the audited financial statements included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2011, which was filed with the SEC on February 24, 2012. The results of operations for the interim periods presented in these financial statements are not necessarily indicative of the results for the full year.

Use of Estimates

The preparation of financial statements in accordance with accounting principles generally accepted in the U.S. requires Digimarc to make estimates and judgments that affect the reported amounts of assets, liabilities, revenue and expenses, and related disclosure of contingent assets and liabilities. Certain of the Company’s accounting policies require higher degrees of judgment than others in their application. These include revenue recognition on long-term license and service contracts, impairments and estimation of useful lives of long-lived assets, contingencies and litigation, patent costs, stock-based compensation and income taxes (valuation allowance). 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.

Cash Equivalents

The Company considers all highly liquid marketable securities with original maturities of 90 days or less at the date of acquisition to be cash equivalents. Cash equivalents include money market funds, certificates of deposit, commercial paper, and investments in government bonds totaling $7,187 and $2,992 at March 31, 2012 and December 31, 2011, respectively. Cash equivalents are carried at cost or amortized cost, which approximates market.

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 primarily include federal agency notes, company notes, and commercial paper. The Company’s marketable securities are classified as held-to-maturity as of the balance sheet date and are reported at amortized cost, which approximates market.

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

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

•

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

•

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

•

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

ASC 825 “Financial Instruments” allows an entity the irrevocable option to elect fair value for the initial and subsequent measurement for specified financial assets and liabilities on a contract-by-contract basis. The Company did not elect the fair value option under this statement as to specific assets or liabilities.

The estimated fair values of the Company’s financial instruments, which include cash and cash equivalents, short-term marketable securities, accounts receivable, accounts payable and other accrued liabilities approximate their carrying values due to the short-term nature of these instruments. The Company records marketable securities at amortized cost, which approximates fair value. The fair value is based on quoted market prices in active markets for identical assets, a Level 1 input.


	March 31, 2012		December 31, 2011
Marketable securities, at amortized cost	$	40,761	$	32,054
Cash equivalents, included above	$	5,303	$	2,096
Money market funds	$	1,884	$	896

Concentrations of Business and Credit Risk

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

Equity Method Investments

The Company accounts for its joint ventures under the equity method of accounting pursuant to ASC 323 “Investments—Equity Method and Joint Ventures.” Under the equity method, investments are carried at cost, plus or minus the Company’s proportionate share, based on present ownership interests, of: (a) the investee’s profit or loss after the date of acquisition; (b) changes in the Company’s equity that have not been recognized in the investee’s profit or loss; and (c) certain other adjustments. Distributions received from the investee (such as dividends) reduce the carrying amount of the investment.

The Company reviews its equity investments for impairment whenever there is a loss in value of an investment which is other than a temporary decline. The Company conducts its equity investment impairment analyses in accordance with ASC 323, which requires the Company to record an impairment charge for a decrease in value of an investment when the decline in the investment is considered to be other than temporary.

Impairment of Long-Lived Assets

The Company accounts for long-lived assets in accordance with the provisions of ASC 360 “Property, Plant and Equipment.” This statement requires that long-lived assets and certain identifiable intangibles be reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Recoverability of assets to be held and used is measured by a comparison of the carrying amount of an asset to future net undiscounted cash flows expected to be generated by the asset. If such assets are considered to be impaired, the impairment to be recognized is measured by the amount by which the carrying amount of the assets exceeds the fair value of the assets. Fair value is determined based on discounted cash flows or appraised values, depending on the nature of the asset. Assets to be disposed of are reported at the lower of the carrying amount or fair value less costs to sell. Through March 31, 2012, there have been no material impairment losses.

Research and Development

Research and development costs are expensed as incurred in accordance with the provisions of ASC 730 “Research and Development.”

Software Development Costs

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

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, also referred to as patent prosecution costs, include internal legal labor, professional legal fees, government filing fees and translation fees related to obtaining the Company’s patent portfolio.

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

Revenue Recognition

See Note 3 for detailed disclosures of the Company’s revenue recognition policy.

Stock-Based Compensation

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

For stock option awards 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 its 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, the Company’s 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 deferred tax assets to the amount expected to be realized.

2. Recent Accounting Standards Update

In May 2011, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2011-04, “Fair Value Measurement: Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRS,” which provides common requirements for measuring fair value and for disclosing information about fair value measurements in accordance with U.S. generally accepted accounting principles (GAAP) and International Financial Reporting Standards (IFRS). The amendments of ASU No. 2011-04 are effective during interim and annual periods beginning after December 15, 2011. Early application is prohibited. The Company has adopted the provisions of this standard and noted no material impact on the financial condition or results of operations of the Company.

3. Revenue Recognition

We derive our revenue primarily from development services and licensing of our patent portfolio:

•

Service revenue consists primarily of software development and consulting services. The majority of service revenue arrangements are structured as time and materials consulting agreements and fixed price consulting agreements.

•

License revenue, including royalty revenue, originates primarily from licensing the Company’s technology and patents where the Company receives royalties as its income stream. Subscription revenue, which includes the sale of web-based subscriptions related to various software products, is recurring in nature.

Revenue is recognized in accordance with ASC 605 and 985 when the following four criteria are met:

(i)

persuasive evidence of an arrangement exists,

(ii)

delivery has occurred,

(iii)

the fee is fixed or determinable, and

(iv)

collection is probable.

Some customer arrangements encompass multiple deliverables, such as patent license, professional services, software subscriptions, and maintenance fees. For arrangements that include multiple deliverables, the Company identifies separate units of accounting at inception based on the consensus reached under ASC 605, which provides that revenue arrangements with multiple deliverables should be divided into separate units of accounting if certain criteria are met. The consideration for the arrangement is allocated to the separate units of accounting using the relative selling price method.

The relative selling price method allocates the consideration based on the Company’s specific assumptions rather than assumptions of a marketplace participant, and any discount in the arrangement proportionally to each deliverable on the basis of each deliverable’s selling price.

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

•

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

•

License revenue is recognized when amounts owed to the Company have been earned, are fixed or determinable (within the Company’s normal 30 to 60 day payment terms), and collection is probable. If the payment terms extend beyond the normal 30 to 60 days, the fee may not be considered to be fixed or determinable, and the revenue would then be recognized when installments are due.

•

The Company records revenue from certain license agreements upon cash receipt as a result of collectability not being reasonably assured.

•

The Company’s standard payment terms for license arrangements are 30 to 60 days. Extended payment terms increase the likelihood the Company will grant a customer a concession, such as reduced license payments or additional rights, rather than hold firm on minimum commitments in an agreement to the point of losing a potential advocate and licensee of patented technology in the marketplace. Extended payment terms on patent license arrangements are not considered to be fixed or determinable if payments are due beyond the Company’s standard payment terms, primarily because of the risk of substantial modification present in the Company’s patent licensing business. As such, revenue on license arrangements with extended payment terms are recognized as fees become fixed and determinable.

•

Subscription revenue is accounted for under ASC 985 “Software”. Subscription revenue is generally paid in advance and recognized over the term of the license, which is generally twelve months, or upon delivery and acceptance if the Company grants a perpetual license with no further obligations.

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

4. Segment Information

Geographic Information

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

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


	Three Months Ended March 31, 2012		Three Months Ended March 31, 2011
Domestic	$	13,571	$	6,070
International		3,475		3,021

Total	$	17,046	$	9,091

Major Customers

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


	Three Months Ended March 31, 2012			Three Months Ended March 31, 2011
Verance Corporation (“Verance”)		52	%		13	%
Intellectual Ventures (“IV”)		19	%		33	%
Central Banks		16	%		26	%
The Nielsen Company (“Nielsen”)		*			11	%

*	Less than 10%

On January 30, 2012, the Company and Verance, a longtime cash based revenue customer, settled all disputes regarding breach of contract and patent infringement claims. In connection with the resolution of these matters, Verance paid the Company $8,852 for amounts due to Digimarc through December 31, 2011 and all claims between the parties were dismissed. Revenue from this payment was recorded in the quarter ending March 31, 2012.

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 related to internal legal labor is allocated to patent costs based on direct labor hours charged to capitalized patent costs.

Determining Fair Value

Preferred Stock

The Board of Directors authorized 10,000 shares of Series A Redeemable Nonvoting Preferred stock (Series A Preferred) 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 at the option of the Company’s Board of Directors at any time on or after June 18, 2013.

The Series A Preferred is redeemable 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. The Series A Preferred has no dividend rights and no rights to the undistributed earnings of the Company.

Stock Options

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

Expected Life. The expected life of awards granted represents the period of time that they are expected to be outstanding. No grants of awards were made in 2012. For 2011, for employee grants, the Company determines the expected life based on historical experience with similar awards, giving consideration to the contractual terms, vesting schedules and pre-vesting and post-vesting forfeitures. Stock options granted generally vest over three to four years for employee grants and one to two years for director grants, and have contractual terms of ten years.

Expected Volatility. No grants of awards were made in 2012. For 2011, for employee grants, the Company estimates the volatility of its common stock at the date of grant based on the historical volatility of its common stock based on historical prices over the most recent period commensurate with the 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 life estimate.

Expected Dividend Yield. The Company has never paid any cash dividends on its common stock. Consequently, the Company uses an expected dividend yield of zero in the Black-Scholes option valuation model.

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


	2011
Expected life (in years)		5.28 – 5.75
Expected volatility		42% - 44	%
Risk-free interest rate		1.0% - 2.0	%
Expected dividend yield		0	%


	Three Months Ended March 31, 2012		Three Months Ended March 31, 2011
Fair value of stock options granted	$	—	$	954

Expected Forfeitures. The Company uses a zero forfeiture for both the stock options granted to employees, which vest monthly, and the stock options granted to the Company’s Directors. Initial option grants, for new Directors, vest 50% on the first anniversary of the date of grant and then monthly thereafter, and annual option grants, for continuing Directors, vest monthly. The Company records stock-based compensation expense only for those awards that are expected to vest, including awards made to Directors who are expected to continue with the Company through the year following the date of grant.

Restricted Stock

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

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

Stock-based Compensation


	Three Months Ended March 31, 2012		Three Months Ended March 31, 2011
Stock-based compensation:
Cost of revenue	$	184	$	110
Sales and marketing		96		85
Research, development and engineering		185		158
General and administrative		834		585
Intellectual property		57		48

Stock-based compensation expense		1,356		986
Capitalized to patent costs		27		11

Total stock-based compensation	$	1,383	$	997

At March 31, 2012, the Company had 10,000 shares of Series A redeemable nonvoting preferred stock, non-vested options to purchase 380,716 shares of common stock and 356,150 shares of restricted stock outstanding.

The following table sets forth 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:


	As of March 31, 2012		As of December 31, 2011
Unrecognized compensation costs	$	10,660	$	9,463

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 through March 2016:


	Stock Options		Restricted Stock
Weighted average period		1.06 years		1.88 years

Stock Option Activity

As of March 31, 2012, under all of the Company’s stock-based compensation plans, options to purchase 753,627 shares were authorized for future grants under the plans. The Company issues new shares upon option exercises.

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


Three-months ended March 31, 2012:	Options			Weighted Average Exercise Price		Weighted Average Grant Date Fair Value		Aggregate Intrinsic Value
Outstanding at December 31, 2011		1,028,238		$	14.23	$	7.61
Options granted		—			—		—
Options exercised		(7,500	)	$	9.64	$	6.30
Options canceled or expired		—			—		—

Outstanding at March 31, 2012		1,020,738		$	14.27	$	7.62	$	14,112

Exercisable at March 31, 2012		640,022		$	11.55			$	10,536

Unvested at March 31, 2012		380,716		$	18.84			$	3,576

The aggregate intrinsic value is based on the closing price of $27.94 per share of Digimarc common stock on March 31, 2012, which would have been received by the optionees had all of the options with exercise prices less than $27.94 per share been exercised on that date.

The following table summarizes information about stock options outstanding at March 31, 2012:


	Options Outstanding						Options Exercisable
Range of Exercise Prices	Number Outstanding		Remaining Contractual Life (Years)		Weighted Average Price		Number Exercisable		Remaining Contractual Life (Years)		Weighted Average Price
$9.64 - $9.91		672,822		6.60	$	9.65		522,034		6.61	$	9.66
$14.99 - $18.01		132,916		7.83	$	15.67		82,501		7.88	$	16.09
$24.35 - 30.01		215,000		9.32	$	27.84		35,487		9.09	$	28.86

$9.64 - $30.01		1,020,738		7.34	$	14.27		640,022		6.91	$	11.55

Restricted Stock Activity

The following table reconciles the unvested balance of restricted stock:


Three-months ended March 31, 2012:	Number of Shares			Weighted Average Grant Date Fair Value
Unvested balance, December 31, 2011		296,710		$	21.90
Granted		112,520		$	24.03
Vested		(49,105	)	$	24.23
Canceled		(3,975	)	$	18.32

Unvested balance, March 31, 2012		356,150		$	21.96

6. Net Income Per Share

Net income per share is calculated in accordance with ASC 260 “Earnings Per Share,” which provides that basic and diluted net income per share for all periods presented are to be computed using the weighted average number of common shares outstanding during each period, with diluted net income per share including the effect of potentially dilutive common shares.


	Three Months Ended March 31, 2012						Three Months Ended March 31, 2011
	Income (Numerator)		Shares (in thousands) (Denominator)		Per Share Amount		Income (Numerator)		Shares (in thousands) (Denominator)		Per Share Amount
Basic EPS
Income available to common shareholders	$	4,999		6,738	$	0.74	$	938		6,864	$	0.14

Effect of Dilutive Securities
Options				46						370
Restricted stock				356						271

Diluted EPS
Income available to common shareholders	$	4,999		7,140	$	0.70	$	938		7,505	$	0.12

There were 75,000 common stock equivalents related to stock options that were anti-dilutive and excluded from diluted net income per share calculations for the three-months ended March, 31, 2012 as their exercise prices were higher than the average market price of the underlying common stock for the period.

There were no common stock equivalents related to stock options that were anti-dilutive for the three-months ended March, 31, 2011 because their exercise prices were lower than the average market price of the underlying common stock for the period.

7. Trade Accounts Receivable

Trade Accounts Receivable

Trade accounts receivable are recorded at the invoiced amount.


	March 31, 2012		December 31, 2011
Trade accounts receivable	$	2,470	$	3,502
Allowance for doubtful accounts		—		—

Trade accounts receivable, net	$	2,470	$	3,502

Unpaid deferred revenues included in accounts receivable	$	1,087	$	2,084

Allowance for doubtful accounts

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

Unpaid deferred revenues

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

Major customers

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


	March 31, 2012			December 31, 2011
Nielsen		40	%		29	%
Central Banks		34	%		45	%
Civolution		15	%		14	%

8. Property and Equipment

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

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


	March 31, 2012			December 31, 2011
Office furniture fixtures	$	410		$	410
Equipment		2,013			1,872
Leasehold improvements		1,048			1,041

		3,471			3,323
Less accumulated depreciation and amortization		(2,071	)		(1,928	)

	$	1,400		$	1,395

9. Intangible Assets—Purchased and Capitalized Patent Costs

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


	March 31, 2012			December 31, 2011
Gross intangible assets	$	3,521		$	3,048
Accumulated amortization		(306	)		(240	)

Intangible assets, net	$	3,215		$	2,808

10. Joint Venture and Related Party Transactions

In March 2012, Digimarc and Nielsen decided to reduce the investments in their two joint ventures to minimal levels while assessing alternative approaches to achieving each of their goals in the emerging market opportunity of synchronized second screen television. In connection with this plan for the suspension of operations, the joint ventures accrued estimated expenses for the quarter’s operations and associated with these changes as of March 31, 2012, including severance costs for joint venture employees. Digimarc’s share of the one-time severance and suspension costs was approximately $500. The Company anticipates its share of funding both the first quarter’s operating expenses as well as these suspension related costs will be a net payment of $700, comprised of approximately $800 to be contributed to TVaura Mobile LLC, offset by approximately $100 of remaining cash from TVaura LLC to be returned to Digimarc.

The investment in joint ventures account balances have been reduced to zero, resulting in an immaterial net gain.

Pursuant to the terms of the agreements and ASC 810 “Consolidation,” the joint ventures are not consolidated with the Company as the minority shareholder has substantive participating rights, or veto rights, such that no shareholder has majority control.

Related Party Transactions


	Three Months Ended March 31, 2012		Three Months Ended March 31, 2011
TVaura LLC:
Capital contributions	$	—	$	400
Revenue(1)	$	—	$	691
TVaura Mobile LLC:
Capital contributions	$	—	$	300
Revenue(1)	$	272	$	—
Total:
Capital contributions	$	—	$	700
Revenue(1)	$	272	$	691

(1)	Technical and development services

At March 31, 2012, the Company accrued $692, net in accounts payable and other accrued liabilities of additional capital contributions to the joint ventures.


	March 31, 2012		December 31, 2011
TVaura LLC:
Accounts receivable	$	1	$	164
TVaura Mobile LLC:
Accounts receivable	$	38	$	—

Summarized financial data for TVaura LLC:


	March 31, 2012		December 31, 2011
Current assets	$	208	$	402
Noncurrent assets	$	—	$	22
Current liabilities	$	5	$	169
Noncurrent liabilities	$	—	$	—


	Three Months Ended March 31, 2012			Three Months Ended March 31, 2011
Revenue	$	—		$	—
Gross profit	$	—		$	—
Operating expenses	$	52		$	717
Net loss from continuing operations	$	(52	)	$	(716	)

The Company’s pro-rata share—net loss	$	(27	)	$	(365	)
The Company’s gain on investment	$	70		$	—

Summarized financial data for TVaura Mobile LLC:


	March 31, 2012		December 31, 2011
Current assets	$	198	$	1,308
Noncurrent assets	$	—	$	—
Current liabilities	$	1,822	$	720
Noncurrent liabilities	$	—	$	—


	Three Months Ended March 31, 2012			Three Months Ended March 31, 2011
Revenue	$	—		$	—
Gross profit	$	—		$	—
Operating expenses	$	2,245		$	350
Net loss from continuing operations	$	(2,245	)	$	(350	)

The Company’s pro-rata share—net loss	$	(1,100	)	$	(172	)
The Company’s loss on investment	$	(50	)	$	—

11. Income Taxes

The provision for income taxes for the period ended March 31, 2012, reflects income taxes for federal and state jurisdictions reduced by available tax credit carry-forwards and tax credits claimed during the period. The effective tax rate for the period ended March 31, 2012 was 38.3%. The valuation allowance against net deferred tax assets as of March 31, 2012, is $0.

The effective tax rate for the period ended March 31, 2012 differs from the effective rate for the period ended March 31, 2011, primarily due to the release of the valuation allowance on net deferred tax assets during the quarter ended June 30, 2011. During the quarter ended June 30, 2011, the Company concluded, based on projections of future income, that it was more likely than not that the Company’s deferred tax assets would be realized.

There was no provision for the period ended March 31, 2011 because the computation of regular current taxable income was fully offset by available net operating loss carry-forwards and tax credits for which a full valuation allowance had been provided.

12. Commitments and Contingencies

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

The Company is subject from time to time to other legal proceedings and claims arising in the ordinary course of business. No such proceedings are currently pending.

13. Stock Repurchases

Summary of common stock shares repurchased:


	Three Months Ended March 31, 2012		Three Months Ended March 31, 2011
Private transaction		—		552,536
Repurchase program		7,607		16,873
Exercise of stock options		2,389		—
Tax withholding obligations on stock options		1,851		—
Tax withholding obligations on restricted shares		19,539		10,876

Total		31,386		580,285

Value of common stock shares repurchased:


	Three Months Ended March 31, 2012		Three Months Ended March 31, 2011
Private transaction	$	—	$	14,927
Repurchase program		198		455
Exercise of stock options		72		—
Tax withholding obligations on stock options		56		—
Tax withholding obligations on restricted shares		473		322

Total	$	799	$	15,704

On January 26, 2011, the Company repurchased 552,536 shares of its common stock from Koninklijke Philips Electronics, N.V., in a privately negotiated transaction. The shares were purchased for an aggregate price of approximately $14,927, including transaction fees. To facilitate the repurchase, the Company sold $10,752 and $2,996 of short- and long-term marketable securities, respectively, prior to their maturity date at an immaterial gain.

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 through April 30, 2010. In April 2010 and April 2011, the Board of Directors approved an extension of the stock repurchase program for one year periods. In November 2011, the Board of Directors approved an additional $5,000 for a one year period. As of March 31, 2012, the Company had repurchased 223,851 shares under this program at an aggregate purchase price of $4,858.

As part of the Company’s 2008 Stock Incentive Plan, stock options are granted to certain employees and restricted stock shares are awarded to certain employees.

Pursuant to the terms of the stock option grants, the Company purchased a number of whole shares of common stock having a fair market value (as determined as of the date of exercise) equal to the amount of the total value of the aggregate exercise price of the options exercised. In addition, the Company withheld (purchased) from shares issued upon exercise of the stock options a number of whole shares of common stock having a fair market value (as determined by the Company as of the date of vesting) equal to the amount of tax required to be withheld by law, in order to satisfy the tax withholding obligations of the Company in connection with the exercise of such options.

Pursuant to the terms of the restricted stock award agreement, the Company withheld (purchased) from fully vested shares of common stock otherwise deliverable to the employee, a number of whole shares of common stock having a fair market value (as determined as of the date of vesting) equal to the amount of tax required to be withheld by law, in order to satisfy the tax withholding obligations of the Company in connection with the vesting of such shares.

14. Subsequent Events

In accordance with ASC 855 “Subsequent Events,” the Company has evaluated subsequent events.

On April 26, 2012, the Board of Directors declared a quarterly dividend of $0.11 per share, payable on May 25, 2012 to shareholders of record on May 11, 2012.

15. Quarterly Financial Information—


Quarter ended:	March 31
*2012*
Service revenue	$	3,048
License and subscription revenue		13,998

Total revenue		17,046
Total cost of revenue		1,810
Gross profit		15,236
Gross profit percent, service revenue		44	%
Gross profit percent, license and subscription revenue		99	%
Gross profit percent, total		89	%
Sales and marketing		1,007
Research, development and engineering		1,998
General and administrative		2,758
Intellectual property		319
Operating income		9,154
Net income		4,999
Earnings per share:
Net income per share—basic	$	0.74
Net income per share—diluted	$	0.70
Weighted average shares outstanding—basic		6,738
Weighted average shares outstanding—diluted		7,140


Quarter ended:	March 31			June 30			September 30			December 31
*2011*
Service revenue	$	3,069		$	3,165		$	3,108		$	3,053
License and subscription revenue		6,022			6,308			5,442			5,872

Total revenue		9,091			9,473			8,550			8,925
Total cost of revenue		1,649			1,690			1,742			1,856
Gross profit		7,442			7,783			6,808			7,069
Gross profit percent, service revenue		48	%		49	%		46	%		42	%
Gross profit percent, license and subscription revenue		99	%		99	%		99	%		99	%
Gross profit percent, total		82	%		82	%		80	%		79	%
Sales and marketing	$	1,102		$	1,017		$	1,166		$	1,051
Research, development and engineering		1,775			1,884			1,958			1,710
General and administrative		2,847			2,270			2,000			2,839
Intellectual property		301			266			259			268
Operating income		1,417			2,346			1,425			1,201
Net income		938			3,626			639			453
Earnings per share:
Net income per share—basic	$	0.14		$	0.54		$	0.10		$	0.07
Net income per share—diluted	$	0.12		$	0.50		$	0.09		$	0.06
Weighted average shares outstanding—basic		6,864			6,696			6,706			6,699
Weighted average shares outstanding—diluted		7,505			7,245			7,344			7,279

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, 2011 filed on February 24, 2012 (the “2011 Annual Report”) and in the audited financial statements and related notes included in our 2011 Annual Report, and other reports and filings made with the Securities and Exchange Commission (“SEC”).

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

All dollar amounts are in thousands, unless otherwise noted.

Digimarc Discover is a registered trademark of Digimarc Corporation. This Quarterly Report on Form 10-Q also includes trademarks and trade names owned by other parties, and all other such trademarks and trade names mentioned in this Quarterly Report on Form 10-Q are the property of their respective owners.

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 technologies, and those of our licensees, span a range of media content, enabling our customers and those of our partners to:

•

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

•

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

•

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

•

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

•

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

•

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

•

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

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

Digital watermarking allows our customers to embed digital data into any media content that is digitally processed at some point during its lifecycle. The technology can be applied to printed materials, video, audio, and images. The inclusion of these digital signals enables a wide range of improvements in security and media management, and new business models for distribution and consumption of media content. Over the years our technology and intellectual property portfolios have grown to encompass many related technologies.

We provide solutions directly and through our licensees. Our proprietary technology has proven to be a powerful element of document security, giving rise to our long-term relationship with a consortium of central banks, which we refer to as the Central Banks, and many leading companies in the information technology industry. We and our licensees have successfully propagated digital watermarking in music, movies, television broadcasts, images and printed materials. Digital watermarks have been used in these applications to improve media rights and asset management, reduce piracy and counterfeiting losses, improve marketing programs, permit more efficient and effective distribution of valuable media content and enhance consumer entertainment and commercial experiences. Our patent portfolio contains a number of innovations in digital watermarking, pattern recognition (sometimes referred to as “fingerprinting”), digital rights management and related fields. 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. As a result, we believe we have one of the world’s most extensive patent portfolios in digital watermarking and related fields, with greater than 1,200 granted and pending U.S. and foreign filings as of March 31, 2012. We continue to develop and broaden our portfolio of patented technology in the fields of media identification and management technology and related applications and systems. We devote significant resources to developing and protecting our inventions and continuously seek to identify and evaluate potential licensees for our patents.

For a discussion of activities and costs related to our research and development, please read the sections titled “Research, development and engineering” under Item 2, “Management’s Discussion and Analysis of Financial Condition and Results of Operations.”

Critical Accounting Policies and Estimates

Detailed information on our critical accounting policies and estimates are set forth in our 2011 Annual Report in Part II, Item 7 thereof (“Management’s Discussion and Analysis of Financial Condition and Results of Operations”), under the caption “Critical Accounting Policies and Estimates,” which is incorporated by reference into this Quarterly Report on Form 10-Q.

Results of Operations

The following table presents statements of operations data for the periods indicated as a percentage of total revenue. Unless otherwise indicated, all references in this Management’s Discussion and Analysis of Financial Condition and Results of Operations to the three-month period relate to the three-month period ended March 31, 2012 and all changes discussed with respect to such period reflect changes compared to the three-month period ended March 31, 2011.


	Three Months Ended March 31, 2012			Three Months Ended March 31, 2011
Revenue:
Service		18	%		34	%
License and subscription		82			66

Total revenue		100			100
Cost of revenue:
Service		10			17
License and subscription		1			1

Total cost of revenue		11			18
Gross profit		89			82
Operating expenses:
Sales and marketing		6			12
Research, development and engineering		12			20
General and administrative		16			32
Intellectual property		2			3

Total operating expenses		36			67

Operating income		53			15

Net loss from joint ventures		(6	)		(6	)
Interest income, net		—			1

Income before provision for income taxes		47			10
Provision for income taxes		(18	)		—

Net income		29	%		10	%

Summary

In 2012, we continue to invest in our growth initiatives, including Digimarc Discover and the second wave of patent inventions, centered on our vision of enhancing computers, networks and other digital devices to see, hear, understand and respond to their surroundings.

Total revenue for the three-month period in 2012 increased 88% to $17.0 million compared to the same period in 2011 primarily as a result of the payment from Verance Corporation (“Verance”), a cash basis customer, for royalties through the fourth quarter of 2011 received in connection with the resolution of our litigation with Verance. See Part II, Item 1 of this Quarterly Report on Form 10-Q. Legal expenses, on the other hand, decreased for the three-month period because the Verance litigation was resolved.

Revenue


	Three Months Ended March 31, 2012			Three Months Ended March 31, 2011			Dollar Increase (Decrease)			Percent Increase (Decrease)
Revenue:
Service	$	3,048		$	3,069		$	(21	)		(1	)%
License and subscription		13,998			6,022			7,976			132	%

Total	$	17,046		$	9,091		$	7,955			88	%

Revenue (as % of total revenue):
Service		18	%		34	%
License and subscription		82	%		66	%

Total		100	%		100	%

We derive our revenue primarily from:

development services provided to government and commercial customers and

licensing our patents.

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

The decrease in service revenue for the three-month period was due primarily to lower activity in the joint venture, including the suspension of operations, offset by increased program work from the Central Banks.

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 increase in license and subscription revenue for the three-month period was due primarily from the payment from Verance for royalties through the fourth quarter of 2011.

Revenue by Geography


	Three Months Ended March 31, 2012			Three Months Ended March 31, 2011			Dollar Increase		Percent Increase
Revenue by geography:
Domestic	$	13,571		$	6,070		$	7,501		124	%
International		3,475			3,021			454		15	%

Total	$	17,046		$	9,091		$	7,955		88	%

Revenue (as % of total revenue):
Domestic		80	%		67	%
International		20	%		33	%

Total		100	%		100	%

The increase in domestic revenue for the three-month period was due primarily to the payment from Verance.

The increase in international revenue for the three-month period was due primarily to increased program work from the Central Banks.

We anticipate revenue growth for 2012, compared to 2011, from our existing customers and from new customers as we continue to expand the marketing and monetization of our intellectual property portfolio.

Cost of Revenue

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

•

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

•

payments to outside contractors that are billed to customers;

•

charges for equipment directly used by the customer;

•

depreciation charges for machinery, equipment and software;

•

travel costs directly attributable to service and development contracts; and

•

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

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

•

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

•

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

•

amortization of capitalized patent costs.

Changes in cost of revenue generally correspond with the fluctuation in revenues. The components of the costs of the varied revenue sources can affect gross profit as explained below.

Gross Profit


	Three Months Ended March 31, 2012			Three Months Ended March 31, 2011			Dollar Increase (Decrease)			Percent Increase (Decrease)
Gross Profit:
Service	$	1,351		$	1,485		$	(134	)		(9	)%
License and subscription		13,885			5,957			7,928			133	%

Total	$	15,236		$	7,442		$	7,794			105	%

Gross Profit (as % of related revenue components):
Service		44	%		48	%
License and subscription		99	%		99	%
Total		89	%		82	%

The increase in gross profit for the three-month period was due primarily to the payment from Verance.

The increase in gross profit as a percentage of revenue for the three-month period was due primarily to changes in revenue mix resulting in higher license revenue which carries a higher margin than service revenue, as a percent of total revenue. The decrease in service gross profit as a percentage of revenue for the three-month period resulted from changes in services cost mix from our various contracts.

Operating Expenses

Sales and marketing


	Three Months Ended March 31, 2012			Three Months Ended March 31, 2011			Dollar Decrease		Percent Decrease
Sales and marketing	$	1,007		$	1,102		$	95		9	%
Sales and marketing (as % of total revenue)		6	%		12	%

Sales and marketing expenses consist primarily of:

•

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

•

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

•

professional services and outside contractors for product and marketing initiatives;

•

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

•

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

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

•

salaries;

•

a payroll tax and benefits factor; and

•

incentive compensation related to our stock compensation plans.

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

Sales and marketing expenses remained relatively consistent for the three-month period.

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

Research, development and engineering


	Three Months Ended March 31, 2012			Three Months Ended March 31, 2011			Dollar Increase		Percent Increase
Research, development and engineering	$	1,998		$	1,775		$	223		13	%
Research, development and engineering (as % of total revenue)		12	%		20	%

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

•

Fundamental Research:

•

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

•

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

•

industry conference participation and authorship of papers for industry journals;

•

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

•

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

•

research in fingerprinting and other content identification technologies.

•

Platform Development:

•

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

•

mobile platform creation to leverage device specific capabilities (e.g. instruction sets and Graphics Processing Units (“GPUs”)).

•

Product Development:

•

creation of Online Services Portal to provide campaign management and routing services for the Digimarc Discover platform;

•

implementation of web-hosted image watermark embedder in support of Digimarc Discover platform; and

•

iterative development and release of the Digimarc Discover application for the iTunes and Android marketplaces.

Research, development and engineering expenses consist primarily of:

•

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

•

payments to outside contractors;

•

the purchase of materials and services for product development;

•

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

•

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

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

•

salaries;

•

a payroll tax and benefits factor; and

•

incentive compensation related to our stock compensation plans.

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

The increases in research, development and engineering expense for the three-month period resulted primarily from increased headcount and compensation-related expenses of $0.3 million from hiring engineers and scientists to facilitate growth in our product and service offerings, including increased investments primarily related to the mobile device market.

We anticipate that we will continue to invest in research, development and engineering expenses at higher levels to support our ongoing research and product initiatives.

General and administrative


	Three Months Ended March 31, 2012			Three Months Ended March 31, 2011			Dollar Decrease		Percent Decrease
General and administrative	$	2,758		$	2,848		$	89		3	%
General and administrative (as % of total revenue)		16	%		32	%

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

General and administrative expenses consist primarily of:

•

compensation, benefits and related costs;

•

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

•

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

•

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

The decreases in general and administrative expenses for the three-month period resulted primarily from:

•

decreased legal fees of $0.2 million related to the litigation matter with Verance;

•

decreased accounting fees of $0.2 million related to the transition to our new auditors; offset by

•

increased compensation-related expenses of $0.3 million primarily related to an additional layer of stock-based awards.

We anticipate that we will continue to incur general and administrative expenses at existing or lower levels in the near term, particularly lower legal fees as a result of our settlement with Verance, while continuing to examine means to reduce general and administrative expenses as a percentage of revenue in the longer term.

Intellectual property


	Three Months Ended March 31, 2012			Three Months Ended March 31, 2011			Dollar Increase		Percent Increase
Intellectual property	$	319		$	301		$	18		6	%
Intellectual property (as % of total revenue)		2	%		3	%

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

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

•

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

•

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

•

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

•

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

We allocate certain costs of intellectual property to cost of service revenue when they relate directly to our service contracts, primarily for support services provided to IV. For direct billable labor hours, we allocate to cost of service revenue:

•

salaries;

•

a payroll tax and benefits factor; and

•

incentive compensation related to our stock compensation plans.

Intellectual property expenses, however, can vary from period to period based on:

•

the level of capitalized patent activity, and

•

prosecution costs and direct labor hours (salaries, payroll taxes and benefits factor and incentive compensation related to our stock compensation plans) related to the patents that were exclusively licensed to IV that are allocated to cost of revenue.

Intellectual property expenses remained relatively consistent for the three-month period.

We anticipate that we will continue to invest in intellectual property expenses at existing levels.

Stock-based compensation


	Three Months Ended March 31, 2012		Three Months Ended March 31, 2011		Dollar Increase		Percent Increase
Cost of revenue	$	184	$	110	$	74		67	%
Sales and marketing		96		85		11		13	%
Research, development and engineering		185		158		27		17	%
General and administrative		834		585		249		43	%
Intellectual property		57		48		9		19	%

Total	$	1,356	$	986	$	370		38	%

The increases in stock-based compensation expense for the three-month period was primarily due to an additional layer of stock-based awards. We anticipate incurring an additional $10,660 in stock-based compensation expense through March 2016 for awards outstanding as of March 31, 2012.

Net loss from joint ventures


	Three Months Ended March 31, 2012			Three Months Ended March 31, 2011			Dollar Increase		Percent Increase
Net loss from joint ventures	$	(1,107	)	$	(537	)	$	570		106	%
Net loss from joint ventures (as % of total revenue)		(6	)%		(6	)%

The increases in the net loss from joint ventures for the three-month period resulted primarily from lower activity and accrued expenses, including severance costs for joint venture employees, in connection with suspending operations of the joint ventures.

Interest income, net


	Three Months Ended March 31, 2012		Three Months Ended March 31, 2011			Dollar		Percent
Interest income, net		58		58			—		—	%
Interest income, net (as % of total revenue)		*		1	%

* Less than 1%

Interest income, net remained relatively consistent for the three-month period.

Provision for Income Taxes.

The provision for income taxes for the period ended March 31, 2012 reflects income taxes for federal and state jurisdictions reduced by available tax credit carry-forwards and tax credits claimed during the period. The effective tax rate for the period ended March 31, 2012 was 38.3%.

We continually assess the applicability of a valuation allowance. Based upon the positive and negative evidence available as of March 31, 2012, we concluded that it is more likely than not that net deferred tax assets will be utilized. Consequently, a valuation allowance has not been recorded to offset net deferred tax assets.

Liquidity and Capital Resources


	March 31, 2012		December 31, 2011
Working capital	$	29,252	$	26,859
Current (liquidity) ratio(1)		6.6:1		8.4:1
Cash, cash equivalents and short-term marketable securities	$	30,875	$	25,663
Long-term marketable securities	$	13,130	$	7,715
Total cash, cash equivalents and all marketable securities	$	44,005	$	33,378

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

The $10.6 million increase in cash, cash equivalents and all marketable securities resulted primarily from:

•

improved operating results, driven primarily from the payment from Verance; offset by

•

investments in our business for both capital and intellectual property initiatives; and

•

purchases of common stock related to the vesting of restricted stock and repurchases made under our stock repurchase program.

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

Other than cash used for operating needs, which may include short-term marketable securities, our investment policy limits our credit exposure to any one financial institution or type of financial instrument by limiting the maximum of 5% of our cash and cash equivalents and marketable securities or $1 million, whichever is greater, to be invested in any one issuer except for the U.S. government and U. S. federal agencies, which have no limits, at the time of purchase. Our investment policy also limits our credit exposure by limiting to a maximum of 40% of our cash and cash equivalents and marketable securities, or $15 million, whichever is greater, to be invested in any one industry category, for example, financial or energy industries, at the time of purchase. As a result, we believe our credit risk associated with cash and investments to be minimal. A decline in the market value of any security below cost that is deemed to be other-than-temporary results in a reduction in carrying amount of fair value. To determine whether an impairment is other-than-temporary, we consider whether we have the ability and intent to hold the investment until a market price recovery and evidence indicating that the cost of the investment is recoverable outweighs evidence to the contrary. There have been no other-than-temporary impairments identified or recorded by us.

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


	Three Months Ended March 31, 2012		Three Months Ended March 31, 2011		Dollar Increase		Percent Increase
Net income	$	4,999	$	938	$	4,061		433	%
Non-cash items		3,433		1,702		1,731		102	%
Changes in operating assets and liabilities		2,181		1,223		958		78	%

Net cash provided by operating activities	$	10,613	$	3,863	$	6,750		175	%

Net income

The increase in operating results for the three-month period was primarily due to the cash payment received from Verance, offset by higher compensation-related expenses due to higher head count, an additional layer of stock-based awards and higher income taxes.

Non-cash items

The increase in non-cash items for the three-month period was primarily the result of net losses from the joint ventures, an additional layer of stock-based awards and deferred income tax expense.

Operating assets and liabilities

The primary changes in the operating assets and liabilities for the three-month period related to:

•

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

•

provision accrual for income taxes payable.

The primary changes in the operating assets and liabilities for the prior year period relate to:

•

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

•

reimbursement from our landlord for the tenant improvement allowance.

Cash flows from investing activities

The cash flows from investing activities for the three-month period and the same period in the prior year related to:

•

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

•

investments made in the patent application and granting process;

•

investments made in joint ventures; and

•

net activity from investing our short- and long-term marketable securities.

Cash flows from financing activities

The cash flows from financing activities for the three-month period related to the increase in purchases of common stock for the following:

•

purchases of common stock as part of our stock repurchase program;

•

purchases of common stock for the withholding of shares upon the vesting of restricted stock to satisfy tax withholding obligations; and

•

the excess tax benefit from stock-based awards.

The cash flows from financing activities for the same period in the prior year related to the increase in purchases of common stock for the following:

•

purchase of common stock from a shareholder in a privately negotiated transaction;

•

purchases of common stock as part of our stock repurchase program; and

•

purchases of common stock for the withholding of shares upon the vesting of restricted stock to satisfy tax withholding obligations.

Commitments and contingencies

Pursuant to the terms of the joint venture agreements with Nielsen, we were obligated to contribute an aggregate of $6.7 million to the joint ventures payable in quarterly installments from July 2009 through October 2011. Upon mutual agreement, the October 2011 payment of $0.7 million was delayed to 2012. In March 2012, Digimarc and Nielsen decided to reduce the investments in their two joint ventures to minimal levels while assessing alternative approaches to achieving each of their goals in the emerging market opportunity of synchronized second screen television. In connection with this plan for the suspension of operations, the joint ventures accrued estimated expenses for the quarter’s operations and associated with these changes as of March 31, 2012, including severance costs for joint venture employees. Digimarc’s share of the one-time severance and suspension costs was approximately $500. The Company anticipates its share of funding both the first quarter’s operating expenses as well as these suspension related costs will be a net payment of $700, comprised of approximately $800 to be contributed to TVaura Mobile LLC, offset by approximately $100 of remaining cash from TVaura LLC to be returned to Digimarc.

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

Our obligations under non-cancelable operating leases for our facilities and various equipment leases, which totaled $3.8 million as of March 31, 2012, are payable in monthly installments through August 2016.

Future Cash Expectations.

In connection with the settlement, renewal and extension agreement with Verance described in Part II, Item 1, Legal Proceedings, we anticipate our cash flow will be higher in 2012 compared to 2011 as a result of payments of royalties based on Verance revenues.

In connection with our IV arrangement, we anticipate our cash flow will slightly improve as a result of:

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

consulting fees payable over two years, and

additional cost savings because IV has assumed the prosecution and maintenance costs related to the patents and patent applications that were licensed to IV that were previously borne by us.

Since the inception of our stock repurchase program in April 2009, through March 31, 2012, our Board of Directors has authorized the repurchase of $10.0 million of our common stock. As of March 31, 2012, we had repurchased 223,851 shares under this program at an aggregate purchase price of $4,858. Shares of our common stock may be purchased in the open market or through privately negotiated transactions, subject to market conditions. This repurchase program does not obligate us to acquire any specific number of shares or to acquire shares over any specified period of time.

We believe that our current cash, cash equivalents, and short-term marketable securities 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 marketable securities balances to satisfy our projected working capital and capital expenditure requirements.

On April 26, 2012, the Board of Directors declared a quarterly dividend of $0.11 per share, payable on May 25, 2012 to shareholders of record on May 11, 2012. The amount of the quarterly dividend payment is expected to be approximately $781.

We may use cash resources to pay future dividends, fund acquisitions or make investments in complementary businesses, technologies or product lines. We do not believe at this time that our long-term working capital and capital expenditures would require us to seek financing to remedy any potential deficiencies. In order to take advantage of opportunities, however, we may find it necessary to obtain additional equity financing, debt financing, or credit facilities. If it were necessary to obtain additional financing 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


	Payment Due by Period
	Total		Less than 1 year		1-3 years		3-5 years		More than 5 years
Total joint venture obligations, net	$	692	$	692	$	—	$	—	$	—
Total operating lease obligations		3,827		832		1,719		1,276		—

Total obligations	$	4,519	$	1,524	$	1,719	$	1,276	$	—

Other than as described above, as of March 31, 2012 there have been no material changes in the contractual obligations disclosed in our 2011 Annual Report.

Off-Balance Sheet Arrangements

Other than the contractual obligations noted above, we do not have any off-balance sheet arrangements that have or are reasonably likely to have a current or future effect on our financial condition, changes in financial condition, revenue or expenses, results of operations, liquidity, capital expenditures or capital resources that are material to investors.

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

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

•

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

•

trends and expectations in revenue growth;

•

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

•

our ability to improve margins;

•

anticipated expenses, costs, margins, provision for income taxes and investment activities in the foreseeable future, including estimated increases in stock-based compensation expenses through March 2016;

•

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

•

variability of contractual arrangements;

•

our profitability in future periods;

•

business opportunities that could require that we seek additional financing;

•

the size and growth of our markets;

•

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

•

the source of our future revenue;

•

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

•

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

•

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

•

our use of cash, cash equivalents and marketable securities in upcoming quarters;

•

anticipated levels of backlog in future periods;

•

the success of our arrangements with Intellectual Ventures;

•

protection, development and monetization of our intellectual property portfolio; and

•

other risks detailed in our filings with the Securities and Exchange Commission, including the risk factors set forth in Part I, Item1A of our 2011 Annual Report.

We believe that the risk factors contained in Part I, Item 1A of our 2011 Annual Report could affect our future performance and the liquidity and value of our securities and cause our actual results to differ materially from those expressed or implied by forward-looking statements made by us or on our behalf. Investors should understand that it is not possible to predict or identify all risk factors and that there may be other factors that may cause our actual results to differ materially from the forward-looking statements. All forward-looking statements made by us or by persons acting on our behalf apply only as of the date of this Quarterly Report on Form 10-Q. We do not undertake any obligation to publicly update or revise any forward-looking statements to reflect future events, information or circumstances that arise after the date of the filing of this Quarterly Report on Form 10-Q.

Item 3.

Quantitative and Qualitative Disclosures About Market Risk.

The market risk disclosures as set forth in Part II, Item 7A of our 2011 Annual Report have not changed materially.

Item 4.

Controls and Procedures.

Evaluation of Disclosure Controls and Procedures

We conducted an evaluation (pursuant to Rule 13a-15(b) of the Securities Exchange Act of 1934 (the “Exchange Act”)), under the supervision and with the participation of management, including the Chief Executive Officer and Chief Financial Officers, of the effectiveness of the Company’s disclosure controls and procedures (as defined in Rule 13a-15(e)) as of the end of the period covered by this Form 10-Q. These disclosure controls and procedures are designed to ensure that information required to be disclosed in our reports that are filed or submitted under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms. Our disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that this information is accumulated and communicated to management, including the principal executive and principal financial officers, or persons performing similar functions, as appropriate, to allow timely decisions regarding required disclosure. Based on the evaluation, the Chief Executive Officer and Chief Financial Officer have concluded that these disclosure controls and procedures were effective as of the end of the period covered by this Form 10-Q.

Changes in Controls

There was no change in our internal control over financial reporting (as defined in Rule 13a-15(f) and 15d-15(f) of the Exchange Act of 1934) that occurred during the fiscal quarter ended March 31, 2012 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

PART II. OTHER INFORMATION.

Item 1.

Legal Proceedings.

Verance Corporation, a Digimarc licensee, filed a declaratory judgment action against Digimarc in the United States District Court in Delaware on September 30, 2010, alleging the invalidity and non-infringement of 22 patents held by Digimarc. Verance Corp. v. Digimarc Corp., 1:10-cv-00831-UNA. The District Court dismissed Verance’s action. On September 9, 2011 Verance filed a Notice of Appeal with the Court of Appeals for the Federal Circuit. On December 6, 2010, Digimarc filed suit against Verance Corporation in the District of Oregon seeking payment for breach of contract by Verance related to Verance’s failure to make payments under the licensing agreement between Digimarc and Verance. Digimarc Corp. v. Verance Corp., CV’10-1489 JE.

In January 2012, Digimarc and Verance entered into mediation, sponsored by the Federal Circuit in Washington, D.C. The mediation resulted in a resolution, on January 31, 2012, of all disputes between the parties, including dismissal of all actions and appeals, a payment of $8,000 by Verance for amounts due through the third quarter of 2011, a payment of approximately $852 for fourth quarter 2011 royalties, entry by the parties into a three year settlement, renewal and extension agreement with blended royalty rates for unified fields of use, and a grant to Verance of nine annual renewal options.

Item 1A.

Risk Factors

Detailed information about risk factors that may affect Digimarc’s actual results are set forth in Part I, Item 1A of our 2011 Annual Report. As of March 31, 2012, there have been no material changes to the risk factors set forth in our 2011 Annual Report.

Our business, financial condition, results of operations and cash flows may be affected by a number of factors, including the factors set forth in our 2011 Annual Report. The risks and uncertainties described in our 2011 Annual Report are those risks of which we are aware and that we consider to be material to our business. If any of the risks and uncertainties develops into actual events, our business, financial condition, results of operations, or cash flows could be materially adversely affected. In that case, the trading price of our common stock could decline.

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds.

In April 2009, the Board of Directors approved a stock repurchase program authorizing the purchase, at the discretion of management, of up to $5.0 million in shares of our common stock through either periodic open-market or private transactions at then-prevailing market prices through April 30, 2010. In April 2010 and April 2011, the Board of Directors approved an extension of the stock repurchase program for additional one year periods. In November 2011, the Board of Directors approved an additional $5.0 million for a one year period. As of March 31, 2012, the Company had repurchased 223,851 shares under this program at an aggregate purchase price of $4,858.

In addition to the stock repurchase program described above, and the withholding (repurchase) of shares of common stock in connection with the vesting of restricted shares, described below, from time to time, we repurchase shares in connection with stock option exercises, to cover exercise price and taxes. For the three-month period ended March 31, 2012, the Company repurchased 2,389 shares in connection with stock option exercises at an aggregate purchase price of $72.

The following table sets forth information regarding purchases of our equity securities during the three-month period ended March 31, 2012:


Period	(a) Total number of shares purchased⁽¹⁾		(b) Average price paid per share⁽¹⁾		(c) Total number of shares purchased as part of publicly announced plans or programs		(d) Maximum number (or approximate dollar value) of shares that may yet be purchased under the plans or programs
Month 1
January 1, 2012 to January 31, 2012		18,213	$	23.95		—	$	5.3 million
Month 2
February 1, 2012 to February 28,2012		1,851	$	30.27		—	$	5.3 million
Month 3
March 1, 2012 to March 31, 2012		1,326	$	28.14		7,607	$	5.1 million

Total		21,390	$	24.75		7,607

(1)	Includes stock option shares and fully vested shares of common stock withheld (purchased) by us in satisfaction of required withholding tax liability.

Item 5.

Other Information.

On March 8, 2012, Digimarc and Nielsen decided to reduce the investments in their two joint ventures to minimal levels while assessing alternative approaches to achieving each of their goals in the emerging market opportunity of synchronized second screen television. A member of each company was chosen to create and implement a plan to reduce investment, scale down the operations of the ventures, transition or terminate employees and recommend an optimal manner to suspend the operations of the ventures.

On April 23, 2012, Digimarc and Nielsen approved the plan submitted by their representatives, suspended the operations of the joint ventures and authorized the return of the remaining cash of TVaura LLC to the members, agreed to the accounting of final expenses for the joint ventures, and authorized the payment of the remaining liabilities of TVaura Mobile LLC. Digimarc expects these actions to be completed by April 30, 2012. In connection with this plan for the suspension of operations, the joint ventures accrued estimated expenses for the quarter’s operations and associated with these changes as of March 31, 2012, including severance costs for joint venture employees. Digimarc’s share of the one-time severance and suspension costs was approximately $500. The Company anticipates its share of funding both the first quarter’s operating expenses as well as these suspension related costs will be a net payment of $700, comprised of approximately $800 to be contributed to TVaura Mobile LLC, offset by approximately $100 of remaining cash from TVaura LLC to be returned to Digimarc.

Item 6.

Exhibits.


Exhibit Number		Exhibit Description

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

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

32.1		Section 1350 Certification of Chief Executive Officer

32.2		Section 1350 Certification of Chief Financial Officer

101.INS		XBRL Instance Document

101.SCH		XBRL Taxonomy Extension Schema Document

101.CAL		XBRL Taxonomy Extension Calculation Linkbase Document

101.DEF		XBRL Taxonomy Extension Definition Linkbase Document

101.LAB		XBRL Taxonomy Extension Label Linkbase Document

101.PRE		XBRL Taxonomy Extension Presentation Linkbase Document

SIGNATURES

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