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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

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

For the quarterly period ended March 31, 2019

OR

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

For the transition period fromto

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)

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

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

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

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit such files).    Yes  ☒    No  ☐

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

Large accelerated filer	☐	Accelerated filer	☒
Non-accelerated filer	☐	Smaller reporting company	☒
Emerging growth company	☐

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

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

As of April 26, 2019, there were 12,127,967 shares of the registrant’s common stock, par value $0.001 per share, outstanding.

Table of Contents

PART I FINANCIAL INFORMATION
Item 1.	Financial Statements (Unaudited):	3
	Consolidated Balance Sheets as of March 31, 2019 and December 31, 2018	3
	Consolidated Statements of Operations for the three months ended March 31, 2019 and 2018	4
	Consolidated Statements of Shareholders’ Equity for the three months ended March 31, 2019 and 2018	5
	Consolidated Statements of Cash Flows for the three months ended March 31, 2019 and 2018	6
	Notes to Consolidated Financial Statements	7
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	17
Item 4.	Controls and Procedures	29
PART II OTHER INFORMATION
Item 1.	Legal Proceedings	30
Item 1A.	Risk Factors	30
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	30
Item 6.	Exhibits	31
SIGNATURES		32

2

PART I. FINANCIAL INFORMATION

Item 1. Financial Statements.

DIGIMARC CORPORATION

CONSOLIDATED BALANCE SHEETS

(In thousands, except per share data)

(UNAUDITED)

	March 31,			December 31,
	2019			2018
ASSETS
Current assets:
Cash and cash equivalents	$	24,275		$	27,278
Marketable securities		13,193			16,378
Trade accounts receivable, net		3,727			3,888
Other current assets		2,026			2,100
Total current assets		43,221			49,644
Property and equipment, net		3,808			3,955
Intangibles, net		6,649			6,649
Goodwill		1,114			1,114
Other assets		3,167			425
Total assets	$	57,959		$	61,787
LIABILITIES AND SHAREHOLDERS’ EQUITY
Current liabilities:
Accounts payable and other accrued liabilities	$	2,337		$	1,092
Deferred revenue		2,700			3,226
Total current liabilities		5,037			4,318
Lease liability and other long-term liabilities		3,079			854
Total liabilities		8,116			5,172
Commitments and contingencies (Note 12)
Shareholders’ equity:
Preferred stock (par value $0.001 per share, 2,500 authorized, 10 shares    issued and outstanding at March 31, 2019 and December 31, 2018)		50			50
Common stock (par value $0.001 per share, 50,000 authorized, 12,135 and    11,891 shares issued and outstanding at March 31, 2019 and December 31, 2018,    respectively)		12			12
Additional paid-in capital		164,119			162,428
Accumulated deficit		(114,338	)		(105,875	)
Total shareholders’ equity		49,843			56,615
Total liabilities and shareholders’ equity	$	57,959		$	61,787

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

3

DIGIMARC CORPORATION

CONSOLIDATED STATEMENTS OF OPERATIONS

(In thousands, except per share data)

(UNAUDITED)

	Three			Three
	Months			Months
	Ended			Ended
	March 31,			March 31,
	2019			2018
Revenue:
Service	$	3,635		$	3,507
Subscription		1,563			1,578
License		462			528
Total revenue		5,660			5,613
Cost of revenue:
Service		1,531			1,563
Subscription		445			482
License		158			140
Total cost of revenue		2,134			2,185
Gross profit		3,526			3,428
Operating expenses:
Sales and marketing		4,950			4,887
Research, development and engineering		4,038			3,947
General and administrative		2,852			2,632
Intellectual property		358			315
Total operating expenses		12,198			11,781
Operating loss		(8,672	)		(8,353	)
Other income, net		237			252
Loss before income taxes		(8,435	)		(8,101	)
Provision for income taxes		(28	)		(11	)
Net loss	$	(8,463	)	$	(8,112	)
Earnings (loss) per common share:
Loss per common share — basic	$	(0.74	)	$	(0.72	)
Loss per common share — diluted	$	(0.74	)	$	(0.72	)
Weighted average common shares outstanding — basic		11,487			11,266
Weighted average common shares outstanding — diluted		11,487			11,266

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

4

DIGIMARC CORPORATION

CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY

(In thousands)

(UNAUDITED)

										Additional						Total
	Preferred Stock				Common Stock					Paid-in			Accumulated			Shareholders'
	Shares		Amount		Shares			Amount		Capital			Deficit			Equity
Three months ended March 31, 2018:
BALANCE AT DECEMBER 31, 2017		10	$	50		11,651		$	12	$	155,793		$	(73,508	)	$	82,347
Exercise of stock options		—		—		46			—		560			—			560
Issuance of restricted common stock		—		—		178			—		—			—			—
Forfeiture of restricted common stock		—		—		(10	)		—		—			—			—
Purchase and retirement of common stock		—		—		(18	)		—		(528	)		—			(528	)
Stock-based compensation		—		—		—			—		1,715			—			1,715
Cumulative effect of the adoption of the new revenue standard, net of tax		—		—		-			—		—			139			139
Net loss		—		—		—			—		—			(8,112	)		(8,112	)
BALANCE AT MARCH 31, 2018		10	$	50		11,847		$	12	$	157,540		$	(81,481	)	$	76,121
Three months ended March 31, 2019:
BALANCE AT DECEMBER 31, 2018		10	$	50		11,891		$	12	$	162,428		$	(105,875	)	$	56,615
Exercise of stock options		—		—		10			—		99			—			99
Issuance of restricted common stock		—		—		255			—		—			—			—
Forfeiture of restricted common stock		—		—		(1	)		—		—			—			—
Purchase and retirement of common stock		—		—		(20	)		—		(486	)		—			(486	)
Stock-based compensation		—		—		—			—		2,078			—			2,078
Net loss		—		—		—			—		—			(8,463	)		(8,463	)
BALANCE AT MARCH 31, 2019		10	$	50		12,135		$	12	$	164,119		$	(114,338	)	$	49,843

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

5

DIGIMARC CORPORATION

CONSOLIDATED STATEMENTS OF CASH FLOWS

(In thousands)

(UNAUDITED)

	Three			Three
	Months			Months
	Ended			Ended
	March 31,			March 31,
	2019			2018
Cash flows from operating activities:
Net loss	$	(8,463	)	$	(8,112	)
Adjustments to reconcile net loss to net cash used in    operating activities:
Depreciation, amortization and write-off of property and equipment		357			380
Amortization and write-off of intangibles		180			146
Stock-based compensation		2,037			1,671
Changes in operating assets and liabilities:
Trade accounts receivable		161			2,614
Other current assets		74			304
Other assets		(33	)		44
Accounts payable and other accrued liabilities		800			(386	)
Deferred revenue		(393	)		(219	)
Lease liability and other long-term liabilities		(174	)		(34	)
Net cash used in operating activities		(5,454	)		(3,592	)
Cash flows from investing activities:
Purchase of property and equipment		(194	)		(302	)
Capitalized patent costs		(153	)		(208	)
Maturity of marketable securities		6,744			18,657
Purchase of marketable securities		(3,559	)		(6,961	)
Net cash provided by investing activities		2,838			11,186
Cash flows from financing activities:
Exercise of stock options		99			560
Purchase of common stock		(486	)		(528	)
Net cash provided by (used in) financing activities		(387	)		32
Net increase (decrease) in cash and cash equivalents		(3,003	)		7,626
Cash and cash equivalents at beginning of period		27,278			40,823
Cash and cash equivalents at end of period	$	24,275		$	48,449
Supplemental disclosure of cash flow information:
Cash received (paid) for income taxes, net	$	(3	)	$	113
Supplemental schedule of non-cash activities:
Property and equipment and patent costs in accounts payable	$	2		$	(64	)
Stock-based compensation capitalized to software and patent costs	$	41		$	44
Right of use assets obtained in exchange for lease obligations	$	2,709		$	—

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

6

DIGIMARC CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(In thousands, except per share data)

(UNAUDITED)

1. Description of Business and Significant Accounting Policies

Description of Business

Digimarc Corporation (“Digimarc” or the “Company”), an Oregon corporation, enables governments, banks, retailers, consumer brands and other businesses around the world to automatically and reliably identify and interact with virtually any form of media. The Company has pioneered the Digimarc Intuitive Computing Platform (“ICP”), a comprehensive set of technologies for identifying, discovering and interacting with digitally-enhanced media. The platform includes Digimarc Barcode, a proprietary method for imperceptibly enhancing packaging, print, images, thermal labels, audio and other objects with data that is detected by enabled devices, such as smart phones, computers, barcode scanners and machine-vision equipment. Digimarc Discover software enables an ecosystem of connected devices to easily identify content or materials and deliver information.

Interim Consolidated Financial Statements

Our significant accounting policies are detailed in “Note 1: Description of Business and Summary of Significant Accounting Policies” of our Annual Report on Form 10-K for the year ended December 31, 2018. Significant changes to our accounting policies as a result of adopting Accounting Standards Codification (“ASC”) 842, “Leases,” effective January 1, 2019, is discussed in Note 10 below.

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

These interim consolidated financial statements should be read in conjunction with the audited consolidated financial statements included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2018, which was filed with the SEC on February 22, 2019. The results of operations for the interim periods presented in these consolidated financial statements are not necessarily indicative of the results for the full year.

Reclassifications

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

Contingencies

The Company evaluates all pending or threatened contingencies or commitments, if any, that are reasonably likely to have a material adverse effect on the Company’s operations or financial position. The Company assesses the probability of an adverse outcome and determines if it is remote, reasonably possible or probable as defined in accordance with the provisions of ASC 450, “Contingencies.” If information available prior to the issuance of the financial statements indicates that it is probable that an asset has been impaired or a liability has been incurred at the date of the financial statements, and the amount of the loss, or the range of probable loss can be reasonably estimated, then the loss is accrued and charged to operations. If no accrual is made for a loss contingency because one or both of the conditions pursuant to ASC 450 are not met, but the probability of an adverse outcome is at least reasonably possible, the Company will disclose the nature of the contingency and provide an estimate of the possible loss or range of loss, or state that such an estimate cannot be made.

Goodwill

The Company tests goodwill for impairment annually in June and whenever events or changes in circumstances indicate that the carrying value may exceed the fair value. The Company operates as a single reporting unit. The Company estimates the fair value of its single reporting unit using a market approach, which takes into account the Company’s market capitalization plus an estimated control premium.

7

Accounting Pronouncements Adopted

In February 2016, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2016-02, “Leases (ASC 842),” which supersedes, “Leases (ASC 840).” ASU No. 2016-02 increases the transparency and comparability of organizations by recognizing lease assets and lease liabilities on the balance sheet and disclosing key information about leasing arrangements. This guidance requires that operating leases recognize a right-of-use asset and a lease liability measured at the present value of the lease payments in the statement of financial position, recognize a single lease cost allocated over the lease term on a straight-line basis, and classify all cash payments within operating activities in the statement of cash flows. The amendments in this update are effective for fiscal years beginning after December 31, 2018, and interim periods beginning in the first interim period within the year of adoption. Early adoption is permitted. In July 2018, the FASB issued ASU No. 2018-11, “Leases (ASC 842) Targeted Improvements,” to provide a transition election to not restate comparative periods for the effects of applying the new standard. This transition election permits entities to change the date of initial application to the beginning of the year of adoption and to recognize the effects of applying the new standard as a cumulative-effect adjustment to the opening balance of retained earnings. In March 2019, the FASB issued ASU No. 2019-01, “Leases (ASC 842) Codification Improvements,” to increase transparency and comparability about disclosing essential information about leasing transactions. The Company adopted the new standard on January 1, 2019 and elected not to restate comparative periods. Upon adoption, the Company concluded no adjustment was required to the opening balance of retained earnings to reflect the impact of adopting the new standard. In addition, the Company recorded right of use assets of $2,709 and lease liabilities of $3,792 and reversed the previously recorded deferred rent liability of $1,083. See Note 10 below for further disclosures.

2. Fair Value of Financial Instruments

The estimated fair values of the Company’s financial instruments, which include cash equivalents, accounts receivable, accounts payable and other accrued liabilities approximate their carrying values due to the short-term nature of these instruments. The Company’s marketable securities are classified as held-to-maturity and are reported at amortized cost, which approximates fair value.

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

March 31, 2019	Level 1		Level 2		Level 3		Total
Money market securities	$	323	$	—	$	—	$	323
Commercial paper		—		28,725		—		28,725
Corporate notes		—		7,733		—		7,733
Total	$	323	$	36,458	$	—	$	36,781

December 31, 2018	Level 1		Level 2		Level 3		Total
Money market securities	$	1,472	$	—	$	—	$	1,472
Commercial paper		—		28,343		—		28,343
Corporate notes		—		12,106		—		12,106
Total	$	1,472	$	40,449	$	—	$	41,921

The fair value maturities of the Company’s cash equivalents and marketable securities as of March 31, 2019 are as follows:

	Maturities by Period
	Total		Lessthan 1 year		1-5 years		5 - 10 years		More than 10 years
Cash equivalents and marketable securities	$	36,781	$	36,781	$	—	$	—	$	—

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 commercial paper and money market funds totaling $23,588 and $25,543 at March 31, 2019 and December 31, 2018, respectively. Cash equivalents are carried at either cost or amortized cost depending on the type of security, which approximates fair value.

8

3. Revenue Recognition

The Company derives its revenue primarily from professional services, subscriptions and licensing of its intellectual property.  Applicable revenue recognition criteria are considered separately for each performance obligation as follows:

• Service revenue consists primarily of revenue received from software development and consulting services. The majority of service revenue arrangements are structured as time and materials consulting agreements.  Revenue for development and consulting services is recognized as the services are performed. Billing for services rendered generally occurs within one month after the services are provided.

• Subscription revenue includes revenue derived from the sale of Digimarc Discover, Digimarc Barcode and Digimarc Guardian products and services, is generally recurring, paid in advance and recognized over the term of the subscription, which is typically one to three years.

• License revenue includes revenue from licensing the Company’s intellectual property where the Company receives license fees and/or royalties. License fees are typically paid in advance and recognized when the customer has the right to the intellectual property and the license period has begun, and royalties are typically billed in arrears and recognized in the quarter in which the royalty was earned.

Some customer arrangements contain multiple performance obligations such as professional services, software licenses, and maintenance and support fees.  The Company accounts for individual products and services separately if they are distinct.  To determine the transaction price, the Company considers the terms of the contract and the Company’s customary business practices.  Some contracts may contain variable consideration.  In those cases, the Company estimates the amount of variable consideration based on the sum of probability-weighted amounts in a range of possible consideration amounts.  As part of this assessment, the Company will evaluate whether any of the variable consideration is constrained and if it is the Company will not include it in the transaction price. The consideration is allocated between distinct products and services based on their stand-alone selling prices.  For items that are not sold separately, the Company estimates the standalone selling price based on reasonably available information, including market conditions, specific factors affecting the Company, and information about the customer.  For distinct products and services, the Company typically recognizes the revenue associated with these performance obligations as they are delivered to the customer.  For performance obligations which are not considered distinct, the Company typically recognizes revenue over the term of the contract as the customer simultaneously receives and consumes the goods and services as the Company performs them.

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

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

	Three		Three
	Months		Months
	March 31,		March 31,
	2019		2018
Service	$	3,635	$	3,507
Subscription
Digimarc Guardian		846		989
Digimarc Discover and Digimarc Barcode		717		589
License		462		528
Total	$	5,660	$	5,613

The Company has contract assets from contracts with customers that are classified as “trade accounts receivable.”  Financial information about trade accounts receivable is included in Note 7.  

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

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

	March 31,		December 31,
	2019		2018
Deferred revenue, current	$	2,700	$	3,226
Deferred revenue, long term		179		46
Total	$	2,879	$	3,272

9

The aggregate amount of transaction price from contractual obligations that are unsatisfied or partially unsatisfied was$16,454and $17,496 as of March 31, 2019 and December 31, 2018, respectively.

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 development services, subscriptions and licensing of intellectual property. The Company markets its products in the U.S. and in non-U.S. countries through its sales and licensing personnel and channel partners.

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

	Three		Three
	Months		Months
	Ended		Ended
	March 31,		March 31,
	2019		2018
Domestic	$	1,317	$	1,451
International (1)		4,343		4,162
Total	$	5,660	$	5,613

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

Major Customers

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

	Three			Three
	Months			Months
	Ended			Ended
	March 31,			March 31,
	2019			2018
Central Banks		68	%		67	%

Long-Lived Assets by Geographical Area

The Company’s long-lived assets are all domiciled in the U.S.

5. Stock-Based Compensation

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

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

Determining Fair Value

Stock Options

Valuation and Amortization Method. The Company estimates the fair value of stock options on the date of grant (measurement date) 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. The Company determines the expected life based on historical experience with similar awards, giving consideration to the contractual terms and vesting schedules of the awards. Stock options granted generally vest over three years and have contractual terms of ten years.

10

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

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

Expected Dividend Yield. The expected dividend yield is derived by the Company’s expected annual dividend rate over the expected term divided by the fair value of the Company’s common stock at the grant date.

There were no stock options granted during the three months ended March 31, 2019 and 2018.

Restricted Stock

The fair value of restricted stock awarded 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 award using the straight-line method. Restricted stock awards granted generally vest over three to four years for employee grants and one to three years for director grants.

Stock-Based Compensation

	Three		Three
	Months		Months
	Ended		Ended
	March 31,		March 31,
	2019		2018
Stock-based compensation:
Cost of revenue	$	182	$	155
Sales and marketing		519		345
Research, development and engineering		354		298
General and administrative		912		801
Intellectual property		70		72
Stock-based compensation expense		2,037		1,671
Capitalized to software and patent costs		41		44
Total stock-based compensation	$	2,078	$	1,715

The following table sets forth total unrecognized compensation cost related to non-vested stock-based awards granted under all equity compensation plans:

	As of		As of
	March 31,		December 31,
	2019		2018
Total unrecognized compensation costs	$	17,895	$	14,055

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

The Company expects to recognize the total unrecognized compensation costs as of March 31, 2019 for stock options and restricted stock over weighted average periods through March 31, 2023 as follows:

	Stock	Restricted
	Options	Stock
Weighted average period	1.10 years	1.61 years

As of March 31, 2019, under all of the Company’s stock-based compensation plans, equity awards to purchase an additional 1,374 shares were authorized for future grants under the plans. The Company issues new shares upon option exercises.

11

Stock Option Activity

The following table reconciles the outstanding balance of stock options:

				Weighted		Weighted
				Average		Average		Aggregate
				Exercise		Grant Date		Intrinsic
Three months ended March 31, 2019:	Options			Price		Fair Value		Value
Outstanding at December 31, 2018		513		$	28.52	$	13.10
Granted		—			—		—
Exercised		(10	)		9.91		5.13
Forfeited or expired		—			—		—
Outstanding at March 31, 2019		503		$	28.89	$	13.26	$	1,251
Exercisable at March 31, 2019		320		$	28.22