Digimarc
Annual Report 2016

Plain-text annual report

THE BARCODE OF EVERYTHING™ Visit digimarc.com/app to download the free Digimarc Discover® app and scan the front cover with your smartphone to experience The Barcode of Everything™. UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-K (Mark One) ☒☒ Annual Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 ☐☐ Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 For the fiscal year ended December 31, 2016 OR For the transition period from to Commission File Number 001-34108 DIGIMARC CORPORATION (Exact name of registrant as specified in its charter) Oregon (State or other jurisdiction of incorporation or organization) 26-2828185 (I.R.S. Employer Identificff ation No.) 9405 SW Gemini Drive, Beaverton, Oregon 97008 (Address of principal executive officff es) (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 Common Stock, $0.001 Par Value Per Share Name of Each Exchange on Which Registered The NASDAQ Stock Market LLC Securities registered pursuant to Section 12(g) of the Act: NONE Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes ☐ No ☒ Indicate by check mark if the registrant is not required to fileff reports pursuant to Section 13 or Section 15(d) of the Act. Yes ☐ No ☒ 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 and posted on its corporate web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes ☒ No ☐ Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be ation statements incorporated by reference in Part III of this Form contained, to the best of registrant’s knowledge, in definitive proxy or informff 10-K or any amendment to this Form 10-K. ☐ Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated fileff r, or a smaller reporting company. See the definit Exchange Act. ff ions of “large accelerated filer,” “accelerated filer,” and “smaller reporting company” in Rule 12b-2 of the Large accelerated filer ☐ Non-accelerated filer ☐ (Do not check if a smaller reporting company) Accelerated filer Smaller reporting company ☒ ☐ Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ☐ No ☒ The aggregate market value of common stock, par value $0.001 per share, held by non-affiliates of the registrant, based on the closing price of our common stock on the Nasdaq Global Market on the last business day of the registrant’s most recently completed fiscal second quarter (June 30, 2016), was approximately $278 million. Shares of common stock beneficially held by each officer and director have been excluded from this computation because these persons may be deemed to be affiff liates. This determination of affiliat determination for any other purposes. rr yrr 17, 2017, 10,689,383 shares of the registrant’s common stock were outstanding. e status is not necessarily a conclusive As of Februar rr ff Portions of the registrant’s proxy statement pursuant to Regulation 14A (the “Proxy Statement”) for its 2017 annual meeting of DOCUMENTS INCORPORATED BY REFERENCE shareholders are incorpor to file the Proxy Statement not later than 120 days after the end of the fiscal year covered by this Annual Report on Form 10-K. nce into Items 10, 11, 12, 13 and 14 of Part III of this Annual Report on Form 10-K. The registrant intends ated by refereff rr Table of Contents PART I Item 1. Business....................................................................................................................................... Item 1A. Risk Factors................................................................................................................................. Item 1B. Unresolved Staff Comments ....................................................................................................... Item 2. Item 3. Item 4. PART II Properties..................................................................................................................................... Legal Proceedings ....................................................................................................................... Mine Safety Disclosures.............................................................................................................. Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities ................................................................................................................ Item 6. Item 7. Selected Financial Data ............................................................................................................... Management’s Discussion and Analysis of Financial Condition and Results of Operations ...... Item 7A. Quantitative and Qualitative Disclosures About Market Risk..................................................... Item 8. Item 9. Financial Statements and Supple uu mentary Data ........................................................................... Changes in and Disagreements with Accountants on Accounting and Financial Disclosure...... Item 9A. Controls and Procedures.............................................................................................................. Item 9B. Other Inforff mation........................................................................................................................ PART III Item 10. Directors, Executive Officers ff and Corporate Governance .......................................................... Item 11. Executive Compensation............................................................................................................. Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters.................................................................................................................................... Item 13. Certain Relationships and Related Transactions, and Director Independence ............................ Item 14. Principal Accountant Fees and Services...................................................................................... Item 15. Exhibits and Financial Statement Schedules ............................................................................... 1 6 18 18 18 18 19 22 23 44 44 44 45 46 47 47 47 47 47 48 SIGNATURES .................................................................................................................................................. EXHIBIT INDEX.............................................................................................................................................. 49 E-1 PART I Unless the context otherwirr seii requires, refee rences in this Annual Report on Form 10-K to “Di“ gii marc,” “we,” “our” and “us” refee r to Digii marc Corporation. All dollar amounts are in thousands except per share amountstt or unless otherwir se noted.dd Percentages within the following tables maya not foot due to rounding. Digii marc, Digii marc Discii over and Guardian are regie stii ered trademarksrr tt and trade names owned by other includes trademarksrr of Digii marc Corporation. This Annual parties, and all other tt such and trade names mentioned in this Annual Report on Formrr 10-K are the property of their respective Report on Form 10-K alsoll trademarksrr owners.rr ITEM 1: BUSINESS The following discussion of Digimarc’s business contains forwarr dd rd-look or the future financial perfor rmance of Digimi these forward-ldd ooking statements. Please see the discii ussion regae Annual Report on Form 10-K in Item 7, Management’s Discussion and Analysis ofo Financial Condition and Results of Operations, under the capta ion “F“ orFF warr arc. Our actual results couldl differff materially from those anticipate rding forward-ldd ooking statementstt rd-Ldd ooking Statements.tt ” i includeddd in this ing statements relating to futurtt e events d in The following discii ussion of our business shouldll be read in conjunction with our consolidatdd ed financial statementstt and the related notes and other Formrr 10-K.KK tt financial infon rmation appepp aring elsell where in this Annual Report on Overview Digimarc Corporation, an Oregon corporation founded in 2008, enables governments and enterprises around the world to give digital identities to media and objects that compumm ters can sense and recognize, and to which they can react. We have developed the Digimarc Discover®, Digimarc Barcode and Intuitive Computing Platform that are designed to optimize the identification of all consumer brand imprmm essions, wherever and whenever they may appear, facilitating modern mobile-centric shopping. The platform includes means to embedm “Digimarc Barcodes,” invisible and inaudible barcode-like information that is recognizable by smartphones, tablets, industrial scanners, and other compumm ter interfaces Barcodes have many applications, including facilitating remarkably faster scanning of products at retail checkout as well as imprmm oved engagement with smartphone-equipped consumers. The Digimarc Barcode is robust yet imperce mm identification of media without visible computer codes like traditional barcodes. ptible by people in ordinary use, allowing for reliable, effiff cient, economical, globally scalable, automatic into virtually all forms of media content, including consumer producd t packaging. Digimarc ff Our media identification and discovery innovations enable our business partners to create numerous applications across a wide range of media content, including solutions that: • • • • • • • Impromm ve the speed of retail checkout; Provide simple and intuitive mobile customer engagement experiences in stores; Quickly and reliably identify and effecti images, e-publu ications, documents and other printed materials, especially in light of non-linear distribution over the Internet; vely manage music, movies, television programming, digital ff Deter counterfeiting of money, media and goods, and piracy of e-publu ications, movies and music; Support uu 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 objeb cts they encounter each day; Provide consumers with more choice and access to media content when, where and how they want it; 1 • • 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 theftff and fraud. Our Intuitive Computing Platform has a proprietary foundation in signal processing innovation known as “digital watermarking,” which allows impem rceptible digital information to be embem dded in all forms of digitally designed, produced or distributed media content and many physical objeb cts, including photographs, movies, music, television, personal identification documents, financial instrut ments, industrial parts and product packages. We referff to the embem dded information as the Digimarc Barcode. This digital information can be detected and read by a wide range of computers, smartphones, tablets and other digital devices. Our inventions allow our business partners and customers to provide persistent digital identities for virtually any media content that is digitally processed at some point during its lifecycle. Our technology can be applied to printed materials, video, audio, and images to suppl y a wide range of consumer engagement, media management and security solutions across multiple consumer and government industry sectors. Over the years our enabling software and business processes, and associated intellectual property portfolio have grown to encompass many related technologies. uu We provide our solutions directly and through our business partners. Our inventions provide a powerfulff element of document security, giving rise to a long-term relationship with a consortium of central banks (the “Central Banks”), and many leading companies in the inforff mation technology industry. We and our business ly propagated the use of our technology in music, movies, television broadcasts, digital partners have successfulff images, e-publu ications and printed materials. Digimarc Barcodes have been used in these applications to improvmm e media rights and asset management, reduce piracy and counterfeiting losses, improm ve marketing programs, permit more effiff cient and effecti commercial experiences. ve distribution of valuable media content and enhance consumer entertainment and ff Digimarc Barcodes can be used to enhance all forms of media and are impemm rceptible to human senses, but quickly detected by computers, networks or other digital devices like smartphones and tablets. Unlike traditional barcodes and tags, our solution does not require publu ishers to give up valuable visual space in magazines and newspapea impercept mm delivers a range of rich media experiences to its readers on their smartphones or tabla ets across multiple media formats, including print, audio, video and packaging. Unique to the Digimarc Discover platforff m is its seamless multi-modal use of various content identification technologies as needed, including Digimarc Barcode when present. rs; nor does it impamm ct the overall layout or aesthetics of the publu ication for readers. Digimarc Barcodes are better. Our Digimarc Discover platform ible in normal use and do all that visible barcodes do, but performff Banknote counterfeit deterrence was the first commercially successful large scale use of our technologies. Innovations based on our existing digital watermarking technology and experience have been leveraged to create new products to deter counterfeiting and tampering of driver licenses and other government-issued secure credentials. In parallel, our business partners, under patent or technology licenses from us, are delivering digital watermarking solutions to track and monitor the distribution of music, images, television and movies to consumers. In November of 2007, we announced a relationship with The Nielsen Company (US) LLC (“Nielsen”) to license our patents in suppo uu rt of Nielsen’s industry leading television audience measurement solutions. In October 2010, we entered into a patent licensing arrangement with IV Digital Multimedia Inventions, LLC, a Delaware limited liability company affilff iated with Intellectual Ventures (“IV”), pursuant to which we granted an exclusive license to sublu icense, subju ect to pre-existing encumbrm ances and a grant-back license, an aggregate of approximately 900 of the 1,200 patents and applications held by us at the time the agreement was entered into, as noted below in the section titled “Technology and Intellectual Property.” The number of patents licensed to IV is now approximately 550. Through ongoing development, our portfolff patents and applications. io not licensed to IV has grown to over 550 In December 2012, we entered into a renewal and extension through 2024 of the Counterfeiff System Development and License Agreement with the Central Banks, with a 5-year extension option. t Deterrence 2 In January 2014, we introduced Digimarc Barcodes for use in consumer product packaging. These Digimarc Barcodes can contain the same information found in traditional universal product codes (“UPC”). The UPC information is invisibly repeated multiple times over the entire package surface. global leader in automatic data capture and industrial automation markets and producer of barcode readers, in introducing the Digimarc Barcode to the consumer producdd t packaging market. The first retail scanner enabled was Datalogic’s MagellanTM 9800i multi-plane imaging scanner. Since then, additional scanner vendors and other channel partners have announced support for the Digimarc Barcode platforff m. Digimarc Barcodes can also connect mobile-enabled consumers directly from packaging to engaging mobile experiences such as additional product , recommendations, reviews, social networks and more. information, special offersff ff We partnered with Datalogic, a Financial Inforff mation About Geographic Areas Financial information about geographa ic areas is included in Note 3 of our Notes to Consolidated Financial Statements. Customers and Business Partners Our revenue is generated through commercial and government applications of our technology. We derive our revenue primarily from development services, subscriptions for products and services, and licensing of our technology and patents. During 2016, we generated the majoa rity of our revenuen long-term contract with the Central Banks, subsu criptions to our anti-piracy and copyriyy ght protection services, and royalties from licensees. from development services under a In 2016, revenuen from government contracts accounted for 63% of our total revenue. Central Banks accounted for substantially all revenue generated under our government contracts. Our government contracts typiyy cally span one or more base years and multiple option periods. Government customers generally have the right to not exercise option periods. As part of our work with government customers, we must comply with and are affeff cted by laws and regulations relating to the award, administration and perforff mance of government contracts. Government contract laws and regulations affeff ct how we do business with our government customers and, in some instances, impomm se added costs on our business. Information about customers that accounted for 10% or more of revenue in the last three years is included in Note 3 of our Notes to Consolidated Financial Statements. Products and Services ting of currency using personal computers and digital reprographics for the last 18 years. We We provide media identification and management solutions to commercial entities and government customers and license our technology and patented inventions to other solution providers. Our largest government customer is the Central Banks, with whom we have been developing, deploying, suppor digital counterfeiff license primarily to commercial entities who use our technology and patented inventions in the media and entertainment industry. Commercial customers use a range of solutions from our business partners and us to identify, track, manage and protect content as it is distributed and consumed—dd either digitally or physically—yy and to enable new consumer applications to access networks and inforff mation from personal computers and mobile devices. Many movie studios, record label sionals and other customers rely on our technology as a cost-effeff ctive means to: ting and enhancing a system to deter s, broadcasters, creative profesff uu a • • • deter piracy and illegal use of movies, music, e-publu ications and images; protect entertainment content from copyrigh yy t infringement; track and monitor entertainment content for rights usage and licensing compliance; • monitor advertisements to verify ad placement and measure return on investment; • • enhance information access, search and provide marketing capabilities related to media content; and enable authorized use of content by consumers. 3 Digimarc Barcodes are easily embem dded into all forms of media and are impemm rceptible to human senses, but the overall layout or aesthetics of their media content. Our Digimarc Discover platform delivers a range of quickly detected by computers, networks or other digital devices like smartphones. Unlike traditional barcodes and tags, our solution does not require content owners to give up valuable space on their media content; nor does it impactmm rich media experiences to smartphones across multiple media including print, audio, video and packaging. Unique to the Digimarc Discover platform is its ability to use various content identification technologies as needed, including our patented technology. Digimarc Barcodes contain the same information found in traditional UPC codes used on consumer goods ff We partnered packing. The UPC information is invisibly repeated multiple times over the entire package surface. with Datalogic, a global leader in automatic data capture and industrial automation markets and producer of barcode readers, in bringing the Digimarc Barcode to the market. The first retail scanner enabled was Datalogic’s MagellanTM 9800i multi-plane imaging scanner. Since then additional scanner vendors and other channel partners for the Digimarc Barcode platform. Digimarc Barcodes can also connect mobile-enabled have announced support consumers directly from packaging to engaging mobile experiences such as additional product information, special offeff rs, recommendations, reviews, social networks and more. uu The market for patent licensing has become more challenging in recent years. As a result, we have shiftedff our focus from direct monetization via enforcement and licensing to: • • • • • facilitating progress toward the realization of our vision to enrich everyday living via pervasive, intuitive compumm ting; encouraging large scale adoption of our technologies by industry leaders; imprmm oving our financial perforff mance by enhancing our competitive differentiation; increasing the scale and rate of growth of our products and services business; and laying a foundation for continuing innovation. Current patent licensees include, among others, AlpVision SA, IV, Kantar SAS, NexGuard Labs B.V., Nielsen, OverDrive, Inc., Signum Technologies, Teletrax B.V., Verance Corporation (“Verance”) and Verimatrix, Inc. Technology and Intellectual Property We seek patent protection for our inventions to differen ff tiate our products and technologies, mitigate infringement risks, and develop opportunities for licensing. Our broad patent portfolff methods, applications, system architectures and processes. io covers a wide range of Many of our patents relate to various methods for embedm ding and decoding digital information in video, audio and images, whether the content is rendered in analog or digital formats. The digital information is generally embem dded by making subtu le modifications to the fundamental elements of the content itself,ff generally at a signal processing level. The changes necessary to embedm noticeable by people during normal use. Because the message is carried by the content itself,ff it is file-forff mat independent. The embem dded digital information generally survives most normal content transforff mations, including compression, edits, rotation, scaling, re-samplm ing, file-forff mat transforff mations, copying, scanning and printing. this information are so subtle that they are generally not u Our intellectual property contains many innovations in digital watermarking, content recognition (sometimes inting”), digital rights management and related fields. To protect our inventions, we have referred to as “fingerprr implmm emented an extensive intellectuat l 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 approximately 1,100 U.S. and foreign patents and pending patent applications as of December 31, 2016. We continue to develop and broaden our portfolio in the fields of media identification and management technology and related applications and systems. We devote significff ant resources to developing and protecting our inventions and continuously seek to identify and evaluate potential licensees for our patents. The patents in our portfolff io have a lifeff of approximately 20 years from the effeff ctive filing date, and up to 17 years after the patent has been granted. ff 4 For a discussion of activities and costs related to our research and development in the last three years, please read “Research, development and engineering” under Part II, Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations.” Markets Our patented inventions are used in various media identification and management products and solutions support ing a variety of media objeb cts, from movies and music to banknotes, secure credentials and consumer uu packaged goods. Each media objeb ct enabled by our inventions creates the potential for several applications, such as: • • • • • • • counterfeiting and piracy deterrence; online e-publu ication piracy protection; content identification and media management; authentication and monitoring; retail point of sale transaction processing; linking to networks and providing access to inforff mation; and enhanced services in support uu of mobile commerce. We believe the market for most of these applications is in the early stages of development and that existing solutions represent only a small portion of the potential market for our products, services and technology. Competition No single competitor or small number of competitors dominate our market. Our competitors vary depending on the application of our producdd ts and services. We generally compete with non-digital watermarking technologies for the security or marketing budgets of the producers and distributors of media objeb cts, documents, products and advertising. These alternatives include, among other things, encryption-based security systems and technologies and solutions based on fingerprinting, pattern recognition, and traditional barcodes. Our competitive position in digital watermarking applications is strong because of our large, high-quality, sophisticated patent portfolio subsu tantial and growing amount of intellectual property in related media security and management innovations that span basic technologies, applications, system designs and business processes. Our intellectual property portfolff allows us to use proprietary technologies that are well-regarded by our customers and partners, and not available to our competitors without a license. We compete based on the variety of features we offeff cost/benefit analysis against alternative technologies and solutions. We anticipate that our competitive position within some markets may be affeff cted by factors such as reluctance to adopt new technologies and by changes in government regulations. r and a traditional and our io ff Backlok g Based on projeo cted commitments we have for the periods under contract with our respective customers, we anticipate our current contracts as of Decembem r 31, 2016 will generate a minimum of $31 million in revenue. We expect approximately $17 million of this amount to be recognized as revenuen during 2017. Some factors that lead to increased backlog include: • • • • contracts with new customers; renewals with current customers; add-on orders with customers; and contracts with longer contractual periods replacing contracts with shorter contractual periods. 5 Some factors that lead to decreased backlog include: • • recognition of revenuen associated with backlog currently in place; contracts with shorter contractual periods replacing contracts with longer contractual periods; • modifications to existing contracts; • • contract minimum payments ending; and expiration of contracts with existing customers. The mix of these factors, among others, dictates whether our backlog increases or decreases for any given period. Our backlog may not result in actual revenuen contracts included in our backlog may be subju ect to modification, cancellation or suspension. We may not realize revenue on certain contracts, orders or awards included in our backlog or the timing of any realization may change. in any particular period, because the orders, awards and Employees At December 31, 2016, we had 180 full-time emplmm oyees, including 58 in sales, marketing, technical support and customer support finance, administration, information technology and legal. uu ; 88 in research, development and engineering, including intellectuat u l property; and 34 in Our emplomm yees are not covered by any collective bargaining agreement, and we have never experienced a work stoppage. We believe that our relations with our emplmm oyees are good. Available Information We make available free of charge through our website at www.digimarc.com our Annual Reports on Form 10- K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, and amendments to these and other reports filed or furnished by us pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934 as soon as reasonably practicabla e after ff we file these materials with the Securities and Exchange Commission. ITEM 1A: RISK FACTORS The following risk factors are those risks of which we are aware and that we consider to be material to our business. If any of the following risks and uncertainties develops into actual events, our business, financial condition or results of operations and cash flows could be materially adversely affeff cted. In that case, the trading price of our common stock could decline. Additionally, we cannot be certain or give any assurance that any actions taken to reduce known risks and uncertainties will be effecti ve. ff RISKS RELATED TO OUR BUSINESS u (1) As a purveyor of disruptive adopting and implem mentingtt in campaigni new and expanded components of our revenue engine that willii need to be tested and proven. srr or other reditii our technologyo ,yy our revenues will be defee rred and delayea d. In additioii n, there are tt technology, if our channel partnersrr and potent ial market participants ersrr defer or delayll successfully ,yy or if competitortt customtt tt our technology s to discii ff tt tt ll engage While the Company’s legacy business remains strong, our primary engines of growth—hh Digimarc Discover® and Digimarc Barcode—are subjeb ct to the market forces and adoption curves common to other disrupr technologies. The market is in early stages of development. The revenuen model anticipates annual subsu criptions are the primary source of income. If adoption takes longer than anticipated, operating losses will continue. tive We expect competing technologies to compete vigorously in the marketplace, and to fight to preserve their market share. While we believe that our technology can do what theirs can do—only better, cheaper and faster—rr the extent they succeed in defending their position, our ability to achieve profitff abla e operations will be impemm ded. tt to 6 With respect to our Digimarc Discover and Digimarc Barcode growthww and prospects, our three majoa r avenuen s for revenue generation include direct sales, web sales, and channel partners. Our growing direct sales force is relatively new, with an average tenurn e of less than two years with the Company. The redesign of our website to facilitate web-based sales is evolving. Most of our channel partners are new. Thus, the engine of growth for en. We are executing strategies intended to make each of these means of revenue revenues is new and unprov ff generation effecti ve. We face many obvious challenges. n (2)2 Our future growth willii depee nd to a material extent on the successful advocacyc of our technology channel partnersrr to their members and customers, and implm emll rs and provided by third partirr es. propagatgg edtt entation of our technologyo by channel partnerr by ll in solutions Our business has long relied on the success of business partners. Our continuing success is largely dependent uu uu Digimarc Discover and Digimarc ting Digimarc Discover and Digimarc Barcode. We have entered urer of over-the-counter pharmaceutical products for the store brand market, to improvm ff iency for retailers and provide consumers easier access to product information from enabled ‘smart’ labels; and on a new generation of business partners suppor into agreements with numerous channel partners to propagate and support Barcode, including brand deployment and pre-media service providers Southern Graphics Systems, LLC, Schawk, Inc., and Diadeis, and consumer packaging solutions companies WestRock Company and Berry Plastics Group,uu all who offerff Digimarc Barcode services to national and store brand owners and consumer products suppl identifiers; Perrigo Company, the world’s largest Inc., who can perforff m large scale serialization of uniqueqq manufact efficff platforms which provide unprecedented consumer engagement via smartphones, such as Shazam Entertainment Limited. Digimarc and GS1 US, the U.S. operation of the organization that maintains the global standards for barcodes, announced a broad collabor Barcode. GS1 US will educate, train and provide access to services to their 300,000 member businesses. Among other things, Digimarc and GS1 US intend to improvmm ff certified, collaboration with GS1 Germany. accurate product information via Digimarc Barcodes. Digimarc has also entered into a similar ation to help the industries served by GS1 to make effeff ctive use of Digimarc e product identification for retailers and consumers with brand- e point-of-sff ale iers; HP, uu a Inc., If our channel partners are not successfulff in advocating and deploying our technology, we may not be able to achieve and sustain profitff able operations. If other business partners who include our technology in their products or otherwise license our intellectual property for use in their products cease to do so, or we fail to obtain other partners who will incorporate, embem d, integrate or bundle our technology, or these partners are unsuccessful in their efforff ts, expanding deployment of our technology and increasing revenuen s will be adversely affect ed. Consequently, our ability to increase revenue could be adversely affeff cted and we may sufferff addition, if our technology does not perforff m according to market expectations, our future sales would sufferff customers seek and emplomm y alternative technologies. other adverse effects to our business. In as ff (3) If leadindd gn companies in the retail and consumer productstt zeii institutions downplay,a miniii mi unable to achieve or sustaitt nii profitablell operations. or rejee ct the use of our technology, industriett ll ii s or stantt dard-settitt ng bodies or deploymo ent may be slowll ed and we maya be Many of our business endeavors, including the Digimarc Barcode, can be impeded mm or frusr trated by larger, more influential companies or by standard-setting bodies or institutt value or use of our technology. A negative position by such compamm nies, bodies or institutions, could result in obstacles for us that we would be incapable of overcoming and may block or impedmm e the adoption of our technology. In addition, potential customers may delay or rejee ct initiatives that relate to deployment of our technology. Such a development would make the achievement of our business objectives in this market difficff ult or impossmm ions downpln aying, minimizing or rejecting the ible. 7 (4) We are subject to riskii and services to achieve and sustaintt profitabi le operatiott ns. skk encountertt ed by companies developio ngii and relying upon new technologi ll es,s productstt Our business and prospects must be considered in light of the risks and uncertainties to which companies with new and rapidly evolving technology, products and services are exposed. These risks include the following: • • • • we may be unable to develop sources of new revenue or sustainable growth in revenue because our current and anticipated technologies, products and services may be inadequate or may be unable to attract or retain customers; intense competition and rapid technological change could adversely affeff ct the market’s acceptance of our existing and new products and services; we may be unable to develop and maintain new technologies upon which our existing and new products and services are dependent which may cause our products and services to be less sustainable and compemm titive or which could make it harder for us to expand our revenue and business; and our licensees may not be able to successfulff royalties paid to us. ly enter new markets or grow their businesses, limiting Some key technologies and solutions of our patent or technology licensees are in the development stage. Consequently, products incorporating our technology and solutions are undergoing technological change and are in the early stages of introduction in the marketplace. Delays in the adoption of these products or adverse compemm titive developments may result in delays in the development of new revenue sources or the growth in our existing revenue streams. We may be required to incur unanticipated expenditures if product changes or imprmm ovements are required. Moreover, new industry standards might redefine the products that we or our licensees are able to sell, especially if these products are only in the prototype stage of development. If product changes or imprmm ovements are required, success in marketing these products by us or our licensees and achieving or sustaining profitff abia lity from these products could be delayed or halted. i nt portion of our current and potentia (5)5 A significa contratt changes. Such volatility and uncertainty mighi tt cts and developll ment of new markets that may involve unpredictable tt delaysa tt and other unexpected t limit our actual revenue in anyn given quarter or year. l future revenue is subject to commercial and government We derive a significant portion of our revenuen from contracts tied to development schedules or development of new markets, which could shiftff for months, quarters or years as the needs of our customers and the markets in which they participate change. Government agencies and commercial customers also face budget pressures that introduce added uncertainty. Any shift in development schedules, the markets in which we or our licensees participate, or customer procurement processes, which are outside our control and may not be predictable, could result in delays in bookings forecasted for any particular period, could affeff ct the predictability of our quarterly and annual results, and might limit our actual revenuen predictable revenuen in any given quarter or year, resulting in reduced and less and adversely affeff cting profitabff ility. We are expanding into new markets, which involve inherent risk and unpredictability. In recent years, ff ion of smartphones and increased consumer demands for product inforff mation, we our vision for intuitive, pervasive computing. As we seek to expand outside our areas of historical expertise, particularly with the proliferat have investigated other technologies that may provide attractive future opportunities, for examplmm e, in the packaging and publu ishing markets. These generally include technologies that leverage our strength in signal processing and support uu we lack the history and insight that benefited us in the watermarking field. Although we have extensive experience in the commercial application of digital watermarking, we are investing in but may not be as well-positioned in these other disciplines. Accordingly, it may be difficff ult for us to replicate our watermarking success in other technologies we might pursue. 8 (6) A smallll number of customtt contract could materially disrii upt our business. ersrr account for a substantiatt l portion of our revenue,e and the loss of anyn large Historically, we have derived a significff ant portion of our revenuen from a limited numberm of customers. Five customers represented approximately 73% of our revenue for the year ended December 31, 2016. Most of our revenue comes from long-term contracts generally having terms of at least three to ten years, with some licenses for the life of the associated patents, which could be up to 20 years from the effecti ve date. The agreements with our licensees generally provide for minimum and/or variable payment obligations. All payment obligations under our license agreements with Nielsen and Verance ended in 2014. Some contracts we enter into contain termination for convenience provisions. If we were to lose such a contract for any reason, or if revenue from variable payment obligations do not replace revenue under the existing fixed payment obligations, our financial results could be adversely affeff cted. ff We expect to continue to depend upon a small number of customers for a significff ant portion of our revenue for the foreseeable future. The loss of,ff or decline in, orders or backlog from one or more majoa r customers could reduce our revenue and have a material adverse effeff ct on our financial results. (7) We were not profitable in 2014, 2015 or 2016 and may not be ablell future, particularlyll Sustained lack of prff record valuatiott n alloll wance againsii if we were to lose large contracts or fail in our new market developll ment initiatives. ofitaff could cause us to incur asset impaim rmii ent charges for long-ligg ved assetstt and/or// tott returnrr to or sustaintt profitability in the red taxaa assets. t our deferff bilityii We incurred net losses in 2014, 2015 and 2016 larga ely due to increased levels of investments in our business to support uu from Verance and license fee payments from Nielsen in 2014. product development and sales growth initiatives, concurrent with the completion of royalty payments Returning to and maintaining profitabff ility in the future will depend upon a variety of factors, including our ability to maintain and obtain more significff ant partnerships like we have with the Central Banks and acquiring new customers for Digimarc Discover, Digimarc Barcode and Guardian. Profitff abia lity will also depend on our effiff ciency in executing our business strategy and capitalizing on new opportunities. Various adverse developments, including the loss of large contracts or cost overruns on our existing contracts, could adversely affeff ct our revenue, margins and profitabff ility. If we continuen to incur operating losses, an impaimm rment to the carrying value of our long-lived assets, ment of our long-lived assets when a triggering event occurs that would indicate that the carrying value may including goodwill, acquired intangible assets, patent assets and property and equipment could result. We test for impairmm not be recoverable. Our methodology for assessing impaimm rment may require management to make judgments and assumptions regarding future cash flows. Our projeo ctions of future cash flows are largely based on historical experience, and these projections may or may not be achieved. Changes to these financial projeo ctions used in our impaimm rment analysis could lead to an impaimm rment of all or a portion of our long-lived assets. Any such impaim rment charge could adversely affeff ct our results of operations and our stock price. We evaluated our long-lived assets for impairmm ment. We cannot guarantee, however, that our long-lived assets will not become impam ired in the future. ment as of December 31, 2016 and concluded there was no impairmm We record valuation allowances on our deferred ff tax assets if,ff based on available evidence, it is more-likely- than-not that all or some portion of the assets will not be realized. The determination of whether our deferred tax assets are realizable requires management to identify and weigh all available positive and negative evidence. Management considers recent financial perforff mance, projected future taxable income, scheduled reversals of deferred tax liabilities, tax planning strategies and other evidence in assessing the realizability of our deferred tax assets. Adjud stments to our deferred tax assets could adversely affect our results of operations and our stock price. We recorded a $6.8 million non-cash income tax charge during 2014 to record a full valuation allowance against our deferred tax assets largely due to the cumulative loss we had incurred over the previous three years, which is considered a significant piece of negative evidence in assessing the realizability of deferred tax assets. As of Decembem r 31, 2016 we determined a full valuation allowance was still appropriate given continued losses. We will not record tax benefits on any future losses until its determined that those tax benefits will be realized. ff 9 (8)8 We maya be adversely affeff cted by variabilityii of contracted arrangements. We periodically agree to modify the terms of contractual arrangements with our customers, partners and licensees in response to changes in circumstances underlying the original contractuatt that we will do so in the future. As a result of this practice, the terms of our contractual arrangements with our customers, partners and licensees may vary over time and, depending on the particular modification, could have a material adverse effeff ct on our financial position, results of operations or cash flows. l arrangements, and it is likely Some of our customers and licensees report royalties to us based on their revenuen and their interpretation and allocation of contracted royalty obligations. It is possible that we may not agree with the judgments of our customers on such matters, and such disagreement may lead to potential disputes and reduced revenuen could result in a distraction to our management and may not result in increased revenues to us but may nevertheless result in friction between us and our customers, and potentially the loss of customers, which may ultimately be harmful to our business. to us. These disputes (9)9 The market for our products is highlyll competitive, compete withi us maya be more successfulff . and profitsii tt than us in gaininii and alterll narr tive technologio es or larger companies that g market share, which wouldll decrease our revenue The markets in which we compete for business are intensely compemm titive and rapidly evolving. We expect competition to continue from both existing competitors and new market entrants. We face competition from other compamm nies and from alternative technologies, including some of our customers and licensees. We also may face compemm tition from unexpected sources. Alternative technologies that may directly or indirectly compete with particular applications of our watermarking technologies include: • • • • • • Traditional anti-counterfeiff (that compete for budgetary outlays) designed to deter counterfeiting, including optically sensitive ink, magnetic threads and other materials used in the printing of currencies; ting technologies—a numbem r of solutions used by many government agencies Image recognition—nn one or several pre-specified or learner d objeb cts or objeb ct classes that can be recognized, usually together with their two-dimensional positions in the image or three-dimensional poses in the scene, such as Amazon Firefly or PTC Vuforia, which provides a stand-alone program illustration of this function; Radio frequency tags—embem dding a chip that emits a signal when in close proximity with a receiver, used in some photo identification credentials, labels and tags; Internet technologies—numerous existing and potential Internet access and search methods are competitive with Digimarc mobile systems and the searching capabilities of Guardian; Digital fingerprr or video track, that can be used to identifyff an image or track, or authenticate the image or track; and ints and signatures—a metric, or metrics, compumm ted solely from a source image or audio Barcodes or QR codes—data-carrying codes, typiyy cally visible in nature (but may be invisible if printed in ultraviolet- or infrared-responsive inks). In the competitive environments in which we operate, producdd t generation, development and marketing processes relating to technology are uncertain and complex, and require accurate prediction of demand as well as successful management of various risks inherent in technology development. In light of these uncertainties, it is possible that our failure to successfulff have a long-term negative effeff ct on our growth and results of operations. ly accommodate future changes in technologies related to our technology could New developments are expected to continue, and discoveries by others, including current and potential compemm titors, possibly could render our services and products noncompetimm tive. Moreover, because of rapid technological changes, we may be required to expend greater amounts of time and money than anticipated to develop new products and services, which in turn may require greater revenuen streams from those products and services to cover developmental costs. Many of the companies that compete with us for some of our business, as 10 well as other companies with whom we may compete in the future, are larger and may have stronger brand recognition and greater technical, financial, marketing and political resources than we do. These attributes could enable these companies to have more success in the market than we have, either by providing better products or better pricing than we can provide. We may be unable to compete successfulff ly against current or future participants in our market or against alternative technologies, and the competitive pressures we face could decrease our revenue and profitff s in the future. (10) An increase in our operations outsidedd of the U.S. subjects us to riskii exposed in our domestictt operatrr iott ns. skk additioii nal to those to which we are We believe that revenuen from sales of products and services to commercial, governmental and other customers outside the U.S. could represent a growing percentage of our total revenuen in the future. Digimarc Discover is not bounded geographically, and we believe Digimarc Barcode will see global deployment. As such, certain contracts will be made and perforff med, in whole or in part, outside of the U.S. Similarly, for Guardian, we perforff m certain functions in various jurisdictions outside of the U.S. International operations are subju ect to a number of risks that can adversely affect our sales of products and services to customers outside of the U.S., or expose us to additional expense or liabilities, including the following: ff • • • • • • • • • • difficulties and costs of staffiff ng, developing and managing foreign operations as a result of distance, language and cultural diffeff rences; the effecff councils and labor unions in some jurisdictions; t of laws governing emplmm oyee and contractor relationships, and the existence of workers’ changes in foreign government regulations and security requirements; export license requirements, tariffsff and taxes; trade barriers; difficulty in protecting intellectual property; diffiff culty in collecting accounts receivable; currency fluctuations; longer payment cycles than those for customers in the U.S; and political and economic instability. We do not have an extensive operational infrastructure for international business. We generally depend on local or international business partners and subcu ontractors for performance of subsu tantial portions of our business. These factors may result in greater risk of perforff mance problems or of reduced profitff abia lity with respect to our international programs in these markets. In addition, if foreign customers, in particular foreign government authorities, terminate or delay the implmm ementation of our products and services, it may be difficuff not be able, to recover our potential losses. lt for us, or we may (11) We depend on our managea ment and keye employees hire or integr ate these emplom yeo es,s we maya not be able to meet our commitmett m tt nts. for our future success. If we are not ablell to retain, Our success depends to a significff ant extent on the perforff mance and continued service of our management and our intellectual property team. The loss of the services of any of these emplmm oyees could limit our growthww or undermine customer relationships. uu Due to the high level of technical expertise that our industry requires, our ability to successfully develop, our products, services, and intellectual property depends to a significant degree market, sell, license and support upon the continued contributions of our key personnel in engineering, sales, marketing, operations, legal and licensing, many of whom would be difficff ult to replace. We believe our future success will depend in large part upon our ability to retain our current key emplm oyees and our ability to attract, integrate and retain new personnel in the future. It may not be practical for us to match the compensation some of our emplmm oyees could garner at other 11 ance or operating results. These circumstances may have a negative effeff ct on the emplmm oyment. In addition, we may encounter difficff ulties in hiring and retaining emplmm oyees because of concerns related to our financial performff market price of our common stock, and emplmm oyees and prospective emplomm yees may factor in the uncertainties relating to our stability and the value of any equity-based incentives in their decisions regarding emplmm oyment opportunities and decide to leave our emplmm oy. Moreover, our business is based in large part on patented technology, which is a unique and sophisticated signal processing technology. New emplm oyees require subsu tantial training, involving significant resources and management attention. Competition for experienced personnel in our business can be intense. If we do not succeed in attracting new, qualifieff d personnel or in integrating, retaining and motivating our current personnel, our growth and ability to deliver producdd ts and services that our customers require may be hampered. Although our emplmm oyees generally have executed agreements containing non-competition clauses, we do not assure you that a court would enforff ce all of the terms of these clauses or the agreements generally. If these clauses were not fully enforff ced, our emplomm yees could freely join our compemm titors. Although we generally attempt to control access to and distribution of our proprietary inforff mation by our emplomm yees, we do not assure you that the confidff ential nature of our proprietary information will be maintained in the course of such future emplmm oyment. Any of these events could have a material adverse effecff t on our financial and business prospects. (12) We may acquire or invest in othett managea ment’s’ attent tt operations and harm our operatingii iott n, result in additioii nal dilutio r companm ii ies or technologi ll n to our stockholdell es in thett results. future, which couldll divert rs, increase expexx nses, disrii upt our We acquired Attributor Corporation (“Attributor”) in December 2012, and we may in the future acquire, or rings, enhance our technical capabilities, expand our operations into new markets or otherwise offeff invest in businesses, products or technologies that we believe could complement or expand our current product and service offeff growthww opportunities. The pursuit of potential acquisitions may divert the attention of management and cause us to incur various expenses related to identifying, investigating and pursuing suitable acquisitions, whether or not they are consummated. r There are inherent risks in integrating and managing acquisitions. We may not be able to assimilate or integrate the acquired personnel, operations and technologies successfulff business following an acquisition. We also may not achieve the anticipated benefitff s from an acquired business due to a number of factors, including: ly or effeff ctively manage the combined • • • • • • • • • • unanticipated costs or liabilities associated with the acquisition; incurrence of acquisition-related costs, which would be recognized as a current period expense; inability to generate suffici ff ent revenue to offseff t acquisition or investment costs; the inability to maintain relationships with customers and partners of the acquired business; the need to implmm ement additional controls, procedures and policies; entry into geographic markets in which we have little or no prior experience, and challenges caused by distance, language and cultural differences; differences in foreign labor and emplmm oyment laws, including classification of emplmm oyees and contractors; disrupr tion of our ongoing business; the potential loss of key emplm oyees; and use of subsu tantial portions of our available cash to consummate the acquisition. Acquisitions could also result in dilutive issuances of equity securities or the incurrence of debt, which could adversely affeff ct our financial position. In addition, if an acquired business fails to meet our expectations, our operating results, business and financial condition may sufferff . 12 (13) (a) We may not be able to adequateltt yll secure patent or other protect iott n for our technologio es. tt Our business depends in part on securing protection for our proprietary technology and successfully licensing our technology to third parties. To protect our intellectual property portfolff copyriyy ght, trademark and trade secret rights, confiden regularly apply for patents to protect our intellectual property, there is no guarantee that we will secure patent protection for any particular technology we develop. io, we rely on a combination of patent, tiality procedures and licensing arrangements. Although we ff Changes in the U.S. and foreign patent laws, or in the interpretation of existing laws, may adversely affeff ct our ability to secure or enforce patents. For examplem , the U.S. Supreme Court issued a decision in 2014 limiting patent eligibility of computer implmm emented inventions. The Leahy-Smith America Invents Act of 2011 (the “America Invents Act”) also codifies several changes to the U.S. patent laws, including the creation of a post-grant inter partes review process to challenge patents afteff the U.S. Patent and Trademark Officff e or comparabla e government authorities in other jurisdictions to review and reconsider the patentability of any of our inventions claimed in our issued patents. Any such proceeding may result in one or more of our patent claims becoming limited, or being invalidated altogether. A limitation or invalidation of our patent claims could adversely affect r they have issued. The America Invents Act allows third parties to petition our financial position and our operating results. ff Patents have finite lives, and our ability to continue to commercially exploit our patents is limited to the term of the patents. Our earliest patents began expiring in July 2012. The size and strength of our portfolio depends on the number of patents that have been granted, offsff et by the number of patents that expire, in any given year. We continue to develop our patent portfolff the extent that we have exploited our earlier patents. io, but we cannot assure you that we will be able to exploit newer patents to As part of our confidff entiality procedures, we generally enter into non-disclosure agreements with our emplomm yees, directors, consultants and corporate partners, and attempt to control access to and distribution of our information. Despite these procedures, third parties technology, solutions, documentation and other proprietaryrr could copy or otherwise obtain and make unauthorized use of our technology, solutions or other proprietary information or independently develop similar technologies, solutions or information. The steps that we have taken to prevent misappropriation of our solutions, technology or other proprietary inforff mation may not succeed. We cannot assure you that the protection of our proprietary rights will be adequate or that our competitors will not independently develop similar technologies, dupluu icate our services or design around any of our patents or other intellectual property rights. (b) We may not be successfulff in enforn cingii our intellectual property righi ts againsii t thitt rd parties. Unlicensed copying and use of our intellectual property or infringement of our intellectual property rights may result in the loss of revenue to us and cause us other harm. If we encounter a company that we believe is infringing our intellectual property rights, we may try to negotiate a license arrangement with such party. If we try and are unable to negotiate a license or secure the agreement of such alleged infringing party to cease its activities, we must make decisions as to how best to enforce our intellectual property rights, which may result in additional costs. The process of negotiating a license with a third party can be lengthy, and may take months or even years in some circumstances. It is possible that third parties who we believe are infringing our intellectual property rights are unwilling to license our intellectual property from us on terms we can accept, or at all. If we cannot persuade a third party who we believe is infringing our technology to enter into a license with us, we may be required to consider other alternar tives to enforce our rights, including commencing litigation. The decision to commence litigation over infringement of a patent is complex and may lead to several risks to us, including the following, among others: • • the time, significaff nt expense and distraction to management of managing such litigation; the uncertainty of litigation and its potential outcomes; 13 • • • • the possibility that in the course of such litigation, the defendant may challenge the validity of our patents, which could result in a re-examination or post grant review of our patents and the possibility that our patents may be limited in scope or invalidated altogether; the potential that the defenff dant may successfully persuade a court that their technology or products do not infringe our intellectual property rights; the impamm ct of such litigation on other licensing relationships we have or seek to establish, including the timing of renewing or entering into such relationships, as applicable, as well as the terms of such relationships; and adverse publu icity to us or harm to relationships we have with customers or others. Also, enforff cement of patent protection throughout the world is generally established on a country-by-country basis and we may not have as much success enforff cing our patents in foreign jurisdictions. If we fail to protect our intellectual property rights adequately, if there are adverse changes in applicable laws, or if we become involved in litigation relating to our intellectual property rights or the intellectual property rights of others, our business could be seriously harmed. In such cases, the value ascribed to our intellectual property could diminish, we may incur significff ant legal expenses that could harm our results of operations and our patents or other intellectual property rights may be limited or invalidated. Any of the foregoing could have a negative effeff ct on the value of our common stock. (c) We maya be subject b to infringement claims and other tt i litigat iott n, which could adversely affect ff our business. As more companies engage in business activities relating to digital watermarking, and develop corresponding intellectual property rights, it is increasingly likely that claims may arise which assert that some of our products or services infringe upon other parties’ intellectual property rights. These claims could subju ect us to costly litigation and divert management resources. These claims may require us to pay significant damages, cease production of infringing products, terminate our use of infringing technology or develop non-infringing technologies. In these circumstances, continued use of our technology may require that we acquire licenses to the intellectual property that is the subju ect of the alleged infringement, and we might not be able to obtain these licenses on commercially reasonable terms or at all. Our use of protected technology may result in liability that threatens our continuing operation. Some of our contracts include indemnity and similar provisions regarding our non-infringement of third-party intellectual property rights. As deployment of our technology increases, and more companies enter our markets, the likelihood of a third party lawsuit resulting from these provisions increases. If an infringement arose in a context governed by such a contract, we may have to refund to our customer amounts already paid to us or pay significant damages, or we may be sued by the party whose intellectual property has allegedly been infringed upon. (14)4 If our revenue modelsll and pricing struc do not gain markerr not be ablell tt to generate new revenue or sustaitt nii existintt g revenue. tures relating to products and services that are under developmll t acceptance, the products and services may fail to attract or retain customers and we maya ent Some of our business involves embem dding digital watermarks in traditional and digital media, including consumer product packaging and related marketing materials, secure documents, audio, video and imagery, and licensing our intellectual property. Our revenuen s result from a combination of development, consulting, subsu cription and license fees from a variety of media identification and management applications. We launched Digimarc Discover in 2011 and the Digimarc Barcode in 2014, both of which incorporat e new business and pricing models. We have not fully developed revenue models for some applications and licensing endeavors. Because some of our products and services are not yet well-established in the marketplace, and because some of these products and services will not directly displace existing solutions, we cannot be certain that the pricing structure for these products and services will gain market acceptance or be sustainable over time or that the marketing for these products and services will be effeff ctive. rr 14 (15) If we are unablell and integrate new technologies effectivtt ely, our growth and the development of our producdd ts and services could be delayea d or limited.dd dards effectively, or if we are unable to develop to respond to regulator yr or industryr stantt e Our future success will depend in part on our ability to enhance and imprmm ove the responsiveness, functionality and features of our products and services, and those of our business partners, in accordance with regulatory or industry standards. Our ability to remain competitive will depend in part on our ability to influence and respond to emerging industry and governmental standards in a timely and cost-effeff ctive manner. If we are unable to influff ence these or other standards or respond to these standards effeff ctively, our growth and the development of various products and services could be delayed or limited. Our market is characterized by new and evolving technologies. The success of our business will depend on our ability to develop and integrate new technologies effeff ctively and address the increasingly sophisticated technological needs of our customers in a timely and cost-effectiv depend in part on our ability to: e manner. Our ability to remain competitive will ff • • • enhance and improvm we offeff r or plan to offeff r; e the responsiveness, functionality and other features of the products and services continue to develop our technical expertise; and develop and introduce new services, applications and technologies to meet changing customer needs and preferences and to integrate new technologies. We do not assure you that we will be successfulff in responding to these technological and industry challenges in a timely and cost-effeff ctive manner. If we are unable to develop or integrate new technologies effect respond to these changing needs, our margins could decrease, and our release of new products and services and the deployment of our technology could be adversely affeff cted. ively or ff (16)6 We may need to retain additiii onal emplm oye new business opportunitiestt to achieve or sustaitt nii profitaff es or contract labor in the future in order to take advadd ntage of arising from increased demand, which could increase coststt and impem de our abilityi bilityii in the short term. ll We have staffeff d our company with the intent of accelerating our product development and sales growthww initiatives while also focusing on achieving and sustaining profitff abia lity. Our current staffinff g levels could affect ff ability to respond to increased demand for our services. In addition, to meet any increased demand and take advantage of new business opportunities in the future, we may need to increase our workforce through additional emplmm oyees or contract labor. Although we believe that increasing our workforff ce would potentially support anticipated growth and profitff ability, it would increase our costs. If we experience such an increase in costs, we may ility in the short term. not succeed in achieving or sustaining profitabff our uu (17) The terms and conditiodd fail to meet deliveryr and other perforff marr ns of our contratt nce requirements. cts could subject us to damagea s, losses and other tt expexx nses if we Our service contracts typiyy cally include provisions imposm ing: • • • development, delivery and installation schedules; customer acceptance and testing requirements; and other performff ance requirements. To the extent these provisions involve perforff mance over extended periods of time, risks of noncomplmm iance ance requirements as promised, or to successfulff may increase. From time to time we have experienced delays in system implem mentation, timely acceptance of programs, concerns regarding program perforff mance and other contractuatt performff damages, as well as increased costs, lower margins, or compensatory obligations in addition to other losses, such as harm to our reputation. Any unexpected increases in costs to meet our contractual obligations or any other requirements necessary to address claims and damages with regard to our customer contracts could have a material adverse effeff ct on our business and financial results. l disputes. If we fail to meet contractual ly resolve customer disputes, we could incur liability for 15 (18) Products deployi againsii u suppor our technologyo t us,s divertrr applicll atiott n of our resources from othett t costs. ngii ll could have unknown defectstt or errors,s which maya give riseii r purposes or increase our projeo ct implm emll to claill ms ii entation and Products and services as complex as those we offerff or develop may contain undetected defecff ts or errors. Furthermore, we ofteff n provide complex implmm ementation, integration, customization, consulting and other technical services in connection with the implmm ementation and ongoing maintenance of our products. Despite testing, defect errors in our products and services may occur, which could result in delays in the development and implmm ementation of products and systems, inability to meet customer requirements or expectations in a timely manner, loss of revenue or market share, increased implm ementation and support development resources, injun ry to our reputation, increased insurance costs, increased service and warranty costs and warranty or breach of contract claims. Although we attempt to reducd e the risk of losses resulting from warranty or breach of contract claims through warranty disclaimers and liability limitation clauses in our sales agreements when we can, these contractual provisions are sometimes limited and may not be enforceable in every instance. If a court refusff es to enforce the liability limiting provisions of our contracts for any reason, or if liabilities arise that were not contractually limited or adequately covered by insurance, the expense associated with defenff ding these actions or paying the resultant claims could be significant. costs, failure to achieve market acceptance, diversion of s or uu ff ff (19) The securityii parties,s which could resultll in the discl othett r busineii systemtt ss interruptions that could damagea ii s used in our product and service offeringsgg maya be circii umvented or sabotagtt ed by third osll ure of sensitive infon rmatiott n or private personal infon rmatiott n or cause our repuee tation and disruii ptu our busineii ss. t our business, damage our reputation, and expose us to litigation and liability. A party who is able to Our business relies on computers and other inforff mation technologies, both internal and at customer locations. The protective measures that we use may not prevent all security breaches, and failure to prevent security breaches may disruprr circumvent security measures could misapprop riate sensitive or proprietary information or materials or cause interruptuu ions or otherwise damage our products, services and reputation, and the propertytt of our customers. If unintended parties obtain sensitive data and information, or create bugs or viruses or otherwise sabotage the functionality of our systems, we may receive negative publu icity, incur liability to our customers or lose the confidence of our customers, any of which may cause the termination or modification of our contracts. Further, our insurance coverage may be insufficie nt to cover losses and liabilities that may result from these events. a ff In addition, we may be required to expend significant capital and other resources to protect ourselves against the threat of security breaches or to alleviate problems caused by these breaches. Any protection or remedial measures may not be available at a reasonable price or at all, or may not be entirely effeff ctive if commenced. (20)0 We maya experxx financial conditiodd ience outagesa n and resultstt of operations. and disrii uptu iott ns of our infraff strutt cture that maya harm our busineii ss, prospec s ts,s We may be subju ect to outages or disruprr tions of our infrastructure, including information technology system failures and network disruptuu ions. Subsu tantially all of our compumm ter and communications hardware is located at a single facility, our corpor inadequate, and our disaster recovery planning may not be sufficff ate headquarters in Beaverton, Oregon. System redundancy may be ineffect ient for all eventualities. ive or ff rr If a natural disaster, cybery incident, weather event, power disruptuu ion, telecommunications failure, act of terrorism or other event occurred that prevented us from using all or a significff ant portion of our facility and/or damaged critical infrastructure, it could harm our abia lity to conduct normal business operations. 16 (21) We are periodically involved in the ordinaii such litigtt atiott n maya adversely affect ff ry courserr of busineii ss in litigt atiott n, and an adverserr resolution of our business, financial conditidd on, resultsll of operations, and cash flows. From time to time, in our normal course of business, we are a party to various legal claims, actions and as part of our patent licensing program, we may bring claims or counterclaims of patent complmm aints. For example,mm infringement to enforce our patent rights. Given the uncertain nature of litigation, we are not able to estimate the amount or range of gain or loss that could result from an outcome of litigation. Litigation can be expensive, lengthy, and disruptuu ive to normal business operations. The results of complmm ex legal proceedings are oftenff diffiff cult to predict. We could incur costs in excess of any established accruals and, to the extent available, excess on our liabia lity insurance. An unfavff orable outcome in any legal proceedings could have a material adverse effect business, financial condition, results of operations, and cash flows. uncertain and ff RISKS RELATED TO OUR CAPITAL STOCK Our common stock price maya be volatile,e and you couldll (22) (( our common stock. tt lose allll or partrr of yoff ur investment in shares of The price of shares of our common stock may fluctuate as a result of changes in our operating perforff mance or prospects and other factors. Some specific factors that may have a significff ant effect common stock include: ff on the price of shares of our • • • • • • • • • • • • • the publu ic’s reaction to our public disclosures; actuatt l or anticipated changes in our operating results or future prospects; potential unfavff orable changes from originally reported royalties by customers resulting from an audit performed by us or a third party, or self-cff orrected by the customer; strategic actions by us or our competitors, such as acquisitions or restructurings; impamm ct of acquisitions on our liquidity and financial perforff mance; new laws or regulations or new interpretations of existing laws or regulations applicable to our business; changes in accounting standards, policies, guidance, interpretations or principles applicable to us; conditions of the industry as a result of changes in financial markets or general economic or political conditions; the failure of securities analysts to cover our common stock in the future, or changes in financial estimates by analysts; changes in analyst recommendations or earnings estimates regarding us, other comparable companies or the industry generally, and our ability to meet those estimates; changes in the amount of dividends paid, if any; future issuances of our common stock or the perception that future sales could occur; and volatility in the equity securities market. (23) Our common stocktt price may increase or decrease on material newsww or developments. As a thinly-traded microcap company, volatility in the equity securities market may disproportionately cause swings in our stock price, upward and downward, on positive and negative developments. We suspect that the effeff cts of computerized trading also exacerbate fluctuations in our stock price. 17 (24) Our corpor acquisition of us that shareholdell rr ate governance documents,s our righi rs maya considerdd ts agreement and Oregon law maya delaya or prevent an ur shares. favorable,ll which could decrease the value of yoff rr Our articles of incorporation and bylaws and Oregon law contain provisions that could make it more difficff ult for a third party to acquire us without the consent of our Board of Directors. These provisions include superuu majoa rity voting requirements for shareholders to amend our organizational documents and limitations on actions by our shareholders by written consent. In addition, our Board of Directors has the right to issue preferred shareholder approval, which could be used to dilute the stock ownership of a potential hostile acquirer. In July 2008, our Board of Directors adopted a rights agreement pursuant to which one one-hundredth (1/100) of a preferre d stock purchase right will be issued for each outstanding share of our common stock. In general terms, our rights agreement works by imposmm ing a significff ant penalty upon any person or groupuu that acquires 15% or more of our outstanding common stock without the approval of our Board of Directors. Oregon law also restricts the ability to vote shares of stock acquired in a transaction that causes the acquiring person to control at least one-fifff thff , one-third or one-half of the votes entitled to be cast in the election of directors (a “control share acquisition”). Shares acquired in a control share acquisition have no voting rights except as authorized by a vote of the shareholders. Although we believe these provisions protect our shareholders from coercive or otherwise unfair takeover tactics and thereby provide for an opportunity to receive a higher bid by requiring potential acquirers to negotiate with our Board of Directors, these provisions apply even if the offerff may be considered beneficff ial by some shareholders. stock without ff ff ITEM 1B: UNRESOLVED STAFF COMMENTS None. ITEM 2: PROPERTIES We lease our principal administrative, marketing, research, and intellectual property development facility, which is approximately 47,000 square feet in size and located in Beaverton, Oregon. In July 2015, we entered into an amendment with the landlord of our corporate offiff ces in Beaverton, Oregon to extend the lease term through March 2024 for rent payments totaling $5.5 million, payable in monthly installments. In February 2015, we entered into a new facilities lease agreement for a facility in San Mateo, California, which is approximately 5,400 square feet in size, with a lease term through March 2020 for rent payments totaling $1.0 million, payable in monthly installments. We lease this facility for sales, marketing and engineering staff in support of our Guardian products and services. See Note 7 of our Notes to Consolidated Financial Statements for uu further lease related disclosures. ITEM 3: LEGAL PROCEEDINGS We are subju ect from time to time to other legal proceedings and claims arising in the ordinaryrr course of business. At this time, we do not believe that the resolution of any such matters will have a material adverse effeff ct on our financial position, results of operations or cash flows. ITEM 4: MINE SAFETY DISCLOSURES Not applicable. 18 PART II ITEM 5: MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES Our common stock began trading on the Nasdaq Stock Market LLC in October 2008 under the symbol “DMRC.” The closing price of our common stock on the Nasdaq Global Market was $26.50 on Februar ry 17, 2017. The following table lists the high and low sales prices of our common stock for the periods indicated, as reported by the Nasdaq Global Market. Years Ended December 31, 2016 2015 High Low High Low First quarter ............................................................... $ Second quarter........................................................... $ Third quarter.............................................................. $ Fourth quarter ............................................................ $ 44.94 $ 32.03 $ 40.13 $ 38.58 $ 26.23 $ 25.04 $ 30.39 $ 26.70 $ 29.71 $ 45.43 $ 49.25 $ 39.34 $ 21.37 20.90 29.88 21.80 At February 17, 2017, we had 254 shareholders of record of our common stock, as shown in the records of our agent. Since many holders hold shares in “street name,” we believe that there is a significaff ntly larger ial owners of our common stock than the numberm of record holders. transferff number of beneficff In August 2016, we sold 1,233 shares of our common stock in an underwritten publu ic offerff ing, plus an additional 185 shares in full exercise of the underwriters’ option to purchase additional shares of common stock, at the price to the public of $30.00 per share. We received $39,953 of cash proceeds, net of discount of $2,447 and ring, and paid $253 in stock issuance costs for legal and accounting fees. underwriter fees of $150, from the offeff In August 2014, we entered into an Equity Distribution Agreement, whereby we could sell from time to time through Wells Fargo Securities, LLC, as our sales agent, ouruu common stock having an aggregate offeff to $30,000. Wells Fargo Securities, LLC received from us a commission equal to 2.50% of the gross sales of common stock for shares having an aggregate offerff gross sales of common stock thereafter, December 31, 2015, the Company had sold 1,026 shares under the Equity Distribution Agreement at an average price of $29.24 resulting in $29,300 of cash proceeds, net of sales commissions of $700, and paid $415 in stock issuance costs for legal and accounting fees. There are no shares remaining to be sold under the Equity Distribution Agreement. for shares sold under the Equity Distribution Agreement. As of ing price of up to $10,000, and a commission of 2.25% of the ring price of up ff We withhold (repurchase) shares of common stock in connection with the vesting of restricted shares to satisfy required tax withholding obligations. 19 The following table sets forth information regarding purchases of our equity securities during the three-month period ended Decemberm 31, 2016: (c) Total number of shares purchased as tal number Average price part of publicly f shares purchased (1) paid per share (1) or programs (b) ) Approximate dollar value of shares that may yet be purchased or programs announced plans under the plans Period Month 1 October 1, 2016 to October 31, 2016 ............ —— $ —— Month 2 Novembem r 1, 2016 to Novembem r 30, 2016 .... 22,408 $ 29.35 Month 3 December 1, 2016 to Decembem r 31, 2016 ..... Total ................................................................... —— $ 22,408 $ —— 29.35 —— $ —— $ —— $ —— $ —— —— —— —— (1) Fully vested shares of common stock withheld (purchased) by us in satisfact ff ion of required withholding tax liability upon vesting of restricted stock. 20 STOCK PERFORMANCE GRAPH The following graph compares the perforff mance of our common stock with the perforff mance of (i) the Nasdaq U.S. Index and (ii) a peer groupuu selected by us. The comparison assumes $100 was invested in our common stock on December 31, 2011 and in each of the two indices at the closing price on that date, and assumes reinvestment of any dividends. We believe that the compamm nies in the peer groupuu are compamm rable to us in terms of line-of-business, market capitalization, revenuen , and number of emplm oyees, and therefore, comprmm ise an appropriate peer groupuu for purposes of compamm ring stock performance. The comparisons in the graph are based on historical data and are not indicative of,ff nor intended to forecast, future performff ance of our common stock. Comparison of Cumulative Total Return $250 $200 $150 $100 $50 $0 12/31/2011 12/31/2012 12/31/2013 12/31/2014 12/31/2015 12/31/2016 Digimarc Corporation Nasdaq Index Peer Group Companies included in the Peer Group index of the stock performance graph are as follows: 8X8 INC AWARE INC BRIGHTCOVE INC CALLIDUS SOFTWARE INC CINEDIGM CORP DATAWATCH CORPORATION ____ __ ___ ____ ____ __ ___ ___ __ ___ __ ___ __ ___ __ ___ __ __ (1) The peer groupu does not include DTS INC from our 2015 peer group,uu which was acquired in 2016. eGain CORPORATION EVOLVING SYSTEMS INC GLU MOBILE INC GUIDANAA CE SOFTWARE IMMERSION CORPORATION ORBCOMM INC PDF SOLUTIONS INC SPARK NETWORKS INC SUPPORT.COM INC TOWERSTREAM CORPORATION ZIX CORPORATION __ 21 ITEM 6: SELECTED FINANCIAL DATA The selected financial data set forth below should be read in conjunction with the consolidated financial statements and the notes to the consolidated financial statements and “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” which are included elsewhere in this report. The following tables set forth our selected financial inforff mation as of and for each of the years in the five-year period ended Decemberm 31, 2016, which has been derived from audited financial statements as of December 31, 2016, 2015, 2014, 2013 and 2012 and for the years ended December 31, 2016, 2015, 2014, 2013 and 2012. Statement of Operations Data Revenue ................................................... Gross profitff percentage............................ Operating income (loss)........................... Net income (loss) ..................................... Earnings (loss) per common share: Earnings (loss) per common share—bas— ic.......................................... Earnings (loss) per common share— diluted ................................................... Weighted average common shares 2016 $ 21,793 61% $ (21,920) $ (21,672) 2015 $ 22,189 Years Ended December 31, 2014 $ 25,658 2013 $ 34,964 60% $ (17,977) $ (17,934) 67% $ (15,223) $ (15,820) $ $ (2.36) (2.36) $ $ (2.19) (2.19) $ $ (2.22) (2.22) $ $ $ $ $ 2012 44,375 85% 14,594 8,272 1.16 1.12 6,757 6,989 $ $ $ $ 77% (2,412) (507) (0.10) (0.10) 6,866 6,866 outstanding—bas— ic (in thousands) ........ 9,188 Weighted average common shares outstanding—diluted (in thousands) ..... 9,188 Cash dividends declared per common 8,198 8,198 7,187 7,187 share...................................................... $ —— $ —— $ 0.22 $ 0.44 $ 0.33 Balance Sheet Data 2016 2015 As of December 31, 2014 2013 2012 Cash, cash equivalents and short-term marketable securities................................. $ Long-term marketable securities.................. $ Total assets .................................................. $ Long-term liabilities .................................... $ Redeemable preferred stock......................... $ 56,134 4,392 78,736 956 50 $ $ $ $ $ 36,187 2,999 56,364 226 50 $ $ $ $ $ 38,323 749 57,416 203 50 $ $ $ $ $ 29,662 5,302 57,197 496 50 $ $ $ $ $ 32,269 6,787 57,331 673 50 22 ITEM 7: 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 l perfor rmance of Digimarc, dd contains forward-looking which involve riskii skk and uncertainties. Our actual results could diffeff r materially from those anticipated in these forward-ldd ooking statements. Please see the discii ussion regae this discii ussion, under the capta ion “Fo“ some of the uncertainties, riskii included at the end of rding forward-ldd ooking statementstt rward-Ldd ooking Statements,” and Item 1A, “Ri“ skii Factorsrr ” for a discii ussion of statements relating to future eventstt or the future financia skk and assumptions associated with these statements.tt ff The following discii ussion should be read in conjunction with our consolidatdd ed financial statements and the related notes and other financial infon rmation appeapp ring elsell where in this Annual Report on Formrr 10-K.KK All dollar amounts are in thousandsdd except per share amountstt or unless otherwir se noted.dd Percentages within the following tables included in this section maya not foot due to rounding. Overview Digimarc Corporation enables governments and enterprises around the world to give digital identities to media and objects that compumm ters can sense and recognize, and to which they can react. We have developed the Digimarc Discover®, Digimarc Barcode and Intuitive Computing Platform that are designed to optimize the identification of all consumer brand imprmm essions, wherever and whenever they may appear, facilitating modern mobile-centric “Digimarc Barcodes,” invisible and inaudible barcode-like shopping. The platform includes means to embedm inforff mation that is recognizable by smartphones, tablets, industrial scanners, and other computer interfaces, into virtuat lly all forms of media content, including consumer product packaging. Digimarc Barcodes have many applications, including facilitating remarkably faster scanning of products at retail checkout as well as imprmm oved engagement with smartphone-equipped consumers. The Digimarc Barcode is robust yet imperceptible by people in ordinary use, allowing for reliable, effiff cient, economical, globally scalable, automatic identification of media without visible computer codes like traditional barcodes. Our growth strategy encompasses both our government and commercial businesses. We plan to continue investing in research and development and sales and marketing to develop and market our products, including Digimarc Discover, Digimarc Barcode and Guardian, and to continue to expand our intellectuat l property portfolio. To protect our significant effoff rts in creating our technology, we have implm emented an extensive intellectual property protection program that relies on a combination of patent, copyriyy ght, 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 the field of digital watermarking and related fields, with approximately 1,100 U.S. and foreign patents and pending patent applications as of December 31, 2016. We continue to develop and broaden our portfolio of patented technology in the fields of media identificff ation and management technology and related applications and systems. We devote significff ant resources to developing and protecting our inventions and continuously seek to identify and evaluate potential licensees for our patents. Critical Accounting Policies and Estimates The preparation of financial statements in accordance with accounting principles generally accepted in the U.S. (“U.S. GAAP”) requires us to make estimates and judgments that affect liabilities, revenue and expenses, and related disclosure of contingent assets and liabilities. On an on-going basis, we evaluate our estimates, including those related to bad debts, contingencies, goodwill, income taxes, intangible assets, marketable securities, propertytt and equipment and revenuen experience and on other assumptmm ions we believe to be reasonable in the circumstances. Actual results may differff from these estimates under differen recognition. We base our estimates on historical the reported amounts of assets, t assumptions or conditions. ff ff 23 Some of our accounting policies require higher degrees of judgment than others in their application. These include revenue recognition, goodwill, impairmm the following critical accounting policies affeff ct our more significant of our consolidated financial statements. ff ment of long-lived assets, contingencies and income taxes. We believe judgments and estimates used in the preparation Revenue recognition: We account for customer arrangements that encompass multiple deliverables, such as ff ional services, software licenses, and maintenance and suppor patent licenses, profess “Multipli e-Element Arrangements.” For arrangements that include multiple deliverables, we identify and divide the deliverables into separate units of accounting at inception if certain criteria are met. We apply ASC 985 to software deliverables when relevant. The consideration for the arrangements under ASC 605-25 is allocated to the separate units of accounting using the relative selling price method. t fees, under ASC 605-25 uu The relative selling price method allocates the consideration based on our specific assumptm ions rather than assumptmm ions of a marketplace participant, and any discount in the arrangement proportionally to each deliverable on the basis of each deliverable’s selling price. Applicable revenuen recognition criteria are considered separately for each separate unit of accounting as follows: • • • is generally determined based on time and materials. Revenue for development and Service revenuen consulting services is recognized as the services are perforff med. Billing for services rendered generally occurs within one month after the services are provided. ff Subscription revenue, which includes revenue from the sale of Digimarc Discover, Digimarc Barcode and Guardian products and services, is generally paid in advance and recognized over the term of the subsu cription, which is generally one to three years. License revenue is recognized when amounts owed to Digimarc have been earned, are fixed or determinable (within our normal 30 to 60 day payment terms), and collection is reasonably assured. If the payment terms extend beyond our normal 30 to 60 days, the fee may not be considered to be fixed or determinable, and the revenuen would then be recognized when installments are due. • We record revenuen from certain license agreements upon cash receipt as a result of collectabia lity not being reasonably assured. • Our standard payment terms for license arrangements are 30 to 60 days. Extended payment terms on patent license arrangements are not considered to be fixed or determinable if payments are due beyond our standard payment terms, primarily because of the risk of subsu tantial modification present in our patent licensing business. As such, revenue on license arrangements with extended payment terms are recognized as fees become fixed or determi nable. rr “ Goodwill: We account for business combinations under the acquisition method of accounting in accordance iness Combinations,” where the total purchase price is allocated to the tangible and identified with ASC 805, “Bus intangible assets acquired and liabilities assumed based on their estimated fair values. The purchase price is allocated using the information currently available, and may be adjud sted, up to one-year from acquisition date, after obtaining more information regarding, among other things, asset valuations, liabilities assumed and revisions to preliminary estimates. ff Contingent consideration, if any, is recorded at the acquisition date based upon the estimated fair value of the contingent payments. The fair value of the contingent consideration is re-measured each reporting period with any adjud stments in fair value being recognized in earnings from operations. The purchase price in excess of the fair value of the tangible and identified intangible assets acquired less liabilities assumed is recognized as goodwill. 24 We test goodwill for impamm irment annually in June and whenever events or changes in circumstances indicate that the carrying value may not be recoverable. Such reviews assess the fair value of our assets compared to their carrying value. We operate as a single reporting unit. We estimate the fair value of our single reporting unit using a market approach, which takes into account our market capia talization plus an estimated control premium. In connection with our annual impamm irment test of goodwill as of June 30, 2016 and 2015, we concluded that there was no impaimm rment because the estimated fair value of our single reporting unit subsu tantially exceeded the carrying value. Impairment of long-lived assets: We assess long-lived assets for impaimm rment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable, in accordance with the provisions of ASC 360 “Pr“ impamm irment assessment include, but are not limited to, a significant decrease in the market price of a long-lived asset, a significaff a current-period operating or cash flow loss combined with a history of operating or cash flow losses. nt adverse change in legal factors or in the business climate that could affect the value of an asset, or ent.” Conditions that could trigger a long-lived asset operty, Plant and Equipmi Recoverability of assets to be held and used is measured by a comparison of the carrying amount of the assets life. If such to future net undiscounted cash flows expected to be generated by the assets over their remaining usefulff assets are considered to be impairm 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 assets. ment would be recognized in operating results at the amount by ed, the impairmm Considerable management judgment is required in determining if and when a condition would trigger an impairmm ment assessment of our long-lived assets and once such a determination has been made, considerable management judgment is required to determine the expected net undiscounted future cash flows to be generated by the assets over their remaining usefulff lifeff and, if necessary, the fair market value of those assets. Assets to be disposed of are reported at the lower of the carrying amount or fair value less costs to sell. Contingencies: We evaluate all pending or threatened contingencies or commitments, if any, that are ff on our operations or financial position. We assess the probability reasonabla y likely to have a material adverse effect of an adverse outcome and determine if it is remote, reasonably possible or probable as definff ed in accordance with the provisions of ASC 450 “Contingencies.” If information available prior to the issuance of our financial statements indicates that it is probable that an asset has been impamm ired or a liability has been incurred at the date of our financial statements, and the amount of the loss, or the range of probable loss can be reasonably estimated, then the loss is accruerr d 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, we 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. Income taxes: We record valuation allowances on our deferred tax assets if,ff based on available evidence, it is more-likely-than-not that all or some portion of the assets will not be realized. The determination of whether our deferred tax assets are realizable requires management to identify and weigh all available positive and negative evidence. Management considers recent financial performance, projeo cted future taxable income, scheduled reversals of deferred tax liabilities, tax planning strategies and other evidence in assessing the realizability of our deferred tax assets. We recorded a $6.8 million non-cash income tax charge during the fourth quarter of 2014 to record a full valuation allowance against our deferred tax assets largely due to the cumulative loss we had incurred over the previous three years, which is considered a significant piece of negative evidence when assessing the realizability of deferr ed tax assets. As of Decemberm 31, 2016, we determined a full valuation allowance was still appropriate due to ff continued losses. 25 We are subju ect to federal and state income taxes within the U.S., and, in the ordinary course of business, there are transactions and calculations where the ultimate tax determination is uncertain. We report a liability (or contra asset) for unrecognized tax benefits resulting from uncertain tax positions taken (or expected to be taken) on a tax return. We recognize interest and penalties, if any, related to the unrecognized tax benefits in income tax expense. Results of Operations—the Years Ended December 31, 2016 and December 31, 2015 The following tables present our consolidated statements of operations data for the periods indicated. Year Ended December 31, 2016 Year Ended December 31, 2015 Revenue: Service ..................................................... Subsu cription............................................. License .................................................... Total revenue ..................................... $ Cost of revenue: Service ..................................................... Subsu cription............................................. License .................................................... Total cost of revenue.......................... ................................................... Gross profitff Operating expenses: Sales and marketing................................. Research, development and engineering ........................................... General and administrative...................... Intellectual property................................. Total operating expenses.................... Operating loss ............................................... Other income, net.......................................... Loss before income taxes.............................. Provision for income taxes............................ Net loss .............................................. $ 12,667 5,808 3,318 21,793 5,673 2,410 414 8,497 13,296 11,888 13,394 8,298 1,636 35,216 (21,920) 258 (21,662) (10) ((21,672)) $ $ 12,517 6,377 3,295 22,189 5,488 3,113 346 8,947 13,242 9,275 12,465 7,954 1,525 31,219 (17,977) 109 (17,868) (66) ((17,934)) 26 Revenue: Service ............................................... Subsu cription....................................... .............................................. . License Total revenue ............................... Cost of revenue: Service ............................................... Subsu cription....................................... .............................................. . License .................... . ............................................. Total cost of revenue Gross profitff Operating expenses: Sales and marketing Research, development and ........................... . engineering ............................. ........ . General and administrative................ Intellectual property........................... Total operating expenses.............. Operating loss ......................................... Other income, net.................................... Loss before income taxes........................ Provision for income taxes...................... Net loss ........................................ Year Ended December 31, 2016 Year Ended December 31, 2015 Percentages are percent of total revenue 58% 27 15 100 26 11 2 39 61 55 61 38 8 162 (101) 1 (99) —— (99( %)) 56% 29 15 100 25 14 2 40 60 42 56 36 7 141 (81) —— (81) —— (81( %)) Summary Total revenue decreased $0.4 million or 2% to $21.8 million, primarily the result of lower subsu cription revenue. Total operating expenses increased 13% to $35.2 million, primarily reflecting higher investment in sales, marketing and engineering as we continue to address importa for Digimarc Discover and Digimarc Barcode. mm nt opportunities in market development and delivery 27 Revenue Revenue: Year Ended December 31, 2016 Year Ended December 31, 2015 Dollar Increase (Decrease) Percent Increase (Decrease) Service .................................... ... $ Subsu cription ....................... License ................................... . ....... .... Total...................................... $ 12,667 5,808 3,318 21,793 $ $ 12,517 6,377 3,295 22,189 $ $ 150 (569) 23 ((396)) 1% (9)% 1% (2( )%) Revenue (as % of total revenue): Service .................................... ... ....... . Subsu cription ....................... .... License ................................... Total...................................... 58% 27% 15% 100% 56% 29% 15% 100% Service. Service revenuen consists primarily of software development and consulting services. The majoa rity of service revenue arrangements are structured as time and materials consulting agreements. Most of our service revenue is derived from contracts with the Central Banks and government agency contractors. The agreements range from several months to several years in length, and our longer term contracts are subju ect 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, reimbursement for third party costs and services. Increases or decreases in the services provided under these contracts are generally subju ect 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 agency contractors are generally shorter term in nature, less linear in billings and less predictable than our longer term contracts because the contracts with government agency contractors are subju ect to government budgets and funding. The increase in service revenue was primarily due to more program work with the Central Banks, partially offsff et by the expiration of minimum support services to IV. Subscription. Subsu cription revenue includes Digimarc Discover, Digimarc Barcode and Guardian products and services, and is generally recurring in nature, paid in advance and recognized over the term of the subsu cription. The decrease in subsu cription revenue was primarily due to lower software license revenue, which is recognized over the associated 12-month support uu period, partially offset by growth in sales of Digimarc Barcode. License. License revenue originates primarily from licensing our intellectual property where we receive license fees and/or royalties as our income stream. The increase in license revenue was insignificant. 28 Revenue by geographyh Year Ended December 31, 2016 Year Ended December 31, 2015 Dollar Increase (Decrease) Percent Increase (Decrease) Revenue by geography: Domestic ................................. $ International ............................ ....... $ . Total............................ 4,776 17,017 21,793 $ $ 6,304 15,885 22,189 $ $ (1,528) 1,132 ((396)) (24)% 7% (2( )%) Revenue (as % of total revenue): mestic ................................. International ............................ ....... . Total............................ 22% 78% 100% 28% 72% 100% The decrease in domestic revenuen was primarily due to lower software license revenuen and the expiration of minimum suppor uu t services to IV. The increase in international revenue was primarily due to more program work from the Central Banks and higher license revenue among international customers. Cost of revenue Service. Cost of service revenue primarily includes costs that are allocated from research, development and engineering, and sales and marketing that relate directly to perforff ming services under our customer contracts and direct costs of program delivery. Costs include: • • • • • • compemm nsation, benefitsff 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; , incentive compensation in the form of stock-based compensation and related payments to outside contractors that are billed to customers; charges for equipment directly used by customers; depreciation and other charges for machinery, equipment and software directly used by customers; travel costs directly attributable to development and consulting contracts; and charges for infrastructurt e and centralized costs of facilities and information technology. Subscription. Cost of subsu cription revenue primarily includes: • • • • • compemm nsation, benefitsff costs of operations personnel; , incentive compensation in the form of stock-based compensation and related ; cost of outside contractors that provide operational support uu amortization of existing technology acquired in the acquisition of Attributor; Internet service provider connectivity charges and image search data fees to suppor to our subsu cription customers; and uu t the services offerff ed charges for infrastructurt e and centralized costs of facilities and information technology. License. Cost of license revenue primarily includes: • • amortization of capitalized patent costs; and amortization of patent maintenance fees. Gross profitii Gross Profit:ff Year Ended December 31, 2016 Year Ended December 31, 2015 Dollar Increase (Decrease) Percent Increase (Decrease) Service .............................................. $ Subsu cription ...................................... License .............................................. Total............................................. $ 6,994 3,398 2,904 13,296 $ $ 7,029 3,264 2,949 13,242 $ $ (35) 134 (45) 54 (0)% 4% (2)% 0% Gross Profitff revenuen (as % of related components): ice .............................................. Subsu cription ...................................... License .............................................. Total............................................. 55% 59% 88% 61% 56%% 51%% 89%% 60%% The increase in total gross profitff was due primarily to higher margins on subsu cription revenue. The decrease in service gross profit as a percentage of service revenue was insignificant. The increase in subsu cription gross profitff as a percentage of subsu cription revenue was primarily due to lower t of our Guardian products and services. operations and contractor costs in suppor uu The decrease in license gross profit as a percentage of license revenue was insignificant. Operatintt gn expenses We allocate certain costs of research, development and engineering, sales and marketing, and intellectual property to cost of revenue when they relate directly to our customer contracts. We record all remaining, or “residual,” costs as sales and marketing, research, development and engineering, general and administrative, and intellectual property expenses. Sales and marketkk ing Sales and marketing................................. Sales and marketing (as % of total revenue).......................... Year Ended December 31, 2016 11,888 $ Year Ended December 31, 2015 Dollar Increase Percent Increase $ 9,275 $ 2,613 28% 55% 42% Sales and marketing expenses consist primarily of:ff • • compemm nsation, benefitsff costs of sales and marketing emplmm oyees and product managers; , incentive compensation in the form of stock-based compensation and related travel and market research costs, and costs associated with marketing programs, such as trade shows, publu ic relations and new product launches; 30 • • ff profess ional services and outside contractors for product and marketing initiatives; and charges for infrastructure and centralized costs of facilities and information technology. The increase in sales and marketing expenses was due primarily to: • • • • increased headcount and compensation-related expenses of $1.8 million; increased charges for infrastructure and centralized costs of $0.3 million due to increased headcount; increased travel expenses of $0.2 million; and increased marketing and professio ff nal fees of $0.2 million related to market development activities. Research, developmo ent and engineering Year Ended December 31, 2016 Year Ended December 31, 2015 Dollar Increase Percent Increase Research, development and engineering ........................................... $ 13,394 $ 12,465 $ 929 7% Research, development and engineering (as % of total revenue) ...... 61% 56% Research, development and engineering expenses arise primarily from three areas that support uu our business model: • Fundamental Research: • investigation of new digital watermarking algorithms to increase robustness and/or compumm tational efficff iency; • mobile device usage models and imaging sub-systems in camera-phones; • • • • industry conferen ff ce participation and authorship of papers for industry journals; survey and studt modeling of intent; y of human and compumm ter interaction models with a focus on mobile devices and development of new intellectual uu support ing diagrams and materials; t property, including documentation of claims and production of research in multi-spectral analyses, machine learning, barcodes, QR codes, fingerpri other content identification technologies; rr nting, and • metadata ranking algorithms for matching Internet file content against referen ff ce database; and • investigation of subsu trates, printing techniques, and printing technology relating to consumer packaged goods. • Platforff m Development: • tuniu ng and optimization of implm ementation models to improvmm attacks and routine transformations, such as JPEG, cropping and printing; e resistance to non-malicious • mobile platform creation to leverage device-specificff capaa bia lities (e.g., instruction sets and Graphics Processing Units); • mobile platform optimization involving usage of multiple sensors simultaneously; • • m embedded environments; systems platform creation and tuning for barcode scanners and machine vision tuniu ng big data analytics transformation and metrics aggregation engine; 31 • • tuning data-driven Internet crawling infrastructure with policy-driven feedback loop; and assembly of master book publis publu ic data sources. u hing catalog based on aggregation and reconciliation of multiple • Product Development: • deliver and enhance the Digimarc Barcode; • maintaining the Digimarc Barcode Manager to provide campam ign management and routing services for the Digimarc Discover platform; • maintaining the web-hosted image enhancement service in suppo uu rt of Digimarc Discover platform; • • • • development and optimization of production level image enhancement tools and quality control services; iterative development and release of the Digimarc Discover application for the iOS and Android platforff ms; real-time analytics portal to support anti-piracy services for the publishing industry; and discovery application for publu ishing industry based on social network connections and shared interests. Research, development and engineering expenses consist primarily of:ff • • • • compemm nsation, benefitsff , incentive compensation in the form of stock-based compensation expense, recruiting and related costs of software and hardware developers and quality assurance personnel; payments to outside contractors; the purchase of materials and services for product development; and charges for infrastructure and centralized costs of facilities and information technology. The increase in research, development and engineering expenses was due primarily to increased headcount and compensation-related expenses of $0.7 million. General and administrative General and administrative...................... General and administrative (as % of total revenuen ).................................... Year Ended December 31, 2016 Year Ended December 31, 2015 Dollar Increase Percent Increase $ 8,298 $ 7,954 $ 344 4% 38% 36% 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 cost of revenue, sales and marketing, research, development and engineering and intellectual property. General and administrative expenses consist primarily of:ff • • compemm nsation, benefitsff and related costs of general and administrative personnel; and incentive compensation in the form of stock-based compensation expense third party and profesff sional fees associated with legal, accounting and human resources; 32 • • costs associated with being a public u company; and charges for infrastructure and centralized costs of facilities and information technology. The increase in general and administrative expenses was due primarily to: • • • increased compensation-related expenses of $0.5 million; and increased profesff sional consulting fees of $0.2 million, partially offseff t by decreased charges for infrastructure and centralized costs of $0.3 million, which were allocated out to sales and marking due to increased headcount. Intellectual propertytt Intellectual property................................. Intellectual property (as % of total revenuen ).................................... Year Ended December 31, 2016 Year Ended December 31, 2015 Dollar Increase Percent Increase $ 1,636 $ 1,525 $ 111 7% 8% 7% 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 refleff cting the effeff ct of capitalized patent costs, primarily consist of:ff • • • • • compemm nsation, benefitsff and related costs of attorneys and legal assistants; and incentive compensation in the form of stock-based compensation expense third party costs, including filing and governmental regulatory fees and fees for outside legal counsel and translation costs, each incurred in the patent process; charges to write-off previously capitalized patent costs for patent assets we abandon; consulting costs related to marketing our intellectual property portfolio; and charges for infrastructurt e and centralized costs of facilities and information technology. Intellectual property expenses can vary from period to period based on the level of capitalized patent activity. The increase in intellectual property expenses was due primarily to increased compensation-related expenses of $0.1 million. Stock-based compensation Year Ended December 31, 2016 Year Ended December 31, 2015 Dollar Increase (Decrease) Percent Increase (Decrease) Cost of revenue........................................ Sales and marketing................................. Research, development and engineering ........................................... General and administrative...................... Intellectual property................................. Total ................................................... $ $ 709 975 1,381 2,182 306 5,553 $ $ 740 775 1,308 1,978 276 5,077 $ $ (31) 200 73 204 30 476 (4)% 26% 6% 10% 11% 9% The increase in stock-based compemm nsation expense was due primarily to increased headcount. We anticipate incurring an additional $9,728 in stock-based compensation expense through Decembem r 2020 for unvested restricted stock awards as of December 31, 2016. Other income,e net Other income, net .................................... Other income, net (as % of total revenue) ........................................ * Less than 1% Year Ended December 31, 2016 Year Ended December 31, 2015 Dollar Increase Percent Increase $ 258 $ 109 149 137% 1% * The increase in other income, net was primarily due to higher interest income as a result of higher cash and investment balances, higher interest rates on cash and investments, and changes in foreign currency. Provisiii on for income taxeaa s The provision for income taxes reflecff ts current taxes, deferred taxes and withholding taxes in certain foreign jurisdictions. For the year ended December 31, 2016, our effeff ctive tax rate was 0% because we have a full valuation allowance recorded against our defeff rred tax assets. The valuation allowance against deferred tax assets as of December 31, 2016 was $24.9 million, an increase of $9.5 million from $15.4 million as of December 31, 2015. We continually assess the applicability of valuation allowance against our deferred tax assets. Based upon the positive and negative evidence available as of December 31, 2016, and largely due to the cumulative loss incurred by us over the previous three years, which is considered a significant piece of negative evidence when assessing the realizability of deferred tax assets, a full valuation allowance is recorded against our deferred tax assets. We will not record tax benefits on any future losses until its determined that those tax benefits will be realized. All future reversals of the valuation allowance would result in a tax benefit in the period recognized. For the year ended December 31, 2015, our effeff ctive tax rate was 0% because we had a full valuation allowance recorded against our defeff rred tax assets. The valuation allowance against deferred tax assets as of December 31, 2015 was $15.4 million, an increase of $8.1 million from $7.3 million as of Decembem r 31, 2014. 34 Results of Operations—the Years Ended December 31, 2015 and December 31, 2014 The following tables present our consolidated statements of operations data for the periods indicated. Year Ended December 31, 2015 Year Ended December 31, 2014 Revenue: Service ..................................................... Subsu cription............................................. License .................................................... Total revenue ..................................... $ Cost of revenue: Service ..................................................... Subsu cription............................................. License .................................................... Total cost of revenue.......................... ................................................... Gross profitff Operating expenses: Sales and marketing................................. Research, development and engineering ........................................... General and administrative...................... Intellectual property................................. Total operating expenses.................... Operating loss ............................................... Other income, net.......................................... Loss before income taxes.............................. Provision for income taxes............................ Net loss .............................................. $ 12,517 6,377 3,295 22,189 5,488 3,113 346 8,947 13,242 9,275 12,465 7,954 1,525 31,219 (17,977) 109 (17,868) (66) ((17,934)) $ $ 11,727 6,203 7,728 25,658 5,077 3,020 334 8,431 17,227 7,974 13,711 8,972 1,793 32,450 (15,223) 55 (15,168) (652) ((15,820)) 35 Revenue: Service ............................................... Subsu cription....................................... .............................................. . License Total revenue ............................... Cost of revenue: Service ............................................... Subsu cription....................................... .............................................. . License .................... . ............................................. Total cost of revenue Gross profitff Operating expenses: Sales and marketing Research, development and ........................... . engineering ............................. ........ . General and administrative................ Intellectual property........................... Total operating expenses.............. Operating loss ......................................... Other income, net.................................... Loss before income taxes........................ Provision for income taxes...................... Net loss ........................................ Summary Year Ended December 31, 2015 Year Ended December 31, 2014 Percentages are percent of total revenue 56% 29 15 100 25 14 2 40 60 42 56 36 7 141 (81) —— (81) —— (81( %)) 46% 24 30 100 20 12 1 33 67 31 53 35 7 126 (59) —— (59) (3) (62( %)) Total revenue decreased $3.5 million or 14% to $22.2 million, refleff cting lower license revenue of $4.4 million primarily due to the end of royalty payments from Verance in the fourth quarter of 2014 and license payments from Nielsen in the first quarter of 2014, partially offsff et by growth in service and subsu cription revenue. Total operating expenses decreased 4% to $31.2 million, reflecting lower spending in research, development t by higher investment in sales and engineering, general and administrative and intellectual property, partially offseff and marketing as we focus on market development and delivery for Digimarc Discover and Digimarc Barcode. 36 Revenue Revenue: Year Ended December 31, 2015 Year Ended December 31, 2014 Dollar Increase (Decrease) Percent Increase (Decrease) Service ........................................ Subsu cription ................................ License ........................................ Total....................................... $ $ 12,517 6,377 3,295 22,189 $ $ 11,727 6,203 7,728 25,658 $ $ 790 174 (4,433) ((3,469)) 7% 3% (57)% )%) (14( Revenue (as % of total revenue): ice ........................................ Subsu cription ................................ License ........................................ Total....................................... 56% 29% 15% 100% 46% 24% 30% 100% The increase in service revenuen was primarily due to higher billable rates under our agreement with the Central Banks and increased program work with a government agency contractor. The increase in subsu cription revenue was primarily due to higher software license revenue, which is recognized over the associated 12-month support by lower Guardian revenue. uu period, and growthww in Digimarc Barcode revenue, partially offset The decrease in license revenue was primarily due to the end of royalty payments from Verance in the fourth quarter of 2014 and license payments from Nielsen in the first quarter of 2014. yh Revenue by geographa Year Ended December 31, 2015 Year Ended December 31, 2014 Dollar Decrease Percent Decrease Revenue by geography: Domestic ..................................... International ................................ Total....................................... $ $ 6,304 15,885 22,189 $ $ 9,596 16,062 25,658 $ $ (3,292) (177) ((3,469)) (34)% (1)% )%) (14( Revenue (as % of total revenue): mestic ..................................... International ................................ Total....................................... 28% 72% 100% 37% 63% 100% The decrease in domestic revenuen was primarily due to the end of royalty payments from Verance in the t by higher fourth quarter of 2014 and license payments from Nielsen in the first quarter of 2014, partially offseff domestic service and subsu cription revenue. The decrease in international revenue was primarily due to lower international license revenuen and lower Guardian revenue from international customers, partially offset by higher service revenue from the Central Banks. 37 Gross profitii Gross Profit:ff Year Ended December 31, 2015 Year Ended December 31, 2014 Dollar Increase (Decrease) Percent Increase (Decrease) Service .............................................. $ Subsu cription ...................................... License .............................................. Total............................................. $ 7,029 3,264 2,949 13,242 $ $ 6,650 3,183 7,394 17,227 $ $ 379 81 (4,445) ((3,985)) 6% 3% (60)% )%) (23( Gross Profitff revenuen (as % of related components): Service .............................................. Subsu cription ...................................... License .............................................. Total............................................. 56% 51% 89% 60% 57% 51% 96% 67% The decrease in total gross profitff was due primarily to lower license revenue, partially offseff t by higher service and subscription revenue. The decrease in service gross profit as a percentage of service revenue was insignificant. The change in subsu cription gross profitff as a percentage of subsu cription revenue was insignificaff nt. The decrease in license gross profit as a percentage of license revenue was due primarily to lower license revenue. Operatintt gn expenses Sales and marketkk ing Sales and marketing................................. Sales and marketing (as % of total revenue).......................... Year Ended December 31, 2015 Year Ended December 31, 2014 Dollar Increase Percent Increase $ 9,275 $ 7,974 $ 1,301 16% 42% 31% The increase in sales and marketing expenses was due primarily to: • • • increased headcount and compensation-related expenses of $1.1 million; increased charges for infrastructure and centralized costs of $0.5 million primarily related to increased headcount; partially offset by ff decreased amortization expense of $0.4 million related to the intangibles acquired in the acquisition of Attributor. 38 Research, developmo ent and engineering Year Ended December 31, 2015 Year Ended December 31, 2014 Dollar Decrease Percent Decrease Research, development and engineering ........................................... $ 12,465 $ 13,711 $ (1,246) (9)% Research, development and engineering (as % of total revenue) ...... 56% 53% The decrease in research, development and engineering expenses was due primarily to: • • decreased headcount and compensation-related expenses of $1.0 million; and decreased use of outside contractors, consultants, and profess ff ional services of $0.3 million. General and administrative General and administrative...................... General and administrative (as % of total revenuen ).................................... Year Ended December 31, 2015 Year Ended December 31, 2014 Dollar Decrease Percent Decrease $ 7,954 $ 8,972 $ (1,018) (11)% 36% 35% The decrease in general and administrative expenses was due primarily to: • • decreased stock compensation expense of $0.5 million; and decreased legal costs of $0.4 million. Intellectual propertytt Intellectual property................................. Intellectual property (as % of total revenuen ).................................... Year Ended December 31, 2015 Year Ended December 31, 2014 Dollar Decrease Percent Decrease $ 1,525 $ 1,793 $ (268) (15)% 7% 7% The decrease in intellectual property expenses was due primarily to: • • • decreased headcount and compensation-related expenses of $0.2 million; and decreased consulting fees of $0.2 million for a third party intellectual property marketing study performed in 2014; partially offsff et by increased write-offff of abandoned patent costs of $0.2 million. 39 Stock-based compensation Year Ended December 31, 2015 Year Ended December 31, 2014 Dollar Increase (Decrease) Percent Increase (Decrease) Cost of revenue........................................ Sales and marketing................................. Research, development and engineering ........................................... General and administrative...................... Intellectual property................................. Total ................................................... $ $ 740 775 1,308 1,978 276 5,077 $ $ 545 674 1,406 2,454 324 5,403 $ $ 195 101 (98) (476) (48) ((326)) 36% 15% (7)% (19)% (15)% (6( )%) Stock-based compensation expense decreased as all outstanding stock options were fully vested by January 2015, which was partially offseff t by expense on new hire stock grants. Other income,e net Year Ended December 31, 2015 Year Ended December 31, 2014 Other income, net .................................... Other income, net (as % of total revenue) ........................................ $ 109 $ * 55 * Dollar Increase Percent Increase 54 98% * Less than 1% The increase in other income, net was primarily due to higher interest income as a result of higher cash and investment balances. Provisiii on for income taxeaa s For the year ended Decembem r 31, 2015, we recognized an income tax provision of $0.1 million on a pretax loss of $17.9 million, resulting in an effeff ctive tax rate of 0%. The valuation allowance against deferred tax assets as of Decemberm 31, 2015 was $15.4 million, an increase of $8.1 million from $7.3 million as of December 31, 2014. For the year ended Decembem r 31, 2014, we recognized an income tax provision of $0.7 million on a pretax loss of $15.2 million, resulting in an effeff ctive tax rate of (4%). The income tax provision included a $6.8 million non-cash charge during the fourth quarter of 2014 to record a full valuation allowance against our deferff assets. red tax Liquidity and Capital Resources December 31, 2016 December 31, 2015 Working capital............................................. Current ratio (1) ............................................ Cash, cash equivalents and short-term marketable securities.................................. Long-term marketable securities................... Total cash, cash equivalents and all marketable securities.................................. $ $ $ $ 58,461 14.1:1 56,134 4,392 60,526 $ $ $ $ 37,610 9.0:1 36,187 2,999 39,186 (1) The current (liquidity) ratio is calculated by dividing total current assets by total current liabilities. 40 The $21.3 million increase in cash, cash equivalents and marketable securities at December 31, 2016 from December 31, 2015 resulted primarily from: • • • • • proceeds from the sale of common stock in an underwritten publu ic offeff ring; and proceeds from stock option exercises; partially offsff et by cash used in operations; purchases of property and equipment and capitalized patent costs; and purchases of common stock related to the vesting of restricted stock. Financial instruments that potentially subju ect 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 majoa r banks and financial institutions and at times deposits may exceed insured limits. Marketable securities include federal agency notes, commercial paper, corporate notes, pre-refunded municipal bonds and U.S. treasuries. Our investment policy requires the portfolff funds will be available within 30 days’ notice. io to be invested to ensure that the greater of $3 million or 7% of the invested Other than cash used for operating needs, which may include short-term marketable securities, our investment ion or typeyy of financial instrument by limiting the policy limits our credit exposure to any one financial institutt 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, U.S. federal agencies and U.S. backed securities, which have no limits, at the time of purchase. Our investment policy also limits our credit exposure by limiting to a maximum of 40% of our cash and cash equivalents and marketable securities, or $15 million, whichever is greater, to be invested in any one industry category, (e.g., financial or energy industries), 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 y results in a reduction in carrying amount to fair value. security below cost that is deemed to be other-than-temporar To determine whether an impam irment is other-than-temporm ary, 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-temporar recorded by us in the years ended Decemberm 31, 2016, 2015 and 2014. y impaimm rments identified or mm mm Cash flows from operating activities The components of operating cash flows were: Net loss .................................................... Non-cash items ........................................ Changes in operating assets and liabilities ............................................... gg activities ....... Net cash used in operatin p Net loss .................................................... Non-cash items ........................................ Changes in operating assets and liabilities ............................................... gg activities ....... Net cash used in operatin p Year Ended December 31, 2016 (21,672) $ Year Ended December 31, 2015 (17,934) $ $ 8,010 7,503 Dollar Increase (Decrease) Percent Increase (Decrease) (3,738) 507 (202) ((13,864)) $ $ 691 ((9,740)) $ (893) ((4,124)) Year Ended December 31, 2015 (17,934) $ Year Ended December 31, 2014 (15,820) $ $ 7,503 9,779 Dollar Increase (Decrease) Percent Increase (Decrease) (2,114) (2,276) (21)% 7% (129)% )%) (42( (13)% (23)% 200% )%) (45( 691 ((9,740)) $ (692) ((6,733)) $ 1,383 ((3,007)) $ 41 Cash flows used in operating activities in 2016 compamm red to 2015 increased by $4.1 million, primarily as a result of a higher net loss and by changes in operating assets and liabilities, partially offsff et by higher non-cash items. The higher net loss was primarily due to higher operating expenses. The changes in operating assets and liabilities was primarily due to changes in other current assets, and deferred rent due to the terms of our amended lease agreement. The higher non-cash items was primarily due to higher stock-based compemm nsation expense. Cash flows used in operating activities in 2015 compamm red to 2014 increased by $3.0 million, primarily as the result of a higher net loss and lower non-cash items, partially offsff et by changes in operating assets and liabilities. of no The higher net loss was primarily due to lower revenues. The decrease in non-cash items reflects the impactm non-cash charge for deferred income taxes in 2015. The changes in operating assets and liabilities was primarily due to changes in other current assets. Cash flows from investingii s activitieii Cash flows used in investing activities in 2016 compamm red to 2015 increased by $10.3 million from $5.2 million to $15.5 million, primarily as a result of higher net purchases of marketable securities from cash received in our underwritten publu ic offeff ring and higher capital expenditures for leasehold imprmm ovements. Cash flows used in investing activities in 2015 compamm red to 2014 increased by $0.8 million from $4.4 million to $5.2 million, primarily as a result of higher net purchases of marketable securities, partially offsff et by lower purchases of property and equipment and capitalized patent costs. Cash flows from financingn activities ii Cash flows provided by financing activities in 2016 compared mm to 2015 increased $25.9 million from $12.0 million to $37.8 million, primarily as a result of higher cash proceeds from the sale of common stock in our underwritten publu ic offeff ring. Cash flows provided by financing activities in 2015 compared to 2014 decreased by $1.4 million from $13.4 million to $12.0 million, primarily as a result of lower cash proceeds from the sale of common stock, partially offsff et by no cash dividends paid in 2015. Future cash expectations tt In August 2016, we sold 1,233 shares of our common stock in an underwritten publiu c offerff ing, plus an additional 185 shares in full exercise of the underwriters’ option to purchase additional shares of common stock, at the price to the public underwriter fees of $150, from the offeff of $30.00 per share. We received $39,953 of cash proceeds, net of discount of $2,447 and ring, and paid $253 in stock issuance costs for legal and accounting fees. u We believe that our current cash, cash equivalents, and short-term marketable securities balances will satisfyff our projeo cted working capital and capital expenditure requirements for at least the next 12 months. We have a $100 million shelf registration statement in place, of which $42,550 was allocated for sales of our common stock under our underwritten publu ic offeri Equity Distribution Agreement entered into in August 2014. The shelf registration statement expires in May 2017. We may use similar or other financing means to raise working capital in the future, if necessary, to support continued investment in our growthww initiatives. We may also raise capital in the future to fund acquisitions and/or investments in complementary businesses, technologies or product lines. If it becomes necessary to obtain additional financing, we may not be able to do so, or if these funds are available, they may not be available on satisfactory terms. ng in August 2016 and $30,000 was allocated for sales of our common stock under the uu ff Contractual Obligations In July 2015, we entered intonn an amendmentnn with the landlord of ouruu corporate officff es in Beaverton, Oregon to extend the lease term throhh ugh March 2024 for rent payments totaling $5.5 million, payabla e in monthly installmentsnn . 42 In February 2015, we entered into a new facilities lease agreement in San Mateo, California with a lease term through March 2020 for rent payments totaling $1.0 million, payable in monthly installments. The following table presents our contractuatt l obligations as of December 31, 2016: Total operating lease obligations ................................... Maturities by Period Total $ 6,350 Less than 1 year $ 784 1-3 years $ 2,015 3 - 5 years $ 1,652 More than 5 years $ 1,899 We cannot make a reasonably reliable estimate of the period of potential cash settlement of our unrecognized tax benefits of $0.5 million and, thereforff e, have not included the unrecognized tax benefits in the table of contractual obligations as of December 31, 2016. Off-Bff alance Sheet Arrangements Other than the contractual obligations noted above, we do not have any off-ff balance sheet arrangements that t on our financial condition, changes in financial have or are reasonably likely to have a current or future effecff condition, revenue or expenses, results of operations, liquidity, capital expenditures or capital resources that is material to investors. Forward-Lookink g Statements This Annual Report on Form 10-K 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,” and variations of such terms or similar expressions are intended to identifyff 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 beliefsff concerning future events impacmm ting us, and below), which are difficff ult to predict and, in many are subju ect to uncertainties and factors (including those specifiedff instances, are beyond our control. As a result, our actual results could differff materially from those expressed in or impliedmm by any such forward-looking statements, and investors are cautioned not to place undue reliance on such statements. We believe that the following factors, among others (including those described in Item 1A. “Risk Factors”), could affeff ct our future perforff mance and the liquidity and value of our securities and cause our actual results to differ materially from those expressed or implmm ied by forward-looking statements made by us. Forward- looking statements include but are not limited to statements relating to: • • • • • • • • • • • concentration of revenuen with few customers comprising a large majoa rity of the revenue; revenue trends and expectations; our future level of investment in our business, including investment in research, development and engineering of products and technology, development and protection of our intellectual property, sales growthww initiatives and development of new market opportunities; our ability to imprmm ove margins; anticipated expenses, costs, margins, provision for income taxes and investment activities in the foreseeable future; anticipated revenue to be generated from current contracts, renewals, and as a result of new programs; variability of contracted arrangements; our profitaff bia lity in future periods; business opportuni t ties that could require that we seek additional financing; the size and growth of our markets; the existence of international growthww opportunities and our future investment in such opportunities; 43 • • • • • • • • • • • the sources 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, interest rate volatility and other limitations on the availability of capital, which could have an impam ct 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 products, including Digimarc Discover, Digimarc Barcode and Guardian;aa our ability to innovate and enhance our competitive differff entiation; protection, development and monetization of our intellectuat l property portfolff io; our plans and intentions with respect to our joint venturt es; and other risks detailed in our filings with the Securities and Exchange Commission, including the risk factors set forth in Item 1A. “Risk Factors.” ff We believe that the factors specifieff d above and the risk factors contained in Item 1A, “Risk Factors,” among our future perforff mance and the liquidity and value of our securities and cause our actual results others, could affect to differff materially from those expressed or implmm ied 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 diffeff looking statements made by us or by persons acting on our behalf apply only as of the date of this Annual Report. We do not undertake any obligation to publu icly update or revise any forward-looking statements to refleff ct future events, information or circumstances that arise afteff r materially from the forward-looking statements. All forward- r the date of the filing of this Annual Report on Form 10-K. ITEM 7A: QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK Our exposure to market risk for changes in interest rates relates primarily to the increase or decrease in the io. We attemptmm to ensure the safetff y and preservation of our invested principal funds by amount of interest income we can earn on our investment portfolio. We do not use derivative financial instruments in our investment portfolff limiting default risk, market risk and investment risk. We mitigate default risk by investing in low-risk securities. At December 31, 2016, we had an investment portfolff io of federal agency notes, commercial paper, corporate notes, pre- refunff ded municipal bonds, U.S. treasuries and money market securities, including those classified as cash equivalents, and short- and long-term marketable securities, totaling $59.8 million. The original maturities of our investment portfolio range from 12 to 520 plus days with an average interest rate of 0.96%. If market interest rates were to decrease immediately and uniforff mly by 10% from levels as of December 31, 2016, the decline of the fair market value of the fixed income portfolio would not be material. ITEM 8: FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA Our Consolidated Financial Statements and the accompanying Notes that are filed as part of this Annual Report are listed under Part III, Item 15, Exhibits and Financial Statement Schedules and are set forth beginning on page F-1 immediately following the signature page of this Form 10-K. ITEM 9: CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE None 44 ITEM 9A: CONTROLS AND PROCEDURES Evaluation of Disclosure Controls and Procedures Our management, with the participation of our Chief Executive Offiff cer and Chief Financial Offiff cer, have carried out an evaluation of the effeff ctiveness of our disclosure controls and procedures (as definff ed in Rules 13a- 15(e) and 15d-15(e) of the Securities Exchange Act of 1934) as of the end of the period covered by this Form 10-K. Based on our evaluation, our Chief Executive Offiff cer and Chief Financial Officff er have concluded that our disclosure controls and procedurdd es, as of the end of the period covered by this Form 10-K, were effect that information required to be disclosed by us in reports that we file or submu 1934 is (i) recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms, and (ii) accumulated and communicated to our management, including our principal executive officff er and principal financial offiff cer, as appropriate to allow timely decisions regarding required disclosure. ive in ensuring it under the Securities Exchange Act of ff Management’s Report on Internal Control Over Financial Reporting Management is responsible for establishing and maintaining adequate internal control over financial reporting as definff ed in Rules 13a-15(f)ff and 15d-15(f)ff under the Securities Exchange Act of 1934. Our internal control over financial reporting is a process designed to provide reasonabla e assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with U.S. GAAP. Any control tt system, no matter how well conceived and operated, and because of inhern only reasonabla e, not absolute, assurauu nce that the objectives of the contrott continn nue monitoring ouruu intenn rnal control tt proceduresuu that may be required to ensureuu the ongoing integrity of ouruu consolidated financial statementsnn . s over financial reportirr ng and will modify or implmm ementnn additional contrott entnn limitations, can provide l system are met. Manaa gementnn is committed to ls and With the participation of our Chief Executive Offiff cer and Chief Financial Officff er, management conducted an evaluation of the effeff ctiveness of internal control over financial reporting based on the framework established in Internal Controt Treadway Commission, (COSO). Based on this evaluation, management has concluded that internal control over financial reporting was effeff ctive as of the end of the period covered by this Form 10-K based on those criteria. Int— egrated Frameworkrr (2013) issued by the Committee of Sponsoring Organizations of the l—ll There was no change in our internal control over financial reporting that occurred during the quarter ended December 31, 2016, that has materially affected, financial reporting. ff or is reasonably likely to materially affeff ct, our internal control over Our independent auditors have issued an audit report on the effeff ctiveness of our internal control over financial reporting as of December 31, 2016, which is included herein. 45 Report of Independent Registered Public Accounting Firm The Boarda Digimarc Corporation: of Directors and Shareholders We have audited Digimarc Corporation’s (the “Company”) internal control over financial reporting as of December 31, 2016, based on criteria established in Internal Controt Committee of Sponsoring Organizations of the Treadway Commission (COSO). The Company’s management is responsible for maintaining effecti effeff ctiveness of internal control over financial reporting, included in the accompanying Management’s Report on Internal Control Over Financial Reporting. Our responsibility is to express an opinion on the Company’s internal control over financial reporting based on our audit. ve internal control over financial reporting and for its assessment of the Int— egrated Frameworkrr (2013) issued by the l—ll ff We conducted our audit in accordance with the standards of the Public u Company Accounting Oversight Board (United States). Those standards require that we plan and perforff m the audit to obtain reasonable assurance about whether effeff ctive internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effeff ctiveness of internal control based on the assessed risk. Our audit also included perforff ming such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion. A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A compamm ny’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonabla e detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the compamm ny are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effeff ct on the financial statements. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effecff controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. tiveness to future periods are subju ect to the risk that In our opinion, the Company maintained, in all material respects, effeff ctive internal control over financial reporting as of December 31, 2016, based on criteria established in Internal Contrott (2013) issued by COSO. Int— egrated Frameworkrr l—ll We also have audited, in accordance with the standards of the Public u Company Accounting Oversight Board (United States), the consolidated balance sheets of Digimarc Corporation and subsidiaries as of December 31, 2016 and 2015, and the related consolidated statements of operations, shareholders’ equity, and cash flows for each of the years in the three-year period ended December 31, 2016, and our report dated Februar unqualified opinion on those consolidated financial statements. ry 23, 2017 expressed an /s/ KPMG LLP Portland, Oregon February 23, 2017 ITEM 9B: OTHER INFORMATION None 46 Certain information required by Part III of this Annuan l Report on Form 10-K is incorporated herein by referff ence to the Proxy Statement for our 2016 annual meeting of shareholders, which we intend to file no later than 120 days afteff r the end of the fiscal year covered by this Annual Report on Form 10-K. PART III ITEM 10: DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE Code of Ethics We have adopted a Code of Business Conduct that applies to our principal executive offiff cer, principal financial offiff cer and controller, as well as a Code of Ethics for Financial Profesff financial officff er and controller. We have made these codes available in the Corporate Governance section of our rporate-go- website at www.digii marc.com/about/ctt ompam ny/co// provision of the codes, or subsu tantively amend the codes, we will disclose that fact on our website within four business days. vernance. If we waive, or implmm icitly waive, any material sionals that applies to our principal The other information required by this item is incorporated herein by reference to the information in the Proxy Statement, which we intend to file with the SEC no later than 120 days afteff this Annual Report on Form 10-K under the captions “Election of Directors,” “Management,” “Report of the Governance and Nominating Committee of the Board of Directors—Au— dit Committee,” and “Other Matters— Section 16(a) Beneficial Ownership Reporting Compliance.” r the end of the fiscal year covered by ITEM 11: EXECUTIVE COMPENSATION The information required by this item is incorporated herein by reference to the information in the Proxy Statement, which we intend to file with the SEC no later than 120 days afteff this Annual Report on Form 10-K, under the captions “Director Compensation,” “Executive Compensation,” “Compensation Committee Interlocks and Insider Participation” and “Compensation Committee Report.” r the end of the fiscal year covered by ITEM 12: SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS The information required by this item is incorporated herein by reference to the information in the Proxy Statement, which we intend to file with the SEC no later than 120 days afteff this Annual Report on Form 10-K, under the captions “Security Ownership of Certain Beneficff Management” and “Equity Compensation Plan Information.” r the end of the fiscal year covered by ial Owners and ITEM 13: CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE The information required by this item is incorporated herein by reference to the information in the Proxy Statement, which we intend to file with the SEC no later than 120 days afteff this Annual Report on Form 10-K under the caption “Election of Directors—Determination of Independence,” and “Related Person Transactions.” r the end of the fiscal year covered by ITEM 14: PRINCIPAL ACCOUNTANT FEES AND SERVICES The information required by this item is incorporated herein by reference to the information in the Proxy Statement, which we intend to file with the SEC no later than 120 days afteff this Annual Report on Form 10-K, under the caption “Audit Fees.” r the end of the fiscal year covered by 47 ITEM 15: EXHIBITS AND FINANCIAL STATEMENT SCHEDULES (a)(1) Financial Statements The following documents are filed as part of this Annual Report on Form 10-K: (i) Report of Independent Registered Publu ic Accounting Firm (ii) Consolidated Balance Sheets as of December 31, 2016 and 2015 (iii) Consolidated Statements of Operations for the years ended December 31, 2016, 2015 and 2014 (iv) Consolidated Statements of Shareholders’ Equity for the years ended December 31, 2016, 2015 and 2014 (v) Consolidated Statements of Cash Flows for the years ended December 31, 2016, 2015 and 2014 (vi) Notes to Consolidated Financial Statements (a)(2) Financial Statement Schedules All schedules have been omitted since they are not required or are not applicable or the requiqq red information is shown in the consolidated financial statements or related notes. (a)(3) Exhibits See the Exhibit Index at page E-1 of this Annual Report on Form 10-K. 48 Pursuant to the requirements of Section 13 or 15(d) 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. SIGNATURES Date: February 23, 2017 DIGIMARC CORPORATION By: /S/ CHARLES BECK Charles Beck ii Title: Chiefe Financial Officeff r Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated: Signature Title Date /S/ BRUCRR E DAVIS Bruce Davis /S/ CHARLES BECK Charles Beck /S/ GARY DESTEFANO o Gary DeStefanff /S/ RICHARD L. KING Richard L. King /S/ WILLIAM J. MILLER William J. Miller /S/ JAMES T. RICHARDSON James T. Richardson /S/ ANDRAA EW WALTER Andrew Walter /S/ BERNAR RR D WHITNEY Bernard Whitney Chief Executive Offiff cer and Chairman of the Board of Directors (Principal Executive Offiff cer) February 23, 2017 Chief Financial Offiff cer and Treasurer (Principal Financial and Accounting Offiff cer) February 23, 2017 Februar ry 23, 2017 February 23, 2017 February 23, 2017 February 23, 2017 Februar ry 23, 2017 February 23, 2017 Director Director Director Director Director Director 49 INDEX TO CONSOLIDATED FINANCIAL STATEMENTS u Report of Independent Registered Public Accounting Firm ................................................................................ Consolidated Balance Sheets ............................................................................................................................... Consolidated Statements of Operations............................................................................................................... Consolidated Statements of Shareholders’ Equity............................................................................................... Consolidated Statements of Cash Flows.............................................................................................................. Notes to Consolidated Financial Statements ....................................................................................................... Page F-2 F-3 F-4 F-5 F-6 F-7 F-1 Report of Independent Registered Public Accounting Firm The Boarda Digimarc Corporation: of Directors and Shareholders We have audited the accompanying consolidated balance sheets of Digimarc Corporation and subsidiaries (the “Company”) as of December 31, 2016 and 2015, and the related consolidated statements of operations, shareholders’ equity, and cash flows for each of the years in the three-year period ended December 31, 2016. These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We conducted our audits in accordance with the standards of the Publu ic Company Accounting Oversight Board (United States). Those standards require that we plan and perforff m the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence support the accounting principles used and significff ant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. ing the amounts and disclosures in the financial statements. An audit also includes assessing uu In our opinion, the consolidated financial statements referr ed to above present fairly, in all material respects, the financial position of Digimarc Corporation and subsidiaries as of December 31, 2016 and 2015, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2016, in conforff mity with U.S. generally accepted accounting principles. ff We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the Company’s internal control over financial reporting as of December 31, 2016, based on criteria established in Internal Contrott Organizations of the Treadway Commission (COSO), and our report dated February 23, 2017 expressed an unqualified opinion on the effeff ctiveness of the Company’s internal control over financial reporting. Int— egrated Frameworkrr (2013) issued by the Committee of Sponsoring l—ll u /s/ KPMG LLP Portland, Oregon February 23, 2017 F-2 DIGIMARC CORPORATION CONSOLIDATED BALANCE SHEETS (In thousands, except per share data) December 31, 2016 December 31, 2015 Current assets: ASSETS Cash and cash equivalents ................................................................................ Marketable securities........................................................................................ Trade accounts receivable, net ......................................................................... Other current assets .......................................................................................... Total current assets ..................................................................................... Marketable securities ............................................................................................. Property and equipment, net .................................................................................. Intangibles, net....................................................................................................... Goodwill ................................................................................................................ Other assets............................................................................................................ Total assets.................................................................................................. LIABILITIES AND SHAREHOLDERS’ EQUITY Current liabilities: Accounts payable and other accrued liabilities ................................................ ff revenue .............................................................................................. Deferred Total current liabilities................................................................................ red rent and other long-term liabilities.......................................................... Total liabilities ............................................................................................ Deferff Commitments and contingencies (Note 13) Shareholders’ equity: ff Preferre d stock (par value $0.001 per share, 2,500 authorized, 10 shares issued and outstanding at December 31, 2016 and 2015).............................. Common stock (par value $0.001 per share, 50,000 authorized, 10,523 and 8,919 shares issued and outstanding at December 31, 2016 and 2015, respectively) .................................................................................................. Additional paid-in capital ................................................................................. it ......................................................................................... Accumulated deficff Total shareholders’ equity........................................................................... Total liabilities and shareholders’ equq ityy .................................................... $ $ $ $ See Notes to Consolidated Financial Statements. $ $ $ 11,638 44,496 5,078 1,695 62,907 4,392 3,570 6,422 1,114 331 78,736 1,523 2,923 4,446 956 5,402 3,160 33,027 4,616 1,487 42,290 2,999 3,010 6,613 1,114 338 56,364 1,657 3,023 4,680 226 4,906 50 50 11 120,985 (47,712) 73,334 78,736 $ 9 77,439 (26,040) 51,458 56,364 F-3 DIGIMARC CORPORATION CONSOLIDATED STATEMENTS OF OPERATIONS (In thousands, except per share data) Year Ended December 31, 2016 Year Ended December 31, 2015 Year Ended December 31, 2014 Revenue: Service............................................................................................. Subsu cription..................................................................................... License ............................................................................................ ............................................................................. Total revenuen $ Cost of revenue: Service............................................................................................. Subsu cription..................................................................................... License ............................................................................................ Total cost of revenue.................................................................. ........................................................................................... Gross profitff Operating expenses: Sales and marketing ........................................................................ Research, development and engineering ......................................... General and administrative.............................................................. Intellectual property ........................................................................ Total operating expenses............................................................ Operating loss ....................................................................................... Other income, net.................................................................................. Loss before income taxes...................................................................... Provision for income taxes ................................................................... Net loss ...................................................................................... Earnings (loss) per common share: ss per common share—bas— ic ............................................................ Loss per common share—diluted ......................................................... Weighted average common shares outstanding—bas— ic................... Weighted average common shares outstanding—diluted................ Cash dividends declared per common share ......................................... $ $ $ $ $ $ 12,667 5,808 3,318 21,793 5,673 2,410 414 8,497 13,296 12,517 6,377 3,295 22,189 5,488 3,113 346 8,947 13,242 11,888 13,394 8,298 1,636 35,216 (21,920) 258 (21,662) (10) ((21,6, 72)) $ 9,275 12,465 7,954 1,525 31,219 (17,977) 109 (17,868) (66) (1( 7,,934)) $ (2.36) $ (2.36) $ 9,188 9,188 —— $ (2.19) $ (2.19) $ 8,198 8,198 —— $ 11,727 6,203 7,728 25,658 5,077 3,020 334 8,431 17,227 7,974 13,711 8,972 1,793 32,450 (15,223) 55 (15,168) (652) ((15,8, 20)) (2.22) (2.22) 7,187 7,187 0.22 See Notes to Consolidated Financial Statements. F-4 DIGIMARC CORPORATION CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY (In thousands) BALANCE AT DECEMBER 31, 2013 .................. Issuance of common stock, net of issuance costs ...... Exercise of stock options........................................... Issuance of restritt cted common stock......................... Forfeiture of restricted common stock....................... Purchase and retirement of common stock ................ Stock-based compensation ........................................ Tax impamm ct from stock-based awards ........................ Net loss...................................................................... Cash dividends declared............................................ BALANCE AT DECEMBER 31, 2014 .................. Issuance of common stock, net of issuance costs ...... Exercise of stock options........................................... Issuance of restritt cted common stock......................... Forfeiture of restricted common stock....................... Purchase and retirement of common stock ................ Stock-based compensation ........................................ Net loss...................................................................... Cash dividends declared............................................ BALANCE AT DECEMBER 31,, 2015 .................. Issuance of common stock, net of issuance costs ...... Exercise of stock options........................................... Issuance of restritt cted common stock......................... Forfeiture of restricted common stock....................... Purchase and retirement of common stock ................ Stock-based compensation ........................................ Net loss...................................................................... Cash dividends declared............................................ BALANCE AT DECEMBER 31,, 2016 .................. Common Stock Shares 7,401 684 202 283 (38) (105) —— —— —— —— 8,427 $ 342 111 150 (31) (80) —— —— —— 8,,919 $ Preferr ed Stock ff Shares Amount 50 — — — — — — — — — 50 — — — — — — — — 50 — 1,418 69 — 212 — (12) — (83) — —— — —— — —— — 10,,523 $ 50 10 — — — — — — — — — 10 $ — — — — — — — — 10 $ — — — — — — — — 10 $ Amount 7 1 —— —— —— —— —— —— —— —— Additional Paid-in Capital Retained Earnings (Accumulated Deficit) Total Shareholders' Equity 41,498 15,988 1,487 —— —— (2,392) 5,580 (1,939) —— —— 8 $ 60,222 12,895 1 1,514 —— —— —— —— —— (2,443) —— 5,251 —— —— —— —— —— 9 $ 77,,439 39,698 2 668 —— —— —— —— —— (2,537) —— 5,717 —— —— —— —— —— 11 $ 120,9, 85 9,368 —— —— —— —— —— —— —— (15,820) (1,654) (8,106) $ —— —— —— —— —— —— (17,934) —— (2( 6,,040)) $ —— —— —— —— —— —— (21,672) —— (4( 7,,712)) $ 50,923 15,989 1,487 —— —— (2,392) 5,580 (1,939) (15,820) (1,654) 52,174 12,896 1,514 —— —— (2,443) 5,251 (17,934) —— 51,,458 39,700 668 —— —— (2,537) 5,717 (21,672) —— 73,,334 $ $ $ See Notes to Consolidated Financial Statements. F-5 DIGIMARC CORPORATION CONSOLIDATED STATEMENTS OF CASH FLOWS (In thousands) Cash flows from operating activities: Net loss............................................................................................ Adjud stments to reconcile net loss to net cash used in operating activities: Depreciation, amortization and write-off of property and equipment................................................................................ Amortization and write-offff of intangibles.................................. Changes in allowance for doubtfu accounts ............................. Stock-based compensation......................................................... ed income taxes ............................................................... ff Deferr Changes in operating assets and liabilities: ulff Trade accounts receivable .................................................... Other current assets .............................................................. Other assets........................................................................... Accounts payabla e and other accruer d liabilities..................... ff revenue .................................................................. Deferred Net cash used in operating activities ............................... Cash flows from investing activities: a Purchase of property and equipment ............................................... Capitalized patent costs ................................................................... Maturity of marketable securities.................................................... Purchase of marketable securities ................................................... Net cash used in investing activities ............................... Cash flows from financing activities: Issuance of common stock, net of issuance costs....................... Exercise of stock options ........................................................... Purchase of common stock ........................................................ Cash dividends paid ................................................................... Net cash provided by financing activities ....................... Net increase (decrease) in cash and cash equivalents ..... Cash and cash equivalents at beginning of period .......... Cash and cash equq ivalents at end of perp iod..................... uu Suppl uu Suppl emental disclosure of cash flow information: sh received (paid) for income taxes, net...................................... emental schedule of non-cash investing activities: Property and equipment and patent costs in accounts payable........ Stock-based compensation capitalized to software and patent costs.............................................................................................. Year Ended December 31, 2016 Year Ended December 31, 2015 Year Ended December 31, 2014 $ (21,672) $ (17,934) $ (15,820) 1,336 1,121 —— 5,553 —— (462) (208) 7 637 (176) (13,864) (1,837) (790) 41,052 (53,914) (15,489) 39,700 668 (2,537) —— 37,831 8,478 3,160 11,638 $ 1,237 1,196 (7) 5,077 —— (64) 1,124 40 125 (534) (9,740) (1,218) (895) 42,264 (45,340) (5,189) 12,896 1,514 (2,443) —— 11,967 (2,962) 6,122 3,160 (38) $ 1,233 35 164 $ $ 73 174 $ $ $ $ 974 1,340 (23) 5,403 2,085 1,316 (1,028) 192 (635) (537) (6,733) (1,399) (1,190) 28,074 (29,871) (4,386) 15,989 1,487 (2,392) (1,654) 13,430 2,311 3,811 6,122 263 140 177 $ $ $ $ See Notes to Consolidated Financial Statements. F-6 DIGIMARC CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (In thousands, except per share data) (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 enterprrr ises around the world to give digital identities to media and objects that compumm ters can sense and recognize, and to which they can react. The Company has developed the Digimarc Discover®, Digimarc Barcode and Intuitive Computing Platforff m that are designed to optimize the identification and whenever they may appear, facilitating modern mobile-centric shopping. The platforff m includes means to embedm “Digimarc Barcodes,” invisible and inaudible barcode-like information that is recognizable by smartpht ones, tablets, industrial scanners, and other compumm ter interfaces product packaging. Digimarc Barcodes have many applications, including facilitating remarkably faster scanning of products at retail checkout as well as improvmm Barcode is robust yet impemm rceptible by people in ordinary use, allowing for reliable, effiff cient, economical, globally scalabla e, automatic identification of media without visible computer codes like traditional barcodes. ed engagement with smartphone-equipped consumers. The Digimarc into virtually all forms of media content, including consumer of all consumer brand impremm ssions, wherever ff ff Principles of Consolidll atdd iott n The consolidated financial statements include the accounts of Digimarc and its wholly-owned subsu idiaries. All intercompany transactions and balances have been eliminated. Use of Estimtt atestt The preparation of the consolidated financial statements in accordance with accounting principles generally accepted in the U.S. requires management to make estimates and judgments that affeff ct 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, goodwill, impamm irment of long-lived assets, contingencies and income taxes. Management bases its estimates on historical experience and on other assumptions that are believed to be reasonabla e in the circumstances, the results of which form the basis for making judgments about the carrying values of assets and from these estimates under liabilities that are not readily apparent from other sources. Actual results may differff different assumptions or conditions. Reclassifii cations 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 effeff ct on the results of operations or financial position for any period presented. Cash Equivalentstt 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 primarily money market securities, corporate notes and certificff ates of deposits totaling $10,881 and $2,401 at Decemberm 31, 2016 and 2015, respectively. Cash equivalents are carried at cost or amortized cost, which approximates market. F-7 DIGIMARC CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued) (In thousands, except per share data) Marketablell Securities The Company considers all investments with original maturities over 90 days that mature in less than one-year from the balance sheet date to be short-term marketable securities. Short- and long-term marketable securities primarily include federal agency notes, commercial paper, corporate notes, pre-refunff ded municipal bonds and U.S. treasuries. The Company’s marketable securities are classified as held-to-maturity and are reported at amortized cost, which approximates market. A decline in the market value of any security below amortized cost that is deemed to be other-than-temporary results in a reduction in the carrying amount. The impamm irment is charged to earnings and a new cost basis for the security is established. To determine whether an impairm 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-temporar ment is other-than-tempormm ary, the Company considers ments identified or recorded by the Company. y impairmm mm Premiums and discounts are amortized or accreted over the life of the related security as an adjud stment to ive interest method. Under this method, dividend and interest yield using a method that approximates the effect income are recognized when earned. ff Fair Value of Financiali Instruments Accounting Standards Certificff ation (“ASC”) 820 “Fa“ ir Value Measurements and Disclosures” defines fair value, establishes a framework for measuring fair value under generally accepted accounting principles in the U.S., and enhances disclosures about fair value measurements. ASC 820 describes a fair value hierarchy based on three levels of inpun measure fair value, which are the following: ts, of which the first two are considered observable and the last unobservabla e, that may be used to • • • Level 1—Pricing inpun ts are quoted prices available in active markets for identical investments as of the reporting date. Level 2—Pricing inpun ts are quoted for similar investments, or inpun ts that are observable, either directly or indirectly, for subsu tantially the full term through corroboration with observable market data. Level 2 includes investments valued at quoted prices adjud sted for legal or contractual restrictions specificff these investments. to Level 3—Pricing inpun ts are unobservable for the investment; that is, the inpun ts refleff ct the reporting entity’s own assumptions about the assumptions market participants would use in pricing the asset or liability. 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 records marketable securities at amortized cost, which approximates fair value. The Company’s fair value hierarchy for its cash equivalents and marketable securities as of December 31, 2016 and 2015, respectively, was as follows: December 31, 2016 Money market securities................................................. Federal agency notes ...................................................... Commercial paper .......................................................... Corporate notes............................................................... Pre-refunff ded municipal bonds (1) .................................. U.S. treasuries................................................................. Total ............................................................................... Level 1 $ 1,218 —— —— —— —— —— $ 1,218 Level 2 Level 3 Total $ —— $ 16,810 16,757 15,753 6,716 2,515 $ 58,551 $ —— $ 1,218 16,810 —— 16,757 —— 15,753 —— 6,716 —— —— 2,515 —— $ 59,769 F-8 DIGIMARC CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued) (In thousands, except per share data) December 31, 2015 Money market securities.......................................... $ Federal agency notes ............................................... U.S. treasuries.......................................................... Corporate notes........................................................ Pre-refunff ded municipal bonds (1) ........................... Commercial paper ................................................... Certificates of deposits ............................................ Total ........................................................................ $ Level 1 Level 2 Level 3 Total 2,001 ——— ——— ——— ——— ——— ——— 2,001 $ —— $ 11,722 7,059 6,884 4,747 3,794 2,220 $ 36,426 $ 2,001 —— $ 11,722 —— 7,059 —— 6,884 —— 4,747 —— 3,794 —— —— 2,220 —— $ 38,427 (1) Pre-refunded municipal bonds are collateralized by U.S. treasuries. The fair value maturities of the Company’s cash equivalents and marketable securities as of December 31, 2016 are as follows: Cash equivalents and marketable securities................... Total $ 59,769 Less than 1 year $ 55,377 Maturities by Period 1-5 years $ 4,392 $ 5 - 10 years More than 10 years —— —— $ Concentratiott ns of Business and Creditii Riskii A significaff nt portion of the Compamm ny’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 subju ect Digimarc to concentrations of credit risk consist primarily of cash and cash equivalents, marketable securities, and accounts receivable. Digimarc places its cash and cash equivalents with majoa r 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 typeyy maximum of 5% of its cash equivalents and marketable securities or $1,000, whichever is greater, to be invested in any one issuer except for the U.S. government, U.S. federal agencies and U.S. backed securities, which have no limits, at the time of purchase. The Company’s investment policy also limits its credit exposure by limiting the maximum of 40% of its 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 marketable securities is believed to be minimal. of financial instrume nt by limiting the rr Contingencies The Company evaluates all pending or threatened contingencies or commitments, if any, that are reasonably likely to have a material adverse effeff ct on the Company’s operations or financial position. The Company assesses the probability of an adverse outcome and determines if it is remote, reasonabla y possible or probabla e 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 impam ired 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. F-9 DIGIMARC CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued) (In thousands, except per share data) Equity Method Investments The Company accounts for its joint ventures under the equity method of accounting pursuant to ASC 323 estments—Equ— ity Method and Joint Ventures.” Under the equity method, investments are carried at cost, plus or “Inv“ minus the Company’s proportionate share, based on present ownership interests, of:ff (a) the investee’s profitff or loss after ff profit or loss; and (c) certain other adjustments. Distributions received from the investee (such as dividends) reduce the carrying amount of the investment. the date of acquisition; (b) changes in the Company’s equity that have not been recognized in the investee’s Goodwill “ The Company accounts for business combinations under the acquisition method of accounting in accordance iness Combinations,” where the total purchase price is allocated to the tangible and identified with ASC 805, “Bus intangible assets acquired and liabilities assumed based on their estimated fair values. The purchase price is allocated using the information currently available, and may be adjud sted, up to one-year from acquisition date, after obtaining more information regarding, among other things, asset valuations, liabilities assumed and revisions to preliminary estimates. ff Contingent consideration, if any, is recorded at the acquisition date based upon the estimated fair value of the contingent payments. The fair value of the contingent consideration is re-measured each reporting period with any adjud stments in fair value being recognized in earnings from operations. The purchase price in excess of the fair value of the tangible and identified intangible assets acquired less liabilities assumed is recognized as goodwill. The Company tests goodwill for impairmm ment annually in June and whenever events or changes in circumstances indicate that the carrying value may not be recoverable. Such reviews assess the fair value of the Company’s assets compared to their carrying 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. Impaim rmii ent of Long-Ligg ved Assetstt The Company assesses long-lived assets for impairmm ment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable, in accordance with the provisions of ASC 360 “Pr“ operty, Plant and Equipmi ent.” l Recoverability of assets to be held and used is measured by a comparison of the carrying amount of the assets life. If such to future net undiscounted cash flows expected to be generated by the assets over their remaining usefulff assets are considered to be impairm 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 assets. ed, the impamm irment would be recognized in operating results at the amount by Assets to be disposed of are reported at the lower of the carrying amount or fair value less costs to sell. Research and Developmo ent Research and development costs are expensed as incurred in accordance with ASC 730 “Re“ search and Development.” F-10 DIGIMARC CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued) (In thousands, except per share data) Software Development Coststt Under ASC 985 “Softwff are,” softwff are 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 beforff e general release and, therefore, Accordingly, the Company has not capia talized any software development costs and has charged all such costs to research and development expense. software development costs qualifyiff ng for capitalization have been immaterial. ff Patent Coststt 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 referr ed to as patent prosecution costs, include internal legal labor, profesff government filing fees and translation fees related to expanding the Company’s patent portfolff sional legal fees, io. ff 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 shorter of the maintenance period or remaining life of the related patent. Revenue Recogno ition See Note 2 for detailed disclosures of the Company’s revenue recognition policy. Stock- Ba- tt sed Compensation The Company accounts for stock-based compemm nsation in accordance with ASC 718 “Compensation—Stock Compensation,” which requires the measurement and recognition of compensation for all stock-based awards made to emplmm oyees 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. The Company’s determination of the fair value on the date of grant is affeff cted by its stock price as well as assumptions regarding a number of subju ective variables. These variables include, but are not limited to, the expected lifeff of the award, the Company’s expected stock price volatility over the term of the award, the risk-free interest rate and the expected dividend yield. Although the fair value of stock-based awards is determined in accordance with ASC 718 and SAB No. 107 “Shared-Based Payma ent,” the Black-Scholes option pricing model requires the input subju ective assumptions, and other reasonable assumptions could provide diffeff ring results. of n The fair value of restricted stock awards 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. Income Taxeaa s The Company accounts for income taxes in accordance with ASC 740 “Incom e Taxes” utilizing the asset and liability method. Under the asset and liability method, deferred income taxes reflect the future tax consequences of differences between the tax basis of assets and liabilities and their financial reporting amounts. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary diffeff rences are expected to be recovered or settled. The effeff ct on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period of enactment. “ The Company records valuation allowances on deferred tax assets if,ff based on available evidence, it is more- likely-than-not that all or some portion of the assets will not be realized. F-11 DIGIMARC CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued) (In thousands, except per share data) The Company is subju ect to federal and state income taxes within the U.S., and, in the ordinaryrr course of business, there are transactions and calculations where the ultimate tax determination is uncertain. The Company reports a liability (or contra asset) for unrecognized tax benefits resulting from uncertain tax positions taken (or expected to be taken) on a tax return. The Company recognizes interest and penalties, if any, related to the unrecognized tax benefits in income tax expense. Accountintt gn Pronouncements Issued But Not Yet Adopdd ted In May 2014, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update “ ue from Contrat of promised goods or services to customers in an amount that ctstt with Customersrr (TopTT ic 606)6 .” ASU No. 2014-09 provides specific the effecff tive date of the new revenue standard for public ff December 31, 2017, and interim periods beginning in the (“ASU”) No. 2014-09, “Reven guidance to recognize revenue to depict the transferff refleff cts the consideration to which the entity expects to be entitled in exchange for those goods or services. The ASU will replace most existing revenue recognition guidance in U.S. GAAP when it becomes effeff ctive. In August 2015, the FASB issued ASU No. 2015-14 to deferff entities by one-year to annual reporting periods beginning after first interim period within the year of adoption. Earlier application is permitted only as of annual reporting periods beginning afteff has developed an implmm ementation plan to adopt this new guidance. As part of this plan, the Company is currently assessing the potential future impamm ct of this standard on the Company’s financial condition, results of operations and disclosures. Based on procedurdd es performed to date, the impactm not expected to have a material impamm ct on the Company, however, the Company will continue to evaluate this assessment. The Company is not far enough along in the evaluation of the impactm revenue to make any conclusions at this time. The guidance permits the use of either the retrospective or cumulm ative effeff ct transition method. The Company plans to utilize the cumulative effeff ct transition method and will adopt this standard effect r December 15, 2016, including interim reporting periods within that reporting period. The Company of this standard on service and license revenues is of the standard on subsu cription ive Januan ry 1, 2018. u ff In February 2016, the FASB issued ASU No. 2016-02, “Le“ ases (TopiTT c 842),” which superuu sedes Topic 840, Leases. ASU No. 2016-02 increases the transparency and compamm rability 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-uff se 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 generally straight-line basis, and classify all cash payments within operating activities in the statement of cash flows. The amendments in this update are effeff ctive for fiscal years beginning afteff r December 31, 2018, and interim periods beginning in the first interim period within the year of adoption. Early adoption is permitted. In transition, lessees and lessors are required to recognize and measure leases at the beginning of the earliest period presented using a modified retrospective approach, which includes a numbem r of optional practical expedients that entities may elect to apply. While the Company is currently assessing the potential future impamm ct of adopting this standard, the Company expects the primary impam ct will be the recognition, on a discounted basis, of our minimum commitments under non- cancelable operating leases on our consolidated balance sheets, resulting in the recording of right of use assets and lease obligations. The Company’s minimum commitments under non-cancelable operating leases are disclosed in Note 7. In March 2016, the FASB issued ASU No. 2016-09, “Compensation – Stock Compensation: Improvements to TT 718).” ASU No. 2016-09 simplifies the accounting for share- Employee Share-Based Payment Accounting (Topic based payment transactions, including accounting for income taxes, forfeiff requirements, and classificff ation in the statement of cash flows. The amendments in this update are effeff ctive for r December 31, 2016, and interim periods beginning in the first interim period within the fiscal years beginning afteff year of adoption. Early adoption is permitted. Any adjud stments should be refleff cted as of the beginning of the fiscal year that includes that interim period. Effeff ctive January 1, 2017, the Company made a policy election to account for forfeiff election will result in an immaterial adjustment to opening retained earnings. Also effect Company will provide emplmm oyees the option to elect the minimum or the maximum statutory tax-withholding rate to be applied on the exercise or vesting of stock-based awards. Upon adoption of this standard, deferred tax assets will be recorded for previously unrecognized excess tax benefits as of December 31, 2016, which we expect will be tures of stock-based awards when they occur versus estimating and applying a forfeiff ture rate. The policy ive January 1, 2017, the tures, statutory tax withholding ff F-12 DIGIMARC CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued) (In thousands, except per share data) offsff et by valuation allowance. Any future excess tax benefits will be recognized in the income tax provision when realized and would be offseff t by any required valuation allowance. The adoption of the standard is not expected to have a material impamm ct on the Company’s financial condition, results of operations, cash flows and disclosures. In August 2016, the FASB issued ASU No. 2016-15, “Statement of Cash Flowsww – Classifici ation of Certain c 230).” ASU No. 2016-15 adds or clarifies guidance on specific cash flow Cash Receipts and Cash Payments (TopiTT issues to reducd e diversity in practice in how certain transactions are classified in the statement of cash flows. The amendments in this update are effeff ctive for fiscal years beginning after Decembem r 31, 2017, and interim periods beginning in the first interim period within the year of adoption. Early adoption is permitted. Any adjud stments should be refleff cted as of the beginning of the fiscal year that includes that interim period. The amendments in this update are to be applied retros practicable if retrospective application would be imprmm acticable. The Company is currently assessing the potential future impamm ct of this standard on its cash flows and disclosures. pectively to all periods presented but may apply it prospectively from the earliest date tt (2) Revenue Recognition The Company derives its revenue primarily from profess ff ional services, subsu criptions and licensing of its intellectual property: • • • Service revenue consists primarily of software development and consulting services. The majoa rity of service revenue arrangements are structured as time and materials consulting agreements. Subsu cription revenue includes Digimarc Discover, Digimarc Barcode and Guardian products and services, is generally recurring, paid in advance and recognized over the term of the subsu cription. License revenue originates primarily from licensing the Company’s intellectual property where the Company receives license fees and/or royalties as its income stream. Revenue is recognized in accordance with ASC 605 “Re“ venue Recognition” and ASC 985 “Softwff are” 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 reasonably assured or probabla e. Some customer arrangements encompass multiple deliverables, such as profesff sional services, software uu fees. For arrangements that include multiple deliverables, the Company licenses, and maintenance and support identifies separate units of accounting at inception based on the consensus reached under ASC 605-25 “Multiple- Element Arrangements,” which provides that revenue arrangements with multiple deliverables should be divided into separate units of accounting if certain criteria are met. The Company applies ASC 985 to software deliverables when relevant. The consideration for the arrangements under ASC 605-25 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 specificff assumptm ions 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. F-13 DIGIMARC CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued) (In thousands, except per share data) Applicable revenue recognition criteria are considered separately for each separate unit of accounting as follows: • • • is generally determined based on time and materials. Revenue for development and Service revenuen consulting services is recognized as the services are perforff med. Billing for services rendered generally occurs within one month after the services are provided. ff Subscription revenue, which includes revenue from the sale of Digimarc Discover, Digimarc Barcode and Guardian products and services, is generally paid in advance and recognized over the term of the subsu cription, which is generally one to three years. 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 reasonabla y assured. 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 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 or determinable. ff Deferre d revenue consists of billings in advance for profess ff ional services, subsu criptions and licenses for which revenue has not been earned. (3) Segment Inforff mation Geographic Infon rmation The Company derives its revenuen from a single reporting segment: media management solutions. Revenue is generated in this segment through development services, subsu criptions 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. Revenue by geographic area, based upon the “bill-to” location, was as follows: Year Ended Year Ended Year Ended December 31, December 31, December 31, 2015 2016 2014 Domestic ...................................................................... $ International (1)............................................................ Total........................................................................ $ 4,776 $ 17,017 21,793 $ 6,304 $ 15,885 22,189 $ 9,596 16,062 25,658 (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. F-14 DIGIMARC CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued) (In thousands, except per share data) Majoa r Customers Customers who accounted for 10% or more of the Company’s revenue are as follows: Central Banks Verance Corporation ("Verance") .................. ...................................................... . ..... . 62% * 57% * 47% 12% Year Ended December 31, 2016 Year Ended December 31, 2015 Year Ended December 31, 2014 * Less than 10% In Septemberm 2014, the Company extended the patent license agreement with Verance through 2023, in effeff ct waiving any future royalties and license fees, in exchange for a $1.0 million license fee payment. The license fee payment was recorded as revenuen upon receipt in the third quarter of 2014. Long-lived assets by geographical area The Company’s long-lived assets are all domestic, domiciled in the U.S. (4) Stock-Bk ased Compensation Stock-based compensation includes expense charges for all stock-based awards to emplmm oyees and directors. These awards include option grants and restricted stock awards. Stock-based compensation expense related to internal labor is capitalized to software and patents based on direct labor hours charged to capitalized software and patent costs. Determtt ining Fair Value Stock Options Valuation and Amortizaii tion Method. The Company estimates the fair value of stock options 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 lifeff 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 terms, vesting schedules and pre-vesting and post-vesting forfeff itures. Stock options consideration to the contractual granted generally vest over three to four years for emplomm yee grants and one to two years for director grants, and have contractual terms of ten years. t 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. Riskii -Fkk reFF e Interest Rate. The Company determines the risk-freeff interest rate using current U.S. treasury yields for bonds with a maturity commensurate with the expected life of the award. Expected Dividend Yield.l 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 years ended December 31, 2016, 2015 and 2014. F-15 DIGIMARC CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued) (In thousands, except per share data) The Company records stock-based compemm nsation expense for stock option awards only for those awards that are expected to vest. 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. The Company records stock-based compensation expense for restricted stock awards only for those awards that are expected to vest. Stock-based Compensation Stock-based compensation: Year Ended Year Ended Year Ended December 31, December 31, December 31, 2015 2016 2014 Cost of revenue ......................................................... $ ................................................. . Sales and marketing Research, development and engineering.................. General and administrative ...................................... Intellectual property................................................. .......... . ......... . Stock-based compensation expense ......... to software and patent costs ... Capitalized a Total stock-based compepmm nsation ................................... $ 709 $ 975 1,381 2,182 306 5,553 164 5,717 $ 740 $ 775 1,308 1,978 276 5,077 174 5,251 $ 545 674 1,406 2,454 324 5,403 177 5,580 The following table sets forth total unrecognized compensation cost related to non-vested stock-based awards granted under all equity compensation plans: Total unrecognized compensation costs........................ $ 9,728 $ 9,549 $ tal unrecognized compensation costs will be adjud sted for any future forfeit ff ures. Year Ended Year Ended Year Ended December 31, December 31, December 31, 2015 2016 2014 11,206 The Company expects to recognize the total unrecognized compensation costs as of December 31, 2016 for stock options and restricted stock over weighted average periods through December 2020 as follows: Weighted average period ................................................. Stock Options 0.0 years Restricted Stock 1.3 years (5) Earnings Per Common Share The Company calculates basic and diluted earnings per common share in accordance with ASC 260 “Ear Per Share,” using the two-class method because the Company’s unvested restricted stock is a participating security since these awards contain non-forfeiff allocated to each class of common stock and participating security as if all of the earnings for the period had been distributed. table rights to receive dividends. Under the two-class method, earnings are “ ningsgg F-16 DIGIMARC CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued) (In thousands, except per share data) Basic earnings per common share excludes dilution and is calculated by dividing earnings to common shares by the weighted-average number of common shares outstanding for the period. Diluted earnings per common share is calculated by dividing earnings to common shares by the weighted-average number of common shares, as adjud sted for the potentially dilutive effeff ct of stock options. The following table reconciles earnings (loss) per common share for the years ended December 31, 2016, 2015 and 2014: Year Ended Year Ended Year Ended December 31, December 31, December 31, 2015 2016 2014 Basic Earnings (Loss) per Common Share: NumNN eratortt : Net loss..................................................................... $ Distributed earnings to common shares ................... Distributed earnings to participating securities ........ Total distributed earnings......................................... Undistributed loss allocable to common shares ....... Undistributed earnings allocable to participating securities................................................................ Total undistributed loss ............................................ Loss to common shares—bas— ic ................................ $ Denominatott r Weighted average common shares outstanding— basic ...................................................................... Basic earningsg (los ( s)) perp common share .................. $ (21,672) $ — — — (21,672) (17,934) $ —— —— —— (17,934) (15,820) 1,553 101 1,654 (17,474) — (21,672) (21,672) $ —— (17,934) (17,934) $ —— (17,474) (15,921) 9,188 ((2.36)) $ 8,198 ((2.19)) $ 7,187 (2( .22)) Year Ended Year Ended Year Ended December 31, December 31, December 31, 2015 2016 2014 Diluted Earnings (Loss) per Common Share: NumNN eratortt : Loss to common shares—bas— ic ................................ $ Undistributed earnings allocated to participating (21,672) $ (17,934) $ (15,921) securities................................................................ — —— —— Undistributed earnir ngs reallocated to participating securities................................................................ Loss to common shares—diluted ............................. $ Denominatott r Weighted average common shares outstanding— basic ...................................................................... Dilutive effeff ct of stock options ................................ Weighted average common shares outstanding— dilutive .................................................................. Diluted earningsg (los ( s)) perp common share ............... $ — (21,672) $ —— (17,934) $ —— (15,921) 9,188 — 8,198 —— 7,187 —— 9,188 ((2.36)) $ 8,198 ((2.19)) $ 7,187 (2( .22)) There were 0, 0 and 175 common stock equivalents related to stock options that were anti-dilutive and excluded from diluted earnings per common share for the years ended December 31, 2016, 2015 and 2014, respectively, because their exercise prices were higher than the average market price of the underlying common stock for the period. There were 187, 230 and 217 common stock equivalents related to stock options that were anti-dilutive and excluded from diluted earnings per common share for the years ended December 31, 2016, 2015 and 2014, respectively, because the Company incurred a net loss for the period. F-17 DIGIMARC CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued) (In thousands, except per share data) (6) Trade Accounts Receivable and Allowance for Doubtful Accounts Trade Accounts Receivable Trade accounts receivable are recorded at the invoiced amount. December 31, December 31, 2016 2015 Trade accounts receivable....................................... Allowance for doubtfu accounts ............................. Trade accounts receivable, net .............................. n Unpaid receivable ....................................................... red revenue included in trade accounts deferff ulff . .... $ .... ...... $ . .......... $ . 5,093 $ (15) 5,078 $ 4,631 (15) 4,616 2,245 $ 2,012 Allowance for doubtfut l accounts The allowance for doubtfu ulff accounts is the Company’s best estimate of the amount of probable credit losses in the Company’s existing trade accounts receivable. The Company determines the allowance based on historical write-offff experience and current information. The Company reviews its allowance for doubtfu accounts each r all means of collection have been reporting period. Account balances are charged against the allowance afteff exhausted and the potential for recoveryrr is considered remote. ulff Unpaid deferred revenue The unpaid deferred revenuen that are included in trade accounts receivable are billed in accordance with the provisions of the contracts with the Company’s customers. Unpaid customers are not included in trade accounts receivabla e nor deferff n red revenuen . deferff red revenuen from the Company’s cash-basis Majoa r customers Customers who accounted for 10% or more of trade accounts receivable, net are as follows: Central Banks........................................................... 57% 62% December 31, 2016 December 31, 2015 (7) Property and Equipment Property and Equipmi ent Property and equipment are stated at cost. Repairs and maintenance are charged to expense when incurred. F-18 DIGIMARC CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued) (In thousands, except per share data) Depreciation on property and equipment is calculated using the straight-line method over the estimated usefulff lives of the assets, generally two to ten years. Leasehold improvements are amortized using the straight-line method over the shorter of the estimated usefulff life or the lease term. December 31, December 31, 2016 2015 Officff e furniture and fixtures ......................................... $ are ........................................................................ Softwff Equipment..................................................................... ements .............................................. Leasehold improvmm Gross property and equipment................................. Less accumulm ated depreciation and amortization.......... Proppertyy and equq ippment, net.................................... $ 1,168 $ 2,146 4,071 1,617 9,002 (5,432) 3,570 $ 1,068 1,748 3,416 1,276 7,508 (4,498) 3,010 Leases Future minimum lease payments under non-cancelable operating leases are as follows: Year ending December 31: 2017 .................................................................................. 2018 .................................................................................. 2019 .................................................................................. 2020 .................................................................................. 2021 .................................................................................. ......................................................................... Thereafter nts ........................................ Total minimum lease pap ymey ff Operating Leases $ $ 784 992 1,023 848 804 1,899 6,350 Rent expense on the operating leases was as follows: Year Ended Year Ended Year Ended December 31, December 31, December 31, 2015 2016 2014 Rent expense ............................................................... $ 1,022 $ 1,045 $ 951 Intangibles Intangible assets are reviewed for impaimm rment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. No impamm irment charges were recorded for the years ended December 31, 2016, 2015 and 2014. Amortization of capitalized patent costs associated with the application and award of patents in the U.S. and various other countries are capitalized and amortized on a straight-line basis over the term of the patents as determined at the award date, which varies depending on the pendency period of the application, generally approximating seventeen years. F-19 DIGIMARC CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued) (In thousands, except per share data) Amortization of intangible assets acquired is calculated using the straight-line method over the estimated lives of the assets. usefulff a Capitalized Intangible assets acquired: patent costs................................................. Estimated Life ) (years) (y 17-20 December 31, December 31, 2016 2015 $ 7,281 $ 6,779 Purchased patents and intellectual property............. Existing technology ................................................. Customer relationships ............................................ Backlog.................................................................... Tradenames.............................................................. Non-solicitation agreements .................................... Gross intangible assets .................................................. Accumulated amortization ............................................ Intanggibles, net .............................................................. 3-10 5 7 2 3 1 250 1,560 290 760 290 120 10,551 (4,129) 6,422 $ 250 1,560 290 760 290 120 10,049 (3,436) 6,613 $ Amortization expense on intangible assets was as follows: Amortization expense.................................................... $ 693 $ 722 $ 1,047 intangible assets recorded at December 31, 2016, the estimated future aggregate amortization expense for the years ending December 31, 2017 through 2021 is approximately as follows: Year Ended Year Ended Year Ended December 31, December 31, December 31, 2015 2016 2014 Year ending December 31: 2017 ................................................................................. $ 2018 ................................................................................. 2019 ................................................................................. 2020 ................................................................................. 2021 ................................................................................. Amortization Expense 657 364 344 300 238 (9) Shareholders’ Equity Preferred Stock In June 2008, the Board of Directors authorized 2,500 shares of preferred of Directors has the authority to issue the undesignated preferred The Boarda determine the powers, prefeff rences and rights and the qualifications, limitations or restrictions granted to or imposmm ed upon any wholly unissued series of undesignated preferff red stock and to fix the number of shares constituting any series and the designation of such series, without any further vote or action by the shareholders. The issuance of stock may have the effeff ct of delaying, deferring or preventing a change of control of the Company without ff preferred further action by shareholders and may adversely affeff ct the voting and other rights of the holders of common stock. stock in one or more series and to stock, par value $0.001 per share. ff ff The Board of Directors authorized 10 shares of Series A Redeemable Nonvoting Preferred ed”) that were issued to certain executive offiff cers at the time of formation. The Series A Preferff ff Preferr 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 stock (“Series A June 18, 2013. red has no ff ff F-20 DIGIMARC CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued) (In thousands, except per share data) The Series A Preferff red is redeemable based on the stated fair value of $5.00 per share. The Series A Preferff red has no dividend rights and no rights to the undistributed earnings of the Company. ComCC mon Stock In June 2008, the Board of Directors authorized 50,000 shares of common stock, par value $0.001 per share. red stock, holders of common stock are entitled to receive ratably those dividends as itted to a vote of its shareholders, including the election of directors. Subju ect to preferen The holders of Digimarc common stock are entitled to one vote for each share held of record on all matters submu to any then outstanding preferff may be declared by the Board of Directors out of funds legally available for such purpose, as well as any distributions to the Company’s shareholders. In the event of the Company’s liquidation, dissolution or winding up, holders of common stock are entitled to share ratably in all of the Company’s assets remaining after liabilities and the liquidation preferen preemptmm ive or other subsu cription or conversion rights. There are no redemptmm ion or sinking fund provisions applicable to the common stock. All outstanding shares of common stock are fully paid and non-assessable. d stock. Holders of common stock have no ce of any then outstanding preferre ces that may be granted payment of ff ff ff ff In August 2016, the Company sold 1,233 shares of its common stock in an underwritten public offeff ring, plus an additional 185 shares in full exercise of the underwriters’ option to purchase additional shares of common stock, at the price to the public $2,447 and underwriww ter fees of $150, from the offeff accounting fees. of $30.00 per share. The Company received $39,953 of cash proceeds, net of discount of ring, and paid $253 in stock issuance costs for legal and u In August 2014, the Company entered into an Equity Distribution Agreement, whereby the Company could ing price of up to $30,000. As of December 31, 2015, the Company had sold 1,026 shares under the sell from time to time through Wells Fargo Securities, LLC, as sales agent, the Company’s common stock having an aggregate offerff Equity Distribution Agreement at an average price of $29.24 resulting in $29,300 of cash proceeds, net of sales commissions of $700, and paid $415 in stock issuance costs for legal and accounting fees. There are no shares remaining to be sold under the Equity Distribution Agreement. Stock Incentive Plan In July 2008, the Company’s Board of Directors initially adopted the 2008 Incentive Plan (2008 Plan). The 2008 Plan provides for the grant of stock options, stock appreciation rights, stock awards, restricted stock, stock units, perforff mance shares, perforff mance units, and cash-based awards, which may be granted to offiff cers, directors, emplmm oyees, consultants, agents, advisors and independent contractors who provide services to the Company and its ff affiliate d companies. The 2008 Plan authorizes the issuance of up to 3,500 shares of common stock. The shares authorized under the 2008 Plan are subju ect to adjud stment in the event of a stock split, stock dividend, recapitalization or similar event. Shares issued under the 2008 Plan will consist of authorized and unissued shares or shares held by the Company as treasury shares. If an award granted under the 2008 Plan lapses, expires, terminates or is forfeiff without having been fully exercised or without the issuance of all the shares subju ect to the award, the shares covered by that award will again be available for issuance under the 2008 Plan. Shares that are (i) tendered by a participant or retained by the Company as payment for the purchase price of an award or to satisfyff tax withholding obligations or (ii) covered by an award that is settled in cash, or in some manner that some or all of the shares covered by the award are not issued, will again be available for issuance under the 2008 Plan. In addition, awards granted as subsu titute awards in connection with acquisition transactions will not reduce the numbem r of shares authorized for issuance under the 2008 Plan. ted or surrendered As of December 31, 2016, under all of the Company’s stock-based compemm nsation plans, equity awards to purchase an additional 1,325 shares were authorized for future grants under the plans. F-21 DIGIMARC CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued) (In thousands, except per share data) Stock Options The Company issues new shares upon option exercises. Options granted, exercised and forfeited ff under the stock incentive plan are summarized as follows: Options outstanding, December 31, 2013....................... Granted...................................................................... Exercised................................................................... or expired................................................... ff Forfeited Options outstanding, December 31, 2014....................... Granted...................................................................... Exercised................................................................... or expired................................................... ff Forfeited Options outstanding, December 31, 2015....................... Granted...................................................................... Exercised................................................................... or expired................................................... ff Forfeited Options outstanding, December 31, 2016....................... Options exercisable, December 31, 2016 ....................... Options 813 —— Weighted Average Exercise Price $ 15.44 —— (202) $ 10.48 (10) $ 24.35 $ 16.97 601 —— —— (111) $ 13.61 —— $ 17.73 —— 9.64 —— $ 19.06 $ 19.06 —— 490 —— (69) $ —— 421 421 $ $ $ Weighted Average Grant Date Fair Value 7.96 $ —— 6.48 9.84 8.42 —— 7.25 —— 8.69 —— 6.75 —— 9.01 $ $ $ $ Aggregate Intrinsic Value $ 4,601 $ 4,601 The aggregate intrinsic value is based on the closing price of $30.00 per share of Digimarc common stock on December 31, 2016, which would have been received by the optionees had all of the options with exercise prices less than $30.00 per share been exercised on that date. The following table summarizes information about stock options outstanding at December 31, 2016: Options Outstanding Options Exercisable Weighted emaining Average Contractual Exercise Weighted Remaining Average Contractual Exercise Number Number Outstanding Life (Years) Price Outstanding Life (Years) Price 140 106 175 421 1.91 $ 9.68 3.08 $ 15.63 4.49 $ 28.64 3.28 $ 19.06 140 106 175 421 1.91 $ 9.68 3.08 $ 15.63 4.49 $ 28.64 3.28 $ 19.06 Exercise Price $9.64 - $9.91 ......................................................... $14.99 - $18.01 ..................................................... $27.61 - $30.01 ..................................................... $9.64 - $30.01 ....................................................... Restricted Stock The Compensation Committee of the Board of Directors has awarded shares of restricted stock under the Company’s 2008 Plan to certain emplmm oyees. The shares subju ect to the restricted stock awards vest over a certain period, usually four years, following the date of the grant. Specificff by Restricted Stock Agreements between the Company and the award recipients. terms of the restricted stock awards are governed F-22 DIGIMARC CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued) (In thousands, except per share data) The following table reconciles the unvested balance of restricted stock: Unvested balance, December 31, 2013 ........................... Granted ...................................................................... Vested........................................................................ .................................................................... ff Forfeited Unvested balance, December 31, 2014 ........................... Granted ...................................................................... Vested........................................................................ .................................................................... ff Forfeited Unvested balance, December 31, 2015 ........................... Granted ...................................................................... Vested........................................................................ .................................................................... ff Forfeited Unvested balance, December 31, 2016 ........................... Number fof Shares Weighted Average Grant Date Fair Value 19.89 $ 448 28.79 $ 283 23.56 (191) $ 25.44 (38) $ 23.09 $ 502 28.96 $ 150 24.78 (213) $ 23.96 (31) $ 24.30 $ 408 29.42 $ 212 25.50 (223) $ 29.15 (12) $ 26.28 $ 385 The following table indicates the fair value of all restricted stock awards that vested during the years ended December 31, 2016, 2015 and 2014: Year Ended Year Ended Year Ended December 31, December 31, December 31, 2015 2016 2014 Fair value of restricted stock awards vested................. $ 6,688 $ 6,350 $ 5,632 (10) Defined Contribution Plan The Company sponsors an emplm oyee retirement savings plan (the “Plan”) which qualifieff s as a deferred salary arrangement under Section 401(k) of the Internal Revenue Code. The Plan combim nes both an emplmm oyee savings plan and company matching plan into one plan under Section 401(k), including a 401(k) Roth option. Emplmm oyees become eligible to participate in the Plan at the beginning of the month following the emplm oyee’s hire date. Emplmm oyees may contribute up to 75% of their pay to the Plan, subju ect to the limitations of the Internal Revenue Code. Company matching contributions are mandatory under the Plan. The Company made matching contributions in the aggregate amount as follows: Year Ended Year Ended Year Ended December 31, December 31, December 31, 2015 2016 2014 Matching contributions ................................................. $ 775 $ 523 $ 511 1) Joint Venture and Related Party Transactions In June 2009, the Company entered into two joint venture agreements with Nielsen to launch two new compamm nies: TVaura LLC (in which Digimarc holds a 51% ownership interest) and TVaura Mobile LLC (in which Digimarc holds a 49% ownership interest). The two joint venture agreements and a revised patent license agreement expanded and replaced the previous license and services agreement between the Company and Nielsen that had been in operation since late 2007. Under the joint venture agreements, the Company and Nielsen agreed to work together to develop new products and services, including the expansion and deployment of those products and services that were in development under the prior agreement. F-23 DIGIMARC CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued) (In thousands, except per share data) Under the terms of the revised patent license agreement, Nielsen agreed to pay Digimarc $18,750 during the period from July 2009 through January 2014, and Digimarc granted to Nielsen a non-exclusive license to Digimarc’s patents for use within Nielsen’s business. The term of the license continues until the expiration of the last patent under the license. The payment terms extended beyond the Company’s normal 30 to 60 day payment terms, thus the license revenue was recognized when the installments were due. In March 2012, Digimarc and Nielsen decided to reduce investments in their two joint venturtt es to minimal levels while assessing alternative approaches to achieving each of their goals in the emerging market opportunity of synchronized second screen television. In October 2015, Digimarc and Nielsen reactivated the TVaura Mobile LLC joint venture to develop solutions for programmers and advertisers to engage with consumers on second screens and otherwise provide enhanced flexibility to brand strategies targeting modern consumers. The enhanced cooperation represents another building block in developing the market for Digimarc Discover and Digimarc Barcode. Neither Digimarc nor Nielsen has contributed any capital to the joint venture since reactivation. As of December 31, 2016, botht Digimarc and Nielsen continued to assess the market opportunities of the TVaura LLC joint venturt e. The Company’s investment in each joint venture was $0 as of Decembem r 31, 2016 and 2015. Pursuant to the terms of the agreements and ASC 810 “Consolidatdd ion,” the joint ventures are not consolidated with the Company because the minority member of each joint venture has subsu tantive participating rights, or veto rights, such that no member has majoa rity control. Related Partytt Transactions Summarized financial information for TVaura LLC has not been provided as the disclosures are immaterial to the Company’s filing given the operations of the joint venture were suspended during the last three fiscal years. The joint venture had no revenuen or expenses for the years ended December 31, 2016, 2015 and 2014, and there were no assets or liabilities as of Decembem r 31, 2016 and 2015. Summarized financial data for TVaura Mobile LLC: Current assets......................................................... Noncurrent assets ................................................... Current liabilities ................................................... Noncurrent liabilities ............................................. $ $ $ $ 40 $ —— $ 11 $ —— $ 45 —— 10 —— December 31, 2016 December 31, 2015 Year Ended December 31, 2016 Year Ended December 31, 2015 Year Ended December 31, 2014 Revenue.............................................................. $ ........................................................ $ Gross profitff Operating expenses ............................................ $ Net loss from continuing operations .................. $ The Company's pro-rata share—ne— t loss............ $ The Company's loss on investment .................... $ —— $ —— $ 5 $ (5) $ —— $ —— $ —— $ —— $ 5 $ (5) $ —— $ —— $ —— —— 5 (5) —— —— F-24 DIGIMARC CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued) (In thousands, except per share data) (12) Income Taxes The provision (benefit) for income taxes reflects current taxes, deferred taxes, and withholding taxes. The ff e tax rates for the years ended December 31, 2016, 2015 and 2014 were 0%, 0% and (4)%, respectively. The effectiv Company continues to provide for a full valuation allowance to offsff et its net deferred tax assets until such time it is more likely than not the tax assets or portions thereof will be realized. During 2015, the Company amended its 2012 federal tax return to carrybr the tax liability, which resulted in a tax refund of $1.3 million. ff offset ack the tax loss generated in 2014 to Components of tax provision (benefit)ff allocated to continuing operations include the foff llowing: Year Ended Year Ended Year Ended December 31, December 31, December 31, 2015 2016 2014 Current: Federal........................................................................ $ State............................................................................ Foreign ....................................................................... Sub-total................................................................ $ Deferred: Federal........................................................................ $ State............................................................................ Foreign ....................................................................... Sub-total................................................................ $ Total tax provision (benefitff )....................................... $ —— $ (11) 21 10 $ —— $ —— —— —— $ 10 $ (2) $ 49 19 66 $ —— $ —— —— —— $ 66 $ (3,378) 1 5 (3,372) 3,516 508 —— 4,024 652 The reconciliation of the statutory federal income tax rate to the Company’s effective income tax rate is as follows: Income taxes computed at statutor yrr Increases (decreases) resulting from: State income taxes, net of federal tt rates .............. Year Ended December 31, 2016 % Year Ended December 31, 2015 % Year Ended December 31, 2014 % $ (7,369) 34% $ (6,081) 34% $ (5,159) 34% tax benefit...................................................... of federal graduated rates ..................... Impactm Federal and state research and experimentation credits........................... Change in valuation allowance......................... Other................................................................. Total............................................................ (1,219) 6% —— 0% (1,298) (4) 7% 0% (700) 5% —— —— (1,112) 5% 9,468 (44)% (1)% 0% $ 242 10 (917) 5% 8,132 (45)% (1)% 0% $ 234 66 (563) 4% 6,916 (46)% (1)% (4)% 158 652 $ F-25 DIGIMARC CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued) (In thousands, except per share data) ff Deferred income taxes reflect the net tax effeff cts of temporary diffeff rences between the carrying amounts of assets and liabia lities for financial reporting purposes and the amounts used for income tax purposes. The tax effects of significaff nt items comprising the Company’s deferred tax assets and deferred tax liabilities are as follows: ff Year Ended Year Ended December 31, December 31, 2016 2015 Deferff red tax assets: Stock based compensation........................................ $ Federal and state net operating losses....................... Goodwill................................................................... Accrued compensation ............................................. Deferred rent............................................................. ff Federal and state research and experimentation credit...................................................................... AMT credit ............................................................... Intangible asset differen ces ...................................... Other......................................................................... Total gross defeff rred tax assets.......................... Less valuation allowance.......................................... ff 1,524 $ 21,089 715 19 344 3,434 92 253 39 27,509 (24,888) Net deferred tax assets...................................... $ 2,621 $ 1,751 12,551 826 51 62 2,322 92 167 74 17,896 (15,420) 2,476 Deferff red tax liabilities: Patent expenditures................................................... $ ces ............................................. Fixed asset differen ff ff Total gross deferred tax liabilities .................... $ (2,012) $ (609) (2,621) $ (2,017) (459) (2,476) Total net deferre ff d tax assets ............................. $ —— $ — The Company had a valuation allowance of $24,888 and $15,420 on deferff red tax assets as of December 31, 2016 and 2015, respectively, an increase of $9,468 during the year ended December 31, 2016. As of December 31, 2016, the Company has federal and state net operating loss carry-forwards of $63,309 and $81,436, respectively, which have a carry-forward of 5 to 20 years depending on the jurisdiction. The gross deferred tax assets for federal and state net operating loss carryforwards acquired in the Attributor acquisition have been reduced to the amount of losses allowed to be utilized in the post-acquisition period before expiration after considering the applicable limitations of IRC Sec. 382. As of December 31, 2016, the Company has federal and state research and experimental tax credits of $4,303 and $1,390, respectively, which have a carry-forward of 5 to 20 years depending on the jurisdiction. The Company records accrued interest and penalties associated with uncertain tax positions in income tax expense in the consolidated statements of operations. For the years ended December 31, 2016, 2015 and 2014, the Company recognized accrued interest and penalties associated with uncertain tax positions of $0, $4 and $6, respectively. The Company does not anticipate any of its unrecognized benefitsff will significff antly increase or decrease within the next 12 months. F-26 DIGIMARC CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued) (In thousands, except per share data) A summary reconciliation of the Company’s uncertain tax positions is as follows: Year Ended Year Ended Year Ended December 31, December 31, December 31, 2015 2016 2014 Beginning balance........................................................ $ Addition for current year tax positions................... Addition for prior year tax positions Reduction for prior year positions resolved during the current year.................................................... Endingg balance ......................................................... . ..... ........................... . . ..... .... $ 425 $ 100 2 (41) 486 $ 306 $ 74 45 —— 425 $ 219 58 29 —— 306 Uncertain tax positions are classified as a long-term liability (or a contra deferred tax asset) on the consolidated balance sheets for uncertain tax positions taken (or expected to be taken) on a tax return. The Company’s open tax years subju ect to examination in the U.S. federal jurisdiction are 2012 through 2015 and applicable state jurisdictions for the tax years 2012 through 2015. To the extent allowed by law, the taxing authorities may have the right to examine prior periods where net operating losses or tax credits were generated and carried forward, and make adjustments up to the amount of the net operating loss or tax credit carryforward. (13) 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 subju ect from time to time to other legal proceedings and claims arising in the ordinary course of business. F-27 DIGIMARC CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued) (In thousands, except per share data) (14) Quarterly Financial Inforff mation—Unaudited March 31 June 30 September 30 December 31 Quarter Ending $ $ 3,148 1,494 815 5,457 2,094 3,363 ......................................................... $ 3,250 1,463 867 5,580 2,190 3,390 2016 Service revenuen Subsu cription revenue ................................................. License revenue ......................................................... Total revenue ............................................................. Total cost revenue...................................................... Gross profitff ................................................................ Gross profitff percent, service revenue ........................ Gross profitff percent, subsu cription revenue ................ Gross profitff percent, license revenue......................... Gross profitff percent, total .......................................... Sales and marketing................................................... $ 2,955 3,305 Research, development and engineering ................... 2,170 General and administrative ........................................ 434 Intellectual property................................................... (5,474) Operating loss............................................................ Net loss ...................................................................... (5,435) Earnings (loss) per common share: Loss per common share—bas— ic ................................. $ (0.64) $ (0.62) $ Loss per common share—diluted .............................. $ (0.64) $ (0.62) $ Weighted average common shares outstanding— $ 2,856 3,379 1,976 462 (5,310) (5,283) 55% 60% 88% 62% 56% 55% 89% 61% $ $ $ 3,252 1,417 907 5,576 2,162 3,414 55% 58% 88% 61% 2,945 3,291 2,039 394 (5,255) (5,198) 3,017 1,434 729 5,180 2,051 3,129 54% 61% 85% 60% 3,132 3,419 2,113 346 (5,881) (5,756) (0.55) $ (0.55) $ (0.57) (0.57) basic........................................................................ 8,533 8,587 9,506 10,111 Weighted average common shares outstanding— diluted..................................................................... 8,533 8,587 9,506 10,111 F-28 DIGIMARC CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued) (In thousands, except per share data) March 31 June 30 September 30 December 31 Quarter Ending ...................................................... ....$ 3,501 1,716 772 5,989 2,416 3,573 2015 . Service revenuen .................................................. . Subsu cription revenue ........................................................ . License revenue .. . ..... Total revenue ......................................................... . ........... Total cost revenue ........................................... ................................................................. . Gross profitff ......................... . Gross profitff percent, service revenue . .... Gross profitff percent, subsu cription revenue ............. . .......... Gross profitff percent, license revenue................ .... Gross profitff percent, total ........................................ . Sales and marketing Research, development and engineering ..................... . General and administrative.................................... ..... . Intellectual property............................................ ........ ..... . Operating loss........................................................ Net loss .............................................................. ......... . Earnings (loss) per common share: Loss per common share—bas— ic Loss per common share—diluted Weighted average common shares outstanding— ....................................................$ 2,090 3,084 2,206 367 (4,174) (4,150) 55% 56% 89% 60% 54% 48% 90% 58% $ $ $ 3,235 1,670 893 5,798 2,449 3,349 $ 2,098 3,025 1,980 291 (4,045) (4,012) ..................................$ (0.52) $ (0.50) $ ...............................$ (0.52) $ (0.50) $ . . $ $ 3,072 1,561 753 5,386 2,098 3,288 61% 48% 89% 61% 2,309 3,236 1,847 367 (4,471) (4,469) 2,709 1,430 877 5,016 1,984 3,032 55% 52% 90% 60% 2,778 3,120 1,921 500 (5,287) (5,303) (0.54) $ (0.54) $ (0.62) (0.62) basic................................................ ......................... . 7,960 8,029 Weighted average common shares outstanding— diluted.............................................................. ........ . 7,960 8,029 8,309 8,309 8,485 8,485 F-29 EXHIBIT INDEX The agreements included or incorporated by referen ce as exhibits to this report may contain representations and warranties by each of the parties to the applicable agreement. These representations and warranties have been made solely for the benefit of the other party or parties to the applicable agreement and: ff • were not intended to be treated as categorical statements of fact, but rather as a means of allocating the risk to one of the parties if those statements prove to be inaccurate; • were qualifieff d by disclosures that were made to the other party or parties in connection with the negotiation of the applicable agreement, which disclosures are not necessarily reflecte agreement; ff d in the • may apply standards of “materiality” that are diffeff rent from “materiality” under the securities laws; and • were made only as of the date of the applicable agreement or other date or dates that may be specified in the agreement. Accordingly, these representations and warranties may not describe the actual state of affaff irs as of the date they were made or at any other time. Additional information about Digimarc may be found elsewhere in this Annual Report on Form 10-K and in Digimarc’s other publu ic filings, which are available without charge through the SEC’s website at http://www.sec.gov. Exhibit Number 2.1 2.2 3.1 3.2 4.1 4.2 4.3 4.4 Exhibit Description Separation Agreement among DMRC Corporation, DMRC LLC, Digimarc Corporation and, with respect to certain sections, L-1 Identity Solutions, Inc. (incorporated by referff ence to Exhibit 2.1 to Amendment No. 2 to the Company’s Registration Statement on Form 10, filed with the Commission on August 13, 2008 (File No. 001-34108))† Agreement and Plan of Merger dated April 30, 2010 between Digimarc Corporation, a Delaware corporation, and Digimarc Oregon Corporation, an Oregon corporation (incorporated by reference to Exhibit 2.1 to the Company’s Current Report on Form 8-K, filed with the Commission on May 4, 2010 (File No. 001-34108)) Articles of Incorporation of Digimarc Corporation (incorporated by referff ence to Exhibit 3.1 to the Company’s Current Report on Form 8-K, filed with the Commission on May 4, 2010 (File No. 001- 34108)) Bylaws of Digimarc Corporation (incorporated by referff ence to Exhibit 3.2 to the Company’s Current Report on Form 8-K, filed with the Commission on May 4, 2010 (File No. 001-34108)) Specimen common stock certificate of Digimarc Corporation (incorporated by referff ence to Exhibit 4.1 to the Company’s Quarterly Report on Form 10-Q, filed with the Commission on July 25, 2014 (File No. 001-34108)) Rights Agreement, dated July 31, 2008, between Digimarc Corporation and Computershare Trust Company, N.A. as Rights Agent (incorpor Report on Form 10-K, filed with the Commission on February 27, 2009 (File No. 001-34108)) ated by reference to Exhibit 4.2 to the Company’s Annual r Second Amendment of Rights Agreement, effect ive as of November 5, 2013, made by Digimarc Corporation and acknokk wledged by Broadridge Corporate Issuer Solutions, Inc., as Rights Agent (incorporated by referff ence to Exhibit 4.2 to the Company’s Quarterly Report on Form 10-Q, filed with the Commission on July 25, 2014 (File No. 001-34108)) ff Form of Certificff ate of Designation of Series R Preferr Agreement filed as Exhibit 4.2 hereto) ff ed Stock (attached as an exhibit to the Rights 4.5 Form of Rights Certificate (attached as an exhibit to the Rights Agreement filed as Exhibit 4.2 hereto) E-1 Exhibit Number 10.1 10.2 *10.3 *10.4 *10.5 *10.6 *10.7 *10.8 *10.9 10.10 10.11 10.12 10.13 Exhibit Description License Agreement between DMRC Corporation and L-1 Identity Solutions Operating Company (incorporated by referff ence to Exhibit 10.2 to Amendment No. 4 to the Company’s Registration Statement on Form 10, filed with the Commission on October 2, 2008 (File No. 001-34108))(1) t Deterrence System Development and License Agreement, dated as of December 6, 2012, nce Counterfeiff between Digimarc Corporation and the Bank for International Settlements (incorporated by refereff to Exhibit 10.2 to the Company’s amended Annual Report on Form 10-K/A, filed with the Commission on August 7, 2013 (File No. 001-34108))(5) Form of Indemnificff ation Agreementnn between DMRC Corporation and each of its executive officff ers and directors (incorporated by reference to Exhibit 10.5 to Amendmentnn No. 2 to the Company’s Registratt tion Statement on Form 10, filed with the Commission on August 13, 2008 (File No. 001-34108)) Emplmm oyment Agreement, effecff Bruce Davis (incorporated by referff ence to Exhibit 10.1 to the Company’s Current Report on Form 8- K, filed with the Commission on August 5, 2014 (File No. 001-34108)) tive as of November 1, 2014, between Digimarc Corporation and Digimarc Corporation 2008 Incentive Plan, as amended (incorporated by referff ence to Exhibit 10.1 to the Company’s Quarterly Report on Form 10-Q, filed with the Commission on April 25, 2014 (File No. 001-34108)) Form of Notice of Stock Option Award and Stock Option Award Agreement under the Digimarcaa Corporation 2008 Incentive Plan (incorporated by reference to Exhibit 10.8 to the Company’s Quarterly Report on Form 10-Q, filed with the Commission on November 24, 2008 (File No. 001-34108)) Equity Compensation Program for Nonemployee Directors under the Digimarc Corporation 2008 Incentive Plan (as amended on February 21, 2011, February 20, 2014 and March 27, 2015) (incorporated by referff ence to Exhibit 10.1 to the Company’s Quarterly Report on Form 10-Q, filed with the Commission on April 28, 2015 (File No. 001-34108)) Form of Indemnification Agreement between Digimarc Corporation and each of its executive officff ers and directors (incorporated by reference to Exhibit 10.1 to Digimarc Corporation’s Annual Report on Form 10-K, as filed by Digimarc Corporation with the Securities and Exchange Commission on March 13, 2006 (File No. 000-28317)) Form of Change of Control Retention Agreement entered into by and between Digimarc Corpora and each of Messrs. Chamness, Meyer, Beck and Rodriguez (incorpor to the Company’s Annual Report on Form 10-K, filed with the Commission on February 25, 2016 (File No. 001-34108)) tion ated by reference to Exhibit 10.9 rr r Patent License Agreement, dated as of June 11, 2009 between Digimarc Corporation and The Nielsen Compamm ny (US), LLC (incorporated by referen ff on Form 10-Q, filed with the Commission on July 31, 2009 (File No. 001-34108))(2) ce to Exhibit 10.1 to the Company’s Quarterly Report Limited Liability Company I Agreement, dated June 11, 2009 between Digimarc Corporation and The Nielsen Company (US), LLC (incorporated by reference to Exhibit 10.2 to the Company’s Quarterly Report on Form 10-Q, filed with the Commission on July 31, 2009 (File No. 001- 34108))(2) Limited Liability Company II Agreement, dated June 11, 2009 between Digimarc Corporation and The Nielsen Company (US), LLC (incorporated Report on Form 10-Q, filed with the Commission on July 31, 2009 (File No. 001-34108))(2) by reference to Exhibit 10.3 to the Company’s Quarterly rr Lease Agreement, dated March 22, 2004, between Digimarc Corporation and PS Business Parks, L.P., as amended on May 13, 2010 (incorporated by referff ence to Exhibit 10.1 to the Company’s Quarterly Report on Form 10-Q, filed with the Commission on July 30, 2010 (File No. 001-34108)) E-2 Exhibit Number 10.14 10.15 10.16 10.17 Second Amendment to Lease, dated July 31, 2015, by and between PD Offiff ce Owner 9, L.P. and Digimarc Corporation (incorporated by referff ence to Exhibit 10.1 to the Company’s Quarterly Report on Form 10-Q, filed with the Commission on October 30, 2015 (File No. 001-34108)) Exhibit Description Patent License Agreement, effeff ctive as of October 5, 2010, between Digimarc Corporation and IV Digital Multimedia Inventions, LLC (incorporated by refereff nce to Exhibit 10.1 to the Company’s Quarterly Report on Form 10-Q, filed with the Commission on April 28,2016 (File No. 001- 34108))(4) Grant-Back License Agreement, dated October 5, 2010, between Digimarc Corporation and IV Digital Multimedia Inventions, LLC (incorpor Annual Report on Form 10-K, filed with the Commission on March 3, 2011 (File No. 001-34108))(3) rated by referff ence to Exhibit 10.13 to the Company’s Patent Rights Agreement, dated October 5, 2010, between Digimarc Corporation and IV Digital Multimedia Inventions, LLC (incorporated by referff ence to Exhibit 10.14 to the Company’s Annual Report on Form 10-K, filed with the Commission on March 3, 2011 (File No. 001-34108)) 10.18 Work Agreement, dated October 5, 2010, by and among Digimarc Corporation, Invention Law Group,uu P.C. and IV Digital Multimedia Inventions, LLC (incorpor the Company’s Quarterly Report on Form 10-K, filed with the Commission on April 28, 2016 (File No. 001-34108))(4) ated by reference to Exhibit 10.2 to r 21.1 23.1 31.1 31.2 32.1 32.2 List of Subsu idiaries Consent of Independent Registered Publu ic Accounting Firm Rule 13a-14(a)/15d-14(a) Certificff ation of Chief Executive Offiff cer Rule 13a-14(a)/15d-14(a) Certificff ation of Chief Financial Offiff cer Section 1350 Certificff ation of Chief Executive Offiff cer Section 1350 Certificff ation of Chief Financial Offiff cer 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 Definff ition Linkbaskk e Document 101.LAB XBRL Taxonomy Extension Labea l Linkbaskk e Document 101.PRE XBRL Taxonomy Extension Label Linkbaskk e Document * Management contract or compensatory plan or arrangement. † Schedules and certain exhibits to this agreement have been omitted pursuant to Item 601(b)(2) of Regulation S- K. Digimarc hereby undertakes to furnish to the Securities and Exchange Commission (the “Commission”) copies of the omitted schedules and exhibits upon request by the Commission. (1) Confidff ential treatment has been granted for certain portions omitted from this exhibit pursuant to an order granted by the Commission on October 21, 2008, under Rule 24b-2 of the Securities Exchange Act of 1934, as amended. Confidff ential portions of this exhibit have been separately filed with the Securities and Exchange Commission. (2) Confidff ential treatment has been granted for certain portions omitted from this exhibit pursuant to an order granted by the Commission on September 10, 2009, under Rule 24b-2 under the Securities Exchange Act of ff 1934, as amended. Confiden Exchange Commission. tial portions of this exhibit have been separately filed with the Securities and E-3 (3) Confidff ential treatment has been granted for certain portions omitted from this exhibit pursuant to an order granted by the Commission on March 17, 2011, under Rule 24b-2 under the Securities Exchange Act of 1934, as amended. Confidff ential portions of this exhibit have been separately filed with the Securities and Exchange Commission. (4) Confidff ential treatment has been granted for certain portions omitted from this exhibit pursuant to an order granted by the Commission on May 6, 2016, under Rule 24b-2 under the Securities Exchange Act of 1934, as amended. Confidff ential portions of this exhibit have been separately filed with the Securities and Exchange Commission. (5) Confidff ential treatment has been granted for certain portions omitted from this exhibit pursuant to an order granted by the Commission on Septemberm 3, 2013, under Rule 24b-2 under the Securities Exchange Act of 1934, as amended. Confideff Exchange Commission. ntial portions of this exhibit have been separately filed with the Securities and E-4 BOARD OF DIRECTORS EXECUTIVE OFFICERS Bruce Davis Bruce Davis Chairman of the Board and Chief Executive Officer Chairman and Chief Executive Officer Digimarc Corporation William J. Miller Independent Director and Consultant Robert Chamness Executive Vice President, Chief Legal Officer and Secretary Former Chairman and Chief Executive Officer Charles Beck Avid Technology, Inc. James T. Richardson Executive Vice President, Chief Financial Officer and Treasurer Joel Meyer Independent Director and Consultant Executive Vice President Intellectual Property Former Senior Vice President and Chief Financial Officer WebTrends Richard L. King Independent Director and Consultant Former President and Chief Operating Officer Albertsons Inc. Bern Whitney Tony Rodriguez Executive Vice President, Chief Technology Officer TRANSFER AGENT Broadridge Corporate Issuer Solutions, Inc. Independent Director and Consultant P. O. Box 1342, Brentwood, NY 11717 (866) 321 8022 shareholder@broadridge.com www.broadridge.com Partner FLG Partners, LLC Gary DeStefano Independent Director and Consultant Former President of Global Operations Nike, Inc. Andrew J. Walter Independent Director and Consultant Former Vice President of Global Business Services The Procter & Gamble Company DIGIMARC CORPORATION 9405 SW Gemini Drive, Beaverton, OR 97008 USA T: +1 800 DIGIMARC (344 4627) T: +1 503 469 4800 F: +1 503 469 4777 www.digimarc.com 

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